Brian J. King
It is no secret that large multinational enterprises (“MNEs”), a large percentage of which are Delaware corporate entities, have long been on the cutting edge of clever ways to minimize, if not avoid, tax liability. Information and misinformation abound with respect to how the world’s most sophisticated tax strategists plan to minimize or eliminate their tax liability. Some commentators even mistake Delaware’s attractiveness as a corporate home for being a tax shelter, when in fact it is not (Delaware’s tax rates, while competitive, are not as low as many states, some of which have no corporate income tax). However, some foreign jurisdictions have laws and programs that, either by design or out of standing tradition, facilitate beneficial tax consequences for companies savvy enough to exploit them. The scope of the problem is huge, and has far-reaching, global implications.
Tax avoidance maneuvers impact corporate income tax, and as we will see, taxable intellectual property (“IP”) transactions as well. MNEs in the tech industry often deal in IP valued in the billions of dollars. For example, the GAFA (tech companies exemplified by Google, Apple, Facebook, and Amazon) synecdoche have been known to spend upwards of $4 billion on just the patent portfolio component of an M&A deal. The four GAFA companies own brands valued (largely due to trademark value) at over $225 billion in the aggregate. When the stakes are this high, even small tax rate improvements can make huge differences.
By strategically manipulating entities and transactions, experts estimate that MNEs avoid anywhere from $50 billion to $200 billion of would-be tax revenue per year, with $50 billion being a conservative estimate for developing countries. Google, for example, became publicly known for its former “Double Irish” tax strategy, whereby through a combination of shell companies and IP licensing self-dealing, it was able to pass about 99.8% of its revenues to tax-free Bermuda by way of an entity in Ireland and a shell company with zero employees in the Netherlands. While this particular loophole is closing (albeit slowly), other opportunities abound.
This strategic tax avoidance is legal, and it should not be confused with the crime of tax evasion. President Obama summarized how many observers feel about this practice, succinctly, “I don’t care if it’s legal, it’s wrong.” To address this problem, politicians on both sides of the pond have called for tax reforms to close the gap between what MNEs should be paying and what they actually pay. The risk is taxing these multinational companies to the point where it becomes less desirable, if not impractical, to continue operating in country and losing them altogether to more favorable or opportunistic jurisdictions.
In response to this possibility, a coalition of the world’s wealthiest countries has been working diligently under the banner of the Organization for Economic Co-operation and Development (“OECD”) on a project known as Base Erosion and Profit Shifting (“BEPS”). OEDC Member countries include most of the G-20, with the conspicuous absence of developing BRICS countries: Brazil, Russia, India, China, and South Africa. The nonparticipation of these developing economies is a major hurdle to any hopes the OECD may have for global adoption of its Action Plan for addressing the “double non-taxation” of MNEs, especially as their economies continue to account for a larger part of the global economy.
Particularly in India, Ernst and Young observes that, “[t]he lack of effective legislation and gaps in information may leave the door open to simpler, but potentially more aggressive tax avoidance than is typically encountered in developed economies.” A key loophole noted by Ernst and Young is that, “the characterization of payments (i.e., business income v. royalty) has been the subject of current litigation as business income in the hands of a non-resident is generally not taxable in India in the absence of a permanent establishment (PE).” The common self-dealing practices of MNEs can be structured to take advantage of loopholes like this, as an article in The Economist noted, “[t]his is particularly popular among technology and drug companies that have lots of intellectual property, the value of which is especially subjective. These intra-company royalty transactions are supposed to be arm’s-length, but are often priced to minimise profits in high-tax countries and maximise them in low-tax ones.”
Ideas have been proposed to fix these tax avoidance schemes, and as the OECD aims, to eliminate “practices that artificially segregate taxable income from the activities that generate it.” In the US, one proposed strategy is a “carrot method” of lowering the corporate tax rate to incentivize MNEs domiciled here to keep revenues here and pay a modest tax on them. A “stick method,” which experts note has been employed in Europe to a large degree of success, involves changing the US tax structure to a territorial method. As opposed to the current system of taxing domestic entities that have done a good job of “relocating” their US source income, the territorial method would tax MNEs on their US source income. Still, as noted in the article cited above, the territorial method could still allow MNE’s to relocate revenue to territories with a lower source income tax rate.
The best resolution, which appears to be a long way from reality based on, among other hurdles, the reluctance of developing economies to participate fully with the OECD, is total global participation in programs designed to eliminate favorable tax havens like Ireland, Bermuda, and the Cayman Islands. Unfortunately, with hundreds of billions of dollars in tax revenue at stake for these venues, this problem will likely not be resolved any time soon.
Brian J. King is a staff editor on Volume 40 of the Delaware Journal of Corporate Law, and is also the President of the Intellectual Property Society at Widener. Brian is enrolled in Evening Division classes, and works full time as a Business Development Manager at CSC Digital Brand Services.
Suggested Citation: Brian J. King, Tax Avoidance Trends Among Multinational Enterprises: An Examination of Intellectual Property Transaction and Corporate Income Tax Avoidance, Del. J. Corp. L. (Apr. 6, 2015), www.djcl.org/blog.