The biggest tax
scam on earth has a very innocent sounding name. It is called �transfer
prices.� That almost sounds boring. It is, however, anything but boring. Abuse
of transfer prices is a key tool multinational corporations use to fool the
U.S. and other jurisdictions to think that they have virtually no profit;
hence, they shouldn�t pay any taxes.
involved in this scam are �model corporate citizens,� or so they would like us
to believe. The truth is that they rob us all blind. The money we lose can be
estimated in the tens of billions, or possibly hundreds of billions of dollars
every year. We all end up paying higher taxes because rich corporations make
sure they don�t.
But don�t take my
word for this.
A few weeks ago,
U.K.-based GlaxoSmithKline (GSK), one of the largest pharmaceutical companies
in the world, together with the Internal Revenue Service (IRS) announced that
GSK will pay $3.4 billion to the IRS to settle a transfer pricing dispute
dating back 17 years. The IRS alleges that GSK improperly shifted profits from
their U.S. to the U.K. entity.
pharmaceutical companies are not alone with these kinds of problems. Merck, one
of the largest U.S. drug companies, also this month disclosed that they face
four separate tax disputes in the U.S. and Canada with potential liabilities of
$5.6 billion. Out of that amount, Merck disclosed that the Canada Revenue Agency
issued the company a notice for $1.8 billion in back taxes and interest
�related to certain inter-company pricing matters.� And according to the IRS,
one of the schemes Merck used to cheat American taxpayers was by setting up a
subsidiary in tax-friendly Bermuda. Merck then quietly transferred patents for
several blockbuster drugs to the new subsidiary and then paid the subsidiary
for use of the patents. The arrangement in effect allowed some of the profits
to disappear into Merck�s own �Bermuda Triangle.�
I have described
many more ways the global drug industry cheats and defrauds our government in
my recent book, �The
Whistleblower, Confessions of a Healthcare Hitman.�
In this article, however, I�m going to focus on how they, and other rich
multinationals, use the tax system to defraud us.
So what�s going on
here, how have multinational drug companies been able to gouge us for years
selling expensive drugs and then avoid paying tax on their astronomical
The answer is
simple. For companies in certain businesses, such as pharmaceuticals, it is
very easy to simply �invent� the price a company charges their U.S. business
for buying the company�s product which they manufacture in another country. And
if they charge enough, poof; all the profit vanishes from the US, or Canada, or
any other regular jurisdiction and end up in a corporate tax haven. And that
means American and Canadian taxpayers don�t get their fair share.
corporations essentially have two sets of bookkeeping. One set, with
artificially inflated transfer prices is what they use to prepare local tax
returns and show auditors in high tax jurisdictions, and another set of books,
in which management can see the true profit and loss statement, based on real
cost of goods, are used for the executives to determine the actual performance
of their various operations.
Of course, not
every multinational industry can do this as easily as the drug industry. It
would be difficult to come up with $6,000 toilet seats. But the drug industry,
where real cost of goods to manufacture drugs is usually around 5 percent of
selling price, has a lot of room to artificially increase that cost of goods to
50 percent or 75 percent of selling price. This money is then accumulated in
corporate tax havens where the drugs are manufactured, such as Puerto Rico and
Ireland. Puerto Rico has for many years attracted lots of pharmaceutical plants
and Ireland is the new destination for such facilities, not because of the
skilled labor or the beautiful scenery or the great beer -- but because of the
low taxes. Ireland has, in fact, one of the world�s lowest corporate tax rates
with a maximum rate of 12.5 percent.
In Puerto Rico,
over a quarter of the country�s gross domestic product already comes from
pharmaceutical manufacturing. That shouldn�t be surprising. According to the
U.S. Federal Tax Reform Act of 1976, manufacturers are permitted to repatriate
profits from Puerto Rico to the U.S. free of U.S. federal taxes. And by the
way, the Puerto Rico withholding tax is only 10 percent.
Of course, no
company should have to pay more tax than they are legally obligated to, and
they are entitled to locate to any low tax jurisdiction. The problem starts
when they use fraudulent transfer pricing and other tricks to artificially
shift their income from the U.S. to a tax haven. According to current OECD
guidelines, transfer prices should be based upon the arm�s length principle --
that means the transfer price should be the same as if the two companies
involved were indeed two independents, not part of the same corporate
structure. Reality is that standard operating procedure for multinationals is
to consistently violate this rule. And why shouldn�t they? After all, it takes
17 years for them to pay up, per the above GSK example, even when they get
which successfully exploits overseas tax strategies to cheat us all is the
hi-tech industry. In fact, Microsoft Corp. recently shaved at least $500
million from its annual tax bill using a similar strategy to the one the drug
industry has used for so many years. Microsoft has set up a subsidiary in
Ireland, called Round Island One Ltd. This company pays more than $300 million
in taxes to this small island country with only 4 million inhabitants, and most
of this comes from licensing fees for copyrighted software originally developed
in the U.S. Interesting thing is, at the same time, Round Island paid a total
of just under $17 million in taxes to about 20 other countries, with
more than 300 million people. The result of this was that Microsoft's worldwide
tax rate plunged to 26 percent in 2004, from 33 percent the year before. Almost
half of the drop was due to �foreign earnings taxed at lower rates,� according
to a Microsoft financial filing. And this is how Microsoft has radically
reduced its corporate taxes in much of Europe and been able to shield billions
of dollars from U.S. taxation.
But remember, this
is only one example. Most of the other tech companies are doing the same thing.
Google recently also set up an Irish operation that the firm credited in a SEC
filing with reducing its tax rate.
Here�s how this is
done in the software industry and any other industry with valuable intellectual
property. A company takes a great, patented, American product and then develops
a new generation. Then, of course, the old product disappears. Some, or all, of
the cost and development work for the new product takes place in Ireland, or at
least, so the company claims. The ownership of the new generation product and
all income from licensing can then legally be shared between the U.S. parent
company and the offshore corporation or transferred outright to the tax haven.
The deal, to pass IRS scrutiny, has to be made using the �arms-length
principle.� Reality is that the IRS has no way of controlling all these
of us working and paying tax in the U.S. can�t relocate our jobs and our income
to Ireland or another tax haven. So we have to make up the income shortfall. In
the U.S. we have a highly educated society with a very qualified workforce,
partly supported by our taxpayers. This helps us generate breakthrough
products. But once a company has a successful product, they have every
incentive to move the second generation of a successful product overseas, to
Ireland and a few other corporate tax havens.
There is only one
problem for U.S. companies with this strategy, and that is that if they
repatriate this money to the U.S., they have to pay full corporate taxes. In
fact, according to BusinessWeek, U.S. multinational corporations have built up
profits of as much as $750 billion overseas, much of it in tax havens such as
the Ireland, the Bahamas, and Singapore to avoid the stiff 35 percent levy
they'd face if they repatriated the funds back into the U.S.
But of course,
Congress, which is basically paid for by our multinational corporations,
generously provided for a one-time provision in the corporate tax code, so that
they could repatriate profits earned before 2003, and held in foreign
subsidiaries, at an effective 5.25 percent tax rate.
And so the game
In the end,
multinational corporations live in a global world which allows them to pretty
much send their money to corporate tax havens at will, and then repatriate this
money almost tax free, with the help of the U.S. Congress.
The people left
holding the bag are you and me. If you want to know learn more about the
corruption in the drug industry, read my new book, "The
Whistleblower, Confessions of a Healthcare Hitman."Peter
Rost, M.D., is a former Vice President of Pfizer. He became well
known in 2004 when he emerged as the first drug company executive to speak out
in favor of reimportation of drugs. He is the author of "The
Whistleblower, Confessions of a Healthcare Hitman." See: the-whistleblower-by-peter-rost.blogspot.com.