In November 2009, eBay Inc announced that an investor group led by Silver Lake
had acquired a majority stake in Internet calling company Skype from the
company. Skype's Estonian founders, Niklas Zennstrom and Janus Friis, retained
a 14% stake and Silver Lake, investors including Andreessen Horowitz and the
Canada Pension Plan Investment Board (CPPIB) held 56%, and eBay retained 30%.
The deal valued Skype at $2.75 billion.
A year and half later, in April 2011, Skype's regulatory filing put the value
of the company at about $5.1 billion. A month later, Microsoft bought the
company for $8.5 billion, and there have been debates whether or not Steve
A simple numerical calculation shows that he did not. The "premium" Microsoft
paid to Skype's owners was roughly what
they would have paid to the US government if Microsoft repatriated its money.
If Microsoft brought back $8.5 billion to the US, it would have paid the 35%
corporate tax, roughly $3 billion.
Thus, as far as Microsoft is concerned, its "net" payment for Skype amounted to
$5.5 billion. However, instead of the US government getting $3 billion, private
equity investors, the Canadian Pension Investment Board and eBay shareholders
got most of it. Thank the US Congress for such a windfall.
This redistribution from potential tax revenues to private equity could not
have happened if corporate taxes were not in the 35% range, inducing US
companies to hold their money in foreign jurisdictions with much lower
US companies with worldwide operations hold cash in foreign lands because they
do not pay US corporate tax on the earnings of their foreign subsidiaries as
they occur: They pay it only when the company repatriates them to the US.
While it is true that select pensioners and shareholders occasionally benefit
from such arrangements too, as many pension funds hold private equity firms in
their portfolio, they would benefit far more if such fiscal incentives to
structure deals did not exist, since more companies would take the IPO route,
and private equity financiers would not be able to get a few billion dollars
for quickly flipping over a company.
To make Skype-type deals, the acquiring company had to accumulate the money
outside the US, and the companies they would be acquiring would have to have
the incentives to register outside the United States too.
With an estimated $600 billion held overseas, mainly by technology and
pharmaceutical companies, successful start-ups have fewer incentives to take
the IPO route in the US, have greater incentives to register in foreign lands
too, and wait for being privately acquired. By registering their patents and
copyrights in either the Netherlands or Luxembourg, their private sale or
purchase would also pay little in the way of taxes.
Which is what they do: Skype was incorporated in Luxembourg, a jursidiction
virtually free of corporate tax. Google's international operations are located
in Ireland, where corporate taxes are 12.5%, but Google does not pay even this
lower rate on the $12.5 billion revenues from its foreign operations.
The money from Google Ireland goes to Google Netherlands Holdings, and
Ireland-based companies do not pay tax on money flowing into a company
registered in another European Union country. After this tax-free Dutch detour,
the money ends up in Bermuda.
Why is Netherlands in the middle? In part because the country has some unique
legal entities, allowing corporations to pay no taxes. The Stichting are
the most common not-for-profit organizations in the Netherlands though
for-profit companies manage to get this tax exempt status, IKEA being the most
prominent. It, like Google, end up paying 3% in taxes.
It's worth making a quick detour to see how this is achieved, since it shows
what options are open to Washington if it wants US companies to compete
internationally and also deal with preventing quick tens of millions of
compensations to managers of private equity firms.
IKEA's parent is Ingka Holding, a Dutch company, entirely owned by Stichting
Ingka, to which Ingvar Kamprad, its founder, donated all his shares in 1982.
This non-profit is dedicated to "innovation in the field of architectural and
However, the foundation's cash is transferred to Stichting IKEA Foundation,
which can use the money for "for investing long-term in order to build a
reserve for securing the IKEA group, in case of any future capital
requirements". (This Thanksgiving, every US family should pray for getting such
charity, use the money to invest in future generations and secure the family
name. Or, instead of praying, vote for it, next year.)
This is not the end of IKEA's legal structure. Inter IKEA Systems, another
private Dutch company but not part of the Ingka Holding group, holds the
intellectual property rights to its "trademark" and "concept". The owner of
this Dutch entity is Inter IKEA Holding, registered in Luxembourg. A separate
company in the Netherlands Antilles owns it, which in turn is run by a trust
registered in Curacao. IKEA, as noted, ends up paying roughly 3% in corporate
Which brings us back to Skype. The Silver Lake Funds that owned shares in Skype
were registered in the Cayman Islands, and eBay's Skype ownership was held by
eBay International AG unit based in Bern, Switzerland. As long as the US has
corporate taxes in the 35% range, whereas those in the rest of the world are
much lower, one should expect:
such registrations to continue;
for the estimated $600 billion of US companies held abroad not to be
for technology and any patent-holding US young companies to register abroad and
rely less on the domestic IPO route.
All the above have the impact of fewer IPOs, restricting options of the vast
majority of US citizens to invest. Add to the above the increased regulatory
and compliance burdens of the last few years and, last but not least, the
extremely low interest rates and it is not surprising that private equity and
venture capital have been by far the two best-performing asset classes in the
US during most of the last 20 years, according to a recent Cambridge Associates
report, but benefiting relatively few.
If Washington wants to prevent redistribution of wealth from the vast majority
of taxpayers to a few players in financial markets, only a drastic revision of
the corporate tax code would do. Paradoxical as this may sound in this
misguidedly deficit-focused debate, where growth and rebuilding-equity is
needed the solution is to drastically lower some taxes while eliminating a
large range of loopholes.
If Washington also managed to stabilize the dollar while changing the tax code,
the disappearance of trillion dollars in derivatives would bring about a
further retrenchment of not only the financial sector but the legal/accounting
sectors too, and bring about a much-needed reallocation of mathematical,
statistical and business minds to other parts of the economy. The future of the
retiring mass of Baby Boomers' pensions would start to be looking better too.
Reuven Brenner holds the Repap Chair at McGill University's Desautels
School of Management, and serves on the Board and investment committee of
McGill's pension fund.
(This is an edited version of an article that is also published by