tax notes

Volume 150, Number 4 January 25, 2016

(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
Corporate Social Responsibility and
Taxation: An Evolving Theory

By Doron Narotzki

Reprinted from Tax Notes, January 25, 2016, p. 455

Electronic copy available at: http://ssrn.com/abstract=2773033


Corporate Social Responsibility and
Taxation: An Evolving Theory
By Doron Narotzki
Doron Narotzki is an assistant professor of tax at
the University of Akron George W. Daverio School
of Accountancy. He thanks Professor Yariv Brauner
and Vered Kuperberg for helpful comments and
Danielle Hickman for outstanding research assis-
tance. All mistakes and inaccuracies are the au-
thor’s.
In this article, Narotzki discusses how corporate
social responsibility (CSR) can affect tax planning.
He argues that although CSR may decrease a
corporation’s short-term profits, greater recognition
and positive feedback from the public will ulti-
mately increase profits in the long term. Narotzki
concludes that a partnership between CSR and tax
planning can help evolve the corporate world into
one that seeks to benefit not only shareholders but
also the public. An expanded version of this article
will appear in volume 16 of the Houston Business
and Tax Law Journal.
A. Introduction
In theory U.S. multinational corporations
(MNCs) face the highest corporate tax rate in the
world, with the United States having a marginal
corporate federal tax rate of 35 percent and an
effective corporate tax rate that could reach 40
percent. However, there is a big difference between
those rates, which are prescribed by law, and the
rates actually levied on typical U.S. MNCs —
mainly due to various tax credits, exemptions, and
other benefits that aren’t discussed or well-known
among individuals who aren’t tax practitioners.
The effective tax rate (ETR) differs from the
statutory tax rate because it attempts to measure the
taxes paid as a proportion of economic income,
while the statutory tax rate indicates the amount of
tax liability before tax credits that could offset the
company’s taxable income. For instance, for tax
year 2010, profitable U.S. corporations that filed a
Schedule M-3 paid an average U.S. federal income
tax rate of 12.6 percent on the pretax worldwide
income reported on their financial statements, ac-
cording to the Government Accountability Office.
When foreign, state, and local income taxes are
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VIEWPOINT
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tax notes™
included, the ETR for profitable filers increases to
approximately 17 percent, well below the top statu-
tory rate of 35 percent.
A study conducted in 2011 by the Citizens for Tax
Justice and the Institute on Taxation and Economic
Policy found that Pepco Holdings Inc. had an
astounding ETR of negative 57.6 percent between
2008 and 2010.1 Most of that resulted from extensive
use of ‘‘complex structures, dubious transactions
and legal fictions’’ to shift profits overseas and
avoid paying U.S. taxes.2 That raises the question: Is
it a legitimate corporate goal to minimize tax?
It is widely known that corporations are in
business to make money. However, most people
would hesitate to agree that a corporation has little
or no responsibility to its own clients. There is
nothing wrong with a company wanting to do well
and fulfill its main objective of being as profitable as
possible while at the same time going above and
beyond customer expectations to keep them happy
with its performance. In fact, some might call that a
business plan.
This article doesn’t address whether corporations
should pay taxes; rather it argues that the new
direction, not only from society’s and the state’s
standpoint but also — perhaps most surprisingly —
from the corporate standpoint, is that corporations
carry a responsibility to pay corporate tax and help
others ‘‘carry the burden.’’ The development of this
idea spawns from the concept of corporate social
responsibility theory, more commonly known as
CSR.3
1
Robert S. McIntyre et al., ‘‘Corporate Taxpayers & Corporate
Tax Dodgers 2008-10’’ (Nov. 2011).
2
Homeland Security and Governmental Affairs Permanent
Subcommittee on Investigations, ‘‘Offshore Profit Shifting and
the U.S. Tax Code — Part 1’’ (Sept. 20, 2012) (Microsoft and
Hewlett-Packard) (statement of Sen. Carl Levin).
3
See Reuven S. Avi-Yonah, ‘‘The Cyclical Transformations of
the Corporate Form: A Historical Perspective on Corporate
Social Responsibility,’’ 30 Del. J. Corp. L. 767 (2005), for a
complete review of the CSR evolvement and debate. See, e.g.,
Michael C. Jensen, ‘‘Value Maximization, Stakeholder Theory,
and the Corporate Objective Function,’’ 12 Bus. Ethics Q. 235
(2002), for previous literature. See also Jensen and William
Meckling, ‘‘The Theory of the Firm: Managerial Behaviour,
Agency Costs, and Ownership Structure,’’ 3 J. Fin. Econ. 305
(1976). But see generally for different perspectives on CSR:
Michael J. Phillips, ‘‘Reappraising the Real Entity Theory of the
Corporation,’’ 21 Fla. St. U. L. Rev. 1061 (1994); C.A. Harwell
Wells, ‘‘The Cycles of Corporate Social Responsibility: An
(Footnote continued on next page.)
455
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COMMENTARY / VIEWPOINT
Over the past few decades, MNCs across the
world have started adopting CSR programs and
self-regulating standards for what are considered
responsible corporate activities. At the same time,
legal developments in the United States have given
corporations even more political power and influ-
ence by allowing them to take an active role in the
day-to-day life of citizens and by recognizing a
constitutional right for corporations to give finan-
cial support to a wide range of electioneering
activities, including the use of corporate funds.4
Although those developments may ultimately have
negative effects, they result in the public expecting
more responsibility and accountability. Thus, it is
important to acknowledge that an MNC has an
unwritten agreement with the public to ‘‘do the
right thing’’ because of its influence on society5 and
because it does so well from a financial standpoint.6
For those reasons corporations are becoming more
influential globally.
B. Corporate Social Responsibility
CSR is an action taken by a corporation to adopt
a specific standard of self-regulation that a corpo-
ration cannot otherwise be forced into and which
doesn’t produce any direct gain.7 The CSR trend
started in the 1950s and gained traction in the 1960s.
One of the most prominent writers on CSR at that
time was Keith Davis, who argued that ‘‘business-
men’s decisions and actions are taken for reasons at
least partially beyond the firm’s direct economic or
technical interest.’’8 Davis argued that at least some
Historical Retrospective for the Twenty-First Century,’’ 51 Kan-
sas L. Rev. 261 (1992); Cynthia A. Williams, ‘‘Corporate Social
Responsibility in an Era of Economic Globalization,’’ 35 UC
Davis L. Rev. 705 (2002); and Ronald Chen and Jon Hanson, ‘‘The
Illusion of Law: The Legitimating Schemas of Modern Policy
and Corporate Law,’’ 103 Mich. L. Rev. 1 (2004).
4
See Citizens United v. Federal Election Commission, 558 U.S.
310 (2010).
5
An MNC will have thousands of employees, and it will
have a large number of subcontractors and other linked com-
panies that deal with it every day and lean on it for their
existence.
6
For example, I doubt anyone would expect Blackberry to
make a donation to a hospital while it has been losing so much
money over the past few years; however, we do expect Apple to
do good and make an effort to improve more than just iPhones.
7 10
Abagail McWilliams and Donald Siegel, ‘‘Corporate Social
Responsibility and Financial Performance: Correlation or Mis-
specification?’’ 21 Strategic Mgmt. J. 603, 603-605 (2000). It is
reasonable to assume that adopting CSR elements may indi-
rectly produce some economic gain for the company that
adopted such regulations, often because of positive public
opinion and increased customer happiness. However, extensive
research by McWilliams and Siegel shows that CSR has a neutral
effect on a corporation’s financial outcomes.
8
Keith Davis, ‘‘Can Business Afford to Ignore Social Respon-
sibilities?’’ 2 California Mgmt. Rev. 1, 70 (1960).
456
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corporate social activities can be justified by having
a good chance of bringing long-term economic gain
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to the corporation.9
A significant contribution to the development of
CSR came in 1971 from the Committee for Eco-
nomic Development (CED) in its publication, Social
Responsibilities of Business Corporations. This was one
of the first times that social responsibility was
directly referring to the corporation and not to its
shareholders.10 The CED stated in its publication
that ‘‘business functions by public consent and its
basic purpose is to serve constructively the needs of
society — to the satisfaction of society.’’11
The important acknowledgment is that the cor-
poration should remain profitable before engaging
in CSR activities. The question now is, what consti-
tutes a socially responsible activity for a corpora-
tion? In 1972 Henry G. Manne answered that
question:
To qualify as a socially responsible corporate
action, a business expenditure or activity must
be one for which the marginal returns to the
corporation are less than the returns available
from some alternative expenditure, must be
purely voluntary, and must be an actual cor-
porate expenditure rather than a conduit for
individual largesse.12
Those definitions show that according to re-
searchers, CSR is a form of corporate strategic
management that sets a higher standard of conduct
than imposed by legal constraints and which envi-
sions CSR as a system for governing transactions
and relations between the corporation and its stake-
holders.
C. Tax Responsibility
On December 9, 2012, The Sunday Times’ headline
reported that Microsoft Co. paid no tax on £1.7
billion of online sales. It was explained that Micro-
soft was channeling cash generated by sales of its
Microsoft Windows 8 operating software to Luxem-
bourg to sidestep tax obligations. To explain how
the alleged tax evasion works, imagine a customer
in the United Kingdom pays to download the new
Windows software and the money is paid (online)
9
Id.
The CED was composed of business people and scholars
and therefore reflects an important view coming from both sides
of the table. It is important to remember that the CED operated
in the late 1960s and early 1970s when social movements were
at their peak regarding environment, worker safety, consumers,
and employee rights.
11
CED, Social Responsibilities of Business Corporations 1, 11
(1971).
12
H.G. Manne and H.C. Wallach, ‘‘The Modern Corporation
and Social Responsibility,’’ American Enterprise Institute for
Public Policy Research, 1, 4-6 (1972).
TAX NOTES, January 25, 2016

to Microsoft in Luxembourg. The software royalties
then go to Microsoft in Ireland, and right after,
dividends can be directed to a parent company in
Bermuda with no U.K. corporate tax being paid.
That entire process is completely legal.
Richard Murphy of the Tax Justice Network13
said, ‘‘Like many other companies, Microsoft is
trying to avoid tax. It has tried hard to represent
itself as doing the best thing for the world, but if
you really want to solve the world’s problems, pay
taxes.’’ He added: ‘‘159 million pounds would more
than pay for a hospital, or provide IT training for
young people so they can work in that industry.’’14
Microsoft’s case wasn’t improved when sources
such as The Guardian reported that although Micro-
soft’s headquarters is in Redmond, Washington,
when it comes to licensing, Microsoft is actually
based in Reno, Nevada. This means Microsoft won’t
pay the tax on software licensing that Washington
state applies. Experts estimate that Microsoft has
avoided paying more than $700 million in taxes over
the past 13 years, while the state of Washington faces
a $430 million deficit in its biannual budget.
Microsoft is hardly alone in this game. Apple Inc.
has been found to use subsidiaries in Ireland to
channel more than $70 billion in worldwide income
away from the United States. The three legal entities
involved (‘‘Apple Sales International,’’ ‘‘Apple Op-
erations Europe,’’ and ‘‘Apple Operations Interna-
tional’’) were all incorporated in Ireland, but
weren’t tax residents . . . anywhere. This complex
structure has allowed Apple to pay an ETR of 2
percent (or less) since 2003.
Meanwhile, Starbucks Co. has also been facing
bad publicity. However, unlike the other MNCs
before it, Starbucks chose a different path. In June
2013 Starbucks released a public statement saying
that it had decided to voluntarily pay more than £5
million in U.K. taxes and £20 million in additional
taxes in 2013 and 2014. The company had reported
losses in 14 of the first 15 years of its existence there
and hadn’t paid any corporate tax in the United
Kingdom since 2008. However, at the same time, the
company had a 31 percent market share and share-
holder reports indicating solid profitability for its
U.S. operations.15
13
Richard Murphy, ‘‘Microsoft — Looking Like It’s in the
Upper Echelons of the Tax Avoiders,’’ Tax Research UK: Richard
Murphy on Tax and Economics (Dec. 9, 2012).
14
Sam Webb, ‘‘Microsoft Avoids Paying £159 MILLION in
Corporation Tax EVERY YEAR Using Luxembourg Tax Loop-
hole,’’ Daily Mail Associated Newspapers, Dec. 9, 2012.
15
Tom Bergin, ‘‘How Starbucks Avoids U.K. Taxes,’’ Reuters,
Oct. 15, 2012. At the parliamentary inquiry, the members of
Parliament questioning Starbucks consistently contrasted Star-
bucks’ losses in the United Kingdom to the significant company
(Footnote continued in next column.)
TAX NOTES, January 25, 2016
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COMMENTARY / VIEWPOINT
A further analysis of the principal operating
company in the United Kingdom, Starbucks Coffee
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Co. (UK) Ltd. (Starbucks UK), showed in fiscal
2011,16 under U.K. financial accounting principles,
turnover of about £400 million, gross profit of £78.4
million, an operating loss after ‘‘administrative ex-
penses’’ of £28.8 million, and a net pretax loss on an
ordinary activity of £32.9 million. During its first 15
years of existence, Starbucks UK paid £8.6 million
of corporate tax on revenue of more than £3.4
billion. Of that amount, all but £600,000 was attrib-
utable to an audit settlement with the U.K. authori-
ties. According to Reuters, the company achieved
those results by paying substantial amounts to
other related group companies: (i) royalties and
license fees paid to a Dutch affiliate, (ii) markups on
coffee purchased via another Dutch affiliate and a
Swiss affiliate, and (iii) interest paid on a loan from
the U.S. parent company.17
While Starbucks reported staggering losses on its
financial statements, its reports to analysts and
shareholders were much more positive. For in-
stance, the Financial Times reviewed the transcripts
of Starbucks’ securities analyst conference calls and
found that in 2009 Starbucks told analysts:
‘‘Canada, the U.K., China and Japan are our largest
international markets and drive the majority of the
segment’s revenue and operating profits.’’18
The key takeaway from this case is that if Star-
bucks can manipulate its successful operations to
result in a minimal tax liability position, any MNC
can. But the company’s decision to voluntarily pay
income tax is shocking. The short, and perhaps even
cynical, explanation for that remarkable decision
would be that it hoped to improve public opinion.
D. Corporate Social Responsibility and Taxation
1. An important step forward. In the words of
Oliver Wendell Holmes Jr., ‘‘Taxes are what we pay
for a civilized society.’’19 Paying taxes is the most
basic and fundamental way that corporations en-
gage with society. When corporations avoid paying
taxes but volunteer to do other CSR activities, they
try to fill the traditional role of the state. Therefore,
instead of doing so, they should first pay their taxes
taxes paid by its largest competitor, Costa Coffee. E.g., Public
Accounts Committee, Minutes of Hearing HC 716 House of
Commons Q235 and Q281 (Nov. 12, 2012). For the market share
figure and ‘‘solid profitability’’ claim, see Public Accounts
Committee Report, 1 House of Commons para. 8 (Nov. 28, 2012).
16
Fiscal 2010 results were generally similar.
17
Bergin, supra note 15.
18
Lisa Pollack, ‘‘Media Said, Starbucks Said,’’ Financial Times,
Dec. 12, 2012.
19
Compania General de Tabacos de Filipinas v. Collector of Internal
Revenue, 275 U.S. 87, 275 (1904) (statement by Holmes).
457
COMMENTARY / VIEWPOINT
and then let the state do its job. Tax responsibility
has evolved to be a part of CSR, and avoiding
corporate tax is simply a socially irresponsible
behavior.
Much of the work done in the past decade by
government and international organizations, such
as the OECD, has been to find ways to limit the
ability of MNCs to avoid paying taxes or even to
limit their ability to minimize their tax liability.
However, many of those efforts were useless. For
instance, the Procter & Gamble Co. transaction in
which it sold 43 beauty brands to Coty Inc. for
about $12.5 billion through a tax scheme often
referred to as a ‘‘Reverse Morris Trust’’ saved the
company between $2 billion to $4 billion in taxes by
some estimates.20 To stop the Robert Morris trans-
action, Congress enacted section 355(e) in 1997.
Under that section, an additional tax is imposed on
the distribution in the spinoff step, the first step,
when 50 percent or more of the corporation that has
been spun off is transferred in a tax-free manner in
the following two years to the spinoff.
As one can easily assume at this point, although
the original scheme has been shut down by Con-
gress, a new way to achieve the same result was
quickly found: the Reverse Morris Trust. Is there a
way to shut down the Reverse Morris Trust? The
simple answer would be yes. Congress can come up
with a new code section to close this loophole, but
it is reasonable to assume that a sophisticated tax
professional will find a new way to achieve the
same result.
That is where CSR can come into play. What
Congress should do is close the loophole, but it is
critical to understand that this will never be the full
answer. Just as citizens make demands of their
country, customers should demand that corpora-
tions pay a reasonable amount of tax. What consti-
tutes reasonable in this context should be
researched and studied by international organiza-
tions such as the OECD. And just like the OECD
had a whitelist and blacklist of countries, it can
create a list of multinational companies that refuse
to fully disclose their tax schemes and tax liabilities.
The OECD final report should include as much
information as possible, while keeping the bottom
line clear. The report should include one main
chapter with the following data:
• the name of the corporation;
• what it does;
• the total income it generated in recent years;
• where the corporation and its headquarters are
located;
20
Allan Sloan, ‘‘For Tax Techies, P&G’s Deal With Coty Is a
Thing of Beauty,’’ The Washington Post, July 16, 2015.
458
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• the applicable statutory tax rate; and
• the corporation’s ETR.
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Another chapter may focus on corporations that
have refused to cooperate with the OECD. Once the
public learns that some corporations are more open
to assuming responsibility, those corporations’ pub-
lic image will skyrocket, and they will see better
financial results through sales and services.
2. Creating the standard. This article suggests that
to tackle the issue of CSR and taxation and build on
the natural evolution, a new standard must be
created. A good place to start is with the OECD
report, ‘‘Harmful Tax Competition — An Emerging
Global Issue.’’21 This report looked to create a set of
international measures for nations to follow to help
combat harmful tax competition. However, in ret-
rospect, as considered by many scholars, the report
failed and had a minimal effect on tax avoidance
and tax evasion.22
One of the main factors contributing to the re-
port’s failure is that it departed from most previous
OECD publications in its rhetorical and substantive
posture, which was clearly designed to threaten
countries that failed to cooperate. Another contri-
bution to its failure is thought to be its focus on
countries instead of MNCs. Essentially, the report
came up with two different approaches to dealing
with harmful tax competition. For member states,
‘‘peer reviews’’ were the main source of defense
against those issues, as long as the members would
continue to exchange information and would be
willing to cooperate. However, other states that were
nonmembers and that were classified as potential
tax havens would be blacklisted.23 Unsurprisingly,
this threatening approach didn’t prove successful,
especially since most tax havens exist because they
offer tax incentives to combat the economic, geo-
graphical, or political disadvantages of operating in
the country.24 It would be crippling to their econo-
mies to remove these incentives, as they control the
locations where MNCs look to invest.25
21
OECD, ‘‘Harmful Tax Competition — An Emerging Global
Issue’’ (1998).
22
Hugh J. Ault, ‘‘Ruling the World: Generating International
Legal Norms,’’ 34 Brooklyn J. Int’l L. 757 (2009); Robert T. Kudrle,
‘‘The OECD’s Harmful Tax Competition Initiative and the Tax
Havens: From Bombshell to Damp Squib,’’ 8 Global Econ. J. 1524,
1524-5861 (2008); J.C. Sharman, Havens in a Storm: The Struggle
for Global Tax Regulation 8 (2006); Richard A. Johnson, ‘‘Why
Harmful Tax Practices Will Continue After Developing Nations
Pay: A Critique of the OECD’s Initiatives Against Harmful Tax
Competition,’’ 26 B.C. Third World L.J. 351 (2006); and Karen B.
Brown, ‘‘Harmful Tax Competition: The OECD View,’’ 32 GW J.
Int’l L. & Econ. 311 (1999).
23
Sharman, supra note 22.
24
Supra note 21.
25
See Avi-Yonah, supra note 3; see also supra note 21.
TAX NOTES, January 25, 2016

Even though the report was unsuccessful, that
doesn’t mean that nothing can or should be learned
from it. The report was revolutionary in creating
criteria and standards by which tax havens can eas-
ily be identified and the steps required for countries
to lose that negative status.26 Adopting the standards
created by the OECD report is a critical step toward
standardizing what constitutes positive tax and so-
cially responsible corporate behavior. However, the
threatening approach, as the OECD used in its re-
port, won’t work for two reasons. First, socially re-
sponsible corporate activity must be voluntary. And
second, to really create a change, we need to get
corporations to truly cooperate.
One way to incentivize corporations is to create a
‘‘good behavior’’ standard, much like the current
‘‘Fair Tax Mark’’ created by Community Benefit
Society.27 Based in the United Kingdom, this orga-
nization’s main objective is to create incentives for
U.K. businesses to promote tax transparency and
fairness. The group offers two versions of the
accreditation according to the type of the business:
(i) U.K. businesses that operate solely in the United
Kingdom; and (ii) U.K.-owned MNCs. However,
the criteria for both types of businesses are gener-
ally measured in the same categories: (i) level of
transparency; and (ii) tax rate, disclosure, and
avoidance.28 The main problem with, or perhaps
weakness of, that accreditation is that the group
behind it lacks the resources and influence to con-
vince corporations to cooperate with them, and
more importantly, to create an international accredi-
tation brand. Individuals look more to the backing
of a highly regarded tax authority as opposed to a
relatively unknown nonprofit.29 Thus, organiza-
tions like the OECD must become involved for that
objective to be achieved.
The OECD report is an excellent starting point,
but other factors must be included as well, such as
the other jurisdictions in which the corporation
operates, the total amount of income it generates in
each of them, the tax benefits it receives in each
jurisdiction in which it operates, the corporation’s
26
Some countries, such as Andorra, The Principality of
Liechtenstein, Liberia, The Principality of Monaco, The Republic
of the Marshall Islands, The Republic of Nauru, and The
Republic of Vanuatu followed those guidelines and were taken
out of the uncooperative tax havens list by 2007.
27
See http://www.fairtaxmark.net (The Fair Tax Mark proj-
ect is managed by the Ethical Consumer Research Association,
which also works with other ethically minded organizations
and campaign groups such as Amnesty International).
28
‘‘Criteria,’’ Fair Tax, available at http://www.fairtax
mark.net/criteria/.
29
Vanessa Houlder, ‘‘Companies Debate Merits of ‘Fair Tax’
Kitemark,’’ Financial Times, Feb. 2, 2015.
TAX NOTES, January 25, 2016
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COMMENTARY / VIEWPOINT
ETR in each jurisdiction in which it operates, and
the corporation’s worldwide average ETR.
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E. Future Outlook
In the global economy, companies are constantly
competing to maximize returns to their sharehold-
ers and to achieve success. Based on the recent
trend towards CSR, this article proposes that a new
standard of CSR, which incorporates responsible
tax practices, be enacted.
The implementation of a new standard would
align with the premise that corporations are now
starting to look to the betterment of society to
increase revenues. Because tax is the most basic way
that corporations can engage in society, those with
aggressive tax schemes to avoid paying the corpo-
rate tax should be labeled as being socially irrespon-
sible. Once it is brought to the attention of the
public that it is beyond Congress’s power to fully
eliminate loopholes and that corporations are able
to take the matter into their own hands, there would
be a demand for MNCs to help carry the burden
and to pay their fair share of taxes.
The largest obstacle will be helping consumers
realize their power to influence MNCs by bringing
awareness to the issue and reinforcing the idea of
creating a standard. Even though the OECD report
failed, research and new terminology will provide
an adequate benchmark for characterizing corpora-
tions that participate in harmful tax competition. As
stated previously, the information to analyze this
type of behavior should include the level of tax
haven involvement, jurisdictions in which a com-
pany operates, amount of income generated in each
jurisdiction, tax benefits received, ETR in each ju-
risdiction, and the company’s worldwide average
ETR. By providing this information to the public in
a straightforward, easily interpreted report, it will
be more likely that citizens will support companies
that don’t participate in aggressive tax planning. In
turn, MNCs will be more likely to refrain from
participating in harmful tax competition and will
look for ways to improve their level of CSR in
taxation, such as voluntarily paying more tax as
Starbucks did in 2013.
Overall, by pairing the ideology of CSR with the
initiative of reducing harmful tax competition, a new
global business standard can be achieved. The bur-
den of taxation would be relieved on the individual,
and the vast wealth of corporations would be redis-
tributed for the benefit of local economies. The
OECD was on the right track to solve the issue of
harmful tax competition, but focusing instead on
encouraging companies to act voluntarily to please
the public may be a more efficient way to achieve
results.
459
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