The Art of Tax Optimization: How Big Businesses Pay Less Than You Think
JEC San Francisco — Taxes are an inevitable aspect of running a business, yet some large corporations navigate the complex tax landscape to minimize their liabilities. In fact, some of the wealthiest CEOs in the world pay less taxes than you! In 2007 and again in 2011, billionaire Amazon CEO Jeff Bezos reportedly paid nothing in federal income taxes. In 2018, billionaire Tesla CEO Elon Musk reportedly did the same thing (Business Insider). How is this possible?
While many businesses follow the rules, others employ legal strategies to optimize their financial position. This article will explore three main ways big businesses avoid paying high taxes, including offshore banking, setting up beneficiaries, and leveraging tax credits and incentives.
Offshore Banking
In 2016, nearly three in four Fortune 500 companies maintained subsidiaries in offshore tax havens, according to “Offshore Shell Games,” an annual study of offshore tax avoidance released today by the U.S. PIRG Education Fund and the Institute on Taxation and Economic Policy. Fortune 500 companies’ offshore cash hoard now totals $2.6 trillion, a sum on which these companies are avoiding up to $752 billion in U.S. taxes. Businesses can take advantage of favorable tax rates by establishing subsidiaries or holding companies in low-tax or tax haven jurisdictions. A Congressional Research Service report found that “U.S. multinational companies collectively reported 43 percent of their foreign earnings in five small tax haven countries: Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland” (Institute of Technology and Economic Policy). For example, a company may license its intellectual property or patents to an offshore entity in the Cayman Islands for an artificially high royalty rate — a payment for the right to ongoing use of an asset. This transfers profits to the offshore affiliate, avoiding higher domestic tax rates. According to Seamus Coffey from the University of College Cork, “Tech firms have commonly transferred intellectual property rights to subsidiaries in Ireland as part of their tax reduction strategies. The subsidiaries then charge royalties back to the U.S. parent company” (Coffey 13).
One such company that participates in offshore tax havens is Nike. The company reported about a dozen subsidiaries in Bermuda, a tax-free British territory, even though it does not operate any stores there. It is likely that instead, these subsidiaries were set up to house Nike’s trademarks so that the U.S. parent company can then pay royalties to those subsidiaries (which will not be taxed in Bermuda) and subtract these payments from its own U.S. tax bill as business expenses. Additionally, the use of complex financial structures and transfer pricing mechanisms enables businesses to allocate expenses and revenues in a manner that minimizes their tax exposure.
Setting Up Beneficiaries and Special Purpose Entities:
Big businesses often establish beneficiaries or Special Purpose Entities (SPEs) to optimize their tax positions. These entities, such as holding companies, trusts, or partnerships, can take various forms and are created to hold assets, manage investments, or facilitate transactions. Corporations can utilize these structures to take advantage of specific tax benefits or loopholes. For example, a company might set up an SPE to hold intellectual property rights, allowing them to allocate royalties and licensing fees to a jurisdiction with favorable tax treatment. This enables the business to reduce its taxable income in higher-tax jurisdictions, ultimately lowering its overall tax bill. A bonus of establishing beneficiaries is the application of transfer pricing. Transfer pricing involves setting the prices for transactions between entities within the same corporate group. A company might sell its products to its subsidiaries at a price that allows for a profit margin in low-tax jurisdictions. By doing so, the company can shift profits to jurisdictions with lower corporate tax rates. While setting up beneficiaries and SPEs is legal, it can sometimes blur the line between tax optimization and aggressive tax avoidance. Regulators and tax authorities closely scrutinize these structures to ensure compliance with the spirit of tax laws.
Leveraging Tax Credits and Incentives
Governments often use tax credits and incentives to encourage certain behaviors or stimulate economic activities. Big businesses are adept at identifying and capitalizing on these opportunities to reduce their tax liabilities. Examples include research and development tax credits, investment tax credits, and renewable energy incentives. Companies can strategically structure their operations to qualify for these incentives through increased research and development spending, capital investments, or environmentally sustainable practices (Klemm 9). By doing so, they benefit from reduced taxes and align their business activities with government priorities. While leveraging tax credits and incentives is legitimate, critics argue that some businesses exploit loopholes and manipulate their activities solely for tax benefits, potentially undermining the intended policy goals.
Conclusion
The ways big businesses minimize their tax liabilities are diverse and often involve complex financial strategies. While these practices are generally legal, they raise ethical questions and contribute to ongoing corporate responsibility and fair taxation debates. As governments around the world grapple with these challenges, striking a balance between promoting economic growth and ensuring a fair and equitable tax system remains a crucial objective.
Sources:
https://pirg.org/edfund/resources/offshore-shell-games-2017/
