Microsoft is shifting a disproportionate amount of its profits to subsidiaries in three low-tax jurisdictions, and HP is using constant short-term loans from its overseas subsidiaries to avoid paying taxes on earnings coming back into the US, said Senator Carl Levin, chairman of the investigations subcommittee of the Senate Homeland Security and Governmental Affairs Committee.
"It is highly dubious that some of these practices comply with existing [tax regulations] or existing law," Levin, a Michigan Democrat, said at a subcommittee hearing.
Microsoft and HP are not alone in massaging the US tax law, Levin said, but a long-term subcommittee investigation has focused on the two companies. Efforts by corporations to lower their US tax burden may not be illegal in many cases, but the practices of HP and Microsoft raise "serious questions," he said.
Many multinational corporations based in the US. "use complex structures, dubious transactions, and legal fictions to shift the profits from those products overseas, avoiding the taxes to help support our security, stability and productivity," Levin added.
Representatives of both companies defended their tax practices, saying they comply with US law. Senator Tom Coburn, a Republican from Oklahoma, blamed Congress for a complicated tax code full of legal loopholes and for a high corporate tax rate.
"Tax avoidance is not illegal," he said. "There's nothing wrong with that. There's nothing immoral with that. It's the system that Congress has set up."
Coburn called for Congress to overhaul and simplify the tax code.
Levin, however, questioned the efforts of Microsoft and HP. In Microsoft's case, the company charges three foreign subsidiaries large licensing fees to sell its products. In 2011, two of those subsidiaries, in the low-tax jurisdictions of Ireland and Singapore, paid about US$4 billion for those licenses, then sold products worth $12 billion, even though US tax law requires the subsidiaries to pay fair prices for the transfer of assets, Levin said.
That allowed Microsoft to move $8 billion in profits offshore and out of US tax jurisdiction, he said.
Microsoft also sells licenses to its subsidiary in Puerto Rico, which then sells the distribution rights of Microsoft products back to the U.S. parent company at a profit, Levin said. Last year, 47 percent of the US sales of Microsoft products were shifted to Puerto Rico, he alleged.
In 2011, Microsoft assigned about 55 percent of its profits to the subsidiaries in Ireland, Singapore and Puerto Rico, said Stephen Shay, a tax law professor at Harvard University. Shay and two other tax experts also questioned the Microsoft and HP methods.
HP uses a different mechanism to avoid US taxes, Levin said. US tax law requires companies to pay US taxes on foreign profits sent back to the US, but there's an exception for short-term loans. In recent years, HP subsidiaries in Belgium and the Cayman Islands have provided a near-constant stream of short-term loans to HP in the US to pay for a variety of expenses, including US payroll and shareholder dividends, Levin said.
In response to repeated questions from Levin, Bill Sample, Microsoft's corporate vice president for worldwide tax, and Lester Ezrati, HP's senior vice president and tax director, both acknowledged that their companies considered the tax implications when setting up the programs in question.
But both also stressed they were operating within the current US tax code.
"Microsoft complies with the tax rules in each jurisdiction in which it operates and pays billions of dollars each year in total taxes, including US federal, state, and local taxes and foreign taxes," Sample said.
Microsoft's overseas subsidiaries help fund the company's research and development efforts, and their profits are a reward for taking that risk, Sample said. Microsoft's sales overseas are growing faster than its US sales, he added.
Levin questioned how a Microsoft subsidiary was taking a substantial risk in supporting the parent company's R&D. "It's all Microsoft money, isn't it?" he said.
Ezrati noted that HP employs about 80,000 people, or about a quarter of its workforce, in the US and paid about $10.3 billion in US salaries in 2011.
Levin questioned the HP loan program, suggesting it was highly coordinated to avoid US taxes. HP has staggered the dates on which the financial quarters of the two subsidiaries end to avoid tax penalties and keep the cash flowing in, he said.
The short-term loans from HP's Belgium and Cayman Island subsidiaries are legal and amounted to a "modest" amount of the company's cash flow in recent years, Ezrati said. The US Internal Revenue Service and auditor Ernst & Young have reviewed the loan program, he added.
"HP takes seriously its obligations to accurately follow accounting principles and pay the taxes it owes," he said.