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Multinational Corporations’ Income Shifting
Internship in Taxation
Multinational Corporations’ Income Shifting
My interest in this topic was inspired during my daily internship works in Marsh & McLennan Companies when dealing with International Tax issues. I noticed that MMC has so many active entities in several small countries but in which barely has no regular business transactions, while found that no physical assets are on active service when I was conducting the depreciation returns for related companies. After inquiring with our international tax planning director, I gradually realize the detailed tax planning process behind the whole picture, and further explored the facts and impacts regarding this worldwide hot and controversial issue.
Implications of Stateless Income in MMC
“Stateless income” tax planning offers multinational firms, but not wholly domestic ones, the opportunity to convert high-tax country pre-tax marginal returns into low-tax country inframarginal returns,by redirecting pre-tax income from the high-tax country to the low-tax one. The main purpose is to make those multinational corporations subjuect only to the third country – normally, a tax heaven country, rather than where the corporations’ profits were really generated or where the parent compnay resides.
Here’s how it works (As shown in the Figure below):
1. One of MMC's subsadiries is a Multinational Firm (for confidential purpose, only use "MMC" rather than the real subsadiary's name in following), headquartered in the USA, it makes profits in United Kingdom from a service that can be fulfilled remotely. But because the tax rate in the United Kingdom is fairly high, MMC fulfils the service directly from Ireland through its Irish Firm A, while a United Kingdom firm providing only basic services to customers and being reimbursed on a cost basis by Firm A. This transaction created only a few taxable profit to the United Kingdom MMC firm;
2. And then, the next step is to transfer the value of the service to another MMC Firm in Bermuda, where the tax rate is zero. This transfer of intellectual property is technically easy when its value is very low, therefore no taxable profits arise in the United States;
3. But when MMC wants to get money from MMC Irealand Ltd to MMC Bermuda Ltd, MMC mush overcome the CFC (controlled foreign corporation) rules that USA might apply to make MMC Bermuda Ltd subject to tax immediately; To avoid this situation, MMC created another company in Ireland - MMC Ireland B, which managed by MMC Bermuda Ltd, and headquarters “checks the box” on A and B for U.S. tax purposes. Consequently, the IRS will then treat A and B as a single Irish company, not subject to CFC rules; while Ireland will treat MMC Firm B as resident in Bermuda, so that it will pay no corporation tax at all.
4. The last problem is how to get the money from MMC Ireland A to MMC Bermuda Ltd while not triggering cross-border withholding taxes. MMC creates a "pivot company" - MMC Belgium Ltd, from which the payments transferred to MMC Ireland A benefit from the "absence of withholding on nonportfolio payments between EU companies", and for those payments from MMC Ireland B to Bermuda benefit from the absence of withholding under domestic Belgian law.
Do Other Multinational Corporations Apply the Same?
The answer seems undoubted. When my research referring to global companies like Apple, Starbucks and Hewlett-Packard, such companies drawing money into pockets all around the world while aggressively reduce their taxes by applying the similar process system. Take Google as an example, which has almost the same tax planning as MMC. Google launched their Ireland Ltd in Dublin, 2003, which has thousands of employees, and meanwhile created a Google Ireland Holding with no physical office but is fully managed by Bermuda Ltd. Thus, Google Ireland Holding is managed from overseas of Ireald but pocesses all the intellectual properties, brand-names and technology rights. And to perfect the whole picture, Google also has another company located in Netherland, thus when customers order services from Google USA, the Ireland Holding Company will handle the sale and pay Ireland Ltd to fulfill the services and transfer the money to Netherland. Finally, according to Dutch law system, the final amount will be paid back to Google Ireland Holding directly and generate 0% Bermuda tax under Irish law.
Responding to Stateless Income
According to IRS’s research, U.S. companies are said to have more than $1.5 trillion sitting offshore. Most frankly claim that they must keep the money overseas in order to avoid the taxes they would face by bringing it back to the U.S.
“We must address the persistent issue of ‘stateless income,’ which undermines confidence in our tax system at all levels” -- U.S. Treasury Secretary Jack Lew has said.
And the IRS is initiating new methods to reclaim stateless income and multinational corporations’ offshore profits. In May 2013, the Senate Permanent Subcommittee on Investigations proclaimed a report announcing that Apple avoided $9 billion in U.S. taxes in year 2012. But Apple’s CEO Tim Cook testified that companies engaged in this high risk game is doing nothing illegal. According to the report from International Monetary Fund (IMF), an estimated loss to the U.S. is about $60 billion each year from tax planning by multinationals corporations - about 1/4 of their revenues from all the corporate income tax. That is why tax avoidance of multinational corporations has brought media attention and public criticism from countries all around the world.
Not only the IRS alone in the battle of against stateless income. The Organization for Economic Co-operation and Development (OECD) has also voiced support for a fundamental reassessment of the rules on taxing multinationals. Tax manipulation is a serious risk to tax revenue, financial sovereignty and marketing fairness. A simple reason for resolving this issue is the globalization, the world today provides open market for saving and investment. Therefore, the after-tax returns from real overseas investments would be no different around the world. Every business unit would suffer the same tax burden. In other words, U.S. firms might face the same tax costs for foreign companies as well as domestic investment, face the same local tax rates as competitors in third countries that applied same tax source rules. A comprehensive action plan was released in 2013 to address this issue in the Base Erosion and Profit Shifting (BEPS) report. The primary purpose is to better align rights to tax profits with real economic activity, 15 separate action steps will be completed in one to two years.
- Florida Tax Review: Stateless Income By Edward D. Kleinbard (Vol.11, 2011 Number 9)
- The Forbes: Excuse Me Apple, Google, Starbucks & HP: IRS Wants To Tax StatelessIncome. By Robert W. Wood (08/06/2013): http://www.forbes.com/sites/robertwood/2013/08/06/excuse-me-apple-google-starbucks-h-p-irs-wants-to-tax-stateless-income
- OECD: Action Plan On Base Erosion and Profit Shifting (2013) http://www.oecd.org/
- Finfacts: IMF explains “Double Irish Dutch Sandwich” tax avoidance By Michael Hennigan (Oct 11, 2013) http://www.finfacts.ie/irishfinancenews/article_1026675.shtml
- Center on Budget and Policy Priorities: Where Do Our Federal Tax Dollars Go? (March 31, 2014)
- Kleinbard: Multinational corporations, stateless income and tax havens (2011a: 753-758)
- REUTERS: IRS pursuing 'stateless income' tax enforcement: official By Patrick Temple (Jul 24, 2013)
- Bloomberg: G-20 Nations "Fully Endorse" OECD Action Plan on Tax Evasion. By Theophilos Argitis and Scott Rose (Jul 20, 2013)
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 REUTERS: IRS pursuing 'stateless income' tax enforcement: official BY PATRICK TEMPLE (Jul 24, 2013)
 Bloomberg: G-20 Nations "Fully Endorse" OECD Action Plan on Tax Evasion. By Theophilos Argitis and Scott Rose (Jul 20, 2013)