How Google cut its taxes by $3.1B: what this technique means for your startup

No doubt many small and medium-sized business owners have read about the “double Irish” structure used by nearly all large U.S. technology companies to dramatically reduce their worldwide effective tax rate.

There are several variations of the structure, but generally, they each initially require a U.S. company to migrate its intellectual property to an offshore subsidiary resident in a low-tax jurisdiction. Then, the offshore subsidiary (instead of the U.S. company) receives royalties on the use of the intellectual property outside of the United States. As a result, tax on the royalties is deferred until they’re repatriated.

The tax deferral can be valuable: in 2010, Bloomberg famously reported that Google used this structure to lower the tax rate on its foreign income to 2.4 percent.

Late last year, the United Kingdom’s Parliament criticized the structure as creating a competitive advantage available only for large companies. But is that true? Or, can smaller companies implement the structure and emulate Google’s results?

The short answer is yes, any company could conceivably implement the structure. But that doesn’t necessarily make it a good idea.

The longer answer requires a company to analyze the costs, benefits, and risks, including the following:

• Although migrating intellectual property offshore can lead to substantial tax savings, this type of tax planning is expensive.  
• A structure will not work if it is not properly executed and monitored for changes in the international tax laws that could affect your company.
• Sophisticated international planning also increases ongoing tax compliance costs and attracts the attention of revenue-hungry legislatures and tax administrators across the globe. For instance, right now, the Organization for Economic Cooperation and Development, an influential international group of governments that share economic development ideas, is studying whether its members should coordinate efforts to reduce the tax benefits attendant to the double Irish.

In weighing whether the expenses and risks involved make international tax planning worth the investment, Google has economies of scale in its favor that smaller companies do not. On the other hand, other factors weigh in favor of companies migrating their intellectual property sooner than later.

For one thing, the tax cost commensurate with the migration only increases as the intellectual property gets more valuable. A startup company can better support a favorable valuation than a more well-known company that has already begun to exploit its intellectual property. As a result, the earlier the U.S. company migrates its IP, the lower the U.S. tax cost imposed on the migration itself is.

And, Parliament’s criticism was right about one thing: companies not engaged in intellectual property migration are at a distinct disadvantage because they’ll continue to pay tax at a much higher rate than their peers.

A forward thinking company may be well advised to begin considering intellectual property migration when it first considers expanding outside of the United States, as that is the first time that valuable deferral can be had.

At that time, based on the company’s own profits projections, a tax adviser can predict when the tax structuring rewards will first outweigh the related expenses, and the tax adviser can counsel the company on the current state of the law – whether risks or opportunities may emerge that could weigh in favor of or against intellectual property migration.