Here's a Corporate Tax Loophole a Porsche Could Drive Through

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PorscheFor years, much of the tax-paying American public has been appalled by the loopholes that U.S. corporations and rich individuals use to reduce their tax liability to the IRS.

Elsewhere in the world, those big money players generally abided by more stringent rules.

But just as the U.S. has exported American culture in everything from entertainment to fast food, so, too, have companies in other countries started mimicking the moves that have made U.S. corporations infamous.

Since 2008, European car companies Volkswagen (VLKAY.PK) and Porsche (POAHY.PK) have been exploring different ways to combine into a single entity. A merger agreement in 2009 led to Volkswagen taking a 49.9% stake in Porsche. But the prospect of a tax bill as high as 1.5 billion euros that would be one result of the merger had led the two companies to postpone the transaction until late 2014 at the earliest.

Yet earlier this month, the companies said they were going through with their merger this year. How did they address the tax problem? By including a single share of Volkswagen stock -- worth less than $200 -- in the $5.6 billion it will pay Porsche, Volkswagen will be able to take advantage of a tax-law quirk that makes the transaction a "restructuring." The net result: Volkswagen will cut its tax bill by as much as 90%.

What's Fair Versus What's Right

As is the case with many U.S. companies that take advantage of similar loopholes, there's nothing illegal about what Volkswagen is doing. In fact, companies typically argue that they have a duty to investors to minimize taxes whenever they can.

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But the amounts involved make such loopholes difficult for ordinary taxpayers to swallow. Bloomberg interviewed one German political leader who noted that the ability of large companies to avoid so much of their taxes undercuts the confidence that all taxpayers have in the tax system. Similar tax shelters that U.S. multinationals take advantage of, such as keeping income locked in foreign subsidiaries rather than repatriating it and paying the resulting tax, have drawn similar ire from U.S. politicians. Large fractions of the cash that large tech companies have on their hefty balance sheets, for instance, represent foreign earnings on which they haven't paid any U.S. taxes.

With the federal budget badly out of balance, the U.S. government has targeted loopholes like these as ways to increase revenue. But the better solution would be to simplify taxes enough that the opportunity for complex tax-avoidance strategies would disappear. Until that happens, you can expect more deals like Volkswagen's to result in more lost tax revenue for countries around the world.

Learn how to be smarter about your taxes: Fool contributor Dan Caplinger pays his fair share of taxes. You can follow him on Twitter here.

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