Weaknesses in both Global Tax Laws and Regulation of MNEs

Part 1

Introduction

The Organization for Economic Co-operation and Development (OECD) published a report to address disreputable Loss and Profit Fluctuation. This report was to respond the above concern by multinational corporations (MNCs). The OECD report recognizes that the existing global tax system has not provided consistent advances in the business environment . This provides MNCs with sufficient chances to adventure in the legal ambiguities and hence benefit from the tax free earnings. The implementation of profit-shifting strategies by MNCs is one of the main causes of base erosion. This work examines the concept of how the multinational companies avoid taxation, its effects and the implication of global law and policies. In the view of OECD, the current condition is a subject to examination of the essentials of the global tax system. This will incorporate deviations to the present global tax laws that will monitor the operations of MNCs. When this is done, MNCs will have to report their profits and pay their taxes in the places where their economic activities and ventures are located. The resulting success is appropriate taxation of MNCs that will lead to a reasonable world tax system .

Taxes avoidance approaches have been embraced by MNCs in industrialized countries. By this, MNCs use numerous tactics to transfer revenue from high-tax to low-tax countries. These strategies include the alteration of intra-firm transfer prices, the company debt-equity structure and the premeditated location of assets as well as overhead costs. The evidence for less industrialized countries is limited . This is significant due to insufficient reliable and consistent data by researchers. The present global financial downturn and the related policies for economic union have raised an issue for the developed countries in avoiding and evading tax. However, the possible significant of the effects are in the developing economies. According to tax revenues in OECD countries, the developing countries get the least. The total tax raised by these countries indicates that the governments cannot acquire financial resources required to assure the citizens’ access to vital services, such as education, clean water and sanitation. Moreover, low tax revenues suggest the necessity for governments to increase debt and aid levels. This in turn questions liability of creditors and donors .

Raising of low tax revenues in developing countries is caused by various factors. The huge informal sectors and high poverty levels lead to subsequent incapacity of minor citizens to pay taxes. The identified reasons are tied with the presence of weak institutional ability to develop the tax source and implement taxpayers’ compliance . The implications of these reasons are significant to the government due to the existence of the shadow economy. This OECD warrants that tax havens have been amalgamated into essential elements of the organizations and approaches related to tax avoidance and evasion practices. MNCs have finance secrecy where there is limited tax information exchange with other authorities and cover the beneficial ownership. This facilitates evasion and avoidance of tax practices thus permitting the taxpayer to hide from tax authorities in a different place. The combined low tax rates and secrecy increase the capability of tax havens to encourage foreign capital easy to movement between countries. This becomes clear by looking into the Foreign Direct Investment (FDI) figures .

The rules to achieve low or no-taxation in relation to financing

Company based in high tax authority accomplishes an operation of tax rate on the income established by providing credits through a remote branch that is subject to a low-tax government. This obliges that the country in which the main offices are located to function as an exception system for remote branches. The low-tax in the branch is achieved where the country of the branch charges a low tax rate on the income as compared to the country of the head office. Hybrid entity is one that is preserved as taxable to person in one country and not in another country. For example, in the other country the profits or losses of the entity are taxed at the level of the members . This disparity in management allows the group to claim a deduction in Country B for a payment that is not taxed in Country A.

Several derivative tools are used to diminish taxes on cross-border payments. For example, derivative fees or interest rate changeovers economically substitute interest payments and thus avoid suppressing tax at source. Many company tax structures emphasizes on assigning significant risks to low-tax authorities, where their returns benefits are promising to the government . This provision contributes to BEPS due to shifting income through transfer pricing arrangements. The price transfer rules regard the designation of assets and risks within a group and are realistic on an entity-by-entity basis. The measures concerning to risk shifting contributes to various issues of transfer pricing. In addition, it is not easy to determine if the payment should be made between members when risk shifting the price

Given that tax laws differ across jurisdictions, can be elucidated by dissimilar legal traditions. This leaves the decision of determination to domestic, as well as treaty based anti-avoidance regulations that make up the benchmark in deciding whether a particular tax strategy should be put into place. The decision is based on shifting of the tax burden to the side of the taxpayer which is dictated by the tax authorities from different countries . However, tax avoidance policies on different jurisdiction tend to protect these companies with the notion that they contribute to economic growth and development of host countries. The ongoing discussions on whether MNCs should pay taxes call for change of strategies in the application of anti-avoidance rules. For instance, the existing rules may be altered to favor tax avoidance on multinational companies.

A significant examination in matters relating to the tax structure of the corporation is that it encompasses interplay of numerous practices and standards that results to the occurrence of BEPs (Base Erosion and Profit shifting). The policy of excluding tax rules of taxation in one country in reference to the territorial tax rules of different country, as well as entity characterization taxation rules in a third country makes it possible for certain transactions to occur. However, these transactions may facilitate the emergence of a tax system that impacts on shifting revenue to jurisdictions where there are no compulsory taxes. Moreover, relevant structures need to be put in place and which directly touch on BEPs where numerous harmonize strategies should be developed. Some of these strategies include reduction of taxation in the source country through shifting of gross profit using trade structures. Similarly, a no taxation strategy should be implemented on the recipient, and this can be attained through arrangements on hybrid mismatch or preferential regimes.

The analysis of BEPs needs to take into consideration various taxation elements that target on limiting tax avoidance on multinational enterprises. Therefore, there is a need to restructure the tax systems in favor of local companies that are not meant to shift the tax burden to taxpayers and domestic companies. One of the major issues of multinational companies is that there is a tendency of taking back profits to mother countries. Hence, the per-capita income of individuals in these countries is affected by the imposition of fiscal policies that are aimed at increasing the amount of taxes to fund the government spending . This implies that the based erosion and profit shifting (BEPs) may have a tendency of manipulating existing tax systems in both the host and parent countries .

Conclusion

The link between MNCs to tax havens engross in profit shifting largely than those MNCs with no tax haven links. This approves the fact that when companies have tax haven associations, they face higher encouragements due to the low tax rates in tax havens and opportunities generated by the secrecy provisions the tax havens offer to shift revenue. The various different reasons to profit shifting and antagonistic tax arrangement also influence the low taxes. The OECD in its recent report indicates that profit shifting to low tax authorities is one of the chief cause for base erosion. This implies that the existing regulations on transfer prices and measures might affect the tax evasion caused by company’s profit shifting. This MNCs practices to shift profits in order reduce the tax revenues collected by governments. In those countries where collected taxes are very low, the revenue predetermined seriously destabilizes the efforts to reduce poverty and capitalize in human development.

OECD states that, the present global tax system is not favorable to the business environment. One of the key complications relates to the fact that the diverse distinct legal entities that form an MNC are still viewed from a tax perception as if they were sovereign. This is not the case as reality shows that these different legal entities follow an overall business procedures, and their management and recording structures have relations that exceeds the nationwide boundaries. OECD acknowledges that each country should tax a reasonable share of the profits made by MNCs operating in its region.

There is a need to treat MNCs as what they really are where multifaceted structures are bound together by consolidated management. This will ensure that MNCs pay their taxes where their economic activities and asset are really located, rather than in authorities where the existence of the MNCs is sometimes untrue, and tax avoidance approaches are common. Through OECD towards BEPS report, the United Nations Tax Committee should discover the extent evolution is towards a common taxation with profit distribution. The unitary approach to the taxation of MNCs will fairly reflect how MNCs currently operate and lead to a more transparent and easy-to-administer system.

 

Part 2

Question 1

International foreign direct investment (IFDI) is the process by which one country invests in the economy of another country. These investments are in the form of either goods or services. IFDI may cause the investing country to have influence over the politics within the host country as the result of giving them too much power. The IFDI are thus able to influence the economy and the labour market in such a method that lots of countries try to set this kind of investments .

Benefits and costs resulting from FDI

Benefits of FDI

FDI raises the Level of foreign investment in the country. Foreign direct investment bridge the gap between preferred investment and nearby mobilized savings. The local capital markets are normally not well developed. They cannot, therefore, meet the capital requirements for bulky investment venture. FDI solves these problems at once as it provides a direct source of external capital. It fills the gap linking preferred foreign exchange supplies and those resulting from net export earnings.

FDI has helped in improvement of technology of the host country. Foreign investment brings with it technological knowledge while transferring equipment and machinery especially to developing countries. This is because the majority of production units in less developed countries use outdated machineries and equipment. This reduces the amount of output and techniques that can trim down the productivity of workers and lead to the production of goods of a lower quality.

FDI has greatly acted as resilient factor during countries financial crisis. For example, in parts of East Asian countries such foreign direct investment was extremely stable during the global financial crisis of 1997-98. In comparing with the other forms of private capital flows like portfolio equity debt flows were subject to large reversals during the same crisis. Furthermore, similar trends were observed in Mexico in, 1994-95 and Latin America, in the 1980. FDI is less prone to financial crises because direct investors typically have an extended perspective in their view when engaging with the host country. Moreover, apart from risk sharing on properties, it is broadly alleged that FDI have improved stimulus to economic growth in the host countries than any other types of capital inflows in the country. FDI provides more than just capital in that it provides ways of access to internationally available technologies and management advancement .

FDI results to increased export competitiveness in the global market. FDI helps the country develop its export performance. The FDI increases efficiency and product quality; FDI makes a supportive impact on the country’s export competitiveness. Furthermore, as the result of the international link of MNCs, FDI provides the country better access to foreign markets. Improved export possibility contributes to the enlargement of the host country economies by soothing demand side hindrance on growth. This is important for those countries which have a small domestic market and must increase exports vigorously to maintain their tempo of economic growth. A good example of a case study is an investment of phone services in several countries that included Brazil, Mexico and India where FDI in the industry that was previously controlled by the government dramatically reduced the cost of manufacturing and improved the after sale service. The introduction of competitiveness led to service improvement in the phone service industry .

FDI helps in the employment creation in the host countries. FDIcreates employment in the various sectors especially in developing countries. FDI trains employees in the course of operation of the investment undertaken which contributes to human capital improvement in the host country. The introduction of FDI in the host country reduces the level of unemployment as it uses some personnel’s from the countries for carrying out their business activities.

Cost of FDI

Before the adoption of FDI, the host government needs to be careful when making a decision concerning conditions and patterns of investment in the country. Inappropriate decision may result to adverse effects on FDI. Some of this cost of poor decision in adoption of FDI is discussed below.

The incorporation of Multi Nation Corporation (MNC) can result to social protest and disorder in the host country. The MNC exerting of too much power by acting as a monopoly in the provision of public goods e.g. electricity and water can result in protest and resentment by the citizens. This can directly result to hostility in the business environment, social disorder and even political instability. A case study that clearly reflects such a scenario happened in Cochabamba, Bolivia in 2000. This was when a local water service was undertaken over by Bechtel which is a conglomerate that led to doubling of prices. This lead to strike and transportation shut down in Cochabamba.

The introduction of FDI may damage the competition of the local industries. This is this primary disadvantage of FDI. The FDI possess technology, skills and capital that locals industries can’t match. The local industries are easily damaged, even driven out of the business and thus result to unemployment. However, competition from more efficient MNC is beneficial to the country as it improves the general productivity and helps the local industry to increase efficiency and modernization .

FDI can result to “decapitalization” as firms established under FDI repatriate earnings to their home country. These results to capital drain especially if the owned company is large. The effect of this is similar to the effect of foreign leaders refusing to have short term loans. The host country can be starved of capital and can result to worsen of economic conditions in the country . This acts as the primary risk of the country becoming too reliant on FDI.

Question 2

The above benefits and costs are usually determined by the level of development and growth of the country and firm. This is clearly shown in the above discussion as the benefits and cost cases that are used for illustration are mostly from developing countries that have not reached self actualization. The introduction of FDI has resulted to great development and economic growth in the host country. This is the case of developing countries .

The FDI is an important aspect for the transfer of technology and usually contribute more to growth and development of the domestic investment. The high productivity of FDI has the effect of increasing the overall investment of the country by providing complementary effect with domestic industry.

Majority of developing countries have eased restriction on FDI and have offered attractive subsidies and tax incentives to attract foreign capital. The rationale behind this is that FDI contributes to development and economic growth through stimulation of capital accumulation by the provision of positive externalities in the form of productivity spillovers to local industries.

The growth and development across the various developing nations is as the result of high concentration of FDI. In 2007, approximately more than half of the FDI to developing countries went to five countries: Russia, Mexico, Brazil, Turkey and China. Least developed economies that include most of the Africa has continued to receive relative little FDI. This tends to be shunned by MNCs by preferring to invest in the countries that are believed to be safe with political stability, education and infrastructure. This creates better working conditions on the MNCs. Low income countries are getting almost equal amount of FDI as the middle income countries. This was the scenario as Africa attracted more attention in the mid 2000 as demand for its commodities grew substantially in the boom period .

The developing countries aim at boosting their development and economic growth. The developing countries are marketing themselves outside their borders to encourage development and growth in the country. This is achieved through the introduction of stimulus that includes FDI. This helps in encouraging productivity gains through the introduction of new process, employees training, managerial skills and access of international markets. This perception has guaranteed solution to the accelerate development and growth of development in the developing country .

The macro studies conclude that FDI has a positive impact on development and growth of a country. The countries with higher levels of per capita income, higher degree of openness, better educated workers and well developed financial system have benefited developing countries significantly. A good example is a case study of Ghana which has attracted MNCs to invest in the country. Furthermore, foreign firms have provided a wide range of assistance to local suppliers of the country social benefits. The report indicates that there are tradeoffs between the costs and benefits incurred as the result of FDI. This indicates there is a need of cross examination of the country governance before acceptance of the investment by the multinational corporation.

 

 

 

References

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Voget, J., 2011. “Relocation of headquarters and international taxation,”. Journal of Public Economics, pp. 1067-1081.

 

 

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