America stands on the edge of a fiscal cliff, facing drastic budget cuts and painful tax increases on the middle class unless we can agree on a comprehensive, balanced deficit-reduction plan. This challenge lends new urgency to a topic I have long pursued as chairman of the Senate Permanent Subcommittee on Investigations: cutting loopholes and gimmicks to avoid paying taxes.
Tax loopholes are one significant cause of the budget deficit, and add to the tax burden that ordinary Americans bear. Recently, my subcommittee held a hearing exposing how multinational corporations have taken advantage of loopholes in tax law and weaknesses in enforcement to shift their profits overseas and avoid paying taxes.
The first step in shifting profits offshore takes place when a U.S. company sells or licenses a valuable asset, such as software developed in the United States, to a subsidiary in a low tax jurisdiction for a price below fair market value. The result is that profits from the sale of that software are then shifted to that tax haven outside of the reach of U.S. taxes.
We showed how Microsoft used this process, called "transfer pricing," to shift $8 billion in income from products developed here in the United States to subsidiaries based in Singapore and Ireland, avoiding U.S. taxes.
We also showed how, through complex transactions, Microsoft was able to use a subsidiary in Puerto Rico to shift nearly half of the profits from Microsoft products sold in the United States to Puerto Rico, avoiding a stunning $4 million a day in U.S. taxes.
The second step involves games played with profits shifted from one offshore entity to another. Under our tax law, companies with income offshore normally don't have to pay U.S. taxes until they bring that money back home to the United States. But, if the income consists of royalties, licensing fees, or other funds that don't require the active involvement of the business, that "passive" income is supposed to be taxed even while offshore.
But our hearing showed how some companies use an IRS regulation, which changed a provision in the tax code, to dodge those taxes. Literally, they're able to check a box on an IRS form and make offshore subsidiaries, and their taxable income, invisible for tax purposes. The subcommittee has learned that from 2009 to 2011, Apple has been able to defer taxes on over $35.4 billion using this loophole. Google has deferred over $24.2 billion in the same period. For Microsoft, the number is $21 billion.
We also showed how some companies use a tax loophole to bring offshore money back to the United States through inter-company loans from offshore subsidiaries. Loans that bring offshore money back to the United States are ordinarily considered as having repatriated the funds, which are then taxed. But there's an exception to that rule for short-term loans.
The hearing showed how Hewlett-Packard used this exception to orchestrate a constant stream of back to back loans from two offshore subsidiaries to bring billions of dollars back to the U.S. parent company. Instead of ensuring taxes were paid on those offshore profits returned to the U.S., the rule was twisted by gimmicks into bringing billions of dollars back into the U.S. tax free.
Still another ruse involves companies taking advantage of accounting rules to boost their profits on paper while avoiding taxes.
Under generally accepted accounting rules, when corporations hold profits offshore, they are required to reserve funds on their financial statements for the future tax bill when the earnings are returned to the U.S. Reserving money for taxes reduces the profit numbers that investors follow so closely in public company SEC filings. So some companies avoid the accounting requirement by asserting that their offshore earnings are permanently or indefinitely reinvested offshore. The result is their financial numbers look better than they should.
And yet, many multinationals have at the same time launched a massive lobbying effort, promising to bring billions of offshore dollars back to the United States if they get a "repatriation tax holiday," a large tax break for returning offshore funds to the United States. On the one hand, these companies assert they intend to indefinitely or permanently invest this money offshore, while planning, on the other hand, to bring it home as soon as Congress grants them a tax holiday. That's not any definition of "permanent" that I understand.
These tax avoidance gimmicks are unfair to the vast majority of American families and businesses who pay their taxes and don't employ armies of accountants and tax lawyers to get out of paying their fair share. Profitable corporations shouldn't be shortchanging America at a time of huge deficits. We simply can't afford their offshore tax dodges.