Tax Analysts Blog

Horse Racing and International Tax

Posted on Apr 22, 2013

In international tax, determining whether the price is right is everything. A multinational can save hundreds of millions of dollars in tax by “selling” foreign rights to its intellectual property (IP) to a wholly-owned subsidiary in a tax haven. The key to success for a multinational is getting the IRS to allow it to sell at a low price. If, as is often the case, the multinational prevails, the subsidiary will soon be generating big profits (on which it pays no foreign tax) that really should have been booked and taxed in the United States.

For decades the IRS has tried to prevent this. It has tried to write tougher regulations, but the agency is so heavily lobbied the rules are always watered down. It goes to court, but the judges always side with the multinationals. And Congress is no help. On technical issues like this it may talk a good game for the cameras, but when it comes to putting detailed rules into legislation, it mutters and stumbles and nothing gets done.

Perhaps those who make our tax rules could learn something from the wonderful world of horse racing. Those dwindling few Americans who still follow the horses know about a common feature on any racing program: the claiming race. To keep things fair a dollar amount is set and no horse whose value is above that amount may enter the race. Now the good folks who run race tracks don’t just take the owner's word for it that a horse is worth less than, say, $10,000. No, they put it to the market test. If it is a $10,000 claiming race anybody can buy any horse entered for $10,000. So, if an owner enters a superior horse into a race intended for those of lower-quality, he runs the real risk of losing his horse at a price below its true value.

Based on the same principle, here’s what the IRS can do to prevent transfer pricing abuse. Before any multinational sells IP to a subsidiary in a tax haven for what it is telling the IRS is a fair price, it should allow any third party to purchase those rights at that price. If the price is right, they have nothing to lose. There is nothing like using a market test to keep folks honest.

Read Comments (2)

Christopher BerginApr 22, 2013

Brilliant, Marty. What a great idea: the market strikes back.

Rusty SteeleApr 22, 2013

In other words, mandate that arm's length pricing is actually ... drum roll
please ... arm's length. Fabulous idea but K Street will never permit such
radical, blasphemous, heresy to take place. Orthodoxy demands that all transfer
pricing be reduced to a bogus exercise in which the "arm's length price" is
whatever our paid consultants declare it to be.

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