Hefty Tax Bill Might Await Motorola, Inc. Dispute Involving Transfer Pricing Could Cost Company $800 Million

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Byline: Anna Marie Kukec Daily Herald Business Writer

Motorola Inc. could face tax liabilities of roughly $800 million if it loses its appeals before the Internal Revenue Service, according to information filed with the U.S. Securities and Exchange Commission.

The IRS has been reviewing the Schaumburg-based company's tax returns for 2001 through 2003 and other years related to a legal accounting practice called "transfer pricing." This involves the price charged on transactions or products between a U.S. parent company and its foreign subsidiaries located in countries with lower tax rates.

Many American corporations with foreign subsidiaries, including those in technology, pharmaceuticals and clothing manufacturers, use transfer pricing. The accounting concept has been around for more than 20 years, but has garnered IRS scrutiny in recent years as more jobs and manufacturing have been transferred overseas, experts said.

The IRS looks at transfer pricing to ensure fairness, said Scott Singer, tax principal at the Naperville accounting firm of DiGiovine, Hnilo, Jordan & Johnson Ltd.

"The IRS often is concerned with companies moving profit from the United States to some off-shore location, like Hong Kong or elsewhere, that has a tax base that is less," said Singer.

The IRS doesn't track how many potential tax dollars could have gone to federal, state and local governments, if all of the profit had been recorded here. But it could be in the billions, experts said.

If it's determined that some of a company's income should have been recorded in the U.S. instead of overseas, the state would benefit, said Illinois IRS spokesman Mike Klemens.

"If it affects their bottom lines, then we would get a share of that bigger base," he said. "So transfer pricing does affect all of us."

How it works

Transfer pricing is a complex tax concept. It allows U.S. companies that do business with their foreign subsidiaries to carve up profits between them, said Thomas Ochsenschlager, vice president of taxation for the American Institute of Certified Public Accountants in Washington, D.C.

When manufacturers can produce goods overseas for less, they can enhance that benefit when that operation is in a country with lower tax rates than the United States.

It then becomes important to determine how much the foreign subsidiary charges the U.S. parent for the goods it produces, known as "transfer price." The higher the transfer price charged by the foreign subsidiary, the lower the income of the U.S. parent when it sells the finished product, said Ochsenschlager.

"Without any guidelines there would be a powerful incentive for U.S. companies to set the transfer price as high as necessary to eliminate most, if not all, the U.S. profit," said Ochsenschlager.

For example, if a U.S. company's subsidiary in Ireland makes radios for $25 and they're sold in the U.S. for $50, together the U.S. company and the Irish subsidiary would make a $25 profit. …