International Taxation

(A discussion of other tax issues, including the performance of HMRC, may be found here. And you might like to follow this link to read a discussion of the regulation of the activities of the technology giants.)

2013 brought intense concern about the failure of large international companies, such as Amazon, Apple, Google and Starbucks, to pay their 'fair share' of UK profits taxes (Corporation Tax).

Most international treaties intended to avert double taxation originated from a time when the big multinationals had production centres planted in the ground that were creating value out of physically traded goods. Over the past two decades the internet has turned that reality on its head, disrupting the way goods and services are distributed and fuelling the growth of web-based groups such as Google and Facebook.  This revolution has been great for consumers, vastly increasing access to information and lowering the cost of goods. But it has also created a situation where some of the biggest companies in the world can choose where the taxable value they create is added and then domicile that value, quite legally, to where they will forfeit the least. This not only deprives governments of much income from sales within their realm, it has also proved open to abuse. It leaves some companies that, by the nature of their business are geographically stuck, at a disadvantage. It is also unfair to smaller businesses with sales confined within borders and that cannot shift profits to other jurisdictions.

Also by way of background, it is worth noting that tax evasion involves deliberately hiding income from the taxman. There was no suggestion that these companies did this. But tax avoidance takes many forms, some more reprehensible than others.

  1. Governments sometimes encourage us to avoid tax so as to encourage us to engage in particular activities. We are, for instance, encouraged to avoid tax by saving money in tax-free ISAs and National Savings, or by growing timber in forests.
  2. Other avoidance is reasonably legitimate. Intellectual property can for instance be held in a subsidiary in a low tax country, and other subsidiaries can be charged royalties for using the intellectual property, so reducing profits and taxes in high tax countries. And some countries (notably Ireland but also the UK) have made a point of encouraging tax avoidance by having lower company profits tax rates than their near neighbours, and so encouraging inward investment by companies such as Apple.
  3. But inappropriate transfer pricing is less acceptable. This takes the form of making unduly large royalty payments or other payments to low- or nil-tax subsidiaries. (The European Commission believe that the Irish Government actually approved such payments by Apple, and thus breached European Union State Aid legislation. Further detail is below.)
  4. Finally, some tax avoidance relies upon companies entering into very strange and complex transactions. These are arguably immoral although not illegal.

Legitimate Avoidance (2 above)

Companies argue, with some justification, that it is up to governments to do something about the second form of avoidance. For instance, companies could instead be made to pay unitary tax on the assumption that their UK profits are equal to their total worldwide profits multiplied by, say, the fraction of their worldwide sales that are made in the UK. One problem with this is that all major countries should ideally make the change at the same time, or else there would be a danger that each would use whatever tax system led to the highest local tax bill, thus increasing taxes in total. Anyway, it is a reasonable assumption that the US would lose heavily, so they are probably not going to agree to it, and would certainly retaliate by punishing UK companies if the UK went alone.

  • Nicholas Shaxson and Sol Picciotto explained unitary taxation very well in the FT in November 2012: 'Fortunately, a far better system is available: unitary tax. Instead of taxing multinationals according to the legal forms that their tax advisers conjure up, they are taxed according to the genuine economic substance of what they do and where they do it. Each company submits to the tax authorities of each country where it does business a "combined report" providing consolidated accounts for the whole global group, ignoring all internal transfers. The report specifies the group's physical assets, workforce and sales and the overall profits are then divided up among jurisdictions according to a formula weighing these three factors. This system would benefit everyone, particularly developing countries. Tax experts have long argued that this approach is better. It is proved, too: most US states already use it successfully for state taxes. The EU's proposal for a common consolidated corporate tax base goes a long way towards this, though its geographical focus should be expanded to require a worldwide combined report. It is possible to move towards unitary taxation without widespread international co-ordination, though that would certainly help.'
  • Google's Eric Schmidt disingenuously told the BBC in May 2013 that his view is "that you should pay the taxes that are legally required. If the British system changes the tax laws then we will comply. If the taxes go up we will pay more." Well - maybe! - but I would bet big money on Google lobbying very hard against any move to unitary taxation.
  • Google argues that it does not have a permanent establishment in the UK - a stance that hardly passes the smell test, given that it employs many thousands in the UK, including hundreds of software engineers.
  • There is some support, even in the US, for making companies such as Amazon pay US State sales taxes - and maybe even profits taxes - on a 'per click' basis. UK Value Added Tax (i.e. its sales tax) is already charged on this basis.
  • And Apple did not hesitate to bare its teeth when appearing before the US Congress in May 2013. Its Chief Executive, Tim Cook, in effect admitted that it had subsidiaries which were not resident in any country and so avoided paying any profits tax. Apple Operations Ltd had sheltered $30bn in profits over 5 years. But Mr Cook warned Congress that he had no intention of repatriating the $100bn held offshore unless the US cut its 33% tax rate. (The UK rate is reducing in stages to 17%.) Like Google's Eric Schmidt, Tim Cook insisted that Apple was acting 'in the letter and spirit of the law'.
  • Guy Whitehead, a senior HMRC official, said in 2015 that he had heard that the Treasury had an agenda not to "annoy" Amazon.
  • The Chancellor announced in his November 2017 Budget that he intended to require companies to withhold income tax (i.e. at 20%) from royalties etc. paid to companies in low tax jurisdictions. But he expected the tax yield to be only around £250m pa - and falling - so this probably wasn't as big a deal as at first seemed.
  • The Chancellor then announced a digital profits tax in 2018, but this too was estimated to bring in only £400m a year - though higher tax rates could bring in further revenue later on, if the tax appears to work well. The downside might be that the UK going alone might reduce the chances that there will be a Europe-wide or even global solution to this problem.

Inappropriate transfer pricing (3 above) is widespread, and regarded as legitimate by most companies and their advisors. The problem is that it is very hard to prove that the price is 'wrong' and HMRC are easily out-gunned by the highly paid and generously resourced economists, accountants and lawyers employed by the large multinationals. If HMRC were seriously to challenge even one multinational, they would need to spend on the scale of the Competition and Markets Authority - maybe £1 million or more per inquiry. No Chancellor is going to commit that sort of resource. Again, the only sensible answer is to probably to move to unitary taxation - see above.

But the European Commission is better resourced and has started using state aid law to tackle state-supported tax avoidance. The Financial Times reported in April 2016 that ' Apple’s chief executive, Tim Cook, [has] made a personal appeal to Ms Vestager [the EU's Competition Commissioner]. ... According to those briefed on the meeting, it was a heated, testy encounter. Mr Cook took aim at the “fairness” with which Ms Vestager conducts her cases — a point of pride for her — and argued that Brussels was pursuing a legally baseless raid on Apple’s $200bn international cash pile. ... The impassioned executive from Alabama seemed frustrated by the cool imperturbability of the Dane. She, in turn, resented his interruptions. Only days after Mr Cook’s visit, Jack Lew, the US Treasury secretary, and his team turned their ire on Ms Vestager. They accused the EU of conducting a crusade against tax avoidance that would set “disturbing international tax policy precedents” and argued that its methodology raised “serious concerns about fundamental fairness”. The thrust of the US allegation was that European probes into Apple, Amazon, Starbucks and McDonald’s unfairly singled out American companies. ...

In part, the sensitivity surrounding Apple is because of the sums at stake, with analysts estimating clawbacks of $8bn or even more. Politically, the fight cuts to the heart of discontent about the size of America’s offshore cash pile, and who will ultimately tax it. According to Moody’s, a credit-rating agency, the offshore balance for all US companies has ballooned to $1.1tn, with the largest shares belonging to Apple, Microsoft, Google, Cisco and Oracle. The Americans argue that European governments have no right to target most of this cash mountain, saying that the tax due on it is simply “deferred”. This means it is logged in the accounts of US companies and, at some unspecified date, will have to be repatriated for taxation.'

There was then much celebration, in some quarters, when the European Commission in September 2016 told Apple to pay €13 billion corporation tax to the Irish government. The Commission did not object to Ireland's very low tax rate (12.5%) but did object, using state aid legislation, to what appeared to be one-off deals between Apple and the Irish government, giving Apple a selective advantage not available to others. All Apple's European sales were routed via an Irish company where the the vast majority of the profits were allocated to a "so-called head office [which] existed only on paper ... It had no employees, no premises and no real activities" - and paid no tax anywhere in the world. The real Irish tax rate was therefore only 0.005% in 2014, according to the Commission.

Even More Artificial Avoidance (4 above)

Many companies also seem to have little hesitation before engaging in the fourth and most reprehensible form of tax avoidance. Accountants PwC are known to have created a seven-tier international corporate structure for at least one client so as to help it reduce its tax bill. And countries such as Luxembourg, the Cayman Islands and Bermuda do very nicely by hosting huge numbers of multinationals' subsidiaries which have no substantive presence whatsoever in those territories.

Are Sales Taxes the Answer?

There are certainly moves in this direction. Both the UK and French governments have announced that they intend to levy taxes on the digital sales revenues of Google, Amazon etc.. - at 2% (UK) and 3% - each raising a few £hundreds of millions a year.

Comment

More generally, this whole area is one where companies feel that they have a fiduciary responsibility to their shareholders to take all legal steps to minimize taxes and so maximize net profits. Google's Eric Schmidt made this point when talking to the BBC is May 2013. Sadly, he was not asked to explain where 'Do no evil' Google draws the line when considering the extent to which it will engage in controversial and arguable unethical tax avoidance. It is certainly the case that Google and others employ large numbers of experts who are tasked with reducing the company's taxes. And it is certainly not the case that Google will cheerfully accept HMRC's decisions as to the taxes that are payable.

It is also worth remembering that lower tax rates can lead to increased revenues if individuals or companies relocate in response. This seems to have happened in the UK after cuts in the highest rates of personal income taxes.

See also the Profits or Ethics?: a discussion of fiduciary duty in this web page.

There are interesting developments in corporate USA following President Trump's tax cuts and reversal of the bits of the American tax code that made it unattractive to repatriate profits from intangible assets such as brands and intellectual property. He has also legislated to require any company whose global tax rate is below a certain figure (initially 13.1%) to pay the difference to the US government. So there is now little point in other countries having even lower rates - at least if those low rates were intended to attract US investment.

 

 

Martin Stanley

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