Silicon Valley firms shelter assets overseas, avoid billions in U.S. taxes

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Credit: Creative Commons/Richie Fingers

The largest tech companies in the Bay Area have avoided paying federal taxes on more than $225 billion they have accumulated through foreign subsidiaries, documents filed with the Securities and Exchange Commission show.

By sheltering their assets overseas, Silicon Valley companies such as Apple, Google, eBay and Hewlett-Packard are able to reduce their annual taxes in some cases by billions of dollars, according to a Center for Investigative Reporting and Bay Citizen analysis of the 50 largest firms’ financial statements filed in 2012.

Widespread tax avoidance by some of California’s most prominent companies has contributed to federal revenue shortfalls as President Barack Obama and Congress consider whether to cut government programs. Some lawmakers say the tax code disproportionately favors powerful companies at the expense of other taxpayers.

“What it demonstrates is that tech firms in particular have very low worldwide rates, and their demands for a more competitive U.S. tax system ring hollow,” said Edward Kleinbard, a tax law professor at the University of Southern California and former chief of staff for the congressional Joint Committee on Taxation. “In fact, the U.S. tax system subsidizes them, and a more neutral tax system would require tech firms to pay substantially more taxes.”

The U.S. tax code allows companies to reduce their tax burden by accumulating assets overseas, and some of the biggest names in the tech industry have perfected the tactic. Instead of paying the top U.S. corporate tax rate of 35 percent, dozens of Silicon Valley giants maintain global tax rates below 15 percent, the CIR and Bay Citizen review of annual financial statements found.

Among the 50 firms, 47 reported having assets overseas that were “permanently reinvested,” a designation that allows them to avoid recording the money as taxable U.S. income, thereby deferring payment of federal and state taxes indefinitely. Many companies designate their holdings overseas even though much of the money is invested in the United States.

Five companies – Cisco Systems, Apple, Hewlett-Packard, Google and Oracle – accounted for more than two-thirds of the $225 billion in accumulated foreign earnings as of Dec. 31, 2012.

Tech companies that relied on foreign income to reduce their taxes include:

  • Apple, which reported $40.4 billion in holdings overseas and had an effective global tax rate of 12.6 percent over the past three years
  • eBay, which reported $10 billion overseas and had an effective tax rate of 15.3 percent over the past three years
  • Google, which reported $24.8 billion overseas and had an effective tax rate of 17.6 percent over the past three years
  • Yahoo, which reported $3.2 billion overseas and had an effective tax rate of 17.9 percent over the past three years
  • Cisco, which reported $41.3 billion overseas and had an effective tax rate of 20.9 percent over the past three years

The companies declined to comment on their offshore holdings or the amount of taxes they paid. The effective tax rate is based on CIR and The Bay Citizen’s calculation using the firm’s publicly available information; companies are not required to make public how much they paid the Internal Revenue Service.

Of the 50 largest Bay Area firms, Santa Clara-based Agilent Technologies had one of the lowest tax rates over the past three years. The scientific instrument maker reported earning $2.8 billion worldwide and paying $156 million in taxes, which comes to an effective rate of 5.6 percent. More than 95 percent of its assets are held by foreign subsidiaries, the company reported last year. Agilent declined to comment.

How we analyzed companies’ financial statements

For this story, the Center for Investigative Reporting and The Bay Citizen set out to learn how much Silicon Valley’s largest tech companies have in assets overseas and how this helps them reduce the amount they pay in U.S. taxes.

We compiled a list of the 50 largest Bay Area tech companies based on their market capitalization, a common measure of a company's size, as of Dec. 31. Then we examined the 10-K statements each company filed last year with the Securities and Exchange Commission; these annual financial statements cover each company’s previous fiscal year.

To come up with our methodology for evaluating how foreign earnings affect companies’ U.S. taxes, we consulted former U.S. Treasury officials, international economists and corporate tax law professors, among others.

We studied the financial information for each of the 50 companies, including global taxes paid, income statements, the number of foreign subsidiaries and the amount deemed permanently reinvested abroad, a tax provision available to multinational corporations that allows them to defer U.S. taxes. We also looked at which companies reported overseas assets but invested that money in the United States.

In computing each company’s effective tax rate, CIR and The Bay Citizen followed generally accepted accounting principles. We divided the amount of taxes reported in the financial statement by the reported income. The pretax income used to calculate the effective rate does not necessarily include all revenue in a given fiscal year, such as income from discontinued operations.

The companies are not required to make public the amount of taxes they paid the Internal Revenue Service.

Our calculation of the effective tax rate likely differs from the amount the companies actually paid, in part because it does not take into account their ability to defer tax payments to future years. In some cases, the effective tax rate is based on a net loss of income, and produces a negative annual rate.

Facebook would rank among the largest Silicon Valley tech companies but is not included on our list of the top 50 because it was too new as a public company to file an annual financial statement in 2012.

CIR and The Bay Citizen vetted the reporting methodology with experts, including a former IRS official who previously worked as an executive of a private accounting firm.

Many of Silicon Valley’s biggest firms will benefit from a two-year extension of a tax provision – included in the January fiscal cliff deal – allowing them to defer taxes on royalties earned by their foreign subsidiaries. The Joint Committee on Taxation estimates this will cost the U.S. government more than $1.5 billion in the next two years.

Large nontech companies such as General Electric, Coca-Cola and Procter & Gamble also reduce their taxes by keeping assets abroad, their SEC filings show, a practice that has caught the attention of some in Congress.

Sen. Carl Levin, D-Mich., chairman of the investigations subcommittee of the Senate Committee on Homeland Security and Governmental Affairs, charged at a hearing in September that U.S. companies have stockpiled $1.7 trillion in earnings overseas, all of which has gone untaxed by the U.S. Treasury.

“The bottom line of our investigation is that some multinationals use our current tax system to engage in shams and gimmicks to avoid paying the taxes they owe,” Levin said at the hearing. “It is a system that multinationals have used to shift billions of dollars of profit offshore and avoid billions of dollars in U.S. taxes, to their enormous benefit.”

On Feb. 7, Sen. Bernie Sanders, I-Vt., introduced a bill that would eliminate companies’ ability to defer taxes on income deemed permanently reinvested.

Levin’s subcommittee is examining Silicon Valley companies that have become efficient at avoiding taxes in part by transferring money among foreign subsidiaries in countries designated by the U.S. as tax havens. A spokeswoman for the committee declined to discuss the investigation, which could be completed as early as this month.

Kimberly Clausing, an economics professor at Reed College in Portland, Ore., estimates that the federal government is losing more than $90 billion in tax revenue annually from U.S. businesses that transfer earnings overseas.

That amounts to nearly half the corporate tax paid by all U.S. companies in 2011. It would be enough to fund public schools and higher education in California for more than two years or cover 206 days of military operations in Iraq and Afghanistan, according to state and federal budget data.

For many multinational corporations based in the United States, Clausing said, the top corporate income tax rate of 35 percent is a myth.

“I think our system’s stated intention and its actual practice have diverged to a point where it’s bordering on ridiculous,” she said. “If you look at the firms in question, they aren’t paying anywhere near that rate.”

In addition to disclosing how much money they hold overseas, companies are required to report to the SEC the amount of federal taxes they would owe if their earnings were transferred to the U.S., with credit for any foreign taxes already paid. Many companies, however, avoid disclosure by citing an exception that estimating their tax burden is impractical.

Of the 50 largest Bay Area tech companies, 17 estimated the U.S. taxes they owed on overseas earnings. If these companies were taxed on that money today, they would owe the U.S. Treasury $25.9 billion, according to their own estimates.

Two-thirds of the companies, however, did not provide an estimate of their potential tax liabilities. Similarly, an October study by the research and advocacy group Citizens for Tax Justice found that 285 companies on the Fortune 500 list reported having overseas earnings, but fewer than 50 provided an estimate of their U.S. tax liability.

“It’s a disgrace,” said Kleinbard, the USC professor. “It’s entirely optional whether companies provide U.S. tax estimates on offshore earnings.”

Not including this estimate could result in sanctions but seldom, if ever, does. Marc Fagel, regional director of the SEC’s San Francisco office since 2008, said he was not aware of any enforcement action against a company that did not estimate its tax bill on overseas earnings.

Seeking tax holiday

Most of the companies analyzed by CIR and The Bay Citizen support a lobbying effort in Washington for a one-time tax holiday that would allow them to transfer foreign earnings to the United States at rates as low as 5 percent.

An industry group, which calls itself the WIN America Campaign, has spent $760,000 on lobbying since it was formed in 2011, federal records show. Among its supporters is the Silicon Valley Tax Directors Group, made up of representatives from dozens of companies in the region, including 28 of the 50 largest tech companies.

One of two co-chairmen of the group, Jeffrey Bergmann, is a vice president of the software company NetApp, which boasted one of the lowest effective tax rates of any top Silicon Valley company in 2011 at less than 7 percent. The Sunnyvale firm has accumulated more than $1.8 billion in earnings overseas.

Bergmann declined to be interviewed for this article but wrote in an email that he supports reducing U.S. tax rates and shifting to a so-called territorial system, with foreign income taxed only in the jurisdiction where a company reports earning it.

“I believe there is over 1.5 trillion dollars that is held offshore because it is too expensive to bring back that money,” Bergmann wrote. “If you taxed those earnings at 5.25 percent, that would raise over $75 billion in taxes virtually overnight and the economic activity that comes with bringing back that amount of cash (regardless of whether the cash is used in the business for capital improvements or distributed to shareholders).”

A similar amnesty was offered in 2004, when the federal government allowed companies to transfer money to the United States at a 5.25 percent tax rate, provided it was spent on research and development and to spur job growth. A 2009 study by the National Bureau of Economic Research, however, found that 92 percent of the $300 billion that companies transferred to the U.S. ended up as dividends to shareholders.

“There was really no effect on jobs or investment,” said Clausing, the economics professor. “It was basically a windfall for shareholders.”

Regardless of how the money from a tax holiday would be spent, Kleinbard, the USC tax law professor, said much of the money held by foreign subsidiaries is actually invested in the U.S.

Kleinbard said it’s a common misconception that these assets remain outside the country. In reality, they often are held in U.S. currency in the form of Treasury bonds and government-backed securities. The difference, Kleinbard said, is that the investments go untaxed.

“The money is not sitting in a strongbox buried in the sand,” he said.

A study of Apple, Google and about two dozen other companies by Levin’s Senate subcommittee in 2011 found that 46 percent of the money the firms held “overseas” actually was invested in U.S. Treasury bonds and other government-backed assets, such as mutual funds and stocks.

“The data shows that, in many cases, the funds that corporations identify as being offshore are really onshore,” the report said. “The presence of those funds in the United States undermines the argument that undistributed accumulated foreign earnings are ‘trapped’ abroad, because nearly half of those funds are already located right here in the United States.”

The study found that Apple, Google, Adobe, Cisco Systems and Microsoft, among others, keep more than three-quarters of their designated foreign holdings in U.S. investments.

“Because foreign earnings of those U.S. corporations are not ‘trapped’ abroad, another tax break is not needed for those foreign earnings to be ‘returned’ to the United States,” the report concluded.

Overseas tax strategies

In December, Bloomberg reported that Google avoided $2 billion in taxes in 2011 by shifting profits to a shell company in Bermuda, a wealthy British territory in the North Atlantic that has no corporate taxes.

Google’s executive chairman, Eric Schmidt, defended the company’s tax payments and said he was “proud of the structure we set up.”

“It’s called capitalism,” Schmidt told Bloomberg. “We are proudly capitalistic. I’m not confused about this.”

The Mountain View-based company took in more than $12 billion in profits in 2011 and paid taxes of $1.4 billion, according to the company’s filing. That comes to a global tax rate of less than 12 percent for the company’s fiscal year and marks the third in a row the firm reported a lower tax rate than the previous year.

Apple, meanwhile, is one of only a handful of companies that doesn't assume all of its foreign earnings to be permanently reinvested. The Cupertino company reported more than two-thirds of its cash – $82.6 billion – held by foreign subsidiaries and subject to taxes. This is separate from the $40.4 billion in earnings it deems “permanently reinvested.”

Former Treasury Department economist Martin Sullivan, an international tax expert, estimated in an interview that Apple avoided at least $2.4 billion in federal taxes in 2011 through its various tax positions, including its leasing of royalties on digital products such as downloaded songs and mobile apps. Apple reported it paid $7.7 billion in global taxes last year, which comes to an effective rate of less than 14 percent.

Netflix was one of three companies in the top 50 that reported no foreign earnings, along with software company Salesforce.com and network hardware firm Riverbed Technology.

Netflix recently expanded its overseas operations and expects to see an increase in foreign investments this year. The movie-rental company reported a tax rate of 37.1 percent in 2011, but after deferrals paid $79 million in taxes – a rate of about 22 percent.

Netflix spokesman Jonathan Friedland said calculating an effective tax rate based on a single year was “not a reliable measure,” but declined to disclose the difference between the company’s effective rate and its reported rate.

“From our perspective, we’ve paid our fair share of taxes,” he said.

This story was edited by Richard C. Paddock and copy edited by Nikki Frick and Christine Lee.

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