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January 28, 2013
Dell's Multiple Restructurings Aid It in Tax Avoidance
by David Cay Johnston

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by David Cay Johnston

Summary by Tax Analysts®

David Cay Johnston discusses a restructuring by Dell Inc. that would enable it and other U.S. multinationals to avoid being taxed on their U.S. profits.

David Cay JohnstonDavid Cay Johnston received the Pulitzer Prize for his coverage of tax policy while at The New York Times. He now teaches at Syracuse University College of Law and is the author of three books about taxes -- Free Lunch, Perfectly Legal, and The Fine Print.

Johnston discusses a restructuring by Dell Inc. that would enable it and other U.S. multinationals to avoid being taxed on their U.S. profits.

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Six years ago, Dell Inc. announced a $12 billion restructuring with huge tax consequences not just for Dell, but also for tax policy. If the deal works as intended, American multinationals can copy it to escape the corporate income tax on profits earned in the United States.

What Dell did was remake itself in a way that lets it escape taxes on profits earned in the United States by running them through a Netherlands entity and newly formed subsidiaries in Singapore and the Cayman Islands.

Dell later quietly dropped the Singapore and Cayman Islands entities in what appears to be a pattern of remaking its corporate structure every few years. This nuanced timing pattern may have great significance as a tool for tax avoidance because IRS corporate audit practices were established on the assumption that companies tend to have stable structures. The IRS rarely audits newly formed entities.

You probably are unaware of this restructuring, even if you are a Dell shareholder or a Wall Street analyst who follows the company. That's because Dell mentioned it in just a single sentence in an SEC filing and, as best I can tell, nowhere else.

Dell's restructuring is important because its founder plans to force out other shareholders by selling the Texas computer maker to a private equity group for a reported $15 billion, complicating open IRS audits.

I would tell you what Dell thinks about these matters, except the company declined to provide any information. Dell public relations executive Jess Blackburn sent me a statement with a telling phrase:

    Dell does not comment on details of its operations as you request. We do understand our responsibility to pay taxes where we do business and we operate in accordance with the letter and spirit of all laws and regulations.

Notice that phrase "where we do business."

The global reorganization I asked about was disclosed in January 2007 on a Form 8-K, the official SEC form for announcing unexpected events. Dell said that just before the end of 2006, it issued more than 475 million shares worth $12 billion to invest in a subsidiary. Here is how Dell put it:

    Dell has modified the corporate structure of certain of its subsidiaries to achieve more integrated global operations and to provide various financial, operational and tax efficiencies.

Dell is one of the biggest companies in the United States, but this item does not seem to have attracted any media attention. That is not surprising, because the language conveys nothing -- unless you have gone through hundreds of Dell filings, court papers, and other documents that convey how significant the move was for shareholders and American taxpayers.

The documents suggest that Dell created companies with no apparent purpose except to funnel profits into jurisdictions where they would be untaxed. In some cases, subsidiary names existed for a day or so and then were changed to the names of existing entities. The company shuffled its subsidiaries like a deck of cards -- a deck stacked against shareholders and the IRS.

Sometimes the deals used companies with identical addresses, suggesting circular flows in which what would be taxable profits in the United States were run through offshore entities with no discernible purpose except escaping tax.

These complex structures replaced an organization that used to be known for its simplicity. Beneath Dell Inc., the parent firm, was a single subsidiary, Dell International, into which everything else was tucked.

I learned about the complex restructurings from Deene W. Lindsey, an American economist educated at Princeton, who now lives in France. Lindsey and his wife are part of a little-known business subculture composed of people who ferret out evidence of money owed to the federal government in hopes of getting paid under section 7623(b).

That section, enacted in 2006, lets individuals who draw the IRS's attention to public documents indicating a tax deficiency get a reward of up to 10 percent of the tax, penalties, and interest collected because of their work.

Lindsey had started looking into Dell's sales tax compliance when he and his wife realized that some of the state filings and court papers they collected over the Internet suggested a section 7623(b) award. At one point they laid out all the paper they had collected to create a diagram for themselves of Dell's actions. It took up the entire floor in one room of their home.

Before one restructuring, Dell Inc. sold products to domestic customers through Dell Catalog Sales Corp., which shared the same address in Texas.

The couple distilled from annual corporate ownership and sales tax filings with state governments, as well as stipulations in various civil lawsuits, that Dell then replaced this simple organizational structure with a hierarchy of tax haven holding companies.

In all, Dell inserted four new companies between the parent and operating entities, which use the same Texas street address.

The result was that a Texas company reported to a Netherlands company that reported to a Singapore company that reported to a Caymans company that reported to what appears to be another Netherlands company that then reported back to the Texas headquarters.

This makes business sense? I cannot fathom how -- except to escape taxes.

Keep that complex structure in mind when you hear all the complaints about how government requires unnecessary paperwork from business. Filling out paperwork can be very lucrative.

The concept of using Dutch, Cayman, and Singapore companies to siphon money out of taxable jurisdictions and into ones with little or no tax is itself not new.

"The restructurings using subsidiaries in the Netherlands, the Caymans, and Singapore appear to have as their only (or overwhelming) purpose to not pay U.S. taxes," said professor Reuven S. Avi-Yonah of the University of Michigan Law School, who reviewed some of the vast store of documents I examined.

"These structures make IRS auditing much more complex," Avi-Yonah said. "Whether Dell owes more taxes is likely, but without a thorough audit there is no way to know."

The documents Lindsey collected suggest that Dell engages in reorganizations that allow it to define where it does business with less regard for substance than for forms that enable it to source profits where they will not be taxed.

Citizens for Tax Justice, in a report last year (Doc 2012-21457 , 2012 TNT 202-22), noted that Dell is one of the few multinationals that discloses how much untaxed profits it holds offshore and the expected tax rate if it brought the money back to the United States.

Dell said it had $15.9 billion of untaxed profits offshore on which it would owe a tax of $5.2 billion, or 33 percent. Since that is almost equal to the 35 percent corporate tax rate, it suggests Dell paid virtually no tax anywhere in the world on those profits, because Congress gives a dollar-for-dollar tax credit on corporate income taxes imposed by other countries.

The document trail Lindsey constructed raises a number of policy questions. Among them is what public benefit arises from allowing transactions to be hidden in plain sight where only a determined and skilled paper trail detective like Lindsey will find them?

For shareholders, the issue is one of disclosing risks and rewards. The basic theory of SEC disclosure is that a company must disclose anything that a reasonable investor would want to know in order to decide whether to buy, hold, or sell a security. Surely a worldwide restructuring to reduce taxes meets that criteria, and in ways that go beyond the boilerplate sentence Dell included in its Form 8-K.

For the IRS, the question is whether its audit techniques can miss significant liabilities. The Dell case calls into question the IRS policy of telling companies in advance what will be audited, sticking only to those issues, and completing audits in fixed time periods, which rewards lethargic compliance with document requests.

For competing companies, the question is whether the disclosure laws unlevel the playing field.

Dell has seasoned counsel who, I am sure, advised that each of these reorganization steps was perfectly legal. But the filings Lindsey sent to me also show what appear to be false filings in which changes were not properly reported. Dell would no doubt argue that these were mere oversights, but it is not up to Dell to judge whether that is so or whether they are part of a pattern of mixing aggressive tax avoidance with poor execution.

The IRS needs to audit Dell, and I think the Senate Homeland Security Permanent Subcommittee on Investigations or the Joint Committee on Taxation staff also needs to investigate.

Just as with Enron, in which the IRS was informed but did not act, the tax agency seems merely to be keeping its inquiry open.

The IRS remanded an audit for the 2004-2006 tax years after Dell protested assessments related mainly to transfer pricing issues. The remand goes to the issues raised in this column about how sophisticated companies are becoming at working around IRS audit policies, which are all available through the agency's manual, revenue rulings, and other documents that Tax Analysts has long played a major role in getting into the open.

Dell's quietly done reorganizations appear, in part, to be timed at two-year intervals. That would by itself complicate work for IRS auditors. But repeat restructurings suggest the company is aware that the IRS tends not to audit new entities.

Lindsey estimates that Dell owes $1 billion in U.S. corporate income taxes. My reading of the documents suggests Lindsey's estimate may be conservative.

Dell made numerous state-level filings that are, at best, inaccurate. If challenged Dell would surely argue these were inadvertent errors, along the lines of ministerial mistakes. The difficulty for Dell is that many of these documents, such as inconsistent Florida and Texas corporate filings, were signed year after year not by various junior members of the legal staff, but by Dell's top tax lawyer.

Of course, all of this assumes that the IRS and the SEC -- the tax police and the securities police -- conduct vigorous investigations, establish whether some filings were false, and, if so, then take enforcement action. SEC Staff Accounting Bulletin 99 is informing on the problems Dell may face (

If an IRS audit were to establish that for a decade Dell has repeatedly restructured to avoid the U.S. corporate income tax, then the tax savings Dell sought could evaporate.

Figure 1

Copyright 2013 Deene W. Lindsey

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Copyright 2013 Deene W. Lindsey

Figure 3

Copyright 2013 Deene W. Lindsey

Figure 4

Copyright 2013 Deene W. Lindsey

Figure 5

Copyright 2013 Deene W. Lindsey

Figure 6

Copyright 2013 Deene W. Lindsey

Figure 7

Copyright 2013 Deene W. Lindsey

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