The Corporate Tax Avoidance Toolbox

Summary

  • Tax Avoidance is legal, frequent and encouraged by competition, countries and consultants
  • Intellectual Property is one of the biggest tools used in tax avoidance
  • There is a thin barrier between Tax Avoidance and Tax Evasion
  • The lawyer & accountant always win

Tax avoidance is legal, although not morally correct in the eyes of public opinion. Paying less tax within the law is a field where companies also compete, incentivized by various country jurisdictions and facilitated by legal and accounting consultants. In fact, it seems that only two companies in the FTSE 100 do not have an offshore subsidiary.

It is therefore important for an informed investor, to also understand how tax avoidance strategies work, besides the public outcry that sometimes makes headlines, and to make an educated guess, if the company is going too far. It is in fact of particular interest for the investors based in the Netherlands, such as B&R Beurs, as the country is usually on the headlines.

Intellectual Property to the rescue

An important tool for tax avoidance is Intellectual Property (IP). Many companies are able to shift profits to a more favourable tax jurisdiction, by simply creating a subsidiary that will hold the rights to IP and charge the rest of the company for their usage.

What can be considered intellectual property? Trademarks, patents and business processes. IKEA and Starbucks stores for example, pay royalties to a different company in the group for the usage of the main trademark and business processes. Other examples include companies within Google and Microsoft, who pay for the patents usage to another subsidiary.

Subsidiaries which would otherwise register a substantial amount of net income, will see their expenses greatly increase, eroding the taxable amount. The income of these royalties is therefore moved to a friendlier taxable environment, and taxed at minimum levels within the group. Sometimes tax avoidance can go too far and become tax evasion, which is considered illegal.

Tax avoidance versus Tax evasion

Imagine you start to charge these royalties at more and more unjustifiable prices, accelerating profit shifting. Adding to that, you also started to pay unjustified high prices to your raw material suppliers which are integrated vertically and thus they are also considered subsidiaries within the company. From one moment to another, an otherwise healthy subsidiary is now a loss-making one, and, guess what, it pays almost no tax at all. That is the case of Starbucks and the graphic below is from a European Commission press release, again with Netherlands in the middle of the rumble.

Figure 1 – How Starbucks obtained an illegal tax advantage (source: European Commission)

Transfer mispricing is one of many fiscal engineering tools, and it can get complex to the point you even lose track of the revenues altogether. Double Irish, Dutch Sandwich, Bermuda Black Hole, Tax Inversion and Family Foundations are some of the architectures you’ll probably continue to see on the news. For more creative companies the various loop-holes between country jurisdictions can significantly reduce their tax burden and, unfortunately, even companies from the sharing economy – the irony – are already doing it: Uber and Airbnb are by now also under investigation.

Tax Shopping

The competition between countries to secure investments is also directly linked to their tax policies, and the term “tax shopping” is becoming a normal thing when a company’s CEO has meetings in various country embassies to receive offers for the best tax environment and other sorts of incentives.

In case you are thinking where to base your company or where to establish subsidiaries, here is a small menu of options to add to the Corporate Tax Avoidance Toolbox, depending on your industry. As in proper marketing, countries also specialize in niches to capture investments:

Figure 2 – Tax Legislation specialized by Country

In conclusion: the lawyer & accountant always win

For a company to succeed in tax avoidance, and avoid mistakes which can culminate even with the arrest of the CEO, tax advisors are essential. The more tax savings a plan brings, usually the more complex it is, and a specialist (and a very well paid) opinion is essential.

Many corporate tax avoidance strategies are sold by the “big four” accounting firms by very lucrative departments. It is therefore not unexpected that these companies will also continue to lobby to keep some of the loop-holes on national legislations. On the other hand, if more restrictive reporting and accounting requirements are demanded by governing bodies in order to decrease tax erosion, then the same accounting firms would again generate another lucrative business.

For steady cash flows it would be probably wiser to stop investing and just open your own accounting firm.

Written by Alex Matoso