When you prepare taxes for your business, you try to avoid paying as much tax as possible. Sometimes doing so puts your business at risk of committing acts that the IRS may not think is legal.
Walmart recently came under scrutiny for allegedly avoiding the payment of $2.6 billion in taxes. According to documents by a former Walmart executive, the company used a Chinese entity to avoid paying billions of dollars in taxes over the course of three years.
Using transactions in other countries to save on U.S. taxes
Up until 2014, Walmart used a subsidiary in Hong Kong to house around $600 million per year. They made an arrangement approved by the IRS that allowed them to pay a commission to a subsidiary in China through Hong Kong. While they only paid a 1.4% commission, they told the IRS they paid a 5% commission, leaving the other 3.6% in the Hong Kong subsidiary. Since the IRS doesn’t tax money that transfers through subsidiaries of other countries, Walmart avoided paying around $200 million in taxes every year.
However, Walmart could not conduct business in Hong Kong. If they did, Hong Kong would charge taxes on the money held in the country. In 2014, the company changed the business structure.
Creating a joint venture
To continue avoiding U.S. taxes while freeing up business in Hong Kong, Walmart created a joint venture between Dutch and British Virgin Island subsidiaries of the company. This joint venture claimed to be Chinese. The joint venture then took the $600 million per year that had previously gone to the Hong Kong subsidiary. At the same time, when the new venture started, Walmart paid itself a dividend of $6 billion.
The reason the former executive thinks that the venture is illegal is because the Chinese government did not recognize the joint venture as a Chinese entity. And since China didn’t recognize it, the joint venture avoided taxes there as well. The former executive thinks that this makes the joint venture a fiction created to avoid U.S. taxes.
IRS ruling could affect future business taxes
Companies pay high taxes, especially larger companies like Walmart. Many will try to look for legal ways to avoid paying taxes. The less a company spends on taxes, the more it can spend on itself.
However, when the way to avoid taxes is unique and complex, the IRS may consider it illegal. The ruling on it can create a precedent for how future businesses save on taxes.
While the IRS has not said yet whether or not it will try to pursue charges against Walmart, the resulting case may create a new precedent for how businesses save on taxes.