Microsoft, Pfizer and other major drug and computer may soon face a having higher U.S. tax bills after the Treasury department said that it would tighten the rules on diverting profit to offshore tax havens.

Earlier last week, the Treasury Department issued regulations limiting cost-sharing arrangements which allow companies to undervalue patents, licenses, trademarks and other intellectual property that is transferred to a subsidiary from a parent company. These new rules require companies to value these assets at the same price they would charge a competitor to acquire them.

The IRS has increasingly been questioning such transfer pricing, which is a legitimate business practice that can be abused when companies either inflate or undervalue the price of goods that are sold between their international subsidiaries to reduce taxable income. Experts say that difficulties in the valuing of intellectual property have led to scuffles between the IRS and companies.

A former Treasury Department assistant secretary of tax policy, Ms. Pamela Olson, said that the rule change was “undertaken out of concern that existing regulations were outdated and that companies were using arrangements under the old regulations to strip income out of the U.S.''

Low-cost transfers allow companies to maximize their income in tax havens such as the Republic of Ireland while at the same time providing their U.S. parent companies with deductions for research and development expenses. Existing rules have helped companies to stockpile over $650 billion in cash overseas. A number of U.S. companies are repatriating those funds to the U.S. under a one-year tax holiday passed by Congress this year.

In recent years U.S. pharmaceutical and computer companies, including Pfizer, Intel Corporation, Microsoft, Oracle Corp., Abbott Laboratories, International Business Machines Corporation. and Apple Computer Inc. have invested in low-tax countries. The Irish Development Authority says foreign corporations employ over 130,000 Irish residents, about 70 percent of who work for U.S. subsidiaries.

Ireland has a corporate tax rate of 12.5 percent, which is quite less then the rate of 35 percent rate charged by the U.S. along with additional amounts charged by U.S. states. The U.S. Department of Commerce reported that in the year 2002, U.S. companies reported $18.3 billion in profit in Ireland, which is about 15 percent of that country's gross domestic product.

For years, the companies avoided paying U.S. rates on that profit by not repatriating the income to the U.S. corporate parent. This year, however, most of those companies are taking advantage of a one-time, 85 percent discount and have returned close to $200 billion at an effective U.S. tax rate of about 5.25 percent. According to J.P. Morgan Chase % Co., ultimately, as much as $350 billion may be repatriated.

The tax break has been particularly useful to drug and computer companies due to the fact that most of their income comes from patents and licenses. The companies divert their income to low-tax countries, seeking to claim as many deductible research and development expenses as possible in the U.S. in order to lower the tax bill on U.S. profits.

According to the Commerce Department, 42% of all U.S. imports and exports last year, amounting to nearly $770 billion in cross-border trade, were intra-corporate transactions.

Those figures don't include licensing and other intangible services, IRS Chief Counsel Donald Korb informed the Global Transfer Pricing Forum in Berlin last September. “Transfer pricing has been an area of particular focus for us,'' Korb said.

The regulations issued last week apply to cost-sharing arrangements between subsidiaries in all countries. The IRS will hold a public hearing in Washington on the regulations on November 16.

Tom Roesser, director of tax affairs for Microsoft, the world's biggest software maker, said he hasn't been able to review the regulations and couldn't discuss them. Paul Fitzhenry, a spokesman for Pfizer, the world's largest drug manufacturer, said he couldn't immediately comment

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