The recent outrage directed at companies like Amazon, Google and Starbucks is perplexing not because these companies are “exploiting” (i.e. using) the legal and tax framework of the European Union Single Market combined with normal international agreements on tax and trade, but because:
- National politicians seem to be fully ignorant of what these frameworks and rules are, and of their own role in creating them;
- Adequate safeguards against abuse exist, are available to HM Revenue & Customs, and would seem to be pretty easy to bring to bear in these cases.
The United Kingdom Public Accounts Committee recently grilled corporate executives on what they deemed to be abusive schemes whereby these companies paid little or no tax in the UK, whilst at the same time their UK executives were being promoted and their UK revenues and success were trumpeted in corporate reports.
The conclusions of the Public Accounts Committee demonstrated their ignorance of the business models of international corporations to an extent which is unacceptable. Particular structures that seemed alien to them were:
- That Google Ireland can act as principal towards advertisers in the UK, whilst employing its UK arm as its sales agent to close contracts with those advertisers. When an advertisement is placed, Google issues an invoice on its Irish letterhead to the customer, and then pays a portion of the invoice value to its UK arm as sales commission. This is the Commissionaire Sales Structure, very common for any dematerialised goods or service, and working just like the Avon cosmetics sales force: the salesperson works “on behalf of” the principal and gets a commission on what they sell;
- That Amazon UK pays away a large royalty out of the UK to an offshore company for the usage of the brand. Royalties for usage of a brand, a trademark, a recipe or other piece of intellectual product (like computer software) are a prime way of drawing income out of a subsidiary at the pre-tax level. All the better when the piece of intellectual product is unique and comparators for its value cannot easily be found.
It is then shocking that UK Public Accounts Committee members appear ignorant of the EU Single Market framework which is the basis of these structures: companies are permitted to establish themselves in any member state and have free access to trade in any other member state. A member state is not allowed to block or otherwise discriminate against a market participant on the basis that it is accessing the market from a different member state. There is no withholding tax on cross-border payments on royalties, interest and dividends within the EU, so that you can set up where you like and move your money around where you like.
That could be seen as an even playing field, but at the next level there is leeway for inter-Member State competition in tax policies that then causes anomalies: regulations always cause anomalies that create loopholes into which abuses throng.
EU member states set their own corporation tax rates. EU member states let their own corporation tax rates – Ireland has a mainstream rate of 12½%, attracting business models to set up there where the goods/service is dematerialised. Norton Anti-Virus download version is sold throughout the EU from Ireland, because the licence fee is then booked into Symantec’s Irish P&L.
EU member states can make their own special tax deals. EU member states can make their own special tax deals – the Netherlands has its Dutch Tax Ruling whereby a letter can be forthcoming that states a fixed amount of tax payable. It has resulted from a conversation about volumes, throughput, margins etc but those details do not appear as conditions in the letter: the amount of tax remains the same whatever the profit, thus acting as declining rate of tax as profits rise, a lure to multinationals.
EU member states can sign their own Double Tax Treaties with non-EU states. EU member states can sign their own Double Tax Treaties with non-EU states – the Netherlands has a very wide set of agreements that specify low or no withholding tax on cross-border payments on trade payments, royalties, and interest to and from countries outside the EU. The Netherlands is usually the country through which the flows to Netherlands Antilles, Barbados, Jersey etc are routed.
So it is the structure of the EU that has allowed companies to land their profits where they like, and that has allowed member states to set tax rates and sign deals with corporates and with other countries that bring Inward Investment to them, but deprive other member states of revenues. And there is a clear pattern: it is the little countries like Ireland, Luxembourg and Netherlands that benefit, and the big countries with money like UK, Germany and France that pay.
In surrendering the rights around and controls over these matters into the EU nexus, largely as a result of the Maastricht Treaty, we appear to be left weapon-less:
- no leverage over the domestic tax rates of other EU member states;
- no say in what special deals those countries can agree where tax rates go below the mainstream ones, e.g. a Dutch Tax Ruling;
- no say in what Double Taxation Treaties other EU member states sign, with whom, and with what alleviations in them.
But this isn’t true: the Revenue & Customs already have all necessary levers to prevent “abusive” or “odorous” exploitation of the structures, meaning where goods and services are supplied into the UK on an intragroup basis by related companies outside the UK at prices that are not “arm’s-length”.
“Arm’s-length” is the well-known guiding principle and has measures on all types of money flow except dividends – which have already been taxed:
Intragroup loans – not of such a size or duration that the borrower could not get the same loan from a bank and with interest and security terms that equate to what a bank would grant. An interesting current variation on this theme is that the Swedish tax authorities are looking at a loan to the Arlanda Express train operator from Macquarie Bank in Luxembourg that is for 35 years, unsecured, and costing 13% per annum. The company says this is bank interest and should all be tax deductible. The Swedish tax authorities are saying that this is a disguised intragroup loan and want to disallow the deduction of interest against Swedish tax, because the terms are implausible for an arm’s-length loan: too long, too high an interest rate, no security. Macquarie must have a cash deposit from the train operator and be acting to disguise an intragroup loan as a bank loan because no banker in his right mind would make this loan. Macquarie’s case is not helped by their being in Luxembourg to begin with and having no office in Sweden from which to do their credit assessment of the borrower (the logic being they need do not credit assessment if they have cash collateral);
Royalties – to be on a level comparable with other similar products. That is not so easy: this is the one where companies have the most flexibility e.g. Nestle rent the recipe for the Maggi seasoning product to their subsidiaries worldwide who manufacture it locally under licence. It is hard to test the licence fee against similar products because they aren’t any (thankfully);
Services – Google pays a commission to its UK subsidiary when the UK subsidiary acts as its sales agent. Is the commission level too low, deflating UK profits and inflating Ireland’s (which would be taxed at 24% and 12½% respectively)? Easy: the advertising industry contains millions of examples of third-party companies acting as sales agents so there is no difficulty in testing Google’s rates against third-party rate cards and determining the difference;
Goods – Starbucks sells the coffee into the UK from Switzerland at a “transfer price”. How easy is it to test that price? Very easy – from the Financial Times. How does the price compare with world coffee prices? Robusta is 111cts a pound today.
In both the Google and Starbucks cases it is very easy to get to a basic position of whether the transfer price looks to be “in the ballpark” or “odorous”, just like with the terms of the loan between Macquarie and Arlanda Express. Thirty-five years with no security is enough to discount that relationship as being arm’s-length.
Starbucks claimed they only added a twenty per cent mark-up in Switzerland so the goods must be fairly priced. That is no argument at all. It is possible that Switzerland was the last in a line of several related companies that bought and sold the coffee, in the same way that the claims by an oil company that “we make no money on UK petrol sales so we have to jack the price up” does not hold water, since the subsidiary for UK petrol sales will be the final link in a long line of subsidiaries from exploration, extraction, refining, tanker fleet etc, with a transfer price between each of them. The economic profit will have been crystallised into a re-invoicing vehicle somewhere in this supply chain, so as to show UK petrol sales as loss-making and justify price increases.
The mark-up on the incoming supply is not how HMRC should attack the transfer price. The attack starts at the price to the consumer of the output (£2.40 a cup), and then identifies and deducts all the costs that the UK operation has to incur in its process in order to convert the inputs including a bag of coffee into the saleable product – and a risk premium. The risk premium is the company profit, which then gets taxed at twenty-four per cent. Output revenues less process costs less profit = input costs. “Input costs” as regards the coffee is the maximum price that the UK operation can afford to pay for the coffee in order to both cover its costs and its risks. Under the assumption that the company is happy to trade in the UK because its risk/return is satisfactory, this computation will deliver the correct transfer price.
HMRC then build a model of the company profit and loss since start-up with the new transfer price compared to the one stated by Starbucks, apply it to the number of kilos of coffee supplied per annum, to derive the revised Starbuck UK profit for each year. Then the difference between each number and the one on Starbuck’s tax return for the respective year is the under-declared profit. Multiply that by the tax rate for the year and you have the unpaid tax:
- multiplied by interest for the interim period
- plus a fine
The tax demand is sent: Starbucks have to contest it from the position of needing to prove it is wrong. This power of Revenue & Customs is known as look-through. Same for Google: re-price the UK business as per an industry-standard advertising rate card, calculate the under-paid tax and send a demand with interest and a fine.
This is absolutely standard fare in this field. So what’s the problem? Have HMRC no idea how to apply their powers, or are the politicians – or are they pretending to be – completely unaware that this is the standard balancing act of international business: how much revenue drawn from wealthy countries with high tax rates can be legitimately shielded from current taxation via “transfer pricing” charged from countries with low-rate, zero-rate or no corporation tax, so as to build up a nest egg there.
So we can do something, which is maybe to tell Starbucks they overpriced the Robusta by $10cts a pound for the last 9 years, or tell Google that its commission rate should have been 9% and not 7%. Does that sort out the UK’s public sector deficit? No it doesn’t.
Particularly in the Google example the extra demand would be for twenty four per cent of two per cent of annual UK revenues, not twenty-four per cent of one hundred per cent. The structure of the EU allows Google to transact its basic business and create 85-90% of “added value” outside the UK but within the so-called Single Market, putting that 85-90% beyond the reach of Revenue & Customs. On the other hand the company concerned has full access to selling in the UK and taking a share of UK wealth with a minimal contribution to UK costs.
That is not shocking: it is the structure of the EU Single Market. What is shocking is that our politicians do not seem to grasp that it is the whole objective of the EU to enable this, and that they themselves, their predecessors, peers, acolytes and help-meets, who have conspired to create it.
Bob Lyddon, General Secretary, IBOS Association