Multinationals are headquartered in one country but have operations worldwide.

Generally, each multinational pays income taxes in the jurisdiction in which it generates its profits. For example, a German company with operations in the United States and Switzerland would pay income taxes to the U.S. government on the profits that its American subsidiary earned in the United States, and its Swiss subsidiary would pay taxes to the Swiss government for the profits it earned in Switzerland.

However, tax rates are not uniform throughout the world, and some jurisdictions lower their taxes rates to encourage businesses to operate or invest in that jurisdiction.

For example, in the United States, Nevada and Wyoming charge no corporate income taxes. Similarly, the Cayman Islands does not impose corporate income taxes on any business that is incorporated in the Cayman Islands. Both the Isle of Man, located in the Irish Sea, and the Bailiwicks of Jersey and Guernsey, located in the English Channel, use zero-10 corporate tax rate systems, whereby financial institutions pay 10% tax on their profits while all other businesses pay no corporate taxes.

Many of the world’s largest economies

(e.g., Australia, Canada, and Germany)

have a corporate tax rate of approximately 30%, while the rate in the United Kingdom is less, at approximately 25%, and the rate in the United States is more, at approximately 39%. (All of these are general tax rates because there are countless exemptions and incentives in each of these countries that affect the actual rate that any one business would pay.)

Because multinationals operate in countries with high and low tax rates, they can strategically arrange their business affairs so as to shift profits from a high-tax regime to a low-tax jurisdiction. They can accomplish this through transfer pricing, whereby one subsidiary of a multinational sells items to another subsidiary of the same multinational.

The sale or transfer price is set so as to shift or move the profits on the sale to the low-tax jurisdiction, thereby reducing the company’s overall tax burden. In an attempt to close this tax loophole, many countries, as well as the Organisation for Economic Cooperation and Development, established transfer pricing guidelines that require that sales between controlled or related companies be at arm’s-length prices. An arm’s-length price is the price that would be charged in the marketplace between a willing seller and a willing buyer that are dealing without coercion.

However, transfer pricing is subject to an enormous amount of professional judgment, especially if the item being transferred does not sell in a competitive market. Also, not all countries use the arm’s-length principle. This means that multinationals can strategically move their profits around the world so as to minimize the taxes that they pay. Consider the following examples:

• The British unit of Amazon.com Inc.

had sales of \($6.5\) billion but paid only $

3.7 million in taxes because it was transferring a substantial portion of its profits through a related company in Luxembourg, where the corporate tax rate is quite low.

• Apple Inc. has been accused of setting up two Irish subsidiaries in order to minimize its taxes; one subsidiary generated \($30\) billion in profits but paid no taxes, while the other had profits of \($22\) billion and paid only \($10\) million in taxes.
• GlaxoSmithKline PLC was assessed \($51\) million in back taxes as a result of transferring revenue from its Canadian subsidiary to a Swiss subsidiary.
• Google. Inc. shifted \($9.8\) billion to a subsidiary in Bermuda, thereby managing to avoid paying \($2\) billion in taxes.
• By moving \($21\) billion of revenue to subsidiaries in Ireland, Puerto Rico, and Singapore, Microsoft Corp. reduced its taxes by approximately \($4.5\) billion.
• Starbucks Corp. voluntarily paid \($15\) million in extra taxes to the British government after the company was accused of abusive transfer pricing policies.
Nonuniform worldwide tax rates encourage multinationals to strategically move their profits to minimize their taxes.
Aggressive transfer pricing is illegal, and companies have been penalized for engaging in such practices. However, many tax practitioners argue that as long as the price falls within the general guidelines of the arm’s-length principle, then transfer pricing makes good business sense. It reduces tax expense and therefore means that there is more money available for distribution to the shareholders in the form of dividends.
Others argue that transfer price manipulation is available only to multinationals.
Nonmultinationals cannot shift profit overseas.
They pay their fair share of taxes based on the profits that they earn within that jurisdiction, while the multinationals, operating in the same tax jurisdiction, avoid paying taxes on the profits that they earned because of an artificial transfer pricing system.

Questions:-

1. Do you consider transfer pricing to be an ethical means of reducing a business’s tax liability? Why, and why not?
2. At what level would a transfer price cease to become reasonable and become unethical and probably illegal?
3. Does transfer pricing impose an ethically unfair tax burden on nonmultinationals that cannot engage in such a scheme because they do not have international operations?
4. Do governments have an ethical responsibility to harmonize tax rates around the world?