Monday, November 20, 2006


Drug companies and other multinational companies based in the U.S. systematically avoid paying tax in the U.S. on their profits. The companies elect to realize profits in low-tax countries and because of this the rest of us have to pay billions of unnecessary taxes to make up for the shortfall.

The biggest tax scam on earth has a very innocent sounding name. It is called “transfer prices.” That almost sounds boring. It is, however, anything but boring. Abuse of transfer prices is a key tool multinational corporations use to fool the U.S. and other jurisdictions to think that they have virtually no profit; hence, they shouldn’t pay any taxes.

Corporations involved in this scam are “model corporate citizens,” or so they would like us to believe. The truth is that they rob us all blind. The money we lose can be estimated in the tens of billions, or possibly hundreds of billions of dollars every year. We all end up paying higher taxes because rich corporations make sure they don’t.

But don’t take my word for this.

A few weeks ago U.K.-based GlaxoSmithKline (GSK), one of the largest pharmaceutical companies in the world, together with the Internal Revenue Service (IRS) announced that GSK will pay $3.4 billion to the IRS to settle a transfer pricing dispute dating back 17 years. The IRS alleges that GSK improperly shifted profits from their U.S. to the U.K. entity.

And U.K. pharmaceutical companies are not alone with these kinds of problems. Merck, one of the largest U.S. drug companies, also this month disclosed that they face four separate tax disputes in the U.S. and Canada with potential liabilities of $5.6 billion. Out of that amount, Merck disclosed that the Canada Revenue Agency issued the company a notice for $1.8 billion in back taxes and interest “related to certain inter-company pricing matters.” And according to the IRS, one of the schemes Merck used to cheat American tax payers was by setting up a subsidiary in tax-friendly Bermuda. Merck then quietly transferred patents for several blockbuster drugs to the new subsidiary and then paid the subsidiary for use of the patents. The arrangement in effect allowed some of the profits to disappear into Merck’s own “Bermuda triangle.”

So what’s going on here, how have multinational drug companies been able to gouge us for years selling expensive drugs and then avoid paying tax on their astronomical profits?

The answer is simple. For companies in certain businesses, such as pharmaceuticals, it is very easy to simply “invent” the price a company charges their U.S. business for buying the company’s product which they manufacture in another country. And if they charge enough, poof; all the profit vanishes from the US, or Canada, or any other regular jurisdiction and end up in a corporate tax-haven. And that means American and Canadian tax payers don’t get their fair share.

Many multinational corporations essentially have two sets of bookkeeping. One set, with artificially inflated transfer prices is what they use to prepare local tax returns, and show auditors in high-tax jurisdictions, and another set of books, in which management can see the true profit and lost statement, based on real cost of goods, are used for the executives to determine the actual performance of their various operations.

Of course, not every multinational industry can do this as easily as the drug industry. It would be difficult to motivate $6,000 toilet seats. But the drug industry, where real cost of goods to manufacture drugs is usually around 5% of selling price, has a lot of room to artificially increase that cost of goods to 50% or 75% of selling price. This money is then accumulated in corporate tax-havens where the drugs are manufactured, such as Puerto Rico and Ireland. Puerto Rico has for many years attracted lots of pharmaceutical plants and Ireland is the new destination for such facilities, not because of the skilled labor or the beautiful scenery or the great beer—but because of the low taxes. Ireland has, in fact, one of the world’s lowest corporate tax rates with a maximum rate of 12.5 percent.

In Puerto Rico, over a quarter of the country’s gross domestic product already comes from pharmaceutical manufacturing. That shouldn’t be surprising. According to the U.S. Federal Tax Reform Act of 1976, manufacturers are permitted to repatriate profits from Puerto Rico to the U.S. free of U.S. federal taxes. And by the way, the Puerto Rico withholding tax is only 10%.

Of course, no company should have to pay more tax than they are legally obligated to, and they are entitled to locate to any low-tax jurisdiction. The problem starts when they use fraudulent transfer pricing and other tricks to artificially shift their income from the U.S. to a tax-haven. According to current OECD guidelines transfer prices should be based upon the arm’s length principle – that means the transfer price should be the same as if the two companies involved were indeed two independents, not part of the same corporate structure. Reality is that standard operating procedure for multinationals is to consistently violate this rule. And why shouldn’t they? After all, it takes 17 years for them to pay up, per the GSK example above, even when they get caught.

Another industry which successfully exploits overseas tax strategies to cheat us all is the hi-tech industry. In fact, Microsoft Corp. recently shaved at least $500 million from its annual tax bill using a similar strategy to the one the drug industry has used for so many years. Microsoft has set up a subsidiary in Ireland, called Round Island One Ltd. This company pays more than $300 million in taxes to this small island country with only 4 million inhabitants, and most of this comes from licensing fees for copyrighted software, originally developed in the U.S. Interesting thing is, at the same time, Round Island paid a total of just under $17 million in taxes to about 20 other countries, with more than 300 million people. The result of this was that Microsoft's world-wide tax rate plunged to 26 percent in 2004, from 33 percent the year before. Almost half of the drop was due to “foreign earnings taxed at lower rates,” according to a Microsoft financial filing. And this is how Microsoft has radically reduced its corporate taxes in much of Europe and been able to shield billions of dollars from U.S. taxation.

But remember, this is only one example. Most of the other tech companies are doing the same thing. Google recently also set up an Irish operation that the firm credited in a SEC filing with reducing its tax rate.

Here’s how this is done in the software industry and any other industry with valuable intellectual property. A company takes a great, patented, American product and then develops a new generation. Then, of course, the old product disappears. Some, or all, of the cost and development work for the new product takes place in Ireland, or at least, so the company claims. The ownership of the new generation product and all income from licensing can then legally be shared between the U.S. parent company and the offshore corporation or transferred outright to the tax-haven. The deal, to pass IRS scrutiny, has to be made using the “arms-length principle.” Reality is that the IRS has no way of controlling all these transactions.

Unfortunately those of us working and paying tax in the U.S. can’t relocate our jobs and our income to Ireland or another tax haven. So we have to make up the income shortfall. In the U.S. we have a highly educated society with a very qualified workforce, partly supported by our tax payers. This helps us generate breakthrough products. But once a company has a successful product, they have every incentive to move the second generation of a successful product overseas, to Ireland and a few other corporate tax havens.

There is only one problem for U.S. companies with this strategy, and that is that if they repatriate this money to the U.S. they have to pay full corporate taxes. In fact, according to BusinessWeek, U.S. multinational corporations have built up profits of as much as $750 billion overseas, much of it in tax havens such as the Ireland, Bahamas, and Singapore to avoid the stiff 35% levy they'd face if they repatriated the funds back into the U.S.

But of course, Congress, which is basically paid for by our multinational corporations, generously provided for a one-time provision in the corporate tax code, so that they could repatriate profits earned before 2003, and held in foreign subsidiaries, at an effective 5.25% tax rate.

And so the game goes on.

In the end, multinational corporations live in a global world which allows them to pretty much send their money to corporate tax havens at will, and then repatriate this money almost tax free, with the help of the U.S. Congress.

The people left holding the bag are you and me.


Anonymous said...

If you signed a contract with Glaxo, even as a contractor, in one of Glaxo's previous incarnations, it had a clause that ANY invention you made up to five years after leaving Glaxo was their property. So, not only pharmacuetical/chemical inventions. And inventions, being property if patented, can be marketed, or used, in any number of ways. The scope of all these "transfers" is much larger than appears on the surface. It is not only international corportions that cause an outflow. Whole governments do the same thing, such as Mexico, which exports its poor. Taking care of anchor babies, or poor people working here, is one thing. But there is now a whole underground nation. They get "transfer payments" in the form of free Medicaid, etc. and Americans pay for this. If we were all rich, it would not be such a problem, but Americans can not themselves afford medical care, often food, and the price of real estate is still out of sight. We need some good treaties on a number of things, a.o. all kinds of "transfers". Anchor babies have mothers AND fathers. Babies, usually, are not responsible for payment of the bills for their births. Parents are. If those parents are foreign nationals there must be a mechanism for repayment and reciprocity. Of course, taxes elsewhere are lower than here. Other countries do not have the outflow that we have and the burdens. And if the taxes are higher, or similar, there are also benefits, a.o. with medical care, that Americans do not have. Moreover, with whole industries and even economic sectors transferred out, in addition to taxpayments, other economies do much better. It is not only the money, it is the multiplier effect, etc. Offshore practices, however, are practised everywhere, and have been for at least half a century. So have hostile takeovers been a fact of life, often first introduced in an area by Americans doing that, as in banking. I remember a first one in 1952 in Europe personally.There are all sorts of profits to be made on balance transferrals and currency arbitrage as well, and accountbalances are used for security, as well as for creating more accounts. It is, de facto, buying and selling of money - currency, credits, projectloans - at a profit, but these kinds of buys and sales are not one shot ocurrences; they have multiplier effects in themselves. If outflows are being held in dollar balances, these dollar balances can be sold on the open market, at a loss, and so be used to devalue the dollar, by hostile "entities". What we need, and in a hurry, is international law to catch up, trade and other agreements and treaties, reciprocity, and reinstatement of some rules and regulations. With the outflow of money, and the influx of illegal and other immigrants, there are all sorts of issues, of property, responsibility, value and validation of agreements made with, or in, other nations, etc. in the personal sphere, as well as business sphere, and, yes, international politics. We are not giving away just the ports, and the money, or our way of life. Much more is at stake.

Anonymous said...


What a scam. I realize now just how completely inept our congress is. I would bet dollars to donuts that if they read your post they would not have a damned idea of what you are talking about.

They would just shake their purty little heads and be off to another fund raiser from those same people, hop on a private jet to go golfing and when asked what they are doing reply, "Fact Finding Trip!"

I guess we get the congress we vote for. No more issues of importance to America but rather wedge issues there are absolutely no plans to change, like Abortion,Gays, Guns, and God.

Why bother doing something that will actually do something for America when you don't have to do anything but say,"I'm for/against the one A and three G's" and then go back to your cushy little job where you "work" a few hours a day three days a week and complain about even that.

I keep wondering just exactly when we lost complete and total control of our government to the corporate pimps that control the congress now.

I'm sure there was a take-over date when it became 100 percent complete. Something like Jan. 21. 2001.

Or something like that.

beeta said...

Lawmakers (I hate to call them that, though they are) are very aware of the way corporations cheat us (they only act stupid about it), since their campaigns are paid for by those stolen tax-dollars.
As for the date we got screwed royally by the corporations......Reagan started the downfall, but I think it started a long time ago when entities were given the same legal rights as people.
I wonder who came up with that nugget of corruption.....anyone knows?
It was a Supreme Court ruling...I think....

Anonymous said...

No, Beetah, you do not quite have it correct. Corporations are legal "persons", not entities, and not persons, as in human beings, either. That is the case not only in the U.S. It was also not a "Supreme Court Ruling". It is a legal necesity as there are many owners of a corporation, who vote, in stockholdersmeetings, but do not do the day to day business and decisionmaking; the corporation does that, or, rather, executives acting on behalf of the corporation. And, yes, Reagan did something. Under him all restrictions and regulations were taken off the table: Free enterprise, an economic theory of the late Milton Friedman, U. Chicago, became the newest faith and fashion. He wrote a book, a.o. "Free to choose". Some economists are true believers, and have faith, in one theory or another, or one theory after another. One said to me, once, that he was a catholic of quaker descent and "believed" in Galbraith's industrial economics. I read all of Galbraith's writings, and as an European, I heard, loudly and clearly, a very, very hot pink, if not red, socialist speaking to me, rather than a man advocating industrial economics. Economic theories are fine by me, I have an economics degree, but common sense is needed in addition to theories. The U.S. plays by one set of rules, but other countries do not follow our example and have different sets of rules. That is what is not working.

Anonymous said...

It's corporate welfare.

US-based companies will play by whatever rules wherever that will give them the best deal. Borders are no obstacle. Patriotism isn't either.

Here's another example of The $104 Billion Refund The most absurd corporate tax giveaway of 2005.

And if corporations ever decide to contest the decision to the US Supreme Court, the bench is packed with corporate-friendly justices like Roberts and Alito and Scalia. So they know they have a better than even chance of winning an appeal.

Here's something else to consider. Ever tried to read a corporation's annual report? Good luck. Tech giant HAL's annual report is designed to confuse. And certainly don't ask any questions during an annual shareholder meeting, otherwise you'll get the two-step. There's a reason they're purposely vague. And being big is an advantage so they can hide all kinds of things.

A couple of examples.
First example: why would a company buy-back it's own stock at its highest price? Smart business? If you like paying the highest price, then of course, but not necessarily in the stockholders' best interest. But what if HAL's CEO's incentives are tied to that. Then the higher the value, the bigger reward he gets.
Second example: what's the best way to reduce a company's pension obligations? Convert all employees from a traditional plan to 401K plan under the radar, and then announce it without much fanfare and hope no one picks up on it. And then the CEO collects $1M/yr for life from the Board of Directors.

As far as Friedman, he was a quack. Nothing more than a corporate-sponsored hack professor promoting corporate-branded "economics". In other words, he was a "corporate whore" parading around as an "expert". Good riddance and he won't be missed.

David Cay Johnston, the NYT investigative reporter, wrote the definitive book on legal tax scams, Perfectly Legal.

This whole thing is like watching the Keystone Cops since the crooks are running things.

It's like the $150+K/yr recipients complaining about the abandoned mothers on public aid getting $200/mth to raise their kids.

Crime does pay. That's why so many (multinational) corporations do it.

Anonymous said...

Hi Dr Rost -

I'm the Business Editor of the Sunday Tribune, a Dublin, Ireland-based
newspaper. I recently came across your blog
in a trawl of references to Round Island One. Since that original Journal
exposé, Microsoft has shifted its practices and no longer has to file
accounts for Round Island One in Ireland, keeping it even less open to

Your piece covers an issue I've been following (you can find it, with some
difficulty, on or cross-posted to my own blog,
and was wondering if you had any thoughts on the prospect for Rangel at
Ways & Means tackling the issue in any prospective change to US tax laws.

As an expat Yank over here, I probably realise more than most how well the
Irish treasury is doing at the expense of the one in Washington.

Best regards,
Richard Delevan
Business Editor
Sunday Tribune

Anonymous said...

Saying Milton Friedman knew economics is the same as saying George W Bush can lead.

MsMelody said...


Actually, it WAS a Supreme Court ruling:

118 U.S. 394
Filed May 10, 1886

The link is

Anonymous said...

Well, did I say Milton Friedman knew economics? I do not think so! But this "debate" is getting interesting. Let us have more of it. So, here is a posit: Republicans, under Reagan, started the deregulation "somthingsomethingvolution". Republicans also are, indeed, against welfare mothers, against a national policy on healthcare and many more issues. This positions come from "ideologies", not from rational factual analysis. Case in point: healthcare, through employment, decided upon by insurers. The insurers like to cash in the premiums, they do not like to pay out. THAT is logical, from their point of the equation. So, if you have an chronic illness, possible future illnes, whatever, you will not get hired, because the INSURER will not allow you to get hired. Result: not only the medical bills, but all the other bills will be paid by the taxpayer through "TRANSFER"-payments. There is that magic word transfer again. Government does not pay this, the populus pays this, as we all pay taxes, Medicare, etc. The whole game of illegal (Mexican) immigrant workers is an identical scheme. Employers get to hire at lower than low laborcosts, and pay no benefits. Those illegals do not pay taxes, but DO get benefits such as Medicaid and other "TRANSFER"-payments. Mexico exports those costs and its indigents, and who pays? The U.S. TAXPAYER. Katrina victims. Many, if not most, were properly INSURED, but insurers are not paying out. They WERE cashing in the premiums, and "religiously" so. Theories and hypotheses are nice, to work with, to model with, but we - I will say it again - also need COMMON SENSE and empirical verfication. So, that was the Republican side of the issue taken under a loupe. Now, for Democrats. Democrats think the "government" is en entity with big pockets and HAS to support them. Taxes, however, is what fills government's coffers, and they come, a.o., from the populus. Democrats, also, were the incentive for the Reagan evolution as other countries had cheaap labor, and labor in the U.S. was not only becoming more and more expensive, but also more and more demanding and militant. If you are in business, and are competing in the global environment, there must be some taps on labor, as well as on business practices. In this environment, small, new start-ups have a difficult time getting off the ground, if they can get started at all. A little thing, such as shelf placement in stores, for example, or productioncosts, or capital investment available, is influenced by laborcosts, capital availability and investment, credit, and much more. A new product is also not protected from international pirating, or small changes, to make a competing and less expensive, or even improved marketable product. That stiffles the market and innovation. There is another issue, and that is the RESISTANCE TO CHANGE by the populus, plus the idea, still, that Americans are just genetically, educationally, and otherwise superior above all others. That should be checked against reality as well. Now, let us hear YOUR point of view.

Anonymous said...

Ms Melody says, Beetah, actually it WAS a supreme court ruling. I wonder WHAT that IT is. Having worked as a department head in International Banking, and elsewhere, outside of the U.S., I can tell you from experience that Corporations are LEGAL PERSONS everywhere I know. And the U.S. Supreme Court had no jurisdiction outside the U.S. and still has not. It is, however, irrelevant. A Corporation could not act, do business, hire personnel, enter into contracts, borrow money, whatever, if it were NOT a LEGAL PERSON. It would have to do daily business through the shareholders. To do business in another fashion it has to be a proprietorship, or a partnership. Corporations, however, have too many persons as "owners" and with a variety of shares for each, to make actual decisionmaking and day to day business possible. Shareholders, however, VOTE (their stock, that is proportionally) in stockholdersmeetings. Moreover, some persons, such as bankers, lawyers, boardmembers, and others may obtain PROXIES and vote others' stock in stockholdersmeetings.I arranged such meetings in the past for several boards, a.o. as a departmenthead in an international bank, and a national bank in Europe, plus I took minutes of such meetings, in shorthand ;), and I can tell you how that works. Beetah and Ms Melody should tell us, precisely, how they think corporations should operate, especially internationally, and with the speed of electronic transfers, with any other than the LEGAL PERSON arrangement. WHAT are you talking about? Just imagine setting up an international projectloan (credit) in syndication with a number of international banks, and have all the shareholders involved, and coming in for meetings to decide on it! Currency exchange rates, dear girls, change like blips on the computerscreen! We used to do that with batteries of telephones and telex, remembering the margins, and trading on the margins. Even that would be too difficult (and fast) for the average shareholder, let alone all the shareholders in concert. Bankers and boardmembers may solicit proxies (to vote others' stock) for particular stockholdersmeetings.

Anonymous said...

Ms Melody appears to refer to specific litigation. There are numerous such cases. That is where corporations infringe upon some rights, for example a states' right vs. a corporate right. Or, it might be something about interstate, vs intrastate, or even international rights and obligations. There is a volume of caselaw. There are two different issues, as I see it. Namely the legal form of a corporation, vs partnerships and proprietorships, and then there are the rules and regulations of business, as had been decided upon via the courts. The problem with Reaganomics is that it abolished a lot of these rules and regulations. This was thought to stimulate business, and it does, however, it stimulates business elsewhere more than it does here, because international corporations can do here now all sorts of things they could not do in the past, and there is no reciprocity. Other countries have not taken all THEIR rules and regulations off the table. And other cultures have other ideas of what goes and does not go. There is, therefore, not a level playingfield, and you can not play a game, where part of the players go by one set of rules and the rest go by a variety of other rules. Even if the economic "model" appeared to be airtight, therefore, it can not work, because it only holds in a limited environment, and that environment is a large and open one of which the limited part is just the U.S. The effective economic model, therefore, is different from the theory.

MsMelody said...


I guess what I object to is that corporations want (expect, get) all the rights of PERSONHOOD, and yet have layers and lawyers to protect them from the responsibilities of personhood.

If corporations could suffer the death penalty when they murder (in other words, the CEO, BOD, and all complicit decision-makers could be held personally liable), and the corporation could be executed (abolished, put out of business), we might see more person-like behavior from these pseudo-people; ethics, morality, etc. just might trump profit and return on investment for shareholders!

Anonymous said...

Hey Anonymous. Glad you got a point-of-view. ;)

And now a word about economists (present company excepted most likely).

Milton Friedman was still a corporate hack. While this article isn't the basis for my opinion, I agree with it.

And btw, Alan Greenspan is a corporate hack and a corporate whore too.

In fact, Mr Kneepads is worse because he dispensed with the charade that as Fed chairman, he should be independent and unbiased. Fiscal prudence was his mantra during the Clinton administration (officially labeled "New Democrat" but in reality "Liberal Republican" aka "Rockefeller Republican"). Under the Bush administration (labeled "Conservative Republican", but in reality "Libertarian"), Greenspan's mantra was all tax cuts are good and balanced budgets don't matter (in other words, go ahead and spend spend spend).

Now why would someone whose supposedly independent preach different things based on which party is in the White House?

The reality is that the president's fiscal policy and budget (determining where money goes) is what determines economic success.

For example, Chile's president Michelle Bachelet, a former doctor, has allocated 60% of her country's budget to social programs. See, it really does matter what an administration's priorities are (health care, children, education). Not the Fed chairman and his policy.

Sad to say, but this is Government 101. This probably comes as a surprise to all the Republicans that wanted to attribute the 90s success to Greenspan. They don't geddit. Republicans are actually awful at government. And Republican politicians are awful at business and investing too. But they are good at doing what they're told by their corporate handlers.

Show me an economist today (other than Paul Volcker) who is actually worth two cents and I'll reconsider my opinion. Otherwise, they're fairly good for nothing except to tell us about the flying monkeys they saw in the crystal ball after a wave of their hand.

Ok. Enough about economists.

I'll cut to the chase on your comment.

Here's the point about Republicans and deregulation (and why Friedman gets bitch-slapped by me).

All their ideas are half-baked. And over the past 25+ years they've not only been proven wrong, they've been proven to be catastrophically wrong. Deregulation was a sham for almost everything it was applied to: airlines, utilities, disastrous trade policies like NAFTA, etc.

Instead of benefitting the public, it was a pipeline for businesses to get rich without any watchdogs.

All this colossal failure comes from implementing a theory with no testing to see if it works. Deregulation? No problem. Remove the checks and balances and use the honor system, which the crooks are using quite adeptly.

The fools don't know the difference between "philosophy" and "ideology".

"Philosophy" says you have ideas, I have ideas, others have ideas, and so let's come to a common ground using all these ideas.

"Ideology" says that "only I have the absolute truth" and "only my way will work". Take no prisoners, it's my way or nothing.

So for the last 25+ years, we've implemented these disastrous policies and the results have been outsourcing, frequent airline bankruptcies and consolidation, utility scams like Enron, an unchecked insurance industry, and more and more monopolies and less and less choice for consumers.

So the ideology used lies to sell it to the public with empty promises. What's worse, is the Democrats were too stupid to understand the argument and make a case against in terms people could understand.

And the result has been the US has lost its place in the world first as a leader and second in competitiveness.

And other countries have paid attention to the mistakes the US has made and capitalized on them.

" the idea, still, that Americans are just genetically, educationally, and otherwise superior above all others. That should be checked against reality as well. Now, let us hear YOUR point of view."

Sure. Pick on our shining examples of George W Bush, the Congress, and the Senate. Oh and lest we forget, the US has the Ozarks too, the original home of child-bride. ;)

Anonymous said...

"I guess what I object to is that corporations want (expect, get) all the rights of PERSONHOOD, and yet have layers and lawyers to protect them from the responsibilities of personhood."

Corporations should never have the rights of a person, because they aren't people.

They are non-living, non-sensient business entities used to transact business between other entities recognized by law. Period.

Face it. They were doing business without being recognized as persons many years before the legal decision.