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This article is written by Simran Ubee, pursuing Certificate Course in Advanced Corporate Taxation from LawSikho.


The nature of companies has changed drastically over the last century. The key assets of multinationals today are their intellectual properties (IPs). Being intangible assets, they can be easily shifted around to tax havens where they can be kept untaxed for years. Microsoft did something quite similar by shifting all of its IP, worth more than a trillion, to a small factory in Puerto Rico which is a tax haven.

Under the present international taxation system, multinationals, especially the tech-giants, can evade trillions in corporate taxes by freely moving around their global profits. This has made the need for a tax system that better aligns the profits being made by the multinationals and real economic activity in states they make maximum sales. A unitary approach to international taxation can be one way in which corporations can be prevented from evading taxes and contributing more to society. 

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This article is about the present system of international taxation and why there is a need for an alternative taxation approach.

The traditional approach to international taxation

The root of the present international taxation system lies in the early twentieth century. The conventional brick-and-mortar businesses had started transforming into transnational corporations (TNCs), which generally operated as integrated businesses under a central command. National tax authorities had concerns that their TNCs would take advantage of the centralized decision making to shift their profits to lower-tax jurisdictions, creating a need for special rules. The League of Nations appointed a Fiscal Committee (1932) under an American lawyer; Mitchell Carroll. His report (Carroll Report) suggested two ways to tax TNCs; the arm’s-length pricing method and the unitary method (aka fractional apportionment). 

Arm’s length principle

The present system of international taxation is based on the ‘Arm’s Length Pricing’ method. It does not consider any TNC as a whole. Every TNC is seen as a group of different parts with each part having its own unique taxable individuality. Thus, every subsidiary of a TNC is taxed differently based on its location. This is known as the ‘separate legal entity principle’ under the international taxation regime. Regardless of the parent company’s location, each of its subsidiaries become a ‘Permanent Establishment’ (PE) in the respective territories for the purposes of taxation. 

Under the ‘arm’s length principle’, the price involved in a transaction between related parties (for instance, the parent company or its subsidiary), must be the same as it would have been had the parties been completely unrelated to each other. The method of ‘Arm’s Length Pricing’ was conceptualised between the two world wars. It was decided as a fundamental rule for evaluating all the trading between the various related parties. However, the principle goes against the economic rationale today – TNCs make far more profit by working closely and trading with each other. 

Tax is a sovereign subject of every state. With the mushrooming of TNCs globally, countries have been restructuring their tax policies to attract business, resulting ultimately in a sharp decrease in corporate taxes. TNCs on the other hand undertake lengthy comprehensive studies of the taxation system in various countries before opening up any new subsidiary. A country with the potential for more tax avoidance markedly becomes a hub for routing the profits made by the TNCs in more lucrative jurisdictions. Using together the principles of separate legal entities and the ‘Arm’s length pricing’, corporations have been finding and creating new ways to avoid paying taxes on their domestic incomes.  

Double Irish, Dutch Sandwich

In 2014, many of the large TNCs were found to be avoiding hundreds of billions of corporate taxes in the US by a scheme famously termed as ‘Double Irish with a Dutch Sandwich’. Under the system, one of the Irish companies would receive large royalties from a TNC’s sales in the US; the Irish taxes being dramatically low, the taxes paid by the TNC were similarly low as well. Using a loophole in the Irish laws, the TNC would then transfer its profits tax-free to another offshore company in a tax haven where it would remain untaxed for years. 

Another Irish company meanwhile would be used for sales to European customers. Similar to the first company, it was being taxed at a very low rate and would subsequently send all of its profits to the first Irish company, using a Dutch company as an intermediary. The scheme was definitely convoluted and required a meticulous understanding of the respective tax systems, but if done right, there could be minimal to no tax paid by the TNC anywhere in the process. The first Irish company in the scheme would receive all the profits of the TNC and then transfer it to the Bermuda company by paying large royalties on the intellectual property. 

These Irish tax loopholes were finally closed in 2015 by the Ireland government under pressure from the European Union. However, a transition period of five years was given to the TNCs, which ended in 2020. Using the ‘Double Irish, Dutch Sandwich’ method, in 2017 alone Google transferred almost 22 billion dollars through a Dutch company, which then redirected the money to Bermuda, a tax haven state. Reports also showed that by the end of 2017 the US’s most profitable companies, including Apple had appropriated almost a trillion dollars offshore to tax havens using the ‘Double Irish’ method. Alphabet, the parent company of Google finally announced in 2020 that they would stop using this tax loophole, but much damage has already been done.

The Double Irish, Dutch Sandwich is just one of the ‘base erosion and profit shifting (BEPS) corporate tax tools that were being used by the world’s most profitable multinationals to shift their profit from higher-tax jurisdictions to lower-tax ones. The Organization for Economic Co-operation and Development (OECD) has defined BEPS as multinational enterprises “exploiting gaps and mismatches” between the tax systems of different countries, costing them 100-240 billion USD of revenue annually. All of this loss, however, can be avoided by using a unitary approach to taxing multinationals.

Unitary treatment of taxation

In the simplest of terms, a unitary approach to international taxation means recognizing that a TNC’s profits accrue at the group level; not individually; they, therefore, need to be taxed on the same basis; as a group, and not individually.  This is the opposite of the fundamental principle of separate legal entities under international taxation. The TNC under unitary taxation has to submit consolidated accounts of all of its subsidiaries for deciding their tax liability. The Carroll Report had reached the conclusion that the unitary taxation approach was the more superior one, but due to its complex nature and political considerations, it was decided that the ‘Arm’s length pricing’ method would be adopted.

‘Arm’s length pricing’ assumes that every company in a group is separate and independent, and therefore should be taxed as such. However, in reality, the only reason these companies are even in a group is that they make more profit in working under common ownership. This excess profit cannot be taxed because the prices charged between each company in the group is adjusted such that only the level that would be earned if they were separate and independent is taxed. 

Unitary taxation has two important elements to it:  combined report and formulary apportionment. 

Combined report

A TNC would be required to produce consolidated accounts in every country it does its business. Along with consolidated accounts, the TNC also would need to provide details of all related entities in the particular corporate group based on the assets, sales, and employees. The advantage of access to consolidated accounts is that the local governments can see if the TNC is using internal transfers to shift their profit to offshore accounts. 

Formulary apportionment

This means enabling every country to tax the global profits of TNCs, by apportioning the profits according to a formula based on assets, sales, and employees, with a global minimum effective tax rate. This would eliminate any incentive for TNCs to shift their profits around different jurisdictions and would lead to massive increases in tax revenues for the national governments.


The United States has been successfully using the unitary tax approach to tax the various multinational tech giants in its jurisdiction. The pressure from many other countries has also prompted the OECD to come up with a uniform system of taxation; the negotiations however have been delayed due to the present pandemic. One downside of the entire scheme may be that the tax havens, which in reality are relatively poorer states, will suffer from the new shift in global taxes. Already hit by the pandemic, this might strike a severe blow to their economies. However, considering the complex nature of the unitary taxation system and the various political interests of states involved, it may be yet another half a decade until a unilateral deal is struck.

Robert Frost, however ironically, was right in his poem ‘The Road Not Taken’. Two paths diverged into the same wood; the one chosen, made all the difference. The decision of the League of Nations in deciding upon the ‘Arm’s Length Pricing’ as the fundamental of international taxation has led to today where many of the most profitable multinationals have been abusing the different tax structures to evade trillions in corporate taxes. However, now we do have an option to change this fundamental assumption under international taxation. The group of companies in the TNCs are not in fact separate but are groups aimed at making collective profits. They should therefore be charged as such. That simply is the idea of unitary taxation. 


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