IN 2005, Amazon rented a five-story building in Luxembourg. By channelling sales through its units there, the world's biggest online retailer could minimize corporate taxes.

These arrangements have deprived European governments of hundreds of millions of dollars in tax. And an examination of accounts filed by 25 Amazon units in six countries shows they also allowed the company to avoid paying more tax in the United States, where the company is based.

In effect, Amazon used inter-company payments to form a tax shield, behind which it has accumulated US$2 billion to help finance its expansion.

Amazon revealed last year that the US Internal Revenue Service wants US$1.5 billion in back taxes. The claim is linked to its foreign subsidiaries and payments made between them.

The issue highlights the way multinationals reduce taxes by parking intellectual property in tax havens and charging affiliates fees for using it. Politicians in rich countries are beginning to target such practices.

Michael McIntyre, a tax expert at Wayne State University in Michigan, said: "The IRS shouldn't be happy about this," he said. "It sounds like they're not."

In a statement an Amazon spokesman said: "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 maximize returns. There is no suggestion the company has broken any laws. Amazon, which started out selling books and now offers everything from tools to toys, paid an average 44 percent tax on its US earnings in the past five years.

Amazon's 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 Amazon.fr in France.

At first it did little to integrate these foreign units.

But in late 1999 the UK unit's principal activity changed from "marketing and selling of books via the Internet" to "the provision of services to other group undertakings."

People shopping on Amazon.co.uk would now do business with a US unit registered in Delaware. There were similar changes at the German business. In effect, the fast-growing European units had become fulfillment operations just to distribute packages and offer customer support.

Amazon's accounts show the bulk of its overseas revenues were now attributed to the US parent.

That shift helped with a problem it faced at home.

By the end of 1999 Amazon's accumulated losses were so large - more than US$1 billion - its accountants would not let the firm recognize them as a tax asset, because it was unclear it could ever make enough profit to use them up. Bringing foreign profits home allowed Amazon to set them against US losses, so the company did not have to pay tax on overseas profits.

That changed in 2003, when Amazon started making a lot more profit in the US. There was a chance foreign earnings would now increase its global tax bill, because US corporate tax rates were higher than in other markets.

Intellectual property

Amazon turned to Luxembourg. As a member of the European Union, businesses based there can sell across EU borders with less red tape. Then there's the tax rate - it has a headline charge on corporate income of 29 percent, but can exempt income a company earns through intellectual property by up to 80 percent. This cuts the effective rate to below 6 percent.

In June 2003, Amazon registered Amazon Services Europe SARL in Luxembourg. The initials stand for Societe a Responsabilite Limitee - a limited company, liable for tax.

A month later, it told UK clients its terms were changing. Contracts with third-party retailers 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 type of limited partnership exempt from income tax in Luxembourg. It has no operational staff or premises, its registered address being the offices of a trust services company in a residential area.

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 European customers.

To be tax efficient, though, 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. Amazon's patents were held by Amazon Technologies Inc, a unit registered in Nevada.

Problem solved

In early 2005, Amazon did an inter-company deal that solved this problem.

Details of the arrangement have never been made public.

Amazon's Luxembourg arrangements have helped it pay an average tax rate of just 5.3 percent on overseas income over the past five years.

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 (US$300 million) a year. At the same time it received up to 583 million euros a 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 US$700 million. But it has not and the deal has allowed Amazon's Luxembourg unit to accrue tax-free cash worth more than US$2 billion.

For Amazon's tax-free money-making machine to work, it had to show it had more than a nameplate in Luxembourg.

In February 2006, it transferred ownership of its UK, German and French businesses to Amazon EU SARL, and ownership of its UK and French web domains to Amazon Europe Holding Technologies.

It also moved some US executives to Luxembourg, hired more locals and began to call Amazon EU its European headquarters.

As the cash built up in Amazon Europe Holding Technologies, the firm started to lend to Amazon EU SARL. Besides funding international expansion, this has generated up to 45 million euros a year in interest since 2005 - all untaxed.

Today, Amazon calls its 300-person Luxembourg operation the nerve-center of an operation which employs tens of thousands of people across the continent.

Transfer pricing is the way corporations trade goods or services between their units. Many multinationals use it.

The Organization for Economic Cooperation and Development, which lays down the rules on transfer pricing, stipulates that it should not be used to shift profits from high tax jurisdictions to low tax jurisdictions.

The IRS declined to comment.