Profit Shifting: Cross border rope tricks

By Shreenivas Kunte, CFA, Adjunct Faculty – Incharge Trade/Research Lab, S.P. Jain Institute of Management & Research

For some time now, astute tax lawyers must have been bringing a smile to Henry David Thoreau. So far corporate tax men have managed to pull a rabbit out of the hat – a different one every year – to optimize – rather minimize their employer’s tax outflow. Tax havens from Singapore to Bermuda have been booming with subsidiary profits in some cases more than 10 times their GDP.

Unsurprisingly some of the tax havens have also been seen to be the source of black or illicit money. Many in India maybe interested in visiting the Swiss Alps but the Indian regulator’s fixation with the Swiss has been more on black money holders in that country. Beyond the photo ops at G20-Brisbane and Prime Minister Modi’s call against black money at the G-20 summit, the world’s leaders continued to be signed in to tighten tax avoidance. The commitment could only increase as a slowing world economy dries tax revenue and black money forces developing country leaders to act. Regulatory requirement could begin to converge as countries under the BEPS (Base Erosion and Profit Shifting) project agree to set rules against profit shifting and tax avoidance.

There could be some low hanging fruits such as denying deduction for a payment that is also deductible in another jurisdiction. On the flip side, convergence among countries and the requirement for popular endorsement (i.e. Parliament for India) could turn out to be as complicated as agreeing on a single currency between countries at odds (India and Pakistan and Bangladesh?).

There has been some reporting in the media against American corporations and the shifting of their profits. Among developed nations, America has the highest corporate income tax rate (39.1%). Some of America’s most profitable and respectable corporations have been seen to be shifting profits to the displeasure of the tax authorities (and other non-government groups). Some of these companies have reincorporated or have setup subsidiaries in low cost countries (such as Ireland). Apple, Starbucks, Caterpillar, Microsoft, IBM, Google, Facebook have been seen to be under tax avoidance scrutiny.

Compared to the developed world, emerging country governments maybe more vulnerable to profit shifting as corporate profits form a larger part of the government’s tax revenues. In order to understand India’s corporate tax collection, the Bloomberg database was screened for NIFTY companies with the lowest effective tax rate. Bloomberg data suggests that Cairn India, Sun Pharma, Tech Mahindra, Wipro and Reliance, are in the top decile of having the lowest five year average effective tax rate (of about 14.2% vs India’s corporate tax rate of about 34%).

In this list, notably, according to the latest financial results, Cairn India’s 100% subsidiary, Cairn India Holding limited is incorporated in Jersey (largest of the Channel Islands, seen as a tax haven). CIHL’s before tax profit has been shown in CI’s annual report to be representing about 70% of CI’s consolidated profit before tax. Sun Pharma’s fully owned subsidiary, Sun Pharma Global Inc, is registered in the British Virgin Islands (seen as another tax haven). SPGI’s latest annual profit of Rs 150815 million, represents more than twice of Sun Pharma’s consolidated profit before tax.

For the record, the other companies in the screen – Tech Mahindra (40 subsidiaries), Reliance (103 subsidiaries), Wipro (64 subsidiaries) – have reported overseas subsidiary profits in their “Financial Statement on Subsidiaries” but the overseas reported subsidiary profit has been relatively insignificant.

The tax strategies being used by all the companies in the screen used for this post could be perfectly legal. Tax saving structures however, could be reviewed for unaddressed regulatory gaps between lower tax havens and higher taxation countries. Profit-shifting for tax saving gives a better return for the company’s shareholders but this maybe to the detriment of the citizens of the country facing the tax revenue loss.

 – SK

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