How Google and Apple Make Their Taxes Disappear

A worker collects orders at Amazon's fulfillment center in Rugeley, central England, Dec. 11, 2012. Amazon is among of a slew of companies being targeted in Europe for tax collection. Phil Noble/Reuters

Around the world, countries are desperately seeking ways to stop multinational companies from earning profits within their borders without paying taxes on them, while stashing trillions in tax havens like the Cayman Islands. The British government, after a search, says it knows how to tax the profits Google earns in the United Kingdom. Its solution is simple and elegant, and it probably won't change a damn thing.

The proposal has come because Britain and many other countries are tired of getting just the table scraps after companies enjoy what tax lawyers call Dutch Sandwiches washed down with a Double Irish. Those are popular names for tax strategies that let companies earn profits in countries with high taxes, but report profits where little or no tax is paid, such as Ireland. The people charged with enforcing tax laws say that is cheating, and some officials and pundits in Europe have invoked what President Ronald Reagan said in a 1983 radio address about tax cheats: "When they do not pay their taxes, someone else does—you and me."

Four years ago, Bloomberg News reporter Jesse Drucker revealed how Apple, Google, Microsoft and other big companies duck taxes on European profits, which set off ongoing coverage of the issue in Europe, where most individuals and small businesses are heavily taxed. Google pays as little as 2.4 percent tax on its offshore earnings, compared with the official 35 percent tax rate on American profits and the 21 percent rate in Britain, its second largest market. Google's worldwide pretax profits grew 72 percent from 2009 to 2013, but profits booked offshore grew more than five times faster, from $7.7 billion to $38.9 billion.

Google's executive chairman, Eric Schmidt, says it complies with all relevant laws. He laid out his position last year in an open letter that has been mocked for suggesting that the answer is simple: Governments should lower the tax obligations of domestic companies to match those paid by multinationals. (Google declined Newsweek's request to comment directly on this matter. Adam Cohen, who manages its government affairs for economic policy issues in Europe, including taxation and competition, offered to discuss the company's position on condition that he would not be quoted and his remarks would not be linked to the company in any way. Newsweek declined his offer.)

European politicians know their constituents are angry that Google and other big companies get an almost tax-free ride. On December 3, George Osborne, Britain's chancellor of the exchequer, told Parliament that a bill would be introduced to stop companies from funneling untaxed profits to those havens. "That's not fair to other British firms," he said. "It's not fair to the British people either. Today we're putting a stop to it."

He announced that Parliament will be asked to offer companies a choice between a 25 percent tax on "profits generated by multinationals from economic activity here" and a 21 percent tax on profits kept in the country. The hope is that companies will pay the 21 percent tax and reinvest the profits in Britain rather than pay the higher tax.

That sounds smart and fair, but it probably won't work because (1) expensive tax lawyers and accounting firms continually devise ever more clever techniques to shift profits to tax havens, and (2) many European governments, as well as the U.S., are complicit in these strategies. "To anyone with even a modicum of knowledge about the world of international taxation, the European Union's recent discovery of tax avoidance in its midst is—there is no better word—farcical," says a prominent international tax lawyer, H. David Rosenbloom of Caplin & Drysdale. "It has been obvious for decades that certain E.U. countries have adopted national policies of luring investments, and therefore jobs, by handing out unprincipled and non-transparent tax benefits," he says. "Luxembourg and Ireland are the principal offenders, but the Netherlands has also done some squirrelly things over the years, and the United Kingdom and Belgium are in no position to throw stones."

Rosenbloom says it's "a mystery why any well-advised company" reports profits in any European country with high taxes, because using tax avoidance rules in these countries "combined with some pretty mindless decisions of the European Court of Justice should allow pretty much anyone to reduce tax to a very low number."

Martin A. Sullivan, a former Treasury Department economist, showed a decade ago that American companies were quickly changing how they reported overseas profits from where they made the money—Britain, Canada, France, Germany—to places where they had little or no actual business activity, such as Ireland, Bermuda, the Cayman Islands and Singapore. Sullivan also laid out the astronomical profits reaped by this ploy, based on revenues, assets and numbers of workers big companies employ in tax havens. The share of U.S.-company profits reported as earned in the U.S. has been steadily falling for decades, he says.

Congress makes it easy for big companies move profits to tax havens. One rule makes it possible for them to make their profits invisible to the IRS merely by checking a box on their tax returns, Joseph Brothers wrote last month in the magazine Tax Notes International. He also suggested that Apple, reacting to a threat by the Irish government to shut down just one of its lucrative, corporate-friendly tax-avoidance laws, will switch strategies to escape taxes there. The Double Irish, Brothers wrote, may soon be replaced by a new kind of Bermuda Triangle. Instead of ships and planes mysteriously disappearing, this would be a triangle of tax treaties between Ireland, the Netherlands and Bermuda, exploiting rules there that do not quite align and creating the space for profits to vanish—at least to the eyes of IRS auditors. If that strategy works, Google and others will likely follow.

The ultimate goal of the big corporate tax dodgers is what tax lawyer Edward D. Kleinbard calls "stateless income"—siphoning profits out of high-tax countries in Europe, Japan and North America and moving them around under various tax treaties until they are not subject to any tax because they are being reported in a nonexistent country called Nowhere.

This article originally incorrectly stated in one sentence the corporate tax rate in Britain. It is 21 percent.