Amazon and their taxes

Reuters is reporting on the history and legal problems of Amazon’s taxes. Apparently, last year the IRS demanded $1.5 billion in back-taxes from “transfer pricing [of their] our foreign subsidiaries,” amounting to just under a tenth of their gross annual profit.

The article doesn’t take much knowledge of tax law to understand, but for the tl:dr crowd, here is the gist:

In 1999, Amazon began to bring foreign profits home from their French and British operations to balance the losses in the US, which at the time amounted to over \$1 billion. As the domestic business got into the black, a new problem appeared: the American corporate tax rate, which is the highest in the world, was beginning to increase the total tax bill. The solution was to set up a number of companies in Luxembourg, which has comparatively low corporate rates. However this arrangement is not particularly tax efficient. So, in 2005 an inter-company deal began license fee transfers among the Amazon affiliated companies the the small European country. The technology, for which the license fee was being paid, has never been formally revealed, but it has allowed the company to transfer profits from high tax areas to a low tax regime. At the same time, one of the companies began  payments to the domestic office in Nevada. The difference has since stayed in Luxembourg as cash and has allowed them to have a reserve in \$2 billion.

In total,

Amazon’s Luxembourg arrangements have helped it pay an average tax rate of 5.3 percent on overseas income over the past five years, less than a quarter of the average rate across its major foreign markets.

After the deal was struck, Amazon began to relocate a number of their European staff to Luxembourg and has since beefed up the entire operation, but now the IRS wants their pound of flesh. And $1.5 billion.

Some might think their strategy is dishonest, but I would say otherwise. It is within US tax law to engage in transfers pricing tax-free, a feature of the code that allows the structure to work. And moreover, the corporate tax rate in American is obscene. We should think carefully, as Adam Thierer notes, on whether we want “tax competition or tax collusion.” I would think that tax competition is the better route, because it demands fiscal  responsibility of governments. It adds, as governments need in these times of ballooning budgets, a huge competitive pressure. It is akin to an entrant in the tax collection “industry.”

First published Dec 14, 2012