How Google Hides Its Profits From the Tax Man

Most people know of two things that Google (GOOG) does well: find information and make money from the ads displayed to searchers. Turns out there's at least one more area in which the company excels: avoiding taxes on foreign profits.

Google has cut its taxes by $3.1 billion over the last three years, according to a report by Jesse Drucker at Bloomberg. Given that its provision for taxes in 2009 were $1.9 billion in total, that's equivalent to cutting payments almost in half.

Overseas business is big for Google, with 53 percent of its 2009 revenue from international operations. To reduce payments by the rate it has achieved, the company uses a complex series of overseas subsidiaries and money transfers that effectively bounce international profits from one place to another until they wind up in Bermuda, a well-known corporate tax haven.

Bloomberg, which discovered the mechanism by examining regulatory filings in six countries, has a great interactive graphic that shows how the scheme works. Here's the short version:

1. Google licenses offshore rights to its intellectual property, which would include the search engine, advertising systems (Google's cash cow), and even such things as Android, to an Irish subsidiary called Google Ireland Holdings. If it takes only a small payment, the company insulates overseas revenue from coming back into the U.S., which has a 35 percent corporate tax rate.
2. Google Ireland Holdings reports that its management is in Bermuda, which makes it exempt from Irish taxes. So far, so slippery.
3. Another subsidiary, Google Ireland Ltd. gets credit for 88 percent of all of Google's overseas revenue. And yet, in 2008 it paid taxes of less than 1 percent because it paid $5.4 billion in royalties to Google Ireland Holdings. The royalty payments only have to be large enough to soak up most of the profits after Google pays its expenses, which would be tax deductible anyway.
4. If the royalty payments occurred strictly within Ireland, they would be taxable. However, Google Ireland Ltd. doesn't pay Google Ireland Holdings directly. Instead, it sends the royalty money to another subsidiary, Google Netherlands Holdings BV in Holland. The Dutch company has no employees. It simply receives the payments.
5. If the money stayed in Holland, the Dutch government would tax it. However, Google Netherlands now sends virtually all of the money it received from Google Ireland Ltd. to Google Ireland Holdings, which isn't taxed by the Irish government.

Google is hardly alone. Many transnational corporations -- Microsoft (MSFT) is one and reportedly Facebook is creating its own mechanisms -- use similar strategies. Some experts estimate that the number of companies that do this runs into the hundreds.

The entire approach is legal. But is it right, in the sense of Google's "don't be evil" motto? It depends on whether you're the one saving money or having to help make up the $1.294 trillion federal budget deficit.

Related:

• Google Android Becomes Apple's Night Terror
• Apple Earnings: Analysts Disappointed by iPad Sales -- and They're Completely Nuts
• IBM Earnings: Profits Soar, Revenue Not So Much, but the Future Looks Bright
• Google Makes Lots on Mobile Ads. What Are You Going To Do About It?
• Google Earnings: Still Crawling Toward Revenue Diversity