Tax...Evasion vs. Avoidance?

The word tax makes most people shudder.  Everyone knows and understands why we pay a percentage of our hard earned money to the Government, but nevertheless the majority of us don’t like it.  Well surely, this is applicable to the business world.  The profits produced by an organisation’s time, effort, capital and resources, is often issued with a 25% corporation tax bill (HMRC, 2012) from the UK government.  Is that fair? Well obviously some corporations don’t agree, hence the existence of Tax Evasion and Tax Avoidance.

Tax revenues are the lifeblood of democratic government and the social contract, but the majority of multinational businesses have been structured so as to enable tax avoidance in every jurisdiction in which they operate.

(Christensen and Murphy, 2004).

Tax avoidance is a legal way of structuring a business in order to avoid paying the highest tax percentage, without breaking the law.  A prime example of a popular way of avoiding tax, is the use of an off-shore ‘tax haven’.  Certain multinational corporations make use of a ‘holding company’, whose headquarters are located in a tax haven. By the use various methods, organisations can conduct business around the globe, yet save paying high tax premiums by filtering money into the holding company.  This sounds very ‘Dell Boy’, but as long as it is done correctly, there is no law being broken.  There are many different types of Tax Havens, a country offering 0% income tax (such as the British Virgin Islands) will benefit certain companies, however a complete tax exemption for all international business operated by non-residents (such as Seychelles) will attract other companies.  For more information on offshore jurisdictions visit:

http://www.offshorebvi.com/offshore.company.providers/choosing.offshore.jurisdiction/

By avoiding tax (legally, of course), surely a company will benefit from increased profits, which in turn will be passed on to shareholders of the company, who are anyone who has invested in the company, such as me or you. So what is the problem, the only one losing is out is the Government, because they can’t get their grubby little hands on the money. Isn't it?

No, not at all, the graph below shows 66.26% is free floating shares that are available to general public.  Yet the 21.66% shows long term strategic holdings by investment banks or institutions seeking a long term return.  These institutions will have large stakes in numerous large corporations, thus benefiting hugely by the increase in dividend payments.  Is this wealth creation or corporate abuse?



 Source: How Corporate Ownership Affects Trading Costs in the Case of UK Firms (2009)

Referring back to the Government point made earlier. Surely, if the Government lose out on potential revenue (from taxes), then the secondary looser is in fact, the UK population. With less corporation tax revenue, the Government will either have to find additional revenue or make cut backs to spending.

Tax evasion is a much more serious act.  The illegal practice where a corporation intentionally avoids paying its true tax liability (Investopedia, 2012). Whoever found guilty on charges of tax evasion are subject to criminal charges, substantial penalties and more often than not, imprisonment.

India have recently been in the business media spotlight, due to 'seismic corruption and rampant tax evasion. With 645 million inhabitants living below the poverty line, India is not the first country when you think of corporation tax.  However, a major problem with India, is the rich are getting richer and the poor getting poorer, which is primarily down to tax evasion.

India is subject to $500 billion illegally deposited in tax havens. This often occurs when money is taken to Dubai/Singapore etc, transferred to Swiss bank accounts and the routed the British Virgin Islands or other tax havens.  India's top corruption official blames not only his rich countrymen but also the 'bureaucratic hurdles' created by overseas financial centres.



An interesting report conducted regarding why American business owners are moving to tax havens.

http://www.cbsnews.com/8301-504803_162-20047260-10391709.html

And finanlly, Geoffrey Colin Powell (a former economic adviser to Jersey), defines a tax haven as:

The existence of a composite tax structure established deliberately to take advantage of, and exploit, a worldwide demand for opportunities to engage in tax avoidance.



Well surely, anyone deliberately aiming to avoid tax, is actually evading tax?

Raising Capital...

When a company (listed on a stock market) has potential investment opportunities yet does not have enough internal capital, it has two main options; Equity finance or Debt finance.  This raises one of the most challenging decisions facing financial managers.  With both options presenting pros and cons, which one should a manager choose and why? 

Equity finance, this raises capital by obtaining capital from investors in exchange for an ownership share of the business.  This capital can come from a wide variety of investors, such as competitors, banks, capital investors, wealthy individuals etc.  The beauty of raising capital in this way is that businesses are not obligated to repay the money back.  However, there is the small issue of handing over a percentage of the business for this capital, thus giving investors ‘a say’ in business decisions.  The use of apostrophes around the words, a say, is because it depends on a certain factors.  Including what type of shares owned by the investor, the percentage of shares owned by the company etc.  51 per cent ownership gives control of the business, so as long as the company itself owns 51 per cent of the majority then they can continue to make the key business decisions.  An additional drawback includes the topic of tax.  In the UK, capital gains tax can apply to investors.  Firstly, the company is taxed on its profits, after this the business is left with its net profit, which it can decide whether to use to issue dividends.  However, once dividends are paid to the investors, this is then taxed again under income tax, and finally, if an investor wishes to sell his/her shares they will be subject to capital gains tax.  Is all this taxing of the same money necessary? That’s a topic for another day…

Back in December 2011, Zynga, a US game company, announced plans for a stock market floatation.  According to the BBC, the firm plans to sell 100 million shares (14.3% of the company), valuing the company as much as $9.04bn.  Zynga have opted to raise capital in order to pursue future investment opportunities.  The minimal 14.3% is no way near enough to risk a takeover, thus still leaving Zynga with the controlling power. 

Having only been listed on the NASDAQ stock exchange for 3 months, Zynga have seen their share price climb to $14.55, a $4.55 premium over the IPO in December.  However, on the day the social games developer reported record revenues in its first earning report as a public traded company, its shares fell 17.8 per cent. Why is this? Record profits yet a fall in share price?  The main reason being is the stock market had expected more.  The stock market had obviously overreacted in relation to the share price, and when the announcement came about regarding record profits, this was not what the stock market were expecting, thus the fall in share price.  Zynga, have performed well and this fall in share price is not their fault.  The stock market has therefore begun to deflate the share price, moving it closer to the ‘fair value’ price.  In regards to ‘Efficient Market Hypothesis’, does this show semi strong form efficiency?  Well yes, course the mistake initially does not help the argument, however upon the news regarding profits; the market reacted quickly and rationally.

Malcolm Walker, CEO of Iceland, has 42 days (from 2^nd Feb 2012) until he and his management team lose their pre-emption rights to purchase additional shares.  Malcolm Walker and his management team currently own 23 per cent of Iceland, yet could lose controlling power of their corporation if they do not match the final offer from one of two private equity firms (Bain Capital and BC Partners).  This is all down to Landsbanki (Iceland’s largest bank) coming into financial difficulty, thus selling its 67 per cent stake in Iceland.  How will Malcom Walker and team raise capital? The equity finance option is unavailable, due to by releasing more shares, he will dilute his percentage held.  Therefore, he is turning to his friends and family, and asking them to purchase shares and in turn hand over voting rights/control back to the CEO and managers.

The raising of capital will always be a difficult decision for owners and managers.  No one likes the thought of debt and the main way of avoiding debt, is by selling percentages of your company, thus losing some control.  



The complex world of the Stock Market

The value of shares… What do they reflect?

The biggest news in the investing world currently is Facebook.  Mark Zuckerberg  (CEO) founded the idea eight years ago and this empire is soon to be floated.  Mr Zuckerberg was proposing a valuation of Facebook at $100 billion.  However, Facebook’s privately traded shares have apparently risen 10 percent since the social networking company filed for an IPO.  According to SharesPost Inc, this percentage increase has pushed the potential market value past the $100bn mark.  So where has this 10 percent increase come from?

Facebook have not produced any ‘good’ news or bad news; yet have experienced a positive share price movement.  Normally this would be accountable to an information leak, however my personal opinion is that Facebook shares are increasing in the hope that they will be a sought-after commodity once the company is floated. 

Does this show stock market inefficiency? Well no not really.  The shares have yet to be floated on the stock market, so surely it cannot be compared to that theory.  What does this increase in share price show? Lets take a similar situation.  Back in 2004, Google Inc. went public and issued shares.  Since then the share price has increase eight-fold.  With this as Facebook’s nearest comparable, investors must be hoping for a similar highly profitable story with the ever-growing social network company. 

Will this increase hold out? This depends on the amount of shares issued by Facebook themselves.  The final amount of shares to be issued is still yet to be confirmed, but information has estimated it to be around the 2.33 billion.  However, if the number reduces, this could cause the share price to increase due to a diluted amount of shares available.  On the other hand, a saturation of shares could reduce the share price. 

What would Warren Buffett do? The self made billionaire has made is fortune by investing when no one else dares.  I think Facebook is not even in his peripherals due to the sheer media coverage and minimal potential returns.  Undervalued shares are what Mr Buffett is on the prowl for in the investing world.

Undervalued shares… how does this come to be?  Well, an example is that of the merge between Xstrata and Glencore.  The newly merged firm would be worth $90bn, with Xstrata accounting for $39bn (BBC Business New, 2012).   However, two of Xstrata’s major shareholders are voicing that they believe this undervalues their shares.  The valuation of Xstrata therefore does not adequately reflect the share price warranted by these two major shareholders.

ARM's Strength

When comparing the use of shareholder wealth maximisation vs. profit maximisation, the benefits are clear.  Shareholder wealth maximisation increases the ability for manager to focus on the long term future of the business, against the myopic [short term] view that profit maximisation can often encourage.  Nevertheless, profit maximisation can in turn fuel the success of shareholder wealth maximisation, as well as other elements, such as increasing sales, increasing market share, etc.  However, shareholder wealth maximisation is an interesting use of words.  The term wealth can be interpreted differently, especially in regards to shareholders.  Do they believe that the company they have invested their hard earned money into, should pay them proportions of the company’s profits? Or, alternatively, invest the profits wisely in order to generate greater value for their shares? 

In 2008 ARM Holdings, currently the world's leading semiconductor intellectual property supplier, celebrated the 10 billionth processor chip shipped.  Since then, ARM’s shares have outperformed their industry.  With some people calling it the ‘iPad effect’, ARM can partially thank Apple's iPhone and iPad for their recent success, with ARM recently declaring that annual profits jumped to £157m from £110m.  However, one of ARM’s biggest threats is that of Intel (the world’s largest semiconductor chip maker, based on revenue) declaring potential entry into the mobile phone industry with a partnership with Google.

“ARM's strategy is for our technology to gain market share in long-term structural growth markets, such as mobile phones, consumer electronics and embedded digital devices.”

With no mention of shareholders, one would wonder why invest.  However, surely an increase in market share will increase share price and in turn shareholders' are happy, yes? No!!! ARM holdings are adopting a 'growth stratergy', which aims to increase sales/revenue, capture market share and beat the competition.  By focusing too much into gaining market share, ARM holdings could be neglecting such elements as profit margins. This combined with the type of industry ARM are in, which requires vast amounts of capital expenditure due to high R&D costs and costly high tech machinery, could leave ARM with reduced capital, increased debts and additionally falling share price. 

Nevertheless, a picture speaks a thousand words.  Since 2008, ARM Holdings plc has clearly outclassed its industry.



(London Stock Exchange, 2012)



However, with the recent success of ARM, share prices have increased a further 7pc with the news that;

Steve Ballmer, Microsoft’s chief executive, announces plans to base the next generation of Microsoft’s Windows operating system on microchips designed by ARM.

Does this all sound too good to be true?  I think so.  I believe the share price of ARM maybe accountable to 'valuation premium'.  An article published by Morningstar states that the research that Brain Colello has carried out, shows the market is overvaluing ARM Holdings.  Mr Colello believes that the firms profitability could come crashing down if ARM does not live up to their lofty expectations.

As I have stated previously, Intel are the main threat to ARM.  Intel are taking a slightly different approach with regarding the development of chips for mobile handsets.  While ARM's directors and financial managers are investing in the R&D and technology for more processing power, Intel are striving for a more energy efficient chip.  With such powerful and dominant forces going head to head in one of the most lucrative markets, this will be an interesting few years for ARM.