Reclaim Democracy!

Corporate Tax Evasion via Offshore Subsidiaries: A Primer

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By Lucy Komisar
First published by Pacific News Service, April 9, 2004

Were you stunned by the revelation, days before your taxes are due, that nearly two-thirds of companies operating in America reported owing no taxes from 1996 through 2000? That over 90 percent of large corporations — with at least $250 million in assets or $50 million in gross receipts — reported owing taxes of only under 5 percent?

The law requires firms to pay 35 percent tax on U.S. profits. Had big business complied, corporate income taxes in 2002 would have been $308 billion instead of only an estimated $136 billion. Do you wish you knew the corporate secret?

Is your town or state suffering from service cutbacks because tax revenues are down? Would you like to cut your tax bite from the current 15 to 35 percent to 5 percent or zero? How do corporations do it?

The General Accounting Office report, commissioned by Senators Carl Levin (D-MI) and Byron Dorgan (D-ND) and released April 5, gave a clue to how. It’s called “transfer pricing,” or improperly shifting income to lower-tax countries.

Firms set up offshore “subsidiaries” which, on their books, perform functions that let them cut onshore taxes. They may sell their own “logo” to the subsidiary and then pay a high price to “rent” it back, deducting “rent” as expense. They may move money to the subsidiary and “borrow” it back, deducting interest payments. If several of their subsidiaries are involved in a deal, the firms may grossly inflate profits assigned to those in offshore tax havens, which levy no or minimal taxes on “profits” claimed there.

The U.S. firm may “trade” with an offshore “shell” it owns — a phony company set up in a tax haven — pretending it’s buying goods or services at a high price or selling its product low, to create deductions. Because the tax haven keeps owners’ names secret, the IRS won’t know the company is “trading” with itself.

Professors Simon J. Pak ( Penn State University ) and John S. Zdanowicz( Florida International University ) examined the impact of over-invoiced imports and under-invoiced exports on 2001 U.S. tax revenues. Would you buy multiple vitamins bought from China at $850 a pound, plastic buckets from the Czech Republic for $973 each, tissues from China at $1,874 a pound, a cotton dishtowel from Pakistan for $154, and tweezers from Japan at $4,896 each?

By contrast, U.S. companies, on paper, were getting very little for their exports. If you were in business, would you sell multiple vitamins to Finland at 61 cents a pound, bus and truck tires to Britain for $11.74 each, color video monitors to Pakistan for $21.90, missile and rocket launchers to Israel for $52.03 and prefabricated buildings to Trinidad for $1.20 a unit?

Comparing claimed export and import prices to real world prices, the professors figured the 2001 U.S. tax loss at $53.1 billion.

We all know that Enron cheated investors by using offshore firms to pretend that money it borrowed was money it earned. We later found it also used shells to hide income from the IRS. Enron had 881 offshore subsidiaries: 692 in the Cayman Islands ; 119 in the Turks and Caicos; 43 in Mauritius and 8 in Bermuda . Enron had no office in the Cayman’s, but Box 1350 there received mail for 500 affiliates. Enron’s 1996 through 2000 pretax U.S.profits were $1.8 billion, but it paid no tax in four of those five years. It even got a rebate! Because of fancy paperwork that invented tax losses even while it was boasting of profits to investors, Enron got back $381 million from the IRS.

Bob McIntyre, who heads the Washington-based Citizens for Tax Justice, says that in 1996-2000, Goodyear’s profits were $442 million, but it paid no taxes and got a $23-million rebate. Colgate-Palmolive made $1.6 billion and got back $21 million. Other companies that got rebates in 1998 included Texaco, Chevron, PepsiCo, Pfizer, J.P. Morgan, MCI Worldcom, General Motors, Phillips Petroleum and Northrop Grumman. Microsoft, run by the world’s richest man, reported $12.3 billion U.S income in 1999 and paid zero federal taxes. In the past two years, Microsoft paid only 1.8 percent on $21.9 billion pretax U.S. profits.

There are some 55 “offshore” zones, including legendary Switzerland ; the Caribbean with money-laundries Grand Cayman , Antigua , Aruba and the British Virgin Islands ; European favorites Luxembourg , Liechtenstein , Monaco , Austria , Cyprus ; and British Channel Islands Jersey, Guernsey , Isle of Man. Many banks in “offshore” centers are subsidiaries of major international banks, including Citibank, Bank of New York and Credit Suisse.

Why does Washington tolerate the offshore tax evasion system? Because powerful people benefit. With President Bush on its board, Harken Energy set up an offshore network that cut its taxes. White House spokesman Dan Bartlett defended Harken for seeking “tax competitiveness,” the preferred euphemism. When Vice President Cheney ran Halliburton, it increased its offshore subsidiaries from 9 to at least 44.

Lucy Komisar is a freelance journalist who is writing a book about the offshore bank and corporate secrecy system.

© 2004 Pacific News Service 

More features on corporate tax evasion and subsidies

Our Hidden History of Corporations in the U.S.

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When American colonists declared independence from England in 1776, they also freed themselves from control by English corporations that extracted their wealth and dominated trade. After fighting a revolution to end this exploitation, our country’s founders retained a healthy fear of corporate power and wisely limited corporations exclusively to a business role. Corporations were forbidden from attempting to influence elections, public policy, and other realms of civic society.

Initially, the privilege of incorporation was granted selectively to enable activities that benefited the public, such as construction of roads or canals. Enabling shareholders to profit was seen as a means to that end. The states also imposed conditions (some of which remain on the books, though unused) like these*:

  • Corporate charters (licenses to exist) were granted for a limited time and could be revoked promptly for violating laws.
  • Corporations could engage only in activities necessary to fulfill their chartered purpose.
  • Corporations could not own stock in other corporations nor own any property that was not essential to fulfilling their chartered purpose.
  • Corporations were often terminated if they exceeded their authority or caused public harm.
  • Owners and managers were responsible for criminal acts committed on the job.
  • Corporations could not make any political or charitable contributions nor spend money to influence law-making.

For 100 years after the American Revolution, legislators maintained tight control of the corporate chartering process. Because of widespread public opposition, early legislators granted very few corporate charters, and only after debate. Citizens governed corporations by detailing operating conditions not just in charters but also in state constitutions and state laws. Incorporated businesses were prohibited from taking any action that legislators did not specifically allow.

States also limited corporate charters to a set number of years. Unless a legislature renewed an expiring charter, the corporation was dissolved and its assets were divided among shareholders. Citizen authority clauses limited capitalization, debts, land holdings, and sometimes, even profits. They required a company’s accounting books to be turned over to a legislature upon request. The power of large shareholders was limited by scaled voting, so that large and small investors had equal voting rights. Interlocking directorates were outlawed. Shareholders had the right to remove directors at will.

In Europe, charters protected directors and stockholders from liability for debts and harms caused by their corporations. American legislators explicitly rejected this corporate shield. The penalty for abuse or misuse of the charter was not a plea bargain and a fine, but dissolution of the corporation.

In 1819 the U.S. Supreme Court tried to strip states of this sovereign right by overruling a lower court’s decision that allowed New Hampshire to revoke a charter granted to Dartmouth College by King George III. The Court claimed that since the charter contained no revocation clause, it could not be withdrawn. The Supreme Court’s attack on state sovereignty outraged citizens. Laws were written or re-written and new state constitutional amendments passed to circumvent the (Dartmouth College v Woodward) ruling. Over several decades starting in 1844, nineteen states amended their constitutions to make corporate charters subject to alteration or revocation by their legislatures. As late as 1855, it seemed that the Supreme Court had gotten the peoples’ message when in Dodge v. Woolsey it reaffirmed states’ powers over “artificial bodies.”

But the men running corporations pressed on. Contests over charter were battles to control labor, resources, community rights, and political sovereignty. More and more frequently, corporations were abusing their charters to become conglomerates and trusts. They converted the nation’s resources and treasures into private fortunes, creating factory systems and company towns. Political power began flowing to absentee owners, rather than community-rooted enterprises.

The industrial age forced a nation of farmers to become wage earners, and they became fearful of unemployment–a new fear that corporations quickly learned to exploit. Company towns arose. and blacklists of labor organizers and workers who spoke up for their rights became common. When workers began to organize, industrialists and bankers hired private armies to keep them in line — sometimes by killing key leaders. They bought newspapers to paint businessmen as heroes and shape public opinion. Corporations bought state legislators, then announced legislators were corrupt and said scrutinizing every corporate operation wasted public resources

Government spending during the Civil War brought these corporations fantastic wealth. Corporate executives paid “borers” to infest Congress and state capitals, bribing elected and appointed officials alike. They pried loose an avalanche of government financial largesse. During this time, legislators were persuaded to give corporations limited liability, decreased citizen authority over them, and extended durations of charters.

Attempts were made to keep strong charter laws in place, but with the courts applying legal doctrines that made protection of corporations and corporate property the center of constitutional law, citizen sovereignty was undermined. As corporations grew stronger, government and the courts became easier prey. They freely reinterpreted the U.S. Constitution and transformed common law doctrines.

One of the most severe blows to citizen authority arose out of the 1886 Supreme Court case of Santa Clara County v. Southern Pacific Railroad. Though the court did not make a ruling on the question of “corporate personhood,” thanks to misleading notes of a clerk, the decision subsequently was used as precedent to hold that a corporation was a “natural person.” (This story was detailed in “The Theft of Human Rights,” a chapter in Thom Hartmann’s Unequal Protection.)

From that point on, the 14th Amendment, enacted to protect rights of freed slaves, was used routinely to grant corporations constitutional “personhood.” Justices have since struck down hundreds of local, state and federal laws enacted to protect people from corporate harm based on this illegitimate premise. Armed with these “rights,” corporations increased control over resources, jobs, commerce, politicians, judges, and the law.

A United States Congressional committee concluded in 1941, “The principal instrument of the concentration of economic power and wealth has been the corporate charter with unlimited power….”

Many U.S.-based corporations are now transnational, but the corrupted charter remains the legal basis for their existence. At Reclaim Democracy!, we believe citizens can reassert the convictions of those who struggled successfully to free us from corporate rule in the past. These changes must occur at the most fundamental level — the U.S. Constitution.

We are indebted to our friends at the Program on Corporations, Law and Democracy for their research, some of which was adapted with permission for this article. Sources include:

Visit our Corporate Personhood page for a huge library of articles exploring this topic more deeply.