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IRS Locks Stable Door After IBM's Tax Horse Bolts

by Leroy Baker, Tax-News.com, New York

08 June 2007


The US Internal Revenue Service's move to close a loophole used by US multinationals with significant foreign income to avoid US taxes has reportedly come too late to prevent IBM from saving $1.6 billion in tax.

On May 31, the IRS issued a notice banning a technique whereby companies buy back their stock using a foreign subsidiary to avoid domestic corporate taxes. The notice said it would disallow any transactions beginning on that day.

According to a report by the Wall Street Journal, the move was prompted after IBM structured a $12.5 billion stock repurchase to benefit from funds it earned overseas without making them subject to US corporate tax rates in a transaction known to tax lawyers as 'Killer B', which circumvents IRS section 367 B covering US taxes on repatriated earnings.

This transaction involved the forming of a new subsidiary in the Netherlands, which used $1 billion in cash and $11.5 billion in borrowed funds to buy 118.8 million shares from institutional investors. This allowed IBM to buy back stock without repatriating retained earnings from its foreign units to the US, IBM Treasurer Jesse Greene told the WSJ.

To repay the loans, IBM will use future earnings from overseas subsidiaries with an average tax rate of 22% after tax credits, thus saving it $1.6 billion in US taxes, the Journal has learnt from a person familiar with the transaction.

While IBM is by no means the only large US multinational to use this technique to avoid US corporate tax, it is thought to be one of the only companies to have publicly disclosed that it undertook such a transaction.

Under current US tax law, companies can defer taxation on certain types of foreign profit as long as the income is held overseas. Corporate tax at 35% becomes due when the money is repatriated.

The IRS has said that such transactions raise "significant policy concerns," but has declined to comment on the specific transaction in question. Neither would the agency confirm whether the May 31 notice was issued in direct response to the IBM transaction.

A comprehensive report in our Intelligence Report series looking at Tax-Effective Global Manufacturing and Financing Structures is available in the Lowtax Library at http://www.lowtaxlibrary.com/asp/subs_reports.asp and a description of the report can be seen at http://www.lowtaxlibrary.com/asp/description_report8.asp

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