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US Multinational Corporations and the Activities of Tax Avoidance Case Solution

Solution Id Length Case Author Case Publisher
1290 3890 Words (10 Pages) Sonja Olhoft Rego
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Tax avoidance is the practice of taking advantage of the tax system to try to save as many taxes as possible. Tax avoidance is within the realms of legal business practices. Tax evasion on the other hand relates to the use of illegal activities by corporations to save taxes. An example of tax evasion is tax sheltering. Tax shelters involve reducing incomes or showing a fall in pre-tax earnings as a way of incurring less taxes. Tax shelter practices are not considered legal. Tactics that are termed as tax aggressive fall in between legal and well-known tax avoidance practices and tax evasive policies (Dyreng, et al., 2008). The general anti-avoidance rule is a law to govern tax avoidance in most of the developed countries. There are also several other legislative instructions that apply to non-compliance of tax. The United States is one of the few countries that taxes its citizens on income that is not generated in the United States. People could migrate to another country from the US and would still be charged tax by the US tax authorities. It is only in the case where a citizen leaves the country and renounces his/her US citizenship that the US tax rates will not be applicable on him/her (Harari, et al., 2012). And it might come as a surprise that some business people claim that they would rather withdraw their citizenship than be taxed the heavy US tax rates (Lenzner & Mao, 1994). There are several tax avoidance and evasion strategies that are elaborated in the following text.

Following questions are answered in this case study solution

  1. Introduction

  2. Tax Rate Differentials Among Countries

  3. How Corporate Culture Effects Tax Avoidance

  4. Transfer Pricing

Case Analysis for US Multinational Corporations and the Activities of Tax Avoidance Case Solution

2. Tax Rate Differentials Among Countries

According to a report by the Government Accountability office from 2008, 75% of the companies which included some of the largest companies running in the United States did not pay any taxes. It is difficult to understand that a country where the corporate tax rate is 35%, most of the companies do not pay them. To avoid paying large amounts of taxes the bigger companies usually transfer their more profitable business units abroad to places where the taxes are lower. They tend to only run operations in the US that incur little or no profits. This way they are not liable to pay taxes to the US government and only pay taxes to foreign governments for the businesses they run in those countries. In a different research conducted by the Government Accountability office revealed that there were cases in which companies would just change their mailing addresses to places in other countries, for the purposes of tax avoidance. It was once found that 18000 US companies had their mailing address to offices in one building in the Grand Caymans. A tax system by the government is being contemplated that would force these companies to pay the difference between the taxes they pay in other countries and the tax rate that applies in the US. This would only be in the case where the foreign tax rate is lower (Neufville, 2009).

i. Tax Havens

Companies use the transfer of funds between the area they operate in and the offshore lands to hide money from taxation. It is estimated that about 1 trillion dollars has been hidden away by Americans in offshore accounts to evade taxes. This has resulted in a loss of tax revenue for the government of about 30 to 40 billion dollars. Various financial institutions and law firms help companies to indulge in schemes that help hide money offshore. Money is transferred to these places using ATM’s and credit cards. Bogus sales and fraudulent loans are also made to shift money offshore (Simser, 2008).

One popular offshore business activity can be derived through a manual written by an individual named Dr. Turpen who explained how to go about offshore activities without getting caught. In his experience what he did was create a company offshore that would own all the assets, and a trust was established offshore that would own the company. The real owner would be considered as a consultant to the company; however, in reality this owner would be running the business as all his recommendations were to be followed by the people seemingly running the company from the offshore areas. Since the owner did not own the assets or the company on paper, the US tax rate on the company’s earnings was not applicable. Funds were transferred through companies owned by Dr. Turpen in the US, and these companies made loans to the offshore business entities. However Dr. Turpen was caught and charged with illegal tax evasion practices (Simser, 2008).

ii. Tax Shelters Provided Through Schemes

Accounting firms have also in the past helped devise schemes for corporations to avoid paying large amounts of taxes. One example is when KPMG, a renowned accounting firm, helped to create unreal tax losses for large corporations and wealthy individuals. These tax losses were made without any reference to real losses of the business or individual. The tax losses were then used to counter-balance on the capital gains. These tax losses were generated by investments in a company that was found by KPMG in offshore lands. Companies and individuals who wanted to show tax losses, invested in the shares of these companies, and through a series of complicated transactions KPMG showed tax losses, which were then offset with any capital gains that the companies occurred. This is how the investing entities were able to lower their taxes on capital gains. This accounting firm was also caught in the act, and its activities for providing artificial tax losses was found guilty by the authorities (Simser, 2008).

iii. Tax Evasion through Offshore Accounts

Using offshore banks to store company earnings is one way to evade taxes. Corporations in the United States often use this tactic to pay lower taxes. By definition an offshore bank is typically located outside the country of residence of the depositor. There are various benefits that are offered by these banks, which help attract money from foreign depositors. These benefits include very little or no taxation, relaxed financial regulations on foreign deposits, the depositor does not have to be actually present at the bank to make transactions and customer information secrecy is highly regarded. These perks however are only awarded by these banks to the non-residents of the country it is located in. Saving in offshore bank accounts also tends to protect the depositor from economic and political instability faced in the depositor’s home country. Little or no taxation helps the international corporations lower their collective tax rates and end up with greater after tax returns. The confidentiality agreements and loose regulations levied on international companies that make deposits in these banks, helps to hide information about company assets from the local government and tax authorities situated in the domestic region of the depositor. It also makes the details of these assets unknown to the different financial parties that might have a claim on the assets of these companies. Since a tidy corporate structure is not required by the offshore banks, the international companies have the option to create derivative contracts that are complex in nature and might not be allowed to be sold through banks in the home country but they can be transacted through these banks (Johnson & Holub, 2003).

Companies in the United States have since a long time complained about the taxation regime they face in the country. It is for these reasons that big organizations have chosen to reincorporate their businesses in other countries where the tax rates are lower. There are several ways for a company to reincorporate its business. One would be to re-establish its headquarters in another country. While another method is the exchange of shares of a US corporation by its shareholders with the shares of a foreign company. If the company relocates its headquarters in another country, then it will face tax rates that are applied by authorities in that country. The lower these taxes are, the more the company saves as its earnings after tax. When the shareholders of a US company decide to exchange shares with a foreign company’s shares, the foreign company in this case becomes the parent company that also owns the US company now, and as a result the company is taxed using the tax rates of the parent company, which have to be lower than that of the United States if the shareholders aim to reduce their tax payments. Companies have also saved taxes by establishing subsidiary firms in other countries, where the tax rates are lower. The taxes incurred by these subsidiaries are hence lower and the overall taxes of the company fall. Enron was popular for such tax saving activities and as a result had avoided paying taxes amounting to 409 million dollars in the last 5 years before its existence (Johnson & Holub, 2003).

3. How Corporate Culture Effects Tax Avoidance

It has been noted that there is a connection between tax evasion by a foreign company operating in the US and the level of corruption that is prevalent in the country where the owner of the company resides. Research indicates that US company owners who belong to a country with a high level of corruption tend to evade taxes more often on average than the owners who belonged to a country where the level of corruption was lower. For example a US company owner that belonged to Nigeria, a country with a high level of corruption, on average evaded 64000 dollars more than a firm that was run by a Swedish owner. This difference however minimizes as companies of larger sizes (greater than $102 million) are compared. Corporate culture dictates how aggressive a company can be in its pursuit to evading taxes. Owners of a company can have influence and render the corporate culture. They can do this by socializing in the workplace, hiring people that fit that culture and though company goals. The culture that the owners of a company bring to the organization impacts among other things the taxes the company aims to save. It has also been found that the executives can change pay packages to employees that would force the employees to practice tax savings on behalf of the executives. In this way corporate governance is also a factor that leads to a company using practices to evade taxes. It has been argued that the lower the corporate tax rate is, the lesser incentive company executives will have in trying to avoid paying these taxes, and better corporate governance may also result from this (DeBacker , et al., 2015). In addition to this, research has also suggested that the greater incentive remunerations are in a company, the lower will be its tendency to avoid paying taxes.

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