SNUbiz News
Tax and Corporate Competitiveness: For Smarter Tax Strategies
Earlier this year, Microsoft overtook Apple and reclaimed its place as the world's most valuable company in total market value. American multinational corporations, represented by Microsoft and Apple, commonly maintain a high market share in the global market through outstanding technology and innovations. These companies are also criticized for employing aggressive tax strategies to avoid paying taxes in full.
In October last year, the United States Internal Revenue Service (IRS) announced their plan to impose $28.9 billion (approximately 39 trillion won) on Microsoft. This is a result of a tax investigation conducted from 2003 to 2014. This is more than the $26.2 billion Microsoft spent to acquire LinkedIn, which amounts to 40% of the tax Microsoft has paid to the U.S. government since 2004 ($67 billion). How could Microsoft avoid such a large amount of tax for so long? Let’s go back in time to the early 2000s when the software for Windows and Office, Microsoft’s trademark products, were sold in CD-ROMs. Microsoft, at that time, was running factories in Puerto Rico, a small island country in the Caribbean. There were 85 workers in the factory who were in charge of burning the software to CDs. In 2003, Microsoft made a major decision; they sold the intellectual property rights of the software developed and owned by the Microsoft headquarters in the U.S. to this factory for $16 billion. After that, the U.S. headquarters continued to pay a large sum of money yearly to its subsidiary in Puerto Rico for using their intellectual property rights. According to ProPublica, an organization specializing in investigative journalism, the Microsoft headquarters moved $39 billion in profit to its Puerto Rico subsidiary.
Why did Microsoft design this deal structure? To reduce taxes. The expenses paid by the Microsoft headquarters in the U.S. to the Puerto Rico subsidiary would reduce the income generated in the U.S., which would, in turn, increase the revenue generated in Puerto Rico. In other words, the income is moved from the U.S. to Puerto Rico. During that period, the corporate tax rate in the U.S. was 35%, whereas the corporate tax rate imposed by the Puerto Rican government on Microsoft was close to 0%. Microsoft was thus able to save $0.35 in tax out of $1 of income by moving its income from the U.S. to Puerto Rico. Microsoft announced that it would appeal the IRS request immediately. Statistics show that when a case is transferred to the Appeals Division, the average taxes are reduced by 80%. So, the final taxes Microsoft ultimately pays will likely be significantly reduced.
It is quite common for corporations to transfer their intellectual property rights to subsidiaries located in countries with low taxes, such as Ireland, and pay royalties to reduce taxes. Not only Microsoft but many American multinational corporations have been using tax strategies to adjust the transaction values, that is, transfer pricing, with overseas subsidiaries for decades. Intangible assets, such as intellectual property rights, are commonly used in such transactions. This is because the value and roles of intangible assets have become more important in recent years, and it is extremely difficult to determine whether the transfer prices of intangible assets are appropriate, making it difficult for tax authorities to impose taxes. Apple is also known to have transferred intellectual property rights to a subsidiary in Ireland to move its income and reduce a huge amount of taxes this way. Since 2016, Apple has been in a legal dispute over this issue with the European Commission, which charged Apple 13.1 billion euros in taxes.
The cases of Microsoft and Apple illustrate the problem of tax avoidance through excessive income transfers, which has become problematic in many countries. There have been frequent cases in which multinational corporations use various methods to avoid paying taxes to their home countries. In response to this problem, about 130 countries agreed to introduce a 15% global minimum tax on multinational corporations. It is a joint effort by the international community to solve the issue of base erosion and income transfer.
Excessive tax avoidance by some corporations deserves criticism. However, it is worth considering corporate tax strategies from a different perspective. Taxes are an essential expense item for corporations, and how much a corporation can reduce their taxes compared to their competitors can directly impact their competitiveness. For instance, suppose that A and B are two companies competing in the global market with similar pre-tax profits. What happens if A pays 30% of its pre-tax earnings in taxes and B pays 10%? B would obviously have an advantage over A in the market. B would be able to use the additional resources gained through tax reduction to invest more and improve its products or launch new products. It can also provide products and services at a low price and drive its competitors out of the market. This is actually taking place in the global market. States have been lowering their tax rates competitively to improve domestic corporations' competitiveness or attract foreign investment. Some companies use tax strategies to pay less tax and gain a competitive advantage. Behind the success of U.S. multinational corporations is the considerable impact brought by such tax strategies. This phenomenon is not only limited to the global market, considering that the same phenomenon can be found in domestic markets. Tax and corporate competitiveness are closely related, and if used appropriately, tax strategies can contribute to increasing the value of a company.
Benjamin Franklin famously said, “In this world, nothing can be said to be certain except death and taxes.” No one can avoid taxes. That being said, some pay relatively smaller amounts in tax and use this to go one step further than others in the market. This is not to suggest that we should all avoid taxes. As the Microsoft case shows, tax strategies come with risks and costs. Corporate tax strategies, therefore, require meticulous analysis of their benefits and costs. This is even more important in this era of corporate social responsibility, as an overly aggressive tax strategy will be highly criticized and cannot be socially justified. The goal of tax strategies for enhancing corporate competitiveness should be to understand the impact of taxes on business transactions in advance and design the optimal transaction structure. For instance, “tax” is an integral part of nearly every corporate decision, including the location of overseas subsidiaries, a company’s organizational structure, executive compensation, capital structure, and the M&A structure. It is crucial for the company to consider ways to make the optical transaction structure by considering the tax implications. This is the time for smart tax strategies that simultaneously account for a corporation's long-term value and social responsibility.
In October last year, the United States Internal Revenue Service (IRS) announced their plan to impose $28.9 billion (approximately 39 trillion won) on Microsoft. This is a result of a tax investigation conducted from 2003 to 2014. This is more than the $26.2 billion Microsoft spent to acquire LinkedIn, which amounts to 40% of the tax Microsoft has paid to the U.S. government since 2004 ($67 billion). How could Microsoft avoid such a large amount of tax for so long? Let’s go back in time to the early 2000s when the software for Windows and Office, Microsoft’s trademark products, were sold in CD-ROMs. Microsoft, at that time, was running factories in Puerto Rico, a small island country in the Caribbean. There were 85 workers in the factory who were in charge of burning the software to CDs. In 2003, Microsoft made a major decision; they sold the intellectual property rights of the software developed and owned by the Microsoft headquarters in the U.S. to this factory for $16 billion. After that, the U.S. headquarters continued to pay a large sum of money yearly to its subsidiary in Puerto Rico for using their intellectual property rights. According to ProPublica, an organization specializing in investigative journalism, the Microsoft headquarters moved $39 billion in profit to its Puerto Rico subsidiary.
Why did Microsoft design this deal structure? To reduce taxes. The expenses paid by the Microsoft headquarters in the U.S. to the Puerto Rico subsidiary would reduce the income generated in the U.S., which would, in turn, increase the revenue generated in Puerto Rico. In other words, the income is moved from the U.S. to Puerto Rico. During that period, the corporate tax rate in the U.S. was 35%, whereas the corporate tax rate imposed by the Puerto Rican government on Microsoft was close to 0%. Microsoft was thus able to save $0.35 in tax out of $1 of income by moving its income from the U.S. to Puerto Rico. Microsoft announced that it would appeal the IRS request immediately. Statistics show that when a case is transferred to the Appeals Division, the average taxes are reduced by 80%. So, the final taxes Microsoft ultimately pays will likely be significantly reduced.
It is quite common for corporations to transfer their intellectual property rights to subsidiaries located in countries with low taxes, such as Ireland, and pay royalties to reduce taxes. Not only Microsoft but many American multinational corporations have been using tax strategies to adjust the transaction values, that is, transfer pricing, with overseas subsidiaries for decades. Intangible assets, such as intellectual property rights, are commonly used in such transactions. This is because the value and roles of intangible assets have become more important in recent years, and it is extremely difficult to determine whether the transfer prices of intangible assets are appropriate, making it difficult for tax authorities to impose taxes. Apple is also known to have transferred intellectual property rights to a subsidiary in Ireland to move its income and reduce a huge amount of taxes this way. Since 2016, Apple has been in a legal dispute over this issue with the European Commission, which charged Apple 13.1 billion euros in taxes.
The cases of Microsoft and Apple illustrate the problem of tax avoidance through excessive income transfers, which has become problematic in many countries. There have been frequent cases in which multinational corporations use various methods to avoid paying taxes to their home countries. In response to this problem, about 130 countries agreed to introduce a 15% global minimum tax on multinational corporations. It is a joint effort by the international community to solve the issue of base erosion and income transfer.
Excessive tax avoidance by some corporations deserves criticism. However, it is worth considering corporate tax strategies from a different perspective. Taxes are an essential expense item for corporations, and how much a corporation can reduce their taxes compared to their competitors can directly impact their competitiveness. For instance, suppose that A and B are two companies competing in the global market with similar pre-tax profits. What happens if A pays 30% of its pre-tax earnings in taxes and B pays 10%? B would obviously have an advantage over A in the market. B would be able to use the additional resources gained through tax reduction to invest more and improve its products or launch new products. It can also provide products and services at a low price and drive its competitors out of the market. This is actually taking place in the global market. States have been lowering their tax rates competitively to improve domestic corporations' competitiveness or attract foreign investment. Some companies use tax strategies to pay less tax and gain a competitive advantage. Behind the success of U.S. multinational corporations is the considerable impact brought by such tax strategies. This phenomenon is not only limited to the global market, considering that the same phenomenon can be found in domestic markets. Tax and corporate competitiveness are closely related, and if used appropriately, tax strategies can contribute to increasing the value of a company.
