Having a global workforce has numerous benefits in terms of innovation and creativity, with the global nature of the workforce allowing for a fertile spread of ideas. Indeed, research published last year from Wharton highlighted how immigrants help not just the flow of ideas but also capital.
The authors state that cross-border VC investment is now at record levels, with this in large part due to the increasingly international nature of entrepreneurship. It represents a significant change however, as previous research has shown that for a long time, VC investments would often be made within about 60 miles of the VC’s headquarters. Investors would largely stay within the confines of their city or region.
This super-localization of investing occurred in large part because obtaining good information about startups was historically very hard. Even knowing a startup existed might have been difficult in the past, unless you were able to attend local events and hear the local gossip. This proximity then allows you to meet with founders, and track the progress of your investment.
When the pattern of investments was analyzed, there didn’t appear to be any discernible trend in where VCs put their money. That was until the researchers began exploring the origins of the entrepreneurs themselves. It appeared that when a VC backed a startup with immigrant founders, they subsequently became more enthusiastic about backing other startups from the founders’ homeland.
Spreading habits
New research from North Carolina State University’s Poole College of Management highlights that such broadening of one’s financial horizons doesn’t just occur with regards to investments but also tax practices.
The study reveals that American companies with a large number of employees in countries with lower tax rates are far more likely to “locate” their earnings in those jurisdictions. What’s more, the Internal Revenue Service (IRS) is also less likely to question these activities.
“Many politicians seek to encourage domestic employment and discourage sending jobs overseas,” the researchers say. “To do that, they’ll need to address elements of corporate tax policy that effectively encourage corporations to ramp up their percentage of foreign employees.”
Foreign affairs
The researchers wanted to examine how, or indeed whether, foreign employment affected the income shifting behavior of large firms. Income shifting is the practice of artificially moving earnings to a lower-tax jurisdiction. A common means of achieving this form of tax avoidance is to charge another division within your company for various services, which in effect transfers income from the part of the company that actually earned the money to the part of the company based in the low-tax jurisdiction.
The researchers looked at annual data from over 800 multinational firms based in the United States from 2000 to 2016. During this period all of the companies recorded at least $100 million in foreign sales in at least one of the years. The firms employed 18,763 employees on average with just under half of them employed outside of the U.S.
The researchers developed models to allow them to examine whether companies were registering unusually high profits in low-tax jurisdictions, which they took as an indicator of income shifting practices being deployed.
Income shifting
The analysis found there appeared to be a correlation between the number of foreign employees and the likelihood of income shifting occurring. What’s more, these companies also appeared to record fewer unrecognized tax benefit reserves on their financial statements, which the authors believe suggests that they’re confident that they won’t be investigated by the IRS for their practices.
“Think of it this way: If a company only has a few employees in a low-tax jurisdiction and claims a huge profit there, the IRS is likely going to single that company out – the amount of profit is out of scale with the size of the operation,” the researchers conclude. “But if a company has a lot of employees in that jurisdiction, the profits appear more reasonable, and the relevant business activities are less likely to get singled out by the IRS for a rigorous audit.”
“One of the takeaways here is that the tax code effectively encourages companies to increase the percentage of their employees who work in foreign jurisdictions that have low tax rates. Not just because of a higher U.S. tax rate, but because the company is better able to substantiate the economic substance of their transactions, resulting in a higher likelihood of defending these aggressive tax planning activities in an IRS audit.”
