Tax Reforms are Coming, Who is Most at Risk? (Round 3: An Update)

In March 2016, I conducted a small research experiment to determine the tech company that is most at risk if tax reforms are implemented in the US. Five months later, the risk started to materialize, not in the US but across the Atlantic. DisclaimerI am neither a tax expert nor a financial analyst. I am not even close to being either one. I am simply writing about tax avoidance in the context of sustainability. Therefore, the analysis here is to contribute to the discussion on tax avoidance as a sustainability risk to companies and should not be taken as investment advice.

Europe Goes after Apple

In August 2016, the European Commission slapped a record $14.6 billion penalty on Apple for failing to pay equitable taxes in Ireland. The EC ordered Apple to pay $14 billion in back taxes to Ireland, a decision that the company continues to appeal. The decision was also a blow to Ireland, which has attracted global companies on the back of a friendly corporate tax regime.

Like many global companies, Apple’s effective tax rate in the US is lower than the 35% federal statutory tax rate but taxes paid in Ireland were extraordinarily low, according to the EC. From 1% in 2003, Apple’s effective tax rate had fallen to 0.005% by 2014, the EC noted. This tax rate is barely a fraction of Ireland’s corporate tax rate of 12.5%. Apple and Ireland have appealed the decision. Apple noted that it is not an outlier in this area, confirming the widespread practice of tax avoidance.

Tighter Tax Laws 

Indeed Apple is not an outlier but just because the practice is so common does not make it right, neither does it reduce a company’s risks of being caught and made to pay back taxes. In July 2016, the EC adopted stronger anti-tax avoidance proposals and notably laid down rules for five typical tax avoidance situations:

  • Interest limitation rules. Multinational groups may artificially shift their debt to jurisdictions with more generous deductibility rules. The directive sets out to discourage this practice by limiting the amount of interest that the taxpayer is entitled to deduct in a tax year.
  • Exit taxation rules, to prevent tax base erosion in the state of origin. Corporate taxpayers may try to reduce their tax bills by moving their tax residence and/or assets, merely for aggressive tax planning purposes.
  • General anti-abuse rule. This rule is intended to cover gaps that may exist in a country’s specific anti-abuse rules, and thereby enable tax authorities to deny taxpayers the benefit of any abusive tax arrangements that may occur.
  • Controlled foreign company (CFC) rules. In order to reduce their overall tax liability, corporate groups can shift large amounts of profits towards controlled subsidiaries in low-tax jurisdictions. CFC rules reattribute the income of a low-taxed controlled foreign subsidiary to its – usually more highly taxed – parent company.
  • Rules on hybrid mismatches. Corporate taxpayers may take advantage of disparities between national tax systems in order to reduce their overall tax liability, for instance through double deductions.

Investigations into tax avoidance can take years because of the complexity of the issue and the opacity of corporate disclosures on taxes paid internationally. However, regulatory pressure is mounting and for companies that have employed tax avoidance strategies and benefit greatly from them, penalty may just be around the corner.

 

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