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Current time:0:00Total duration:6:47

Video transcript

let's say that I run a country or I run a company I should say that is based inside of the United States so this right over here is my company maybe I have some smokestacks of some kind so that is my company and it makes a million dollars in pre-tax profits 1 million dollars and this is before tax so pre-tax profits and let's say that the country that I'm in in the way I've drawn it this is the United States let's say at the time that I make those pre-tax profits the corporate tax rate is 35% 35% tax rate so it's pretty straightforward to think about how much taxes I would have to pay I would pay 35% on this 1 million dollars or essentially I would pay three hundred fifty thousand dollars in taxes three hundred and fifty thousand dollars in taxes and I would have six hundred fifty thousand left in profit so six hundred and fifty thousand left in profit now what I want to think about let's say my company wants to get little bit more creative about how it might save on taxes so what it does is it realizes that there's an island not too far off the US coast and directory several of them that has a substantive ly lower tax rate and I'm just picking it arbitrary but let's say it has a five percent a five percent corporate tax rate five percent tax rate so how can this company which is physically or for the most part based in this country somehow benefit from this lower tax rate that is happening offshore well what they'll typically do is set up another subsidiary one that this company owns and controls but it is set up in this little island nation so let's set it up right over here so that's the other company and what I'll do is it'll tend to give it maybe oftentimes it'll give it some intellectual property maybe patents trademarks things like that so it gets all of the intellectual property of the parent company so given given the intellectual the intellectual property and then what it can say is well and this is owned this is owned by the parent entity so I'll draw a little dotted line here it's owned and controlled by this country this company that's based in the u.s. and what they'll say is look we don't have a million dollar pre-tax profit anymore because we need essentially license the use of these tray of this of this intellectual property whether it's trademarks copyrights patents we got to pay this entity right over here some amount of money to use that intellectual property so let's say that they say we're going to pay them we're going to pay them I don't know eight hundred thousand dollars and this is essentially transfer pricing in theory one there's there should be a way of deciding what is the fair rate for that intellectual property but oftentimes that intellectual property is fairly unique so it's hard to determine a market rate which really just leaves this company decide it for itself so let's say let's decide let's go into that reality where instead of this reality this company before it had a million in pre-tax profits but now it's paying 800,000 in royalties and licensing to this entity right over here so out of that 1 million you have 800,000 going offshore you have 8 800,000 goes offshore and so the real pre-tax profit for this company now based on accounting for it this way based on paying this subsidiary that's offshore for use of the intellectual property the company now has six hundred K or I should say 200k in pre-tax profits 200k so that was before the licensing now this is after the licensing this is the new pre-tax number this is the new pre-tax number and so in the u.s. it would only pay 35% of the $200,000 instead of paying three hundred fifty thousand dollars in taxes it would now pay so it's no longer three hundred fifty in taxes 35% of two hundred case 70 K in taxes 70 K in taxes and the US I guess you could say parent company would show a profit of two hundred K minus the 70 K of one hundred and thirty thousand dollars so one hundred and thirty thousand I would call it net profit we could say post tax post tax profit and then this character right over here let's say it has very minimal cost let's say has no cost for a simplification it would have some to do some paperwork it would all of this would essentially be profit and you know maybe have a few thousand dollars in cost but we won't we'll ignore that for now so all of this would be its pre-tax profit it would have to pay five percent of it five percent in taxes to this to this country right over here so five percent of eight hundred thousand is forty thousand dollars so it would pay forty thousand in taxes to the government of this island right over here and then it would be left with the remainder seven hundred sixty thousand dollars so it would have seven hundred and sixty thousand I guess you could call that in its net profit after paying taxes net net profit so you can see here the company saved substantially on taxes it paid seventy thousand in the US and forty thousand abroad so it paid a total of a hundred ten thousand in taxes versus the three hundred fifty thousand it would have had to pay if it was based purely purely in the United States so you might say hey this is a great thing companies you know why even have an eight hundred thousand transfer price why not do a million and obviously if you do it a little bit too ridiculously it'll get more and more scrutiny so there's some balancing influence there and obviously if there is a market for this intellectual property or that type of intellectual property or if you are licensing to other people that might dictate what this is but you might say well why not do this night and day well the question is you now have this profit and it might be in the form of cash we go into other videos in more depth when it might not be but you have essentially this profit but you won't be able to get it back into the United States without paying a tax on it so if you want to get it back the United States and that's actually the check the reason why we do tax repatriation of funds is so that companies can't do this night and day essentially transfer profits abroad and then bring the cash back in in order to close this loophole that's why the repatriation of this funds are the repatriation of these funds are actually taxed and I'll let you think about and it obviously depends on what the transfer prices are and things like that but essentially in order what what this tax rate would have to be in order for a company to come out neutral but and there's other ways to getting around it and I'll other videos later so this of ways that this cache can be put to use and it still is not actually taxed