Controlling Global Taxes
International tax planning may be complicated, but its rewards can be significant. Consider the case of Wind River Systems, a $25-million software developer in Alameda, Calif., whose success owes plenty to the way the company has managed its international tax liabilities over the past five years.
With operations around the world -- three wholly owned subsidiaries in Europe, majority ownership in a joint venture in Japan, and distribution agreements with independent contractors in other nations -- Wind River faces corporate tax rates that can be much higher than those for companies that operate only in the United States. So it has devised a "transfer-pricing" strategy that minimizes its global tax rates, bringing them to an average of less than 36%, compared with a worst-case scenario of almost 50%. "Your goal should be to come as close as possible to the U.S. marginal effective rate of 34%," says Dale Wilde, Wind River's chief financial officer.
The goal of transfer pricing is to set international prices so that more profits are realized in those countries that have lower tax rates. Wilde defines transfer pricing this way: "You're trying to get a realistic measure of your overall operations and to price accordingly. In a case like ours, where the parent company absorbs all production and development costs, it doesn't make sense not to factor those costs into the price of goods sold abroad." Translation: for Wind River, there's no reason to price software sold in France, for example, so high (and to keep costs so low) that the company's French subsidiary earns higher profits and pays a higher tax bill than its U.S. counterpart does.
So does it make sense to lose money on all ventures based overseas and declare all profits in the States, thus paying the lowest possible overall tax bill? Don't even think of it. Just as the IRS pays strict attention to the profits that foreign companies with U.S. operations declare for U.S. tax purposes, foreign governments closely examine the tax statements of U.S. businesses and their overseas subsidiaries. Companies that appear to transfer price too aggressively run the risk of costly audits.
Another caveat: while your transfer-pricing strategy needn't be set in stone for eternity, you cannot be tweaking it constantly to accommodate recent financial results. "If one of our foreign subsidiaries had a particularly good year," explains Wilde, "I couldn't charge that subsidiary more for our software products so that it would recognize less profit, thus minimizing its taxes. That country's tax authority would come down on us in a second." The United Kingdom, France, and the Netherlands are among the nations that are more aggressive about auditing foreign companies' transfer-pricing policies.* * *