Academic journal article Journal of Economics & Management

A Model of Aggressive Tax Optimization with the Use of Royalties

Academic journal article Journal of Economics & Management

A Model of Aggressive Tax Optimization with the Use of Royalties

Article excerpt


The topic of aggressive tax optimization has given rise to many controversies for many years. This discussion is constantly stoked by the disclosure of new data about the scale and mechanisms used by these entities to avoid taxation. This topic has also been of interest to the governments of many states because some estimates indicate that the amount of losses for government budgets is huge. Preliminary OECD calculations [OECD 2015] suggest that the total losses amounted to between $100 billion and $240 billion per annum, which represents 4% to 10% of the global corporate income tax receipts. Other research clearly demonstrates that it is multinational corporations which intentionally create networks of ties that reap the greatest benefits from this. For example, an analysis of cumulative financial figures of the 50 largest US corporations for 2008-2014 has demonstrated that the effective income tax rate for at least 40 of them was way lower than the nominal tax rate of 35% [Oxfam America 2016]. The verification of 2014 figures of the largest Fortune 500 corporations has shown that at least 358 of them had, as a minimum, one company established in tax havens. In some cases, these entities did not have many offshore companies, but the total income located in them was huge. The 50 corporations together had placed over $1.5 billion in tax havens! The first place is taken by Apple, which in 2014, reported a gigantic amount transferred to offshore companies: over $180 billion [CTJ 2015].

Researching this topic is not easy because it concerns information that is strictly protected by economic actors. The precise estimate of the scale of this phenomena and the resultant losses is certainly not possible. This problem is also noted by numerous scientists [Gravelle 2010; Fuest et al. 2013; Raczkowski 2015]. This also applies to a detailed catalogue of transaction types used by companies to avoid taxation. Partial knowledge of the subject is, of course, gained from the regularly reported scandals initiated by leaks of confidential data. It is enough to mention the cases unearthed in just the last three years: Panama Papers (2016), Swiss Leaks (2015) and Lux Leaks (2014). Still, this is just fragmentary data ["The Guardian" 2016; ICIJ 2014, 2015].

In the context of the above considerations it is worth noting a particular lack of comprehensive analyses that would precisely describe the mechanisms and types of transactions used by multinationals as part of aggressive tax optimization. The most important include, among others, the skillful use of transfer pricing, fees for intangible services, royalty transfers, establishing offshore companies, the flow of loans and dividends. The fragmentary information revealed clearly indicates that the most popular mechanism in this regard is to build the appropriate structure of associated companies and circulate royalties between them. This mechanism has even gained a special name: the Double Irish or the Dutch Sandwich.

Further to the above, the main purpose of this article is the detailed analysis of transactions associated with aggressive tax optimization based on the flow of royalties within supranational groups and the development of a model presenting all transactions and tax benefits. The considerations start with the presentation of theoretical aspects of the problem being described: explaining the differences between tax optimization, tax avoidance and tax dodging as well as defining key terms. Then, general rules of royalty flows with the use of optimization techniques as well as a detailed model picturing the extensive structure implemented by Google and other multinationals are presented. The final part mentions the main controversies associated with this subject.

2.Theoretical background

Tax reduction methods can take many forms. Some of them are legal and raise no doubts, some are focused on searching for and taking advantage of loopholes in the law [Machan 2012]. …

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