Introduction to International Tax Planning

When international tax experts design tax planning strategies, they must not only have a thorough understanding of the tax laws in relevant countries and regions but also consider the attitudes of tax authorities toward tax planning. In fact, the latter is often more important than the former. After all, tax planning is not a science—it’s an art. How the law enforcers' perception often matters more than the lawmakers' intention. Many countries and regions make it nearly impossible to challenge the tax authorities in court, or even if it’s possible, the odds of winning are slim. China is a prime example of this.

Therefore, one crucial element of international tax planning is understanding the "red lines" of tax authorities. As taxpayers, it’s best not to cross those lines. Generally, there are two ways to understand these boundaries:

1. Tax cases, including administrative reviews and court rulings, although these depend on whether the country in question has a robust legal system and follows common law principles.
2. Interpretations and guidance issued by tax authorities, which explain how they view tax laws and their enforcement.

This article uses the Practical Compliance Guidance (PCG) issued by the Australian Taxation Office (ATO) as an example to demonstrate how tax authorities’ guidance can be leveraged for international tax planning.

On January 22, 2021, the ATO released a document titled Key Compliance Risks for Large Corporate Groups (referred to as the "Guidance"), which outlines the primary compliance risks faced by multinational corporations operating in Australia. This document serves as an excellent starting point for understanding international tax planning. Given the ATO’s reputation as one of the strictest tax authorities in the world, its approach can offer valuable insights even for tax planning outside Australia.

The Guidance identifies seven key compliance risks for cross-border taxation:

1. Profit shifting
2. Related-party debt
3. Offshore service centers
4. Domestic supply chains
5. Intangible assets and non-arm’s-length transactions
6. Offshore permanent establishments
7. Foreign residents selling Australian property

These compliance risks highlight the primary areas of focus for multinational tax planning. Using this Guidance as a foundation, let’s explore how businesses attempt to avoid taxes, how tax authorities counteract these efforts, and the ongoing tug-of-war between the two.

I. Profit Shifting

The first compliance risk highlighted by the ATO is profit shifting. Anyone with even a basic understanding of international tax would be familiar with the BEPS Action Plan. BEPS stands for Base Erosion and Profit Shifting, which refers to global efforts to combat tax avoidance by multinational corporations and high-net-worth individuals. While the term itself may not clarify much, it’s enough to understand BEPS as a worldwide initiative to curb cross-border tax avoidance.

BEPS represents the most significant development in international tax over the past few decades and has involved the participation of numerous countries and regions in global tax reform. Although we won’t delve into the specifics of BEPS here, the name alone indicates that profit shifting is a top global tax concern. Unsurprisingly, the ATO lists profit shifting as its first compliance risk in the Guidance.

However, the ATO does not provide a clear definition of profit shifting, instead offering the following perspective:

"Some multinational corporations’ tax planning exceeds reasonable boundaries, which is why we are increasingly focused on global profit shifting."

If you ask the ATO what constitutes "reasonable boundaries," they likely won’t have a definitive answer and will respond with the standard global tax authority reply:

"It depends on the facts and circumstances."

That said, the ATO does know when profit shifting is undoubtedly occurring: when profits are transferred to entities with no physical office, staff, or operating costs, it’s clearly a tax avoidance. However, even if there are some offices, employees, and operating costs, that doesn’t necessarily mean profit shifting isn’t happening.

Take Apple as an example. Apple saved billions of dollars in taxes by shifting profits to Ireland, where it had offices, employed thousands of staff, and incurred tens of millions of dollars in annual operating costs. Does this count as profit shifting? If so, how large must the office be, how many employees are needed, and how substantial must the operating costs be to avoid being accused of profit shifting? This ambiguity makes it difficult for the ATO to clearly define "reasonable boundaries."

In addition to these objective factors, there are also subjective reasons for the lack of clarity. If the ATO suspects a company of tax avoidance, it has the authority to make tax adjustments it deems appropriate, even without specific legal grounds. Clearly defining the boundaries of reasonableness would limit the ATO’s flexibility in dealing with taxpayers and make it easier for taxpayers to design avoidance schemes that exploit these clear boundaries.

As a result, it is extremely challenging for companies to engage in large-scale profit shifting under the ATO’s scrutiny. Even if a feasible plan exists, it would require meticulous design by professional legal and tax teams, ongoing maintenance and restructuring, and the resources and determination to litigate against the ATO if necessary. For companies lacking these preparations, it’s often more effective to simply pay their taxes and focus their energy on growing their business.