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* Tax benefits turn "good deal into a great deal"-expert
* Deal gives Google 17,000 patents
* Acquisition highlights lack of rules for valuing patents
By Lynnley Browning and Nanette Byrnes
FAIRFIELD, Conn./CHAPEL HILL, N.C., Aug 31 (Reuters) -- Google Inc's (GOOG.O) blockbuster acquisition of Motorola Mobility Holdings Inc (MMI.N) will bring an unusual stable of tax and accounting benefits to the search-engine giant, already one of Corporate America's most savvy users of such perks.
The deal also underscores a trend by technology companies to snap up patents in a bid to stave off competitive threats and patent-infringement lawsuits. Google's patent portfolio is seen as one of the weakest in the industry.
By agreeing on Aug. 15 to pay $12.5 billion in cash for struggling Motorola Mobility's vast portfolio of 17,000 patents and 7,500 pending patent applications on top of its handset business and television set-top boxes, Google is building a defensive bulwark for its Android phone software, already available on Motorola phones among others.
The acquisition, Google's largest ever, has legal tax and accounting benefits, many associated with the money Motorola Mobility has lost over the years, according to experts who have studied its details.
"The tax benefits of the deal make what was a good deal into a great deal," said Robert Willens, a New York accounting and tax expert. He estimated that through the acquisition, Google can expect to reap $700 million a year in tax deductions from future profits each year through 2019. Google also will be able to immediately reduce its taxes by $1 billion due to Motorola Mobility's U.S. net operating loss, and by a further $700 million due to its foreign operating loss, he said.
These are deductions which Motorola Mobility has been unable to use because of a faltering business that has failed to generate the revenue against which to offset them. The deductions include those for research and development, tax losses in the United States and abroad, and credits carried over.
While Motorola Mobility has lost $3.9 billion on its U.S. business pre-tax over the past three years and generated a $630 million pre-tax profit on its operations abroad, Google made $11 billion in global pre-tax profit last year.
In 2009, the Internal Revenue Service changed rules that previously said the tax benefits associated with a loss-making company could only be used by that company to offset its own income. The change, according to Willens, "makes Motorola Mobility that much more valuable to Google, which will clearly utilize the losses."
The IRS kept a separate rule saying that a company could not acquire another company primarily for its tax benefits -- something Willens said Google was not doing, even as it benefited from the tax component of the acquisition.
The acquisition further highlights the lack of transparency in accounting rules on how intangibles such as patents, brand names and the like are valued and their worth to investors.
Google has yet to announce the value it will give Motorola's intangibles, but experts agree it will be far more than what is currently on the cell phone maker's books. In a recent filing, Motorola Mobility reported an amortized value of $176 million for its intangible assets as of July 2, 2011.
Valuing patents may be more an art than a science.
Kevin Smithen, an analyst at Macquarie Capital, an investment firm in New York, estimated the $12.5 billion purchase price represented a $4.5 billion value for Motorola Mobility's patent portfolio, $3.2 billion in cash the company holds, a $3 billion handset and TV set-top business, and $1.7 billion in net operating loss tax benefits it has been unable to use.
Willens estimated the $12.5 billion deal will include $3 billion in goodwill, or the value Google expects to generate from Motorola Mobility's brand, know-how and other intangibles, not including the patents. He added that Google would be able to immediately use the $1 billion in U.S. operating losses absorbed from Motorola Mobility, thanks in part to how goodwill is amortized.
Even before the acquisition, Google was an adept manager of its corporate tax bill.
According to its Securities and Exchange Commission filings over the past five years, its foreign earnings soared to 54 percent of its total profits in 2010, from 33 percent in 2006. Meanwhile, its foreign revenue nudged up more slowly, to 52 percent from 43 percent. Experts say the difference can be explained by Google's increasing use of its subsidiary operations in the low-tax jurisdiction of Ireland.
Since 2006, Google has never paid more than 2.9 percent in foreign taxes on its foreign earnings, well below Ireland's statutory 12.5 percent corporate rate and a fraction of the 35 percent U.S. rate. In the United States, the company pays a far larger slice of its earnings in taxes -- 33 percent in 2010. But with more and more profit being recorded overseas, Google's combined global tax rate is dropping. Last year the company's worldwide tax bill came to 21 percent of profits. The search giant now holds $17.5 billion in profits outside the United States. In its filings, Google says it intends to leave that money overseas permanently, but the company is part of a group of firms lobbying Congress for a one-time chance to repatriate their foreign cash at a reduced tax rate.
Motorola Mobility, spun off from Motorola Inc in early 2011, appears to have used foreign tax jurisdictions less extensively, though financial filings do not detail its offshore subsidiaries and other entities. Before the merger announcement, Peter Look, the company's corporate vice president for tax, was leading development of a global tax function to manage over 100 legal entities spread out across 40 countries. It is not clear if those entities refer to operating subsidiaries or offshore entities.
Aaron Zamost, a Google spokesman, declined to answer questions about the tax and accounting benefits of the deal. Motorola Mobility also declined to provide further information on the deal.
Under accounting rules, assets developed in-house are not recorded as an asset on a company's balance sheet. Even when such assets are acquired, through a merger or acquisition, their value is recorded as a short-lived asset or as goodwill.
"This Motorola deal highlights this anomaly in the accounting today," said Esther Mills, president of Accounting Policy Plus, an advisory firm in New York specializing in complex accounting matters.
The Obama administration has proposed tightening up definitions of intangibles and foreign goodwill to make them taxable and making foreign entities with a single, U.S. owner subject to U.S. income tax, even if they are in a low-tax jurisdiction. Separately, the IRS is increasingly concerned about abuses in which companies low-ball the prices they charge subsidiaries for goods and services and thus pay correspondingly less tax.
Where Google books revenues from the Motorola patents could play a big role in further lowering its corporate tax bill.
"I assume that's what they have in mind -- to convert the Motorola business to lower-tax jurisdictions," said James Hines, a corporate taxation professor at the University of Michigan.
Under IRS rules on transfer pricing, a legal and controversial financial maneuver governing the prices companies charge their divisions and subsidiaries for goods and services sold between them, Google could shift Motorola's patents to a low-tax jurisdiction. They would have to pay a fair price for their use, but tax experts argue that upfront cost is often well worth the future tax savings. Google could also use a cost-sharing agreement, a form of transfer pricing that governs the development of new patents and technologies.
In a 2008 analysis, Professor Ronald Dye of the Kellogg School of Management at Northwestern University said cost-sharing agreements could cut a company's tax bill by 80 percent compared with pure transfer pricing agreements. But he said it was "impossible" to tell what that would look like from Google's and Motorola Mobility's recent filings.
Paul Flignor, an economist at DLA Piper in Chicago, said that "pen strokes move IP," adding that Google's acquisition provides it with a golden opportunity to further shrink its taxes. "Google will be very aggressive about that." (Reporting by Lynnley Browning in Fairfield, Conn., Nanette Byrnes in Chapel Hill, N.C., and Dena Aubin in New York; Editing by Howard Goller and Tim Dobbyn)