Most business enterprises seek to expand over time in order to survive and become profitable. Increased size often allows economies of scale in both production and distribution. Companies can develop new earning potential by expanding and add greater stability to earnings through diversification. Complex organizational structures help achieve business objectives such as increased profitability and reduced risks. Also, these complex structures allow the company to reduce its overall tax burden. One such strategy is discussed in this paper. Transfer pricing allows the company to price the inter-company transactions. Transfer pricing simplifies the accounting of transactions that take ...view middle of the document...
Transfer prices that deviate from the arm’s length price become a concern when they are misused to lower profits of a component of an entity which is situated in a country that levies high taxes and raise profits of another component of the same overall entity which is situated in a country that levies no or low taxes. Such a deviation from the arm’s length price is called “transfer mispricing.” Countries that levy low are no taxes are generally termed as tax-havens (Refer Annexure 1 for a list of tax-havens). Transfer pricing is the major tool for corporate tax avoidance, also referred to as Base Erosion and Profit Shifting (BEPS) (Transfer Pricing, Wikipedia, 2015).
Tax Havens do not have a generalized definition. As per Organization for Economic Development and Co-operation (OECD), a tax haven typically has characteristics like no or low taxes, lack of effective exchange of information, and lack of transparency. Refer Annexure 1 for a detailed list of tax havens which have some or all of the above characteristics. In addition, any country with a low tax rate could be considered as a potential location for shifting income too. In addition to Ireland, three other countries in the OECD not included in Annexure 1 have tax rates below 20%: Iceland, Poland, and the Slovak Republic (Gravelle, Jane. G, 2015).
U.S. Multinationals are not taxed on income earned by foreign subsidiaries until it is repatriated to U.S. parent. Hence, the tax burden for a company is low when the profits are shifted from a high-tax jurisdiction to low-tax jurisdiction. Tax avoidance happens when profits are shifted by U.S. parent company to its subsidiaries in low-tax jurisdiction and by U.S. subsidiaries to its foreign parent situated in low-tax jurisdiction (Gravelle, Jane. G, 2015).
In 1950, corporate taxes accounted for 26.5% of the total federal tax revenue. In comparison, 2013 figures show that the corporate taxes account for only 9.9% of the total federal tax revenue. This decline in corporate taxes is due to in part to the shifting of income offshore. (Refer Annexure 2 – Share of corporate income taxes in federal revenue) (Levin, Carl and Coburn, Tom, 2012).
Current estimates indicate U.S. MNCs have more than $1.7 trillion in undistributed foreign earnings and keep at least 60% of their cash overseas (Levin, Carl and Coburn, Tom, 2012).
Annexure 3 lists some of the MNCs with foreign cash balances greater than $5 billion and exhibits the magnitude of profits moved offshore by some of the largest, most successful U.S. Corporations.
Annexure 4 shows that foreign profits of U.S. Controlled Foreign Corporations (CFCs) significantly outpace the total GDP of some tax-havens. These numbers clearly indicate that the profits in these countries do not appear to derive from economic motives related to productive inputs or markets but rather reflect income easily transferred to low-tax jurisdictions (Levin, Carl and Coburn, Tom, 2012).