The US keeps dodging the reputational bullets

The ongoing round of the OECD’s BEPS Project has attracted considerable attention.  This has been particularly true since the foreign ministers of the G7 included a paragraph in their communiqué after a meeting in early June setting out the principles of an agreed position and following Ireland’s recent decision not to coalesce with more than 130 countries on a statement after a meeting of the “inclusive framework”.

Ireland’s position is frequently assessed in the light of profits ending up in no-tax jurisdictions such as Bermuda (as was the case with Google) or being stateless (as achieved by Apple up to 2015).  These are egregious outcomes.  Companies should not be able to shift their profits to locations where they have no substance and companies should not be stateless because they have to exist somewhere. 

International agreements were never required to eliminate these outcomes. It has only been US companies that were involved yet somehow the US has dodged the reputational bullet that should have been aimed at it for allowing, and even encouraging, its companies to engage in such practices. 

Profit Shifting – The First Step

The most high-profile example of a company shifting profits to Bermuda is Google.  Google was incorporated in 1998 and sought to established an EMEA headquarters in 2003.  In setting up its international tax structures the IMF set out the steps Google took:

…the first step is to transfer the patent from which the value of the service is derived to Firm H in (say) Bermuda, where the tax rate is zero. This transfer of intellectual property is made at an early stage in development, when its value is very low (so that no taxable gain arises in the United States).

After this first step, the rest doesn’t matter significantly to the outcome; the profit will end up in Bermuda.  In Google’s case, “Firm H” was Google Bermuda Limited which was registered in Bermuda.  As part of the first step Google Inc. entered a licensing agreement with Google Bermuda for the use of Google’s technology and intellectual property outside the Americas.

Of course, this technology is the result of R&D activities undertaken in the US.  The US could require that if the license acquired by Google Bermuda is valuable most of the profit should be attributed to the R&D activities in the US.

One way to do this would be via a profit-split agreement where Google Bermuda, say got to keep 10 per cent of the profits from licensing Google’s technology outside the Americas and Google Inc. got 90 per cent of the profit because it undertook the key value-adding R&D activity.

However, the US tax code allowed Google to use a cost-share agreement.  This meant Google Bermuda and Google Inc didn’t split the profit between them but shared the burden of the R&D costs between them – with the shares each paid based on the size of the market they covered. 

In rough terms, the Americas made up 50 per cent of Google’s market so Google Inc. covered 50 per cent of the total R&D cost.  And the international markets Google Bermuda had a license for were the remaining 50 per cent so Google Bermuda, and its subsidiaries, covered the other 50 per cent of the total R&D cost.

As Google technology turned out to be hugely valuable relative to the R&D costs it incurred Google Bermuda and its subsidiaries earned huge profits.  This is no longer possible under the OECD revised guidelines for transfer pricing (see paragraph 6.42) but it was possible in 2003.

Without this first step of locating IP in Bermuda the rest of the structure is largely moot.  The license had to get out of the US at low cost (relative to its value) and the ongoing payments back to the US for the license had to be low (relative to the profits generated).  The US tax system allowed both of these to happen.

Profits in Bermuda – Cui  Bono?

As the US system allowed the above to happen it was in the US’s interest that the license be located in a no-tax jurisdiction such as Bermuda.  If the license was located in a jurisdiction with a 25 per cent corporate tax rate then US tax revenues would ultimately be lower.  As Hines and Rice (1994) concluded:

Low foreign tax rates influence business behavior in many ways, making it difficult to assess their overall impact on U. S. tax collections, but one component of their impact appears to be greater tax collections as a consequence of generating fewer foreign tax credits.

This can be illustrated with the one-off “deemed repatriation tax” introduced by the Tax Cuts and Jobs Act of 2017 (TCJA) .  This was introduced to allow the US collect tax on offshore profits that US MNCs had not formally repatriated to the US.  In its annual report for 2017, Google set out the following:

The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion.

From 2003 to 2017, Google reported cumulative foreign profits of $91.7 billion and a cumulative provision for foreign taxes of $5.8 billion, giving an effective foreign tax rate of 6.3 per cent.

For the one-time tax imposed on those profits by the TCJA, any foreign taxes paid were credited at around 40 per cent as the rate of the tax was less than the headline rate that applied at the time the profits were earned (35 per cent). 

Adding 40 per cent of Google cumulative foreign tax provision from 2003 to 2017 to the $10.2 billion estimate of the liability under the one-time tax gives $12.5 billion.  This equates to 13.6 per cent of cumulative foreign profits over the period and is in line with the rates for the one-time tax, particularly the 15.5 per cent rate on foreign cash.

However, if instead of been able to achieve a foreign tax rate of just over 6 per cent, Google had a foreign tax rate of 25 per cent then its liability under the one-time tax would have been reduced to around $3.2 billion. It is because Google had a low foreign tax rate that the US tax owed under the one-time tax were $10.2 billion.  The US allowed the license to use Google technology escape relatively cheaply, and ultimately it was US tax receipts that benefitted from Google locating its IP in Bermuda.

The IP Comes Home

In December 2019, Google announced that it would be no longer licensing its IP from Bermuda:

“As of December 31, 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S.”

This has resulted in a large drop in outbound royalty payments from Ireland to the euro area (of which payments to The Netherlands make up by far the largest amount).

Royalty Imports to Euro Area 2008-2021

Although Google’s IP was located in Bermuda, Google did not make payments from Ireland to Bermuda due to the presence of an Irish withholding tax at the time.  If getting profits to Bermuda in a tax efficient manner was the objective Ireland was not the place to do it. 

It was achieved using the EU’s Interest and Royalties Directive and the provision in The Netherlands that did not impose a withholding tax on royalty payments to Bermuda.  Thus, the ending of Google’s IP licensing in Bermuda shows up in Ireland as a reduction in royalty payments to The Netherlands. 

The royalty payments continue to be made from Ireland but for the past 18 months have been directed to the US.  This has meant a reduction (to zero) in the profit Google reports in Bermuda and a jump in the profit reported in the US.  This can be seen in the company’s most recent annual 10K report.

Google 10K 2020 Domestic Foreign Income

The increase in profit attributed to domestic operations is clear with an associated reduction in profit from foreign operations.  Has the discontinuation of Google’s Bermuda structure increased its tax bill? No. In 2020, Google had an effective rate of 16 per cent – which is lower than the effective rates it had when it was shifting billions in profit to Bermuda.

From 2003 to 2017, Google’s overall effective tax rate was 25.8 per cent, including the one-time transition tax.  In the three years since the TCJA was introduced, Google’s effective tax rate has been 14.1 per cent. 

The US may have recaptured the profits it let escape with the 2003 cost-share agreement but the Tax Cuts and Jobs Act is certainly living up to the first part of its name.  It is the US that is the biggest tax haven for US companies.

Appel’s IP Stays Put

The US has always been a significant tax haven.  This was highlighted with Apple case.  Apple also set up a cost-share agreement between the parent and a subsidiary but with Apple the IP didn’t take a first step to a no-tax jurisdiction such as Bermuda. It just stayed in the US.

In his opening statement to the 2012 US Senate hearing on Apple’s tax affairs Sen Carl Levin noted that:

In short, these companies’ decision-makers, board meetings, assets, asset managers, and key accounting records are all in the United States. Their activities are entirely controlled by Apple Inc. in the United States.

Apple didn’t move its IP to Bermuda; it kept it in the US.  And bizarrely, the US allowed a company to operate in its jurisdiction, earn huge profits and not be subject to immediate tax.  As Sen. Levin set out the key functions, assets and risks that made these companies profitable were all located in the United States.

Apple didn’t have to be concerned about royalty payments and withholding taxes.  It just kept the profit in the US.  In its state-aid case, the European Commission argued that this profit should be attributed to the branches that these companies had in Ireland.  This was rejected by the General Court of the European Union which ruled that Commission needed to do more than just stating that the profits should be attributed to the Irish branches:

228  In its primary line of reasoning, the Commission concluded that the Apple Group IP licences held by ASI and AOE should have been allocated to the Irish branches due to the lack of staff and physical presence of those two companies, without attempting to show that that allocation followed from the activities actually carried on by those Irish branches. In addition, the Commission inferred from that conclusion that all of the trading income of ASI and AOE should have been regarded as arising from the activities of the Irish branches without attempting to show that that income was representative of the value of the activities actually carried out by the branches themselves.

These companies might have been “stateless” for tax purposes but in reality their key value-adding activities were all based on the US.  A country that allows companies to operate within its jurisdiction and not subject them to immediate tax is a tax haven. 

The US will collect tax on those profits – via the one-time transition tax from the TCJA – and will again benefit from the IP not being in a location where foreign tax was paid. However, the amount ($37.3 billion) is much lower than what would have been collected if the US imposed the federal corporate income tax on those profits when they were earned.

The IP Escapes Scot Free

As is well known, Apple changed their structure from the start of 2015.  This involved Apple relocating the IP license to Ireland for the rights to sell Apple products outside the Americas.  This led to tumultuous changes in Ireland’s national accounts, including a 26 per cent growth rate.

The right to sell Apple products outside the Americas is a hugely valuable (especially when the cost of the license is based on R&D costs not profit).  When moved to Ireland in 2015, the IP was probably worth something in the region of $250 billion and linked to annual profits of around $30 billion a year.  This is very different to Google who moved their IP to Bermuda in 2003 before the company starting generating huge profits.

We know $250 billion of IP was transferred to Ireland.  We also know where it came from – the US.  How much tax did the US charge when this asset was bought by a now Irish-resident company asset? Nada. Not a cent.  The US allowed $250 billion of IP to leave without so much as a nod to the IRS.  It was the US being a profit sieve on a grand scale. 

Maybe Ireland deserved the cheap jibes because the IP and the associated profits landed here but the US has completely escaped scrutiny for allowing the IP to escape scot free.  That the IP was in the US was the essence of the case used by Ireland and Apple to have the Commission’s state-aid finding overturned by the General Court of the EU.


A statement like “the ship sank because it was overwhelmed by water” will be true but uninformative.  What we need to be told is something like “the ship sank because poorly-fitted rivets led to a failure of the hull.”  If I was the shipbuilder, I would much prefer the blame be loaded on the water not my poorly-fitted rivets.

Huge profits in Bermuda and companies being “stateless” are egregious outcomes.  But it doesn’t matter if the ship these sailed on were in Irish, Dutch, Singaporean, Malaysian, Mexican, Peruvian or any other waters. Sure, some of these could have better policed their waters but the outcome was going to be same.  The ship was holed below the waterline by the US shipbuilders. And others getting the blame suits them just fine.

One reply on “The US keeps dodging the reputational bullets”

Excellent post, Seamus. It was established US policy for successive administrations to provide unoffical state aid to these MNEs. It allowed them to capture enormous economic rents and to secure a hugely unfair competitive advantage over their global competitors. That was the economic detriment committed by the US against the interests of consumers, voters and competitors in all the countries in which these MNEs operated or generated revenues. Now that the Biden administration is seeking to amend the US’s previous ways it wants to be lauded for its virtue and for the rest of the world to turn a blind eye to its previous vice.

The fact that Ireland secured a share of these economic rents by facilitating their capture is neither here nor there in this context. If we didn’t facilitate some of the capture and receive a share in return there were no end of other countries which would have done so – with many countries already providing their own “suite of services”.

The case against succesive Irish governments is that they did not deposit the share of these economic rents captured by Ireland in a sovereign wealth fund. Yes, we did build up the Pensions Reserve Fund, but we blew it. And yes, there were some half-hearted attempts at creating a ‘rainy day’ fund, but we’ve frittered away a small fortune that we owed to the future. I accept it could have been counter-productive if they had been defined officially as economic rents – as the Norwegians can with the surplus earned on the exploitation of their oil and gas reserves, but they could and should have been ferretted away.

But since most economic activity in the state is driven by the sustained capture of economic rents – coupled with a ferocious official rejection of any assertions that economic rents are being captured, I suppose we should not be surprised that we have health, housing and cost of living crises and that there is grossly inadequate provision of essential public services on an efficient, effective and universal basis – as they have been provided in most other advanced economies for decades.

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