Mid term report tax planning strategies for multinational corporations a profit shifting perspective

CHAPTER 1: FUNDAMENTAL OF TAX PLANNING AND PROFIT-SHIFTING 1.1 Overview of tax planning 1.2 Components in tax planning for MNCs in Vietnam 1.2.1 Types of taxes applied to MNC 1.2.2 Tax l

FOREIGN TRADE UNIVERSITY

HO CHI MINH CITY CAMPUS

Lê Thị Hoang My - 2112153097

Ho Chi Minh City, thang 05 nim 2024

TABLE OF CONTENT INTRODUCTION

CHAPTER 1: FUNDAMENTAL OF TAX PLANNING AND PROFIT-SHIFTING 1.1 Overview of tax planning

1.2 Components in tax planning for MNCs in Vietnam

1.2.1 Types of taxes applied to MNC

1.2.2 Tax landscape for foreign businesses in Vietnam

1.2.3 The need for tax planning in MNC - Phuc

1.3 Tax Planning Strategies for MNC

1.4 Definition of Profit Shifting

1.5 Mechanisms

1.6 Characteristics

1.7 Current policies against Profit Shifting

CHAPTER 2: PROFIT-SHIFTING CASE STUDIES

2.1 The case of Google

2.2 The Case of Starbucks

LIST OF ABBREVIATIONS

Abbreviation Meaning

MNC Multinational Company

SUK Starbuck United Kingdom

BEPS Base Erosion and Profit Shifting

CIT Corporate Income Tax

OECD Organisation for Economic Co-operation and

INTRODUCTION The interconnected world of today fosters a flourishing landscape for Multinational Corporations (MNCs) These economic giants operate across national borders, navigating a complex maze of tax regulations Strategic tax planning becomes crucial for their financial health, and profit shifting — the practice of maneuvering profits

to lower-tax jurisdictions — emerges as a prominent tactic This essay delves into the intricate world of profit-shifting strategies employed by MNCs

This research aims to shed light on the methods and motivations behind profit shifting The author will dissect various channels used for this purpose, including transfer pricing, manipulation of intangible assets, and strategic debt financing By analyzing these methodologies, the essay seeks to understand the rationale driving MNCs to engage

im such practices Exploring factors like tax rate discrepancies, industry-specific considerations, and the overall global tax environment will provide a holistic view of the motivations behind profit shifting

The essay will further explore the economic and regulatory implications of profit shifting We will investigate its potential to erode tax bases in high-tax countries, impacting their ability to fund crucial public services Additionally, the research will examine ongoing efforts by international organizations to address aggressive tax avoidance practices and create a more equitable global tax landscape Ultimately, this essay aims to provide a comprehensive understanding of profit-shifting practices within MNCs By dissecting the methods, motivations, and outcomes, this research contributes

to the ongoing discourse on corporate tax responsibility and paves the way for potential international tax reforms

CHAPTER 1: FUNDAMENTAL OF TAX PLANNING AND PROFIT-SHIFTING 1.1 Overview of tax planning

The process of examining a financial plan or circumstance from a tax standpoint is known as tax planning Making sure there is tax efficiency 1s the goal of tax planning One can make sure that every component of a financial plan operates together with the highest possible tax efficiency with the aid of tax planning A financial plan's tax

planning is an important element Success hinges on lowering tax obligations and improving the capacity to contribute to retirement plans

To minimize litigation, tax disputes with authorities must be resolved Conflicts often arise between tax collectors and taxpayers regarding the amount of money to be collected and how to reduce tax obligations Reducing litigation protects taxpayers from lawsuits To reduce tax liabilities, tax disputes with authorities need to be resolved Conflicts between tax collectors and taxpayers revolve around the amount of money to be collected and how to minimize tax liability Lowering litigation protects taxpayers from lawsuits Efficient tax planning and administration contribute to economic stability by ensuring a robust flow of income This benefits both the economy and its citizens Tax planning aims to transfer funds from taxable sources to income-generating projects, optimizing the use of donations for worthwhile endeavors and promoting productivity There are 4 types of Tax Planning: Short-range tax planning, Long-term tax planning, Permissive tax planning, and Purposive tax planning

1.2 Components in tax planning for MNCs in Vietnam

1.2.1 Types of taxes applied to MNC

In Vietnam, a Permanent establishment (PE) is defined as “a fixed place of business through which a foreign enterprise carries out part or the whole of its business or production activities in Vietnam” Foreign enterprises with their PEs in Vietnam shall pay tax on the taxable income earned in Vietnam (irrespective of whether it relates to the PE) and on the taxable income generated out of Vietnam and related to the operations of the PEs The PE of a foreign enterprise shall include:

e Physical locations: This includes branches, operating offices, factories, workshops, transportation vehicles, mines, oil and gas fields, or any site involved in extracting Vietnamese natural resources

e Temporary projects: Construction sites, installation or assembly projects also qualify as PEs

e Service providers: Establishments offering services, including consulting services, through employees or independent contractors, can be considered PEs

e Agents and representatives: Agents acting on behalf of the foreign company, or representatives with the authority to sign contracts in the company's name, and establish a PE Even representatives without signing authority can create a PE if they regularly deliver goods or provide services within Vietnam

All taxes in Vietnam are imposed at the national level; there are no local, city, or provincial taxes Enterprises should pay tax in localities where they are headquartered or have duly registered branches Most companies and foreign investors in Vietnam are subject to Corporate Incom Tax (CIT) Corporate income tax comes with a standard rate

of 20% (PwC, 2024) This rate can vary for some specific industries, such as oil and gas

or natural resources exploitation industry, etc In special cases, the preferential CIT rates

of 10%, 15%, or 17% would be applied given that certain qualifications are satisfied Foreign enterprises with their PEs in Vietnam shall pay tax on the taxable income eamed in Vietnam (irrespective of whether it relates to the PE) and on the taxable income generated out of Vietnam and related to the operations of the PEs Payments made to foreign contractors are subject to a tax called Foreign Contractor Tax These contractors are defined as foreign businesses operating in Vietnam without establishing a legal entity

or generating mcome directly from the country This applies even if the services are performed outside the country

In respect of Vietnamese enterprises earning income from overseas investment, CIT (or a kind of tax with a nature similar to CIT) paid in a foreign country or paid on behalf of its partner in the country receiving the investment (including tax levied on the dividend) is allowed to be creditable The credit shall not exceed the CIT amount payable

in Vietnam The foreign income tax that is entitled to exemption or reduction in accordance with the foreign law shall also be credited

1.2.2 Tax landscape for foreign businesses in Vietnam

For a long time, Vietnam has been offering special tax incentives for multinational companies (MNCs) to facilitate an appealing business environment in the country Given that the official standard rate is 20%, there are certain cases where investors only have to bear a CIT rate of merely 3% However, starting in 2024, the country will be

implementing the Global Minimum Tax (GMT) policies which require large MNCs whose revenue is more than £750 million to pay the minimum CIT rate of 15% and in cases where the applied rate is lower, a top-up tax amount will be imposed This policy has been developed and agreed upon by 137 countries as an attempt to fight against tax avoidance tactics and ensure a more transparent business environment

However, the implementation of this policy is not without drawbacks It is estimated that, according to the database provided by Hoang (2023), more than 100 MNCs operating in Vietnam such as Samsung and Panasonic will suffer from tax increases due to the new law From the government’s point of view, this will generate an estimated 14 trillion VND ($600 million USD) in additional tax revenue annually Nonetheless, this would lessen the attractiveness of Vietnam as a business location as the tax rates will not be as low as previous incentives offer Hence, the government 1s conducting other programs, aside from low CIT rates, to attract foreign direct investment

in the long term

1.2.3 The need for tax planning in MNC - Phuc

For multinational corporations (MNCs), navigating the complexities of international tax law is essential Effective tax planning offers a powerful tool to optimize their financial health One key benefit is reduced tax burdens MNCs can leverage differences in global tax rates by strategically structuring operations This might involve locating subsidiaries in low-tax jurisdictions to minimize their overall tax bill Another advantage is avoiding double taxation, where the same income gets taxed twice Well- designed tax plans and treaties can ensure MNCs are not unfairly burdened Tax planning also helps navigate complex international regulations MNCs can ensure compliance with transfer pricing rules, tax treaties, and other laws, avoiding penalties and legal issues Beyond minimizing tax liabilities, effective planning can optimize cash flow By influencing when and where taxes are paid, MNCs can free up resources for investments

or other business needs

The global tax landscape is constantly changing Proactive planning helps MNCs stay informed and manage potential risks associated with evolving tax laws It's crucial to

distinguish between legal tax avoidance (minimizing taxes) and illegal tax evasion (avoiding taxes altogether) MNCs should ensure their strategies remain within legal boundaries Effective tax planning allows MNCs to minimize tax burdens, optimize cash flow, and mitigate risks However, maintaining ethical and legal practices is paramount Responsible tax planning strengthens an MNC's financial health while fostering a positive reputation

1.3 Tax Planning Strategies for MNC

Multinational corporations (MNCs) operating across various countries have opportunities for tax planning However, it's crucial to navigate these strategies within the legal framework and avoid crossing into aggressive tax avoidance Here's an overview of some common tax planning methods for MNCs including profit shifting, transfer pricing, and tax haven

Profit shifting is a sophisticated approach employed by multinational corporations (MNCs) to relocate profits with lower tax rates strategically It can be achieved through various methods, including intangible asset location, where valuable IP such as patents or trademarks is moved into nations offering much more favorable tax rates By doing so, MNCs can collect fees from subsidiaries situated in high-tax jurisdictions, effectively shifting profits Another method is transfer pricing, wherein prices for goods and services exchanged between subsidiaries in different countries are manipulated to shift profits to entities in low-tax regions Additionally, MNCs may navigate controlled foreign corporation (CFC) rules designed to prevent profit sheltering in tax havens Despite these regulations, some companies exploit loopholes or employ complex structures to achieve similar outcomes, highlighting the intricate nature of profit-shifting strategies in the global business landscape

Transfer pricing refers to the prices set for transactions between affiliated companies within an MNC These transactions can involve goods, services, intellectual property, or loans Since there's no external market to determine a fair price, MNCs have more flexibility, which can be used for tax optimization The Arm's Length Principle serves as the standard for tax authorities, stipulating that prices between related parties

should resemble those in transactions between unrelated entities However, determining a truly "arm's length" price can prove intricate, allowing room for maneuvering Additionally, MNCs may establish subsidiaries in high-tax countries to manage low- profit activities like administration These subsidiaries then pay inflated prices for goods

or services sourced from entities in low-tax jurisdictions, effectively redistributing profits Such strategies illustrate the complexity and potential for exploitation within transfer pricing frameworks, underscoring the challenges faced by tax authorities in ensuring fair taxation across multinational operations

Tax havens are countnes or territories with meager corporate tax rates, often coupled with lax regulations and banking secrecy Multinational corporations (MNCs) frequently set up subsidiaries in these locations for several reasons Firstly, they aim to diminish their overall tax lability by channeling profits through these subsidiaries, benefiting from the lower tax rates offered Additionally, profits held in tax havens can be reinvested or kept offshore, enabling MNCs to postpone tax payments until funds are repatriated This dual strategy of reducing the immediate tax burden and deferring taxes exemplifies the allure and utility of tax havens for multinational entities seeking to optimize their financial operations

1.4 Definition of Profit Shifting

Profit shifting strategy involves making payments to other group companies in order to move profits from high-tax jurisdictions to low-tax regimes Multinational Corporations are particularly fond of at utilizing these strategies strategies and exploiting the gaps in tax policies to minimize tax expenses Similar to Base Erosion tactics, profit shifting involves manipulating the flow of income across different company locations One common method is through intra-group payments, often in the form of royalties or interest Because these payments are considered business expenses, they can be deducted from pre-tax profits, ultimately increasing the overall profit available to shareholders Tax-motivated profit shifting changes the effective tax rates paid by multinational corporations For example, in the extreme case of costless profit shifting, multinational corporations could entirely avoid corporate income tax by shifting all profits into a country with no (or mimimal) corporate income tax Then its effective corporate income tax rate for investment becomes zero— even in the high-tax country

Although some of the schemes used are illegal, most are not This undermines the fairness and integrity of tax systems because businesses that operate across borders can use Base Erosion and Profit Shifting (BEPS) to gain a competitive advantage over enterprises that operate at a domestic level Moreover, when taxpayers see multinational corporations legally avoiding income tax, it undermines voluntary compliance by all taxpayers Several regulations have been set out to restrict unwanted actions but as these laws have not been very detailed, shifting small amounts of profits is still relatively inexpensive Shifting a greater amount of profit may require complex set up such as payments for intellectual properties (IP), or constructing plans, etc Any profit shifting through tax avoidance additionally carries a risk of detection and penalties, which is likely to rise with the amount of tax avoided

Given that Profit Shifting is frequently implemented by various MNCs at different scales, there exist several techniques via which companies can achieve their ultimate purpose of profit-shifting Among these, Tax Inversion and Transfer Pricing can be said

to be the most well-known (Holtzblatt, Jermakowicz, & Epstein, 2015)

Transfer Pricing refers to the act of changing the pricing of goods and services sold between affiliates By lowering the price of goods and services sold by parents and affiliates in high-tax jurisdictions and raising the price of purchases it makes from its affiliates, income can be shifted

Tax Inversion itself is the controversial tactic that allows a US-based multinational company to restructure so that the U.S parent is replaced by a foreign parent, to avoid paying U.S taxes on some or all of its profits Thus, a company that does most of its business in the United States can cut its federal tax bill by merging with or acquiring an overseas company in a lower-tax country and then relocating its headquarters there

1.5 Mechanisms

2.2.1 Tax planning channels

MNEs haves various options for lowering their corporate tax burden, that is including relocating their profits from higher-taxation countries to lower-taxation nations Transfer price optimization is aims to maximize tax benefits by optimizing related entity transactions’ prices within the range of potential market-based, or "arm's-length," prices For instance, by choosing a low price within the range for the transfer of goods and services from high-tax to low-tax entities, or the other way around

The first channel of tax planning can be seen is the distribution of intangibles, assets, and risks Distributing ownership of income-producing intangibles, assets, and risks in low-tax nations to reroute profits from high-tax nations through intra-group agreements Operational functions are more difficult to relocate, and the primary value- generating tasks that manage and capitalize on those risks, assets, and intangibles may be contracted out to the legal owner to be carried out in higher-tax jurisdictions

Manipulation of the debt's location can also generally speaking, interest paid on debt is deductible from taxable income Finding MNE external and internal debt in an entity located in a nation with a higher tax rate enables this entity to reduce its tax payments and offset its profits

There are also the tax system mismatches, such as preferential tax treatment and negotiated tax rates in this situation MNEs can lower their corporate tax burden by taking advantage of variations in the tax treatment of entities, instruments, or transfers between nations (OECD, 2014a) This can happen even if there isn't a distinction in the statutory tax rates MNEs may also be able to lower their tax burden by negotiating lower tax rates and preferential tax treatment for their particular firms

Hybrid instruments and transfers is also important These are instruments that are handled differently in two nations, such as being treated as equity in one and debt in another Because the income is regarded as a tax-exempt dividend in the second country, this may lead to non-taxable income there and an interest deduction in the first

Besides, there are also hybrid entities for tax planning For tax purposes, the same entity may receive different treatment m two different countries For example, an organization may be deemed as a non-resident taxpayer by any nation (referred to as

"stateless entities") and accomplish double non-taxation of profits in this way As an alternative, an entity may be regarded in one country as a taxable entity and in another as anon-taxable entity, such as a partnership (in which the partners pay taxes rather than the entity itself) This may lead to an income exclusion in the first country and an income deduction in the second

MNEs may also reallocates specific incomes to capitalize on preferential tax treatment provided by certain nations (or regions within them), such as financial services

or intellectual property (such as patent boxes) Although not as much as MNEs, domestic businesses can still gain from preferential tax treatment because they are unable to move their income internationally to take advantage of these benefits on a bigger scale Negotiated tax rates refer to lower tax rates that are specific to a given firm and are negotiated between the tax authority and the MNE

2.2.2 Profit-shifting mechanism

Multinational companies (MNCs) have a number of options when it comes to moving their profits to nations with lower tax rates They pay less in taxes overall as a result Typical strategies include strategically using loans between subsidiaries (intra-

company debt), manipulating the prices of goods traded between subsidiaries (transfer pricing), and putting valuable intellectual property in low-tax nations Governments in nations with higher corporate tax rates may see a decrease in tax revenue as a result of these practices

2.2.2.1 Transfer Pricing Manipulation

Beyond simple manipulation of transfer pricing, profit shifting is also caused by multiple mechanisms that are very important MNCs may use product sourcing strategies, such as paying a premium for raw materials or components obtained from a subsidiary in

a nation with high taxes This inflates profits in the low-tax country where the finished product is manufactured and artificially lower the taxable profits in the high-tax country Another way to manipulate a sales channel is to set up a shell company in a low-tax jurisdiction to serve as an intermediary Products are sold at a low cost to the shell company by the high-tax subsidiary, and the shell company subsequently resels them to the end user at a significantly higher markup Profits were redirected to the low-tax jurisdiction through this plan Lastly, MNCs may establish service subsidiaries m high- tax nations with the express purpose of turning a loss By charging exorbitant fees to other MNC subsidiaries, these subsidiaries further lower taxable profits in the high-tax nation These actions demonstrate the intricacies of the profit-shifting tactics used by multinational corporations to reduce their overall tax liability

2.2.2.2 Exploiting Intangibles

MNCs have the ability to manipulate tangible goods in addition to using intellectual property for profit shifting They might create "captive low-tax entities” in tax-friendly jurisdictions These subsidiaries mainly serve as a valuable intelectual property, such as patents or trademarks and also legal address The high-tax subsidiaries then have to pay the low-tax entity significant royalties in order to use this intellectual property, this effectively transfers profits, even though the intellectual property may have originated elsewhere, to the low-tax nation

2.2.2.3 Cost Sharing Agreements

Cost-sharing arrangements are manipulated by MNCs in order to achieve their profit-shifting objectives By means of "cost allocation manipulation,” they are able to bargain for CSAs that alocate a larger share of research and development expenses to their subsidiaries with high taxes Even when the real R&D is carried out in nations with low tax rates, this still occurs, the high-tax nation's taxable profits consequently decrease Some MNCs also make use of "buy-in payments.” In this case, a low-tax subsidiary contributes significantly up front to a high-tax subsidiary's ongoing R&D project Even though this payment undervalues the contribution made by the low-tax subsidiary, it can still be set up as a tax-deductible expense in the high-tax country MNCs can further lower their tax obligations by utilizing these strategies found in cost-sharing agreements

in high-tax countries

2.2.2.3 A Mathematical Glimpse into Tax Optimization

A common tactic used by many MNCs is profit shifting, which tries to reduce their overall tax liability Using this tactic, one can lower tax obligations in high-tax nations and increase reported profits in low-tax jurisdictions by manipulating pre-tax profits Although a single, all-inclusive equation cannot adequately capture the complexity of transfer pricing techniques and international tax law, a conceptual model can clarify the fundamental workings

The equation can be made:

Profit-HighTaxCountry (Before Shift) = Taxable Profit-HighTaxCountry (After Shift) + Profit-Shifted

Profit-HighTaxCountry (Before Shift) represents the pre-tax profit that the multinational corporation's subsidiary in the high-tax nation made This represents the entire economic contribution of the subsidiary before deducting any taxes

Taxable Profit-HighTaxCountry (After Shift) represents the taxable profit that the subsidiary reports following the use of profit-shifting techniques This value is probably going to be substantially less than the pre-shift profit because of these strategies

Profit-Shifted represents the part of profit that has been fictitiously moved to a country with low taxation In the end, the MNC's total tax burden is decreased because this "shifted" profit avoids taxation in the high-tax nation

The regulations governing transfer pricing and the unique tax laws of various nations influence these mechanisms' efficacy The formula, however, offers a framework for comprehending how MNCs manipulate pre-tax profits (Profit_HighTaxCountry (Before Shift)) in order to increase the profit reported in low-tax jurisdictions (Profit Shifted) and reduce tax liabilities in high-tax countries This draws attention to the possible conflict between government efforts to collect taxes and corporate tax optimisation strategies

1.6 Characteristics

Profit shifting, a prevalent practice in tax planning, involves maneuvering profits among different jurisdictions to minimize tax obligations Characterized by distinct methods and far-reaching consequences, it presents a complex challenge in the global tax landscape

One hallmark of profit shifting is the exploitation of tax havens — countries with minimal corporate tax rates and stringent secrecy laws MNCs establish subsidiaries or channel intellectual property mghts (IPR) to these havens, significantly reducing their overall tax burden For example, a 2017 study by the Tax Justice Network estimated that developing countries lose an average of $190 billion annually due to profit shifting by MNCs

Profit shifting frequently involves underreporting profits in high-tax countries This can be achieved through transfer pricing — manipulating the prices of goods and services traded between subsidiaries For instance, an MNC might sell goods to a subsidiary in a tax haven at an artificially inflated price, thereby reducing its taxable profits m the high-tax country MNCs leverage complex webs of subsidiaries to facilitate profit shifting They may establish shell companies in low-tax jurisdictions with the sole purpose of channeling profits or holding intangible assets These transactions often lack economic substance, serving primarily to minimize tax liabilities

The magnitude of profit shifting is significant, impacting both public finances and corporate behavior Estimates suggest that profit shifting reduces global tax revenues by