EN
DE
In an era of global operations, multinational corporations deploy a suite of sophisticated strategies to legally move profits from high-tax to low-tax jurisdictions. These methods include transfer pricing, debt allocation, and royalty routing. While often compliant with current regulations, they raise major concerns for tax authorities across the world.
Transfer Pricing: Manipulating Internal Transactions
Transfer pricing allows corporations to set the price of goods and services traded between affiliated entities. When a parent company sells to a subsidiary located in a high-tax country, it may inflate the price to transfer profits to an affiliate based in a jurisdiction with a much lower tax rate. According to several studies, the majority of global profit shifting takes place through such pricing adjustments.
The OECD Transfer Pricing Guidelines require that these transactions follow the arm’s length principle, meaning they must reflect market conditions. However, multinationals often exploit complexity around intellectual property and intangibles to distort valuations and reduce their global tax burden.
Debt Allocation: Extracting Profits through Internal Loans
Another powerful method used by large corporations is the strategic allocation of debt. A subsidiary in a high-tax country may borrow from a related entity based in a low-tax jurisdiction. The interest payments made on this internal loan are tax-deductible in the borrowing country, effectively eroding the local tax base. Meanwhile, the interest income is received in the low-tax location.
This approach, often referred to as earnings stripping, has been widely used by multinationals, particularly those based in the United States. It is estimated that roughly one third of international profit shifting is conducted through intra-group financing mechanisms.
Royalty Routing: Shifting Income through Intellectual Property
A third strategy involves the internal licensing of intellectual property. A subsidiary based in a high-tax country may pay royalties to another subsidiary that holds the company’s intellectual property rights and is located in a tax-favorable jurisdiction. These royalty payments reduce taxable income in the high-tax country and concentrate profits in the low-tax one.
This model has been widely adopted by technology and pharmaceutical firms. In many cases, the entity receiving the royalties has limited operational substance, existing primarily to collect revenue and benefit from a friendly tax regime.
Classic Structures: The Double Irish and Dutch Sandwich
Among the most famous structures in international tax planning is the combination known as the Double Irish with a Dutch Sandwich. In this model, a company registers two Irish subsidiaries. One is tax resident in a zero-tax jurisdiction and holds the intellectual property. The second is tax resident in Ireland and earns revenue from sales in Europe and elsewhere. It pays large royalties to the first entity, effectively stripping profits out of Ireland.
To avoid withholding taxes, the payments often pass through a Dutch company before reaching the final low-tax destination. Although Ireland phased out the Double Irish regime, variations of this structure remain in use, and similar planning continues elsewhere under new names.
Policy Response and Ongoing Challenges
The OECD’s Base Erosion and Profit Shifting (BEPS) initiative, launched in 2013, marked a global attempt to reduce the scale of these practices. Key outcomes include enhanced transparency, stricter transfer pricing rules, and most recently, the introduction of a global minimum corporate tax under Pillar Two. These reforms aim to ensure that large multinationals pay a minimum level of tax regardless of where they operate.
Nevertheless, enforcement remains a challenge. The use of intangibles, differences in national tax codes, and the mobility of capital all continue to provide multinationals with legal tools to minimize their tax exposure. While compliance burdens are increasing, so is the sophistication of corporate tax planning.
Conclusion
Multinational corporations continue to rely on a range of legal mechanisms to shift profits across borders, primarily through transfer pricing, intra-group financing, and royalty-based intellectual property structures. These strategies are often embedded within complex corporate frameworks, such as the Double Irish or IP-holding companies. Despite recent international reforms, tax optimization remains a fundamental pillar of global financial planning.
If you would like to assess whether your international structure is optimally configured from a tax perspective, Paulson & Partners offers confidential strategic consultations. Contact us to explore how your corporate structure can be aligned with regulatory requirements while maximizing tax efficiency and long-term resilience.
