Strategies Used by American Companies for Tax Avoidance
America has been the hub of financial and entrepreneurial activity ever since the end of World War 2. However, over the past few years, the number of corporations that are using America as their base has been steadily declining. This is because of the unfavorable tax policies in America.
America is the only country in the world that combines a high tax rate with an international tax system. This means that the American government reserves the right to tax all the profits of an American corporation regardless of where they are generated and that too at very high rates! It is true that America is a big market, and companies are, in many ways, dependent upon it. However, then too, the tax policies are just too restrictive. This is the reason that companies in America use a wide variety of strategies to reduce their tax liabilities. Some of these strategies have been mentioned in this article.
- Moving Headquarters out of America: The best strategy to avoid an expensive tax regime is to move out of it. This is the reason why so many big corporations are moving out of America.
In the 1980s, 18 out of the top 20 companies in the world were incorporated in America. However, now only 8 out of the top 20 companies are incorporated there. Companies like Burger King have famously moved their headquarters out of America. The reason behind this is that there are several companies such as Ireland which are providing a better corporate tax regime. The tax regime is better in general. However, these countries provide special incentives to companies that move their headquarters to their country. This is because the worldwide revenues are taxed in headquarters. Therefore the tax base increases, and the country can earn more tax revenue with a lower tax rate.
- Blending Income from Higher and Lower Tax Countries: As mentioned above, America taxes its corporations on income earned abroad. However, it also provides tax credits. This is done to level the playing field and avoid double taxation.
For instance, if a company generates profits in France and pays 15% tax there and the tax rate in the United States is 21%, then the American government will give credit for the 15% and only charge balance 6% tax. However, if another country, let’s say Japan charges a 30% tax, then America will not take any additional tax since 30% is already greater than 21%.
Corporations use this strategy to lower the overall tax rate. They time the movement of profits from low and high-income companies in such a way that the average of the tax paid in foreign countries almost equals the domestic tax rate. Blending income helps reduce further tax liability in the United States.
- Timing Repatriation of Income: Another strategy commonly used by companies is to time the repatriation of their income to America. Under American tax laws, companies are not taxed when they generate income in foreign countries. Instead, companies are taxed when they repatriate this income to America.
Hence, if a company can delay the repatriation, it can also delay the taxation indefinitely. This helps companies bottle up their profits and move them in a year when the company is experiencing losses.
Generally, an economic downturn comes every ten years or so. This is when the sales and profits of the company take a hit. If the company is facing a loss, it can repatriate some of the profits stored abroad. Even after these additional profits, the company will still break even or be under the taxation threshold. As a result, they will not be taxed and will be able to sneak in some of the stored profits tax-free!
- Research and Development Spending: The American tax code has generous provisions for research and development expenses. A lot of tax credits are provided to companies who spend on research and development in America.
Sometimes, the entire expense can be written off in the year in which it was done. This helps lower the tax base and hence the tax payable. Multinational companies use this provision to evade taxes. This is done by concentrating all the research and development activities in America. However, when the R&D team does come up with a breakthrough, it is used by all subsidiaries in different countries to generate a profit. The worldwide research expenses are just accumulated in one place in order to lower the American tax liability.
- Foreign Investments: Many times, companies finance their activities by taking high-interest loans from their own subsidiaries.
Bonds are issued and sold to the subsidiary itself. As a result, when coupon payments are made, the interest payment reduces the taxes payable in America, which is a low tax company. However, it increases income in another country. This leads to higher profits in another country. Once again, these profits are stored in subsidiaries abroad and can be deferred indefinitely by avoiding repatriation.
The bottom line is that American corporations undertake a lot of shenanigans. If the government were to rationalize the tax rate, a lot of this would stop, and the revenue generated by America may actually end up increasing. This argument has been the main reason behind Donald Trump’s rationalization of corporate tax rates.
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