Taxation of Multinational Corporations (Term Paper Sample)

What is the best solution to tax digital multinational companies? Over the past few decades, technological advancements have led to significant transformations and evolutions in a multitude of industries and sectors that hitherto were unheard of, and perhaps unimaginable. Arguably, the most influential of these was the creation of the internet, as this allowed a global network of communications and information technology to arise for anyone, anywhere, anytime; as long as they are connected to it. The adoption of this technology has now occurred on a scale such that companies have adapted it in order to aid digitise their business, ultimately leading to a digitalization of the economy, or in other words the use of digital technologies to change business models and locate new revenue streams for a given firm (“OECD and Taxation of the Digital Economy,” 2022). Although boasting positive developments for everything from productivity of businesses and individuals alike, to the education and training systems that are being implemented in order to provide support to those having to adapt to changes in their workplace; there are also various negative implications to this new age of digitalization that is becoming the focal point for how companies operate (“Digitalization of the Economy,” n.d.). Despite there being various issues that should be addressed, this essay will focus on the one that is arguably resulting in the most third party damage to governments and working-class individuals, tax avoidance and tax evasion. An estimated 427$ billion are being lost due to tax abuse by multinational corporations, 182$ billion by private tax evasion and 1.38$ trillion worth of profit are being shifted by corporations in order to continue paying extremely low corporate tax rates (“$427 billion lost to tax havens every year,” n.d.). The most severe aspect of these immoral transfers of wealth is that they are primarily done through developing countries, who are exposed to the damage at inflated levels. Latin Americas and Africa's tax losses are equivalent to 20.4% and 52.5% of their annual health budgets respectively (“$427 billion lost to tax havens every year,” n.d.). It has reached the point where the multinational corporations are so focused on putting money in the pockets of their C level management that they are willing to put the lives of others at risk; and considering that the ongoing Coronavirus pandemic is killing tens of thousands every day in these continents, this money is wrongfully stripping life saving equipment and medicine from those that need it most. In order to counter the issues of both tax avoidance and tax evasion, governments and international communities have created programs and initiatives such as the BEPS (Base Erosion and Profit Shifting) which was launched in 2013 and involves over 115 negotiating comprehensive packages, to put an end to profit shifting. However, until 2020 it was decided that the issue of taxing the digital economy would not be discussed, resulting in countries such as India, Spain and Italy to develop their own tax systems on digital revenue services (“International corporate tax avoidance in an era of changing firms,” 2018). Although the OECD countries did finally provide a solution to taxing digital services, through the creation of the Pillar one and Pillar two proposals that aim to provide transparency, equity and efficiency, these will only be implemented in 2022/2023 (“OECD and Taxation of the Digital Economy,” 2022). The drastic lengths of time between the problem being identified and a solution being implemented, can lead one to question whether these measures will be sufficient; or more specifically, The extent to which the OECD Pillar 1 and Pillar 2 initiatives will provide adequate solutions to the tax avoidance and evasion being undertaken by digital multinational corporations. In order to yield accurate results, secondary research methods, focusing on the utilisation of government census’, academic journals and reports originating also from credible sources such as Bloomberg and institutes. Theoretical Background The rapid and extensive digital transformation of the economy has theoretical benefits that may one day allow for developing countries to strengthen their economies to the point where they will have the capacity to compete with countries that currently run the global economy. Research has demonstrated that the boost of digital technologies can provide a growth of 5.7% (325,000$ million) in Latin America and the Caribbean over just 10 years, and connecting eleven million homes to the internet in these regions would generate over 400,000 jobs (“How big tech companies avoid taxes and what can be done about it,” 2019). However, in order to do so, the current tax framework needs to be adjusted to fit the two pillar initiatives so multinational corporations cannot cheat their way out of taxes. Currently, the international tax framework still follows a “brick and mortar” approach, in the sense that everything from broader tax policies and tax administration methods follow a nexus rule based on physical presence, and profit allocation rules are based on the arm's length principle, which now need to be adapted in order help eliminate double taxation and most importantly prevent profit shifting to these less economically developed countries (“Action 1 - OECD,” n.d.). The most common method of profit shifting involves a multinational corporation using a subsidiary it has in a tax haven to charge all costs to the subsidiaries in other countries. For example, by registering their intellectual property (branding and logo) in Bermuda - a zero tax location- Nike was able to move large chunks of their profit, which resulted in it being able to build up billions in untaxed profit offshore. It was as simple as the Bermudian subsidiary charging expensive royalty fees to the Nike subsidiaries used in other countries for using their intellectual property, allowing for operational costs to increase, and revenue to rise at inflated levels (“What is profit shifting?”, 2021). Another method that is commonly used by Fortune 500 companies under the current tax framework is through price manipulation. Essentially, what it consists of is when an entity in the supply chain increases the prices, hence increasing the costs for the next stages of production. As a result the profit eligible for taxation in the next plant's jurisdiction is greatly decreased. A similar situation may occur when an entity sells its products at a level below the active market rate, resulting in the profit in its own jurisdiction eligible for taxation being decreased, lowering the cost for the further processes in the supply chain. (“How do companies avoid paying international taxes?,” 2021). However, due to the fact that the paperwork and formalities would be too complex and far too recognizable as collusion if this was done between the producer and the retailer, what occurs is that the multinational corporation will purchase the entities in the supply chain and internally manipulate the prices. This will result in the corporation being able to not only benefit from reduced profits taxed in high- tax government countries and more profits being taxed in low- tax government countries, but also from the final product being sold to its distributors at an above market level (“How do companies avoid paying international taxes?,” 2021). The final most common method that allows for multinational corporations to avoid tax is debt shifting. Essentially, a subsidiary of a multinational corporation is allowed to internally borrow money from one of its subsidiaries in a low-tax jurisdiction and pay significant interest on that debt; and with interest being tax deductible, it reduces the firm's overall tax bill. Moreover, what may occur in some cases, is that the corporations choose to also move portions of their assets and employment to other countries in order to continuously shift their debt and cause any auditors to be stuck with complex and detailed paperwork for any recorded movements (Bilicka, 2020) Analysis The fact that digital companies’ marginal cost of productions are essentially nothing, any amount of revenue accruing to them has to be taxed effectively, despite the claims that tech leaders are making that this will have significant impacts on their ability to provide services worldwide. As mentioned previously, the solutions to this taxation issue lie in the hands of the BEPS action plan, which consists of 15 actions and since the 5th of October 2015 -since the final reports that outlined consensus recommendation were published- has successfully resulted in the initial steps being made to counter the issues of digital taxation (“How big tech companies avoid taxes and what can be done about it,” 2019). However, out of all of these 15 action points, the two pillar initiative is the plan that the OECD has the most confidence in. As of October 2021, over 135 countries have joined this solution to ensure that multinational corporations will pay their fair share of tax no matter the jurisdiction that they operate under (“Action 1 - OECD,” n.d.). Pillar one will pay attention to re-allocating the taxing rights from the home markets that the corporations are established into the actual markets that they earn profits as well as where core business activities and operations take place, regardless of whether there is any physical presence. It is estimated that under this Pillar one initiative alone, over 125$ billion will be re-allocated to market jurisdictions each year, allowing for an equitable transfer of wealth. (“Action 1 - OECD,” n.d.) Moreover, in order to promote equity and fairness, companies with a global revenue of more than 20$ billion and pre-tax profits that exceed 10% of costs would be eligible for market countries to tax. As a r...