“How Do Tax Haven Schemes Work?

Imagine a hypothetical pharmaceutical company creates a new drug. Before putting it on the market, they sell the drug patent to a subsidiary that consists of just a post office box in the Cayman Islands, at practically no cost. The drug is produced, marketed and sold to U.S. customers in the United States. The U.S. company then pays inflated ‘royalties’ or ‘licensing fees’ to the offshore subsidiary. It deducts this “expense” from its taxable income, thereby avoiding corporate taxes.

The technique used by the hypothetical pharmaceutical company manipulates ‘transfer pricing,’ which refers to prices theoretically charged in transactions between subsidiaries of the same corporation. To shift profits offshore, one entity will undercharge or overcharge the other so the profits are booked to the tax haven country, while ‘business expenses’ are booked to the company in the higher tax country.”

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