Then felt I like some watcher of the skiesWhen a new planet swims into his ken.

- John Keats

In 1932, Professors Adolf A. Berle and Gardiner C. Means published The Modern Corporation and Private Property. In that seminal work, the professors described the alienation of power over property by executives and corporate management from the putative owners of that property, i.e., the shareholders. Berle updated that theme in 1959 in his Power Without Property.

Back then, property was presumed to be essentially bricks and mortar or other tangibles. There were some intangibles, generally involving copyrights, patents or other identifiable contractual rights, e.g. leaseholds. But that notion of property has been transmuted in this Third Millennium, an era which I have dubbed that of the "Four I's" - the Internet, intangibles, intellectual property and information.

In this era we see the power-property dichotomy accelerating at an exponential pace, with increasing institutionalization through mutual funds, 401(k)s, the securitization of bundles of assets that are embedded in the bellies of corporations and stepped-down into new entities with their layers of participation, i.e., tranches.

And mind you, I have not even yet alluded to derivatives - whatever that amorphous theme may imply. In all this, my recent ruminations led me to the dating of the Big Bang for this era of the Four I's to Aug. 18, 2004, i.e., the date on which Google went public via its somewhat unorthodox initial public offering. And it is Google that I have tracked since then - without, I should add, buying or selling its shares at any time.

I believe that it is Google that should be tracked by academics and, I suggest, regulatory agencies, because my deliberations lead me to the view that with its especially favorable tax and financial market positioning, it might evolve into an especially opportunistic venture capital or hedge fund capable of sucking the air from actual or potential competitors.


It is with that as prologue that I take up Google's July appeal to the Securities and Exchange Commission to rescue it from a tsunami that is flooding its banks with billions on billions of dollars. The ill wind inducing this dilemma for Google is the SEC rule that requires that a registrant with investments (excluding U.S. Treasuries) that exceed 40 percent of its total assets must follow the much stricter rules applicable to mutual funds - a fate that Google wants to avoid.

The basis for Google's plight can be seen at a glance on its Sept. 30, 2006, balance sheet. Of its gross assets of about $15.7 billion, more than $10.4 billion represent cash, cash equivalents and investments - clearly way over the SEC's 40 percent standard. The other assets on the balance sheet comprise property and equipment at $2.2 billion, non-marketable equity securities at $1 billion and other assets at $2.1 billion.

We, of course, are aware of the fact that Google is richly endowed (at least that is what the marketplace tells us) with enormous sums of assets that are not on its balance sheet - intellectual, informational and other intangible assets. But since these enormous presumptive values are not on Google's balance sheet, they cannot count in the 40 percent reckoning.

This condition is evidenced especially dramatically by juxtaposing the $15 billion book value shown by the balance sheet with the approximate $150 billion market value reckoned by Wall Street. That $135 billion gap is presumed to reflect the intellectual, informational and other intangible properties embedded in the company, but which had not been reflected by the bookkeepers. For the present, I will leave this great gap with a catechism, to wit:

* Do all of these tens of billions of dollars of off-the-books intangibles belong entirely to Google and its shareholders?

* Who, in fact, has paid and continues to pay for them?

* Is Google really compensating those who ultimately can be seen to have provided these properties? If so, how?

Ultimately, Google's plight can be seen to be rooted in the fact that its revenues are essentially in cash but the catalysts that importantly induce those revenues do not, in great measure, call for the actual outflows of cash. Thus, to the extent that Google's raison d'être is derived from the Internet, it exploits that remarkable technological phenomenon essentially cost-free. That felicitous condition stems from the fact that the technological development, albeit paid for by the public out of the public purse, was never patented so as to require the payment of royalties or any other form of revenue participation.

And then, a hefty portion of Google's compensation expense for those who are importantly contributing to its revenue production is paid in the form of stock options or corresponding programs of stock-based compensation. This kind of compensation, however enormous, is reflected only to a relatively minor extent when it reckons its earnings for the purposes of financial reporting; no matter how it is reflected for financial reporting, it is not a cost that requires the expenditure of cash. Nonetheless, and this is of most critical import, these non-cash compensation costs actually result in a most felicitous inflow of funds - to which I now turn.


To demonstrate this phenomenon, follow me through the labyrinth of Google's numbers for its first full fiscal year, 2005, after its August 2004 IPO.

We pick up the trail with two readily identifiable numbers on its income statement, i.e., its income before income taxes amounting to $2,142 million, with a hefty income tax provision of $676 million.

Now, let us pause here to focus on that $676 million provision for income taxes for the year 2005. According to the income tax footnote in Google's annual report, we are informed that had the company's taxes for the year been equal to the 35 percent normal corporate tax rate, the tax expense would have been $750 million, a difference of $74 million. According to that footnote, that reduction was exceeded by a wide margin by a foreign tax differential of $134 million.

That differential will undoubtedly be seen to be the consequence of Google's astute management's ability to shift the attribution of revenues to tax-sheltered countries.

References in Google's press releases and management's discussion and analyses indicate that Ireland is such a tax haven, and it has been also noted in The Wall Street Journal for Nov. 11, 2005. It is a lot more expeditious to shift the presumptive tax domains for intangible revenues than it would be for those derived from brick-and-mortar activities.

But then we turn to its statement of cash flows, where we note a reference to cash paid for taxes in the amount of $154 million - very much less than the figure reckoned by the bookkeepers on the income statement, i.e., the $676 million. Most of that divergence is discernible from another item on the cash flows statement, "tax benefit from stock-based award activity" - shown as a part of the cash inflows from operations, in the amount of $434 million - and that is the cash cow, the critical item, in this Google tax labyrinth, contributing importantly to the company's embarrassment of riches.

Just what is this $434 million tax benefit, which permitted Google to severely reduce the $676 million tax bill toted up by the bookkeepers?

As noted, much of Google's compensation cost is embedded in its various stock option and other off-the-books stock compensation programs. During the year, Google executives exercised stock options by paying $85 million as their cost. However - and this is the critical point - the shares they acquired at the time of their exercise were worth about $1.4 billion more than their cost - that $1.4 billion represented additional compensation to the executives, and concurrently represented a $1.4 billion compensation expense for Google that would appear only on its tax return, and it was that $1.4 billion tax deduction that translated into that $434 million tax benefit.

By way of updating those data for the first nine months of 2006:

* Income before taxes amounted to $2,826 million.

* The corresponding provision for income taxes amounted to $780 million.

* For the nine-month span we do not have a corresponding footnote; nonetheless, we can do some reckoning, thus: Had the tax provision amounted to 35 percent of the company's pre-tax income, $2,826 million, the provision would have been $989 million; instead, the bookkeepers toted up such taxes at but $780 million - a staggering $209 million below the standard tax burden for U.S. corporate enterprises.

But even that $780 million tax provision toted by the bookkeepers is naught but an accounting cipher; according to the cash flow statement, Google paid out only $351 million in income taxes, a divergence of $429 million. Most of that gap may be accounted for by another figure on the CFS, i.e., "tax benefit from stock-based award activity, $329 million."

Thus, Google garnered a tax benefit as a consequence of the employees' exercise of their stock options during the nine-month span of $329.1 million - a number that equates to about $1.2 billion dollars of tax deductions reflected on its tax return, but not on its books.

And then squirreled down at the bottom of the statement of cash flows we note that Google did ante up $351 million of income taxes during the nine months - hence it actually paid only 12.4 percent of its pretax income. (For an overview of Google's tax accounting for its stock compensation programs, see box, page 30.)


And so now we come to my "Quo Vadis?" challenge.

At the outset, in an August 28 press release, Google sought to respond to the query, "What is the 1940 Act and why are we requesting an exemption?" In their response, Google noted that favorable action by the SEC would mean that "if we invested in a broader range of short-term securities, we would not be an 'investment company' for the purposes of the Investment Company Act of 1940."

Such a "broader range of short-term securities" (which could include municipals), rather than investments in U.S. governments, "could have a direct implication on our ability to invest in the business and stay ahead of our competitors. Also, the SEC concurrence would allow us to earn higher returns, preserve capital and help us to create sustainable competitive advantages for the long term."

Sadly, I find their response to their query disingenuous. Thus:

* I find it entirely incredible that the de minimus basis-point spread between tax-exempt securities and U.S. Treasuries could significantly affect the company's "ability to invest in the business and stay ahead of our competitors."

* Ironically, to the extent that Google uses its abundance of cash and cash equivalents to engage in research and development, and invest in its business otherwise to stay ahead of their competitors, it would, as a consequence, induce a salutary effect on the 40 percent limitation.

Accordingly, I urge the SEC to reject Google's petition so that the company would be constrained to provide greater transparency to its investment proclivities. Nonetheless, and regrettably, I presume that the SEC will look with favor on Google's petition, having granted corresponding licenses to Yahoo! and Microsoft.

And so now, when responding to conditions like those confronting Google, I propose first, and least daunting, that Google, et al., be required to set forth in significant detail and specificity the taxing jurisdictions and kinds of taxes actually paid in cash during each reporting period. Clearly, communities cannot pay their bills with accruals on the books of their corporate constituents. I expect that this very transparency might serve to moderate some of the aggressiveness on the part of management to divert income to low tax havens.

Moving now more aggressively on my part, I suggest that consideration be given to the imposition of what might be deemed to be a "severance tax" based on the utilization of the Internet and other intangibles and information properties that have been created over past generations and paid for from the public purse, either directly or by taxation.

Granted, this will call for creative and cosmic thinking, but it is just that kind of thinking that makes it possible for us to engage in buying, selling and trading carbon-emission credits. It may be that such a severance tax (however measured) might have to be imposed and apportioned globally; but then I ask, why not in our global economy and environment otherwise?

We have, in various circumstances, found ways to measure air and other environmental rights relating to physical properties; accordingly, I am confident that when pressed to do so, standards would evolve to measure the intellectual, informational and other intangible elements entering into Google's stream.

Finally, I turn to what is undoubtedly the most daunting of the challenges in the "Quo vadis?" catechism, that relating to the enormous tax benefit derived from the stock compensation programs. Conceptually, I question the entitlement of a corporation to a tax deduction based on an instrument created by itself by engraving or electronic inscription. Accordingly, the ultimate response might well involve an agonizing re-appraisal of the nature, conduct, rights, responsibilities and accountability of the modern corporation in this era of information, intellectual and intangible properties, and, more specifically, of precisely what a share of stock represents in this new era.

For the present, I will finesse the issue with the following peremptory proposal: Allow as a deduction as ordinary and necessary business expense on corporate tax returns only what the accountants and auditors have determined to be ordinary and necessary business expense under generally accepted accounting principles; for the year 2005 the deduction would have amounted to $201 million, and for the nine months ended Sept. 30, 2006, the deduction would amount to $324 million.


This, then, is my commentary regarding certain developments deemed critical as Google evolved from its "Big Bang" IPO of August 2004.

There is no question but that Google's management is exercising enormously increasing power over property (from within both the public and private sectors). Such a condition demands of the company absolute transparency and, reciprocally, oversight by scholars in academe, regulatory agencies, legislative bodies and various governmental agencies.

Most assuredly, such an environment will provide exhilarating challenges to my colleagues in the groves of academe and elsewhere, providing opportunities for research, writing, teaching and speaking.

Abraham J. Briloff, CPA, Ph.D., is the Emanuel Saxe Distinguished Professor Emeritus at Baruch College/City University of New York.

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