Capitalism 101

I was just wrapping up business at the lemonade stand when the man walked over.

"Son, I couldn't help but notice that you stiffed your last two customers when you were making change. You screwed them for an extra two bits."

I looked down at the ground sheepishly. Selling lemonade is hard work after all and I didn't think anyone would notice the few extra coins bouncing around in my pocket. Next was sure to come the big lecture.

"That's not the way we do things in America, son." A tear welled up in the corner of my eye as the tall stranger prepared to let me have it.

"This is what you're going to do. We will take the lemonade business off shore and register it in the Cayman Islands. Using the Apple strategy we won't bring any of the profits back into the country where they are taxable but we can still get a few fat tax subsidies from Uncle Sam anyway. Like G.E., we can get billions back in tax rebates that we never have actually paid. Pure genius. We'll create an in house Irish entity and sell the lemonade stock to them and your debt to the United Sam will be practically nil. The old double irish strategy. You with me, son?"

I nodded my head in rapt attention.

"The company arranges for the rights to exploit intellectual property outside the United States to be owned by an offshore company. This is achieved by entering into a cost sharing agreement between the U.S. parent and the offshore company, in the terms of U.S. transfer pricing rules. The offshore company continues to receive all of the profits from exploitation of the rights outside the U.S., without paying U.S. tax on the profits unless and until they are remitted to the U.S.. On top of the double irish we will use something called the dutch sandwich. Bet you never heard of that? I'm giving you the keys to the kingdom, son. Rich people don't need to fleece people at lemonade stands or rob liquor stores. We hire rich tax attorneys to do our stealing on the books and real legit. Get me? It's brilliant. The people that write the tax code know all the trap doors."

"The dutch sandwich fits in with the double irish like bacon and eggs. The addition of a Dutch Sandwich to the Double Irish scheme further reduces tax liabilities. Ireland does not levy withholding tax on certain receipts from European Union member states. Revenues from income of sales of the products shipped by the second Irish company are first booked by a shell company in the Netherlands, taking advantage of generous tax laws there. Funds needed for production cost incurred in Ireland are transferred there, the remaining profits are transferred to the first Irish company in the Cayman Islands or Bermuda. If the two Irish holding companies are thought of as "bread" and the Netherlands company as "cheese," this scheme is referred to as the "Dutch Sandwich." The Irish authorities never see the full revenues and hence cannot tax them, even at the low Irish corporate tax rates. There are equivalent Luxembourgish and Swiss sandwiches available on the menu. All very delicious and quite filling."

"Of course, if you want to make lemonade, you have to start with lemons. Ralph Reed came up with this one and it's a beaut. Find an island chain like the Marianas Trenches that can grow citrus. No minimum wage. You bring in workers from China to work for pennies on the dollar and we get you a waiver so we can still claim that the lemonade is made right here in the ol' US of A. Jack Abramoff helped suss this one out. If anyone says anything, we merely point out that we are exposing the heathens to christendom. God and country and of course, our own swiss bank account while we are at it."

"You'll like this last one too. Made popular by a certain Republican candidate for President, wink, wink. Take your compensation in the form of "carried interest" and claim that such profits should be treated the same way a real capital investment in a partnership is treated, even though it is awarded as compensation for your management expertise and work and not as a return on an actual investment made. Sleazy yes, but legal as hell. You claim that you are a partner in the firm and that your compensation is a distribution of the partnership's profits (usually from gains on sales, and hence eligible for preferential capital gains) to them rather than compensation income.  As such you benefit from the extraordinarily preferential rate for capital gains in the current law as enacted under the Bush administration (generally 15%)."

"Of course after you buy those poor reeling companies your strategy is to put them far deeper into debt, using the debt to pay off the equity firm partners, then raid the pension plan, outsource the jobs and leave their tattered husks to rot in the midday son. Beauty of capitalism, son."

"Then there are the management fee conversion waivers. The conversion of management fees from ordinary income to capital gains is accomplished by "waiving" the fees (not necessarily across-the-board throughout the life of the firm, but often selectively and on a quarter-by-quarter basis),  Instead of getting fees, the partner claims they are "converted" to a share of related profits --i.e., they become an additional carried interest--and hence eligible for treatment as (deferred) capital gains from the firm."

"This private equity stuff is beautiful, really no risk and no skin, you look at businesses to raid that will finance themselves after you have destroyed them. Merely fruit waiting to be plucked."

"So, what do you think, kid?"

Johnny looked at the man carefully.  'I don't know, mister. I may have to get out of lemonade and go back to cutting lawns. This whole lemonade business just feels way too sleazy for me."

© Robert Sommers 2012