Taxation and Ethics
The Panama Papers is the most recent evidence that we are living in highly transparent world.
With the increasing level of transparency forced upon them by “moral hackers” and whistleblowers, it is important for both companies and individuals to realize that all business actions may at some point in the future be publicly exposed and be subject to governmental and public judgment. The public scrutiny of any and all business actions is not only concerned with the legality of the actions but more and more we see that companies are expected to be good corporate citizens and individuals are expected to be patriots; they are expected to be ethical in their business dealings and to do the right thing for their nation. Both companies and individuals should endeavor to make sure that their actions can withstand public scrutiny from both legal and ethical perspectives.
One particular area that requires ethical decision-making is that of tax practices, especially those related to differentiating between tax avoidance and tax evasion. Tax avoidance is to use legal means available to pay less tax; this is also referred to as tax planning, which is a legal act. Tax evasion is used to conceal facts, to misrepresent one’s income, holdings, transactions, etc., in an attempt to illegally pay less tax.
Tax avoidance is legal and tax evasion is illegal. Clearly tax evasion is also unethical but is tax avoidance? Sometimes ethical scrutiny can make the line between tax avoidance and tax evasion quite thin.
Below we shed the light on two examples of ethical scrutiny of implemented tax savings strategies, which in the recent past received ample news coverage.
Dividend arbitrage is a widely used practice whereby banks combine legal and financial instruments to help clients save money by lowering the withholding tax to be paid on the dividends. It would be difficult in this brief newsletter to present a detailed description of how the dividend arbitrage technique works but quite simply explained, the tax burden is lowered by temporarily transferring the ownership of shares, when dividends are received, to a country with lower tax rates. This strategy may allow clients to reduce their taxes on dividends anywhere from 10 to 30 percent.
From a financial point of view, one would consider this to be a good strategy because it helps clients keep more of their money. However, recently we have seen an increased debate and questioning, both by policy makers and regulators, on the ethics of the dividend arbitrage technique.
Tax avoidance, while legitimate, can be seen as overly aggressive and unethical when legal and financial instruments that were not created for that purpose are used to lower taxes, often referred to as taking advantage of loopholes. This point of view clearly opens up the debate about whether or not dividend arbitrage can be seen as ethical, even if it were still legal.
Another example that triggered an ethical discussion on tax planning is the Double Irish Strategy, which has been applied by companies such as Google and Facebook.
By applying this strategy, Google and Facebook were able to move their profits to countries where they must pay little or no tax. Simply explained, the Double Irish Strategy works as follows: The U.S. parent company forms a subsidiary in Ireland, which has very low tax rates. The parent signs a contract giving European rights to its intangible property (patent and rights) to this new Irish company. In return, the new Irish company agrees to market or promote the products in Europe.
Thus, all the European income—that previously would have been taxed in the U.S.—should now be taxed in Ireland. And here comes “the double.” Then the Irish company changes its headquarters to Bermuda. As result, a free ride—no US tax, no Irish tax, and no Bermuda tax!
Tax avoidance, even though it is completely within legal guidelines, can be perceived as an indication of individual or corporate greed. Many people are recognizing that often times, “business as usual” may be good for the individual or the corporation but not good for the country.
Such a perception can hurt a company’s public image and, consequently, end up harming the company’s overall success. A company that loses the public’s trust regarding its ethics could suffer an adverse effect on its profits. Regardless of whether or not the tax-avoidance strategies employed by the individual or corporate citizens of a nation are legal, if they are perceived as unethical because the citizen is avoiding paying “a fair share,” there can be repercussions for the bottom line.
For many years, various organizations have posted information about “green companies,” in which individuals who are concerned about the environment can invest their money.
There are mobile apps such as Buycott that allows consumers to scan the product barcode and get immediate information about the company’s status in good corporate citizenship, and make a purchase decision. As more and more information comes out on who are the good corporate citizens and who are not, investors could be likewise influenced.
From a management perspective, for the best public image of corporate social responsibility the safest tactic when managing the company’s tax policy would be not to test the limits of the law.
From a larger, social perspective, the ongoing fight against unlawful and/or unethical practices will be won when the costs to companies for applying these tax savings strategies are greater than the benefits that accrue.
With more and more moral hackers at work, that day may be approaching sooner than we think. We all know that in business that it always comes down to the bottom line. One thing that has always helped the bottom line in business is seeing a trend and attempting to be ahead of the curve.
It will be interesting to see who ends up being more profitable and enduring—the ethical corporation that is more transparent in its dealings and pays its fair share at home and thereby gains greater investor and consumer support (who themselves are under increasing pressure to be perceived as ethical people) or the corporation that continues to do business as usual by taking advantage of every legal to pay less tax.
In conclusion, we can state that although tax avoidance practices are legal, it is good advice that when examining tax practices, whether for an individual or a corporation, to take a step back and analyze and manage all of the issues related to tax planning from both legal and ethical perspectives.