What you need to know about tax avoidance
Hardly anyone likes paying tax. That's true for private citizens, but also for many multinationals. To maximise their profit, some companies stash their income in tax havens. How exactly does that work? And are there other options? Tax lawyers Jan Vleggeert and Tanja Bender explain.
What do we mean by tax avoidance?
Tax avoidance is somewhere between saving tax on the one hand and evading tax on the other. Saving tax is completely legal and we all do it. House owners, for example, can deduct mortgage interest from their taxable income. On the other hand, anyone engaging in tax evasion is acting illegally. This could be a painter, for example, who fails to declare a paid job to the Tax Office. Tax avoidance is somehere in between, Jan Vleggert, Professor of Tax Law, explains. 'It may be legal under the law, but there are people who think it is undesirable or immoral. It applies to some large multinationals who divert their profits to so-called tax havens with very low rates of tax.'
Why is there so much opposition in society against tax avoidance?
Tax avoidance is mainly only possible for large multinational concerns. American coffeehouse chain Starbucks, for example, makes wide use of complex constructions in order to pay less tax. The local coffee place on the corner of the street generally doesn't have an army of tax lawyers, so they have to pay the full amount of tax. This leads to unfair competition. Not only that, these companies make use of the infrastructure of a country, but they pay hardly anything towards maintaining these facilities. 'Paying tax becomes more acceptable if you see that others are also paying at the same rate,' Vleggeert says. 'At the moment, that's not always the case.'
What is the role of the Netherlands in tax avoidance?
There are those – mainly American multinational concerns – who channel their money to a country where the taxes are low, such as Panama, the Cayman Islands or Bermuda. But it's no simple matter to get money into these tax havens. If the profit made by an American company goes directly to the Cayman Islands, that company will often have to pay a considerable percentage in source taxation in the United States and the other countries where the profit is generated. What many multinationals do is they set up a mailbox company in the Netherlands that can serve as a transit port for the royalties and interest. Vleggeert: ‘Because the Netherlands has agreed bilateral tax treaties with many countries, multinationals often don't have to pay source tax. The Dutch Tax Authority itself doesn't levy source taxation. Consequently, the profit reaches the tax haven without any tax having been paid.'
Should the rules on tax avoidance be tightened up?
There is now a broad consensus among the public and policy-makers that tax avoidance on the present scale should be stopped. 'The treaties that make avoidance possible mainly date from a very different time from the present day,' Tanja Bender, Professor of International Tax Law, comments. ‘The role of intellectual property has become much more important in recent decades. The Starbucks brand name and logo, for example, are worth much more than the cups of coffee they sell. That makes tax avoidance easier. There are logistical reasons for not upping sticks and moving your complete coffee business to the Cayman Islands. But by locating your brand rights on the Cayman Islands and then "hiring" these rights to your own branches all over the world, a multinational can make sure that the royalties find their way to a tax haven with hardly any tax being paid.'
What measures can we take to prevent tax avoidance?
The Organisation for Economic Development and Cooperation (OECD) - a partnership of 35 mainly Western countries - took a package of measures in 2015 aimed at tightening up the rules on taxation of multinationals. One of the measures is that an anti-abuse clause should be added to the bilateral tax treaties between countries. The source country - that is the country where the profit is generated - may levy source taxation if the money is channelled to a tax haven in order to reduce the tax liability. Vleggeert believes that these measures do not go far enough. He would like to see countries levying source taxation on all transactions within a company that go to a tax haven. 'The European Union could draw up guidelines on this.' Bender is more cautious: 'The OECD measures are an important step. Additional EU rules may bring about a level playing field within Europe, but they are highly unfavourable from the perspective of competition. Non-EU countries such as the US and soon the UK as well will benefit from these rules, and multinationals will still be able to use other routes to avoid tax.'
Why did the OECD not take these measures earlier?
The problem is, of course, that countries have different interests. Many countries receive more money in their coffers when multinationals pay more tax, but a country like the Netherlands also benefits from the present situation. Because a lot of money passes through the Netherlands, it generates company taxation. And the mailbox companies create employment in Amsterdam, for example, for lawyers, tax advisers and their staff. 'The present method also works as a breeding ground for the Netherlands,' Bender explains. 'When a multinational concern discovers that the Netherlands is a good environment for companies wanting to set up business here, a small mailbox company may gradually develop into the European headquarters of the company. ’
About the interviewees
Jan Vleggeert is Professor of Tax Law at Leiden University. He previously worked as tax adviser for ING and Loyens & Loeff.
Tanja Bender is Professor of International Tax Law at Leiden University. She is also Professor of Global Law at the University of Connecticut. She was previously tax adviser at PWC.