Ethics in the Tax Affairs of Multinational Corporations - Coursework Example

Ethics in the Tax Affairs of Multinational Corporations (MNCs) Abstract Companies are required to pay tax. This essay looks at the place of ethics in regard to the paying of tax by MNCs. The essay is developed from the argument that companies have to pay tax as part of their social contract with the societies where they operate. At the same time, it is argued that MNCs are not obligated to pay the highest tax rate, and thus, they can apply mechanisms such as transfer pricing to reduce tax liability. This is illustrated using the case of Google. The essay suggests that although the place of ethics in the tax affairs of MNCs is not very clear, a place can be seen in terms of the position that one takes when looking at how and whether MNCs pay tax. Introduction “Companies have a responsibility to pay corporation tax in the jurisdictions where they operate” [Angel Gurria – quoted by Wetherly and Otter (2014, p. 27)]. The importance of paying taxes is that governments use tax revenues to build schools, ensure that there is a public education system, support health services and provide other amenities to the public (Christianaid.org.uk 2015, p. 1). In other words, tax revenue is the essence of the social contract (Christensen & Murphy 2004, p. 37). However, opinions are varied on whether it is good to avoid paying tax (Shaw 2017, p. 196). In literature, there have been numerous cases of multinational corporations (MNCs) such as Google, Starbucks and Amazon avoiding to pay tax (Christianaid.org.uk 2015, p. 3; Kavoussi 2012; Rawlinson 2016). Undeniably, there are good reasons why MNCs need to pay tax in the jurisdictions in which they operate. Equally, MNCs have reasons why they need to avoid paying some of the taxes that they are required to pay. This essay will delve into the discussion on MNCs’ tax obligations and tax avoidance and analyse whether or not there is a place for ethics in the tax affairs of MNCs. MNCs’ tax obligations and tax avoidance One of the most common arguments that have been put forward about companies is that corporations have to pay their fair share of taxes (Christianaid.org.uk 2015; de George 2001, p. 52). The key point in such arguments has been that when companies pay taxes, they help in improving the quality of life of millions of people through the services that governments provide to the public using proceeds of taxation (Otusanya 2016, p. 31). Therefore, it is expected that companies will pay their taxes as part of their responsibility to the society. Taxation of MNCs is a complicated issue because such companies operate in many countries (Srivastava 2008, p. 234). Tax affairs of MNCs are affected by issues such as host country and home country taxes as well as other factors (Srivastava 2008, p. 234). For instance, if a company has different departments or units located in different countries, it has to pay tax in each of the countries in which it operates. For large corporations with operations in very many countries, paying tax in each of the countries of operation can be a heavy burden. It is possibly because of this reason that large MNCs try to avoid paying some taxes in the countries in which they operate, an example of such corporations being Google as noted above. Avoidance of tax by MNCs is mainly accomplished through transfer pricing. Transfer pricing entails fixing the price for dealings that encompass the transfer of services and goods from the parent unit of a corporation to an affiliate, or from one affiliate of the company to another affiliate (Markham 2005, p. 9; Siddaiah 2010, p. 264). One of the aims of transfer pricing is to increase the level of profit of an MNC by decreasing the MNC’s overall tax liability. A multinational company can decrease its overall tax responsibility by shifting profits away from units that are in high-tax areas to units that are in low-tax areas (Siddaiah 2010, p. 264). For instance, assume that an MNC that is headquartered in Melbourne has an affiliate in India. The parent unit of the company supplies some components to its subsidiary in India. Supposing that the tax rate in Australia is low while the tax rate in India is higher, the MNC can fix a high transfer price for the parts that are supplied to the subsidiary in order to reduce the taxable profits of its affiliate in India. At the same time, the company can raise the taxable profits of the parent unit in Australia. Given that the profits of the subsidiary unit are to be subjected to higher tax rates, and simultaneously, the revenues of the parent unit are subjected to a lower tax rate, the resultant effective tax rate for the MNC may become lower, thus leading to higher amounts of after-tax profits for the corporation. In the case of Google, the company had a tax regime that involved transactions between its own affiliate units that often saw declaration of revenues in regions with lower tax rates, making the company to pay lower taxes. For instance, in 2012, the tactic employed by Google helped the company to pay only £11.6 million to the UK Treasury in spite of having generated a massive £3.4 billion in its business operations in the UK (Rawlinson 2016). Google defended its actions of avoiding tax in various countries, arguing that it was “proud” of the strategy and that it pays a lot of taxes in legally prescribed ways (Kavoussi 2012). The problem with transfer pricing is that even though the practice is not illegal, it enables MNCs to pay lower taxes in some countries, to the detriment of the societies in such countries. As observed by Sikka and Willmott (2010, p. 343), “The mobilization of transfer pricing for tax avoidance, and sometimes evasion, is largely invisible to the public and is difficult and expensive for regulatory authorities to detect”. That is, it is possible for MNCs like Google to avoid tax through transfer pricing, and the processes involved remain hidden to the public such that it is not even easy to detect that a company has avoided paying tax. Is there a place for ethics in MNCs’ tax affairs? A big question that needs to be answered is whether there is a place for ethics in the tax affairs of MNCs. As argued above, MNCs, just like individuals and other business entities, have to pay tax as part of their responsibility towards the societies in which they operate (Christianaid.org.uk 2015; de George 2001, p. 52). At the same time, it has been argued that “Individuals do not like paying taxes, they take a variety of actions to reduce their tax liabilities, and on many occasions they succeed” (Alm & Torgler 2011, p. 635). The implication of the assertion by Alm and Torgler (2011) is that individuals (and possibly companies) are interested in making sure that they pay no taxes or pay much reduced taxes. It is arguably because of such a line of thinking that MNCs like Google and others would like to use all possible mechanisms that enable them to reduce their taxes. Along this line, a critical question would be whether it is wrong to legally apply measures to reduce the tax that an entity is supposed to pay. The answer is no. This view is supported in a classical opinion made by Judge Learned Hand in a ruling pertaining to “Commissioner v. Newman, 159 F.2d 848 (CA-2, 1947)” (Hansen, Crosser & Laufer 1992, p. 679), where it was indicated that “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose a pattern which best pays the treasury” (Shaw 2017, p. 196). The judge also added that there is “nothing sinister in so arranging affairs to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands” (Shaw 2017, p. 196). Further, the judge noted that “taxes are enforced extractions, not voluntary contributions. To demand more in the name of morals is mere cant” (Hansen, Crosser & Laufer 1992, p. 679). The implication of the ruling by Judge Hand is that although companies are required to pay tax, they have to pay taxes within the existing frameworks of law. Further, the ruling implies that there is nothing wrong with corporations using legally available approaches to reduce the level of tax that they can pay. Therefore, whether ethics has a place in the tax affairs of MNCs is not a very clear issue. On the one hand, it can be argued that MNCs have an ethical responsibility to pay tax as part of their social contract with the societies in which they operate. By paying tax, MNCs can be seen to be behaving ethically (Christensen & Murphy 2004, p. 37). On the other hand, MNCs get involved in mechanisms such as transfer pricing to reduce the level of tax that they are liable to pay. From the perspective of the social contract, avoiding tax is unethical because doing so reduces government revenues, and this has a notable detrimental impact on the provision of public services, public utilities and infrastructures (Otusanya 2011, p. 316). Also, avoiding tax that a company is required to pay can be regarded socially irresponsible (Dowling 2014) especially because tax avoidance may involve some financial arrangements and instruments that are not anticipated or intended by the government (Back 2013). Yet, at the same time, it is not illegal to engage in tax avoidance practices (Back 2013; Shaw 2017, p. 196). Therefore, it can be argued that there is a place for ethics in MNCs’ tax affairs, and the place depends on how one looks at what is ethical or unethical with respect to how and whether MNCs pay tax. Conclusion In conclusion, although it is not very clear whether ethics has a place in the tax affairs of MNCs, it can be argued that there is some place, and this standpoint depends on how one looks at what is ethical or not in regard to MNCs’ tax affairs. On the one hand, MNCs have to pay tax as part of their social contract with the societies in which they operate. At the same time, MNCs are not under an obligation to pay the highest tax rate, and they can use mechanisms they deem fit to reduce their tax liability. Avoiding tax can be regarded unethical, especially given that governments depend on tax revenues to provide services to the public, but at the same time, MNCs may deem it ethical to reduce their taxes so as to increase their profitability. References Alm, J & Torgler, B 2011, ‘Do ethics matter? Tax compliance and morality’, Journal of Business Ethics, vol. 101, no. 4, pp. 635-651. Back, PF 2013, ‘Avoiding tax may be legal, but can it ever be ethical?’, The Guardian, 23 April, viewed 7 January 2016, . Christensen, J & Murphy, R 2004, ‘The social irresponsibility of corporate tax avoidance: taking CSR to the bottom line’, Development, vol. 47, no. 3, 37–44. 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Wetherly, P & Otter, D 2014, The business environment: themes and issues in a globalising world, 3rd edn, Oxford University Press, Oxford. Read More