How Offshore Corporate Income Tax Savings Works:

A quick practical example responding unfortunately belatedly to a student who, congrats, graduated a week or so ago and who asked, what was what with proposals from the Obama administration to tax US corporate income parked offshore? I ran across a short Bloomberg article giving a practical example of what's at issue with respect to Microsoft. The issue is this:

Obama on May 4 proposed outlawing or restricting about $190 billion in tax breaks for offshore companies over the next decade. Such business groups as the National Foreign Trade Council, the U.S. Chamber of Commerce and the Business Roundtable have denounced the proposed overhaul.

U.S. tax rules let companies defer paying corporate rates as high as 35 percent on most types of foreign profits as long as that money remains invested overseas. Obama says he wants to end such incentives to keep foreign profits tax-deferred so that companies would invest them in the U.S.

Here's how the current tax arrangements function for Microsoft:

Barry Bosworth, an economist in Washington at the Brookings Institution research center, said many software companies such as Microsoft have exploited tax and trade rules in the U.S. and other countries to achieve a low overall tax rate.

Typically, he said, a company like Microsoft develops a product like Windows in the United States and deducts those costs against U.S. income. It then transfers the technology to a subsidiary in Ireland, where corporate tax rates are lower, without charging licensing fees. The company then assigns its foreign sales to the Irish subsidiary so it doesn't have to claim the income in the United States.

"What Microsoft wants to do is deduct the cost at a high tax rate and report the profits at a low tax rate," Bosworth said. "Relative to where they are now, the administration's proposals are less favorable, so there will be some rebalancing on their part."

There is nothing illegal or unethical about this, of course; the tax rules were developed understanding these effects. It's an asymmetrical relationship; deduct at the high country rate and pay tax abroad at the low country rate. But given that the rules were set up with the effect of giving companies like Microsoft an effective lower tax rate - 26%, according to the article - a change in that rate will cause what Bosworth calls, a trifle blandly, "rebalancing," which is to say adjusting for the tax hit by moving jobs offshore. (It's also not very clear to me how the proposed change leads to increased investment in the US, unless one thinks of the tax paid in the US as a form of investment in the US government's investment plans.) However, good idea or not, the article gives a useful, quick, and real life example of how the current system works drawing on Microsoft.