Accounting and Society - Australian Tax Office - Case Study Example

Accounting and Society Name Instructor Course Accounting and Society Executive Summary Australia being one of the high taxation countries is undergoing a problem of many multinational countries transferring profits in other countries with low tax regimes so that they could minimize the profits that they pay in Australia. The report has used the agency theory to evaluate some of the reasons why some companies transfer profits and others do not. The report has also assessed some of the ways the Australian Tax Office (ATO) could use to encourage multinationals to pay taxes using the legitimacy theory. From the report findings, some companies transfer taxes because of issues to do with international tax competition and the acquisition of intelligent property. Other corporations do not transfer taxes because of issues to do with maintaining profitability and helping in its investments in that country. Some approaches that the report has recommended for the ATO is the implementation of the Tax Transparency Code and the Diverted Profits Tax approaches. Table of Contents Executive Summary 2 Table of Contents 3 Introduction 4 Agency Theory 4 Reasons for Profits Transfer 5 Reasons for not Transferring Profits 6 Legitimacy Theory 8 Summary 9 References 11 Introduction There is a tendency for many Australian companies, which belong to some multinational corporations to evade paying the tax they are required to pay through transferring their profits to other countries (Needham, 2013). Therefore, in the eyes of the Australian Tax Office (ATO), the profits that they earn on the large revenue numbers become very small which is rather ironical. These profits become reduced because the companies incur some expenses when transferring its profits to some low tax regions so that they would not incur even more costs in paying taxes (Needham, 2013). On the other hand, there are still some companies that have chosen not to transfer their profits to the low tax regions because of various reasons (Needham, 2013). The report will use the agency theory can be used to explain why some companies in Australia choose to transfer profits to lower tax regions and others do not. On the other hand, the report will use the legitimacy theory to evaluate some of the ways that the ATO could use to encourage the Australian companies to record their profits and pay their taxes in the country. Agency Theory The agency theory is regarded as a supposition which takes to explain the relationship which exists between the agents and the principles in business (Lambert, 2006). The theory is primarily concerned with tackling the problems which could exist in the agency relationships either because of the unaligned goals or the difference in preventing various risk levels (Lambert, 2006). The typical agency relationship that can be found in finance is that which occurs between the company executives, who are the agents, and the shareholders who are the principal(s). The theory also solves the problems which may arise because of the differences between the desires and the goals between the agent and the principal (Lambert, 2006). This situation mostly arises when the principal is unaware of the agent’s actions or the resources may have prohibited him from obtaining that information. In a nutshell, agency theory seeks to explain how relationships can be organized where the principal determines the work and the agent does the work (Lambert, 2006). Reasons for Profits Transfer One of the reasons why companies in Australia transfer taxes in low tax regions is because of the international tax competition and issues to do with the foreign investments (Bartelsman, and Beetsma, 2003). The world is facing a significant competition when it comes to their tax regimes, and in most cases, the countries with low tax regimes often win in this competition. Australia is one of the countries that are associated with very high corporate taxes (Bartelsman, and Beetsma, 2003). Relating the problem to the agency theory, in this case, the Australian government which is represented by the ATO is the principal, and the companies are the agents. The principal, which is the ATO, requires the agents, which are the multinational corporations, to pay taxes on all the profits that they have earned. Instead, the agents decide to transfer their profits to other countries where they feel that they would not have to pay as much taxes on their profits as they have to do in Australia. Although Australia has high investment levels, which is what makes the companies invest in it, its tax regime is high as well that does not make it as competitive as in other countries which make them transfer their profits in those countries (Gravelle, 2009). Since the agency theory has an underlying assumption that both parties are guided by self-interests, it best suits to explain why the companies (agents) transfer profits which are to reduce the costs of tax while the ATO (principal) wants to have more revenue in the form of corporate tax (Gravelle, 2009). Another reason for multinational companies to transfer their profits in other low tax regimes is because of the aspect of the acquisition of intellectual property (Clausing, 2009). The multinational corporations usually incur a lot of payments to the Australian government when accessing the intellectual property from overseas (Clausing, 2009). As the principal, the Australian government requires the agents to pay for every intellectual property they acquire from abroad which will be used for their operations through the licensing arrangements that the principal has put in place. These licensing arrangements are regarded as a form of transfer pricing (Clausing, 2009). One of the features of this high technology transfer pricing us that a significant amount of the payments made by the agents reflect in the Australian Bureau of Statistics as the licensing fees for the acquired intellectual property (Neighbour, 2002). Additionally, the multinational corporations (agents) incur various other transfer pricing forms like making payments for their business services and the interests that are incurred by related companies. Thus, going back to the underlying assumption of the agency theory which is self-interest, the agents incur a lot of costs just for operating in Australia, and since their aim is to make as much profit as possible, they reduce their tax through transferring some of their profits in tax havens (Clausing, 2009). Reasons for not Transferring Profits When some multinational corporations are transferring profits from Australia to other low tax regions, some of them choose not to transfer these profits and therefore, pay the corporate taxes as they are required to do (Sikka and Willmott, 2010). Although Australia is a high tax jurisdiction, it is also a country that is highly favorable for business with numerous opportunities for earning profits. Various multinational companies which are agents according to the agency theory try to minimize the taxes that are charged by the Australian government which is the principal, through transferring profits because of the belief that if they do so, then their businesses will be unprofitable (Sikka and Willmott, 2010). On the other hand, some of the agents do not transfer profits because they perceive it as an additional cost that would rather be paid to the principal; furthermore, whether or not they transfer profits, their businesses will not be unprofitable. One important fact that the companies which do not transfer profits understand is that a business which is more profitable as compare to saving money in financial institutions will also be profitable even before or after being taxed (Neighbour, 2002). This remains to be true even after the decrease or increase in corporate tax. Thus, as much as the agency theory is guided by self-interest and economic prosperity for both parties, the agents have particular levels of moral responsibilities for their actions (Neighbour, 2002). Therefore, the companies choose not to transfer profits because whether or not the transfer, their business will still be profitable, and they acknowledge the moral obligation that they have for their principal which is to pay taxes for the profits that they have earned. Another reason for some companies not transferring profits is because of the issue of investment (Gravelle, 2009). Many of the multinational companies transfer profits so that they could increase the funds that they have which can be spent on further investment which will, in turn, lead to job creation. However, for companies which do not transfer profits argue that paying fewer taxes does not limit the funds that it will have for investments, instead, it maintains the ability of the company to invest more so when it comes to getting the financial assistance of the financial institutions in Australia (Gravelle, 2009). When the multinational corporation resolves to pay taxes for all the profits it has incurred, in the case, they need to approach any financial institution for assistance it is likely to be accorded the assistance based on its integrity when it comes to paying taxes. Any other government institutions will also be readily available for them for any help or partnerships that it would like to form (Neighbour, 2002). Following the agency theory, it is a depiction of a positive relationship between the principal and the agents which are healthy for the smooth running of the company. In the end, the company is likely to make more successful investments and increasing its profits for its operations in that country (Neighbour, 2002). Legitimacy Theory Legitimacy theory describes that companies are required to operate within the boundaries of its social contract and norms of the society that is around them (Campbell, 2000). This means that they are required to ensure that the activities that they engage in are perceived positively by the outside parties, they are in line with their cultures and norms, and they do not pose a threat to cause the societal change of the norms (Campbell, 2000). The legitimacy theory is associated with the role of explaining an organizational behavior in the development and implementation of the voluntary environmental and social information disclosure so that they could fulfill the social contract that allows the outside parties to recognize their objectives as well. In consistency with the legitimacy theory, many businesses have sort to maintain, repair, or gain their legitimacy through the use of environmental and social reporting (Campbell, 2000). In a nutshell, the legitimacy theory offers some useful insights for the corporate environmental and social disclosers. The ATO could encourage the Australian companies to record their profits and pay their taxes in Australia through developing a Tax Transparency Code (Henry et al., 2009). This way, the Australian government through the ATO could encourage higher levels of tax transparency in the corporate sector and more so by the multinational companies. The ATO can do this through encouraging those businesses which obtain a $100 million turnover or more to publish that information so that they could support a better and greater informed scrutiny from the public (Henry et al., 2009). Publishing this financial information for the public to read and scrutinize is a depiction of high transparency levels both on the ATO’s and the company’s side. This is also in line with the legitimacy theory which stipulates that the people in public need to be involved in the business undertakings. When the company gains a positive image from the public as well as the ATO regarding tax compliance, then it gains a competitive advantage from most of its international competitors (Henry et al., 2009). Another approach that could be used is the Diverted Profits Tax (James, 2002). This approach will oversee that the multinational companies pay the correct taxes on the earned profits that are made in Australia. The Diverted Profits Tax will give the ATO some greater powers on the way to handle the multinational companies that are not cooperative in tax payment (James, 2002). At the same time, the approach will provide some strong tax incentives for the multinational companies that choose to pay the correct taxes. According to the legitimacy theory, the businesses are required to fulfill their obligation of paying tax which is mainly channeled towards the enhancement of public welfare and the improvement of their living standards. Therefore, aside from the multinationals being penalized heavily for tax evasion, they also need to be ashamed in the eyes of the society because it is like they are evading the responsibility that they have on the society that is around them. This approach of the Diverted Profits Tax will also reinforce the position of Australia has among the implementation and the reinforcement of the toughest laws in combating tax avoidance (James, 2002). Summary Many multinational companies have resolved to transfer their profits to other countries with low tax regimes so that they pay lower taxes on the profits that they earn. This has led Australia losing a lot of revenue which is what has resulted in them developing approaches of how to ensure they obtain this revenue. The report has used the agency theory to explain the reasons why some companies choose to transfer profits, and some companies do not transfer them. It has also evaluated some of the measures that the ATO could use to encourage the payment of correct taxes by the multinational corporations using the legitimacy theory. References Bartelsman, E.J. and Beetsma, R.M 2003, Why pay more? Corporate tax avoidance through transfer pricing in OECD countries. Journal of Public Economics, vol. 87, no. 9, pp.2225-2252. Campbell, D.J 2000, Legitimacy theory or managerial reality construction? Corporate social disclosure in Marks and Spencer Plc corporate reports. In Accounting forum, Vol. 24, No. 1, pp. 80-100. Clausing, K.A 2009. Multinational firm tax avoidance and tax policy. National Tax Journal, vol. 62, no. 4, pp.703-725. Gravelle, J.G 2009, Tax havens: International tax avoidance and evasion. National Tax Journal, vol. 62, issue. 4, pp.727-753. Henry, K., Harmer, J., Piggott, J., Ridout, H and Smith, G 2009, Australia’s future tax system, Canberra, Commonwealth Treasury. James, S 2002, The future international tax environment. In The International Taxation System (pp. 105-119). Springer, New York. Lambert, R.A 2006. Agency theory and management accounting. Handbooks of management accounting research, pp.247-268. Needham, C 2013, Corporate tax avoidance by multinational firms. Library Briefing. Neighbour, J 2002, Transfer pricing: Keeping it at arms' length. Organisation for Economic Cooperation and Development. The OECD Observer, no. 230, p.29. Sikka, P and Willmott, H 2010, The dark side of transfer pricing: Its role in tax avoidance and wealth retentiveness. Critical Perspectives on Accounting, vol. 21, no. 4, pp.342-356. Read More