Multi-nationals such as Starbucks, Apple, and Amazon have been under the spotlight lately due to the low amount of tax they pay in comparison to their total earnings. For example, Google reported that it paid US$248 million in taxes on foreign income of US$7.633 billion. However, it is difficult to discern from mainstream media reports exactly what the issue is. An explanation and example are provided below.
When doing business in more than one country, by necessity or choice, assets and services need to be made available in different countries. This provides the option of arranging that use advantageously. Take, for example, Crispy Fried Turkey (CFT), a hypothetical fast-food chain that operates across the US, UK, Australia, and New Zealand. Its spread of taxable income and tax payable is detailed in Table 1.
After a visit from its advisor, CFT decides to sell its intellectual property (i.e. its secret recipe) to a new company it incorporates in the Cayman Islands. For use of the recipe, each company in the various countries makes a royalty payment to the Cayman Islands company. The royalty payments are tax-deductible in the countries of origin. However, the Cayman Islands corporate income tax rate is 0%. This produces the result detailed in Table 2.
This example is a simple illustration of one of the ways tax can be reduced with some restructuring. In this case, the corporate tax rate in another country was used to reduce CFT’s total tax payable. Another option would have been to set up a corporate head office, complete with back-office support staff and financial services in a low tax rate country, and charge the wider global group for use of those services.
The results achieved in this example are not far from reality. A report by the US Congressional Research Service states that in 2008 American multi-national companies reported 43% of their overseas income through tax havens like Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland, while only 4% of their foreign workforce and investments were in these countries.
The current regime dates back to a time when cross-border business was not as common. While technology and globalization have grown exponentially over the last decade or so, the tax regime has not adapted. The tax revenue forgone by governments is prompting a re-think as to what is appropriate.
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