Google cut its global tax bill through strategies including the 'Double Irish and Dutch Sandwich', writes JESSE DRUCKER

THE US Internal Revenue Service is auditing how Google avoided federal income taxes by shifting profit into offshore subsidiaries, including Irish-registered companies, according to a person with knowledge of the matter.

The revenue service is looking at how Google valued software rights and other intellectual property it licensed to its international units, according to a source who spoke to Bloomberg. It has requested information from Google about its offshore deals after three acquisitions, including that of YouTube for $1.65 billion. The transfer overseas of these kinds of rights has enabled Google to attribute earnings to foreign units that pay lower taxes.

While Google’s potential liability isn’t clear, similar deals between companies and offshore arms are often the subject of disputes over hundreds of millions of dollars in taxes, according to Daniel Frisch, an economist at Horst Frisch which advises businesses on transfer pricing – the allocation of income between units in different countries.

In 2006, the service settled a case with drugmaker GlaxoSmithKline for $3.4 billion. “The very biggest transfer-pricing tax disputes are over transfers of intangibles to offshore subsidiaries,” Frisch said.

Google, owner of the world’s most popular search engine, has cut its worldwide tax bill by about $1 billion a year using a pair of strategies called the Double Irish and Dutch Sandwich, whereby it moves profits through its companies in Ireland, the Netherlands and Bermuda.

Google reported an effective tax rate of 18.8 per cent in the second quarter – less than half the average combined US and state statutory rate of 39.2 per cent. “This is a routine inquiry,” said a spokesman for Google in the US, who declined to comment further. A spokesman for the service said federal law prohibits it from discussing specific taxpayers.

US companies are sitting on at least $1.375 trillion (€1 trillion) in earnings in their foreign subsidiaries on which they have paid no federal income taxes, according to a May report by JPMorgan Chase. Companies including Google, Cisco Systems, Pfizer, Apple and Microsoft are lobbying Congress for a tax holiday on bringing home these profits, which would otherwise be subject to US income tax at the 35 per cent corporate rate, with a credit for foreign taxes already paid.

The Obama administration is opposed to that tax break and has been stepping up criticism of tax breaks for various industries and for millionaires. Last week, Senate Democrats proposed a new super tax on people earning at least $1 million a year, a move that would generate an estimated $453 billion over the coming decade.

The French tax authority also began reviewing Google’s income-shifting in December, examining transactions between the company’s French and Irish subsidiaries.

The French inquiry was prompted by the October 2010 Bloomberg article on the company’s tax-cutting strategy, according to two people who have knowledge of the investigation. A spokesman for the French budget ministry, which oversees the tax authority, declined to comment.

Multinational companies cut their tax bills by shifting earnings into subsidiaries in offshore tax havens, a strategy that is drawing increased scrutiny from the revenue service. In May, the service appointed its first transfer-pricing director, Samuel Maruca. Last year, it announced the assignment of additional agents and attorneys to examine a few large companies as part of a pilot programme.

The service would not discuss whether Google was one of those companies.

Moving profit abroad is particularly important for cutting the tax bills of technology and pharmaceutical companies because of their valuable and easily transportable collection of patents and copyrights. Google, Cisco, Facebook, Microsoft and Forest Laboratories, have used tax-cutting strategies that move profits into units – often with no employees or offices – in havens such as Bermuda, the Cayman Islands and Switzerland.

The service has engaged in high-profile disputes with multinationals over their transfer pricing. In 2006, it announced it was settling its dispute with GlaxoSmithKline. In 2009, it lost a US Tax Court case against Veritas, now a part of security software maker Symantec. In that dispute, over intellectual property rights moved to an offshore subsidiary, the service sought payments of $545 million. The Veritas win was a setback for the service’s ability to enforce transfer-pricing rules, according to David Rosenbloom, a US attorney and director of the International Tax programme at New York University School of Law.

Income shifting by multinational companies cost the US $90 billion in federal tax revenue during 2008, according to a March article in trade journal Tax Notes by Kimberly Clausing, an economics professor at Reed College.

Google cuts its tax bill by about $1 billion a year using a technique that allocates profits to a unit managed out of a law firm in Bermuda, where there is no corporate income tax. In 2009 this subsidiary collected €4.34 billion in royalties from a Google unit in the Netherlands, according to a Dutch corporate filing.

Google held $18.8 billion in cash in its foreign subsidiaries at the end of June, almost half its total $39.1 billion in cash and liquid assets.

The service has already approved a major part of Google’s strategy. In 2006, the US tax authority signed off on a 2003 intracompany transaction that moved foreign rights to its search technology to an Irish subsidiary managed in Bermuda called Google Ireland Holdings. That deal – known as a “buy in” in tax parlance – meant subsequent profit overseas based on those copyrights has been attributed to foreign subsidiaries rather than to Google in the US, where the technology was developed.

The service’s approval came in an accord known as an advance pricing agreement. Those arrangements are part of a programme intended to forestall disputes with companies, including disagreements over the price paid by offshore units for patent and other intellectual property rights.

That deal between the service and Google only covered rights the company held as of the 2003 licensing deal with its Irish unit. It didn’t cover copyrights subsequently acquired by the US parent which were then moved abroad. Following that 2003 transaction, Google made several acquisitions, spending $1.65 billion on YouTube in 2006; $625 million on e-mail security service Postini in 2007; and $3.2 billion on web-advertising firm DoubleClick in 2008.

The service is now examining the prices paid by the foreign subsidiaries for the rights to software and other intangibles moved offshore that formerly belonged to these three companies. According to US Treasury Department rules, foreign units licensing rights from their US parents are supposed to pay an “arm’s length” price, or the amount that would be paid by an unrelated company.

If the offshore subsidiary pays too little, that has the effect of shifting income overseas, thus helping the parent avoid US income taxes.

Google’s taxes have drawn scrutiny from the Securities and Exchange Commission. Last December, the commission asked Google for “greater detail” about the profit it said it had earned in countries with lower tax rates and the impact on its effective tax rate. The commission said in a February letter it had completed its review of Google’s filings. It is unclear what action, if any, the commission took.

In August, Google said it was spending $12.5 billion to acquire Motorola Mobility Holdings, the telecom-equipment and mobile-phone maker. Google said it was completing the deal primarily for Motorola’s collection of patents. Google did not respond to a question on whether it would be moving any of those patent rights offshore. – (Bloomberg)