How Double Tax Agreement Can Be Misused in the Cross-Border Activities by Multinational Companies

Double taxation is a common problem that multinational companies face when conducting cross-border activities. To prevent this, countries sign Double Taxation Avoidance Agreements (DTAAs) to ensure that income is only taxed once.

However, some multinational companies may misuse these agreements to avoid paying taxes altogether. In this article, we will discuss how double tax agreements can be misused in the cross-border activities by multinational companies.

Misusing DTAAs through Treaty Shopping

Treaty shopping is a strategy whereby a company incorporates in a country with favorable tax rates to exploit the tax treaties between that country and others. This strategy lets a company enjoy numerous benefits such as tax exemptions and reduced rates.

When a company incorporates in a country with favorable tax rates, it can exploit the tax treaties between that country and others, and effectively “shop” for the most beneficial treaty. This process is essentially a way to avoid paying taxes altogether. Treaty shopping is a popular method used by large corporations to avoid paying taxes.

Misusing DTAAs through Transfer Pricing

Transfer pricing is another method used by multinational companies to misuse double tax agreements. It is a way for a company to artificially manipulate its pricing to reduce the taxable income in one country and shift profits to another country with more favorable tax rates.

For example, a company may sell goods/services from a low-tax country to a high-tax country, at a lower price than the market rate. This effectively reduces the income of the company in the high-tax country, while increasing the income of the company in the low-tax country.

In conclusion, Double Taxation Avoidance Agreements (DTAAs) were created to ensure that income is only taxed once, but multinational companies may misuse these agreements to avoid paying taxes altogether. Treaty shopping and transfer pricing are some of the means used for such misuse.

The negative impact of such misuse is that it reduces revenue for countries, which ultimately results in insufficient resources for public services and infrastructure development. Governments must take strict measures to prevent such misuse and ensure that multinational companies pay their fair share of tax.