The Paradise Papers – Tax, Legality and Morality
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Another leak from the secretive tax havens came out in the last few weeks. Millions of documents containing transactions of the biggest companies and wealthy individuals were leaked. There is a bit of momentum building against these tax jurisdictions, who seem to no longer be fit for their purpose in this globalised world. The arguments start to get mixed up in what is legal and what is morally correct, making the situation even more complex.
Through the papers we learnt that a leading global brand such as Apple has been cleverly avoiding paying taxes globally while simultaneously increasing sales and accumulating enormous profits of $1,6 trillion. Wealthy individuals have also been named, from the Queen to U2 frontman Bono. The masses took to social media (no doubt using their iPhone devices) and these individuals were vilified for being tax dodgers and self-centred hypocrites.
At this point it is important to differentiate between tax evasion and tax avoidance.
Tax Evasion is a criminal offence that involves illegal ways of paying less tax – for example, not declaring all your taxable income.
Tax Avoidance, in contrast, involves companies/people implementing strategies to reduce their tax bill using legal tax planning initiatives. Examples are contributing pre-tax money into retirement funds or tax-free saving accounts, or offsetting interest on a bond against rental income on an investment property.
How do multinational companies avoid tax legally?
A tax haven is a country or a jurisdiction whose rules help to facilitate tax avoidance by offering much lower tax rates than other countries. They do this to attract investment into the country or jurisdiction. Popular tax havens are Bermuda, Jersey, Malta, Mauritius and Dubai.
What is Apple? A listed US company? A Chinese company? An Irish company? A global company? Where should Apple pay its taxes? Its intellectual property is developed in the US, manufacturing is done in China, and the company is serviced from Ireland. The corporate tax rate in the US is 35%, South Africa has a rate of 28%, Mauritius is 15%, Malta 5% and Bermuda is 0%. Regulating and taxing global companies is complex, and it is critical to understand Transfer Pricing or more accurately Profit Shifting.
This was not such a big issue 30 years ago, but now with globalisation and technological advances, we are seeing many companies setting up entities in these different tax havens looking for the best tax rates. This in turn creates tax competition between the different jurisdictions.
How does this effect you and me?
According to Christian Aid, $160bn per annum has been lost to the developing world alone though profit shifting. Even the OECD is warning of the damage to developing countries caused by profit-shifting. What happens is that Apple will sell all their products in SA, but the Irish subsidiary will charge the SA company a fee for services rendered and very little profit or taxes are paid in SA. Not only are these huge numbers lost to the SA taxman, but we have also lost the potential from increased wages and the enormous multiplier effect.
Will the Paradise Papers effect a change in society? It certainly could, as the European Union and the US Senate have been chasing Google and Apple for a few years now about their operations in Ireland. Apparently, Apple only paid 18% on their revenue globally.
There has to be a co-ordinated effort by all governments to decide how they are going to tax these global entities. But all it takes is just a few countries or jurisdictions to breakaway and offer tax incentives, and then we are back to where we are today. We have seen the corporate tax rate in the UK decline from 30% in 2007 to 19% today, with further declines possible, depending on the outcome of the Brexit negotiations. You can be assured they will consider lowering their taxes to attract investment and become one of the biggest offshore tax havens in the world.
Trump is actively moving on tax reform now. When he calls for US companies to come back, he knows they won’t do this unless he reduces US tax rates. A country like Ireland would be crippled if they forced it to change its corporate tax laws. Ireland taxes Apple at only 2.5%, but benefits greatly from increased employment and its multiplier effect in that country.
The next step
Transparency is the only way forward. No secrecy can be allowed. The politicians need to talk and compromise, and come up with a strategy to level the playing fields. The reality is that the politicians are becoming more protective and nationalistic. This allows these lawful aggressive tax avoidance strategies to continue as the playing field remains uneven.