Ideas & Debate

How to identify and deal with tax evasion schemes by multinationals

cash

When superstar companies fail to pay their fair share of taxes, it compromises service provision in host countries. PHOTO | FILE

Give Caesar what belongs to Caesar, urged Jesus Christ. But the sentiment worldwide has been that multinationals are not giving Caesar a fair share of taxes.

The advent of globalisation has led to the rise of what the Economist magazine calls superstar companies. These include multinationals such as Uber, Google and Facebook, among other giants. To them, the world is a play ground.

To maximise returns, superstar companies reduce their tax liabilities by exploiting gaps in international tax laws. They engage in aggressive tax evasion through base erosion and profit shifting (BEPS) techniques.

BEPS is a tax avoidance strategy used by multinationals where profits are shifted from jurisdictions that have high taxes (such as the US and many Western European countries) to those that have low or no taxes — the so-called tax havens.

Thus, such companies fail to contribute their fair share of taxes to the countries they operate in. In their defence, superstar companies argue that they are just playing by the rules.

Tax avoidance offers them a competitive advantage over local companies which cannot apply international tax rules. This distorts competition. It causes countries to suffer revenue loses. It threatens countries’ tax sovereignty and makes global tax unfair.

Taxes are used to provide services to the people. When superstar companies fail to pay their fair share of taxes, this compromises service provision.

Therefore, BEPS presents the ugly side of globalisation, a phenomena Harold James, a Princeton professor, aptly describes as ‘‘globalisation eating its young.’’

Getting hold of superstar companies to pay taxes is an uphill mission. They operate in a digital world characterised by high finance mobility.

Their business models are multi-sided and operate on networked platforms. Their trading is high speed and payments online. Commercial laws are yet to get sophisticated enough to catch up with the evolution of the digital economy.

In avoiding taxes, superstar companies employ an array of BEPS strategies. These include the transfer price manipulations in intra-group, cross-border transactions.

Through this technique, multinationals shift income from high tax jurisdictions to low tax countries via transfer mispricing.

Second, the use of royalty payments schemes on intangible assets. Superstar companies are technology-intensive. Their values reside in their proprietary intellectual assets.

They transfer these intellectual properties to their affiliate in low or zero-tax countries and have head office and affiliates pay royalties, eroding their taxable bases.

Third, interest deductions on intra-corporate loans where multinationals located in low-tax jurisdictions extend loans to affiliates in high-tax nations, then make huge interest payment deductions eroding the taxable base.

Fourth, the use of tax havens. Multinationals incorporate holding companies in zero or low-tax jurisdictions where they bank profits, reducing overall corporate tax.

Lastly, use of inversions where a superstar company shifts its corporate headquarters to a low-tax jurisdiction by acquiring or merging with a firm in a low tax country, reducing overall corporate tax liability.

Kenya has attempted to tackle BEPS by requiring multinationals operating in the country to formulate transfer pricing policies and transfer price to foreign affiliates be at arm’s length.

Equally, there are thin capitalisation rules putting a ceiling on debt financing and interest provisions aimed at preventing interest free loans within a
multinational.

In addition, tax laws attempt to restrict artificial avoidance of permanent establishments. Elsewhere, the Organisation for Economic
Cooperation and Development (OECD), a club of rich countries, released a report on multinationals in October 2015, itemising various action points to tame them.

Political pressure has also been applied to derail multinationals’ activities. For example, President Barack Obama’s administration torpedoed a planned merger of US-based Pfizer and Dublin-based Allergan.

Obsolete laws

However, addressing the multinationals issue requires more inclusive and proactive efforts which should lead to re-writing of obsolete international tax laws.

Some of the mechanisms which may be applied include: Establishing a global tax body, preferably under the auspices of United Nations, to spearhead comprehensive reforms on international tax law.

Second, having a unitary system of international taxation where a multinational is taxed as single entity on consolidated accounts and profits apportioned to each country where it operates. Third, the abolition of tax havens.

A United Nations report on the promotion of a democratic and equitable international order made a similar suggestion, for tax havens only serve to distort the international tax regime.

Lastly, enforcing the territorial approach in taxation where multinationals would be required to pay taxes in a country where income is earned.

This would be achieved by having country-by-country tax reporting mechanisms in order to spot payment mismatches between where firms do business and where they are taxed.

Of course, this is easier said than done. Nevertheless, these recommendations as well as OECD action points will lead to fairness in international
taxation, curtail multinationals’ tax evasion techniques and contribute towards reforms in global taxation.

The author is an Advocate of the High Court of Kenya. [email protected].