There are many multinational companies which are using various ways to save tax amount. These companies use various schemes to shift profit from high tax country to lower tax country
It is estimated that around US$420 billion in corporate profit is shifted by multinational companies to 79 countries every year, which equates to around US$125 billion in loss of revenue of tax in these countries.
Channels of Profit shifting to lower tax countries
There are generally three main channels to shift profit into lower tax countries i.e. 1)Register an Intangible asset such as trademark / patents / copyright in Tax heaven countries,
2)Debt shifting and
Let’s take an example how these Channel works? And how companies avoid paying hefty amount of tax on income.
The multinational company set up another company in the country where there is almost no corporate tax. These companies use multiple ways to get rid out of paying hefty tax amounts to government.
Following are one of the most popular ways which companies use to avoid paying tax;
Register an Intangible Assets
The multinational companies register their intangible assets into lower tax countries and then these companies’ pay royalties to the lower tax countries. Then multinational company shows it as an expense in the balance sheet and pays 0% tax in the country where tax rate is almost zero.
Let’s understand this with the help of an example,
Suppose if ABC Ltd. (Indian Company) register an intangible asset in PQR Ltd. (located in Bermuda) and then ABC Ltd pay royalties to PQR Ltd.
In the above case, ABC Ltd. will pay royalties to PQR Ltd and it will show as an expense in the balance sheet and will claim deduction on it. At the same time even if it’s a profit to PQR Ltd. they will not pay tax on it because the tax rates are almost 0 in Bermuda (Country where corporate tax is 0%).
Debt shifting is another way, which is used by multinational entities to shift the profit.
In this scenario, the multinational companies borrow loan from another company where corporate tax is almost zero.
For Eg. ABC Ltd. (Australia) takes loan from XYZ Ltd. (Bermuda) for a purpose just to avoid paying tax. Then ABC Ltd pays interest on the loan and shows as an expenditure in the balance sheet and XYZ Ltd pays zero tax on the profit amount received as an interest.
Transfer pricing is an accounting and taxation practice that allows for pricing transactions internally within businesses and between subsidiaries that operate under common control or ownership.
Transfer is the third Channel that can be used by multinational Companies, when there is trade between two associated enterprises. In this transaction, the price should be decided on the arm length basis, which means price should be same between two associated Enterprises as it would be if two non-associated entities traded with each other for same services / Goods, this price is known as Arm’s Length Price.
Let’s understand with the help of example;
ABC Limited manufactures Shoe for cost of Rs. 2000 and willing to sell pair of Shoe to Unrelated party at Rs. 4000. Now ABC Limited have to pay tax at Rs. 2000 in India which will come around Rs. 600.
But there is another way to lower tax on same profit, Now in this case, ABC Limited will sale to its subsidiary XYZ limited (Bermuda) at RS 2500, and report profit of Rs. 500 in Australia, in this case the tax amount will be Rs. 150 (30% Tax Rate ). On the other hand XYZ Limited sale pair of Shoe to Unrelated party (Company PQR ) at Rs. 4000, and earn profit Rs. 2000 without paying taxes.
Using this scheme ABC Limited saved huge amount of tax on every pair of Shoes.