Transocean Transfer Pricing and Corporate Inversions

Martin Sullivan had the perfect line four years ago for this corporate inversion debate:

By inverting, a multinational is no longer subject to U.S. tax from its foreign operations. In addition, the transactions often are accompanied by planning techniques that strip income out of the United States.

His paper documented the drop in the effective tax rate for certain oil drilling rigs that did corporate inversions between 1999 and 2002. Ensco complained about this back then but they have joined the club since. About the same time, Senator Baucus used the Senate Finance Committee to blast Transocean:

Transocean, still largely physically located in the U.S., moved its headquarters to the Cayman Islands in 1999, thus avoiding U.S. taxes, and has since relocated the headquarters to Switzerland. Baucus led the fight in the Senate to shut down this practice, known as corporate inversion, and successfully passed the American Jobs Creation Act of 2004, which closed loopholes in the tax code that made corporate inversion possible. Baucus sent a letter today calling on Transocean to provide detailed documents and explanations relating to the company’s tax practices. This information will help the Finance Committee discern the tax benefits Transocean received by exploiting the loopholes closed by the American Jobs Creation Act of 2004 and determine whether further legislative action is necessary to prevent erosion of the U.S. tax base through corporate inversions.

I read the questions for the CEO of Transocean and I hate to say but the Senator completely missed the boat – as in Bareboat Charter arrangements, which I’ll explain in a moment. His notion that Transocean is largely physically located in the U.S. is simply not true. Yes about 25 percent of their activity is here but they have oil drilling rigs all over the world. Oil drilling rig multinationals are an incredibly simply issue as all they do is to combine very expensive equipment with workers so the only issue is who gets the profits from their equipment, which is predominantly these rigs which often cost $500 million a piece. The trick is that formal ownership of the rigs is transferred to tax havens, which lease the use of the rigs to the operating affiliates in places like the US and the UK. Now if this planning technique does not offend you – the intercompany lease rates should. The UK government certainly is according to Reuters:

"Currently, some companies making significant operating profits in the UK are able to move up to 90 percent of these profits overseas and out of the UK tax net," a spokeswoman for the UK Treasury said … Osborne's change, which will limit the amount companies can deduct from profit for such lease payments to 7.5 percent of the historical cost of the rig, will replace generous deductions calculated on the market value of rigs, which has been soaring. Andrew Cox, Tax partner at Deloitte, said HMRC had most recently agreed in 2008 that drillers could take tax deductions of up to 15 percent of the market value of a rig each year.

Finance Minister George Osborne is very frustrated with his national income tax authority for not challenging clearly excessive intercompany lease deductions. I would submit to Senator Baucus that we should be equally upset with the IRS for their failure to challenge overly aggressive transfer pricing. Rather than get lost in endless and ineffective tax rules, why not simply look at the real economics of these multinationals transfer pricing?