September 30, 2015
REGARDING TAX OPTIMIZATION OF MULTINATIONAL COMPANY’S ACTIVITIES
Multinational Corporate Entities (MCE) progressively expanding in the economic space of Uzbekistan not only by direct international investments in the economic sector, but also in the form of attraction of high-tech and as the international standards of management as well. Accordingly, we should to consider the need for creation of favorable legislative base in tax, customs, currency, antimonopoly regulation sectors in the republic, as well as to determine the legal status of MCE for application of the legislation.
Strife towards minimizing the tax burden
It is known that the tax is the obligatory and gratuitous payment, which is collected by the governmental authorities of various levels from the organizations and individual persons for financial assurance of activities of state and/or municipal structures. As we see, the tax is directly connected with institutes of certain state and supports its activity. Therefore, each state independently defines an order, rates and ways of taxation and pursues a tax policy proceeding from the economic and political interests.
The globalization process and development of international economic activity lead to emergence of international tax relations among the participants. As long as each of the states in the territory of which is conducted the commercial activity, has the right to rely on payment of the corresponding tax, there will be a conflict of interests between the states (conflict of two tax jurisdictions – the states of source and the state of resident) that leads to emergence of double taxation. The double taxation not only harms an international trade by exceeding the tax burden of the taxpayer, but also it contradicts to the basic principle of taxation, where the same object can be suffered from one type of tax only once (the single tax principle) .
Moreover, many states, in order to attract the international direct investments or international companies to their economy, create favorable tax regime (so-called international tax competition), in the form of lowered tax rates, privileges or absence of some types of taxes that in its turn, stimulates the economic entities to make a transfer of their incomes and production from one jurisdiction to another.
As the result of international tax competition is the international tax tribunal which is often used by the Multinational companies (multinational corporate entities) for optimization of taxation through their under control groups which are in various jurisdictions. From other hand, the growing value of service component of economics, IT products that can be delivered via Internet, ensured the companies to arrange the production activity in the remote places from the actual arrangement of the clients.
Some case studies from the world's business practice
According to the general rule, the tax law defines the duty of tax payment, and there is no obligation to pay more, than the law demands (principle of obviousness). Usage of this principle often began to be practiced by the MCE at tax planning.
Inland Revenue Commissioners v Duke of Westminster Case can be used as example, during investigation of which the judge stated that the taxpayers have a right freely arrange their activity for tax avoidance that are due for payment, and they are not obliged to pay more taxes than it’s suggested . On this case, the court construed the legislation literally, explaining the uselessness of consideration of law through the lens of moral obligation of the taxpayer. However, this statement was modified, particularly, that the courts should not be confined by literally interpretation of law, but serve the purposes of legislation and foresee the legislative intent during creation of law. The main recommendation in this case, was the clarification of true legal nature of made transaction and contemplated actions that shall have a commercial goal, and not directed for tax avoidance.
For nowadays using more smart tax planning schemes by the Multinational Corporate Enterprises have become ordinary and even an integral element of good business governance. Some company leaders even view the tax avoidance as part of fiduciary duties to shareholders and indicate to lawmaker’s omissions to qualify such conducts as illegal. For instance, by protecting the Google’s tax-planning arrangements related to legal transfer of revenues from international subsidiaries for $9.8billion into Bermuda in 2011, Google’s Chairman Mr. Eric Schmidt reportedly expressed, “I am very proud of the structure that we set up. We did it based on the incentives that the governments offered us to operate” .
Lately, such practices of global highly profitable MCEs, like Apple, General Electric, Google, and Starbucks has found a substantial media attention and worldwide public criticism. For instance, in UK, a tenth of Apple's global market, in 2013, the corporate tax payment of Apple was only £11.4 million after declaring £100 million in revenue, however, the number of UK sales of Apples estimated by experts approximately £10.5 billion which means that a tax rate of just over 1% .
Unfortunately, Apple is not alone in such tax planning with cut of its corporate taxes. According to 2014 Financial Report of Xerox, it’s earning before tax was $629 million while it paid zero tax to federal income tax . For last five years Xerox’s US effective tax rate was only 5.4% (while corporate tax rate in US – 35%) for $3.6 billion profits. Such actions of MCE’s are extremely carefully considered, therefore, they could not be recognized as illegal.
Through the correct tax planning based on use of its own multinational structure, as well as tax privileges and preferences, correctness of choice of the tax regulations and objects of taxation, the MCEs reach the tax optimization of their incomes on the basis of lawful tools. Here it is important to consider that tax planning did not cross a fine line and did not turn into the tax avoidance or tax evasion .
What do MCEs use for tax planning?
The tools of tax planning used by Multinational Corporate Entities for decreasing of tax burden and increasing of cash flows free from taxes can be different. For instance:
- use of tax heavens, i.e. establishing of the parent company or special affiliate companies (or the intermediate company) in the countries with favorable or preferential taxation, or in offshore zones;
- establishing of foreign representation, that gives the chance to declare the profits in the country of their origin, where the representation functions, but not in the home country of the parent company;
- transportation service of MCE’s operations through its own transportation and shipping companies registered in offshore zones;
- applying the provisions of international agreements regarding avoidance of the double taxation (ensuring the tax exemption, deductions and credits) for exemption, deduction or decrease of paid taxes at a source of payment of dividends, percent, royalty or expenses on payment of interests on provided loans from taxable profit;
- use of transfer pricing in calculations between structural divisions of MCEs, which are under different jurisdiction;
- creation of special conditions of intra-group contracts for delivery of goods and services;
- transfer of losses within the holding for set-off of such losses in the state with a high rate of income taxes (group relief for losses);
- foreign economic activity on the basis of agency agreements, partnership or the general investment activity with the local companies without creation of the legal entity;
- financing of structural division by provision of credits or loan rather than an investment in share capital (debt financing);
- purchase of shares shortly before the announcement of dividend, and sale upon getting the dividends (dividend stripping);
- establishing of affiliated insurance company for getting a cheap insurance covering of own operations (captive insurance) and others.
Where it leads to and how to reduce the impact of excessive use?
As we see, the plenty of tax planning tools gives an opportunity to Multinational corporate entities easily to avoid the income taxes of groups. However, here is important to note that, many above-mentioned, and the other tools of tax planning are not considered as the tax planning practice no more; they become as excessive use based on disadvantages and omission of tax legislation.
Aggressive international practice of MCE’s evasion of tax payment creates at least the following harmful consequences:
- reduces the state revenue coming from tax payment, and the state expenses related to enforcement of tax regulations of MCE are increasing;
- blows up the integrity, fairness and honesty of tax systems, the huge part of tax burden will be on other taxpayers, but not on MCEs;
- there will be competitive imbalance between local business entities, small and medium business enterprises and MCEs, who have an opportunity to use the international tax preferences for tax planning.
Moreover, state’s provision of a big tax privileges and tax remission to the companies with direct foreign investments limits the opportunities of the local companies to refinance in business the money assets from the similar tax privileges exempted from possible application.
For prevention of excessive use, many countries of the world in their tax legislation have corresponding restrictive provisions.
Inland Revenue Comrs. v Collco dealing Ltd. сase can be used as example, where the excessive use in international agreements on exemption from the double taxation by purchases of shares somehow before the announcement of the dividend ends by application of item 4(2) of the Law on Finance of 1955, according to which the persons having the right for exemption from income tax according to any legislation , are subject for income taxation in terms of dividends on stocks that are sold, issued or purchased in any way after October 26, 1955, and not more than 6 years before date in which the payment of dividends shall be announced, as well as from the dividends paid from profit, which are saved up before the date in which the shares were purchased.
The rule about set-off of losses for decrease in tax base in Great Britain was received by restrictions regarding MCE, whose affiliate companies are in the states of the EU that signed the Contract on European Union of 1992.
For instance, the Marks & Spencer v David Halsey case, where the Court held that the Company Marks & Spencer could reduce the tax base at the expense of foreign losses, including, in case all other opportunities were exhausted, namely:
- Affiliated nonresident company used all possible ways of loss record in the country of its registration, including by transfer of losses to the third party or offset of losses and profit, got for the previous periods;
- Losses of foreign subsidiary cannot be considered in the country of its registration for future periods, neither by this company, nor by the third party.
Transfer pricing: Some specific features
It is worth separately to say about use of transfer pricing by multinational corporate entities for minimization of taxation. Use of the transfer prices as that is not the excessive use in payment of taxes. Nevertheless, in majority of cases, transfer pricing is the tool ensuring the minimization of taxes for all consolidated structure of multinational corporate entities by transfer of tax base on the affiliate who is in the jurisdiction that guarantees the various tax preferences.
For your reference
Transfer pricing is realization of goods or services by the affiliated persons on in-company, different from market prices. It allows redistribute the total profit of shareholders in favor of persons being in the states with more low taxes. This the most simple and widespread system of international tax planning intended to minimization of paid taxes.
The states, in its turn, cannot but consider the influence of the transfer prices on definition of tax base; therefore, they develop the regulatory and legal acts interfering to manipulation by prices within multinational corporations. The first country that adopted the special legislation on regulation of transfer pricing in 1960 was the USA. From the international standards directed on regulation of activity of multinational corporate entities, including the questions of transfer pricing within its structures, was the Guidance of the Organization for Economic Cooperation and Development (OECD) in 1995 “On transfer pricing for multinational corporate entities and tax authorities”.
According to this Guidance, for ensuring the equal position of independent and affiliated persons, the states within the national legislation are applying the principle “at arm's length”. The essence of this principle consists in the analysis of certain business operation from the point of view of actions under similar circumstances of the independent third parties. In other words, in compliance with “rules of arm’s length” calculation of tax duties shall be performed based on the market process on transactions between mutually dependent taxpayers. Correction of taxpayer’s income for taxation can be made irrespective of, whether intention to minimize the tax payments was in this case, and it is implemented in case of discrepancy of the applied prices to the principle of “arm's length”.
Use of transfer pricing is the optimization of taxation, which even though is the legitimate right of the taxpayer, but it arouses heightened interest among tax authorities. Now, transfer pricing is in common practice as a tool of tax planning in multinational corporate entities in global economic space.
For your reference
For nowadays, almost all the states undertake the legal arrangements on incurring the MCE’s for taxation, offering a favorable conditions for taxation; as well as they undertake the arrangements to resist the excessive use of taxes.
Survey of the trend provided by the KPMG shows that almost all the countries are decreasing their corporate tax rate collected from the companies . For instance, according to KPMG survey in 2014, UK corporate tax rate was 21%, but starting from April 2015, it was dropped to 20%. And the average rate of corporate tax within twenty years in Asia dropped from 28,9% to 21,9%, in Europe from 23,7% dropped to 19,8%, and the global tax rate decreased from 27,5% to 23,6%, that gives an opportunity to assume that many states want to counter the withdrawal of their companies (funds) to the “tax heaven countries” in search of more favorable conditions of taxation.
For comparison, the corporate tax rate in companies in Ireland is 12,5%, and 0% in Bahamas, Bermuda, Cayman Islands, Bahrein, Vanuatu and Island of Man.
What to do? – Some actions for improving the situation
In the epoch of globalization, the capital became very mobile. Powers of tax authorities are still limited within the country of their jurisdiction that leads to loss of huge tax revenues. According to the government’s estimates, annually 255 billion USD are being lost due to expense of international tax avoidance and tax evasion. The USA, for instance, try to compensate such losses due to cuts in public expenditure for health care, education and infrastructure, or by increase of tax burden to less mobile small companies.
For solution of problems connected with tax injustice both on national, and on international levels, there will be required the political will, and support of the community.
As an example, we can quote the actions of the US Government when it was proposed to introduce a new method of the taxation into the budget of 2016 fiscal years, in terms of revenue earned by the American MCEs, such as "Apple", "General Electric", "Microsoft" and "Pfizer" outside the country. This method of taxation specified the one-time corporate tax in terms of all income earned during all previous time by the MCE outside the country and estimated at 2,1 trillion USD of 14% (238 billion. USD) . These taxes are to be spent for infrastructure of the country and reconstruction of the main highways and roads.
For reduction of cases of tax evasion, and unjustified optimization of tax expenses it is also expedient to strengthen the international tax cooperation between the states.
For instance, the government of Uzbekistan strictly supports such cooperation. This is evidence from the fact that on April 3, 2015 Uzbekistan and the USA have signed the intergovernmental agreement on improvement of observance of the international tax legislation concerning the US “Foreign Account Tax Compliance Act” (FATCA). The FATCA law demands from the foreign banks to provide the tax account information of American clients to the US Internal Revenue Service, that this law is aimed to limit and prevent the tax evasion through the foreign transactions on the part of citizen or tax residents of the USA who are investing both directly, and through the foreign financial institutions outside the US. Thus, Uzbekistan became the first country in the Central Asia, where the agreement of FATCA was signed with the United States.
It is obvious that development of the effective mechanism of the international tax planning contributes to growth after the tax revenues, allowing hence using the saved funds in investment and production processes that ensures the growth and development either the company, and the state in general, increasing its national wealth.
Undoubtedly, use of legal opportunities of tax planning should not be considered in the negative point of view. However, reduction of tax obligations also shouldn't be reached as a result of excessive use of taxation by tax avoidance and tax evasion which in its turn shall not belong to optimization of the taxation (for example, placement of intermediate structure in low-tax jurisdictions without intention to do business in such states).
Important to keep the balance of interests of each of the party of international taxation, as well as do not allow the excessive use and do not breach the rules of conduct within the tax space that is established by the legislation.
It should be noted that the international community, in particular, of OECD for resistance to tax avoidance, actively fight against the international tax abuses, and achieve the information transparency of the international financial streams, and make the “lists” of low-tax and offshore states, and the countries that do not disclose the financial information on taxpayers.
Our local companies also should know, the opportunities of the international tax planning, because nowadays the domestic companies more and more become involved in the processes of international tax planning during their implementation of foreign economic activity.
We hope that this survey of the foreign practice will help the managers, and financial managers of the companies in their choice of the best way of tax optimization that to be reached as a result of systematic use of the opportunities given by the tax law, international and bilateral agreements.
Reuven S. Avi-Yonah «International tax as international law», 182, Cambridge University Press, 2015.
“Google’s Tax Avoidance Is Called “Capitalism” Says Chairman Eric Schmidt, Telegraph (U.K.) (Dec.12, 2012). http://www.telegraph.co.uk/technology/google/9739039/Googles-tax-avoidance-is-called-capitalism-says-chairman-Eric-Schmidt.html.
Matt Gardner «Head of Consortium of Leading Corporate Tax Avoiders to Testify on Benefits of a Balanced Budget», Corporate Taxes News, March 19, 2015. http://www.taxjusticeblog.org/archive/ federal_tax_issues/ corporate_taxes_1/.
Tax evasion - is the minimization of tax duties by the lawful way, providing a complete set of information to tax authorities. Tax evasion is a tax violation, which is as a rule performed in the form of illegal use by the economic entities of the tax privileges, untimely payment of taxes and concealment of the income, not providing or untimely providing the documents required for calculation and payment of taxes.
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JV “Aral Sea Operating Company” LLC
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