International Taxation - Research Proposal Example

? International Taxation Introduction The rapid globalization in the recent decades has given rise to a large number of multinational companies (MNCs) that have that have operations in several countries. The growth of international business has brought with it the challenges of harmonization of business strategies in the different geographical locations of operations. One of the most glaring challenges is the issue of taxation. In most countries, the tax unit is considered to the individual company. The local registered subsidiaries of multinational companies have to pay individual tax returns in their respective countries. Essentially, this means that a multinational company with hundreds of companies worldwide is not regarded as a single economic entity but rather as an amalgam of independent tax paying companies1. There has been intense debate on whether it would be wise for the international taxation to be changed to allow for the holding company to pay the group’s consolidated tax. The proponents of this argument state that it would be much more convenient and efficient for consolidated tax returns as applicable to multinational companies. Anti-avoidance legislation Tax avoidance can be defined as the lawful measures that a firm may take in order to reduce their liability to payment of tax. It should be noted that tax avoidance is not illegal but its effect on the economy may be dire. The question of avoidance of tax has been of great contention considering the fact that the firms have a responsibility of being diligent in their dealings with the state. In order to mitigate the negative impacts of tax avoidance, governments have been in the forefront of enacting anti avoidance legislation that is aimed at sealing the loopholes that allow for tax avoidance. One of the strategies that governments have used is the adoption of general anti avoidance rule. The logic of this strategy is the fact that legislation has limits on the extent to which it may foresee all arrangements of taxpayers2. Therefore, a general anti avoidance rule may operate within existing laws or provide a caveat against general tax avoidance issues. In the United Kingdom, governments have implemented anti avoidance provisions that are targeted to deal with specific abuses of tax law. This is consistent with the legal view that legislation should be specific and outline the specific circumstances under which liability arises. There are scenarios whereby the anti avoidance laws are applied retrospectively in order to comprehensively account for previous abuse of the law. However, the United Kingdom courts require concrete proof of avoidance before a conviction can be upheld. In Parnington v The Attorney General3, the courts ruled that for the government to recover tax the prosecution must bring the subject to the letter of the law. It is not sufficient to have a case that is just backed by the spirit of the law. In the context of Canadian law, the courts lay emphasis on the substance of the legal arrangements in a given transaction rather than the economic outcome of the transactions. The interpretation of the Income Act 1976 is literal and the burden of proof of avoidance is upon the prosecution. The Revenue Canada department gave guidelines that expressly allowed the taxpayers to be subjected to minimum pay. However, cases of crafty tax planning grew exponentially leading to a major decline in the amount of revenue that the government collected. This led to the enactment of a general anti avoidance legislation that reinforced anti avoidance provisions in the Income Tax Act 1976 and the Goods and Services Act 19873. The essence of the rule was to distinguish from between abusive and legitimate tax avoidance measures. Australia has had a longstanding general anti avoidance rule over the years. The statutory provision in section 260 of the Income Tax Act of 1936 dictates that a contract that seeks to alter the liability for income tax is null and void. The application of the anti avoidance rules use predication test, the antecedent doctrine test and the choice test to determine cases. In the case Newton v FCT44, the court ruled that the major issue was not the desire by the taxpayer to avoid paying tax but rather the methods which would be employed to actualize the scheme. It is also not illegal for a taxpayer to choose a law that allows them to pay the lowest tax possible. The United States has explicit legislation that targets the tax payment of international companies. The controlled foreign corporation (CFC) rules were created to prevent the use of foreign companies to avoid payment of tax. This was because the previous laws allowed for U.S. citizens to be shareholders of foreign companies but exempted them from paying income tax from the earnings of the company until they have received direct payment. Besides, the U.S. does not have taxing authority over foreign companies that have no U.S source of income. However, if there are U.S. citizens holding shares in the foreign company, then they are liable to pay taxes on the income they receive from the company. If tax was to be charged on the consolidated income of the holding company, then there would be minimal need for anti avoidance rules relating to multinational companies. This is because the MNCs would be paying tax in the country where the holding company is registered and the tax is distributed to all regions where the MNCs have a presence. The risk of tax avoidance would be minimal since the companies will be under one tax regime thus effectively regulated. In retrospect, a multinational company would be subject to several anti avoidance legislations which would be cumbersome to comply with. For instance, some countries allow for legitimate tax avoidance while others condemn tax avoidance of any nature. Thus, it would be difficult to align the financial reporting of the multinational company in a manner that addresses all the issues in each country of operation. Transfer Price Manipulation Issues involving transfer pricing account for the majority of tax cases in the globe. Transfer pricing refers to the price that companies that are related charge each other for transactional business between themselves. The major point of concern is whether related companies charge the appropriate price for the services and goods that they exchange. Some companies skew the transfer prices in order to reap maximum business benefits. For instance, if a company in a high tax regime might sell goods to sister company in a low tax regime at cheaply. Thus, the companies will effectively paying taxes in regions that it considers having high rates. The main aim of effective transfer prices is to ensure that the prices that related ventures charges each other are a true reflection of what unrelated enterprises would have charged each other. An effective transfer price regime should be able to allow multinational companies and revenue authorities to divide taxable income in a fair and equitable manner amongst the countries of operation5. Transfer pricing manipulation is practiced by the multinational companies in order to avoid paying taxes in countries that they deem to have high tax rates. This means that some countries actually lose tax earnings despite having multinational companies operating in them. However, a consolidated tax regime would ensure that no country loses out in tax earnings. The multinational would be treated as a single economic entity and the tax due would be charged on the consolidated returns across all its operations. Therefore, the multinational company would have no leeway to avoid paying taxes in any country. Arms Length Principle The arm’s length principle states that the transfer prices should be controlled such that they reflect the transfer prices in the liberal market place. Essentially, this means that the transfer prices between related entities should be similar to those of unrelated enterprises. Each constituent of a multinational enterprise is treated as an independent taxable entity. The income of the subsidiary is reconstructed based on transactions that are hypothetical which would have taken place if the subsidiary was doing business with other constituents of the multinational company at arm’s length6. This means that the prices charged between the related multinational company’s subsidiaries should reflect the true prices that unrelated entities would charge each other. One of the methods used to implement the arm’s length principle is the comparable uncontrolled price method7. The transaction between related subsidiaries is considered to be controlled. In this context, the arm’s length principle is used to evaluate whether the transfer price used in related enterprises compare well with a similar uncontrolled transactions. It is the obligation of the multinational company to ensure that controlled transactions are in tandem with uncontrolled transactions. The other method that that can be used is the resale price method. This means that the price that a related subsidiary sales goods to its counterparts is evaluated in comparison with the resale price of the commodity. The difference between the transfer price and the resale price should be within acceptable profit margins. For instance, if a subsidiary is involved only in the sale of goods then the resale price can be an effective measure for obtaining the arm’s length price. Cost plus method can also be used to determine the appropriate transfer price. This is especially applicable to the manufacturing sector where the costs of manufacture can be considered plus the appropriate gross profit. Controlled profits method assesses the results in a controlled transaction to investigate whether they are arm’s length. The objective measures of profitability in a fair trading market for a similar business are compared with the profitability attained in the controlled environment. In considering comparable profits, a taxpayer must establish what it considers to be arm’s length price for transactions and this value is compared with the industry average. If the price is within tolerable limits, the tax authorities accept it. However, if the prices are outside the acceptable range the authorities may adjust the prices to reflect the market prices. The method that is used to determine the fair transfer price differs depending on the circumstances and nature of transaction. However, the determination of transfer prices is overly difficult since it is almost impossible to find comparable actual transactions8. This means that the transfer prices that may be calculated is hypothetical and hence capture the full transaction in question9. The other shortcoming of arm’s length consideration for transfer price is that different countries may arrive at different prices for the same transaction. This may lead to the dire situation of double taxation. This may arise since each country will charge tax depending on its own assessment of the value of the transactions. It should be noted that a viable way of avoiding double taxation is through consolidation of tax regimes across different geographical locations. Countries should come up with unified methodologies of calculating the tax chargeable on multinationals and the responsibility of collecting the tax should be upon the country in which the holding company lies. Taxation Based on Consolidated Accounts In the U.S, regional companies are taxed based upon consolidated accounts. The tax revenue is shared among the individual state in which the company regional company has operations. In order to implement this kind of tax regime, the states have harmonized taxation laws that are uniform. A regional company is only required to file tax returns in the state that it is headquartered. The other states in which it has operations are paid tax revenues depending on the percentage of business that was generated from the state. This method of taxation is important since it enables firms to align its business strategy in line with a single taxation regime10. In Australia, the operation of multinational companies is also subject to a single tax regime. The resident companies are required to pay tax on their worldwide income and capital gains. The advantage of the tax regime in Australia is the limit on extra tax on income generated from the operations of subsidiary companies. This goes along in helping to avoid the issue of double taxation. In the event that the parent company based in Australia has to pay tax for the second time on income from subsidiaries, a tax credit is issued to compensate the company. The Australian government also provides tax reliefs for companies that are seeking demerger. Tax free de-mergers are an incentive that allows for multinationals to easily establish themselves in the country and scale up operations. Shareholders also benefit from deferral of capital gains tax and obtain tax reliefs on dividends11. The government of Australia also provides favourable tax regimes for multinationals that set operations in the country. Provision of tax treaties and income conduit helps in encouraging multinationals to set shop in the country12. Thus, it can be argued that actively engaging multinational companies by providing consolidated taxation helps to spur development in the resident country. Conclusion Harmonization of tax returns across different geographical locations is an important measure that can allow for smooth operations of multinational companies. The world has globalized rapidly and the businesses of the future inherently operate in several countries. Advances in technology and the growth of online technology companies have also made the movement of capital across geographical boundaries to become very rapid. Therefore, it is necessary for countries across the world to implement international tax regimes that are unified. Most importantly, the taxation of multinational companies should be done in the country where the holding company is based13. The tax should be calculated based on the consolidated returns of the company and the tax revenues are then shared among the countries. Consolidation of international taxation regimes can help in sorting out the issue of tax avoidance and transfer price manipulations. This is because the company will be taxed based on the consolidated returns and therefore all the income would be accounted for eventually. In conclusion, the system of taxation based on consolidated returns is desirable and will go a long way in streamlining the performance of multinational companies. References Angharad. M, O. Lynne., Principles of International Taxation (Aspen Publishers, London 2012). Anorld, B M. Mclyntire. International Tax Primer (Oxford University Press, Oxford 2002). Jonathan, S & D. Booth. Booth: Residence, Domicile and UK Taxation. (Tottel Publishers, London 2009). Joseph, J. International Taxation (Concepts and Insights). ( Foundation Press, New York 2005). Hollande, G. International Business and Taxation ( Pearson, New York 2011). Langer, J. Income Taxation of Foreign Related Transactions (McMillan, London 2002). Michaels, C. Principles of International Taxation ( Pearson Publishers, New York 2009). Richard, L. International Taxation in a Nutshell ( McGraw Hill, New York 2004). Ring, Y. Brauvner. U. S. Taxation: Case and Materials ( Harper Collins, New York 2010). Thompson, S. U. S International Tax Planning and Policy. (Prentice Hall, New York 2007). Read More