Taxation in tax heaven regimes (“How do companies

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Last updated: April 26, 2019

Taxationis a crucial part of the society and government.

It is a required payment togovernments to fund public goods and services, to stabilize the economy, toinfluence behaviors, and to redistribute income. There are different types oftaxes, such as social security tax, income tax, sales tax, excise tax, propertytax, and so on. In this paper, the author will focus on an indispensable partof the taxation system, corporate income tax. Corporate tax is precious for countriesbecause governments can raise a considerable amount of funds to supportgovernment decisions financially.

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Perhaps more importantly, corporate incometaxes play a role in the stability of the governments, making governmentsfunction properly. However, corporations are becoming more and more aggressivein making tax avoidance (Habu,2017).Lots of firms transfer their assets or cash to offshore companies, which areregistered in tax heaven regimes (“Howdo companies avoid tax? ,” 2014).

In thoseregimes, the owner of the assets can avoid national taxes in their residentcountry (“Howdo companies avoid tax? ,” 2014). By doing so,corporations can reduce the corporate tax bills and have free access to all thebenefits provided by governments. Since corporate tax avoidance still exists,and more and more international firms are accused of avoiding taxes, the authorwill then try to analyze the causes behind it and see if the current taxprinciples can be amended to overcome the problem. Therefore, the centralquestion of this paper is “how can the general anti-avoidance rule(GAAR) in Europeangovernments be further amended to prevent tax avoidance from happening?”. Thepaper includes three parts. In the first part, a description and analysis ofthe corporate tax and tax avoidance will be illustrated. The author mainlyfocuses on the causes of the tax avoidance, the forms of tax avoidance, theconsequences of tax avoidance, and the efforts that European governments haveput into the process of tax avoidance prevention. In the second part, theauthor’s opinions about improvements in the corporate tax principles will beindicated.

In the third part, research will be conducted. The research consistsof three aspects, which are the current European principles that are aimed atprevention of tax avoidance, and possible modifications that can be made tothose laws.Part 1 ThePrimary cause of tax avoidance is the save of revenues.

By taking a series ofactions, firms can save a tremendous amount of revenues that are taxable.Directors of corporations think that the tax payments reduce the company’swealth-generating activities, impeding firms’ growth (Dowling,2013).Therefore, they utilize the loopholes in the tax principles to achieve theirgoal of tax avoidance. There are several forms of tax avoidance schemes, which includetransfer pricing structures, tax rate negotiations, and domicile location (Raiborn,Massoud, & Payne, 2015).

Also, some USfirms use a rule called “check the box” rule to avoid taxes (Raibornet al., 2015). Most of the methods that firms useto prevent tax rely on tax heavens, which have an extremely low tax rate fornon-residents (Fisher,2014).Tax authorities consider the tax avoidance legitimate. However, the abuse oftax avoidance may result in adverse outcomes for the society. First, ifcompanies avoid paying tax, then states may not function properly because ofthe lack of funds. Second, the non-payment of corporate tax becomes burdens ofthose who are not capable of avoiding taxes (Dowling,2013).

Thus, it intensifies the inequality in the society and destroys civilian’sconfidence in the tax law (Dowling,2013).Third, companies making tax avoidance arrangements are free riders of all thebenefits provided by local governments. These companies may provoke other localbusinesses into the tax avoidance arrangements. However, European governments took steps to preventtax avoidance from happening. In the EU member states there are two forms ofanti-avoidance rules that are prevalent; one is based on the specificanti-avoidance rule (SAAR) governed by the general principles of prohibition ofabuse stated in court jurisprudence, the other is based on a written judicial lawwhich prohibits the abuse – general anti-avoidance rule (GAAR) (Belevica & Grasis, 2016). The SAAR focuses on the specificknown tax avoidance arrangements; however, the GAAR can be considered as ageneral rule which enables tax authorities to nip the tax avoidance behaviorsin the bud (PricewaterhouseCoopers). The SAAR consists of transfer pricerules, thin capitalization rules, rules limiting interest deductibility,controlled foreign company rules (CFC), and so on (Johansson, Skeie, & Sorbe, 2017).

The SAAR is both effective and complicated,but it is not adequate to deal with a variety of business arrangementsinvolving tax avoidance (“The Role of a GeneralAnti-Avoidance Rule in Protecting the Tax Base of Developing Countries,”2017).Therefore, the adoption of the GAAR is approved, ensuring the completeness ofthe anti-avoidance system. Despite that GAAR involves uncertainties, it stillplays a role of safeguard and is viewed as a supplement of SAAR (PricewaterhouseCoopers). Unlike the SAAR that is statutory,the GAAR can also be juridical, which is another reason why it is utilized (“The Role of a GeneralAnti-Avoidance Rule in Protecting the Tax Base of Developing Countries,”2017).

BecauseSAAR deals with the known arrangements and can only be amended by adding newtax avoidance arrangements that have been detected, the GAAR, which is aprecaution to prevent tax avoidance, will be the primary focus in this paper. TheGAAR has been essential for the EU member states to avoid tax avoidance, and ithas been functioning properly for decades. However, due to the rapid change inthe business world, the rule has to be amended to be future-proofing.  Inrecent years, numerous multinationals have been criticized for beingaggressively minimizing the taxes that they were supposed to pay (CAMPBELL,2016).Multinationals such as Google, Amazon, Starbucks, and Apple are on thecriticism list. According to reports, Starbucks had sales revenue of £400m inthe UK, but paid no corporation tax; Amazon made £3.35bn in the UK in 2011 butpaid a corporate tax of £1.

8 million; and Google, which had a turnover of£395m, reported a tax expenditure of only £6m. All these reports keep being onthe front pages of all kinds of papers, making the tax avoidance furtherattention-getting (Barford& Holt, 2013). These reports make people assumethat the GAAR is out of date and should be replaced by new rules; however,according to the analysis, there are still about 20 countries using the GAAR worldwide(Ernst& Young, 2013). Of all the countries surveyed,China is the one which benefits significantly from the adoption of the GAAR.Based on its reports, in 2011, 248 GAAR cases were started, and 207 concluded,with taxes collected as a result totaling around CNY24billion (US$ 3.81billion). The successful application of GAAR in China indicates that the GAARis still effectual.  Thefeasible approach is to modify the GAAR, making it future-proofing.

Progressivity, simplicity, neutrality, and stability are four core principlesthat we have to concern. In respect of the progressivity, the GAAR should beup-to-date because the new businesses can take advantage of the loopholes ofthe current GAAR to gain a tax benefit. The progressivity of the GAAR can avoidthis situation from happening. Additionally, GAAR should be less dense,reducing the uncertainties involved due to the complexness.

As a rule, itshould also be neutral, ensuring the fairness for stakeholders. Finally, itshould be reliable and stable.Part 2Fromthe author’s point of view, the GAAR can be further amended. This opinion canbe concluded by analyzing the current GAAR.

GAAR has wider provisions andgrants taxman discretionary authorities; therefore, the GAAR can be used todetect the arrangements of tax avoidance efficiently (GUPTA& SHERRY). There are several vital steps inthe GAAR that have to be taken when identifying the tax avoidance arrangements.The first step is to target transactions that may comply with a technicalinterpretation of the law but generate tax benefits the government considers tobe unintended or inconsistent with the spirit of the law (Ernst& Young, 2013). Then the tax authorities define theartificial scheme, transaction or arrangement that is utilized to gain a taxbenefit in the suspected business arrangements.

The third step is to applysubstance and purpose test as a filter for determining whether a transaction islegitimate. However,steps required in the GAAR also have drawbacks. The most arguable disadvantageis that the discretionary rights granted to the judges by GAAR createuncertainties. Final decisions can be unconvincing for companies becausearguable cases are usually left to the judges who have discretionary rights (Paulson,2013).Therefore, uncertainties are usually involved in cases judged using GAAR (Ostwal). Fear of firmsmay be intensified due to the unconvincing decisions of tax authorities.

Also,the present GAAR has failed in defining ‘commercial substance’ and ‘tax benefit;Therefore, the decision to classify an arrangement vests is in the hands of thetax authorities who may exploit their rights (GUPTA& SHERRY; MP). This has led to negative sentimentsin the environment. Thus, it is vital that decisions taken today should beevaluated with a fundamentally strong law which has clear guidelines which canbe well interpreted by both the stakeholders and tax authorities (GUPTA& SHERRY).

Furthermore, over-inclusiveness andinefficiency are drawbacks of the GAAR too (Agunbero,2015).Many firms consider the tax payments as a cost to the firms; therefore, many ofthem take actions to minimize the fees. There are firms that spend lots ofmoney finding loopholes in the tax laws to avoid taxes. However, not alltax-avoidance schemes are illegal and fall under the scope of the GAAR (Agunbero,2015).

Thus, it is essential to identify the abusive tax planning and moderate taxplanning. However, the definition of abusive planning is interpreted by judges.The level of the tax planning may not be easy to distinguish. And thenon-abusive transactions of tax planning can fall under the scope of a GAARwithout it being the purpose of the legislator (Agunbero,2015).Moreover, the punishments inflicted on firms avoiding taxes abusively are toomild.

Penalties only apply when the taxpayer is accused of gross negligence orfraud. The schemes that companies plan to avoid taxes are not considered illegitimate;therefore, no lawsuit can be filed, and no fine can be levied. Therefore,the author is convinced that the GAAR can be modified, and the modificationsshould be made on the defects mentioned above. The first modification is on thediscretional rights granted to taxmen. The GAAR is a rule which guides taxmento make decisions (Ostwal).

If all the disputablecases are left to the court, then this rule loses its meaning of existence (Ostwal). So, additionalguidelines should be added into the GAAR to help judges make decisions. But itis not saying that the discretionary rights of the taxmen should be fully abolished.It is acceptable that taxmen are allowed to interpret tax principles when thetaxmen cannot find supportive laws to make a decision (GUPTA& SHERRY). Therefore, the first modificationis to increase the reliability of the GAAR to a point to which firms can puttrust into the GAAR.

The subsequent adjustment should be made on the clarity ofthe definition of the “commercial substance.” (GUPTA& SHERRY). The substance test is a crucialstep in the process of identification of tax avoidance arrangements (Paulson,2013).Therefore, the definition should be as clear as possible to ensure that it canbe interpreted by both the stakeholders and taxmen.

Moreover, there should beguidelines which can help judges distinguish extent of tax avoidance schemes.Not all tax avoidance schemes are illegal. Judges should be able to distinguish abusive tax-avoidance planning frommoderate tax-avoidance planning.

Furthermore, severe penalties should be partof the GAAR as well. If firms are only required to repay the amount of moneythey avoided, the tax avoidance behaviors will never be eliminated. Anti-taxavoidance is not only related to the use of the GAAR but also correlated withthe behavior of governments, the general public, and companies. Tax avoidanceis created by human beings, not nature. Therefore, change in the stakeholders’ behaviorwill also eliminate tax avoidance arrangements.  Governmentsplay an essential role in the process of elimination of tax avoidance.

Oneeffective way they can use is to promote the firms that are not involved in anytax avoidance arrangements, indirectly reducing other suspected firms’ socialinfluence. Additionally, governments should introduce preferential policieswhich are only applied to firms against the tax avoidance, making suspectedfirms worse off. And all the procurements of the governments should be madefrom firms against the tax avoidance. Help from other corporations is alsonecessary.

Companies should make statements to stand against tax-avoidancearrangements. Also, the big companies such as Google, Apple, Amazon, GeneralElectric should be the first ones making the statements. These giant companiesshould be the pioneers in the process of the anti-avoidance campaign.

Thegeneral public is also a nonnegligible part of the anti-avoidance campaign. Andthey are the principal victims under the tax avoidance arrangements. They shouldadjust their behavior by opposing those involved in the tax avoidancearrangements in the media, stopping to purchase products from them, and ceasingworking for them.

If all the stakeholders make adjustments on their behavior,the tax avoidance arrangements will decrease significantly.Part 3Theresearch question of my paper is “how can the GAAR in European governments befurther amended to prevent tax avoidance from happening?”. To conduct theresearch, a hypothesis has to be made, which is “the GAAR in European governmentscan be further amended by decreasing discretionary rights to judges,elaborating on definition of ‘commercial substance’, introducing penalties, andreducing inclusiveness.” There are several questions that have to be concerned whenproving this hypothesis. First of all, what are the current tax avoidance rulesused in Europe? Second, is there a need to modify the GAAR? Third, is itfeasible to alter the GAAR? Fourth, what are the consequences of themodifications? In this research part, all those questions will be answered toprove the hypothesis. Europeangovernments use both the GAAR and SAAR to prevent the tax avoidance behaviors.The GAAR aims to provide all-encompassing provision to shield tax statutes fromcontrived aggressive arrangements aimed at exploiting loopholes in a tax regime(Paulson,2013).The GAAR is applied where an arrangement has met the technical requirements ofthe law but is nonetheless an unacceptable arrangement (Paulson,2013).

The SAAR, on the other side, is more precise and specific. The SAAR focus onspecific known arrangements aimed at gaining a tax benefit; therefore, itminimizes the efforts required to identify artificial arrangements.Additionally, the SAAR doesn’t grant tax authorities discretionary rights andcannot be used to detect the artificial arrangements not included in it. Owingto the SAAR’s nature that it is aimed at preventing the known artificialarrangements from happening, only the modification of GAAR will be discussed inthe research.Thesociety is changing over time and so the business arrangements. The law must beflexible and receptive to change, so that stays fair, relevant and up-to-date (“WHATIS LAW REFORM?,”). A law based onoutdated values will lead to an erosion of people’s confidence and trust of thelaw (“WHATIS LAW REFORM?,”).

By analyzing allthe tax avoidance arrangements made by those multinational corporations inrecent years, it is easy to conclude that the current tax law is not doing itsjob. And the exposures of those arrangements have been making the public losethe trust of the tax law because the part of the tax due that has been avoidedby the firms is becoming burdens on their shoulders (Dowling,2013).Therefore, modification of the tax law is necessary.Modificationsof the tax law should be made for the shortcomings of the tax law, and thereare several drawbacks. The major shortcoming is that the GAAR containsuncertainties (Ostwal).

Theuncertainties are mainly caused by the discretionary rights left to the taxauthorities to explain tax laws and identify complex tax avoidancearrangements. The second weakness is that the definitions of the ‘tax benefit’and ‘commercial substance’ are not clear. This defect is also essential becausethe ambiguity of the definitions of the terms may lead to the abusive ofdiscretionary rights by taxmen. A trustworthy law should have clear guidelineswhich can be interpreted by both the stakeholders and tax authorities (GUPTA& SHERRY). The third drawback is that the GAARis so inclusive that all kinds of tax avoidanceschemes fall under the scope of the GAAR. A broad rule should also containguidelines which distinguish abuse tax avoidance planning from moderate taxavoidance planning. Furthermore, punishments on the tax avoidance behaviors aretoo mild. To play its role as a safeguard, more punishments are necessary.

Thefirst corresponding solution should be to limit taxmen’s discretionary rightsand provide more guidelines for taxmen to follow when making decisions. Theseguidelines will not only provide a basis for decisions by judges but alsoindirectly reduce taxmen’s discretionary rights. The second should be to specifythe definitions of the commercial substance and tax benefit to avoid the samecases being treated differently. Definitions are main contents of a rule. Therule will never be stable and trustworthy without the definitions of all terms.The third approach is to avoid inclusiveness by adopting rules which can helpjudges distinguish different levels of tax avoidance schemes.

The finalapproach is to introduce more punishments on different types of tax avoidancebehaviors. Severe penalties will strengthen the rule.Byanswering all the questions mentioned above, it can be concluded that the GAARcan be further amended to prevent tax avoidance.

However, several limitationsare involved in the process of acquiring conclusion. First, there are not manysources that are related to the modifications of the GAAR available. It isimpossible to make detailed and feasible solutions based on all the sourcesavailable. Second, no statistical data to support the findings in the papers.Therefore, some findings may not be convinced. Third, the sources available arenot easy to be verified.

So, it is possible that some of the sources are nottrustworthy. Therefore, the research question needs further investigation.ConclusionInconclusion, the author first stated the cause of the tax avoidance, which isthe greed of firms. Then the forms of the tax avoidance were expressed, whichare transfer pricing structures, tax rate negotiations, and domicile location.Moreover, consequences of the tax avoidance were also discussed, which are thatstates may not function properly, the financial burden on civilian will beheavy, and firms are free riders on government infrastructure. Then twoanti-tax avoidance rules, SAAR and GAAR, were illustrated.

SAAR deals withspecific known arrangements, and the GAAR deals with the artificialarrangements that are unknown. Then the stakeholders’ behaviors wereinvestigated. The research question of the paper is “how can the GAAR inEuropean governments be further amended to prevent tax avoidance fromhappening?”. To answer this research question, the shortcomings of the GAAR wereanalyzed, which are uncertainties, unclear definitions, inclusiveness, and mildpunishments. For each shortcoming, the author created one responding solution.The first solution is to reduce judges’ discretionary rights and add newguidelines to provide a basis for judges to avoid uncertainties.

The secondsolution is that all the definitions of the GAAR should be elaborated on tolessen ambiguities. The third approach is to introduce guidelines which helpjudges distinguish abusive tax-avoidance schemes from moderate tax-avoidanceschemes. The last solution is to complete the punishments system of the GAAR toempower the GAAR. Severe punishments can reduce tax avoidance arrangementsfurther.

Finally, the author concluded that the GAAR in European governmentscan be amended, but several limitations encountered when doing the research mayrequire further work on this research question.

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