Introduction: fact, the firm’s usage of the mechanisms

Introduction:

 

On July 2017, The Guardian reported
that the tax evasion by U.S. Multinational corporations using offshore
jurisdictions was estimated to be $130 billion a year (The Guardian, 17). The
large Multinational Firms based in U.S. are denying the government of a huge
sum of money each year by means of different legitimate tax minimizing methods.

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In fact, the firm’s usage of the mechanisms provided in the tax code to reduce
taxes are completely legal under the laws of U.S. Over the years, it has
motivated lots of large corporate institutions to make use of tax haven
countries by setting up shell companies and funneling massive amount of revenues
in order to avoid paying hefty sum of taxes. The existence and usage of Tax
Havens by Multinational Corporations has thus caused the U.S. authorities
billions of US dollar on lost taxes. Countries popular to be used as tax havens
offer low, attractive and in many cases non-existent tax rates allowing the large
MNCs to avoid paying taxes in the United States. This process of corporate tax
avoidance has long affected the country’s economic activities by impeding the
source of income for the government as well as undermining the sovereign tax
laws of the country.

    
In this paper, the following question is looked into. What are the
impacts of tax havens on corporate tax avoidance in the U.S.? This paper will
look into different aspects of how tax havens have impacted in the avoidance of
corporate taxes by different multinational corporations in the United States. This
paper will present different arguments and discussion to vividly portray these
impacts. It will also effectively demonstrate the magnitude of such impact caused
by the existence of tax havens as well as include an example from the real
world.

    
This paper is divided into several sections and the introduction is
followed by a theoretical framework. The section of the theoretical framework
will include a general background of the topic including relevant theories and
logical reasoning. It is followed by discussions and the formation of the
hypothesis. At last, the conclusion is presented with an answer to the research
question along with limitations, recommendations and scopes of further
development in the future. The research in this paper is descriptive and
collected through various literature reviews and academic journals.

 

Theoretical framework:

 

Taxation is an important source of
generating revenues for the U.S. government. A significant part of this taxation
revenue is contributed by corporate companies operating in the U.S. territory. The
functional business enterprises and corporations running their operations in
the U.S. are subjected to the corporate tax laws of the country and are thus
required to pay a definite amount of tax on the profit generated by them. In an
effort to minimize the amount of tax payable, big corporations can often make
use of different legal mechanisms and loopholes to maximize their profits while
avoiding the payment of their fair share of corporate taxes. Weisbech (2004,
p.2) mentioned that the typical corporate tax shelter case is difficult and
almost always would be ambiguous regarding the transaction and whether it is a
permitted tax reduction or not. In addition, he further pointed out that in a welfare-based
framework, the class of socially accepted optimal activities in response to
taxation rules are perfectly legal avoidance. As a result, different forms of
legal tax reducing opportunities arise for the big multinational enterprises.

One of the most widely valued mechanisms for avoiding corporate taxes is the
use of tax havens. The restrictive definition of tax havens, the countries with
low or non-existent tax rates, lack of transparency and information sharing,
opportunities for bank secrecy with little or no economic activity to obtain a
legal status are characterized as tax havens (Gravelle,2009, p.728). He has
also stated the broader definition that tax havens are characterized as a low-tax
country with the goal of attracting capital. Furthermore Gravelle (2009, p.728)
mentioned that corporate tax avoidance transpires in both narrowly and broadly
defined tax havens which arises from either legal avoidance or illegal evasion.

Weiner & Ault (1998, p.603) stated that The Organization for Economic Development
and Cooperation (1988) initially identified the features of tax haven as no or
low taxes, ineffective information exchange and transparency and no requirements
for substantial activities. Gravelle (2009, p.730) mentioned that the list for
tax havens has been created and changed over time and currently has three lists
including white, gray and black list in accordance to the degree of commitment
of the tax haven countries. Richardson & Taylor (2015, p.479) stated that
although firms can utilize tax havens for legitimate business purposes to
facilitate fund transfers between corporate members and lower costs, a great
deal of concern has been expressed by Internal Revenue Service (IRS), Government
Accountability Office (GAO) and other government agencies including Homeland
Security and Government Affairs regarding tax havens and their impact in
playing a major role in significantly reducing corporate tax liabilities. As
such, this debate concerning the existence and impact of tax havens on U.S.

economy has led to various tax reforms and modified legislations. Rosenzswig
(2010, p.927) stated that in the years 1962, 1967, 1976, 1986 and in 1993, the
United States enacted or fundamentally revised its anti-tax-haven legislation
which currently acts as the driving force behind most international tax policy.

    
Tax havens have gradually come into existence and flourished
economically in the last century. This growth is based on the numerous
advantages and benefits that the tax havens provide. These benefits are
captured and fully utilized by the U.S. based Multinational corporations in
order to minimize their tax liabilities. The use of tax havens is widely
characterized by the different incentives and perks they provide. The different
ways and tactics used by the U.S. multinational firms in minimizing their tax
liabilities has a strong impact on the corporate tax avoidance in the United
States. These U.S. based firms strategically incorporate their subsidiaries and
shell corporations in their preferred tax havens. The tax havens are chosen
based on the multinational’s incentives that emphasizes the firm’s economic
benefits, investment opportunities and the varying tax benefits. Hanlon &
Heitzman (2010, p.150) claim that tax havens have played a vital role for the U.S.

based firms in terms of debt and investment locations, accounting earnings and
tax revenues and such the tax havens act as financial centers which facilitate
the movement of capital between different jurisdictions. This paper focuses on
various significant incentives influencing the U.S. multinational businesses to
utilize tax havens and their impacts on the corporate tax avoidance. 

    
The use of tax havens The opportunity to shift corporate profits is one
of the major benefits obtained by any U.S. multinational firm utilizing tax
havens. U.S. multinational firms are exempted from paying taxes on the income
earnings by their foreign subsidiaries until it is repatriated to the U.S.

parent company as dividends. The repatriated income is also granted a credit
against the U.S. tax for the foreign tax paid for the repatriated income.

Gravelle (2009, p.732) mention that tax havens are related both to U.S. parent
companies shifting profits abroad to low tax jurisdictions as well as the
shifting of profits out of the United States by foreign parents of U.S.

subsidiaries. This leads to a large sum of tax liable corporate profit being
shifted from the United States to various tax havens which is subsequently
converted into tax free income for the multinationals. This corporate profit
shifting is also conducted in forms of allocating debts and earnings stripping.

Gravelle (2009, p.732) state that in the practice of earnings stripping, debt
is associated with firms in high tax jurisdiction or conversely the unrelated
debt is not subject to tax by the recipient. In such cases the multinational
firms benefit from taking high leverage in U.S. and shifting profits in the tax
havens while paying no taxes on the debt in U.S. This opportunity for shifting
profits has been a significant determinant for the issue of corporate tax
avoidance in the U.S. in respect to which Dowling (2013, p.175) mention that
corporate tax avoidance is prevalent in multinational corporations since its
multiple locations allows it to organize its activities and realize its profits
from countries with the most favorable tax regime. Thus, over the years, the
process of corporate profit shifting has been eased and facilitated by tax
havens which has ultimately benefitted the U.S. multinational corporations to
avoid their corporate tax liabilities.

    
The tax havens are effectively used by U.S. multinational firms to
exploit the opportunity of transfer pricing and utilize the policies regarding
investment in intangible assets. Richardson and Taylor (2015, p.463) mention that
tax audits conducted by the Internal Revenue Service (IRS) portrayed that U.S.

multinational firms use tax havens in combination with the transfer pricing
aggressiveness in order to achieve both financial and tax benefits. The greater
purpose of transfer pricing is to maximize corporate profits and it generally
takes place between affiliates under common control through the sale of goods
and services. These affiliates are generally subsidiaries or shell corporations
based in the tax havens which are owned and operated by the parent U.S.

multinational corporate entities themselves. These transactions conducted by
the firms make use of transfer pricing opportunities to minimize tax
liabilities. Radu (2012, p.400) state that transfer pricing is one of the
current practices of multinational firms by which they buy products from
multinational branches located in offshore centers without profit and which in
turn is resold in the world without having to pay fees and tax and this process
according to the OECD represents 50% of the international trade. The function
of transfer pricing is further expedited for the U.S. based multinational
businesses owing to tax deductibility of investments in intangibles. Gravelle
(2009, p.734) claim that intangible investment including research costs as well
as advertising expenses for establishing band names are eligible for tax credit
which provides significant incentives for U.S. multinational firms to make
investments in the United States and subsequently shift profits of successful
intangible investments to low tax jurisdictions resulting in negative tax rates
for such investments. Grubert (2003, p. 225) claim that nearly half of the
profitability of U.S. multinational companies between high and low tax
jurisdictions is generated by transfer of intangible assets including
intellectual capital and additionally through re-allocation of the debts. These
processes play a decisive role in determining the profitability of the
multinational corporations and thus continually keep on promoting the use of
tax havens.

    
The case of Starbucks is a relevant example of corporate tax avoidance
by U.S. multinational firms using tax havens. Starbucks is a prominent U.S.

based multinational company that owns the world’s largest chain of coffee
houses. The company operates all around the world with numerous subsidiaries
and affiliated entities. This particular case emphasizes on the corporate tax
avoidance by Starbucks for its operation in the U.K but nevertheless this case
of a U.S. multinational corporation using tax havens to avoid paying corporate
taxes paints a relevant and appropriate picture of this complex issue. The
British news service Reuters reported that the executives of the U.S. based
multinational firm Starbucks described its U.K. operations as being successful
and to be considered as model while the company consistently reported net
losses to the U.K. tax authority and only once in 14 years reported taxable
profit in the U.K. (Bergin, 2012). In the educational case study of Starbucks
and its tax avoidance, Campbell and Helleloid (2016, p.41) state how the
Starbucks U.K. took advantage of affiliated companies under common control in
order to report taxable loss to the tax authorities. The case study further indicates
the use of different Starbucks business operations in low tax jurisdiction to
transfer the royalty payments and make use of transfer pricing. The U.S. based
multinational firm financed the firm’s U.K. operation by adopting inter-company
debt with comparably higher interest rates. These interest payments of
Starbucks U.K. actually represent the interest revenue for another Starbucks
entity which would be subjected to corporate tax but that entity would be
placed strategically in a tax haven with lower tax rates than the U.K. (Bergin,
2012).

    
The various impacts of tax havens and the benefits provided by these tax
shelters have incentivize the U.S. multinational corporations in avoiding
corporate tax. The discussions presented in the paper has linked these various
methods and techniques used by the firms to minimize and avoid paying their due
share of the corporate taxes. This particular phenomenon has lead to the
formation of the hypothesis for the paper. The proposed hypothesis states that
with increased benefits and incentives provided by the tax havens, the rate of
corporate tax avoidance by U.S. multinational corporations will go up.

 

 

 

 

 

Conclusion: 

 

The concerns regarding the use of
tax havens by U.S. multinational businesses and their corporate tax avoidance
has emerged out to be one of the more significant issues in U.S. Tax reforms in
the recent times. The paper has looked into the different incentives provided
by tax havens and their impacts on the corporate tax avoidance. There have been
limitations in conducting empirical research regarding this issue owing to the
secrecy of the information pertaining the tax liabilities and its payments by
the corporate multinational firms. The web of complex laws, rules, regulations
and policies regarding corporate tax payments have further contributed in firms
using tax havens for corporate tax avoidance. One of the limitations of this
paper is the lack of research relating to the possible positive impacts of tax
havens and its relation to corporate tax liabilities.

    
The game of corporate tax avoidance using tax havens have been stimulated
by financial gains of the U.S. corporate companies. The concerns regarding
morality and social responsibility of these multinational firms on the issue of
corporate tax avoidance has been widely criticized. The impact of such tax
shelters and its role in aiding the U.S. multinational firms to avoid their
corporate tax liabilities has posed consistent threat to the economic and
political sovereignty of the United States. The role of the U.S. government can
be debated regarding the issue for resolving the problem with tax havens but in
reality, the decision to change the tax laws of another country cannot be
directly enforced by the United States. Rosenzwig (2010, p.940) states that the
answer to the issue of tax havens have developed over time and modern developed
countries harmed by tax havens should combat the issue by punishing the tax
havens or the taxpayers investing in them. Several other methods and techniques
have emerged to facilitate the actions against tax havens and minimize the rate
of corporate tax avoidance. Gravelle (2009, p.747) mentioned the use of the
carrot and stick approach to tax havens which involves the paying of
transitional aid to residents of tax havens for moving away from such
activities and actively withholding the aid for non-cooperating tax havens. The
other approach mentioned to combatting this issue includes the implementation
of Qualitative Intermediary (QI) program to verify the ownership of foreign
corporations. The use of alternative techniques such as treating shell
corporation as a U.S. firm, introducing stricter penalties, utilizing IRS
resources, treating dividend abuse and imposing restrictions on foreign trusts
can all act in minimizing the negative impact of tax havens on corporate tax
avoidance. In addition, the U.S. multinational firms have to perceive their
corporate social responsibilities and pay their fair share of corporate tax
liabilities. Thus, with the joint efforts of the U.S. government, tax
authorities, IRS and the corporate multinational firms, this complex problem of
corporate tax avoidance can be settled. This in turn will minimize the impacts of
tax havens on corporate tax avoidance in the United States.