Google grooves around with Transfer Pricing

The following is a synopsis of an article published on Yahoo! finance dated Oct 21, 2010.

[To reduce its overseas tax bill, Google uses a complicated legal structure that has saved it $3.1 billion since 2007 and boosted last year's overall earnings by 26 percent. While many multinationals use similar structures, Google has managed to lower its overseas tax rate more than its peers in the technology sector. Its rate since 2007 has been 2.4 percent. According to company disclosures, Apple (Nasdaq: AAPL), Oracle (Nasdaq: ORCL), Microsoft (Nasdaq: MSFT), and IBM (NYSE: IBM) - which together with Google make up the top five technology companies by market capitalization - reported tax rates between 4.5 percent and 25.8 percent on their overseas earnings from 2007 to 2009. It is remarkable that Google's effective rate is that low, considering that this company operates throughout the world, mostly in high-tax countries where the average corporate rate is well over 20 percent. The corporate tax rate in the U.K., Google's second-largest market after the U.S., is 28 percent. So, how does Google grooves around with Transfer Pricing to gain a tax advantage?

A company's obligation to its shareholders is to try to minimize its taxes and all costs, but to do so legally. The setup lowers Google's overseas tax bill, but it also affects U.S. tax revenues as the government struggles to close a projected $1.4 trillion budget gap. Google Ireland licenses its search and advertising technology from Google headquarters in Mountain View, Calif. The licensing agreement allows Google to attribute its overseas profits to its Irish operations instead of the U.S., where most of the technology was developed.

The subsidiary is supposed to pay an "arm's length" price for the rights, or the same amount an unrelated company would. Yet because licensing fees from the Irish subsidiary generate income that is taxed at 35 percent, one of the highest corporate rates in the world, Google has an incentive to set the licensing price as low as possible. The effect is to shift some of its profits overseas in an arrangement known as "transfer pricing." This, too, is legal. In 2006 the IRS approved Google's transfer pricing arrangements, which began in 2003, according to Google's SEC disclosures. Transfer pricing arrangements are popular with technology and pharmaceutical companies in particular because they rely on intellectual property, which is easily transportable across borders.]

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