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Tax Avoidance by Multinational Corporations

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Drawing on some real life examples of tax avoidance by Multinational Corporations (MNCs), what are the advantages and disadvantages of global MNCs’ using loopholes to pay less corporate tax?

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Student ID: 1308346

Introduction:

Taxation is the main source of income for most of the developed countries in the world. Multinational corporations with subsidiaries in different countries use loopholes in the laws to reduce their tax liabilities. Needham (2013) has defined tax avoidance as “seeking to minimize a tax bill without deliberate deception but contrary to the spirit of the law”. Firms evade to Tax Havens or use various methods such as transfer pricing and corporate debt-­‐equity to avoid the payment of taxes. Palan (2002) defines tax havens as “countries that have enacted tax legislation especially designed to attract the formation of branches and subsidiaries of parent companies based in heavily taxed industrial nations.” The author also claims that nearly half the stock of money in the world either passes through Tax Havens like Ireland or reside in them.

Ican (2009) cited by Awodiran (2014) states transfer pricing as an internal pricing policy of an organisation at which goods or services are transferred between divisions in different countries. Sikka (2009) insists that transfer pricing is the biggest tax avoidance scheme. Corporate debt-­‐equity refers to the inter-­‐company loans that entities in lower-­‐tax states give to subsidiary companies in higher-­‐tax countries (Needham, 2013). This generates interest income to subsidiaries in lower-­‐ tax states and in higher-­‐tax countries it reduces the taxable profit (Needham, 2013). Brennan and Solomon (2008) have cited Parkinson’s (1993) definition of corporate governance as “the process of supervision and control indented to ensure that the company’s management acts in accordance with the interests of shareholders”.

This essay will evaluate the advantages and disadvantages of Multinational Corporations benefiting from loopholes to pay less corporate tax using various examples including Starbucks, Google and Amazon. The disadvantages of the tax avoidance in the modern world seem to overpower its advantages.

How Multinational Corporations benefit from the Tax Loopholes: MNCs constitute a major part of the world’s GDP with functions centralised at the world or regional levels. With the emergence of digital economy, MNC’s can locate more of their operations away from consumers (Needham, 2013). Most of the tax avoidance methods are aided by digital economy and the rising value of intangible assets like brands. Multinational Company’s gain competitive advantages over their competitors using various tax avoiding strategies.

Bergin (2012) reported that Starbucks, since opening its first store in the UK in 1998 has sales of over 3 Billion but paid only £8.6 Million in income taxes. Bergin (2012) also disclosed that the coffee giants paid no tax on sales of £1.2 Billion in the UK in the last three years. In comparison, McDonald’s paid over £80 Million on £3.6 Billion sales (Bergin, 2012). BBC News (2013) reported that Starbucks, as part of its tax affairs transferred money in terms of royalty payments to a sister company in Netherlands. It borrowed money from other parts of business at high interest rates and bought coffee beans from a company in Switzerland.

Google managed to reduce its tax rate to 2.4 percent by using strategies such as the ‘Double Irish’ and ‘Dutch Sandwich’, reports Drucker (2010). Its tactics depend on

transfer pricing, that allow the company to allocate income to tax havens and attribute expenses to higher tax nations. Drucker (2010) further reports Plotkin, a senior director at PWC, claiming that high tax rates in countries like the US motivate companies to move their income and operations to tax havens. Ireland has offered tax incentives to attract MNC’s since the 1960s and also firms can shift earnings out of the country without any major tax consequences. The double Irish method, as a strategy to limit taxes is becoming very popular. Benefits from tax earnings boosted Google’s earnings by 26 percent in 2009 (Drucker, 2010).

International Business Times (2014) reported that Amazon UK benefits from its subsidiary in Luxembourg, Amazon EU SARl, reduces its tax bill in the UK. Amazon UK paid only £4 million in taxes in 2013 even though it routed £11 Billion through its subsidiary in Luxembourg. Amazon has over 5000 employees in the UK, still benefits from the extremely low tax rates in Luxembourg. Amazon’s tax bill in the UK was only 0.1% of its £4.3 Billion sales in 2013. High street brands like John Lewis claim that Amazon’s accounting tactics gives the Internet giants an unfair advantage. They have attacked the company for shielding its profits from the taxman in UK by using the Luxembourg loophole.

Reputation Concerns for Companies:

Forbrum and Shanley (1990) have stated that a firm’s reputation plays an integral part to gain a competitive advantage and the management will consider the reputational costs while making any decisions, including tax decisions. Grahman (2013) also argues that one of the primary factors for companies considering tax

avoidance are reputational concerns. Bankman (2004) cited by Grahman (2013) suggests that a firm on an aggressive tax avoidance spree may be termed as a ‘poor corporate citizen’. This can adversely affect the firm’s market outcomes. For instance, it was reported by New York Times how GE avoids taxes in the US. GE rubbished claims on their website claiming they legally paid the owed tax amount. Graham (2013) reported that it was witnessed that the public responded with claims to never buy GE products again. Even Starbucks came under attack for wiping out its profits in the UK and retaining its controversial offshore structure. On the other hand, Hanlon and Slermond (2009) investigated the reaction of the market to the firm’s news of tax avoidance. It was witnessed that a there was a significantly low negative market reaction. If the company wasn’t thought to be a tax avoider in the previous times, a positive reaction was recorded. The authors also claim that the retail sector has a more negative reaction from the market. In contradiction to the empirical-­‐archival methodology used by Hanlon and Slermond (2009), Graham (2013) reports that 69.5% of the firms that responded to his survey feel that potential harm to the reputation of the company is a very important reason preventing firms to engage in tax planning.

Tax Shaming: The culture of a shaming and naming of companies involved in tax avoidance seem to be growing amongst social groups, media and politicians. Houlder (2014) reported UK uncut, a pressure group against tax avoidance, claiming that if tax avoiders are forced to pay taxes than looming housing crisis can be averted.

Whereas, a senior minister ruling out naming and shaming of companies involved in tax avoidance, claimed that it breaches taxpayer’s confidentiality (Mulholland, Syal and Wintour, 2012). Kennedy (2014) also argues that economic forces exert a stronger force in the long run and shaming is not a substitute for corporate tax reforms.

West (2012) on the other hand suggests that it’s better to have a system where social pressure encourages companies to pay tax rather than tightening the law. The media revolution has made it easier for consumers to shame companies to behave responsibly (West, 2012). Like in the case of Starbucks, they could have continued to pay taxes at the same rate as long as they didn’t mind the bad publicity. But they chose to pay more and get good public relations. The company paid £5m as corporation taxes in 2013, its first tax payment since 2009 (BBC News, 2013). West (2012) insists that the system can’t function without strong moral pressures but also suggests change in the tax system.

Affects of Tax Avoidance on the Government: In most countries, taxes pay for services such as infrastructure, healthcare, education, safety and other essential services offered by the government. Tax loopholes have led to a significant loss of revenue to the governments. Drucker (2010) reports that according to a professor at Reeds College, Portland the income shifting costs the US government around $60 billion in annual tax revenue. Godfrey (2014) claims that the developing nations are hit the hardest and lose an estimated £62bn each year.

Tax avoidance has become very common with companies trying to pay as little as they can. G20 governments have agreed to crackdown on tax avoidance, but they have left behind poor countries still vulnerable to exploitation (Robertson, 2014). Martin (2013) states that there is a clear link between the stability of state and taxation. In the long run tax avoidance can hamper development and create unsustainable patterns of taxation. West (2012) argues that it is difficult for any government to design a tax system with no loopholes, especially with MNC’s paying a lot more for tax specialists than HRMC.

Affects of Tax Avoidance on Consumers, Employees and Shareholders: The fear of the public is much greater than that from the governments for companies engaged in tax avoidance practices. Berg (2014) argues that there are unspoken benefits of tax avoidance by MNCs as it puts pressure on the government to lower corporate tax rates. Even though this minimizes tax revenue, the consumers and workers benefit from the low tax rates. Barford and Holt (2013) reports that with the better understanding of the corporate tax avoidance, the outrage amongst the public is growing. The authors have also reported that with tax shaming, consumers can boycott products. But relatively low people take direct action. Discussions of tax avoidance are at an all time high with the rise of tax shaming and newspapers doing their own investigations. Particularly the social media has become dangerous for the companies; claim Barford and Holt (2013). Martin (2013) stated that companies do not re-­‐invest the profits for benefits and raises of existing employees and recruiting new employees. Their focus remains on

retaining the high profits they earn. Due to the complex arrangements of the expenses of low paid temporary workers by their employers, there are warnings for them to be chased for unpaid taxes (Kemp, 2012). Hence, there are no significant benefits for the employees working in the companies engaged in tax avoidance. Kim, Li and Zhang (2011) state that tax avoidance was viewed as a value maximizing activity for the corporate shareholders in the traditional theory but this overlooks the separation of ownership and control. The authors claim that there is a positive association between tax avoidance and the firm’s crash risk of specific returns. Desai and Dharmapala (2006) argue that only a small component of the firm’s value that shareholders are concerned about depend on tax avoidance practices. Shareholders of companies like Starbucks that are in public eye have more to lose than less visible firms that are engaging in these practices. In the wake of Starbuck’s tax avoidance row, its revenue fell by 3.4%.

Conclusion: Peña (2014) quotes Freidman (1973) as “the social responsibility of business is to increase its profits”. Freidman’s position on the matter has been abandoned by most concepts of CSR. The missing link between the CSR and tax is that there is a direct impact of taxation on profits. Companies were reluctant to incorporate taxation as a CSR issue because they saw tax payments as transfers from shareholder to the state. The link between taxation and CSR has emerged with the growing interest of social groups, media and activists as illustrated in the essay. The coverage of tax sandals has forced the companies like Starbucks to take measures to avoid negative

publicity. Initiatives like this help to incorporate taxation as an element of CSR. MNCs can benefit from corporate governance adopting clear standards of CSR in the area of taxation.

One of the most progressive forms of taxation for governments is from multinational companies. The previous efforts to structure business taxes uniformly in order check evasion to tax havens and transfer pricing have resulted in conflict of interest amongst big and small nations (Needham, 2013). The countries differ in design of their tax systems whereas some have higher overseas income compared to others. Government should consider establishing a global institution to ensure that taxation delivers for public interest and oversees the governance of taxation globally. It should define the minimum standard of disclosure and transparency for companies. In the wake of tax avoidance, even Ireland has decided to do away with the ‘Double Irish’, a tax structure that allowed companies like Google, Facebook and Apple to shelter profits in billions from taxes (Rubin, 2014).

With the emergence of tax shaming and applying Graham’s (2013) findings on reputation costs, supported by example of Starbucks, the essay concludes that the disadvantages of tax avoidance overpower the advantages for all the stakeholders in the society. In the 21st century, tax avoidance by MNCs is unacceptable and immoral.

Reference List: Needham, C. (2013). Corporate tax avoidance by multinational firms. Library of the European Parliament, pp.1-­‐5. Palan, R. (2002). Tax Havens and the Commercialization of State Sovereignty. International Organization, 56(1), pp.151-­‐176. Awodiran, Muideen Adeseye, Transfer Pricing: A Tax Avoidance Tool of Multinational Corporations (July 7, 2014). Available at SSRN: http://ssrn.com/abstract=2463201 Sikka, P. (2009). Prem Sikka: 'Transfer pricing' is the biggest tax avoidance scheme of all. [online] The Guardian. Available at: http://www.theguardian.com/commentisfree/2009/feb/11/taxavoidance-­‐tax [Accessed 24 Dec. 2014]. Brennan, N. and Solomon, J. (2008). Corporate governance, accountability and mechanisms of accountability: an overview. Acc Auditing Accountability J, 21(7), pp.885-­‐906. Bergin, T. (2012). Special Report: How Starbucks avoids UK taxes. [online] Uk.reuters.com. Available at: http://uk.reuters.com/article/2012/10/15/us-­‐ britain-­‐starbucks-­‐tax-­‐idUKBRE89E0EX20121015 [Accessed 24 Dec. 2014]. BBC News, (2013). Starbucks pays UK corporation tax. [online] Available at: http://www.bbc.com/news/uk-­‐politics-­‐23019514 [Accessed 24 Dec. 2014].

Drucker, J. (2010). Google 2.4% Rate Shows How $60 Billion Is Lost to Tax Loopholes. [online] Bloomberg. Available at: http://www.bloomberg.com/news/2010-­‐10-­‐
21/google-­‐2-­‐4-­‐rate-­‐shows-­‐how-­‐60-­‐billion-­‐u-­‐s-­‐revenue-­‐lost-­‐to-­‐tax-­‐loopholes.html

[Accessed 3 Jan. 2015]. West, E. (2012). By shaming Starbucks into paying its taxes, UK Uncut is fighting on the side of capitalism – Telegraph Blogs. [online] News -­‐ Telegraph Blogs. Available at: http://blogs.telegraph.co.uk/news/edwest/100192715/by-­‐shaming-­‐starbucks-­‐ into-­‐paying-­‐its-­‐taxes-­‐uk-­‐uncut-­‐is-­‐fighting-­‐on-­‐the-­‐side-­‐of-­‐capitalism/ [Accessed 4 Jan. 2015].

International Business Times UK, (2014). Amazon Facing Fresh UK Tax Avoidance Row. [online] Available at: http://www.ibtimes.co.uk/amazon-­‐facing-­‐fresh-­‐uk-­‐tax-­‐ avoidance-­‐row-­‐1449978 [Accessed 2 Jan. 2015]. Fombrun, C. and Shanley, M. (1990). WHAT'S IN A NAME? REPUTATION BUILDING AND CORPORATE STRATEGY. Academy of Management Journal, 33(2), pp.233-­‐258. Graham, J., Hanlon, M., Shevlin, T. and Shroff, N. (2013). Incentives for Tax Planning and Avoidance: Evidence from the Field. SSRN Journal. Hanlon, M. and Slemrod, J. (2009). What does tax aggressiveness signal? Evidence from stock price reactions to news about tax shelter involvement. Journal of Public Economics, 93(1-­‐2), pp.126-­‐141.

Houlder, V. (2014). UK Uncut to stage tax avoidance protests -­‐ FT.com. [online] Financial Times. Available at: http://www.ft.com/cms/s/0/1355daf4-­‐db7f-­‐11e3-­‐ b112-­‐00144feabdc0.html#axzz3OYikKbxz [Accessed 5 Jan. 2015]. Mulholland, H., Syal, R. and Wintour, P. (2012). Tax-­‐avoiding firms should not be named and shamed, says minister. [online] the Guardian. Available at: http://www.theguardian.com/business/2012/dec/03/tax-­‐avoiding-­‐firms-­‐not-­‐ named-­‐shamed [Accessed 4 Jan. 2015]. Kennedy, J. (2014). Shaming is no Substitute for Corporate Tax Reform | InsideSources. [online] Insidesources.com. Available at: http://www.insidesources.com/shaming-­‐ is-­‐no-­‐substitute-­‐for-­‐corporate-­‐tax-­‐reform/ [Accessed 3 Jan. 2015]. Robertson, J. (2014). G20 tax avoidance pledge 'still leaves poor countries vulnerable'. [online] the Guardian. Available at: http://www.theguardian.com/business/2014/nov/16/g20-­‐tax-­‐avoidance-­‐pledge-­‐ still-­‐leaves-­‐poor-­‐countries-­‐vulnerable [Accessed 5 Jan. 2015]. Berg, C. (2014). The unspoken benefits of tax avoidance. [online] ABC News. Available at: http://www.abc.net.au/news/2014-­‐09-­‐23/berg-­‐the-­‐unspoken-­‐benefits-­‐of-­‐tax-­‐ avoidance/5762176 [Accessed 6 Jan. 2015]. Barford, V. and Holt, G. (2013). The rise of 'tax shaming'. [online] BBC News. Available at: http://www.bbc.co.uk/news/magazine-­‐20560359 [Accessed 6 Jan. 2015].

Martin, C. (2013). Tax avoidance and the implications for civil society · Blog · INTRAC. [online] Intrac.org. Available at: http://www.intrac.org/blog.php/36/tax-­‐ avoidance-­‐and-­‐the-­‐implications-­‐for-­‐civil-­‐society [Accessed 4 Jan. 2015]. Godfrey, C. (2014). Tax rules facilitate avoidance, with developing countries the biggest losers. [online] the Guardian. Available at: http://www.theguardian.com/sustainable-­‐business/tax-­‐avoidance-­‐multinationals-­‐ developing-­‐countries-­‐oxfam-­‐report [Accessed 6 Jan. 2015]. Kemp, P. (2012). 'Abusive tax avoidance' affects temporary workers. [online] BBC News. Available at: http://www.bbc.co.uk/news/business-­‐19977308 [Accessed 4 Jan. 2015]. Kim, J., Li, Y. and Zhang, L. (2011). Corporate tax avoidance and stock price crash risk: Firm-­‐level analysis. Journal of Financial Economics, 100(3), pp.639-­‐662. Desai, M. and Dharmapala, D. (2006). Corporate tax avoidance and high-­‐powered incentives. Journal of Financial Economics, 79(1), pp.145-­‐179. Peña, I. (2014). Is tax the next big corporate social responsibility issue?. [online] Ictd.ac. Available at: http://www.ictd.ac/en/tax-­‐next-­‐big-­‐corporate-­‐social-­‐ responsibility-­‐issue [Accessed 4 Jan. 2015]. Rubin, B. (2014). Ireland to close tax loophole favored by US tech giants -­‐ CNET. [online] CNET. Available at: http://www.cnet.com/uk/news/ireland-­‐to-­‐close-­‐tax-­‐ loophole-­‐favored-­‐by-­‐us-­‐tech-­‐giants/ [Accessed 5 Jan. 2015].

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