Research Review on Corporate Tax Avoidance

MULTINATIONAL CORPORATIONS MINIMIZE TAX LIABILITIES

AND GOVERNMENTS USE TAXATION POLICIES TO COMBAT
AGGRESSIVE TAX EVASION.

Student Name: Ruth Maneesha Evanjalin Gomis

Student ID: 4659/ 23824989

Date: 04th April 2023

Module: International Tax Systems
Lecture Name: Mr. Dimuthu Heenpella
Code: ACC3024
Word Count: 2378

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Research Review on Corporate Tax Avoidance

Acknowledgment

I would like to thank my lecturer, Mr. Dimuthu Heenpella, for leading and assisting me in
completing the assignment on corporation tax evasion on this auspicious occasion of its
successful completion. I couldn't have finished the work in time without his help.
On this occasion, I'd also like to express my gratitude to my friends and family, without whom I
would not have been able to complete this project in such a short amount of time.

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Research Review on Corporate Tax Avoidance

Table of Content

Acknowledgment....................................................................................................................................2
Table of Content.....................................................................................................................................3
Abstract.....................................................................................................................................................5
Introduction..............................................................................................................................................6
1.0 Awareness of the complexity of tax systems......................................................................7
1.0.1 Globalization................................................................................................................................7
1.0.2 Double taxation...........................................................................................................................7
1.0.3 MNC operations..........................................................................................................................7
1.0.4 E- commerce...............................................................................................................................7
1.0.5 Cross border transactions..........................................................................................................7
1.1 Efforts taken by countries to Simplify tax system..............................................................8
1.1.1 Double tax treaty.........................................................................................................................8
1.1.2 Examples of Tax treaties...........................................................................................................8
1.1.3 Tax Model Conventions.............................................................................................................8
1.1.4 Laws introduced by countries to Simplify tax..........................................................................8
2.0 DOUBLE TAXATION PRESENTS CHALLENGES AND OPPORTUNITIES FOR
HARMONISATION...................................................................................................................................9
2.1 Double Taxation...........................................................................................................................9
2.2 Reasons for existence of Double Taxation............................................................................9
2.2.1 Corporate Double Taxation....................................................................................................9
2.2.2 International Double Taxation.............................................................................................10
2.3 Challenges created through double taxation......................................................................10
2.3.1 Loss of tax revenue of developing countries.....................................................................10
2.3.2 Discourage trade and investment.......................................................................................10
2.3.3 Pass-through taxation...........................................................................................................10
2.4 Remedial actions used by countries overcome Counter double taxation...................11
2.4.2 DTA examples.......................................................................................................................11
2.4.3 Double Tax Avoidance Agreement (DTAA).......................................................................11
2.4.3 What are the benefits of the DTAA?...................................................................................11
2.4.4 Relief from Double Taxes....................................................................................................11
3.0 Tax avoidance, evasion, and the role of tax havens are discussed..................................12

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3.1 Tax Avoidance............................................................................................................................12

3.2 Tax Avoidance methods...............................................................................................................12
3.2.1 Thin capitalization.................................................................................................................12
3.2.2 Transfer Pricing.....................................................................................................................13
3.1.3 Countries actions discourage tax avoidance.....................................................................13
3.3 Tax Evasion.................................................................................................................................13
3.4 Tax haven.....................................................................................................................................14
3.4.1 Role of tax haven..................................................................................................................14
3.4.2 Benefits and Drawbacks of tax haven................................................................................14
3.4.3 Example of a tax haven........................................................................................................14
Conclusion.............................................................................................................................................15
References.............................................................................................................................................16

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Abstract

The increased complexity of business operations and the globalization of markets have led to
an increase in tax avoidance. Although tax authorities have developed increasingly complicated
anti-abuse legislation, tax evasion can still happen by utilizing the uncertainties and loopholes
that tax complexity presents. In order to comprehend these tax problems' causes and the
government's response to them, this report seeks to shed some light on both.
This review of the literature demonstrates how governments use tax laws to deter aggressive
tax evasion by levies on specific industries for specific goals. To further streamline their tax
systems, nations are negotiating double taxation agreements. The complexity of various
national tax systems must be acknowledged by nations. This paper has therefore identified the
issues with double taxation and the prospects for harmonization. It has also assessed tax
evasion, avoidance, and the function of tax havens in preventing aggressive tax avoidance.

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Introduction

Tax complexity is caused by the need to comply with the law. It can present three major
challenges for tax professionals: more time updating, a higher likelihood of making errors and
omissions, and more opportunities to take advantage of ambiguities and loopholes. Corporate
profits and overseas income are both impacted by the tax practice known as double taxation.
Legislation, forming a business as a sole proprietorship, parent ship, or forgoing dividend
payments, and turning shareholders into employees of the companies they own are all ways to
mitigate it. By lowering tax distortions, tax harmonization enhances resource allocation.
The use of multinational firms to hide earnings in tax havens and globalization have intensified
the already contentious debate on tax avoidance. The main topics this report will cover include
the need for people to be aware of the complexity of MNE tax systems, the potential for
international harmonization of double taxation, and the steps taken by the tax authority to
combat double taxation, tax avoidance, and evasion as well as to deter investment in tax
havens.

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1.0 Awareness of the complexity of tax systems

According to (Loo, McKerchar, & Hansford, 2009) introduction of the self-assessment system
has increased tax complexity in many nations. The reasons for the Complexity of tax systems
are as follows

1.0.1 Globalization
Global tax systems are facing challenges due to globalization and economic gaps. Tax
collection, composition, and enforcement have changed over time due to globalization and
become complex. The IMF 2008 examine that financial globalization has a direct impact on
corporate tax policy.

1.0.2 Double taxation

Double taxation occurs when taxes are paid twice on a single dollar of income therefore
complication arises. (Davies, 2009) find the choice of multinational corporations to locate in
treaty countries is positively impacted by DTTs (double tax treaty).

1.0.3 MNC operations

Multinational enterprise taxes are levied against every subsidiary of a parent company that
is located in a different tax jurisdiction, tax complexity has increased, BEPS project and
OECD initiatives increase tax complexity between multinational firms (OECD, 2011).
Taxation is more complex when there are multiple MNC operations in different countries.

1.0.4 E- commerce
E-commerce transactions may enhance access to tax havens, making it complex for
governments to track down and recognize taxation. The government must address the
complexities of e-commerce to ensure its success according to (Mercuro and Medena ,
2000)

1.0.5 Cross border transactions

Cross-border tax regulations outline how income earned overseas and by foreign
companies is taxed locally because both domestic and international taxes will be more
complicated. The OECD examines the territoriality, withholding taxes, tax conventions, and
CFC regulations of OECD member nations' cross-border tax systems (Controlled foreign
corporations).

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1.1 Efforts taken by countries to Simplify tax system

Tax systems have been simplified through OECD Tax Model conventions and double tax treaty
concepts.

1.1.1 Double tax treaty

The purpose of a "double taxation treaty" or "double taxation agreement" is to prevent or reduce
the double taxation of an investor's income by both countries, promoting international trade and
investment. According to Braun and (Zagler, 2014). It is becoming more typical.

1.1.2 Examples of Tax treaties

 Austria - Germany Income and Capital Tax Treaty (2000). ...
 Austria - Italy Income and Capital Tax Treaty (1981) Art. ...
 Belgium - Germany Income and Capital Tax Treaty (1967) Art. ...
 Belgium - Netherlands Income and Capital Tax Treaty (2001) Art.

1.1.3 Tax Model Conventions

Influential model tax conventions include those of the OECD and the United Nations.

To prevent double taxation, the OECD Model Convention calls for the source nation to give up
all or part of its tax on income received by citizens of the other treaty party.

The source country's taxing powers are subject to fewer limitations under the United Nations
Model Convention. The source country is free to tax royalties paid by its citizens, as long as it
complies with the provisions to resident of the other country.

1.1.4 Laws introduced by countries to Simplify tax

UK Government
The UK government has developed laws to increase accountability, discipline, and accessibility
of tax policy-making, as well as initiatives to update the framework for tax administration.
China Government
The Chinese Administration of Taxation SAT is implementing 15 steps to modernize and
streamline tax administration, including transfer pricing rules.
USA Government

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Reforms have made the tax system simpler, flatter, and more transparent, shifting the base of
American taxation from income tax to consumption tax. To reduce tax evasion and boost
investment, Congress have simplified the tax rate structure, lower the rates on dividends and
capital gains, eliminate deductions and credits, and raise capital expensing..

2.0 DOUBLE TAXATION PRESENTS CHALLENGES AND

OPPORTUNITIES FOR HARMONISATION.

2.1 Double Taxation

Paying income taxes twice on the same source of money is referred to as double taxation in tax
law. It may occur as a result of international trade, investment, corporate and individual income
taxation, or both, when the same money is taxed in two different countries.

2.2 Reasons for existence of Double Taxation

2.2.1 Corporate Double Taxation

When a company pays taxes on its earnings and then its shareholders pay personal taxes on
dividends or capital gains, this is known as double taxation. The two taxes on corporate profits
are justified by the fact that corporations are distinct legal entities and by the imposition of
individual dividend taxes, which prevent affluent shareholders from dodging their income taxes
on their gains. Business owners can prevent double taxation or reduce overall taxes by opting
not to pay dividends.

2.2.2 International Double Taxation

Foreign income is taxed in both the country where it is earned from and the country where the
investor resides, which has an impact on multinational organizations and individuals living
abroad. The result could be double taxation
Taxpayers are burdened by double taxation, which also raises the cost of products and
services, deters cross-border investment, and violates the tax fairness principle. It may result in
more taxes, higher prices, and less capital movement...

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2.3 Challenges created through double taxation

2.3.1 Loss of tax revenue of developing countries

DTAs increase FDIs, but studies find substantial negative tax revenue loss, but not account for
the potential benefit.
2.3.2 Discourage trade and investment
Double taxation must be eliminated through legislation, as it discourages investment and
incentivizes businesses to invest more rather than keep their profits therefore it will be a
challenge because it has been eliminated through legislation.
2.3.3 Pass-through taxation
The double taxation syndrome is avoided by investments with a flow-through or pass-through
structure, such as proprietorships and limited partnerships. However, convoluted double
taxation agreements can still require US citizens living abroad to file taxes in both countries.
2.3.4 Literature on Double Taxation challengers
Complying with multiple tax systems can be difficult and expensive for small enterprises
(Durante, 2022), and double taxation can lower competitiveness and deter investment,
economic growth, and capital flow. It can also lead to unfair tax treatment (Asen, 2023).

2.4 Remedial actions used by countries overcome Counter double

taxation

2.4.1 Double Tax Agreements (DTA) literature review

DTAs are agreements between developing and developed nations that lessen the burden of
double taxation and enhance information exchange (Barthel et al., 2009). The rise in foreign
direct investments (FDIs) is one of the benefits of signing DTAs (Neumayer, 2007).

2.4.2 DTA examples

China has signed 98 of the 102 double taxation avoidance agreements with Taiwan, Cambodia,
Macau Special Administrative Region, Hong Kong, and Macau have also signed double taxation
avoidance agreements with UK.
India has DTAA agreements with more than 80 nations, including the USA, Australia, France,
Canada, and the UK. The DTA ensures that revenue from cross-border transactions is not
subject to double taxation.
2.4.3 Double Tax Avoidance Agreement (DTAA)
A DTAA is a contract between two countries that forbids taxpayers from paying taxes twice—
once in the country of origin and again in the country of origin. It creates rules for how revenue
from international transactions is managed to prevent double taxes.

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2.4.3 What are the benefits of the DTAA?

 The DTAA seeks to promote investment by offering tax benefits and avoiding double
taxation.
 It ensures that companies will pay taxes in just one country, avoiding double taxation.
 DTAAs provide legal clarity.
 Benefits are restricted to citizens of the two participating countries under the DTAA.
 The DTAA's rules state that under certain situations, concessional tax rates may be
offered.

2.4.4 Relief from Double Taxes

Exemption technique
Taxpayers are not subject to taxation in the country or jurisdiction in which they reside, but they
are required to pay taxes in the nation where their income is earned. This method, which is used
in tax havens, promotes international trade and investment.

Credit for foreign taxes (FTC)

By reducing the tax burden in one nation by the amount of tax paid in another, the foreign tax
credit technique lowers the tax burden in both countries.

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3.0 Tax avoidance, evasion, and the role of tax havens are
discussed.

3.1 Tax Avoidance

Furthermore maximizing the net present value of free cash flows after taxes is what economists
refer to as tax avoidance by Brealey (2008). Tax avoidance can lead to corruption, money
laundering, and displacement of non-financial sector activity according to Preuss (2013)

3.2 Tax Avoidance methods

3.2.1 Thin capitalization

When a corporation is heavily financed by debt as opposed to equity, it is said to have thin
capitalization. Due to the ability to deduct interest paid or incurred, debt is frequently a more tax
efficient method of financing. Multinational companies can structure finance agreements to
maximize tax advantages by allowing interest to be paid in tax-efficient jurisdictions
Company R, a corporation from Country A, establishes a group affiliate Company G in Country
B with an investment of 10 in equity capital and a loan of 90 from Company X at a 10% interest
rate.

Loan 90
Country A Country B

Company R Company G

Lender Lender
Repay 90 + 10%
interest
Company Y is financed by

10Equity/90 Debt

Pre Tax and pre interest taxable profit 15

Deduction of interest payment 9

Post interest taxable profit 6

Tax rate 30%

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Research Review on Corporate Tax Avoidance

If Company R and G both participate the same condition above but with a 1: 1 Debt to equity
ratio the tax revenue for Country B will be 3Bn Since in this scenario ratio is Debt to equity ratio
9:1 Company G generates pre-tax income of 15 for year 2019, and must pay interest to
Company R at 10% a total interest payment of 9. The remaining taxable profit of Company G is
6Bn and taxed at a 30% tax rate, which generates tax revenue of 1.8 for Country G. Therefore it
has occurred a (3-1.8= 1.2) tax avoidance.

3.2.2 Transfer Pricing

Transfer pricing is the practice of multinational corporations that sell their own goods and
services at exorbitant prices in order to siphon revenue away from their home nations.
Selling a carton of bananas for $100 to an associate headquartered in a tax haven allows
multinational corporations to avoid paying taxes on those sales. The tax haven affiliate then
makes a $200 profit by selling the container to a Polish affiliate for $300. The container is
subsequently sold to a grocery store for $300, which brings the Polish affiliate no profit in
Poland. As a result, neither Ecuador nor Poland collect taxes from the multinational, nor the
$200 in profits transported to the tax haven are similarly untaxed. By doing this, they avoid
paying taxes and failing to support the communities where they do business.

3.1.3 Countries actions discourage tax avoidance

The OECD has released new rules to prevent treaty shopping and abuse, including an updated
definition of "permanent establishment" and a multilateral instrument to implement the BEPS
measure. Tax auditors will collaborate with tax officials in poor nations to enhance outcomes
and increase tax audit capability.

3.3 Tax Evasion

Companies and rich people utilize tax evasion and avoidance as a strategy to raise their
earnings and capital by avoiding and evading taxes according to Bakre, 2007; Palan et al.,
(2010). Palan (2010) argues that tax avoidance is permissible, but excessive avoidance might
turn it into tax evasion, which is illegal.

3.4 Tax haven

Low-tax jurisdictions are known as tax havens, and both businesses and individuals can evade
taxes there. Tax havens are frequently used by foreign investors, and 59% of American
multinational corporations have ties to one or more of them. (Desai, Foley and Hines, 2006).

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3.4.1 Role of tax haven

Tax haven countries have experienced rapid economic growth due to foreign investment and
low tax rates, and their public sectors are comparable to those of other countries. Multinational
corporations are increasingly using tax havens to avoid taxes. (Eurostat 2015).
3.4.2 Benefits and Drawbacks of tax haven
BEPS (Base Erosion Profit Shifting) has been effective in battling tax havens, but additional
forceful measures are required to boost the state's ability to collect taxes and aid in the wealth
redistribution process. A collection of legislative frameworks called tax planning aims to lower
taxes, and in light of the economy's globalization, it is crucial to manage taxes properly.

3.4.3 Example of a tax haven

Top tax havens are the British Virgin Islands, Cayman Islands, Bermuda, The Netherlands,
Switzerland, Luxembourg, Hong Kong, Jersey, Singapore, and the United Arab Emirates.

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Conclusion

This investigation examined how well-informed taxpayers were about taxes, how complicated
the income tax system was, and the underlying causes of non-compliance avoidance. It was
found that self-employed taxpayers lack awareness of the technical aspects of the system.
Multilateral approaches to multinational corporations' income taxes must take into account
various taxing jurisdictions, incentives, transfer pricing, thin capitalization, and tax administration
The globalization, MNC activities, double taxation, and e-commerce-related tax complications
have been underlined by the author. To avoid this, it is necessary to uphold international
accords and steer clear of tax regulations that conflict with one another (Spangle et al. 2012).
Also utilized to reduce tax obligations are tax havens. According to Palan (2010), tax evasion
can happen as a result of excessive tax avoidance. A number of nations employ tax treaties and
agreements to simplify their tax systems.
The difficulties and possibilities of double taxation, including tax evasion, avoidance, and the
function of tax havens, are covered in this paper. It also considers methods to simplify complex
tax systems as well as their complexity.

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Base erosion and profit shifting - OECD (no date) Base erosion and profit shifting - OECD
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BEPS actions - OECD (no date) OECD BEPS. Available at:

https://www.oecd.org/tax/beps/beps-actions/ (Accessed: March 30, 2023).

Borrego, A.C., Lopes, C.M.M. and Ferreira, C.M.S. (2016) “Tax complexity indices and their
relation with tax noncompliance: Empirical evidence from the Portuguese Tax
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https://doi.org/10.1016/j.tekhne.2016.07.003.

Double taxation (2022) Corporate Finance Institute. Available at:

https://corporatefinanceinstitute.com/resources/accounting/double-taxation/ (Accessed:
March 30, 2023).

Gale, W.G. (2017) Tax simplification: Issues and options, Brookings. Brookings. Available at:
https://www.brookings.edu/testimonies/tax-simplification-issues-and-options/ (Accessed:
March 30, 2023).

How can countries tackle tax avoidance? (no date) World Economic Forum. Available at:
https://www.weforum.org/agenda/2015/10/how-can-countries-tackle-tax-avoidance/
(Accessed: March 30, 2023).

Kagan, J. (2022) What double taxation is and how it works, Investopedia. Investopedia.
Available at: https://www.investopedia.com/terms/d/double_taxation.asp (Accessed:
March 30, 2023).

Lenz, H. (2018) Aggressive tax avoidance by managers of multinational companies as a

violation of their moral duty to obey the law: A kantian Rationale - Journal of Business
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violation of their moral duty to obey the law: A kantian Rationale - Journal of Business
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Person (2023) Double tax avoidance agreement – meaning and advantages, DTAA - Advantages
of Double Taxation Relief, Avoidance Agreement - ABC of Money. Aditya Birla Capital.

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taxation-agreement (Accessed: March 30, 2023).

Saad, N. (2014) “Tax knowledge, tax complexity and tax compliance: Taxpayers’ view,”
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