Challenges of taxing multinational companies.

INTRODUCTION

 

Multinational companies are large companies which operate in multiple countries, with business operations and investments in different parts of the world. Multinational companies often have a centralized headquarters in one country, where key decisions are made and where the company's management team is based. They may also have regional offices or subsidiaries in other countries, which can operate independently or under the direction of the central headquarters. One of the main influences for companies to expand globally is to tap into new markets and access resources that are not available in their home country. This allows them to increase sales, reduce production and operation costs, and diversify their revenue streams. However, operating in multiple countries also comes with challenges. Multinational companies may navigate different legal and regulatory regime, cultural discrepancies, and currency exchange rates. They are also subjected to a complex mode of operating their businesses as they play in more than one ground at the same time and they’re subjected to different social and environmental impacts from all play grounds[1].

Multinational companies are subject to intense scrutiny from the public and regulators, particularly when it comes to serious issues such as tax avoidance, labor practices, and environmental impacts. To address these concerns, many giant multinational companies have implemented sustainability policies and initiatives, and engage itself in some social works to build trust from the community. Multinational companies are major players in the global economy, they bring new technologies, skills, and business practices to the host country, which can lead to increased productivity and innovation. They also create new jobs and provide training and development opportunities for local workers. Multinational companies can also drive demand for local goods and services, supporting the growth of local suppliers and distributors. Additionally, these companies may invest in research and development, supporting the growth of industries and contributing to the knowledge economy of the host country. Multinational companies can be an important driver of economic growth and development in the countries in which they operate. While they face challenges in navigating different markets and regulatory environments, they also have the opportunity to contribute to sustainable development and positive social impact[2].

TYPES OF MULTINATIONAL COMPANIES

Global Companies: Global companies are large corporations that operate in multiple countries with a highly centralized organizational structure and have a central administrative office in the home country[3]. They outsource production to developing countries to save time and production costs while making use of local resources. These companies typically have a strong brand presence and standardized products or services across all their markets i.e Apple. They may use a hub-and-spoke model, where they have a central headquarters that oversees all operations, or a matrix model, where they have different functional areas (such as marketing, finance, and operations) that work together across multiple countries. Global companies often prioritize efficiency and cost-effectiveness in their operations, with a focus on leveraging economies of scale and scope. They also have a strong research and development function to develop new products and technologies for all their markets.

Transnational Companies: Transnational companies have a more decentralized organizational structure, with significant decision-making authority given to regional offices. Parent company has little control over the foreign branches and a hub-and-spoke model do not apply here because every regional office of the company has the superior power of making company’s decisions in that region without depending to any foreign offices’ opinion. These companies adapt their products and services to meet local market demands and have a strong focus on innovation. They often have a highly diverse workforce with a range of cultural backgrounds, and may have operations in a wide range of countries. Transnational companies may use a variety of strategies to manage their global operations, such as building regional teams with local expertise who are well connected to environment and society.[4]

International Companies: International companies have operations in multiple countries, but with a primary focus on developing new products or features that will help them gain a competitive edge in local markets. International companies utilize the resources of the parent company to conduct research and to innovate new products which resemble needs of the local community. These companies may maintain a centralized structure, with a focus on efficiency and cost-effectiveness, but each regional office may develop its own products and marketing strategies to attract local customers i.e Coca Cola.  International companies may face challenges in adapting to local business practices and regulations, and may need to develop strong partnerships with local distributors or agents to effectively penetrate new markets.

CHALLENGES OF TAXING MULTINATIONAL COMPANIES

Taxation is a crucial source of revenue for governments, enabling them to fund public services and support economic development. However, in the context of multinational companies (MNCs), taxation can be a complex and challenging issue. MNCs operate in multiple countries, with different tax systems and regulations, and often have sophisticated tax planning strategies to minimize their tax liabilities.          The following are the challenges of taxing multinational companies and vivid examples of how these challenges manifest in real-world scenarios;

Transfer pricing: Transfer pricing refers to the practice of setting prices for goods and services traded between different entities within a multinational company. MNCs can manipulate transfer prices to shift profits to low-tax jurisdictions, reducing their overall tax burden. For example, a multinational company may sell goods to its subsidiary in a high-tax country at a low price, while selling the same goods to its subsidiary in a low-tax country at a higher price, thereby artificially reducing its profits in the high-tax country. This can result in a significant loss of tax revenue for the high-tax country[5].

Let's say that Company A, a multinational corporation, has a subsidiary in a high-tax country, Country X, and a subsidiary in a low-tax country, Country Y. Company A manufactures a product that it sells to both of its subsidiaries. To reduce its tax liability, Company A engages in transfer pricing. It sets a high price for the product it sells to its subsidiary in Country X and a low price for the product it sells to its subsidiary in Country Y. This results in artificially low profits in Country X, where taxes are high, and artificially high profits in Country Y, where taxes are low. For example, the cost of producing the product is 100,000 tzs. Company A sells the product to its subsidiary in Country X for 120,000 tzs and to its subsidiary in Country Y for 80,000 tzs. The subsidiary in Country X then sells the product to customers for 150,000 tzs, generating a profit of 30,000 tzs, on which it pays taxes. The subsidiary in Country Y sells the product to customers for 120,000 tzs, generating a profit of 40,000 tzs on which it pays lower taxes.

This results in Company A minimizing its tax liability in Country X and maximizing its profits in Country Y. This practice can result in a significant loss of tax revenue for Country X and can be seen as unfair competition for local companies. Governments and international organizations have been working to address transfer pricing practices by multinational corporations, such as through the Base Erosion and Profit Shifting (BEPS) project. The BEPS project aims to provide a coordinated international approach to addressing tax avoidance strategies used by multinational companies, including transfer pricing.

Base Erosion and Profit Shifting (BEPS):  Is another challenge of taxing multinational companies. BEPS refers to the practice of shifting profits from high-tax countries to low-tax countries by exploiting gaps and inconsistencies in tax rules and regulations. MNCs can use a variety of strategies to engage in BEPS, such as shifting intellectual property to low-tax jurisdictions, using hybrid financial instruments to take advantage of different tax treatments, and manipulating the allocation of debt and equity within the group. For example, a multinational company may use a subsidiary in a tax haven to hold its intellectual property rights, and then charge high royalties to its subsidiaries in high-tax countries, reducing its overall tax liability[6].

Let's say that Company A is a multinational corporation that owns intellectual property (IP) related to a popular product that it sells worldwide. Company A decides to register the IP in a low-tax country, Country X, where the tax rate is significantly lower than in other countries where it operates, such as Country Y. Company A then charges high royalties to its subsidiaries in Country Y for the use of the IP. The royalties paid by the subsidiary in Country Y reduce its profits, and therefore its tax liability, in that country. At the same time, the royalties paid by the subsidiary in Country Y increase the profits of Company A in Country X, where taxes are lower[7].

For example, Company A owns the IP for a popular software product and charges its subsidiary in Country Y 10 million per year to use the IP. The subsidiary in Country Y generates 50 million in profits from sales of the product but has to pay 10 million in royalties to Company A. This means that the subsidiary's taxable income in Country Y is reduced to 40 million, on which it pays lower taxes. Meanwhile, Company A receives 10 million in royalties from the subsidiary in Country Y, which it reports as income in Country X, where taxes are lower.

This practice of registering IP in low-tax countries and charging high royalties to subsidiaries in high-tax countries is a common form of Base Erosion and Profit Shifting (BEPS). It allows multinational corporations to artificially shift profits from high-tax countries to low-tax countries, reducing their overall tax liability. This can result in significant revenue losses for countries where the subsidiaries operate and can be seen as an unfair advantage for multinational corporations over local companies.

Digitalization: Digitalization is a third challenge of taxing multinational companies. Digitalization refers to the trend towards online platforms and digital technologies, which enable MNCs to conduct business globally without a physical presence in each country. This can make it difficult for countries to tax MNCs, as traditional tax rules are based on the physical presence of a company in a particular country. For example, a multinational company may generate significant revenue in a particular country through digital transactions, but not have a physical presence in that country, making it difficult for that country to tax the company's profits. For example, Instagram, a popular social media platform owned by Facebook under META company, is a good example of the challenges posed by digitalization for taxing multinational companies. Instagram has millions of users worldwide, and the company generates revenue from advertising and sponsored posts[8].

One of the challenges of taxing Instagram is that the company does not have a physical presence in many of the countries where it operates. For example, Instagram may generate revenue from advertising targeted to users in Tanzania, but it does not have an office or employees in every Tanzania[9]. This makes it difficult for tax authorities to determine where the income from that advertising should be taxed, and which country has the right to tax it. To address these challenges, many countries and international organizations are proposing new tax rules for digital companies like Instagram. For example, the European Union has proposed a Digital Services Tax (DST) that would impose a tax on the revenue of large tech companies based on the location of their users. Similarly, the OECD's BEPS project includes proposals for a new taxing right that would allow countries to tax companies that have a significant economic presence in their jurisdictions, even if they do not have a physical presence.

STRATEGIES TOWARD COMPETENT MULTINATIONAL CORPORATE TAXATION SYSTEM

To address these challenges, governments and international organizations have developed a range of initiatives aimed at improving the taxation of multinational companies. One such initiative is the Base Erosion and Profit Shifting (BEPS) project, launched by the Organization for Economic Co-operation and Development (OECD) in 2013. The BEPS project aims to address gaps and inconsistencies in tax rules and regulations that enable MNCs to engage in BEPS. The project has resulted in the development of a range of recommendations and guidelines for countries to implement in their domestic tax systems, such as rules for the taxation of digital businesses and the prevention of treaty abuse.

Another initiative aimed at improving the taxation of multinational companies is the introduction of the digital services tax (DST) in many countries worldwide include Tanzania. The DST is a tax on revenue generated by certain digital businesses, such as online advertising and social media platforms. The DST is designed to address the issue of digitalization, ensuring that multinational companies are paying their fair share of tax in the countries where they generate significant revenue, even if they do not have a physical presence in those countries. However, the introduction of the DST has been controversial, with some arguing that it could lead to double taxation and hinder innovation in the digital economy[10].

In Tanzania, DST become effective on 1 July, 2022[11]. Digital Services Tax is charged at 2% of gross payment to a non-resident person who receives payment with a source in the United Republic of Tanzania from an individual. The ministry of finance stated that, the objective was to keep pace with rapid growth in the digital economy, increase government revenue and ensure equity. This tax was targeted to non-residents/citizens of United Republic of Tanzania who receives payment from citizens of Tanzania. Unfortunately, mode of its implementation has not been put public and it is unknown as to who will be given mandate to collect those taxes and which punishments are set for those who will be in default of the requirements

CONCLUSION

The challenges of taxing multinational companies are complex and multifaceted. The rise of digitalization has only added to these challenges, making it difficult for policymakers to ensure that the tax system is fair and effective. However, actions have been taken to improve the taxation of multinational corporations, including the implementation of the BEPS project by the OECD and the proposal of a Digital Services Tax by the European Union. While these efforts represent steps in the right direction, implementing effective tax rules for multinational companies will continue to require international cooperation and agreement among countries. Nevertheless, it is important to address these challenges and ensure that multinational companies are held accountable for paying their fair share of taxes, as this is crucial for promoting economic growth and social stability.

 

REFERENCE

JOURNALS

Schoenmaker, D., & Schramade, W. (2020). Taxing the digital economy: The EU proposal. Journal of International Economic Law, 23(1), 19-42. https://doi.org/10.1093/jiel/jgz042

Egger, P. H., & Kreutzer, M. (2020). The impact of tax havens on real economic activity. National Tax Journal, 73(3), 623-648. https://doi.org/10.17310/ntj.2020.3.06

OTHER SOURCES

Study Smarter, “Multinational Company”, Retrieved at https://rb.gy/ainwz Accessed May 14, 2023.

PIIE, (2021),” How do companies avoid paying international taxes?” Retrieved at https://rb.gy/yxofk Accessed May 14, 2023.

Wall street mojo, “Multinational Company”, Retrieved at “https://www.wallstreetmojo.com/multinational-company/ Accessed May 14, 2023

TRA, “Transfer of Profit Guidelines”, Retrieved at https://www.tra.go.tz/tax%20laws/TP%20Guideline.pdf Accessed May 14, 2023

OECD. (2015). Final report on BEPS action 1: Addressing the tax challenges of the digital economy. https://rb.gy/ihe9n Accessed May 14, 2023.

Tax Justice Network. (2021). The State of Tax Justice 2021. https://www.taxjustice.net/reports/the-state-of-tax-justice-2021/ Accessed May 14, 2023.

WEF, (2019), “Corporate Tax, Digitalization and Globalization”, Retrieved at https://rb.gy/lxh2f Accessed May 14, 2023.

Business Going Digital, (2021), “Taxing the digitalized economy”, Retrieved at https://rb.gy/xvhut Accessed May 14, 2023.

Auditax International, (2022). “Tanzania Introduces Digital Services Tax”, Retrieved at https://rb.gy/m51f3 Accessed at May 14, 2023.

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[1] Study Smarter, “Multinational Company”, Retrieved at https://rb.gy/ainwz Accessed May 14, 2023.

[2] PIIE, (2021),” How do companies avoid paying international taxes?” Retrieved at https://rb.gy/yxofk Accessed May 14, 2023.

[3] Wall street mojo, “Multinational Company”, Retrieved at “https://www.wallstreetmojo.com/multinational-company/ Accessed May 14, 2023

[4] ibid

[5] TRA, “Transfer of Profit Guidelines”, Retrieved at https://www.tra.go.tz/tax%20laws/TP%20Guideline.pdf Accessed May 14, 2023

[6] OECD. (2015). Final report on BEPS action 1: Addressing the tax challenges of the digital economy. https://rb.gy/ihe9n Accessed May 14, 2023.

[7] Tax Justice Network. (2021). The State of Tax Justice 2021. https://www.taxjustice.net/reports/the-state-of-tax-justice-2021/ Accessed May 14, 2023.

[8] WEF, (2019), “Corporate Tax, Digitalization and Globalization”, Retrieved at https://rb.gy/lxh2f Accessed May 14, 2023.

[9] Business Going Digital, (2021), “Taxing the digitalized economy”, Retrieved at https://rb.gy/xvhut Accessed May 14, 2023.

[10] Schoenmaker, D., & Schramade, W. (2020). Taxing the digital economy: The EU proposal. Journal of International Economic Law, 23(1), 19-42. https://doi.org/10.1093/jiel/jgz042

[11] Auditax International, (2022). “Tanzania Introduces Digital Services Tax”, Retrieved at https://rb.gy/m51f3 Accessed at May 14, 2023.