IRS Seeks More Power to Probe Foreign Firms : Taxes: The agency wants broader access to financial data amid allegations that offshore companies are shifting billions in profits overseas.
The Internal Revenue Service may soon win greater powers to aid its crackdown on foreign-owned firms in the United States, which allegedly are ducking billions of dollars in U.S. taxes by improperly shifting profits to their parent firms overseas.
An IRS hearing is scheduled today in Washington on proposed regulations giving the agency broad new access to a greater number of foreign financial documents. The regulations are attacked as onerous by multinational firms, but federal tax authorities say they are necessary to stop what they view as a significant compliance problem.
The proposed rules, authorized by Congress, are part of a two-year campaign to recapture lost tax revenues estimated as low as $13 billion by the IRS to as much as $50 billion by such congressional critics as Rep. Duncan Hunter (R-El Cajon). The IRS has also increased audits of firms and begun assembling a team in its Glendale office to specialize in cases involving foreign-owned companies, tax professionals say.
Although the issue appears to be a technical tax matter, in fact it represents a high-stakes battle between the United States and foreign governments over how to split the billions of dollars in tax revenue from multinational firms.
For the United States, the alleged tax delinquency exacerbates the federal budget deficit, increases demands on American taxpayers and places U.S. competitors of foreign-owned firms at a competitive disadvantage, Hunter and other critics charge.
But foreign governments, aiming to collect the taxes themselves, could retaliate by intensifying scrutiny and regulatory burdens on U.S. firms abroad, some tax experts predict. At worst, they say, the issue could erupt into international tax wars, rivaling the trade wars of the 1980s.
“We now have the potential for a trade war: I protect my product, you protect your product. The same thing could happen in the tax arena: I tax your subsidiary more than I should; you tax my subsidiary more than you should,” said Michael Granfield, a tax expert and vice chancellor of planning and budgeting at UCLA.
Foreign firms say their lower profits and tax payments were not caused by cheating but by legitimate factors. One important reason was the near doubling in value of the Japanese yen against the U.S. dollar since 1985, said Robert Dillon, executive vice president of Sony Corp. of America. The currency appreciation essentially doubled the cost of Japanese imports, but many firms held prices down, choosing to retain market share over profitability.
“A lot of the (charges) are gross simplification,” Dillon said.
Many Japanese firms also suspect that they are being targeted for scrutiny, although the IRS denies it. As many as 80 Japanese-owned firms are under review in Southern California alone, ranging from banks to auto manufacturers to consumer electronics firms, said Saburo Oto, co-managing partner of the Japanese practice unit of Deloitte & Touche, an accounting firm.
“There is still an undercurrent of resentment holding over from the second World War,” said one executive of a Japanese-owned firm. He added, however, that the federal scrutiny of Japanese firms has also been triggered by the sheer growth in their presence and volume of imports.
Hunter said the scrutiny is justified by IRS statistics showing that Japanese firms paid fewer taxes than foreign firms in general. In 1987, for instance, Japanese firms reported earnings of only 0.12 cents on the dollar, compared to 0.82 cents for all foreign firms. U.S. firms in comparable industries, he said, earned returns averaging 5 cents.
The IRS keeps confidential the names of firms being audited. But one case that has reached public tax court involves Yamaha Motor Corp. The IRS claims that Yamaha understated its gross profits by $500 million. As a result, the firm reported $5,272 in taxes due between the years 1980 and 1984, but the IRS argues it owes $127 million.
In a nine-month study last year, a congressional subcommittee concluded that nearly half of 36 foreign-owned auto, motorcycle and consumer firms reviewed paid little or no federal taxes.
According to tax experts and congressional investigators, U.S. subsidiaries shift profits overseas by paying parent firms inflated prices for goods and services--a transaction known as “transfer pricing.” U.S. firms, such as Apple Computer, have been accused by the IRS of the same practice.
By paying excessive prices for goods, U.S. subsidiaries reduce their taxable profit. The oversight subcommittee of the House Ways and Means Committee also found that parent firms charged excessive insurance, freight and other charges.
For instance, one foreign parent sold TV sets to an unrelated distributor for $150, while its subsidiary paid $250 for the same model, the subcommittee found.
Charles V. Fingal, tax partner at Deloitte & Touche, told a seminar in Los Angeles this week that the IRS has been given wider access to foreign records and increased the number of audits of foreign-owned firms.
Fingal and others criticized the proposed regulations as unwieldy and unworkable. Essentially, they would require firms to create a vast number of new records, such as profit and loss statements for individual products.
James Schenold, international tax partner at the accounting firm of Price Waterhouse, said most of his clients say they will need to hire as many as five additional staff members to collect the required information.
The real problem, Granfield said, is that even if the IRS collects all of the information, there is still no accurate way to determine what a particular firm’s transfer price should be. Unless a better way is developed, Congress and others may simply slap foreign-owned firms with a minimum tax--an action bound to be even more controversial.
No foreign governments appear to have called for retaliation. But, terming it an issue of “reciprocity,” an official with the Japanese Embassy in Washington said it was possible that the Japanese government could respond to the stringent IRS regulations with stricter rules against U.S. firms in Japan.
CONGRESSIONAL FINDINGS More than half of 36 foreign-owned auto, motorcycle and electronics firms investigated paid little or no income tax.
Firms avoided U.S. taxes by shifting profit to overseas parents.
The major scheme was inflating prices for goods purchased from overseas parents. This lowered taxable profit in the United States.
Firms also reported excessive freight, insurance, interest and other fees.
Customs duties were also evaded.
Source: House Ways and Means Committee, Oversight Subcommittee
Receipts and U.S. income taxes paid by foreign-controlled U.S. corporations Receipts (in billions) 1981: $371 1982: $363 1983: $390 1984: $459 1985: $514 1986: $543 1987: $687 Taxes paid (in billions) 1981: $4.1 1982: $3.4 1983: $3.4 1984: $4.5 1985: $3.6 1986: $3.0 1987: $4.6 Source: Internal Revenue Service RECEIPTS VS. TAXES Foreign-controlled U.S. corportions, 1987 receipts versus taxes.
1987 taxes paid by country Taxes paid (in billions) Great Britain: $1.4 Japan: $0.9 Canada: $0.3 West Germany: $0.3 Other: $1.5 1987 receipts by country Receipts (in billions) Japan: $185 Great Britain: $103 West Germany: $63 Canada: $52 Other: $285 Source: Internal Revenue Service
