by TonyLiberty
1) A company in the U.S. sets up a subsidiary in a country with low or no taxes, like the Cayman Islands.
2) The subsidiary owns things the parent company needs, like intellectual property or trademarks.
3) The subsidiary charges the parent company licensing fees to use that intellectual property.
Here is an example. Company X will shift its earnings somewhere else to avoid the U.S. corporate tax rate:
A) U.S. company makes $50 billion profit. But it owes its Cayman Islands subsidiary, Company Y, $50 billion in licensing fees (for the intellectual property (IP) that Company X needs to use).
B) Company Y charges Company X $50 billion for the IP license, resulting in Company X’s profit becoming $0. Now the U.S parent company, Company X, has zero profit and pays zero taxes.
C) Company Y books the $50 billion profit but pays near zero taxes because of the Cayman’s tax laws.
Do you think transfer pricing is an ethical or unethical practice?