Bolstered by new auditing powers, federal tax officials are investigating many U.S. subsidiaries of Japanese companies on the suspicion that they have underpaid corporate income taxes by billions of dollars. As foreign-owned assets in the United States more than tripled in a decade to $1.8-trillion, the gross income that foreign-owned companies made here more than doubled.
But the total taxes they paid hardly changed, data compiled by the IRS show.
Of the 36,800 foreign-owned companies filing returns in 1986, more than half reported no taxable income.
Tax officials assert that some subsidiaries understate income, thus minimizing tax liability, by manipulating transactions with parent companies.
But the IRS has been frustrated in efforts to audit these companies' returns because important financial records are often kept at headquarters abroad, in foreign languages, with much less detail than would be required in the United States.
To aid IRS investigations, Congress has provided an important tool.
Under a little-noticed provision of a law signed by President Bush on Dec. 19, Congress gave the tax agency broad authority to assess taxes on foreign-owned companies that fail to comply promptly with demands for records or testimony.
Those that do not cooperate can be fined as much as $10,000 a month, with no limits on the cumulative penalty.
The law has important implications for U.S. distributors of cars and electronic goods made in Japan.
The law applies to all foreign-owned businesses, but Japanese-owned companies have attracted IRS attention because they are active in manufacturing industries where federal investigators have found a potential for abuse.
"We don't target a particular country for enforcement," said Charles S. Triplett, deputy associate chief counsel of the tax agency.
"Nonetheless, it's pretty clear that the Japanese do a lot of business here and have many U.S. subsidiaries acting as distributors of manufactured goods."
One IRS official said suspected underpayments amounted to at least $12-billion.
Critics of the IRS say the agency sometimes cites extreme cases or amounts to support its contention that the government has been cheated.
But tax experts, accountants and economists outside the government say tens of billions of dollars are at issue in cases involving U.S. affiliates of foreign companies.
IRS data show that in 1986 U.S. subsidiaries of foreign companies took tax deductions of $544-billion against total receipts of $543-billion.
A recent study by the Congressional Joint Committee on Taxation expressed concern about the issue.
"There is some indication that the level of tax payments of foreign-owned businesses in the United States is unusually low," the report said.
Multinational companies, including those based in the United States, face difficult tax questions all the time because they do business in countries with widely varying tax systems.
Allocating income and deductions among national units of a multinational company is thus a complex area of tax law.
Tadashi Iwashita, a financial counselor at the Japanese Embassy in Washington, said that Japanese companies conscientiously tried to comply with U.S. tax laws.
The Japan Tax Association, a group of tax experts from major Japanese companies, said the IRS was partly to blame because it had not established "concrete guidelines" for determining the appropriate price in transactions between units of a multinational company.
Federal tax officials say American distributors of foreign-made goods can reduce their profits, and thus their tax liability, by paying high prices to the parent corporations for goods, services and technology.
Under federal law, a parent company is supposed to charge its subsidiary the same price as a buyer would pay an unrelated seller in the open market _ the "arm's length price."
The IRS, responding to a big increase in foreign investment in the United States, says that "the examination of transactions between foreign parents and their U.S. affiliates will become an increasingly important part" of its enforcement work.
Alexander Zakupowsky Jr., a lawyer for the U.S. subsidiary of Yamaha Motor Co., said:
"There is a clear pattern of the IRS looking at the importation of Japanese products into the United States."
Yamaha makes motorcycles. Its U.S. subsidiary imports and distributes them.
In a case pending in the U.S. Tax Court, the IRS asserts that Yamaha's U.S. affiliate understated its income and overstated the amount it paid to the parent company for motorcycles and related products.
It contends that the subsidiary underpaid income taxes by a total of $133-million from 1977 through 1984 and is trying to collect that amount, plus $13-million in penalties.
The taxation of foreign companies doing business in the United States, an esoteric area of tax law for many years, has suddenly attracted the attention of politicians concerned about foreign investment and trade.
Rep. Richard A. Gephardt of Missouri, the leader of the Democratic majority in the House, and Sen. Jesse Helms, R-N.C., have expressed concern that foreign-owned companies are paying lower taxes than U.S.-owned companies with similar sales.
"That is wrong, and we've got to do something to turn it around," Gephardt said.
Helms asserted that the disparities gave foreign-owned companies an unfair competitive edge.
James E. Wheeler, a professor of accounting at the University of Michigan in Ann Arbor, who worked for the IRS on sabbatical leave in 1986-87, said:
"On the average, foreign-owned U.S. corporations pay substantially less tax to the U.S. government than the American firms with which they compete."
They also report lower profits.
"The extremely low rate of return on the assets of U.S. companies owned by foreign corporations is astonishing and unbelievable," Wheeler said.
"In my view, they are just trying to avoid U.S. income tax."
Japanese executives, lawyers and accountants say Japanese companies are often willing to accept low profits for a decade or more while they try to gain a foothold in the U.S. market.
But U.S. officials say the subsidiaries of Japanese companies continue reporting low profits long after they have gained a secure position.
As part of its investigation, the IRS has retained an economist to collect information in Japan on taxes paid by Japanese companies that do business in the United States.
The economist, Kozo Yamamura, is a professor at the University of Washington in Seattle and has edited an important study of Japanese investment in this country.
In a typical case, the federal government asserted in the early 1980s that Toyota Motor Corp. in Japan had records needed by the IRS.
Federal auditors issued a summons for huge amounts of confidential business data kept at Toyota's Japanese headquarters.
They wanted to see if Toyota was charging U.S. distributors more than it charged Japanese car dealers for the same cars.
Toyota fought the summons.
The case ended in 1987, when Toyota's American sales unit was reported to have paid an undisclosed amount of additional taxes.
Michael F. Patton, an international tax lawyer who used to work at the IRS and now works at Ernst & Young, an accounting firm, said:
"The new law puts a lot of power in the hands of IRS agents. If they conclude that a foreign-owned company has not complied with a request for information, they can make an arbitrary assessment of taxes."
Under the law, if the tax agency requests records and a foreign-owned company fails to produce them, the government can levy taxes solely on the basis of information available to the IRS, without regard to data that might later be supplied by the taxpayer.
"Foreign companies will not like this law in the least," said John E. Lanman, international tax partner at Ernst & Young.
"They will see it as an intrusion on their business, a violation of national sovereignty. Many Japanese companies are very concerned about what they see as the Draconian powers given to IRS."