MNCs increase a government’s reliance on value-added taxes or GST (VATs, which are viewed by many as regressive) and reduce government tax receipts that can be used to fund education, expand health care, combat poverty, invest in infrastructure, and otherwise contribute to the nation’s economic development.
Pakistan government gave tax incentives, pro rich tax exemptions alone reduced tax collected by an amount equivalent to 23% of total government revenue, PKR 600 billion and in a last decade the amount was calculated 1500 billion according to one of Oxfam study “ Abolish the pro rich tax exemptions for right to life”. Yet these concessions account for only a portion of lost potential revenue. The use of inflated transfer pricing arrangements and royalty and management fees further reduce government tax receipts. Which needs to further investigates how much the quantum of state revenues lost due to tax avoidance practices.
“Companies have an important role to play in societies across the world and one of those contributions is tax payments which are vital; it enables governments to provide infrastructure, education to workforces of the future, and pay for essential services.” Katharine Teague, Senior Private Sector Adviser, Christian Aid
Corporate tax policy, a previously mysterious topic, has crept into the mainstream as austerity efforts across Europe are seen in the context of record corporate profits and falling corporate tax receipts. Increased public interest has raised the reputational risks associated with corporate tax avoidance and spurred politicians and government leaders in Europe and the United States to begin pushing for corporations to “pay their fair share.” however, in developing countries this case is not taking at the agenda because of wrong perception that country like Pakistan might lost the FDI of MNCs. In fact the potential revenues lost undermining the state responsibility to protect the human rights and in case of the companies – infringement of human rights by not compliance the respecting the human rights.
In emerging markets like Pakistan, MNCs often negotiate tax concessions with the national government, utilise special economic zones (SEZs) and adopt royalty and fee structures that result in tax payments incommensurate with a company’s operational activity. These tax strategies minimise a company’s corporate tax burden, but they also undermine national development by eroding a country’s tax base, an issue that should be of particular concern for companies and investors with an economic interest in the growth of an emerging market consumer class. Preventing aggressive corporate tax practices and mitigating the related risks will require action on the part of governments, regulators and companies themselves.
In perspective of MNCs, this tax avoidance is not a win win situation, actually it is a completely lose game. How it works, the following arguments provide business case for MNCs;
• Tax avoidance strategies have become more common and aggressive. Aggressive tax positions concerning inflated royalty and management fee structures, transfer pricing arrangements, intra-company loans and the location of intangible assets and high-value business functions pose material reputational, operational and financial risks to MNCs.
• Austerity measures and reduced tax receipts have increased public and government scrutiny in both developed and emerging markets, while high-profile media campaigns have exposed the tax avoidance strategies of MNCs like Apple, Starbucks and Google, eroding brand value and leading to multiple protests and boycotts.
• For consumer MNCs operating in emerging markets, tax avoidance strategies pose medium- to long-term risks to profitability by increasing the risk of tax-related penalties, damaging relationships with local governments and eroding the corporate tax base that accounts for a significant portion of the potential and actual government tax revenue necessary for economic development and the growth of a consumer class.
• In emerging markets, the reputational risks can be particularly severe as large MNCs are frequently targeted by protest groups when they are not seen as a being good corporate citizens.
The global debate is shifting and as regulators look to crack down on corporate tax avoidance, it is in companies’ best interests to proactively adopt responsible tax practices. First and foremost, MNCs should not locate group companies in tax havens unless there is a justification based on legitimate economic activity. Corporate tax transparency remains inadequate which prevents investors from accurately assessing the risk of corporate tax positions. Steps to improve transparency include a formal tax policy and code of conduct as well as a country-by-country breakdown of revenue and taxes paid.
Here is a glimpse of some tax avoidance practices, how corporate use as tax planning:
Common Tax Avoidance Strategies for MNCs
Transfer Pricing (Royalties and Service Fees): A MNC will locate supplies, intellectual property and high-value operations in low-tax jurisdictions like Ireland or Switzerland. The MNC will then charge inflated royalty and/or service fees to a subsidiary, which reduces taxable income in the subsidiary country and inflates profit in the low-tax jurisdiction (which is subsequently taxed at a much lower rate). This strategy is supported by a bilateral double tax avoidance treaty between the low-tax jurisdiction and the subsidiary country, which may negate local withholding taxes on management fees, for example.
Negotiated Incentives: Company or industry specific tax incentives and capital allowances that are often negotiated by a MNC with the government or development agency. Such incentives are provided to encourage investment and expansion by MNCs. Since 2008, Zambia Sugar (an Associated British Foods subsidiary) has been subject to a 15% corporate tax rate instead of the regular 35% rate because Zambia agreed to recognize its income as “farming income,” a provision typically allowed only for domestic farmers. The company received a second tax incentive in 2012 that reduced the tax rate on income generated from expanded operations. In Pakistan many sectors got such deals especially fertilizer, auto, IT software and textile sectors etc. And ironically, big business men turned politician made regulatory regimes in their vested interests which translate into Pakistan as tax havens.
Intra-Group Financing: MNCs often provide intra-company loans to subsidiaries. The interest paid on these loans reduces taxable income for the subsidiary. In some cases, a MNC will charge inflated royalty, management or other fees to an emerging market subsidiary, which reduces the subsidiary’s taxable income. The MNC will then provide a loan at a rate that may even exceed market rates. The interest paid on this loan further reduces taxable income in the emerging market and inflates income earned in the country where the loan originated. Starbuck’s provided its UK subsidiary with a 2011 loan at Libor plus 4%, while Starbucks group bonds carry a coupon of Libor plus 1.3%. SABMiller’s wholly owned Mauritius subsidiary, Mubex, serves as a supplier to SABMiller’s Ghanaian subsidiary, Accra Brewery. Upon sourcing from Mubex, Accra Brewery’s gross profit declined dramatically. At the same time, Accra Brewery received a GBP 8.5 million loan that provides a GBP 76,000 annual tax shield. The Ghanaian corporate tax rate is 25%, while MNCs in Mauritius are taxed at 3%.
Treaty Shopping: An umbrella term that refers to the routing of international payments through a third jurisdiction to exploit unique tax benefits. For example, when a MNC obtains a loan for its operations in an emerging market, it can route the loan through a country that has a tax treaty with the emerging market country to avoid local withholding taxes on interest payments. Bilateral tax treaties can also be exploited to reduce or eliminate taxes on dividends paid by the emerging market subsidiary to the parent. The prevalence of routing international payments through tax havens is reflected in OECD statistics on foreign direct investment (FDI). For example, in 2010, Barbados, Bermuda and the British Virgin Islands received more FDI (5.11% of global FDI) than Japan (3.76). That same year, the British Virgin Islands alone were the second largest investor in China (14% FDI), ahead of even the United States (4% FDI).