Everything You Need To Know How Large Corporations Avoid Paying Taxes?

The practice is usually legal, though many companies find loopholes or exploit existing laws to minimize their tax burden. Regardless of the legalities, organizations are afforded a significant competitive advantage over rival firms that do not reduce their tax expense.

The question of how corporations avoid paying taxes has been raised recently in the wake of President Trump’s tax reform plan, specifically the repeal of “a big one” that would have enabled multinational organizations to deduct their foreign-earned income from their US taxable income.

For example, Apple Inc. could lower its taxable income to zero by earning most of its revenue outside the US.

Here is a closer look at some of the practices companies follow to minimize their tax burden.

Geographic Shifting of Excess Assets

Typically, a corporation may have excess assets, such as cash from operations or funds from investors. The corporate structure itself often encourages the company to shift these funds abroad in an attempt to reduce its taxable profit.

At the same time, corporations enjoy many advantages in foreign markets for this type of revenue.

To illustrate, consider an offshore corporation that earns $100 million on sales in Europe and profits $90 million through normal operations in that country. If the corporation repatriated this money, it would likely face a corporate income tax rate of 30%.

However, if it shifted this money to a subsidiary in a low-tax country, such as Ireland, then only 5% would be paid on the profits.

When an organization shifts its assets to foreign markets, it can also shift its liabilities. For example, if a corporation shifts $100 million into its Irish subsidiary and decides to reinvest $80 million of this in fixed assets for that branch’s operations in Europe, then any depreciation will be attributable to the Irish branch.

This is particularly beneficial for corporations with excess cash from operations or investors they do not want to pay corporate income tax on.

Another option for a corporation is to shift its excess cash to its bank account at a local subsidiary rather than moving it abroad. This can be done by keeping local accounts in the name of the domestic entity but charging them in foreign currency. If the account has a balance of $100 million, then $80 million could potentially be shifted offshore and gain tax-free treatment under current law.

Beneficiaries Of Export Subsidies

The Export-Import Bank (EXIM) was created in 1934 to finance purchases of goods and services by international firms that are doing business with the US government.

The bank offers subsidized loans for projects that will create jobs in the US. The structure of the EXIM makes it attractive for large corporations to shift their foreign operations to countries that offer a low corporate tax rate, thus reducing the amount of taxes payable in their home country.

Permanent Shifting Of Excess Assets

Each year, corporations report their profits for the previous year to the IRS and declare that a certain amount of their income is generated by foreign markets. Therefore, a large number of funds can be shifted abroad in this manner to avoid corporate income tax.

Although this practice is illegal and should not be used, it has been done by many large corporations since the 1990s. This type of shifting has been particularly used in banking operations where a corporation may hold deposits made by clients in one country while earning profits in another.

For example, a US firm may have an account with a foreign bank that is funded by deposits in the account. The bank will then notify the US company that it has exceeded its borrowing limits and that the funds must be repaid.

If the company does not repay, local regulators can deem it in default on the grounds of non-performance. This can result in penalties and/or imprisonment for shareholders and losses for bond rating agencies who view them negatively.

The key question is whether this practice of shifting profits from one place to another could be used to avoid paying corporate income tax. Although it is illegal and results in penalties, many companies have managed to avoid paying corporate income tax via this practice.

Reporting Only Interest Income To Foreign Governments

A US company can reduce the amount of taxes a foreign subsidiary pays if it shifts the vast majority of its interest income to that branch.

For example, if a corporation earns $100 million in profit from its offshore branch and $90 million in interest, then only $10 million will be taxable. This is accomplished by having the US parent pay interest to a foreign subsidiary at an artificially high rate and then shifting the majority of the profit from interest income.

The strategy works because the offshore branch will not recognize this interest in its income tax return. In effect, the foreign branch can deduct the interest income it receives from its US parent at a rate of zero.

Therefore, it does not have to pay tax on this amount. This is an attractive benefit for foreign subsidiaries because interest payments may be virtually tax-free in some countries and a relatively high form of revenue for these businesses. After all, it is stable and earned through deposits.

Restoration Of Tax-Free Capital Across Branches

A US company can also shift profits from one branch to another without paying corporate income tax.

For example, a US company can pay interest to its Cayman Islands branch and use the profits from this payment to fund a new subsidiary in the Netherlands. The Netherlands then uses the funds to invest in a project in Poland that results in an income tax-free gain of $10 million.

This type of shifting of profits is similar to the process discussed above but with an additional benefit. If these projects are successful, these gains will increase their taxable income on foreign sales to the US parent company.

For example, let’s say a Polish subsidiary earns $20 million from overseas operations and returns $2 million as interest income to its US parent.

Conclusion

Large corporations can avoid paying taxes by utilizing a variety of methods. While these methods may be legal, they are often criticized as being unfair.

Despite this criticism, the government has been slow to change the laws that allow these corporations to avoid paying their fair share.

This leaves taxpayers responsible for making up the difference.

What can we do to ensure large corporations pay their fair share? Share your thoughts in the comments.