Tax is a liability that almost every citizen of a country has to bear if he/she makes an income within the taxable limit. Normally, progressive taxation on many taxes such as the income tax is implemented in every country, the more you earn the more you pay in tax. So by the above mentioned logic, a highly successful multinational company, say Apple pays way more amounts of money in tax than an average higher middle class citizen right? Well the answer is surprisingly No, as a matter of fact Big Companies avoid paying taxes all together in many cases
Is it illegal for them to not pay taxes? If yes, how are they getting away with it? Why the government is not intervening? In order to find the answer to all these questions, we need the answer to a crucial one first which is what exactly is Tax Avoidance and Tax Evasion.
What Is The Difference Between Tax Avoidance and Tax Evasion?
Although these two terms are always used as a substitute for each other there are a lot of differences between them.
Tax Avoidance is the use of various loopholes and elements in the tax code to minimize or in some cases completely avoid taxable incomes all together. Some examples are using Deductions and Tax Credits as prescribed under the tax code. To sum it all up Tax Avoidance is LEGAL.
Tax Evasion is the use of malpractices such as income misrepresentation, deduction inflation, hiding of income to avoid paying taxes. Tax Evasion is ILLEGAL.
So the Large MNCs follow Tax Avoidance which is completely legal as it uses loopholes within the tax code to avoid paying taxes. Let’s take an example to better understand the various aspects of Tax Avoidance.
Amazon paid exactly $0 in federal income tax for the year 2018 on an income of $11 Billion and they did it legally. As per the Tax Code in most countries, companies don’t have to pay taxes if they incur losses for that financial year, and for the first 6 years, Amazon operated entirely on losses as they invested a lot of their earnings into company growth and research & development overheads which are also non taxable and acts as tax credits. Furthermore, they set up subsidiaries and factories in countries where the corporate tax was much lower than USA (which has the highest corporate tax in the world at 21%, reduced from previous rate 35%). They also relocated their products to tax free zones like Bermuda thus avoiding other taxes. After claiming more deductions, their net tax liability amounted to $0.
Reasons Behind Tax Avoidance
While the MNCs resort to loopholes in order to avoid paying high rates of taxes, the countries which act as their tax free subsidiaries also have their own reasons. Firstly, having a factory of a company like Apple or Amazon set up in their country is always a welcome sight as it helps in boosting their employment and growth rate and gives them exposure to the latest technological side of the market and after every successful venture more and more companies set up their factories in these countries. Bermuda is a prime example of how helpful it is to have large companies on board.
Other than being less taxable, these countries also have cheap labor and material costs so naturally, large companies gravitate towards developing nations for subsidiary purpose.
Although these tactics have a lot of advantages for both parties, there is an extreme amount of taxable income for the parent countries which gets completely nullified due to Tax Avoidance. So what possible solutions are there?
Lowering of corporate tax is the first step, and although this may lead to less taxes in the initial stages, this opens up the door for the large companies to set up factories in the home country itself rather than shifting abroad. Lets take an example to better understand the situation.
Suppose Company A is a small company which makes $20000 profit per year and pays a corporate tax of 20% which amounts to $4000. Another company B earns a profit of $200000 per year and in order to avoid paying high tax rates, it sets up all its factories in lesser countries and thus pays no tax at all. So the total tax is just $4000. Now if the home country lowers its tax rate to 10%, this would encourage the large company B to set its other factories in the home country itself, so the total tax here will be (10% of 4000) + (10% of 200000) which amounts to a total of $24000, which is 6 times the previous amount despite being half the tax rate.
Another method involves the Unitary Model of Taxation whereby the taxes on charge at the place where the economic activity takes place rather than where it is reported.
Many different methods of avoiding tax avoidance are being implemented but as of now it seems like the situation will stay as it is.
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