By Kim Dixon
WASHINGTON (Reuters) - Microsoft Corp and Hewlett-Packard Co pushed back against claims by a U.S. Senate panel on Thursday that they used offshore units and loopholes to shield billions of dollars in profits from U.S. taxes.
Calling tax avoidance rampant in the technology sector, the Senate's Permanent Subcommittee on Investigations said tech companies used intellectual property, royalties and license fees in overseas tax havens to skirt taxes.
The panel subpoenaed internal documents from the companies and interviewed Microsoft and HP officials to compile its report, which uses the companies as case studies.
"The tax practices and gimmicks range from egregious to dubious validity," Democratic Senator Carl Levin, chairman of the panel, said at a news conference.
Officials at HP and Microsoft strongly denied any wrongdoing, noted tax officials had not objected to the structures and said there were valid reasons for tax planning.
Senator Tom Coburn, the top Republican on the panel, signed onto the new report but blamed Congress.
"Tax avoidance is not illegal. Congress has created this situation," Coburn said, criticizing the complex tax code and the 35 percent corporate tax rate, among of the world's highest, though few companies pay that statutory rate.
The subcommittee said that from 2009 to 2011, Microsoft shifted $21 billion offshore, almost half its U.S. retail sales revenue, saving up to $4.5 billion in taxes on goods sold in the United States.
This was accomplished, the report said, by aggressive transfer pricing, where companies value intra-company movement of assets. Corporate units must use a fair market price to value transfers, but critics say they are manipulated to minimize tax.
The report also said the software giant shifts royalty revenue to units in low-tax nations, such as Singapore and Ireland, avoiding billions of dollars of U.S. tax.
Levin said one Microsoft Singapore unit was legally headquartered in Bermuda and had no employees. Levin asked Microsoft's tax vice president, William Sample, if the reason was to cut its tax bill. "Yes, that is correct," Sample said.
Sample also said several offshore units employ hundreds of workers, which Levin noted was a tiny fraction of its workforce.
IRS CITES CHALLENGE
Internal Revenue Service officials are not allowed to comment on specific taxpayers, but Chief Counsel William Wilkins said enforcing transfer pricing law "has been the IRS's most significant international enforcement challenge."
U.S. companies have at least $1.5 trillion in profits sitting offshore. Most say they are keeping them there to avoid U.S. tax. Of the top 10 companies with the biggest offshore cash balances, five are in the technology sector.
"The high-tech industry is probably the No. 1 user of these offshore entities to transfer intellectual property," Levin said.
The panel said Hewlett-Packard funded U.S. operations with a stream of intra-company loans, using an exception in the law for short-term loans, to avoid billions of dollars in taxes.
Levin said more than 90 percent of HP's cash was sitting offshore, as opposed to about 65 percent of revenue coming from countries outside the United States.
An HP spokesman said in a statement that the hearing was a politically motivated attack.
"We are disappointed to see what appears to be a politically motivated attack on one of America's largest employers," HP spokesman Michael Thacker said before the hearing.
Lester Ezrati, an HP tax vice president, said HP used cash faster in the United States for valid reasons including that certain payments like pensions must be made with U.S. cash.
"HP has an overall strategy to minimize expenses and that is what generates where the cash is located," and "one of those expenses is taxes," Ezrati said.
REPATRIATED PROFITS TAXABLE
Under tax law, foreign profits are subject to U.S. tax when they are "repatriated," or brought into the United States, usually in the form of a dividend.
One internal document released by the panel suggested that HP routinely brought money into the U.S. without paying U.S. tax. An HP presentation noted that "without planning, repatriation of foreign earnings could lead to tax payments."
Loans by the foreign units to a related U.S. entity are considered a dividend for tax purposes but there is an exception for loans that are repaid within 30 days, according to the committee's tax experts.
HP set up a complicated series of short-term loans starting in 2008 to these businesses that were continuous without gaps, to get around that provision, the panel found.
Big companies have lobbied for a tax holiday to let them bring offshore profits into the United States at a reduced tax rate, arguing that the profits are trapped offshore. That effort has fallen flat amid reports suggesting such a program would cost the government significant revenue and not produce U.S. jobs.
The report on transfer pricing "mocks the notion that profits of U.S. multinationals are 'locked-up' or 'trapped' offshore," Levin said.
The subcommittee also criticized accounting giant Ernst & Young for blessing HP's practices.
Ernst & Young partner Beth Carr said that the firm stands firmly behind its auditing for HP.
(Additional reporting by Lynnley Browning; Editing by Kevin Drawbaugh and Alden Bentley)