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DDTC Working Paper 1215

                      income tax policy could not be seen as isolated   3.2. The Schemes
                      expanse as it also affected other countries, and
                      vice versa.                                         Multinational  firms  own  various  channels
                                                                       to  shifting  profit.   However,  two  popular
                         Under     globalization,   multinational      profit  shifting  strategies  are:  transfer  price
                      enterprise  could utilize asymmetrical tax       manipulation  and   debt   shifting,  since
                      systems that  will  bring the highest economic   opportunities and incentives are greater for
                      return.  Such  asymmetrical  system  starts  with   both schemes. Supremacy of both schemes can
                      national  tax  sovereignty  to design their tax   be traced from number of disputes, limelight, or
                      policy, irrespective of the other country’s policy.   any empirical studies.
                      The  interaction between  these  national  tax
                                                                          Transfer price manipulation is an effort to
                      systems then  creates tax  distortionary effect,
                                                                       over or under invoice a related party in order
                      since there are  possibilities to over taxation
                                                                       to exploit cross-border differences in corporate
                      (double  taxation)  and  under  taxation  (double
                                                                       tax rates.  Transfer price manipulation is not
                      non-taxation).The  current  international  tax
                                                                       only  about  the  pricing  of  product  or  service;
                      system  also  creates  opportunities  to  profit
                                                                       currently, migration of  intangible  property,
                      shifting, namely by separate accounting
                      approach  and treatment of interest expense .    business restructuring, and payment of
                                                                       management fee without substance are getting
                         Furthermore, the intense of tax competition   popular. Intangible property -which is the most
                      to attract  capital  yet permits countries  to   disputable  area in transfer  pricing nowadays-
                      maintain  different  corporate tax  rates, which   involves debates on legal  and economic
                      distort business decision  making.   All  else   ownership,  as  well  as  valuation  technique.
                      being  equal,  profit  shifting  is  a  corporate   Moreover,   commercial   dynamics   would
                      tax  rate sensitive activity. In general,  with   most often render  business  restructurings
                      consideration of various empirical results, 1%   unavoidable and often serves as a scheme  to
                      increase of tax rate difference will have impact   transfer price manipulation. Changing business
                      of 0.8% decrease in pre-tax profitability.   This   scheme  (legal  form)  without  reallocation
                      is exacerbated by the existence of tax  haven    of  functions, assets, and risks (economic
                      countries.  Study  by  Jansky  and  Praats  found   substance)  potentially  will  change  allocation
                      that Indian multinational firms with tax havens   of remuneration within  the multinational
                      network  would  result  in  1.5%  less  profit  and   enterprises in an unfair way. 20
                      have  11.4%  higher  debt  ratios  than  with  no
                      connection.  In the end, it is worth noting         On  the  other  hand,  financing  strategy
                      that  international  evidences  on  profit  shifting   through debt is more preferable  since  debt
                      strategies provide ample  proof of the  fact     is a  tax  base  reduction element,  and  as  a
                      that  corporate tax  rate differences  tend  to be   consequence,  lowers  the  cost  of  capital.
                      followed by aggressive tax planning.             Moreover,  incentives  to  fund  their  foreign
                                                                       related  party by intercompany loan  increases

                                                                    16. Kimberly  A. Clausing, “Multinational Firm  Tax Avoidance and Tax
                                                                    Policy,” National Tax Journal Vol. LXIl, No. 4, (2009): 703-725. At the
                   11. Separate accounting approach warrants variation of calculation of   scene, Google, Amazon, Starbucks,  and Apple were among the most
                   taxable profit for each  country,  as  to determine the  amount of  tax to   popular example on how the business takes opportunity from mismatch
                   be collected by tax authority. With separate accounting system, internal   of tax policies across countries. See detail profit scheme by Google in
                   transactions within a multinational enterprise will much depend on tax   Clemens Fuest, et al., “Profit Shifting and ‘Aggressive’ Tax Planning by
                   consideration, since no countries apply unitary framework to comprehend   Multinational Firms: Issues and Options for Reform,” ZEW Discussion
                   the business as a whole and see how multinational enterprise allocates   Paper, No.13-044 (2013).
                   their profit.  See  Arnaud de Graaf,  “International Tax  Policy Needed  to   17. For instance, see trend in transfer pricing disputes as discuss in detail
                   Counterbalance  the ‘Excessive’ Behaviour of Multinationals”,  EC Tax   in Eduardo Baistrocchi and Ian Roxan (eds), Resolving Transfer Pricing
                   Review, Vol. 22, Issue 2 (2013): 106.            Disputes: A Global Analysis  (Cambridge: Cambridge University Press,
                   12.  Tax treatment of  interest and dividend payments is commonly   2012).
                   distinguished. The  first will be deductible when computing corporate   18. Lorraine Eden, “Taxes, Transfer Pricing, and the Multinational
                   income tax liability, the second will not. For multinational enterprise, this   Enterprise,” in The Oxford Handbook of International Business, ed. Alan
                   situation incentivized them to fund their subsidiaries (intra-group) with   M. Rugman. (New York: Oxford University Press, 2009), 593.
                   excessive debt (thin capitalization).            19. Loek Helderman, Eduard Sporken dan Rezan Okten, “The Revised
                   13. Arthur J.  Cockfield,  “Introduction:  The  Last Battleground of   OECD Discussion  Draft on Transfer Pricing Aspects  of Intangibles,”
                   Globalization,” in Globalization and Its Tax Discontents: Tax Policy and   International Transfer Pricing Journal, Vol. 21, No.1 (2014): 5.
                   International Investments, ed. Arthur J. Cockfield. (Toronto: University of   20. Anuschka J. Bakker and Giammarco Cottani, “Transfer Pricing and
                   Toronto Press, 2010), 5.                         Business Restructuring: The Choice of Hercules before the Tax Authorities,”
                   14.  See  Jost  H.  Heckemeyer  and  Michael  Overesch,  “Multinational’s   International Transfer Pricing Journal, Vol. 15, No. 6 (2008): 276; and
                   Profit Response to Tax Differentials: Effect Size and Shifting Channels,”   Joel Cooper and Shee Boon Law, “Business Restructuring and Permanent
                   ZEW Discussion Paper, No. 13-045, (2013).        Establishments,” International Transfer Pricing Journal, Vol. 17, No. 4
                   15.  Petr Jansky and  Alex Prats,  “Multinational Corporations and the   (2010): 249.
                   Profit-Shifting: Lure of Tax Havens,” Christian Aid Occasional Paper, No.   21. Aswath Damodaran,  Applied  Corporate Finance (John Wiley and
                   9 (2013): 9.                                     Son, 2010), 493.
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