Historical Context
Profit shifting is a strategy used by multinational corporations (MNCs) for decades. The practice gained significant attention in the late 20th and early 21st centuries as globalization facilitated the movement of capital and goods across borders. Historically, tax havens like Switzerland, the Cayman Islands, and Ireland have been prime destinations for profit shifting due to their favorable tax policies.
Types/Categories of Profit Shifting
- Transfer Pricing: Adjusting prices of goods and services sold between subsidiaries to lower taxable income in high-tax jurisdictions.
- Intercompany Loans: Structuring loans between subsidiaries to create interest deductions in high-tax countries.
- Intellectual Property (IP) Migration: Transferring patents, trademarks, and other IP to subsidiaries in low-tax jurisdictions.
- Treaty Shopping: Using a series of legal entities to take advantage of tax treaties and reduce withholding taxes.
- Hybrid Instruments and Entities: Utilizing financial instruments and entities that are treated differently across tax jurisdictions to minimize taxes.
Key Events
- 1998: OECD begins addressing harmful tax practices.
- 2013: G20 mandates the OECD to develop the Base Erosion and Profit Shifting (BEPS) Action Plan.
- 2015: OECD releases BEPS reports with recommendations for international tax reform.
- 2017: US Tax Cuts and Jobs Act introduces measures to combat profit shifting.
- 2021: OECD proposes a global minimum tax to curb profit shifting.
Detailed Explanations
Transfer Pricing
Transfer pricing involves setting prices for goods and services sold between subsidiaries. MNCs may inflate prices in transactions between high-tax and low-tax jurisdictions to shift profits.
Mathematical Models: Arm’s Length Principle
The arm’s length principle, established by the OECD, ensures that intercompany transactions are priced similarly to transactions between unrelated parties. This principle is often used to combat abusive transfer pricing practices.
Charts and Diagrams
Example of Profit Shifting Structure
graph TD;
A[Parent Company] --> B[Subsidiary in High-Tax Country];
A --> C[Subsidiary in Low-Tax Country];
B --> C;
B --> D{Goods/Services};
C --> E{IP/Intercompany Loans};
Importance and Applicability
Profit shifting has significant implications for global tax revenue. Governments lose billions of dollars in tax revenue due to these practices, leading to calls for tighter regulations and international cooperation.
Examples
- Tech Companies: Many tech giants have been scrutinized for shifting profits to jurisdictions like Ireland and Bermuda to benefit from low tax rates.
- Pharmaceuticals: Pharma companies often transfer IP to subsidiaries in low-tax countries to reduce taxable income.
Considerations
- Compliance: Companies must navigate complex international tax laws to ensure compliance.
- Ethics: While legal, profit shifting raises ethical questions about fair taxation.
- Regulatory Risk: Increasing international cooperation and new regulations may pose risks to profit shifting strategies.
Related Terms
- Tax Avoidance: Legal strategies to minimize tax liability.
- Tax Evasion: Illegal methods to avoid paying taxes.
- Base Erosion: Reduction of the taxable base through profit shifting.
- Tax Havens: Jurisdictions with low or no tax rates.
Comparisons
- Tax Avoidance vs. Tax Evasion: Both aim to reduce taxes, but tax avoidance is legal, whereas tax evasion is illegal.
- Profit Shifting vs. Transfer Pricing: Transfer pricing is a method often used within profit shifting strategies.
Interesting Facts
- According to a study by the IMF, profit shifting causes annual revenue losses of 600 billion USD globally.
- Apple Inc. was ordered to pay €13 billion in back taxes to Ireland after being found to have engaged in aggressive profit shifting.
Inspirational Stories
The OECD BEPS Initiative: The OECD’s BEPS initiative represents a milestone in international tax cooperation, showcasing how nations can work together to combat tax base erosion and ensure fair taxation.
Famous Quotes
“The avoidance of taxes is the only intellectual pursuit that still carries any reward.” — John Maynard Keynes
Proverbs and Clichés
- “The only certainties in life are death and taxes.”
- “Nothing in life is certain except death and taxes.”
Expressions, Jargon, and Slang
- Double Irish: A tax strategy involving two Irish companies to minimize tax liabilities.
- Dutch Sandwich: Combining the Double Irish with a Dutch subsidiary to further reduce taxes.
- Tax Shelter: Investments or strategies used to decrease taxable income.
FAQs
Is profit shifting illegal?
How do countries combat profit shifting?
References
- OECD (2015). “Base Erosion and Profit Shifting: Final Reports.”
- International Monetary Fund (2020). “Policy Options to Tackle the Harms of Profit Shifting.”
- U.S. Department of the Treasury (2017). “Tax Cuts and Jobs Act.”
Summary
Profit shifting is a significant issue in global finance, impacting tax revenues and raising ethical and regulatory concerns. While it can provide tax benefits to corporations, ongoing efforts by international bodies and governments aim to curb these practices to ensure fair taxation and reduce revenue losses. Understanding profit shifting is crucial for professionals in finance, economics, and international business.
