| Figure 1
He is talking about our trade with another company in another country. We are the parent company, they are one of our subsidiary companies. This means that they belong to us, that in the end we decide what they do and do not do, what happens to their profits.
We, the parent company, are located in the 'home country'. The subsidiary company is located in another country, namely in the 'host country'.
The Finance Director is simplifying the picture for our benefit:
The subsidiary company buys goods at £100 each. They repack them and then export them from their country to our country, selling them to us at a price of £200 each. They are transferring them to us for a transfer price of £200.
So they have made a profit of £200-£100=£100 and we are getting them at a price of £200. This case is illustrated by Figure 1 (Case 1).
Having imported them at £200 each we sell them for £300 and thus make a profit of £300-£200=£100.
Our overall profit is thus £100 in the subsidiary company's host country and another £100 in the multinational's home country, a total of £200.
However, we need to consider the tax these companies have to pay on their profits, as the rates of tax (company or corporation tax) is different in the two countries.
The subsidiary has to pay corporation tax of 20% of the £100 profit and so the tax amounts to £20. Our home-country corporation tax is 60% of the £100 profit, and so our tax amounts to £60.
Overall, tax paid is £20+£60=£80 and this reduces our before-tax profit of £200 to an after-tax profit of £200-£80=£120.
The subsidiary contributed £80 to this profit, while our own operations contributed £40. The after-tax profit generated by us, that is by the parent company in the home country, was smaller because we paid corporation tax of 60% which compares with the subsidiary's 20%
All the numbers given so far are illustrated by Figure 1 (Case 1). Our Finance Director points out that as the overall after-tax profit is 40% of the selling price we should be pleased with the outcome.
However, we can tell the subsidiary what to charge and can make the transfer price whatever we like. The transfer price is arbitrary, depending as it does only on agreement between ourselves and the subsidiary, and thus on ourselves.
Consider Case 2 (see Figure 1). The transfer price is now £280 (compared with the previous £200). This has the effect of shifting before-tax profits from the parent company's home country (corporation tax 60%) to the subsidiary's host country (corporation tax 20%).
Overall, we now pay less tax (£36+£12=£48) and as the before-tax profit is unchanged (£200), the after-tax profit becomes £200-£48=£152 and that is much more than the corresponding profit of £120 we made with a transfer price of £200.
The subsidiary contributes £144 to this while our own contribution is £8.
Our overall after-tax profit is now 51% of the selling price.
Merely by changing the transfer price to an arbitrary higher figure of £280 we have increased our overall after-tax profit from £120 to £152, increased it by a staggering 27%.
As the transfer price is arbitrary, it can be £300 (see Figure 1, Case 3). This means that we are buying and selling at the same price of £300.
Overall tax paid is now £40 and our after-tax profit becomes £160.
The subsidiary contributes £160 to this while our own contribution is £0.
So what we have done is to shift all our profits to the subsidiary and do not need to pay tax in the home country.
But we need not stop there. The parent company can shift even more of its profits to the subsidiary. It can make a loss and this is illustrated by Case 4.
This case shows what happens if the transfer price is increased to £400. The subsidiary makes a profit of £300 and we make a loss of £100 on each item.
This loss can be used by us to reduce our tax liability on other profitable operations carried out by the parent company in the home country. As a result we pay correspondingly less tax.
The subsidiary pays corporation tax of £60 on their profits while we, the parent company, reduce our tax bill by £60, in effect getting a rebate of £60.
Hence the overall result is that we pay no tax at all on this transaction and our after-tax profit becomes £200.
We can take this one step further and make the Transfer Price £500 (see Case 5).
The subsidiary now makes a profit of £400 and we make a loss of £200.
The subsidiary pays corporation tax of £80 on their profits while we, the parent company, reduce our tax bill by £120, in effect getting a rebate of £120.
Hence the overall result is that we get a tax rebate of £120 in the home country, pay £80 corporation tax in the host country, and are thus left with a tax rebate of £40 on this transaction. Adding this to our profit increases the after-tax profit from £200 to £240.
So by increasing the purely arbitrary transfer price we doubled our after-tax profit, increasing it by 100%.
This was done without any change to our procedures, operations or added value, was done by merely changing book entries.
So where do these additional profits come from?
They arise from tax avoidance. In other words it is possible for a multinational company to minimise its liability for corporation tax by transfer pricing.
This is legal until governments legislate to prevent this practice.
But note that in the cases we discussed, the tax paid to the host-country government increased, while the tax paid to the home-country government decreased, case by case. In other words, one government's loss is the other government's gain.
So one government can be expected to want to legislate against unfair transfer pricing practices, while the other government can be expected to object to, and to resist, such legislation.
The parent company operates in the home country. The government of that country or state spend money on behalf of its citizens - providing education, health care, social security, protection against crime and security against attack from outside. It collects much of the money it needs from citizens and companies by means of a tax on income - those who earn most pay most, those who earn least pay least. This tax is called Corporation Tax when it is collected from companies (corporations) and Income Tax when it is collected from individuals.
Say a multinational has increased its profits by tax avoidance. As the government's expenses have not changed it must make up this shortfall elsewhere. From its other tax payers, say from its citizens. So its citizens pay more tax, the government can now spend the same amount as before, the multinational's profits have increased.
In other words, the multinational's increased profits arise from money which is in effect collected by the government by taxation from its taxpayers.
The multinational, and this means the owners and directors of the multinational, are thus in effect taxing the people and in this way increasing the multinational's profits and thus their own incomes and wealth.
A matter far removed from earning reasonable profits from providing needed quality goods and services at reasonable prices in open competition with other corporations.
Many multinationals have grown to a size where they threaten or dominate the economic and financial independence and well-being of many countries. Multinationals are accountable to their directors and owners for profitability and growth instead of being accountable to elected representatives of the people for acting for or against the national interest.
Studies published in the USA, for example, tell us much about the extent to which multinationals can avoid paying tax on their profits. These present a disturbing picture.
It seems that at times some top companies pay no federal income tax or obtain an overall rebate. Tax allowances appear to add well over $100bn each year to the accounts of US corporations, and are thus given to owners and directors.
It has become common knowledge that multinational enterprises can operate against national interests.
That multinationals <1> can gain so much profit from tax avoidance, that is from in effect taxing the population, is a case in point.
Multinationals need to be made accountable to elected representatives of the people, for their policies and for acting for or against the national interest.
|<1>||It has become common knowledge that multinational enterprises can operate against national interests. And occasionally one sees multinationals referred to as 'transnationals' or as 'global'. The words 'transnational' and 'global' are not at present associated with antisocial operations and apparently that is why they are sometimes used as a label for a multinational.|
|A list of other relevant current and associated reports by Manfred Davidmann on leadership and management.|
|Style of Management and Leadership||Major review and analysis of the style of management and its effect on management effectiveness, decision taking and standard of living. Measures of style of management and government. Overcoming problems of size. Management effectiveness can be increased by 20-30 percent.|
|Role of Managers Under Different Styles of Management||Short summary of the role of managers under authoritarian and participative styles of management. Also covers decision making and the basic characteristics of each style.|
|Motivation Summary||Reviews and summarises past work in Motivation. Provides a clear definition of 'motivation', of the factors which motivate and of what people are striving to achieve.|
|Directing and Managing Change||How to plan ahead, find best strategies, decide and implement, agree targets and objectives, monitor and control progress, evaluate performance, carry out appraisal and target-setting interviews. Describes proved, practical and effective techniques.|
|The Will to Work: What People Struggle to Achieve||Major review, analysis and report about motivation and motivating. Covers remuneration and job satisfaction as well as the factors which motivate. Develops a clear definition of 'motivation'. Lists what people are striving and struggling to achieve, and progress made, in corporations, communities, countries.|
|Work and Pay||Major review and analysis of work and pay in relation to employer, employee and community. Provides the underlying knowledge and understanding for scientific determination and prediction of rates of pay, remuneration and differentials, of National Remuneration Scales and of the National Remuneration Pattern of pay and differentials.|
|Work and Pay: Summary||Concise summary review of whole subject of work and pay, in clear language. Covers pay, incomes and differentials and the interests and requirements of owners and employers, of the individual and his family, and of the community.|
|Exporting and Importing of Employment and Unemployment||Discusses exporting and importing of employment and unemployment, underlying principles, effect of trade, how to reduce unemployment, social costs of unemployment, community objectives, support for enterprises, socially irresponsible enterprise behaviour.|
|Inflation, Balance of Payments and Currency Exchange Rates||Reviews the relationships, how inflation affects currency exchange rates and trade, the effect of changing interest rates on share prices and pensions. Discusses multinational operations such as transfer pricing, inflation's burdens and worldwide inequality.|
|Organising||Comprehensive review. Outstanding is the section on functional relationships. Shows how to improve co-ordination, teamwork and co-operation. Discusses the role and responsibilities of managers in different circumstances.|
|Social Responsibility, Profits and Social Accountability||Incidents, disasters and catastrophes are here put together as individual case studies and reviewed as a whole. We are facing a sequence of events which are increasing in frequency, severity and extent. There are sections about what can be done about this, on community aims and community leadership, on the world-wide struggle for social accountability.|
|Social Responsibility and Accountability: Summary||Outlines basic causes of socially irresponsible behaviour and ways of solving the problem. Statement of aims. Public demonstrations and protests as essential survival mechanisms. Whistle-blowing. Worldwide struggle to achieve social accountability.|
|Co-operatives and Co-operation: Causes of Failure, Guidelines for Success||Based on eight studies of co-operatives and mutual societies, the report's conclusions and recommendations cover fundamental and practical problems of co-ops and mutual societies, of members, of direction, of management and control. There are extensive sections on Style of Management, decision-taking, management motivation and performance, on General Management principles and their application in practice.|
|Using Words to Communicate Effectively||Shows how to communicate more effectively, covering aspects of thinking, writing, speaking and listening as well as formal and informal communications. Consists of guidelines found useful by university students and practising middle and senior managers.|
|Community and Public Ownership||This report objectively evaluates community ownership and reviews the reasons both for nationalising and for privatising. Performance, control and accountability of community-owned enterprises and industries are discussed. Points made are illustrated by a number of striking case-studies.|
|Ownership and Limited Liability||Discusses different types of enterprises and the extent to which owners are responsible for repaying the debts of their enterprise. Also discussed are disadvantages, difficulties and abuses associated with the system of Limited Liability, and their implications for customers, suppliers and employees.|
|Ownership and Deciding Policy: Companies, Shareholders, Directors and Community||A short statement which describes the system by which a company's majority shareholders decide policy and control the company.|
|Creating, Patenting and Marketing of New Forms of Life||Evaluates problems in genetic manipulation, and consequences of private ownership of new life-forms by multinationals. Lists conclusions and recommendations about man-made forms of life, their ownership and patenting, about improving the trend of events.|
|The Right to Strike||Discusses and defines the right to strike, the extent to which people can strike and what this implies. Also discussed are aspects of current problems such as part-time work and home working, Works Councils, uses and misuses of linking pay to a cost-of-living index, participation in decision-taking, upward redistribution of income and wealth.|
Reorganising the National Health
An Evaluation of the Griffiths Report
|1984 report which has become a classic study of the application and effect of General Management principles and of ignoring them.|
The Site Overview page has links to all individual Subject Index Pages which between them list the works by Manfred Davidmann which are available on the Internet, with short descriptions and links for downloading.
To see the Site Overview page, click Overview
Copyright © Manfred Davidmann 1991, 1996, 2006
All rights reserved worldwide.
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