By setting up in Luxembourg, and channelling sales through its units there, the worlds biggest online retailer could minimise corporate taxes. It was a move with big financial consequences.
Amazons Luxembourg arrangements have deprived European governments of hundreds of millions of dollars in tax that it might otherwise have owed. An examination of accounts filed by 25 Amazon units in six countries shows how they also allowed the firm to avoid paying more tax in the US, where it is based.
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.
Amazon declined to answer questions about its tax affairs for this story. In an email 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. The Luxembourg structure fulfils a corporate obligation to shareholders to maximise returns. There is no suggestion the firm has broken any laws; Amazon paid an average 44% 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.
Amazons 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. But in late 1999, accounts for the UK business show, the UK units principal activity changed from marketing and selling of books via internet to the provision of services to other group undertakings.
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 Amazons accumulated losses were over $1 billion.
In 2003, when Amazon started making a lot more profit in the US. There was a chance the foreign earnings would now increase its global tax bill because US corporate tax rates were higher than in other markets such as UK.
Amazon turned to the tiny country of Luxembourg, which offers a variety of advantages. Its a member of the European Union, so businesses based there can sell across EU borders with less red tape. Then theres the tax rate.
Luxembourg has a headline charge on corporate income of 29%, but under certain circumstances it will exempt income a company earns through intellectual property by up to 80%, a government spokesperson said.
This cuts the effective tax rate to below 6%. Tax advisers and academics say rates close to zero can be achieved using other methods.
In June 2003, Amazon registered Amazon Services Europe SARL in Luxembourg with the initials Societe a Responsabilite Limitee a limited company, liable for tax.
A month later, it told clients in the UK its terms were changing. Contracts with third-party retailers who used Amazon to sell their products would no longer be handled in the US but with the Luxembourg unit. In June 2004, Amazon established another Luxembourg entity Amazon Europe Holding Technologies whose purpose was to hold shares in Amazon group companies and to acquire ... any intellectual property rights, patents, and trademarks licenses and generally to hold, to license the right to use it solely to one of its direct or indirect wholly owned subsidiaries.
This group was set up as a Societe en Commandite Simple or SCS, a type of limited partnership that a Luxembourg government spokesman said is exempt from income taxes. It has not had any operational staff or premises, its registered address being the offices of a trust services company in an upmarket residential area west of Luxembourgs old town.
A month later, this company established a third Luxembourg company, Amazon EU SARL, whose principal purpose was to sell, auction, rent or otherwise distribute products or services of all types via Amazon websites.
This taxable unit was to become, on paper at least, the supplier of all goods and services to Amazons European customers.
To be tax efficient, Amazon needed to shift the profit this unit would make into its untaxed parent. The easiest way to do this was for Amazon EU SARL to pay Amazon Europe Holding Technologies a fee to license the Amazon technology it would use to sell things.
There was just one problem: Amazon Europe Holding Technologies had no technology to license. Amazons patents including the Amazon brand and its 1-click ordering software were held by Amazon Technologies Inc, a unit registered in Nevada. In early 2005, Amazon did an inter-company deal that solved this problem.
Details of the arrangement have never been made public. CFO Tom Szkutak told analysts on a conference call a few weeks afterwards that the deal to create the Luxembourg operation involved shifting certain operating assets offshore and that it would boost the groups 2005 tax bill by $58 million but beneficially impact our effective tax rate over time.
Amazons Luxembourg arrangements have helped it pay an average tax rate of 5.3% on overseas income over the past five years, less than a quarter of the average rate across its foreign markets.
Company accounts show that since 2005, Amazon Europe Holding Technologies started to make payments to Amazon Technologies Inc in Nevada of up to 230 million euros ($300 million) each year. At the same time it received up to 583 million euros each year from its European affiliates.
The difference stayed in Luxembourg. Had Amazon remitted all that to the US and then paid the headline US corporate income tax rate on it, the firm would have incurred taxes of more than $700 million. But it has not and the deal has allowed Amazons Luxembourg unit to accrue tax-free cash worth more than $2 billion.