When we left this subject, boys and girls, the grasshopper asked if a lot of big companies were just really bad at making money. And as Spot replied, that is what King Banaian wants you to think. Spot recommends his original post, because you'll need it to understand this one.
The genesis of the discussion is the GAO's recent report of corporate tax liability, or in many cases lack of it. To repeat one of its findings, for the largest companies, just for good order's sake:
During the eight-year period covered by the report, 72 percent of foreign-owned corporations went at least one year without owing taxes, and the same was true for 55 percent of domestic corporations.
The report finds that most of the zero tax liability returns were from reported operating losses, not tax loss carry forwards, tax credits, or the like. In other words, the companies mostly said, straight up, "We lost money this year."
According to a figure from Sens. Levin and Dorgan (who requested the study) and quoted by the Professor, corporate sales last year were $2.5 trillion. And that's just to the Defense Department! Kidding.
That seems a little, odd, doesn't it, Spotty?
Indeed grasshopper, it does. The purpose of the study as requested by Sens. Levin and Dorgan was to examine whether one technique, the transfer price mechanism was part of the explanation. International trade is an increasingly large component of US GNP. And, related-company transfers are a large part of that trade. Spot had a statistic and a link, but he can't find it right now. Perhaps for the next installment.
In other words, there is a whole lot of selling and buying going on involving companies under common control. In such a situation, the price paid by one unit of a company in one country to a unit in another country is known as the "transfer price," and by definition it is not an "arm's length" bargain.
Transfer pricing can be abused. From the report:
Tax liabilities may also be reduced through transfer pricing abuse. Any company that has a related company, such as a subsidiary with which it transacts business, needs to establish transfer prices for those intercompany transactions. The transfer price should be the “arm’s length price,” i.e., the price that would be charged if the transaction occurred between unrelated companies. Section 482 of the Internal Revenue Code provides IRS authority to allocate income among related companies if IRS determines that the transfer prices used by the taxpayer were inappropriate. How transfer prices are set affects the distribution of profits and ultimately the taxable income of the companies. The following is an example of abusive cross-border transfer pricing. A foreign parent corporation with a subsidiary operating in the United States charges the subsidiary excessive prices for goods and services rendered (for example, $1,000 instead of the going rate of $600). This raises the subsidiary’s expenses (by $400), lowers its profits (by $400), and effectively shifts that income ($400) outside of the United States. At a 35-percent U.S. corporate income tax rate, the subsidiary will pay $140 less in U.S. taxes than it would if the $400 in profits were attributed to it.
The GAO did find transfer price abuse in some of the low or no tax liability returns, but had difficulty saying how much:
Transfer prices are the prices related companies, such as a parent and subsidiary, charge on intercompany transactions. By manipulating transfer prices, multinational companies can shift income from higher to lower tax jurisdictions, reducing the companies’ overall tax liability. As we noted in our previous reports, researchers acknowledge that transfer pricing abuses may explain some of the differences in tax liabilities of foreign-controlled corporations compared to U.S.-controlled corporations. However, researchers have had difficulty determining the exact extent to which transfer pricing abuses explain the differences due to data limitations.
US-based multinationals can do this, too: shifting earnings to tax-haven jurisdictions where the income is still reported as part of the world-wide earnings of the company for financial reporting purposes, but less of the income is subject to US taxation.
Moreover, some of the companies you think of as red, white, and blue, aren't. Stanley Tools is now incorporated in, gasp, Bermuda! Spot wonders if all the executives wear Bermuda shorts in their New Britain, Conn. headquarters, which didn't move an inch.
Professor Banaian's answer here is to throw up his hands and say, in effect, that you can't collect taxes from these multinational companies, so why bother to try? Spot says that Banaian is such a defeatist! Sort of like George W. Bush who says that we might as well abolish the estate tax, because rich people will figure out ways to evade it, anyway.
That's enough for today, boys and girls. Next time, we'll look at another popular way to move income off shore.