Tax Planning in digital economy


How does business avoid taxation from a high tax country? How is income moved from one jurisdiction to another without paying taxes? And what role does the digital economy play in shifting income?

Here is an example of the Multinational Enterprise, which has structured its operations globally through subsidiaries and associates. 

Multinational company  (MNC) structure in BEPS planning

Four countries used in these transactions are as follows:

Market Country – is the country where the products are sold and which is revenue-generating. The state, which is a market, will often be a jurisdiction with high tax. 

Intermediate Country 1 – is the country which has a high tax, but a favorable double taxation treaty with Market Country. Hence any remittance made from Market Country to the Intermediate Country will have no withholding taxes. 

Intermediate Country 2 – is the country which is a low tax jurisdiction. Intermediate Country 1 has a favorable treaty with Intermediate country 2 (say they are part of European union). Intermediate Country 1 has a favorable treaty with Intermediate country 2. 

Resident Country of Parent company – This is a high tax country, which has no CFC rules, and it does not tax the profits earned by subsidiaries in other countries. 

How is tax reduced or minimized in the market country?

  • By Avoiding Taxable Presence

Digital environment assists in reducing the taxable presence in the market country. Besides, under Articles 5 and 7 of the OECD Model Tax Convention, a company is subject to tax on its business profits in a country of which it is a non-resident only if it has a permanent establishment (PE) in that country. 

  • By minimizing the functions/assets and risks in the market country

In case the taxable presence exists in the market company, the functions and assets (for example, patents, intangibles) are owned by sister concerns in the low tax jurisdiction. By stripping the company of operating profits in the market country, stating the risks are with the company in another country, the tax impacts are reduced. 

  • Maximizing deductions in market jurisdictions

Another way of shifting the income is by maximizing the tax deductions. It could be through thin capitalization or high payment of royalties. High infusion of debt, assists income to be shifted to another country like the interest, which is tax-deductible. 

  • Avoiding Withholding Tax

A company attracts withholding tax while receiving the payment from the country in which he is not a resident. But some country has treaties with other countries where withholding tax is not applied, which helps in treaty shopping. 

How is tax reduced in the intermediate company?

The tax in an intermediate country is reduced by the application of preferential domestic tax regimes, the use of hybrid mismatch arrangements, or excessive deductible payments made to related entities in low or no-tax jurisdictions. 

How is tax reduced in the ultimate parent company?

The parent companies will avoid tax on the profits transferred from the subsidiaries from low tax territory, in the residence country if that country has an exemption or deferral system for the foreign source income and either does not have a controlled foreign company (CFC) rules that apply to income earned by multinational corporations of the parent, or has a regime with inadequate coverage of specific categories of passive or highly mobile income, including in certain particular income concerning intangibles. 

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