Tax avoidance – Tax Havens and the Taxation of Transnational Corporations

MARKUS HENN
June 2013

Tax avoidance and tax evasion by transnational companies and the role played by tax
havens have recently received much media attention, when it transpired that prominent
companies such as Starbucks and Apple pay virtually no income taxes on their
massive international profits. The case of the world’s largest commodity trader, Glencore,
demonstrates that tax evasion by multinationals also affects developing countries.
Tax issues and the detrimental role played by tax havens are now firmly on the
international policy agenda, for example at the G20.

Transnational companies employ a number of techniques to benefit from the crosscountry
nature of their transactions, as well as from loopholes and contradictions
in the tax legislation of countries involved to evade and avoid taxes. The paper discusses
the role of tax havens and preferential tax schemes, the abuse of intra-firm
transfer pricing, and describes how different treatment of companies in different
countries can result in »double non-taxation«.

Various approaches to deal with these challenges exist, but have to be improved and
strengthened. This goes for transfer pricing rules, transparency requirements (such
as country-by-country reporting, centralised registers providing »beneficial ownership
« information), and deductibility restrictions; anti-avoidance measures such as
blacklists, the elimination of the abuse of double taxation agreements (e. g. »treaty
shopping«); or the wider use of withholding taxes, especially in the case of developing
countries. Given the tremendous shortcomings of the current transfer pricing
system, a system change in the form of »unitary taxation« needs to be further
thought through and tested.

CONTENTS

1. Globalisation, Tax Havens, and the Taxation of Transnational Corporations � 1
1.1 Introduction. . . 1
1.2 Corporate Taxation in the Globalised Economy. . . 1
1.3 Tax Havens and Tax Competition. . 1
2. How Transnational Corporations Avoid and Evade Taxes. . . 2
2.1 Figures on TNC Tax Avoidance and Evasion. . . 2
2.2 Low-tax Countries and Preferential Tax Regimes. . . 3
2.3 Transfer Pricing and Its Abuse. . . 4
2.4 Qualification »Mismatches« and Derivatives. . . 5
2.5 The Examples of Glencore, SAB Miller, IKEA, and Apple. . . 5
3. International Rules and Solutions. . . 7
3.1 Transfer Pricing Rules: Arm’s Length Principle and Substance Clauses. . . 7
3.2 Country-by-Country Reporting and Beneficial Ownership. . . 8
3.3 Deductibility Restriction, Anti-Avoidance Rules, and Blacklists. . . 9
3.4 Double Taxation Agreements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10
3.5 Withholding Taxes. . 10
3.6 Unitary Taxation. . . 11
4. Conclusion and Recommendations. . . 12
References. . . 13

1.1 Introduction
The taxation of transnational corporations (TNCs) has caused heated debates and generated strong criticism from civil society in recent years. In the United Kingdom (UK), protesters seized Starbucks branches in early 2013, accusing the company of evading taxes. Many of the large Internet and computer companies – but also companies from other sectors – based in the United States (US) are suspected of paying almost no taxes there, on their overseas profits. In 2011, Argentina accused Glencore, the world’s largest commodity trader, of tax evasion. In spring 2013, the release of an extensive database on tax haven activities (»offshore leaks«) pushed the global debate even further.
The G20 have been examining the issue of tax havens for some time, stating in 2009 that »the era of bank-
ing secrecy is over«. Together with the Organisation for Economic Co-operation and Development (OECD), they set up a blacklist of tax havens – which, however, was soon empty. In 2011, they renewed their commitment with strong rhetoric and released another blacklist. Currently, G20 finance ministers are again attempting to deal with the issue, and at their meetings in February and April 2013, took some preliminary decisions to intensify efforts to tax TNCs. In support of the G20, the OECD released its report »Addressing Base Erosion and Profit Shifting«, which illustrates aggressive tax avoidance methods (OECD 2013). For the September G20 summit, the OECD will present an action plan to be endorsed by the heads of state.
This text is an introduction into the debate on taxing TNCs. It gives an overview of the primary techniques TNCs use to evade and avoid taxes, the role of tax havens for tax evasion schemes, and solutions to the problem. Given the complexity of the issue, this text is neither exhaustive on tax havens in general, nor on the taxation of corporations in specific, but shows how these issues are linked.
In general, the taxation of companies and business activities is a difficult task for states. While it is clearly reasonable to tax a share of a company’s profit, it is less clear exactly what should or should not be taxed; this includes, for instance, the question of which costs are deductible from the taxable profit. The problem is worsened by the fact that wealth is no longer strictly tied to tangible assets, such as factories, but also to intangibles, like intellectual property rights. This includes patents or licences that generate cash flow through royalty payments or fees.
The difficulties of taxation are multiplied by any transnational business activity. If there is a company that is active in two different countries, it is not easy to determine which country has the right to tax the profits: Is it the country where the parent company is located? Or is it the country where the affiliate is doing the actual business? And what about modern forms of business where activities are no longer tied to easily traceable factories, but can be undertaken from any place in the world with global outreach, or carried out in the virtual space of the Internet? On what basis can countries still claim the right to tax profits from these types of global or even virtual activities?
There can be no definitive answers to such questions, if for no other reason than the fact that all states are justified in defending their right to tax, in the interest of their citizens. In any case, some answers can be offered after first looking closer at the techniques and conditions that corporations use today to avoid and evade taxes and minimise their tax burden.

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Tax Havens and the Taxation of transnational corporations

 

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