profit shifting

U.S.-based multinational corporations are using complex merger deals to avoid paying taxes on $12 billion a year in taxable foreign earnings that they repatriate back to the U.S., according to a new study.

U.S. multinationals are required to pay U.S. corporate income taxes upon repatriation of foreign earnings earned in lower tax jurisdictions. But researchers from the University of Maryland, McGill University, and Washington University found that between 1990 to 2004, some $184 billion in foreign income returned to the U.S. without being taxed.

The paper confirms earlier research showing that companies that earn money in low-tax nations are likelier than their peer companies to invest that money abroad, in order to keep it there. But it also shows that companies facing high repatriation taxes are making domestic acquisitions through extraordinarily complex maneuvers.

“Our results suggest that MNCs strategically structure M&A deals to avoid repatriation tax costs and that domestic acquisitions are a prevalent channel for these firms to consume cash trapped overseas,” the study concludes.

Among the complex mechanisms used by multinationals including IBM, Johnson & Johnson, and Eli Lilly is one known as a “Killer B” deal, in which a profitable foreign subsidiary declines to issue a dividend to the parent company, which is normally taxable. Instead, the parent company acquires a domestic subsidiary. The foreign entity then purchases stocks from the parent company with cash, and transfers that stock to the U.S. subsidiary, in exchange for the stock of the U.S. subsidiary.

“The result of this head-spinning process: A tax-free return of profits to the U.S.,” the study says.

Although not illegal, this is an “inappropriately aggressive” practice, according to study co-author Emmanuel Zur, assistant professor of accounting and information assurance at the University of Maryland’s Robert H. Smith School of Business. “Congress intended that that money should be taxed,” he said in a news release. “That is the spirit of the law, and that was the intention of lawmakers.”

Zur noted that the Obama administration has been aggressive about cracking down on corporate tax avoidance. In September, it announced new regulations to curb a wave of corporate inversion deals.

“But these companies have so many lawyers working for them that they are always going to be a step ahead,” Zur said.

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