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Posted on October 10th, 2012, by

Today, the process of shifting profits from one jurisdiction to another becomes the mainstream trend because many companies attempt to avoid taxation of their profits and, thus, minimize their financial losses. Obviously, the shift of profits from one jurisdiction to another is a radical but very helpful tool, which companies can use to minimize taxation. At the same time, many countries tend to prevent such shifts in order to maximize state budget revenues from taxation. In such a situation, it is possible to speak about the conflict of interests of companies, which attempt to decrease their financial losses, and the government, which attempt to maximize revenues of the state budget.

As a result, the tension between the state and business increases because of the opposite goals of the state and business. In actuality, it is extremely important to develop policies which could balance the movement of profit and prevent its shift from one jurisdiction to another because, as a rule, such a shift leads to the decrease of state budget revenues. On the other hand, companies shift their profits from one jurisdiction to another to survive in the time of a severe economic crisis. Hence, they develop a variety of forms of shifting profits from one jurisdiction to another because, if the fiscal pressure is high, this is the only way to survive in the time of economic crisis.

On analyzing the problem of shifting profits, it is important to lay emphasis on the fact that profits are normally shifted from one jurisdiction to another to minimize the fiscal pressure since profits are shifted to jurisdiction where taxes are lower. As a result, companies can save their profits and use them to develop their business. In addition, while shifting profits abroad, companies can expand their business internationally since many countries encourage foreign investments, while the shift profits opens larger opportunities for investments in local economy.

In this respect, it is worth mentioning the fact that the trend to shift profits from one jurisdiction to another has grown stronger due to the process of globalization, which actually encouraged the free movement of capital between countries and eliminated or minimized fiscal barriers, which could prevent the shift of profits from jurisdiction to another. Moreover, some countries of the world intentionally encouraged the shift of profits to their jurisdiction to develop the local banking system. Such offshore zones became truly tax heavens for foreign companies which shifted their profits to countries with a low fiscal pressure on profits.

Obviously, such a situation is extremely harmful for any economy because the shift of profit leads to consistent losses of the state budget, which cannot increase revenues through taxation of profits. In addition, the national economy suffers from consistent loss of capital which is exported from the country, while in the time of a severe economic crisis the loss of capital leads to the further deterioration of the situation in the national economy. In such a situation, many companies prefer to shift their profits to jurisdiction, where they can feel safe and secured from taxation that will decrease profits of companies. In fact, the shift of profits becomes a vitally important decision for companies, which face a serious deterioration of their financial position and when the fiscal pressure is constantly growing.

Naturally, the state attempts to prevent the shift of profits from its jurisdiction to another one. In response, companies develop different forms of shifting capital from one jurisdiction to another in order to protect their capitals. At this point, it is worth mentioning the fact that many of such forms of shifting profits are illegal. In actuality, it is possible to define several the most popular forms of shifting profits from one jurisdiction to another.

First of all, it is worth mentioning transfer pricing. In fact, this is a form of fake billing. In actuality, transfer pricing is an accounting shell game used by companies to structure internal transactions so that profits are reported in offshore jurisdictions that have lower corporate tax rates. In such a way, the USA lost $53 billion in corporate taxes in 2001. The most of this money ends up in offshore accounts. Profits of the US multinational corporations’ subsidiaries in no-tax Bermuda, for example, rose from $8.5 billion to $25.2 billion.

Another form of shifting profits is income stripping. In this scheme, money is lent by an offshore subsidiary to the US parent company, for instance, or another subsidiary located in the USA, and paid back to the offshore company at higher interest rates. That interest payment is than deducted from the US company’s federal taxes. One of the examples of such income stripping occurred at Tyco, which set up a Luxemburg-based subsidiary to finance most of the company’s debt. The Luxemburg subsidiary made loans to Tyco units in the USA and elsewhere, which then deducted the interest payment from their taxable income in the USA.

Furthermore, it is worth mentioning such form of shifting profits as parking intellectual property offshore. This form of reduction taxes and shifting profits is grounded on relocating intellectual property offshore and charging headquarters and other divisions of the company royalty payments. This scheme is common among the corporate sectors such as pharmaceutical industry computers and software, who have established dozens of subsidiaries in Bermuda.

Also, companies use hybrid corporations, as a form of shifting profits from one jurisdiction to another. Basically, hybrid corporations are used in an ownership chain to reduce taxes. A company can eliminate or significantly reduce income and withholding taxes in such country as the US, the tax heaven and the country in which the foreign operating company resides by restructuring its form in this manner. As a result, hybrid corporations allow shifting profits from the USA, for instance, abroad to the foreign operating company, which is naturally located abroad.

Finally, it is possible to name such a form of shifting profits as special purpose elements and derivatives. Some tax shelter deals involve the use of special purpose entities (SPE) and structural financial instruments such as derivatives. In such a way, profit not only can be moved abroad to a lower tax jurisdiction, but also from one income accounting to another. They can even be used to move money across time to a reporting period where a tax rate may be lower. These deals may also be used to hide the identity of the ultimate beneficiary. One of the examples of such special purpose entities is Enron.

It proves beyond a doubt that all of the aforementioned forms of shifting profits from one jurisdiction to another produce a negative impact on economies from which the profits are shifted. Consequently, governments attempt to prevent shifting profits. However, in actuality, it is quite difficult to eliminate absolutely all forms of shifting profits from one jurisdiction to another since in the course of time new forms may arise. Nevertheless, recently, world leaders have decided to struggle on the tax heavens. However, it does not necessarily meant that such a decision will put the end to shifting profits because it is very difficult to regulate and prevent shifting profits. In this respect, it should be said that the most efficient way to prevent shifting profits is the minimization of taxation, which makes the shift of profits unnecessary and simply illogical.

At this point, it is important to understand that not many governments can take such a decision to minimize fiscal pressure on profits because the decrease of taxes will naturally lead to a consistent drop of state budget revenues. On the other hand, such a decision can bring positive effects in a long-run perspective because the decrease of fiscal pressure will not only prevent the shift of profits from one jurisdiction to another, but it will also stimulate the economic development because companies will able to use their capitals more efficiently while their financial losses will be minimized.

Thus, it is obvious that the prevention of the shift of profits is important but the only efficient way to do this is to create favorable conditions of taxation within the national jurisdiction. Otherwise, new forms of shifting profits can be invented.

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