The removal of trade barriers has increased the level of globalization. With globalization, more firms are establishing international activities. Companies are moving their businesses to foreign countries and faced with the decision of producing goods at home state or producing goods at low-cost countries abroad. Though the decision to relocate is guided by factors such as the wage levels and productivity level, taxation plays a significant role in globalization decisions. Firms are locating subsidiary companies in countries that offer tax incentives and low-tax countries. The prospect of needing to pay taxes on the profits of a company is considered when making relocation decisions. As firms move their activities to foreign countries tax has become a contentious issue.
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Different countries have different tax regulations on foreign companies, and global firms have come up with various ways to avoid paying taxes. The global taxation structure is one that is faced with enormous challenges, and recent reports indicate that multinationals such as Google and Starbucks have taken advantage of the global tax structure to avoid paying taxes. Research has revealed that it was difficult to tax a multinational since there is no single global fiscal policy. This article sheds light on the various ways that companies use to avoid paying taxes or pay lower taxes.
The United States has a unique international taxation policy. Unlike most countries, it taxes income from a foreign source. The U.S. hosts some foreign companies, and it is a home country for various multinational firms. The U.S. uses the same rates on domestic enterprises and resident multinational corporations. The current tax rate is 35%. The U.S. multinationals are allowed to get a tax credit for taxes paid to foreign income earned abroad.
However, the firms are expected to pay taxes on the income they have made from the foreign subsidiaries when the revenue is returned to the U.S. To explain this concept of taxation takes a U.S. multinational firm X with a subsidiary in France. X will pay taxes on profits made in U.S. Suppose the company after-tax profits in the France subsidiary is $500 and it decides to repatriate $200. Then the company will have to pay U.S. tax on the $200 plus the proportion of tax on this amount.
If the company paid a percentage of tax of $50 to France on the $200, then the company will pay taxes under the U.S. on a base of $250, but the company can request for a tax credit on $50 France tax. Company X only decided to repatriate $200; the remaining $300 can be invested in the France subsidiary. This $300 is treated as a deferral, and it is free from the U.S. income tax, and it will only be taxed when it is repatriated.
Unlike the U.S., most countries use the territorial tax system which does not tax foreign incomes. Countries such as Japan, U.K., Italy, Germany, and France exempt the foreign income taxation. If multinational X were a France company based in the U.S., then it would not be expected to pay taxes on repatriation of foreign profits. Other countries have come up with a universal taxation system, and in such cases, a multinational is not expected to pay taxes to home country if the subsidiaries are located in countries with a similar tax regime.
States are operating different taxation system; thus, it has become difficult to tax global companies. It is hard to determine the number of profits that can be allocated to a particular country. For instance, whiskey is made in Scotland, but it is exported to various countries. It becomes hard to determine if the profits made out of whiskey sales should be taxed in Scotland or in the countries where it is sold. Taxation is usually done on profits which in simple terms is the revenues minus the expenses. With multinationals, the income and the cost do not occur at the same place. A company such as Google has built websites in the U.S. and technology used is designed in the U.S. hence the costs are incurred in the United States. However, Google sells advertisement in European countries hence the revenues are made in Europe: this raises the question on where the profits should be taxed should be taxed on costs, employment or earnings?
As countries are trying to figure out a single taxation method, multinational companies have taken advantage of the current tax situation to avoid taxes. Some countries are rated as lower tax countries because they set the low corporate tax to encourage investment and stimulate economic growth. The lack of a single taxation method for multinationals has created loopholes for companies to evade paying taxes. Today, the global market is recognizing some of these loopholes as legitimate tax minimization methods. One of the methods used is shifting assets to countries with lower tax rates. A good example is the European Union which requires companies to pay income tax to revenue made within the borders of the country.
Therefore, a multinational based in Spain will pay taxes to Spain, but a subsidiary located in Germany will pay taxes in Germany. Companies are taking advantage of this rule and shift their assets to countries with lower tax rates to minimize tax obligations. For instance, Ireland is one of the countries with a lower tax rate. It has a tax rate of 12.5% making it a favorable state to establish a business. A multinational that is located in the United States which has a high tax rate of 35% and a subsidiary in Ireland can transfer its assets to Ireland branch to minimize taxes.
The growing flexibility of multinationals is raising serious taxation concerns. It has become hard to tax multinationals, and it has created loopholes for these companies to evade tax. With taxation being a primary source of revenue and a way of ensuring business are responsible, there is a need to address global tax system. Countries must come together and change tax systems to eliminate loopholes and ensure that multinationals pay the required amount of tax in the home and host countries.
