By Carolyn Lochhead  SF Gate

Washington — Silicon Valley multinationals aggressively exploit foreign tax havens in Bermuda, Grand Cayman and elsewhere to dodge U.S. taxes, according to a bipartisan Senate report issued Thursday.

Hewlett-Packard, based in Palo Alto, and Microsoft, based in Seattle, were singled out as case studies of tax strategies employed widely by tech companies in the report by the Senate Permanent Subcommittee on Investigations, chaired by Sen. Carl Levin, D-Mich. Ranking Republican Tom Coburn of Oklahoma joined in the report.

Both companies cooperated with the investigation.

“High tech is probably the No. 1 user of offshore entities” to avoid U.S. taxes, Levin said. That’s because many of their assets are intangible intellectual property, which is hard to value and easy to move.

Levin called some of the activities “highly dubious” legally. Coburn primarily faulted Congress, saying the activities are symptomatic of the need for tax reform.

“We’ve transferred growth out of this country,” Coburn said, “yet we are critical when people take advantage of the statutes, rules and regulations we ourselves have created.”

U.S. multinationals have an estimated $1.7 trillion parked overseas, amounting to 60 percent of their cash, the committee said. Companies do not have to pay taxes on overseas earnings until they are brought into the United States.

Hewlett-Packard employed a loan scheme that moved earnings from overseas entities to its U.S. base to avoid U.S. taxes, the report said. Levin said the company made a continuous stream of ostensibly short-term loans from subsidiaries in the Cayman Islands and Belgium to the parent company. That enabled HP to avoid the 35 percent corporate tax rate on repatriated foreign earnings, Levin said.

During a long and testy questioning by Levin, the company’s senior vice president for taxes, Lester Ezrati, said the Internal Revenue Service reviewed the loans and “did not find the tax treatment contrary” to the law. He said the program accounted for a “modest” amount of the company’s liquidity.
Microsoft employed offshore entities in Puerto Rico, Bermuda and Ireland to sell its patents, licenses and other intellectual property developed in the United States to its own overseas subsidiaries at beneficial prices that help the company avoid U.S. taxes, the report said.

Last year, 47 percent of Microsoft’s U.S. sales were shifted to Puerto Rico under this arrangement, Levin said, allowing the company to avoid U.S. taxes on “47 cents of each dollar of sales revenue it receives from selling its own products right here in this country.”

The report showed that many Silicon Valley giants hold most of their cash overseas, according to financial filings this year: Hewlett-Packard (100 percent), Cisco (89 percent), eBay (88 percent), Oracle (84 percent), Apple (67 percent) and Google (48 percent).

The 35 percent U.S. corporate tax rate is the world’s highest, but most multinationals pay far lower rates by using tax-avoidance strategies. Corporate taxes have plummeted as a share of federal revenue, from a high of 32.1 percent in 1952 to less than 9 percent now.

During that period, payroll taxes have made up a growing share of federal revenue, increasing from less than 10 percent of revenue in 1952 to 40 percent now, while individual income taxes have remained constant, at about 42 percent of federal revenue.

By avoiding taxes, multinationals shift the U.S. tax burden to individuals and domestic businesses that cannot take advantage of overseas tax havens, Levin said.

Robert Hoffman, vice president of government relations for the Information Technology Industry Council, which represents large tech companies, accused Levin of issuing “incendiary reports” but failing to help overhaul a tax code that no longer works in a global economy.

“Companies are forced to spend tens of millions of dollars to comply with a set of illogical rules and incentives in order to reduce tax costs and remain competitive,” Hoffman said. “Congress created this system, and it’s up to Congress to fix it.”

Stephen Shay, a tax professor at Harvard Law School, said the combination of tax deferral on overseas earnings with deductions for expenses on those earnings, creates “a powerful incentive to shift income offshore.”

The tech industry, Republicans including presidential nominee Mitt Romney, and three outside groups asked to advise President Obama have called for a “territorial” tax system that does not apply U.S. taxes to foreign earnings.

Corporations would pay taxes on foreign profits only where they are earned. Supporters argue that most industrial countries use that system, and that it would allow multinationals to bring overseas earnings home without a penalty, boosting jobs.

Carolyn Lochhead is The San Francisco Chronicle‘s Washington correspondent.
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