Thursday, March 22, 2012

Tax Management Contracting Strategies

A lot of people think that the loss of American jobs and jobs in other locations is the result of lower labor rates. While that may be part of the cause, aggressive tax management programs that are allowable under tax laws has driven a larger share of it in countries that have large corporate tax rates. For example the U.S. Corporate tax rate is Thirty-Five percent any company that makes over eighteen million dollars. The tax rate forced them to do to that to remain competitive. An article in the New York Times last year said that 55% of the U.S, Corporations paid nothing in one or more years over a seven-year span. How did they do that? How did companies like Cisco get forty billion dollars in off-shore accounts? How did Apple get sixty-four billion in off-shore accounts?

Here are several examples:

1.Companies have products produced in locations where the labor is lower cost, but they will also have those products be purchased by a foreign subsidiary in a tax haven or lower tax country. That company adds significant overhead and profit to the product and then sell that product at what’s called the transfer price to all the company’s subsidiaries including the U.S. based sales subsidiaries. For the profits they make in those tax havens they pay no tax. To those U.S. and other country sales subsidiaries, the transfer price is a cost to them and they will add their local overhead and profit. The net income on the sale of that product will only be a small portion of the actual profit that was made on that sale. The remaining profit, as long as it’s held off-shore, is never subject to U.S. Tax. To repatriate that profit, a company is subject to a ten-percent tax. So there is also a negative incentive to bring money back into the United States to invest.

2.Companies will have services provided by subsidiaries based in tax havens or lower tax rate countries. For example Ireland has a corporate tax rate of only ten-percent versus the U.S.’s thirty-five percent. When they sell services to the U.S. subsidiary or other subsidiaries, they will include overhead and profit on those services. That profit accrues in that country, not the U.S. or the other subsidiary countries To the U.S, subsidiary the purchase of those the services is an expense. This means that the profits they make in another country are reduce the amount of taxes the U.S. Company pays on the profits they make.

3.For international shipment of commodities such as oil, the cargo may be sold a number of times while that good is in transit. All of the profits from those sales, since they occur in international waters, are international sales are not taxable.

4.To avoid conducting business within a country where the corporate taxes are high companies will do a number of things. They may make all international sales from a tax haven so the profits the make there are not taxed. They may even agree to have the sale occur while the item is in transit or in a free trade zone where the profit will not be taxed locally.

While a company may get some benefit of lower employee costs by producing products or perform services in low labor cost locations, that is not the biggest reason why they do it. In fact for many products the labor cost as a percentage of the total cost of the product is small. What they do know is if they produce it and sell it in a country that has a high tax rate they will pay more taxes on the profits they make. If they implement tax management contracting strategies on who they buy from, where they take delivery, what company they use to make the purchases, where the transfer price or service sales price is established they can use them to manage taxes they pay. The impact of that is huge. For some companies the difference can be a matter of survival. For other companies it’s a matter of greed.

In the U.S. the corporate tax rate is simply not working. Few companies pay it. It’s driving jobs and investment out of the U.S. It’s creating situations where companies like Cisco and Apple have huge cash reserves outside the U.S. The cost of using those monies to invest in the U.S. is as high as corporate tax rates in other countries. This creates a negative incentive for companies to invest in traditional manufacturing or services positions in the U.S. What the tax rate has also done is force companies to move those traditional manufacturing and service jobs out of the U.S. The loss of those jobs has only added to the U.S.’s and other countries problems as fewer individuals are paying taxes because they are out of work, or they are paying less because they had to take lower wage positions to survive. It has also put a huge drain on assistance programs compounding the problem.

I’d love to see Apple producing IPads, IPhones and IPods and all their other products in the U.S. I know that won’t happen until the tax laws change. Why should they? The tax laws are providing a negative incentive against investing in the U.S. and hiring U.S. workers to manufacture them.