By Luc Cohen
NEW YORK (Reuters) - When Keurig Green Mountain Inc (NASDAQ:GMCR) said last December it was shifting its coffee buying operation to Lausanne in Switzerland from its headquarters in Waterbury, Vermont, it said the move would establish the company as a "global beverage player."
The seller of brewing machines and single-serve coffee pods said nothing about a little-known exemption in the U.S. tax code that for many years has benefited Starbucks Corp (NASDAQ:SBUX) and other U.S. companies who trade in some commodities.
In internal presentations, Keurig said the move was aimed at expanding into the European market and gaining access to Switzerland's talent pool of coffee traders, one source familiar with the transition told Reuters. But as the move took shape it became clear that tax savings were a key part of the plan, this person said.
Accountants and professors specializing in taxation told Reuters that Keurig is positioned to benefit from the 1970s-era exemption for commodities trading. By moving coffee buying, Keurig can also shift some income to Lausanne, where the tax rate is less than 10 percent. In Vermont, it faces a U.S. federal corporate income tax rate of up to 35 percent, and a state tax rate of up to 8.5 percent.
Keurig's new Swiss operation will be able to record profits by purchasing green coffee beans at one price, and selling them at a markup to the North American businesses that roast the coffee and sell it to consumers, the source said. This effectively shifts profits from the U.S. parent company to the Swiss entity in an entirely legal maneuver.
"The fact that Keurig is doing this is pretty clearly due to a loophole in the law that doesn't make a whole lot of sense," said Matt Gardner, executive director of the Institute on Taxation and Economic Policy, a nonpartisan Washington, D.C. think tank.
A Keurig spokeswoman declined to comment in response to a list of questions emailed by Reuters. When Reuters first reported the shift to Switzerland last December, the company declined to predict how its tax bill would be affected. Its overall effective tax rate in the fiscal year to September 2014 was 35.4 percent.
The U.S. tax code normally prohibits this type of activity, requiring foreign subsidiaries that act as buying agents for U.S.-based parents to send profits back to the United States to be taxed.
But in 1975, Congress added an exemption, allowing offshore subsidiaries to keep profits abroad if they came from the trade of four commodities: black pepper, cocoa, coconut and tea. Coffee, bananas and crude rubber were added in 1978.
Clearly, there are benefits to operating in Switzerland besides tax savings. At least half the 90 million bags of coffee traded each year goes through Switzerland-based companies, according to the Swiss Trading and Shipping Association, and the country is a center for commodity finance and logistics.
Still, the tax exemption provides an incentive for Keurig, the tax experts said. Starbucks made a similar move in 2001, establishing Starbucks Coffee Trading Company in Lausanne. A source familiar with that move said the agricultural commodities exemption was a key factor.
In a written statement in response to questions from Reuters about its arrangement, Starbucks said "we comply with all relevant tax rules, laws, OECD (Organization for Economic Co-operation and Development) guidelines and pay a global effective tax rate of 34 percent."
There is a downside to the tax strategy that can be associated with the shift. The profits will need to be kept offshore, as once they are brought back to the U.S. they can be taxed. That is fine if a company needs the money for a big expansion overseas – which was the case with Starbucks in the past 14 years.
Keurig, which did 87 percent of its business in the United States last year, and almost all the rest in Canada, has said overseas growth is a "key element" of its business strategy and last year began introducing its brewers in the United Kingdom, South Korea, Australia and Sweden, according to a corporate filing.
Keurig has previously said a small group of staff would move from the U.S. to Switzerland but it has declined to be specific about how many positions will be eliminated in Vermont, telling local media it will be fewer than 100. Keurig Trading has been hiring several buyers in Switzerland from Swiss commodities traders.
While Keurig Trading will be arranging the shipment of beans from places like Brazil or Colombia to where they are roasted and sold, the coffee's trajectory will not change and there are unlikely to be any beans physically passing through Switzerland. That has largely been the case for Starbucks, according to several sources with knowledge of the arrangement.
It is unclear how much tax Keurig, whose shares have been sinking for much of this year because of a drop in sales, will save in the move. The tax specialists interviewed said it was difficult to estimate Keurig's total tax savings without knowing the internal transfer price at which the Swiss arm sells coffee to the U.S. parent, which Keurig has declined to disclose. In its last fiscal year, Keurig committed to buying $407.7 million worth of coffee.
During a 2012 investigation into Starbucks' United Kingdom tax payments, Member of Parliament Margaret Hodge accused the world's largest coffee chain of "exporting your profits to minimize your tax."
Starbucks' then-chief financial officer Troy Alstead testified that its Swiss operation charges other Starbucks entities a 20 percent markup on beans, which coffee traders say is well above industry norms of more like 1-2 percent.
When the exemption was introduced in the 1970s, industry lobbyists argued it was necessary because the commodities included were not grown in the United States in "commercially marketable quantities."
That logic might make sense if the companies set up subsidiaries in countries where the agricultural commodities are grown and paid local taxes there, the experts said. But in reality, buying subsidiaries are normally set up in places like Switzerland, which have "no connection to where the commodity is grown or where it is destined," said Bret Wells, associate law professor at the University of Houston.
In addition to Starbucks and Keurig, companies with Swiss trading subsidiaries that could benefit from the exemption include spice seller McCormick (NYSE:MKC) & Co, the largest U.S. importer of black pepper, and Chiquita Brands International, the largest U.S. importer of bananas, which is owned by Brazilian juice company Cutrale Group and investment firm Safra Group. McCormick and Chiquita did not respond to requests for comment.
"It doesn't make sense. I don't know why it's there," said Larry Pollack, tax partner at KPMG in New York, who said he once advised a client to take advantage of the exemption. "Someone must have had a strong lobby back then."