From the course: Accounting Foundations

Strategy 2: Shift income from one pocket to another

From the course: Accounting Foundations

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Strategy 2: Shift income from one pocket to another

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- The second basic tax planning strategy is to shift income from one pocket to another, such as from a high tax state or country to a low tax state or country. As an example, let's consider Microsoft. Now, is this a US company? Well, the company is based in the United States, but where is its income generated? Here you can see Microsoft's income for 2022, '23, and '24. And you can see rather quickly that Microsoft has generated much of its income outside the United States. Well, why would the company structure its operations like that? Well, in its publicly available financial statements, Microsoft reports that it produces and distributes products and services through regional operating centers in Ireland and Puerto Rico. Okay, well, why those two locations? Simple, tax rates are lower than in the United States. Here's another exhibit with average tax rate information for three companies, ExxonMobil, Microsoft, and Walmart. You can see that Walmart has an average tax rate of about 25%. Microsoft comes in with an average tax rate of 18%, and Exxon has an average tax rate of 29%. Well, why this big variance in average tax rates for these US companies? Well, each of these organizations employs different operating strategies that affect their worldwide average tax rate. ExxonMobil has to pay taxes based on where they find and process the oil, and the tax rates in those locations are high. Walmart, primarily based in the United States, pays slightly above the US corporate tax rate, which at the time was 21%. Note, Walmart's total income tax rate is a little higher, primarily because of state income taxes in the United States. Okay, so why is Microsoft's tax rate so low at 18%? Remember, the US corporate tax rate at the time was 21%, and the answer, Ireland and Puerto Rico. Microsoft specifically chose those locations for its regional operating centers because of the lower tax rates in those jurisdictions. Now, this strategy of moving operations to another country in order to avoid high local tax rates is controversial. Some commentators say that this is unpatriotic. But remember that the straightforward business purpose of employing this basic tax planning strategy, shifting income from a high tax state or country to a lower tax state or country, it's to reduce taxes and increase profits for the shareholders of the company. Is this right? Is this ethical? Well, that's not for me to decide, but it is clear why a company does it.

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