A U.S. Senate committee memo said Microsoft Corp. usedaggressive international tax maneuvers to avoid billions of dollarsin taxes over the past three years.

The committee memo, released for a hearing today in Washington,said Microsoft used transactions with subsidiaries in Puerto Rico,Ireland, Singapore and Bermuda to save at least $6.5 billion intaxes. The committee also revealed that Hewlett- Packard Co. hasused a series of short-term internal loans that allowed the companyto tap its offshore cash for domestic operations without payingtaxes, according to the memo.

Senator Carl Levin, a Michigan Democrat and chairman of thePermanent Subcommittee on Investigations, didn't accuse thecompanies of acting illegally, though he said he was “highlydubious” that HP was in compliance with the tax law.

Such financial maneuvers “may be in your temporary interest as acorporation,” Levin told Bill Sample, Microsoft's corporate vicepresident for worldwide tax, at the hearing. “It increases yourprofits and reduces your taxes, but there's a heavy cost to theUnited States,” Levin said.

Levin and the panel's top Republican, Tom Coburn of Oklahoma,sent the memo to committee members.

Coburn described the moves as “properly legal tax avoidance” bycompanies taking advantage of a tax code that needs anoverhaul.

“Our report is about the symptoms of the disease, not the realdisease,” he said at the hearing.

The report describes the ways companies can move profits outsideof the country and keep them there to avoid U.S. taxes.

“We comply with U.S. and foreign tax laws,” Sample said at thehearing. “That is not to say that the rules cannot beimproved.”

U.S.-based companies owe U.S. taxes on profits they earn aroundthe world. They receive credits against that liability for taxespaid to foreign governments, and they don't have to pay U.S. taxesuntil they bring the money home.

The gap between the 35 percent U.S. corporate tax rate and lowertax rates in the rest of the world gives companies an incentive tobook profits outside of the U.S. Levin said technology companiescan easily move intangible assets such as patents outside of theU.S. with intra-company transactions at low prices.

Hard to Value

Those intangible assets are hard to value, and disputes aboutthe correct price for such intra-company transactions are common.When foreign subsidiaries in low-tax countries pay too little,either up front or over time, they can get annual profits paid tothem out of proportion to what they paid.

“The high-tech industry is probably the number-one user of theseoffshore entities to transfer intellectual property,” Levinsaid.

In questioning Sample, Levin outlined how Microsoft usestransactions within the company, all with its own money, to assignabout 47 percent of its income from U.S. sales to a Puerto Ricosubsidiary, and how it shifts some income from around the world toa Bermuda subsidiary that has no employees.

Levin's investigators sent letters to companies and usedsubpoenas to get information that companies don't typicallydisclose. He said they focused on Microsoft and HP to show patternsthat are common across U.S. companies.

Levin attributed such tax avoidance in part to a lack ofenforcement by the Internal Revenue Service, gaps in IRSregulations and “loopholes” created by Congress.

Levin emphasized HP's use of loans to tap its offshore cash. Theloans, the report said, are structured to comply with the letter oftax rules that allow short-term loans from subsidiaries in Belgiumand the Cayman Islands to the parent company.

Although long-term loans would trigger tax consequences, thealternating-loan program provided a potential continuous stream ofmoney for HP.

The memo, citing company documents, said as much as $5 billionwas available to the parent company in 2008 and that the companyborrowed from $6 billion to $9 billion in 2010. HP holds $29.1billion in untaxed earnings outside the U.S., according to thecompany's most recent annual filing.

Fiscal Calendars

IRS rules allow companies to take loans from foreignsubsidiaries without tax consequences within a given fiscalquarter. The Belgian and Cayman subsidiaries have different fiscalcalendars.

The company developed a schedule that allowed loans from theBelgian subsidiary within its fiscal quarters, and then loans fromthe Cayman subsidiary with a calendar that covered the periods whenthe Belgian subsidiary was crossing from one quarter to thenext.

Lester Ezrati, a senior vice president for tax at HP, said atthe hearing that the company did have gaps in its borrowing fromthe foreign subsidiaries. He also said the IRS didn't raiseconcerns when it examined the loans during a recent audit.

HP has fully complied with U.S. tax law, the company said in astatement.

“We are disappointed to see what appears to be a politicallymotivated attack on one of America's largest employers,” itsaid.

Bloomberg News

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