Saturday, February 1, 2014

I'll take one Double Irish, and better throw a Dutch sandwich in there

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If you never thought that accountants could architect great works just like Gaudí or some other famous architects who I can’t possibly name, you need to think again. Today we are going to talk about a tax avoidance (not evasion) system that when you first hear it, may be somewhat complex, but I’ll do my best to dumb it down to our simpleton level. This is the infamous “Double Irish with a Dutch Sandwich (DIWDS).” Yes I know it sounds like some crazy sexual act, or something you might purchase at Starbucks, but in fact it is a strategy that has prolonged the payment of US corporate tax for many of the behemoth tech companies we know and love today. I suggest you pay attention because this is currently an issue that is being debated, guaranteed a company you love is using it, involves a lot of countries, and involves a LOT of money. After reading this, you will be able to debate your position on the issue more effectively.

Let us use my favorite “example company” from college business classes as our protagonist in this explanation. XYZ Corp, headquartered in the US, is a company who sells “widgets.” This company happens to be very successful, and thus faces a large bill from Uncle Sam on their revenues.  What they can do is set up the first of the “double Irish” companies in Ireland, sell the intellectual property to it for royalty fees and make it a tax resident of a “tax haven” by transferring central management and control to that “tax haven,” usually in Bermuda or the Cayman Islands (tax rate 0%.) They then set up a second Irish shell company as a wholly owned subsidiary of the first with tax residence in Ireland, and license the rights to that intellectual  for royalties or fees. The second Irish company who is the one that takes in the profits at the applicable competitive Irish tax corporate tax rate of 12.5%.

To take this a step further, lets add the Dutch Sandwich. So we have our US headquarters and our two Irish subsidiaries. Now XYZ corp sets up another subsidiary in the Netherlands (who have very competitive tax laws) and sends all the profits to that company. This is because “Ireland does not levy withholding tax on certain receipts from European Union member states.” Money that is needed for regular expenses is sent back to the Irish subsidiary with Irish tax residence, and the rest of the money is sent to Bermuda, by way of the other subsidiary. Because why pay Ireland’s 12.5%, when you can pay Bermuda’s 0%.

Some things to keep in mind here are that the money sent through this system is from the sales of the goods or services OUTSIDE THE US. This is not possible if the income can be shown to be booked within the United States. Also, if the company wishes to bring the cash back into the US, it must pay repatriation tax. So basically, XYZ corp is just delaying its tax bill, not really avoiding it.

The US has about a 40% corporate tax rate (35% for federal + ~5% weighted average for the different states. When you look at the rest of the world, this is dog shit, or at least not competitive. But on the contrary, we probably have greater infrastructure needs that require capital higher than other countries. So this is kind of where the debate starts; should we make companies pay more or less. Either way, companies see these tax rates too, and try their hardest to avoid them (not evasion like I said before, but avoid. The DIWDS is completely legal btw. ) A corporation’s first responsibility is to provide a positive return to their shareholders, and reducing their tax liability helps do just that.

The DIWDS is pretty much reserved for tech companies from my research. This is because tech companies’ business units can be purely intangible goods, where they can make money from intellectual property (patents, trademarks, copyrights, etc,) licensing their software, or downloads from the cloud as a few examples. A grocery store simply cannot set up a shell corporation in Bermuda, and honestly say that that shell corporation had anything to do with the sale of the goods in BFE, USA. But a tech company can…….

My research yielded little in the way of the history behind the DIWDS, but I did learn that Apple was one of the pioneers of the strategy way back in the 1980’s. And not only was Apple one of the pioneers of the strategy, they are one of the biggest defenders today of the strategy. 

Tim Cook, Apple’s CEO, has testified before Congress in favor of lowering the corporate tax rate, or giving corporations a repatriation tax holiday, where the companies who have income overseas that they want to bring back to US soil can, for a limited amount of time, pay a discounted tax rate or no tax rate at all. In fact, Apple last year took out a loan (even though they have more than enough cash to foot the bill) to pay for the dividends to the shareholders of their stock. The repatriation taxes they would have paid to Uncle Sam would have been more than the interest they would have paid on the loan. So, they basically enriched the banks, instead of the coffers of our country because it made sense financially to do that.  And that is where the debate comes from, should we have incentives for companies to look after their shareholders, or the country?

I hope this got you thinking at least a little bit. I first learned about this topic back in college when some of my peers and I were doing a competition called xTax . We BS’ed our way through a PowerPoint presentation for some PricewaterhouseCoopers partners, and we used the DIWDS as one of our contentions. It is tough to understand just the basics of the movement of money, let alone the global impact. But it is something that we will surely see again in the news, sooner than later.


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