[IMGCAP(1)]Google has contrived a convoluted way to determine its income tax responsibilities to the U.S. and other taxing jurisdictions, in part by shifting income to its operations in Ireland.

All the while the company has been flying its "don't be evil” banner, it was proceeding against the interests of its homeland, as we noted in earlier commentaries (see Google’s SOS to the SEC and The Case of Google).

Consider the following:

Income taxes actually paid to all of Google’s taxing jurisdictions – federal, state and foreign – totaled $538, $883, and $1,224 million during 2006, 2007 and 2008 respectively. These cash payments represented 13.4, 15.6 and 17.6 percent of income over the years respectively.

Revenues attributed to foreign sources amounted to $4,575, $7,896 and $11,160 million over the years 2006, 2007 and 2008, respectively. These sums represented 43.1, 47.6 and 51.2 percent of the company’s aggregate revenues for those years respectively.

Google reported that its pretax income from foreign sources amounted to $1,318, $2,467 and $3,794 million for those years respectively. These sums represented 32.9, 43.5 and 54.6 percent of Google's entire pretax income for those years respectively.

Finally, Google’s income tax expense on the hefty presumptive foreign source income amounted to $29, $51 and $71 million, which represented 3.1, 3.5 and 4.2 percent over the three years respectively.

Based on disclosures in the company’s SEC filings, its diversion of tens of billions of dollars of revenue, and billions and billions of dollars of resultant taxes to foreign jurisdictions, was essentially attributable to the capability of shifting such revenues to Ireland.

Speaking metaphorically, Ireland has law offices with file cabinets lined with “honey," a 12.5 percent tax blended with opportunistic interpretations of the tax treaty and statutes, and capable of accommodating licensing agreements. Those licensing agreements in turn attract the royalties derived from Google's foreign exploitations.

Because the Tax Code, particularly Section 482, expressly directs the Secretary of the Treasury, and hence the Commissioner of Internal Revenue, to resist such practices, we assert that the IRS Commissioner is failing to fulfill his responsibilities to the extent that he does not in fact reject tax returns which reflect such ploys.

We recognize that Google is not alone in availing itself of these facilities. Both Microsoft and Yahoo, for example, reportedly have also used similar tax strategies. We have dubbed them “Four I” enterprises — i.e., intangible, informational, intellectual, Internet. They are similarly using the Ireland bypass to avoid or evade their corresponding tax responsibilities to the United States.

The clue to guide us through Google’s tax labyrinth is simple enough. It is disclosed in footnote 15 to the company's financial statement, included with the SEC annual report for 2008: "Revenues by geography are based on the billing address of the advertiser."

That, in our view, is the ultimate absurdity. Assume that an advertiser-vendor is a California enterprise that has outsourced responsibility for processing Google-initiated orders. That processing would include the direction for the filling of the order, the billing and the electronic collection of the invoice, as well as receiving and paying Google’s bill, again electronically.

Assume also that the merchandise was manufactured in Ohio, warehoused in New Jersey, and shipped to a clicking customer in New York. Because the outsourced facility is in Calcutta or conceivably incorporated in a computer program nestled in Dublin, Google’s advertising revenues from those clicks would be deemed foreign and thereby immunized from U.S. corporate income taxes.

To close the loop, the only role for the metaphoric Dublin file drawer other than sending and collecting on the invoice would be to receive and relay the click to the advertiser-vendor’s processor, wherever it is located.

Google tells us that more than half of its revenues and related income belong offshore so the income attributable to those foreign sources avoids U.S. income taxes. The company thereby essentially avoids foreign income taxes. 

To round out this critique of Google’s misbegotten revenue allocation calculus, let us take note of another disclosure in footnote 15 to the company’s financial statements. As of the close of 2008, out of long-lived assets aggregating $11.6 billion, $9.8 billion were in the United States, so only $1.8 billion, or less than 16 percent, were in foreign countries, including Ireland. According to an article in the Nov. 7, 2005 Wall Street Journal, a Google spokesman said the company established operations in Ireland to be close to its European customers. “Because that business is done outside of the U.S. it is taxed according to international law,” he said.

That sounds like blarney to us.

Over the scores of years since the original enactment of Section 482 of the Tax Code, intended "to prevent evasion of taxes or clearly to reflect the income,” the Treasury and the IRS have promulgated a vast body of regulations to interpret, clarify or exemplify that Congressional enactment. 

The critical flaw in Google’s modus operandi is rooted in its misbegotten interpretation and implementation of the pervasive paradigm set forth in the regulations pertaining to “arm's length.” For Google, it would appear that arm's length implies stuffing that hypothetical file drawer in Ireland not with the length of an arm but with a whole arm, together with half of Google’s torso and of its brain power.

Whether it be the transfer of the property calling for Ireland to pay to the United States the arm’s length value of the property thus transferred, or to grant to Ireland the franchise to service whatever it is that Ireland was called upon to do, all that Ireland would be entitled to based on any fairly interpreted notion of arm's length would be a mere pittance.

We suggest that the IRS refrain from issuing additional regulations, interpretations or exemplification of Section 482. Such new promulgations encourage contrived transactions or other opportunistic maneuvers to advance the tax avoidance objectives of the enterprises. This point was made especially felicitously in a decision by United States Circuit Judge Henry J. Friendly in a 1964 criminal case. ”In our complex society, the accountant’s certificate and the lawyer’s opinion can be instruments for inflicting pecuniary loss more potent than the chisel or the crowbar,” he wrote.

Instead, we urge that the IRS commissioner proceed consistent with the pragmatic precept suggested by the late Justice Potter Stewart, to make known that, while he cannot define irrational or unfair by reference to Section 482, he knows the unfair or irrational when he sees it. Correspondingly, we accountants have the so-called smell test.

Whether by sight or smell, if the accountant senses the unfair or irrational in an income attribution program for a particular enterprise, he should then shift the burden of proof to the enterprise to demonstrate its fairness and rationality. The burden thus transferred would call upon the taxpayer enterprise to describe in the greatest detail the activities pursued in each taxing jurisdiction, and then to demonstrate with the utmost specificity the value added in each such jurisdiction.

In our view this should not be an especially daunting burden for technologically sophisticated enterprises. For Google, it would be a slam dunk.

Abraham J. Briloff, CPA, Ph.D., is the Emanuel Saxe Distinguished Professor Emeritus at Baruch College/City University of New York. Leonore A. Briloff, MBA, CPA, is a member of the Estate Planning Committee of the New York State Society of CPAs. The authors constitute the firm of A.J. & L.A. Briloff, CPAs.


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