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2013-08-02 05:59:10
Andrea Murad
What do Bermuda, Singapore and the Cayman Islands have in common? Yes, a warm
and inviting climate suitable for growing tropical fruits and foreign company
profits.
The tax-haven business is one that many nations have jumped into. Providing
low-to-no tax rates to foreign corporations that open subsidiaries in a country
can attract overseas investment and provide benefits for its local citizens.
Companies can profit, too. For one, corporations with foreign headquarters or
subsidiaries can pay certain taxes at a much lower rate than what they would
pay on revenue in their own nation. Lower taxes mean that the company generates
more profit from each product sold.
And shareholders often benefit, at least in part, from higher share prices and
increased dividends as a result of stronger earnings.
But the business model is not without risks. Nations that rely on the income
brought by their tax-haven status can suffer if companies suddenly decide to
move their business elsewhere.
Corporations can come under fire if they are seen as avoiding homeland taxes.
You can [go from] a very prosperous tax haven to nothing overnight, said
Aswath Damodaran, professor of finance at New York University s Stern School of
Business.
Corporations can come under fire if they are seen as avoiding homeland taxes.
In addition, they could be stuck with higher taxes or other expenses if the
nation that hosted their offshore subsidiary suddenly changes its laws. And
shareholders can get antsy if these risks cause share prices to drop.
Despite drawbacks, global companies take advantage of tax havens whenever they
can. The practice is legal, and shows no sign of going away, experts said.
Money will find its way to the places with the lowest taxes, and countries can
t stop this, said Damodaran.
For the average investor, and others who might not realize they are impacted by
corporate tax shifts, the key is to understand how companies use these as part
of their business.
What s in it for the corporations?
To placate Wall Street s focus on the bottom line, corporations work to
minimize taxes.
Any dollar saved on taxes is an additional dollar for profit, said chartered
financial analyst Jason Voss, content director at the CFA Institute.
For example, Actavis, a specialty pharmaceutical company with global
headquarters in Parsippany, New Jersey, will likely benefit handsomely after
its purchase of Irish pharmaceutical company Warner Chilcott closes, expected
at the end of the year. As part of the deal, Activis plans to relocate to
Ireland, which could lower its expected 2013 tax rate from about 28% to 17%.
Many companies see their tax departments as places to save money.
If you want an example of the worth of the tax department to profits, look at
the size of the deferred tax assets line on any company s balance sheet,
wrote Voss in an email.
Deferred tax assets offset income in future quarters, lowering a company s
future tax obligation and freeing up capital. Banks like Citigroup, Bank of
America, and JP Morgan Chase have been criticized for offsetting income in this
manner.
Firms that sell products that are not tied to a specific geographic region have
the easiest time shifting taxes. When you buy something on the Internet, songs
or software, for example, a company can process that sale in a country with
minimal taxes, said Damodaran.
For investors, which often include mutual fund and global pension accounts, the
practice can be a mixed bag.
Although increased profits make short-term shareholders happy, long-term
shareholders prefer a company use its cash to drive the long-term success of
the company, said Voss. Shareholders want to see management s talents being
used to build better products rather than managing cash. It s the products that
ultimately earn profits and contribute to stronger returns for investors.
What s in it for the countries?
Tax-haven status can be a real boon for countries without natural resources, a
large industrial base or significant tourist income. If a company has a large
office in a tax haven, there can be a big benefit for the local community, from
jobs to better infrastructure that s built to support the needs of
multinationals, said Damodaran.
The most successful tax havens have political stability, a legal system to
protect rights if something goes wrong and an infrastructure to move money in
and out of the country. Those are all important for the company and its
shareholders, who, after all, are taking the risk vis-a-vis owning the company
s stock.
You need a consensus that the tax haven is not up for debate no matter who
runs the government, you re going to see the same policies, said Damodaran.
Switzerland, the Netherlands and Ireland, among others, have done this
particularly well, said Nicole Tichon, executive director of Tax Justice
Network USA.
(These countries have) a low-tax system with a more sophisticated financial
system and government, she said.
By charging fees on the dollars that flow through their country, a tax haven
can earn revenue that vastly exceeds those from local taxes or industry.
Gross domestic product, which calculates the health of a country s economy,
tells the story. In 2011, for example, the US and UK had GDP per capita of
$48,113 and $38,961, respectively, according to the World Bank, while the per
capita GDP of Bermuda was $86,072, Ireland was $48,249, Singapore was $47,268
and Switzerland was $83,326.
Unequal benefits
Still, not all parties benefit equally. Most tax havens benefit the country s
elite such as government officials and those in the financial services industry
rather than the average citizen, said Tichon.
And smaller subsidiaries offer very little economic substance for a host
country. If there s a law office with one or two people, it doesn t generate
economic activity, said Tichon.
When a company doesn t pay local taxes, local residents sometimes must pay
higher taxes to fund public services.
Of course, when a company doesn t pay all or most of its taxes in its home
country, it isn t contributing to the pot of money that funds improvements
like roads and other services that people living in the headquarter s state
also need.
For example, Apple employees need public roads and other services just to get
to work, said Voss. But if Apple, which holds significant amounts of revenue in
tax havens, isn t paying local taxes, taxpayers in the area may foot the bill.
Effectively, locals can end up subsidizing the big hometown companies whose tax
maneuverings shift their revenue abroad.
It s like a reverse Robin Hood, said Voss.