Uber stands to save billions—if it ever makes them, that is.
A little-noticed line in Uber's 2019 second quarter tax filing could mean enormous tax savings in the future. Using some old tax avoidance techniques, Uber has a way to shelter potentially tens of billions of dollars from the tax man, whether in the U.S. or EU.
The only question is whether the company will ever make any profits to take advantage of benefits, which are completely legal and will remain available for years.
Here's how it works. For decades, corporations structured themselves "so that they had an offshore entity in a low-tax jurisdiction where not so coincidentally, most of the profits ended up," explains Valrie Chambers, an associate professor of taxation and accounting at Stetson University. "Company taxes went down and shareholders were pleased. This phenomenon happened worldwide."
The line that gave away Uber's plans were in its Q2 earnings filing for the quarter that ended June 30. It noted "a transfer of certain intellectual property rights among wholly owned subsidiaries [in the Netherlands]."
Uber looks to be using a strategy popular among tech companies. They shift ownership of their own intellectual property (IP)— things like patents, copyrights, business processes, trademarks, and trade secrets—to a wholly owned subsidiary in a low-tax region.
"As different elements of that business require use of that property, it can be leased back [to those elements] to optimize where profits may fall within a corporation," said Jason Gerlis, USA sub-regional director of professional services firm TMF Group. The parent company and all its other divisions need legal access to the IP to operate, so they pay licensing fees to the subsidiary.
U.S. and international accounting rules treat the fees as expenses, even though the cost is really only on paper as money remains with the overall corporation and the parent company typically developed the IP. Uber would now pay its division in the Netherlands for the rights to use the business processes, software, and probably even trademarks and branding.
The process is called "earnings stripping" because it shifts profits from the higher tax area to the lower one by treating use of the IP as a business expense. The fees turn profits in one country into expenses that become revenue in another. All perfectly legal.
The mechanisms have become so sophisticated, using wholly owned subsidiaries in such countries as the Netherlands and Ireland, that the tactics gain such nicknames as the Dutch Sandwich and Double Irish. (Uber did not respond to Fortune's request for comment.)
Creating the tax breaks
By transferring the intellectual property to the Dutch subsidiary, Uber also created a massive tax break. There was a "step-up in basis to a fair market value" for the IP, according to Ryan Dudley, partner and co-practice leader of the international tax group of accounting firm Friedman. That is, the value of the IP was recalculated under accounting rules to determine what it would be worth now.
The new IP value generated a big set of "deferred tax assets"—like pre-paid tax payments or credits—in the Netherlands of $6.1 billion, according to Dan Lynch, an associate professor of accounting and information systems at the University of Wisconsin-Madison, who read the quarterly filing. The taxes would be calculated through multiplying profits by the tax rate. The rate could be either 25% or 7%, the lower number reserved for profits from IP "innovation" developed in the Netherlands, according to Dudley.
But given that the innovation largely happened in the U.S., the likely tax rate would be the 25% one. The result: The company's operations in the Netherlands could process $24.4 billion in profits without having to pay income taxes. Uber could send the $24.4 billion from the U.S. to the Netherlands over time as license fees use of the IP, shifting what otherwise would be profits in the U.S. to the Dutch division that wouldn't owe taxes itself.
One wrinkle: Because of the 2017 U.S. tax bill, Uber wouldn't be free of all tax on that profit. The legislation created a new tax called GILTI (standing for "Global Intangible Low Tax Income" and pronounced "guilty") assessed on such shifted earnings. But the rate is 10.5%, rather than the new standard corporate rate of 21%. The company can effectively still slash the tax bill on $24.4 billion in profit by half.
There would also be additional savings because Uber would avoid state taxes, including in such high-tax jurisdictions as California. "The California tax [alone] might be worth more than the federal tax," Dudley said.
Because of its previous red ink, Uber has a tax loss of $5.1 billion in the U.S. it can carry forward. That allows it to shield a separate $5.1 billion in U.S. profits from taxes here. Adding together $5.1 billion and $24.4 billion, the company can partially or completely shield a total of $29.5 billion in profits, altogether saving nearly $3.7 billion in tax payments.
And maybe losing the tax breaks
The irony is that with all the ways Uber could reduce taxes, it might not be able to at all—because, as investors well know, it isn't making profits.
In the Q2 filing, the company stated that it had put the Dutch and U.S. tax benefits into a "variation allowance," which is accounting terminology for putting the benefits to the side because management thinks there will be no way to use them in the foreseeable future, according to Lynch. "[W]hen companies book tax allowances, they predict future non-profitability," he said.
The foreseeable future also seems to be a long time. Under U.S. accounting rules, the $5.1 billion in losses can be carried forward for up to 20 years, says Dudley. Dutch rules would force Uber to recognize the tax breaks over a period of five years, at 20% a year. Once an amount is recognized, the company has six years to use it.
Some arithmetic suggests that Uber management conservatively may not expect profits for a whole generation (or until they can replace or supplement human drivers with self-driving cars).
Sounds like quite a long ride, at least for investors.
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