Researching the tax contribution of companies

In Chapter 1 we outlined how companies can arrange their affairs to avoid tax. MNCs can shift profits on paper to different national jurisdictions with lower tax rates. National companies can evade or avoid paying taxes, often through corruption at the local level.

When campaigning at the local level, the link between an MNC’s tax behaviour and a situation on the ground is not always obvious. But if a company is not paying the taxes it should, ultimately it is citizens who are deprived of services. Secrecy and lack of transparency in financial reporting are factors that enable international tax dodging to take place. They also make it difficult to research companies.

This section will explain the different types of business taxation, then we will walk you through the steps to a successful research project on MNC taxation.

Step 1: Defining the problem and the research questions

The typical tax-related research question when looking at a company is quite simple: Does this company pay a fair amount of tax in your country?

Companies may also be assisting others in tax dodging and be active in the so-called ‘tax avoidance industry’. Or you may be dealing with banks that invest in companies that are violating environmental and labour laws as well as engaging in tax evasion or avoidance. Furthermore, tax may be linked to corruption in your country, with politicians granting illegitimate tax deals to national and multinational corporations. Finally, you may think that the tax rates imposed on the company in question, or the tax exemptions it has been given by the government, might be unjust.

Here, however, we will only deal with questions you might ask in relation to how much tax companies are, or should be, paying by law in your country.

The big tax questions can be broken down into several sub-questions:

What is a fair amount of tax which the company should pay? Does it comply?

• Has the company demonstrated willingness to tax compliance?
• Have tax authorities questioned the company’s tax payments?
• How does it report on its profits and taxes in its annual financial report? What does it say in its explanatory note to the tax payments in the consolidated income statement?
• If it pays less than a fair amount, are there indications as to what tax avoidance strategy it is using?

The questions you need to ask:

• Does the company belong to a foreign multinational?
• What is the company structure?
• Which annual report reveals tax-relevant information about the company?
• Are its subsidiaries located in secrecy jurisdictions without having substantive operations there?
• Does the company make use of subsidiaries to lower its tax payments?
• What are the transfer-pricing practices of the company?
• Do subsidiaries use accelerated depreciation methods?When looking at data from the tax haven subsidiaries or from the ultimate parent company, are there interest payments to tax haven subsidiaries from the local company accounts?

Step 2: Preparing the research and deciding on your methodology

In many ways, preparing your research on company taxation follows the same steps as those outlined above in government tax policy research. The question you need to answer first is: What information do I need and how do I get it?

In order to answer this question, first map organisations that have already researched and published on tax justice issues and the specific company you are looking at.

Start with a far-reaching internet search for the company’s name – it’s amazing what you can turn up by going as far as page 20 of the results.

Next, search the internet for non-governmental organisations (NGOs) and social movement campaigns that may have already targeted the company in question or worked on the issue of tax justice.

Once you’ve mapped out your field and identified what kind of information is missing to provide evidence for your advocacy efforts, choosing your methodology and entry point is crucial.

Before starting to conduct the research, you’ll need to work out the availability of the data, which is usually the major constraint to a successful research outcome.

Before delving into the primary data research, map your available sources and assess the feasibility of carrying out the research, including outsourcing some parts of it to consultants (accounts, lawyers, economists) if needed.

For preliminary research, you can turn to the organisations listed above. Have a look at the research guides provided on their websites and consult the list of sources they suggest. You may also want to investigate tax courts, government department websites, press statements from stock exchanges, and reports filed with regulatory bodies.

Step 3: Planning your research

Once you know your possible partners, existing research and available sources, make a research plan with a realistic time frame.

In the section ‘Researching government tax policy’ above, we outlined good practice in planning research, developing terms of reference and identifying timescales. The resources you need for company research may be different than for government policy research. You’ll need access to different databases. Sometimes these reports are freely accessible, but in other cases you need to pay subscription fees.

You should be aware of the risks of doing company research. You may invest significant resources only to find what you suspected to be untrue. You may face delays in verifying claims about a company, and even if you are certain about malpractice you may be unable to publish due to legal risks.

Step 4: Collecting and analysing data

Now, it’s time to start familiarising yourself with financial reports and, in case you are dealing with an MNC, with company structures.

Existing data can assist you in the identification of possible malpractices, and can then be used to dig deeper, make plans for further research and start a dialogue with, or start a campaign targeting, companies.

Because tax evasion and avoidance are made possible through the use of global profit-shifting and inter-firm trade, we concentrate here on MNCs. In order to read the financial statements of an MNC, it is important to first understand its structure.

The section below will guide you step by step through finding out how an MNC is structured, where you can find a financial report relevant to tax, and how to read it. It highlights issues that might indicate an irregularity in the company’s tax payments and suggests further steps.

Country-level estimates of trade mispricing

In Chapter 1 we explained how transfer-pricing abuse involves the manipulation of prices of transactions between subsidiaries of multinationals or, more specifically, the sale of goods and services by affiliated companies within an MNC to each other at artificially high or low prices. A similar practice can occur between unrelated companies. This is called false invoicing. Together they are usually called ‘trade mispricing’.

If your research question involves looking at the big picture to analyse how much your country may be losing as a result of trade mispricing, you can look at national and international statistics.

Christian Aid, in its report False Profits: Robbing the Poor to Keep the Rich Tax Free, estimated the amount of mispricing between non-EU countries and the EU and the US. On the basis of this, the organisation estimated the amount of potential tax revenue lost by each country. While this is a relatively crude way to estimate the losses, it can provide useful evidence for advocacy and the need for further investigation.

The UN Comtrade database can also be used for similar types of investigation.

The structure of multinational companies

As mentioned above, an MNC is a web of cross-owned companies which are liable for tax on an individual basis. A controlling parent company will control several subsidiaries in different formations. Each subsidiary has its own books. Let’s have a look at what some companies may look like.

Intermediary parent companies

In many cases, intermediary companies are established for bringing together aspects of the company’s business operations. These intermediary companies can be called ‘holding companies’, ‘international trade companies’ or even ‘letter box companies’, ‘conduit companies’ and ‘shell companies’. The last three clearly imply that the companies have no real operations but simply are used for financial or legal operations.

It is not necessary to map the whole structure of a corporation to find out whether it owns subsidiaries located in tax havens. In fact, a large MNC may have thousands of subsidiary companies worldwide so it is inefficient and usually impossible to describe the complete corporate structure.

Before you search specialised databases, always check the company website.

Publicly listed companies have to inform their (potential) shareholders and provide annual reports and other investor information. Private companies have fewer reporting obligations and may not publish annual reports. Finding information on these companies can be difficult and requires alternative sources, such as the business press and the internet.

Once you have determined the corporate structure, in most cases you will want to do analysis of three areas:

1. the consolidated statements of the MNC globally
2. the subsidiaries of the MNC concerned in your own country
3. the related companies with which your subsidiaries have relationships.

It makes sense to start with 1 and 2 in parallel; 3 comes later. For example, you may be able to find the name of the subsidiaries in your country via the MNC’s accounts. If you can get the subsidiaries’ accounts, they usually tell you the name of the intermediary holding company (or if it’s registered on the local stock exchange, you can get shareholding information). You can piece together bits of information by working in both directions – get accounts of whatever subsidiaries you can, and often you are able to fill in the gaps.

The consolidated statements of the MNC globally: reading a company’s financial report

The main source of the overall financial structure (sometimes called holding structure) of a multinational is the consolidated annual report of the parent company. You want to identify whether the company has internal financing companies that might play a crucial role in tax avoidance strategies or other dubious financial constructions.

Finding the right report

The easiest way to obtain the annual report of a company is to go to the investor section of the company website, for example:

• Unilever: www.unilever.com/investor-relations/index.html
• British Petroleum: www.bp.com/investors

You should look for the following:

• Consolidated financial statements or financial report. This is the second part of a full annual report. NB: Consolidated statements include financial information of the company and all its subsidiaries of which it holds 50 per cent or more.
• Parent company financial statements. These are unconsolidated annual accounts. Unlike the consolidated financial statements, they provide separate data on the parent company of the multinational, excluding the subsidiaries. If such statements are available, they are usually included in the annual report or Form 20-F report.⁶
• Historical overview with figures over the last 5 or 10 years. Such an overview is usually not included in annual reports and can be helpful to analyse developments over time.

Some companies also publish a sustainability report or a corporate responsibility report. Such reports may contain additional financial information, so it is a good idea to download these as well. The Global Reporting Initiative has a guideline on reporting on tax which may make it easier to find tax information in the CSR report.

The structure of an annual report

Annual reports have a more or less standardised structure. In general, a report consists of two main parts:

1. Operational review. The operational review describes how the business and strategy of the company have developed over the past year. It includes a general description of the company’s business and an analysis of the markets in which the company operates. Sometimes it has separate chapters on different business divisions. Although the operational review includes many graphs and tables with financial data, this part of the report is not so relevant for a financial analysis. Usually all the financial data in the operational review is also included in the financial statements, often in a more structured way and in more detail.
2. Financial statements.These are the company’s annual accounts with explanatory notes. This is the part of the annual report that you need to focus on. Often the financial statements have a separate table of contents at the beginning of this second part of the annual report.The financial statements also have a more or less standardised structure. The main parts are the following:
   • Statement of directors’ responsibilities. This is a short section explaining the responsibilities of directors with regard to the preparation of the financial statements.
   • Independent auditor’s report. This section indicates the information in the annual report that has been audited, explains the responsibilities of the auditor, and gives the opinion of the auditor about the financial report.
   • Consolidated balance sheet. The balance sheet provides an overview of all assets to which the company is entitled and of the company’s liabilities to other parties at the end of the year.
   • Consolidated income statement. The income statement provides an overview of the revenues and costs of the company over the past year. It also includes the company’s tax information.
   • Consolidated cash flow statement. The cash flow statement section provides an overview of all money transactions performed by the company over the past year.
   • Accounting policies. These explain the rules that have been used to prepare the financial statements.
   • Notes to the consolidated accounts. Many items in the balance sheet, income statement, and cash flow statement refer to explanatory notes. These notes are numbered and explain the items that they refer to in more detail.
   • Parent company financial accounts. These are unconsolidated annual accounts that provide separate data on the parent company of the multinational, excluding all the subsidiaries.

   The order of these parts can be different and some companies include additional sections, such as a consolidated statement of recognised income and expense.

   Some future financial obligations may not be apparent from the balance sheet. If you try to interpret financial ratios, always compare them to the ratios of other companies in the same industry. What is relatively high in one industry may be low in another.

Reading the income statement

This section explains how to read an income statement.

Notes to the accounts: related party transactions

Not all companies give such detailed breakdowns as this example, but many do. ‘Payables’ are amounts owed at the end of the year, while ‘payments’ are the amounts spent during the year.

Notes to the accounts: Shareholders’ information

This company has a controlling stake. Using an internet search engine, we can find that it’s also owned by the ultimate parent, SABMiller Plc, and that it is based in Switzerland.

Cash flow statement: This shows the payments that were actually made and received during the year.

The subsidiaries of the MNC concerned in your own country

You may be able to glean a lot about a company’s subsidiaries at the country level.

In some countries, tax courts hear cases brought by companies challenging the revenue authorities and put the relevant files online. It is important to check tax court cases, because they may require a company to put its tax return into the public record. Checking the company’s registry or registrar general and the Securities Exchange Commission is a good place to start.

The single most useful item in subsidiary accounts is related party information. Transactions with tax havens will be visible. When considering this, a distinction needs to be made between transactions and payables/receivables. The latter is the position at the end of the year, and could be just a fraction of the total annual payments. As this information is in the accounts of companies at both ends of the transaction, you may be able to establish a pattern (for example, if there is a Dutch company that seems to own the group’s intellectual property).

Having gleaned this information, you should be able to piece together a picture of whether a company is paying a fair amount of tax or whether it is structured to avoid tax. This is a complex area and you should be wary of making claims about companies that are not fully checked for accuracy and legal risks.

Step 5: Controlling the quality of your research (validation)

For company research, follow the same guidance on quality control as outlined above for government research. However, in addition it is crucial to be aware of risk of libel.

When you provide the companies you have highlighted with the opportunity to review your report, this review process in itself can often deliver additional data, as managers often wish to explain the findings. In fact, you may actually use this process as a data collection technique, by posing additional questions to company representatives, or to float suspicions to see what response this will elicit.

Steps 6 and 7: Dissemination and follow-up

Follow the same steps as for government tax policy research reports.