11/07/2010

Transfer Pricing

A recent Bloomberg article talked about Google and their incredible success at using transfer pricing. Transfer pricing is more than just shifting costs from one division to another. Creative use of transfer pricing allows multinational corporations to use tax haven countries to shelter profits from restrictive tax laws. Through a system of shell companies and creative pricing structures, Google is able to move it's profits to countries like Bermuda where there is no corporate income tax. It takes a complicated system of in-house accountants and bankers to keep all of the money accounted for and keep the transactions legal. However, all the extra time and effort is well worth it as a company the size of Google can literally save billions of dollars in tax liability. These practices are very common among large corporations. In fact, it is estimated that it costs the U.S. about $1.4 trillion in lost revenue. The fact that the U.S. has such high corporate tax rates is the reason that companies are motivated to go to such lenghts to avoid corporate taxes. It might be time for the U.S. to reevaluate its corporate tax structure to try to capture some of these lost revenues.

5 comments:

Grant said...

First, While these transfer pricing schemes are legal and quite common especially among large international firms I know at least one SUU professor who would not hesitate to note that such practices are very difficult to justify ethically. Secondly, while it may sound from this article that the IRS is sitting by and allowing this to happen from talking with a transfer pricing professional I know working for a large consulting firm they are actively working to close loopholes such as these and insure companies pay a fair tax, unfortunately political factors are also at work and the government has to operate with those obstacles in mind.

Dave said...

I am not sure where Ralphie got the figure of $1.4T in losses from. That figure is absurd, unless they are talking about something like the present value of all future tax avoidance.

Let me start by noting that what is called transfer pricing here, and which is the more common usage in the business press, is not the same as transfer pricing as discussed in managerial economics texts. Here it is about the location where your prices are accounted for (and taxed), whereas in managerial economics it is mostly about what one unit of a business should charge another unit for intermediate products. The ideas are related, but not tightly.

Now that this is out of the way, transfer pricing is big business these days. As Ralphie points out, this is mostly a result of tax rate differentials. Once again, politics has created a mess, and business address that with accountants and lawyers.

Alfred said...

I think the tax haven is a smart idea for companies that can successfully navigate the international tax arena. No person or organization is obligated to pay more taxes than they are required. I don’t think anyone pays the government more than they legally owe out the generosity of their heart. I love the quote, “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands: Taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.”
-Honorable Learned Hand, U.S. Appeals Court Judge, Helvering v. Gregory, 69 F.2d 809 (1934).
There is a reason that companies are going overseas. If the government wants more of its corporations’ taxes then maybe it should reevaluate its corporate taxing strategy and give greater incentives so that these organizations will actually want to stay home.

Alfred said...

Dave, Rico got his 1.4T from page one but that is referring to the budget gap. The number for transfer pricing that I think should have been quoted is on page two. According to Clausing, it should be around 60 billion.

delta said...

The big question that comes to my mind is the ethics surrounding such loopholes. I suppose that the government is going to have to be a little more pro-active to address all the issues that will continue to arise in the globalized world. They may have to start being more competitive to give businesses more reason to invest in operations within the United States.