In the United States, 12 percent of all federal revenue comes from corporate income tax. Of this, half comes from multinationals — corporations that have major presences in countries other than their home nation. Recently, concerns about how these companies pay taxes in the countries they do business in have forced the international community to respond.
According to the Tax Foundation, American corporations — in 2009 — earned nearly $417 billion in taxable income internationally and paid more than $104 billion in foreign taxes, for an average effective tax rate of 25 percent.
“Reporters and lawmakers who criticize U.S. companies for ‘avoiding’ taxes on their foreign earnings need to be more careful with their language and acknowledge that our worldwide tax system requires U.S. firms to pay taxes twice on their foreign profits — once to the host country and a second time to the IRS — before they try to reinvest those profits back home,” the Tax Foundation stated. “Any discussion about reforming the corporate tax code must keep these facts in mind.”
Such talk has not kept the leaders of the G-20 from addressing the potential “global tax chaos.” On Friday, the chancellor of the Organization for Economic Cooperation and Development introduced a two-year action plan that seeks to address and remedy questionable corporate tax practices. Officials hope the plan will empower national tax authorities to crack down on some of the areas the international community agrees are being exploited by multinational tax-dodgers. These initiatives would trigger changes to international tax treaties, with timelines ranging from 12 to 30 months.
The plan sets out 15 separate actions that are needed to modernize the international tax system. The actions include “requiring online multinationals with extensive warehouse operations in an overseas country, such as Amazon, to pay local tax on any profits arising from sales in that country;” “forcing multinationals to disclose to every tax authority a country-by-country breakdown of profits, sales, tax and other measures of economic activity such as headcount; “tougher rules to block transfers of high-value and mobile ‘intangible’ assets, such as brands and intellectual property rights, to tax havens where there is little or no associated business activity;” and cracking down on “tax regimes found to have too soft an approach to multinationals deploying overseas finance subsidiaries through establishing a new international benchmark for appropriate taxation of controlled foreign companies.”
Also included in the plan are calls for “wider measures to combat predatory tax competition policies emerging in some financially stretched countries, which risk a ‘race to the bottom’ climate on tax;” “a raft of treaty updates to neutralize the tax advantages of complex financial instruments, schemes and structures, including hybrid capital, interest payment deductions and over-capitalization;” “a requirement on multinationals to disclose the most aggressive ‘tax planning’ structures to the authorities otherwise often relying on limited, local data that does not show the impact of transnational schemes to lower tax” and “new mechanisms to fast-track the introduction of OECD recommendations rapidly around the world.”
‘Creative bookkeeping’
American-based companies must pay taxes on the totality of their earned income — domestic or internationally — to the Internal Revenue Service. The IRS, however, credits the company with any taxes it paid to a foreign government on these revenues. So, for example, if a company made $1,000 in France, it would pay the European Union the $240 it owes in taxes. Once the company brings the remaining $760 to the United States, or “repatriates” it, the company would need to pay the $350 in U.S. taxes it owes on the income. However, since the company already paid taxes on the money to France, the portion the company paid to France will be credited to the tax bill, so the company owns only $110 in American taxes.
This is done so that an American company will not be penalized for investing internationally. However, many companies have found “loopholes” to minimize their tax liability. For example, profits are taxable only once they are returned to the United States. To avoid paying these taxes, many companies simply reinvest the profit earned internationally on foreign assets or allow foreign-based subsidiaries to hold the profit on the corporations’ behalf.
The computer firm Apple, for example, has been accused of funneling billions in overseas profits — which, for tax purposes, exist “nowhere” and can be construed as imaginary — through the company’s Irish subsidiaries in order to take advantage of Ireland’s low corporate tax rate. One such subsidiary, Apple Sales International, saw pre-tax earnings of $22 billion in 2011, but paid only $10 million in tax. That’s an effective tax rate of just 0.05 percent.
“Apple wasn’t satisfied with shifting its profits to a low-tax offshore tax haven,” said Sen. Carl Levin (D-Mich.), chairman of the Senate Permanent Subcommittee on Investigations, during a hearing featuring testimony from Apple Chairman Tim Cook. “Apple sought the Holy Grail of tax avoidance. It has created offshore entities holding tens of billions of dollars, while claiming to be tax resident nowhere. We intend to highlight that gimmick and other Apple offshore tax avoidance tactics so that American working families who pay their share of taxes understand how offshore tax loopholes raise their tax burden, add to the federal deficit and ought to be closed.”
Other corporations work to wipe out the foreign component of their tax obligation. The Financial Times has reported that Apple avoided paying corporate taxes in the United Kingdom in 2012, despite having a pre-tax profit of more than $100 million in the country. Apple did this, in large part, by offering stock options as employee compensation, making that portion of the payroll a tax deduction. Facebook used a similar trick to get a $429 million tax refund on its American taxes, despite having over $1 billion in tax liability.
Apple also minimized its taxes by hiding its profits among its various subsidiaries. But Apple is not alone in its tax-dodging. In Great Britain, Google and Amazon both have effective tax rates of less than 1 percent. Starbucks claimed it made no profit on $1.8 billion in sales in Great Britain, but claimed 15 percent profit in shareholders’ statements. Starbucks ultimately agreed to pay $15 million in fines each year for the next two years.
“With the backdrop of these difficult times, in the area of tax, our customers clearly expect us to do more,” said Kris Engskov, Starbucks’ U.K. managing director, to the London Chamber of Commerce.
Starbucks has since promised to pay its 2013 and 2014 taxes.
According to Citizens for Tax Justice, 18 of the United States’ largest companies — including Apple, Microsoft, Nike, Dell and American Express — have more than $282 billion in unrepatriated assets and owe the IRS more than $92 billion in foreign profit taxes.
Apple has defended its actions.
“Apple complies fully with both the laws and spirit of the laws. And Apple pays all its required taxes, both in this country and abroad,” Cook’s statement to the Senate Permanent Subcommittee on Investigations read. “Apple welcomes an objective examination of the US corporate tax system, which has not kept pace with the advent of the digital age and the rapidly changing global economy. The company supports comprehensive tax reform as a necessary step to promote growth and enable American multinational companies to remain competitive with their foreign counterparts in both domestic and international markets.”
The United States is currently opposing any effort to strengthen international tax laws that specifically target digital companies, feeling that it is unfair to narrowly target a subset of firms. The United States is currently pushing for tweaks in the existing treaties and advocating moderate changes to the tax rules. This is putting the U.S. in opposition to much of the G-20, particularly France, which feels the existing tax system is inadequate and specific protections should be written out explicitly in a new tax package.
“Nowadays it is possible to be heavily involved in the economic life of another country, e.g. by doing business with customers located in that country via the internet, without having a taxable presence therein,” said the OECD reported to the G-20 in February. “In an era where non-resident [corporate] taxpayers can derive substantial profits from transactions with customers located in another country, questions are being raised as to whether the current rules ensure a fair allocation of taxing rights on business profits, especially where the profits from such transactions go untaxed anywhere.”