(1) The taxpayers have a natural intention to minimize their tax liability and it is not always illegal for businesses to involve in activities that help them reduce their tax liability, in fact, it is a part of the business activities. Taxpayers are allowed in indulge in those activities for minimizing their tax liability which is not in violation of General Anti Avoidance rules of the Australian Taxation Office (McLaren 2008). The methods that are used by the taxpayers to reduce their tax liability broadly fall into the three activities namely tax planning, tax avoidance and tax evasion. The tax planning, tax avoidance and tax evasion activities are distinguished by their morality and legality. The main point of difference between tax planning, tax avoidance and tax evasion is what is acceptable under the law and what is not acceptable or considered illegal. Tax planning refers to those activities by which the taxpayer genuinely tries to exploit the tax provisions, incentives and normal business structures that will enable the taxpayer to reduce their tax liability or achieve a favourable tax outcome. (Xynas 2011) The main characteristic of all tax planning activities is that they are according to the purpose and intention of the law. Tax planning focuses mainly on four actions- reducing the taxable income, claiming the allowable deductions to the maximum extent possible, reducing the tax rate applicable and deferment of tax payments up to certain extent (Xynas 2011).
There was a time when tax avoidance activities were not considered as illegal, however, the recent amendment in laws and various judicial proceedings have now made it clear that if a tax minimization activity which has not been specifically considered as illegal, will be questionable if it has been entered with the main purpose of avoidance of tax and as a result has resulted in a violation of the law (Xynas 2011). Thus, tax avoidance activities are those activities or schemes for minimizing tax which is not completely illegal but is not genuine and has been entered for the sole reason of obtaining a tax benefit. Tax avoidance involves attaining a tax benefit by taking advantage of a loophole in the law. On the other hand, tax evasion activities are regarded as highly illegal and involve fraudulent presentation or non-disclosure so as to avoid payment of taxes (McLaren 2008). Tax evasion is considered as a criminal act, where taxpayers indulge in fraudulent ways to minimize their tax liability or avoid payment of taxes altogether (Xynas 2011). Tax evasion activities involve a violation of the rules of the law. Under tax evasion activities a taxpayer who has earned a taxable income either intentionally does not pay any tax on it or payer lesser tax than he is actually required to pay.
There is only a thin line of difference between tax evasion ad tax avoidance. Certain tax minimization activities that were regarded as tax avoidance activities in the past are now regarded as tax evasion. Xynas (2011) stated that there is a thin line of difference between what is considered as acceptable tax planning and what is considered as illegal and unacceptable has undergone a major change in the last four decades. The main point of differentiation between tax evasion and tax avoidance is that tax evasion consists of illegal and unlawful ways to avoid payment of taxes while tax avoidance comprises of lawful means to reduce minimize tax liability.
(2) The term transfer pricing is used to refer to the method used for allocation of profit so as to arrive at the net profit or loss of associated organizations in those countries where the multinational corporation carries on its business (Malesky 2015). It includes activities such as defining prices for transactions of sale purchase of goods between divisions of the same corporate entity and allocation of charges for goods and services between those entities which are controlled by the same legal entity (Malesky 2015). The concept of transfer pricing has gained an increasing advantage in the last decade with the rapid globalization of the economy and international expansions and diversifications of business from all parts of the world. As different business set up their branches, associates, and units in foreign countries which are subject to different tax regimes and legislations, the businesses are required to employ the concept of transfer pricing for the purpose of allocation of costs and overheads and for devising ways to estimate the transfer prices for goods and services (Sikka and Willmott 2010).
In the present business environment of globalization, the business corporations are required to estimate correct costs related to transfer of goods and services within their own divisions, joint ventures, affiliates and subsidiary companies located in foreign countries so as to be able to measure their performance and make a correct determination of the profits or losses made by the business for a particular accounting period. However, as the method for allocation of overheads and costs are quite subjective in nature, the multinational corporations are able to exercise a lot of discretion in the allocation of these costs to specific products or services or to its divisions, joint ventures, subsidiaries etc. (Sikka and Willmott 2010). In ideal circumstances, the transfer price determined by the multinational corporation or its division should be equivalent to the "arms length price", i.e. what would be charged by a seller from an unrelated and independent buyer. However, the arm's length price is not available in a number of situations, which provides an absolute discretion to the multinational corporations to determine the transfer price. This availability of discretion enables the multinational corporations to reduce their taxes and maximize their profits by transferring most of the profits to those entities which are located low tax regimes.
There is no doubt that transfer pricing helps to avoid double taxation but it is widely used as a tool shift profits from those jurisdictions that are subject to a high tax regime to those which are subject to a low tax regime. The multinational corporations try to abuse the transfer pricing technique by inflating their expenses in high tax jurisdictions and maximizing their incomes in low tax jurisdictions. According to an argument put forward by a fellow member of the Brookings Institution, almost every multinational corporation has used transfer pricing to shift its profits to its associates, joint ventures or subsidiaries locate in different tax jurisdictions of the world (Sikka and Willmott 2010). This is how transfer pricing is facilitated tax avoidance which is not possible to be easily identified by the regulators.
The transfer pricing affects many aspects such as tax authorities, stock markets, accountants, multinational agencies, governments etc. The transfer pricing provisions are important to the top executives of the company because their financial rewards are paid to them on the basis of the earnings of the company (which can be manipulated easily using transfer pricing techniques). Transfer pricing is of importance to the government as well because it has an impact on the taxes that are levied on the profits made by the companies, which are in turn used by the governments to finance their public expenditure (Sikka and Willmott 2010). Transfer pricing has an impact on the stock exchange as well because it is able to impact factors such as earnings, dividends, return on capital and share prices which are all the important aspects about the performance of a company which are considered significant by the stock market (Hampton and Sikka 2005). A lot of accounting firms are using transfer pricing as an area for expanding their revenues by advising those transfer pricing arrangements which enable their clients to minimize their tax liability by shifting profits to preferable locations. Hence, transfer pricing enables corporations to relocate their profits, helps in tax avoidance and has an effect on the distribution of wealth and public goods (Hampton and Sikka 2005). There is also a lot of evidence which suggests that transfer pricing leads to exploitation of the underdeveloped economies at the hands of developed countries and also lowers the impact of inflows foreign direct investment (Malesky 2015).
The multinational corporations expand their operations in other countries with the objective of maximizing their economic opportunity and also provide economic growth to host countries, however, the transfer pricing activities of the multinational corporations have been reported to contribute towards an increase in exploitation of labour, exploitation of resources, unsustainable growth, and degradation of the environment of both the host country as well as the home country (Taylor and Richardson 2012). A major part of the international trade is made of intra entity sales and purchases and commercial transactions between various units or divisions of the same corporation. However the transfer pricing transactions are mainly used to misrepresent the accounting profits and evade taxes. Moreover, the most significant financial implication of transfer pricing is that it leads to consumption of scarce resources that involve costs. However practically, it does not lead to creation of any new value for the economy (Sikka 2017). Another financial and political impact of transfer pricing is that causes the government of developing countries to lose their tax revenue owing to abuse of transfer pricing and tax malpractice which is carried out by multinational corporations through foreign direct investment.
Most of the developing countries have weak taxation systems and lack resources to challenge the transfer prices used by the multinational corporations. According to a claim made by the tax authorities of China, almost 90 percent of the multinational corporations make money under the table i.e. do not report 90 percent of their earnings (Sikka 2017). The example of Coca Cola is a strong example of how multinational abuse transfer pricing for wealth retention and exploit the developing and underdeveloped countries. In case of Coca Cola, it had decided to further expand its operations in Vietnam, although it been reporting losses from its existing capacity in Vietnam over last 10 years and never paid any money in the form of corporate taxes (Malesky 2015). This made it evident that Coca Cola was exploiting the resources of Vietnam while misrepresenting its losses. The case of Coca Cola is one of the thousands of Companies that are under scrutiny for misutilizing the transfer pricing provisions.
There is no doubt that globalization has a number of positive outcomes in the form of increase in employment opportunities, rapid economic development, increased opportunities for investment and higher economic growth. However, it has significant negative impacts on the society due to facilitation to tax avoidance and capital flight. Certain researches have been done over negative impacts of transfer pricing on society (Sikka and Willmott 2010). Another important findings of some other researches is that transfer pricing contributes to global poverty (Malesky 2015). Transfer pricing has several other negative impacts on society including its contribution in widening social inequalities and reduction of resources that are available for public use. Transfer pricing is used as a tool to transfer wealth through facilitation of tax avoidance and shifting of profits to low tax jurisdictions. Therefore, a increased research into the impact of transfer pricing has suggested that it provides opportunities for tax avoidance, capital flight, and exploitation of economies of poor and underdeveloped companies (Malesky 2015).
The accounting professionals provide consulting and technical advice to multinational corporations on how they can use the transfer pricing provisions for tax avoidance while comply with the rules at the same time. The multinational corporations are exploiting the transfer pricing provisions with the support of accountants and lawyers to retain their wealth. The accounting professionals definitely indulge in providing such advice because of their own interests in the form of a major increase in their consulting revenue and an increase in their clientele (Bartelsman and Beetsma 2003). However, such provision of services by accounting firms which enables multinational corporations to avoid their taxes, is very much against the ethics of the accounting profession. Further, if multinational organizations are indulging in transfer pricing with the main motive to avoid payment of taxes and to retain their wealth, they are not acting as socially responsible organizations (Sikka and Willmott 2010). On one side multinational corporations want to portray themselves as those organizations that promote sustainable growth and development and are aware of their corporate social responsibility; however at the same time these multinational corporations want to shift their tax payments from society to its investors (Ylönen and Laine 2015). By promoting tax avoidance and shifting of profits, transfer pricing plays a role in promoting in-equal distribution of income and wealth (Sikka and Willmott 2010).
Bartelsman, E. J. and Beetsma, R. M. 2003. Why pay more? Corporate tax avoidance through transfer pricing in OECD countries. Journal of Public Economics, 87(9-10), pp.2225-2252.
Hampton, M.P. and Sikka, P. 2005. Tax avoidance and global development. In Accounting Forum (Vol. 29, No. 3, pp. 245-248). Taylor & Francis.
Malesky, E. J. 2015. Transfer pricing and global poverty. International Studies Review, 17(4), pp.669-677.
McLaren, J. 2008. The distinction between tax avoidance and tax evasion has become blurred in Australia: Why has it happened. J. Australasian Tax Tchrs. Ass'n, 3, p.141.
Mehafdi, M. 2000. The ethics of international transfer pricing. Journal of Business Ethics, 28(4), pp.365-381.
Sikka, P. 2017. Accounting and taxation: Conjoined twins or separate siblings?. In Accounting Forum (Vol. 41, No. 4, pp. 390-405). No longer published by Elsevier.
Sikka, P. and Willmott, H. 2010. The dark side of transfer pricing: Its role in tax avoidance and wealth retentiveness. Critical Perspectives on Accounting, 21(4), pp.342-356.
Taylor, G. and Richardson, G. 2012. International corporate tax avoidance practices: Evidence from Australian firms. The International Journal of Accounting, 47(4), pp.469-496.
Xynas, L. 2011. Tax Planning, Avoidance and Evasion in Australia 1970-2010: The Regulatory Responses and Taxpayer Compliance. Revenue Law Journal, 20(1), p.6714.
Ylönen, M. and Laine, M. 2015. For logistical reasons only? A case study of tax planning and corporate social responsibility reporting. Critical Perspectives on Accounting, 33, pp.5-23.
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