LUXEMBOURG: In 2005, Amazon rented a historic five-storey building in Luxembourg's Grund quarter, right at the bottom of a steep rock-walled valley below the old town.By setting up in Luxembourg, and channelling sales through its units there, the world's biggest online retailer could minimize corporate taxes.
It was a move with big financial consequences.
Amazon's Luxembourg arrangements have deprived European governments of hundreds of millions of dollars in tax that it might otherwise have owed, as reported in European newspapers. But a Reuters examination of accounts filed by 25 Amazon units in six countries shows how they also allowed the company to avoid paying more tax in the United States, where the company is based.
In effect, Amazon used inter-company payments to form a tax shield for the group, behind which it has accumulated $2 billion to help finance its expansion.
Amazon revealed last year that the US Internal Revenue Service (IRS) wants $1.5 billion in back taxes. The claim, which Amazon said it would "vigorously contest", is linked to its foreign subsidiaries and payments made between them.
The issue highlights the way multinationals reduce their taxes by parking intellectual property in tax havens and charging affiliates big fees for using it. Politicians in rich countries are beginning to target such practices, which have been used by other multinationals including Google and Microsoft.
US Senator Carl Levin has called the tactics "gimmickry." Michael McIntyre, a tax expert at Wayne State University in Michigan, said that while Amazon's arrangement, and others like it, looked like commercial transactions, they actually only served to reduce taxes.
"The IRS shouldn't be happy about this," he said. "It sounds like they're not."
Amazon declined to answer questions about its tax affairs for this story, the latest in a Reuters series on corporate tax avoidance. In an emailed statement a spokesman said that "Amazon pays all applicable taxes in every jurisdiction that it operates within."
The group has come under scrutiny from tax departments in at least six countries over the past six years. Tax authorities in the United States, UK, Germany, France and Luxembourg declined to comment, citing rules on taxpayer confidentiality.
The Luxembourg structure, outlined by media including the Guardian newspaper in April, fulfils a corporate obligation to shareholders to maximize returns. There is no suggestion the company has broken any laws; Amazon, which started out selling books and now offers everything from tools to toys, paid an average 44 per cent tax on its US earnings in the last five years.
This is an examination of how Amazon set up its tax shield, and how it works.
Amazon's first foray abroad came in 1998, when it bought online retailers in Britain and Germany and rebranded them Amazon.co.uk and Amazon.de. In 2000, it launched a French website, Amazon.fr.
At first it did little to integrate these foreign units, former senior executives say. Even product purchasing - where Amazon would later squeeze huge savings by negotiating hard with suppliers - was handled independently in different markets.
"There were no real operational synergies in our early years. The units operated largely independently," said Todd Edebohls, current CEO of recruitment website Inside Jobs, and Amazon's Director of Business Development and Sales between 1999 and 2007.
But in late 1999, accounts for the UK business show, the UK unit's principal activity changed from "marketing and selling of books via the Internet" to "the provision of services to other group undertakings."
People shopping on Amazon.co.uk would now do business with a US unit registered in Delaware. There were similar changes at the German business: in effect, the fast-growing European units had become fulfillment operations just to distribute packages and offer customer support. Amazon's accounts show the bulk of its overseas revenues were now attributed to the US parent.
That shift helped with a problem it faced at home.
Founded in 1995 and listed two years later, the company lost money every year until 2003. This was standard practice for a dotcom startup: Amazon focused on market share rather than profit.
But by the end of 1999 Amazon's accumulated losses were so large - more than $1 billion - that its own accountants would not let the firm recognize them as a tax asset, because it was unclear it could ever make enough profit to use them up. Bringing foreign profits home allowed Amazon to set them against US losses, so the company did not have to pay tax on overseas profits, according to Stephen Shay, a professor of tax law at Harvard University.
SERVICES, NOT BOOKS
That changed in 2003, when Amazon started making a lot more profit in the United States. There was a chance the foreign earnings would now increase its global tax bill, according to Shay, because US corporate tax rates were higher than in other markets such as Britain.
Amazon turned to the tiny country of Luxembourg. The Grand Duchy has a population of 500,000 - half the size of Rhode Island - and offers a variety of advantages. It's a member of the European Union, so businesses based there can sell across EU borders with less red tape. Then there's the tax rate.