Common Corporate Tax Avoidance Strategies

Common Corporate Tax Avoidance Strategies

Although tax avoidance has existed for centuries, it has increased considerably in recent decades due to the increasing international mobility of capital. Due to Panama papers, tax avoidance practices have recently received a lot of attention and critics during the last months. Governments make attempts to tackle the large-scale tax avoidance and highlight the need of good tax governance. At the same time, they are entangled in a destructive competition with other countries to attract foreign investors by means of fiscal stimuli. A recent report of SOMO explains and examines the five most commonly used tax avoidance strategies of large Dutch MNEs.

PRESENCE IN TAX HAVENS: This strategy is well-known; companies construct artificial structures, for example via letterbox companies that only exist on paper, in order to make use of the favorable corporate income tax rate that is applicable in the jurisdiction. Companies ensure that their profits flow through this jurisdiction in order to lower their entire tax expense.
THE BELGIUM ROUTE: Belgium has the so-called notional interest deduction, which offers companies the possibility of determining a notional interest on its own equity and then subsequently deducting that interest from the taxable income. This is similar to the tax deductibility of interest on loans or debt owed.
SHIFTING PROFITS THROUGH ROYALTIES: Reimbursement must be made for the use of the company’s intellectual property (IP) rights, such as patents and trademarks: royalties. By inflating these royalty payments, profits can be shifted just as is the case with interest payments. The location of the intellectual property rights is therefore important. Looking solely at the letter box companies – SOMO stated that the subsidiaries with a very small number of employees – Switzerland turns out to be the most popular destination for intellectual property rights followed by the Netherlands, due to (amongst other things) the lack of withholding taxes on royalties in both countries.
EXPLOITING PATENT BOXES: A form of tax incentive for corporates that grants preferential tax treatment to revenue from intellectual property (IP). Patent boxes are increasingly becoming popular in the EU, with the United Kingdom, Belgium, Spain, Portugal, France, Ireland, Italy, the Netherlands, Luxembourg, Malta, Cyprus and Hungary having relatively recently adopted or announced this form of tax incentive. In a recent study, the European Commission notes that patent boxes “offer a large scope for tax planning for firms” since it is easy for companies to allocate a high portion of their profits to their patents, thereby moving profits across borders, away from where production takes place and into the low-tax patent box.
SHIFTING PROFITS THROUGH INTEREST PAYMENTS: Misuse of intra-group financing – group entities within a corporate group which finance each other – is a well-known evasion strategy. The interest which must be paid on the intra-company loan by the borrowing subsidiary can reduce the taxable profits in the one country (with high tax rates) and, on the contrary, increase profits in the other country (which has low rates) where the lending subsidiary is based. According to SOMO, companies provide very little insight into these types of transactions between group entities.

⇒ Do you know of any further common ways to avoid corporate taxation?
⇒ What kind of (practical) solutions do you think should be implemented to limit these five tax avoidance strategies? By whom?

Source: SOMO (2016) Big Companies, Low Rates

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Daniel Adanri
Student (Other), United Kingdom

Tax Planning Strategies

Tax planning strategies refer to the proactive and strategic actions taken by companies to minimize their tax liabilities within the boundaries of the law. These strategies involve analyzing the company's financial situation, transactions, and applicable tax regulations to identify opportunities for optimizing tax payments. The goal is to legally reduce the amount of tax a business owes, thereby maximizing its after-tax profits and cash flow.

Importance of Tax Planning

Tax planning strategies are essential for businesses for following main reasons:

MINIMIZE TAX LIABILITIES: By implementing effective tax planning strategies, businesses can minimize their tax liabilities. This allows them to retain more of their earnings and allocate funds towards growth initiatives, investments, and other business priorities.
IMPROVE CASH FLOW: Lower tax liabilities mean higher cash flow for businesses. By optimizing tax planning, companies can ensure they have more funds available for day-to-day operations, expansion, and capital expenditures.
ENHANCE COMPETITIVENESS: Reducing tax burdens can improve a company's competitive advantage. With lower tax expenses, businesses can potentially offer lower prices, invest in research and development, or allocate resources to marketing and advertising, giving them an edge over competitors.

Typical Tax Planning Strategies

Some common tax planning instruments for businesses include:

TAX ENTITY SELECTION: Choosing the right legal structure for the business, such as a sole proprietorship, partnership, corporation, or limited liability company (LLC), can have significant tax implications. Each entity type has different tax treatment, and selecting the appropriate structure can help optimize tax benefits.
INCOME SHIFTING: Shifting income from a high-tax bracket entity to a lower-tax bracket entity or individual can help reduce the overall tax burden. This strategy can involve structuring transactions, timing income recognition, or utilizing family members in the business.
INVESTMENT/EXPENSE MANAGEMENT: Careful management of investments and expenses can help minimize taxable income. Businesses can explore deductions and credits available for research and development, employee benefits, depreciation, charitable contributions, etc.

Tax planning strategies are typically conducted with the guidance of tax professionals, such as accountants or tax consultants, who have expertise in tax laws and regulations and can provide personalized advice based on the specific circumstances and goals of the business, ensuring compliance and maximizing tax benefits within applicable legal frameworks.