Computer and drug companies such as Microsoft and Pfizer may face a higher U.S. tax bill after the Bush administration said it would tighten...

Share story

Computer and drug companies such as Microsoft and Pfizer may face a higher U.S. tax bill after the Bush administration said it would tighten rules on diverting profit to offshore tax havens.

The Treasury Department issued regulations this week limiting cost-sharing arrangements that allow businesses to undervalue patents, licenses, trademarks and other intellectual property transferred to a subsidiary from a parent company.

The new rules would require companies to value these assets at the same price they would charge a competitor to acquire them.

Most Read Stories

Unlimited Digital Access. $1 for 4 weeks.

The Internal Revenue Service is increasingly questioning such transfer pricing, a legitimate business practice that can be abused when companies inflate or undervalue the price of goods sold between their international subsidiaries to reduce taxable income. Difficulties in valuing intellectual property have led to tussles with the IRS, experts said.

The rule change was “undertaken out of concern that existing regulations were outdated and that companies were using arrangements under the old regulations to strip income out of the U.S.,” said Pamela Olson, former assistant secretary of tax policy at the Treasury Department and now a partner at the Skadden, Arps, Slate, Meagher & Flom law firm in Washington, D.C.

The low-cost transfers allow companies to maximize their income in tax havens such as Ireland while providing their U.S. parent companies with deductions for research and development expenses.

Existing rules have helped companies to stockpile more than $650 billion in cash overseas. Many U.S. companies are repatriating those funds under a one-year tax holiday passed by Congress this year.

U.S. drug and computer companies, including Pfizer, Intel, Microsoft, Oracle, Abbott Laboratories, IBM and Apple have invested in low-tax countries in recent years. The Irish Development Authority says foreign corporations employ 130,000 Irish residents, about 70 percent of whom work for U.S. subsidiaries.

Ireland has a corporate tax rate of 12.5 percent, compared with the 35 percent rate charged by the U.S. government and additional amounts charged by states.

American companies reported $18.3 billion in profit in Ireland in 2002, according to Commerce Department data, or about 15 percent of Ireland’s gross domestic product.

Until this year, the companies avoided paying U.S. rates on that profit by not repatriating the income to the U.S. parent. This year, most of them are taking advantage of a one-time, 85 percent discount and have returned about $200 billion at an effective U.S. tax rate of about 5.25 percent, according to the American Shareholders Association.

As much as $350 billion may be repatriated, according to estimates by JPMorgan Chase.

The tax break has been particularly useful to drug and computer companies because much of their income comes from patents and licenses. The companies divert income to low-tax countries and seek to claim as many deductible research and development costs as possible in the U.S. to lower the tax bill on U.S. profits.

According to the Commerce Department, 42 percent of all U.S. imports and exports last year — about $770 billion in cross-border trade — were intra-corporate transactions.

Those figures don’t include licensing and other intangible services, IRS Chief Counsel Donald Korb told the Global Transfer Pricing Forum in Berlin last year. “Transfer pricing has been an area of particular focus for us,” he said.

The regulations issued this week apply to cost-sharing arrangements between subsidiaries in all countries. The IRS will hold a public hearing on the regulations Nov. 16 in Washington, D.C.

Tom Roesser, Microsoft tax-affairs director, said he hasn’t been able to review the regulations and couldn’t discuss them. Pfizer spokesman Paul Fitzhenry , said he couldn’t immediately comment.