US Tax Holidays

Posted by Nanette Byrnes, from Business Week. (http://www.businessweek.com/careers/managementiq/archives/2008/08/tax_holidays.html )

It’s August, so you may be on vacation. But for an awful lot of corporations operating in the US, every day is a tax holiday. So says a report out today by the US General Accounting Office highlighting the number of US- and Foreign-controlled companies that have claimed zero tax liability in recent years.

The GAO’s study was ordered up by Senator Carl Levin, Democrat from Michigan and chairman of the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Government Affairs. Its conclusions focus on the fact that large foreign corporations are more likely to avoid taxes than US companies.

Like most of these studies, the GAO’s report looks at taxes as accounted for on the corporate income statement, not the cash taxes actually paid. (By that measure, 42 of the companies in the S&P500 had an actual tax rate of less than 10% over the past 5 years, another 58 paid less than 16%, and neither group paid anything like the statutory corporate tax rate of 35%).

According to the GAO, in recent years the gap in the number of US and foreign companies enjoying a tax free year has significantly narrowed. Though the authors didn’t go into exactly how both groups are sidestepping the tax man, they did indicate that transfer pricing looks to be a culprit. Transfer pricing is how much one part of a company charges another for something.

In a 2003 story on corporate taxes, we dug up and example of how this worked for hotel chain Hyatt.:
In one U.S. tax court case that is still pending, the IRS accused hotelier Hyatt International of paying too little for the Hyatt brand and other services provided by its U.S. parent. The IRS alleges that from 1976 to 1988, various Hyatt companies underreported income by $100 million because of those lowball fees. In an October, 1999, ruling on some aspects of the case, U.S. Tax Court Judge Joel Gerber ruled that the $10,000 one-time fee International had paid for each hotel bearing the Hyatt name was far too low. Hyatt declined to comment because the broad case is ongoing.

Tax economist Martin Sullivan, thinks half of the sharp drop in the foreign tax rates of U.S. multinationals — from 49.6% in 1983 to 22.2% in 1999 – is the result of similar shifting of income from foreign countries with a higher tax rate to those with lower rates.
Beyond shedding some light on the impact of transfer pricing, the report also shows:
• Fewer large foreign-controlled companies are paying no taxes today than in the past. That figure has declined since its 2001 peak of more than 50%.

• More US companies (large and small) reported zero tax liability in 2005 (the most recent year included) than foreign-controlled companies.

• 72% of foreign-controlled companies reported no tax liability some time between 1998 and 2005, while 55% of US-controlled companies did so.

• The biggest tax breaks come from deductions for salary and wages, and from a category called “other” that includes travel expenses, legal fees, and insurance, as well as dividends paid on stock owned by employee stock ownership plans.