Multinational corporations strategically employ international transfer pricing and tax inversion to place their operations in low tax-rate countries, resulting in lower income taxes.
We cover the corporate income tax strategies that corporations often use that you should know about.
Corporate income tax strategy #1: International transfer pricing
What is international transfer pricing?
Companies can manage where their profits are reported through international transfer pricing. International transfer pricing is the act of selling products from one division to another within the same corporation, but located in different countries.
In other words, they strategically place operations in low tax-rate countries.
What are the benefits of international transfer pricing?
When a company is able to provide accurate transfer pricing documents, it is eligible for a number of tax breaks that allow it to avoid paying taxes in many countries.
Avoiding high tariffs
By sending goods to nations with high tariff rates and employing low transfer charges, transfer pricing helps to reduce duty expenses by lowering the duty base of such transactions.
Lower tax rate
Transfer pricing ensures profits for products and services in many countries with a lower tax rate.
Reduced tax liability
A transfer pricing document serves as a foundation for calculating the entire cost of association between two organizations, which aids in the avoidance or reduction of tax liability.
Reduced duty costs
In international trade, duty costs are a significant challenge. You will have to deal with such costs on a regular basis if you run a worldwide corporation.
Transfer pricing aids businesses in lowering their duty costs. Furthermore, organizations can ship goods to nations with high tariffs at low transfer costs.
Reduced income taxes
Organizations can also significantly cut their income taxes in nations with high tax rates. This is accomplished by overpricing the items being exported to countries with lower tax rates.
As a result, overall profits are balanced, and enterprises can make more money.
What are the risks involved in international transfer pricing?
- There may be disagreements between an organization’s divisions about pricing and transfer procedures.
- In terms of time and labor, there are significant additional costs associated with implementing transfer prices and maintaining a comprehensive accounting system to support them. Transfer pricing is a time-consuming and sophisticated approach.
- It’s tough to set pricing for intangible commodities such as services.
- Buyers and sellers fulfill various jobs and, as a result, take different risks. For example, the seller may decline to provide a product guarantee. However, the buyer’s price would be affected by the discrepancy.
Case study: How Google uses international transfer pricing
According to the Corporate Finance Institute, Google is a good case study of how a big corporation employs the international transfer pricing strategy.
In Singapore, Google has a regional headquarters and an Australian subsidiary. Users and Australian businesses benefit from the Australian subsidiary’s sales and marketing help. Google uses the Australian subsidiary for research services all around the world.
Google Australia had a profit of roughly $46 million on revenues of $358 million in 2012-13. After claiming a $4.5 million tax credit, Google Australia had a projected tax payment to be AU$7.1 million.
Corporate income tax strategy #2: Tax inversions
What is tax inversion?
Another strategy that corporations can use to decrease the tax rate is to move their legal headquarters to a location with lower tax rates.
Corporations can do the tax inversion practice because the corporate structure is relatively flexible. On the other hand, if the business’ structure leans more towards a partnership, where the partnership’s tax law is different from country to country, this inversion practice is not possible.
What are the benefits of tax inversions?
Corporations invert to take advantage of reduced tax rates, mainly found in tax-haven countries. A company’s global income is no longer taxed in the United States once it has been inverted. It is only responsible for paying taxes on income earned in the United States.
What are the risks involved in tax inversions?
1. There’s a chance you’ll lose your expertise.
You need to work with tax and legal consultants who have completed inversions in the country where you seek to re-incorporate. Tax inversion isn’t a “do-it-yourself” undertaking.
2. The danger to shareholders.
It’s also crucial to consider any potential tax implications for your stockholders. You’ll be trading shares in the old firm for shares in the new one when you incorporate. Shareholders may face severe tax repercussions if it is not correctly constituted.
3. The danger of making the front page.
In addition, tax inversions aren’t widely discussed in the media. Despite being fully legal, opponents contend that the practice is unpatriotic and unfair. While it’s doubtful that Congress will adopt new legislation prohibiting tax inversions anytime soon, the U.S. Treasury Department is considering what steps it may take to discourage them further in light of recent media attention.
Case study: How Walgreens uses tax inversions
According to the American For Tax Fairness Organization, Walgreens, which had $72 billion in U.S. sales in 2014, inverts with a Swiss corporation and will likely save $4 billion in U.S. income taxes over the next five years. If Pfizer was successful in its attempt at an inversion with AstraZeneca in the UK, it would have saved $1 billion a year in taxes in the US.
So, do large corporations abuse these tax rules to evade legitimate income taxes? This is up to national governments to decide.
One example of the relationship between the government and corporations regarding tax inversions is the U.S. government’s policy on reporting income arising from intellectual property.
In 2008, the U.S. government decided that all U.S.-based corporations must compute how much income is generated from intellectual property. Then the corporations must pay U.S. income tax on that intellectual property-related income no matter where the income is generated in the world.
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