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Tax is revenue for the government to meet the social costs like funding public infrastructure, alleviating poverty, providing healthcare etc whereas on the other side Tax is a cost for firms operating in a given country. Generally from the government perspective they try to maximize the income from taxation and from the corporate perspective Tax liability are minimized.
Given the different scenarios the purpose of taxation runs in opposite directions and has a positive impact for the former and negative impact for the latter. In my further study I am highlighting various issues like Globalization and its impact on transfer pricing, trade-off between corporate social responsibility and tax avoidance and also trade-off between management control systems and transfer pricing.
In a large scale organization and Multi-national enterprises operating in different countries due to the advent of globalization in the 21st century; Organization’s have a complex manufacturing and distribution channels. There are various business transactions in the complex supply chain networks between the subsidiaries, affiliates and the parent company; so from the manufacturing activities the companies allocate various costs such as procuring raw materials from suppliers, labour and personnel costs and the manufacturing overheads in manufacturing the final products and transporting them to the distribution centers for sales purposes. This entire process in a supply chain also consists of transfer pricing costs from the below cycle in figure 1.
Figure 1: Supply chain network and transfer pricing:
REGIONAL SALES CENTER
Testing and R/D CENTERS
Costs are allocated at every stage in the supply chain and the transfer price is also included in the retail price of the product with a higher profit margin. Transfer pricing is based on the “arm length principle” where the dealings between the subsidiaries, affiliates and the parent company should be considered as dealings between different entities not among divisions within the same company. There is less room for price negotiations and better Transfer price compliance.
Let me highlight the key issues in Tax avoidance and limitations of Transfer pricing:
- Globalization: Multi-national firms operating in different continents are subject to tax jurisdictions and regulations in different countries. Corporate tax rates are higher in some countries and lower in other countries especially the developing countries. For Ex: Corporate tax rate in Australia is 28.5-30% on the contrary tax rate in Hungary is 9%. MNC’s generally show their Earnings before Interest and tax in low tax countries or tax heavens like Cayman Islands and show their deductions (expenditures) in high income tax countries. The multinational internet search engine Giant Google operates its cloud computing servers in Cayman Islands and channelizing it’s 560.6 million$ lucrative revenue of advertising through low income tax country like Sinagpore while generating sales of 4.3 billion A$ from Australians for services in 2018. Google had a corporate tax expense of only 26.5 million $ in Australia and is fighting legal battles with ATO (Australian tax office) over hefty tax avoidance. Similarly Facebook the Social media giant has allegations over paying 11.8 million AU$ in tax despite generating billions of dollars in revenue. Google and Facebook argue that they operate at arm’s length from its subsidiaries saying Google Australia pays a fair price to access products and receive compensation for the services it provides to the company globally. Google argued that it pays huge amount of taxes in US where it is primarily based. ATO and ASIC ( Australian securities and investment commission ) are doing stringent Audit reviews get hold of MNC’S that non-comply with tax regulations.(Khadem N,2019)
Capitalism and Globalization move parallel i.e. in capitalist countries firms only motive is to maximize shareholder’s wealth by achieving competitive edge and reducing costs through financial engineering. Earlier many companies like Ford, Apple etc operated manufacturing plants in US where the cost of labour was high but today many MNC’s operate in countries like China and India where cost of labour and overheads are low to maximize their profit earnings but this is at a social cost which generate lower tax revenues and rampant unemployment. The city of Detroit is a prime example of criminal activates and unemployment due to shutting down of American factories. (Sikka and Willmott, 2010)
- Trade off between Corporate Social Responsibility and Taxation: As discussed earlier Firms primary motive is to maximize shareholders wealth i.e. increases post-tax earnings at the cost of other stakeholders like the community. There should be a balance between tax minimization and CSR activities. In the literature review done there is a negative relationship between higher moral ethics and transfer pricing aggressiveness i.e. companies with higher moral ethics will have lesser transfer price aggressiveness and legal principles that advocate tax savings as a right do not override moral ethics and CSR. (Lanis and Richardson, 2012)
- Trade off between Management Control Systems and Transfer Pricing: Responsibility accounting is holding Managers of various divisions of a large organization accountable for their core business operations in form of cost, profit and investment center. Today business have complex manufacturing and distributions process so transfer pricing is essential in intra company transactions and meanwhile prevent independent autonomy for divisional managers on price negotiations and profit margin. In Manufacturing plants managers are accountable only on allocating overheads and direct labour cost being a cost center and sales distribution managers accountable only on revenue being a revenue center. Companies use cost plus and resale minus method for transfer pricing compliance.
However to achieve better trade-offs between Transfer price compliance and Management Control systems Companies generally use a single set of transfer price book and also integrate cost and revenue centers into one profit center since cost and revenue centers are for MCS and profit center is for TP tax compliance. Multiple transfer prices result in disputes with tax regulators. (Cools and Slagmulder, 2009)
Tax avoidance is moreover a topic of debate and revisions in tax laws for taxation regulators all over the world; Due to various tax regulations and rates all across the world and business operating across the globe it becomes a real challenge for individual taxing countries to trace tax avoidance in their countries ; Transfer pricing on arm’s length principle is commendable but the real loophole for tax regulators is to synchronize with internal control systems since they differ in every organizations.
- Khadem, N. (2019). Google, Facebook make billions in Australian sales but pay less than $40m in tax. ABC News. [online] 30 Apr. Available at: https://www.abc.net.au/news/2019-05-01/google-facebook-make-billions-in-australian-sales-pay-little-tax/11060474 [Accessed 12 Jul. 2019].
- Lanis, R. and Richardson, G. (2012). Corporate social responsibility and tax aggressiveness: An empirical analysis. Journal of Accounting and Public Policy, 31(1), pp.86–108.
- 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.
- Cools, M. and Slagmulder, R. (2009). Tax-Compliant Transfer Pricing and Responsibility Accounting. SSRN Electronic Journal, Journal of Management Accounting Research, 2009, v. 21, pp. 151–78(0812–695X).
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