Multinational businesses and tax planning: perfectly legitimate with sustainable economic substance

A new book by Axel Smits and Isabel Verlinden helps multinationals
structure optimally from a tax perspective

Brussels, 1 July 2009 – The current economic climate is increasing  budgetary pressure in a growing number of countries. Tax authorities are sharpening their focus in order to lay claim to their share of the shrinking mass of tax revenues on a European – and even a worldwide – scale.

Three questions are crucial in identifying what income a given country may claim tax on: (1) who made the profit? (2) how much is it? (3) where was it generated?

That said, this last aspect means that certain rules of the game have to be honored before choosing a tax-friendly location.

Companies operating on a cross country basis that fail, or fail adequately, to hinge their tax planning on their business strategy are increasingly being asked by the taxman to justify the business rationale for setting up certain fiscal/legal structures. Naturally, the tax office may not question the appropriateness of a decision to set up a given structure – tax optimisation is perfectly legitimate; but a robust legal and operational structure is needed.  The crucial factor is whether there is sufficient ‘economic substance’ to the structure, mainly meaning a qualitative concept in the sense of: what employees work in a given country with the necessary qualifications to credibly manage business risks in a durable manner?

In their latest book, Axel Smits and Isabel Verlinden, together with their colleague Pascal Janssens, explain a number of facets of this ‘substance’ element. They shed light on the concept of economic substance in an international context from various viewpoints: first, there is the legal structure of MNCs (for which it is important to determine where they are effectively tax resident, or who the actual fiscal beneficiary is) and, on the other hand, the operating model is decisive for monitoring taxable profits using transfer pricing techniques. The authors also delve into the tax rules in 44 countries and how they stack up to the OECD legislation (double taxation treaties, transfer pricing guidelines) and European law.

It’s worth remembering that it is still perfectly possible to use tax planning techniques to mitigate the tax burden, just as it is clear  in today’s economic climate that every business cost should be limited. Despite the only-too-justified increased focus and rules on abusive profit-shifts, from a competitive viewpoint it is especially important to restrict tax outlays on the basis of a sustainable operational structure. 

Note for Editors

‘Substance – Aligning international tax planning with today’s business realities’ by Axel Smits and Isabel Verlinden can be purchased via www.pwc.com/substance.