Medtronic Inc. (NYSE:MDT) is under the spotlight at the IRS for profit-shifting practices that effectively cut its corporate tax rate in half.
The IRS targeted Medtronic in a $958 million lawsuit in U.S. Tax Court over the way the company shifted income to offshore units, according to Bloomberg.
Medtronic paid income taxes at a rate of 16.8% in 2011, less than half of the standard federal rate of 35% for corporate income, by attributing much of its profits to a foreign facility, according to the news service.
The federal tax bureau is cracking down on so-called "transfer pricing," whereby income is allocated among branches in different countries. It’s a legal tax maneuver companies can use to attribute profits from a product made and sold in the U.S. to a unit in a foreign country. Medtronic gleans more than half of its $16 billion annual take from U.S. sales of devices made in Puerto Rico, but much of that is attributed to a post office box in the Cayman Islands.
Medtronic is not alone. A tax break for companies with facilities in Puerto Rico lapsed in 2006, leading many to take advantage of transfer pricing. One example is Boston Scientific (NYSE:BSX), which is also battling the IRS over a similar beef that includes at least one half-billion-dollar tab for transfer pricing between foreign and domestic Guidant subsidiaries.
"By aggressively shifting income to offshore affiliates, companies appear to be getting U.S. tax benefits that are equal to or greater than the ones they did under the old Puerto Rico tax break," Harvard Law professor and former U.S. Treasury deputy assistant secretary Stephen Shay told the news service. "That almost certainly was not the intent of the repeal."
JP Morgan estimated that tax-deferred offshore earnings amount to at least $1.38 trillion for a swath of companies including Medtronic, BSX, Microsoft (NSDQ:MSFT) and Pfizer (NYSE:PFE). With the government running up deficits, the IRS is eager to recover that lost revenue.