Education

Corruption transition

D. MURALI | Updated on October 30, 2011 Published on October 30, 2011

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Research Roundup

The abstract of ‘ A Journey from a Corruption Port to a Tax Haven' – a paper by Shafik Hebous and Vilen Lipatov, Faculty of Economics and Business Administration in the Goethe University Frankfurt – speaks of sketching a model according to which tax havens attract corporate income generated in corrupted countries. “In our framework, tax havens have two opposite effects on welfare. First, tax havens' services have a positive effect on welfare through encouraging investment by firms fearing expropriation and bribes in corrupt countries. Second, by supporting corruption and the concealment of officials' bribes, tax havens discourage the provision of public goods and hence have also a negative effect on welfare,” the authors describe.

Based on firm-level data on outbound FDI, they find empirical support for one hypothesis implied by their model – that firms' investment in highly corrupt countries is associated with a high probability of having affiliates in tax havens. Hence, a policy recommendation in the paper is that eliminating tax havens' operations must be considered from a global perspective. The authors add that a dynamic approach may reveal further welfare effects of shutting down tax havens by modelling the transition from a corrupt country to a non-corrupt country. “While a tax haven can support investment (and corruption) in corrupt countries in view of their weak institutional setup, eradicating corruption can substantially enhance foreign direct investment. Such a framework can be a fruitful topic for future research.”

Of relevance to current discussions, closer home, on corruption and havens.

Havens and sources

Technology multinational corporations should either share their gross profits between the tax havens and the relevant resident or source country, or ensure that at least 10 per cent of the gross profit is paid to the relevant resident or source country. Thus suggests Cynthia Obiri, Doctorate of Finance Student in the Swiss Management Centre. An example cited in Obiri's recent paper ( www.ssrn.com) is about how Google Ireland Ltd's 2009 gross profit of €5.5 billion was subjected to an “administrative expense” of €5.467 billion paid to its Bermuda headquarters for the right to operate, which reduced its operating profit to a measly €45 million.

Though Google's tax practices are legal and “above board” as defended by the company spokesperson – because the global internet giant simply uses national tax differences to its advantage in the global tax system – the author rues that when technology companies sell their intellectual property to a tax haven-resident controlled foreign holding (CFH) company, the result is serious economic impairment suffered by countries such as Ireland.

The tax plan suggested in the paper, therefore, is that the technology company must consider both its shareholders and the environment.

“As such, the company's IP ownership should be relocated to Bermuda or a zero-tax country as a CFH. Furthermore, the technology company must also relocate its UK headquarters to Ireland, in order to take advantage of the 12.5 per cent basic tax rate. However, the cost of using the IP, i.e., the amount charged by its Bermuda CFH must be half of its gross profits.”

A plea for equity in the tricky world of tax planning.

Mission creep

The paper by Andrew P. Morriss of the University of Alabama, and Lotta Moberg of the George Mason University, titled ‘ Cartelizing Taxes: Understanding the OECD's Campaign Against ‘Harmful Tax Competition', frets that the organisation has become a convenient vehicle for many policies. “The organisation offers an arena for networking and informal opportunities for changing sentiments without media scrutiny. It is also convenient as having developed an image as a benign organisation of technocrats not under the political influences which many of their peers in other organisations are.”

While tax experts within the OECD (Organisation for Economic Cooperation and Development) were well established to claim global prominence in technical tax issues, expanding into broader issues on taxation such as tax competition allowed for more responsibilities and funding, the authors reason.

“The OECD staff enjoys excellent jobs for academics, with high salaries and benefits. The organisation offers enjoyable work, opportunities to participate in important international venues while obtaining the merit of having held a prestigious appointment at one of the world's top organisations.”

Among the larger lessons from the OECD's mission creep – from technical expertise used to reduce friction in trade among its members to efforts to coerce substantive changes in non-members' tax laws – is the force of political national agendas and international bureaucrats working in tandem, as underlined by the authors.

The continuing fight against “harmful tax competition” serves as a good example of how politicians' pursuit of their interests can be enhanced by the willingness of an international organisation to take on more tasks, the authors argue. “Considering issues now exploding into public consciousness like public pensions, healthcare funding, and the environment, there are more potential areas in which politicians will find useful the role of organisations like the OECD. Perhaps the OECD itself will be there to help.”

Cautionary views that are worth taking note of.

Tax strategies

Is aggressive financial reporting positively associated with aggressive tax reporting? Is the sustainability of a firm's tax strategy associated with the persistence of firms' earnings and earnings components (i.e., accruals and cash flows)? Are investors' expectations of the persistence of earnings, accruals, and cash flows influenced by the sustainability of firms' tax strategies?

Using a sample of firm-year observations from 1998 to 2009, Sean T. McGuire, Stevanie S. Neuman, and Thomas C. Omer, of the Texas A&M University's Department of Accounting, explore these questions and find that firms with more sustainable tax strategies have more persistent pre-tax earnings, cash flows, and accruals.

To the uninitiated, it may come as a surprise to know that tax departments have become increasingly integrated into the firm's strategic decision-making process due to increased scrutiny from regulators and a focus by some firms on tax departments as profit centres within the firm, as the intro notes.

For example, the mission statement of the tax department at the Rio Tinto Group, one of the leading international mining firms in the world, states that the company “pursues a tax strategy that is sustainable in the long-term” and that its “tax strategy is aligned with [its] business strategy,” the paper informs.

Valuable insights for analysts.

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Published on October 30, 2011
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