There has been a lot in the news recently of large multinational firms like Google, Amazon and Apple dodging taxes or not paying their fair share. What are the techniques they adopt to successfully do this whilst remaining within the confines of the laws of the countries they operate in?
Transfer pricing is the main tool used by MNCs (Multi-National-Corporations) to reduce their tax liabilities. An MNC is usually made up of different subsidiaries (basically businesses or departments within the business, wholly owned by the ‘parent’ company – the MNC) and so profits can be shifted about to different subsidiaries. Subsidiaries can be different departments or firms, or it could be the different operations around the world.
For example Rhys Inc may be based in the US (as a large proportion of the world’s MNCs are) but have operations in the UK, France, China etc. These different businesses within different countries, although owned by Rhys Inc in America, are likely to be registered as separate companies. So in Britain Rhys Inc will own Rhys Ltd. In the UK Rhys Inc wont pay corporation tax (this will be paid in the US) but Rhys Ltd will have to.
According to the reports made on https://www.federal-ein-application.com/irsein/ss4-online/ , in the UK tax rates are around 23% (they are currently on a downward trend) but in Luxembourg the rate is only 21% and in Ireland only 12.5%, it is also important to remember that in the UK (and in most countries) corporate tax is only paid on profits and not on sales.
Therefore if Rhys Ltd could get its profits to be made with the Irish subsidiary of Rhys Inc, then Rhys Inc would make larger profits as it has to pay less tax. This can be done through transfer pricing, whereby Rhys Ltd would buy a good from the Irish subsidiary for an extortionate price. For example Rhys Ltd could purchase a stapler from the Irish subsidary for £500, therefore pushing up its costs, but making a large profit at the Irish subsidiary.
If this is done on a large scale, Rhys Ltd can end up making a loss, or only breaking even (that is its costs are equal or greater than its revenue) and will therefore not have to pay any tax, because tax is only paid on profits. Furthermore Rhys Ltd may even be able to offset the tax he pays on future profits (if there are any) with the losses it is currently making.
So although Rhys Ltd made a loss, that doesn’t mean that Rhys Inc made a loss, in fact it has benefited from this practise by paying less in taxes. Because Rhys Ltd was purchasing expensive goods from the Irish subsidiary, the Irish firm made a large profit (remember the Irish subsidiary is also owned by Rhys Inc), which it has to pay 12.5% corporate tax on, but this is a lot less than the UKs 23%, and so Rhys Inc managed to avoid paying 10.5% worth of taxes on its operating income in the UK and hence deprived HMRC of vital tax revenue. This is a practise that was adopted by Starbucks, who purchased highly expensive (way above the market price) coffee beans from its Swiss subsidiary, because the Swiss tax rate is lower than the UK rate, and then the UK subsidiary posted a loss and hence didn’t have to pay tax in the UK.
These countries with low tax rates and with low transparency are often known as tax havens, and there is growing international pressure to try to shut them down, or at least make them more transparent through international agreements on sharing information on the amount of taxes firms pay within countries.
There are also other ways in which a country can avoid paying tax, they can take loans from different subsidiaries to get tax relief and they can also conduct their sales abroad. This is how Google and Amazon have avoided paying their fair share of taxes; they conduct their sales in Ireland (Google) or Luxembourg (Amazon) and only have distribution or advertising in the UK. So Amazon have a UK website as well as UK based distribution centres, but all sales are sent to Luxembourg and are conducted their, and so the UK company doesn’t make money from UK purchases, and hence wont make a profit and then wont be liable to pay taxes. Meanwhile, Google has its sales team based in Ireland, so anyone in the UK wishing to buy something off of Google (usually advertising space) is in contact (through email or phone) with an Irish sales person and so the UK company doesn’t have to pay tax on any profits made through sales, even if the sales were made off of British based customers.
Although some firms are dodging paying corporate tax, in effect freeriding on the infrastructure and provision of public goods by a nation’s government and also putting smaller or more honest firms at a competitive disadvantage, MNCs do still provide a lot of employment (and tax is generated on this), invest in infrastructure and capital goods, and have to pay the full rate on other taxes.