Schemes Involving Profit Shifting to Tax Havens (Low Tax Country)
Title : Fictitious management fee paid to foreign subsidiary and transfer pricing of sales of products to move profits to low tax country
Presented in : Tokyo International Centre at International Taxation for Asian Countries Training (JICA)
Maneuvers of tax planning opportunities of inter-company transactions in the hands of the parent company between a foreign subsidiary located in a low tax country and another foreign subsidiary located in a high tax country to finance XCo’s investment abroad and shift profits from high-tax country to a low tax country.
The Facts of this case are as follows:
- XCo operates and has a factory in country X of producing the product called Z
- XCo has a wholly owned foreign subsidiary: ACo located in a tax haven country A; and has a share of 40% of another foreign subsidiary : BCo located in a non-tax haven country B.
- ACo transfers capital of 25% investment to BCo.
- BCo pays false management fee to ACo in order to help manage marketing this Z product to the open market.
- The management service is done for BCo by ACo. According to the DTA of country A and B, because the management service is not done in Country B, then it does not constitute as a permanent establishment of ACo.
- ACo pays dividend to XCo.
- A is a tax haven country with little or no tax and has no treaty with country X.
- B is a high-tax country and has no tax treaty with country X.
- A and B have a tax treaty
The Concerns for this case are as follows:
- XCo was easily able to manage taxation advantages by shifting profits to ACo as a tax haven, and make BCo (a high-tax country) bear the cost of buying product Z expensively before selling product Z to the open market. Moreover, BCo received little net income due to having to pay management fee to ACo.
- Suspiscion that ACo was built so as the Return on Investment of XCo will not be taxed in X country, but accumulated in ACo.
- No cost of equity in the form of dividend was paid from XCo, from its investment of 40% to BCo.
The Background for this case:
During the audit of XCo, auditors found evidence from the consolidated financial statements that XCo had received dividend from its wholly owned foreign subsidiary (ACo) that was located in a tax haven, but no dividend from BCo. Meanwhile, XCo had been given a loan from the bank. XCo itself had a fabric that produces the product Z and auditors realized that XCo had been selling the product to ACo in a tax haven country. Auditors had also noted that ACo had paid dividend to XCo, before XCo had paid the interest to the bank.
- XCo sells product Z to ACo at low price.
- ACo sells product Z to BCo at high price.
- BCo sells product Z to the open market at market price.
This type of tax planning is for XCo to reduce tax burden by: income to be taxed in a low tax jurisdiction.
- When the bank gives loan to XCo, XCo finances BCo capital in the form of loan and equity.
BCo hinders the cost to pay tax on:
- Interest loan to XCo, by transfering income to ACo in paying managing fee.
- No dividend is paid because BCo bought product Z in high price (overpricing Z product) and also pays managing fee to ACo.
High profit is pulled in ACo as a tax haven with low rate tax, so that the return on equity of XCo will not be taxed in country X, but accumulated in country. The dividend paid from ACo to XCo is the approximately same value as the interest paid by XCo to the bank.
-Olina Rizki Arizal-