Some of the largest companies around the world operate in multiple locations. This allows them to take advantage of wider markets, cheaper transport and of course, lower taxes. In many cases, we see companies selling in one country, but locating their Headquarters in another, where tax rates are cheaper and hence their tax bills are lower. Much criticism has been levelled at such companies, who are accused of not paying their fair share in tax. There has been a crackdown on these companies and the UK is playing a leading role in this tightening of tax laws. Google is the latest company to face a large payment in backdated taxes.
This is a company with a complex structure, which has involved Bermuda as a key location, with its zero rate of corporation tax and a Irish European base. Though locating its business in different countries is legal, it has now agreed to pay HMRC £130 million in back taxes from 2005, following a 6 year investigation. Google will also change its accounting system such that it pays more tax in Britain for sales in this country.
Google may be the first in a line of companies making such changes to its accounting practices following a global drive to tackle the low levels of taxes paid by these large companies. This change in tax rules may bring welcome relief to government coffers, though criticisms remain about the ‘real’ figure that Google owes. As an example of this: in 2013, Google’s UK revenues were $5.6bn. Yet it only paid £20.5m in tax on its UK profits. The Head of Google Europe, Matt Brittin said:
“The rules are changing internationally and the UK government is taking the lead in applying those rules so we’ll be changing what we are doing here. We want to ensure that we pay the right amount of tax.”
Mr Brittin was clear in saying that these back dated taxes are not evidence that they had been paying too little tax in previous years. He confirmed that they were abiding by tax laws at the time and that tax laws are now changing and hence so will the amount of tax they pay. He continued:
“I think there was concern that international companies were paying only in respect of profits that they make and those were the rules and the pressure was to see us pay in respect of the sales we make to UK customers – and the same for other companies…So, we are making a change because we want to continue to comply with the rules and the rules are changing.”
As the push to tighten tax laws changes, with firms paying more tax on sales as well as profits, we may observe more companies changing their accounting structures. The OECD has taken a big step in simplifying international tax laws and the coming years will tell us just how big an impact this will have and whether companies such as Google will face tax bills in other European countries as well. The following articles consider this taxing matter.
Google agrees £130m UK tax deal with HMRC BBC News, Kamal Ahmed (23/01/16)
Google strikes £130m back tax deal Financial Times, John Gapper (22/01/16)
Google strikes deal with UK tax authority Wall Street Journal, Sam Schechner and Stephen Fidler (23/01/16)
Google agrees to pay HMRC £130m in back taxes The Guardian, Kevin Rawlinson (23/01/16)
Google tax labelled ‘derisory’ by Labour’s John McDonnell BBC News (23/01/16)
Google to pay £130 million UK back taxes, critics want more Reuters, Tom Bergin (23/01/16)
Google to pay UK £130m in back taxes The Telegraph (22/01/16)
Google says it will pay £130m in back taxes Independent, Adam Barnett (23/01/16)
Google ‘agrees’ to pay £130m in extra UK tax after outrage when it coughed up just £20m on UK sales of nearly £4bn Mail Online, Imogen Calderwood (22/01/16)
Google agrees to pay $185 million in UK tax settlement Bloomberg, Brian Womack (23/01/16)
Questions
- What is the difference between a tax on sales and a tax on profits?
- How can companies legally avoid tax? Do you think they have a moral duty to pay tax?
- If firms face higher rates of taxation, how will this affect their costs and profits?
- Why are the larger multinationals, such as Google more able to engage in tax avoidance schemes?
- Do you think the problem of tax avoidance is one of the negative consequences of globalisation?
- Is the criticism about the ‘low’ amount of taxes paid to HMRC justified?
- The OECD has taken a leading role in tightening international tax policy. Do you think this will negatively impact the competitiveness of the global market place?
- What are the costs and benefits to a country of having a low rate of corporation tax?
On Monday 23rd November, the US based pharmaceutical business Pfizer (producer of Viagra) announced that it had reached a $160 billion deal to acquire the Irish based pharmaceutical business Allergan (producer of Botox). If it is successful it will be the third largest deal in takeover history.
In a previous blog on this website a number of reasons were discussed to explain why businesses may engage in mergers and acquisitions (M&As) Are large mergers and acquisitions in the interests of the consumer . These include market power, access to growing markets, economies of scale and reducing x-inefficiency. One of the interesting things about the Pfizer and Allegan deal is the importance of another factor that was not discussed in the article – tax avoidance.
Rates of corporation tax vary considerably between countries and may deter some businesses from operating in the US where it is at the relatively high level of 35%. This compares with a rate of 20% in the UK, 12.5% in Ireland and 0% in Bermuda. The global average rate is 23.7% whereas the average across EU countries is 22.2%.
However, a far bigger incentive for a US firm to merge with or acquire businesses in other countries is the unusual way the US authorities tax profits. Most countries use a territorial system. This means that tax is only paid on the profit earned in that country. For example if a UK multinational business has subsidiaries in other countries it only pays corporation tax in the UK on profits earned in the UK. The profits earned by its subsidiary businesses would be taxed at the rate set by the government in the country where they were located.
The US authorities use a worldwide system. This means that profits earned by a subsidiary in another country are also taxed in the US. This is best explained with the help of a simple numerical example.
Assume a US multinational earns $100,000 in profits from a subsidiary based in Ireland. These profits will be taxed in Ireland at the rate of 12.5% and the company would have to pay $12,500 to the Irish government. If that profit was returned to the US it would be taxed again at a rate of 22.5%: i.e. 35% – 12.5%. The company would have to pay the US authorities $22,500.The worldwide system means that the total rate of tax paid by the firm is 35% but it is split between two different countries. If the territorial system was used, the firm would only pay the $12,500 to the Irish government.
So how could M&As change things? If an M&A enables a US multinational business to change its country of incorporation (i.e. move the address of its headquarters) from the US to another country that operates a territorial system its payments will fall. This is sometimes referred to as tax inversion. As the Bloomberg columnist Matt Levine stated:
If we’re incorporated in the U.S., we’ll pay 35 percent taxes on our income in the U.S. and Canada and Mexico and Ireland and Bermuda and the Cayman Islands, but if we’re incorporated in Canada, we’ll pay 35 percent on our income in the U.S. but 15 percent in Canada and 30 percent in Mexico and 12.5 percent in Ireland and zero percent in Bermuda and zero percent in the Cayman Islands.
As a result of the merger with Allergan, Pfizer will move the address of its headquarters to Ireland even though its global operations and executives will still be based in New York. It has been estimated that this will generate a one off tax saving of $21 billion as Pfizer would avoid having to pay US taxes on $128 billion of profits generated by its non US subsidiaries.
A number of US politicians have condemned the proposed deal. For example Hilary Clinton stated:
This proposed merger, and so called inversions by other companies, will leave US taxpayers holding the bag.
Twenty US companies have moved their headquarters to countries that operate a territorial system of taxation since 2012. These include Burger King’s move to Canada and Medtronic’s move to Ireland.
The US government has tried to tighten the rules but the two major parties disagree about how to deal with the problem.
Articles
Pfizer Seals $160bn Allergan deal to create drugs giant BBC News,(23/11/15)
Pfizer’s $160bn Allergan deal under pressure in the US BBC News,(24/11/15)
Pfizer set to buy Allergan in $150bn historic deal The Telegraph,(23/11/15)
Pfizer and Allergan poised to announce history’s biggest healthcare merger-corporate-tax The Guardian,(22/11/15)
Pfizer takeover: what is a tax inversion deal and why are they so controversial? The Guardian,(23/11/15)
Questions
- The newly merged business would jump above Johnson and Johnson to become the world’s largest biotech and pharmaceutical company in the world. Who are the other biggest eight Biotech and pharmaceutical businesses in the world?
- What exactly is a subsidiary? Give some real-world examples.
- How have the US authorities changed the rules in an attempt to deter tax inversions?
- Assume that a US multinational makes $1 million profit in the US and $1 million profit from its subsidiary in Ireland. Explain how changing its country of incorporation from the US to Ireland will alter the amount of corporation tax that it has to pay.
If you ask most people whether they like paying tax, the answer would surely be a resounding ‘no’. If asked would you like to pay less tax, most would probably say ‘yes’. Evidence of this can be seen in the behaviour of individuals and of companies, as they aim to reduce their tax bill, through both legal and illegal methods.
Our tax revenues are used for many different things, ranging from the provision of merit goods to the redistribution of income, so for most people they don’t object to paying their way. However, maintaining profitability and increasing disposable income is a key objective for companies and individuals, especially in weak economic times. Some high profile names have received media coverage due to accusations of both tax avoidance and tax evasion. Starbucks, Amazon, Googe and Apple are just some of the big names that have been accused of paying millions of pounds/dollars less in taxation than they should, due to clever (and often legal) methods of avoiding tax.
The problem of tax avoidance has become a bigger issue in recent years with the growth of globalisation. Multinationals have developed to dominate the business world and business/corporation tax rates across the global remain very different. Thus, it is actually relatively easy for companies to reduce their tax burden by locating their headquarters in low tax countries or ensuring that business contracts etc. are signed in these countries. By doing this, any profits are subject to the lower tax rate and are thus such companies are accused of depriving the government of tax revenue. Apple is currently answering questions posed by a US Senate Committee, having been accused of structuring its business to create ‘the holy grail of tax avoidance’.
Many may consider the above and decide that these companies have done little wrong. After all, many schemes aimed at tax avoidance are legal and are often just a clever way of using the system. However, in a business environment dominated by the likes of Google, Apple and Amazon, the impact of tax avoidance may not just be on the government’s coffers. Indeed John McCain, one of the Committee members asked:
…Couldn’t one draw the conclusion that you and Apple have an unfair advantage over domestic based corporations and companies, in other words, smaller companies in this country that don’t have the same ability that you do to locate in Ireland or other countries overseas?
The concern is that with such ability to avoid huge amounts of taxation, large companies will inevitably compete smaller ones out of the market. Local businesses, without the ability to re-locate to other parts of the world, pay their full tax bills, but multinationals legally (in most cases) manage to avoid paying their own share. With a harsh economic climate continuing globally, these large companies that aim to further increase their profitability through such means as tax avoidance will naturally bear the wrath of smaller businesses and individuals that are struggling to get by. It’s likely that this topic will remain in the media for some time. The following articles consider some of the companies accused of participating in tax avoidance schemes and the consequences of doing so.
Is Apple’s tax avoidance rational? BBC News, Robert Peston (21/5/13)
Apple’s Tim Cook defends tax strategy in Senate BBC News (21/5/13)
Senator accuses Apple of ‘highly questionable’ billion-dollar tax avoidance scheme The Guardian, Dominic Rushe (21/5/13)
Apple’s Tim Cook faces tax avoidance questions Sky News (21/5/13)
EU leaders look to end Apple-style tax avoidance schemes Reuters, Luke Baker and Mark John (21/5/13)
Apple Chief Tim Cook defends tax practices and denies avoidance Financial Times, James Politi (21/5/13)
Apple CEO Tim Cook tells Senate: tiny tax bill isn’t our fault, it’s yours Independent, Nikhil Kumar (21/5/13)
Miliband promises action on Google tax avoidance The Telegraph (19/5/13)
Google is cheating British tax payers out of millions…what they are doing is just immoral’: Web giant accused of running ‘scandalous’ tax avoidance scheme by whistleblower Mail Online, Becky Evans (19/5/13)
Multinational CEOs tell David Cameron to rein in tax avoidance rhetoric The Guardian, Simon Bowers, Lawrie Holmes and Rajeev Syal (20/5/13)
Fury at corporate tax avoidance leads to call for a global response The Guardian, Tracy McVeigh (18/5/13)
Questions
- What is the difference between tax evasion and tax avoidance? Is it rational to engage in such schemes?
- What are tax revenues used for?
- Why are multinationals more able to engage in tax avoidance schemes?
- Is the problem of tax avoidance a negative consequence of globalisation?
- How might the actions of large multinationals who are avoiding paying large amounts of tax affect the competitiveness of the global market place?
- Is there justification for a global policy response to combat the issue of tax avoidance?
- What are the costs and benefits to a country of having a low rate of corporation tax?
- How would a more ‘reasonable’ tax on foreign earnings allow the ‘free movement of capital back to the US’?
Original post
Starbucks’ UK sales in 2011 were worth £398m. Costa’s UK sales were worth £377m. But while Costa paid £15m in corporation tax in 2011/12, Starbucks paid nothing! In fact since opening its first coffee shop in the UK in 1998 it has paid just £8.6m in taxes on UK sales of £3bn.
How is this possible? Let’s look at Starbuck’s 2011 UK sales. Even though these were worth £398 million, its costs were recorded as £426.2m, giving a loss of £28.2m. Costa, by contrast, reported a taxable profit of £49.7m.
So is Starbucks a commercial failure in the UK, recording year after year of losses? Not at all. Starbucks regards the UK as a highly profitable part of its business. As the Independent article below states:
…in its briefings to stock market investors and analysts during the past 12 years, Seattle-based Starbucks has consistently stated that its UK unit is “profitable” and three years ago even promoted its UK head, Cliff Burrows, to run its vastly larger US operation.
So how can reported UK losses be reconciled with a profitable UK operation? The answer lies in transfer pricing.
Transfer pricing refers to the prices a company charges itself when goods or services are transferred within the company but from one country to another. By varying the transfer prices, a company can choose where to make its profits. Thus if Starbucks’ US operation charges high prices to its UK operation for various services, such as royalties for the use of branding or for management services, or lends money to its UK operation at high interest rates, Starbucks’ profits will rise in the USA and fall in the UK.
Companies employ tax advisers (see for example) and ‘transfer pricing managers’ to help them move their profits from high tax countries to low tax countries. In Starbuck’s case, by charging its UK operation high prices for such things as ‘use of its logo’ it has chosen to move all its profits out of the UK and thus avoid UK corporation tax.
Apart from denying the UK government tax revenues, the practice by Starbucks distorts competition as competing UK companies, such as Costa, AMT, Caffè Ritazza and the many small independents, do not have the same opportunity for transfer pricing and do pay UK corporation tax. As the Guardian article by Richard Murphy below states:
We do have homegrown coffee shops in the UK. A lot of them. And they have to pay their taxes in full here in the UK. They can’t make payments to offshore entities for the use of their logos or advice on how to add hot water to coffee just to avoid tax: they have to pay in full on what they earn in this country. What Starbucks is doing may be legal, but what it also shows is that business does not operate on a level playing field in the UK.
And, as some of the articles below demonstrate, it’s not just Starbucks. Amazon, Facebook and Google have also been accused of avoiding taxes in the UK by engaging in forms of transfer pricing.
Update
On 12 November senior executives from Starbucks, Google and Amazon appeared before the House of Commons Public Accounts Committee to give evidence on their non-payment of corporation tax and their apparent lack of profits in the UK. As you will see from the videos, the MPs were unimpressed by the answers they received.
At the G20 finance ministers meeting in Mexico the previous week, George Osborne, the UK Chancellor, and Wolfgang Schäuble, the German Finance Minister, called for “concerted international co-operation to strengthen international tax standards that at the minute may mean international companies can pay less tax than they would otherwise owe”.
There seems to be mounting international pressure on multinationals to cease using transfer pricing as a means of avoiding paying taxes. Whether it will be successful remains to be seen.
Further Update (June 2013)
In June 2013, After continuing criticism of its tax avoidance policies, Starbucks agreed to pay £10m in corporation tax tin 2013/14 and a further £10m in 2014/15.
Articles for original post
Starbucks UK tax bill comes under scrutiny The Telegraph, Helia Ebrahimi (15/10/12)
Good bean counters? Starbucks has paid no tax in UK since 2009 Independent, Martin Hickman (16/10/12)
Special Report: How Starbucks avoids UK taxes Reuters, Tom Bergin (15/10/12)
Business Starbucks ‘paid no UK income tax’ since 2009 Channel 4 News (16/10/12)
Starbucks ‘paid just £8.6m UK tax in 14 years’ BBC News, Vicki Young (16/10/12)
Starbucks’ tax payment is ‘unfair’ say independent cafes BBC News, Joe Lynam (16/10/12)
Starbucks ‘paid just £8.6m UK tax in 14 years’ BBC News (16/10/12)
What the Starbucks tax expose means for ordinary companies Tax Research UK, Richard Murphy (16/10/12)
Starbucks ‘pays £8.6m tax on £3bn sales’ The Guardian, Simon Neville (15/10/12)
How much tax do Starbucks, Facebook and the biggest US companies pay in the UK The Guardian Datablog (16/10/12)
Amazon: £7bn sales, no UK corporation tax The Guardian, Ian Griffiths (4/4/12)
Facebook criticised for £238,000 UK tax bill last year BBC Radio 1 Newsbeat, Dan Cairns (11/10/12)
U.S. Companies Dodge $60 Billion in Taxes With Global Odyssey Bloomberg, Jesse Drucker (13/5/10)
EBay ‘pays £1.2m in UK tax’ on sales of £800m BBC News (21/10/12)
Articles for update
Starbucks, Google and Amazon grilled over tax avoidance BBC News (12/11/12)
Companies have ‘social responsibility’ to pay tax BBC Today Programme (12/11/12)
MPs slam Starbucks, Amazon and Google on tax Reuters, Tom Bergin (12/11/12)
A highly taxing session for the men from Amazon, Google and Starbucks The Guardian, Simon Hoggart (12/11/12)
Starbucks is leeching tax revenue from UK The Telegraph, Lord Myners (12/11/12)
UK and Germany agree crackdown on tax loopholes for multinationals The Guardian, Patrick Wintour and Dan Milmo (5/11/12)
Britain, Germany target tax from multinationals Deutsche Welle (5/11/12)
HMRC unable to stop multinational tax avoidance accountancylive, Sharon Khin (6/11/12)
Starbucks ‘planning changes to tax policy’ BBC News (3/12/12)
Articles for further update
Starbucks pays UK corporation tax for first time since 2009 BBC News (22/6/13)
Starbucks pays corporation tax, promising the Exchequer £20m over two years IndependentHeather Saul (2/6/13)
Starbucks pays first tax since 2008 The Telegraph, Kamal Ahmed (22/6/13)
Report of Public Accounts Committee
Tax avoidance by multinational companies UK Parliament (3/12/12)
Questions
- Explain how a multinational company can use transfer pricing as a means of reducing its overall tax liability.
- Why may transfer pricing lead to an inefficient allocation of resources?
- What policies can governments adopt to clamp down on the use of transfer pricing to limit their tax liability in their country?
- What insights are shed by game theory in explaining why it may be very difficult to reach international agreement to clamp down on tax avoidance?
- Is it immoral for companies to seek to minimise their tax liability? What are the limits of economics as a discipline in establishing an answer to this question?
The Chancellor of the Exchequer, George Osborne, delivered the annual Budget on 23 March. He was very keen to have a ‘Budget for growth’ given the pessimism of consumers (see Table 1, UK, line 3, in Business and Consumer Survey Results, February 2011) and the bad news on inflation (see 4.4% and rising?).
But what could he do? Despite being urged by the Labour opposition to stimulate aggregate demand by cutting the deficit more slowly, he ruled out this alternative. It would be perceived by markets, he argued, as a sign that he was ‘gong soft’ on the commitment to tackle the deficit.
If stimulating aggregate demand directly was out, the alternative was to use supply-side policy: to provide more favourable conditions for business by cutting ‘red tape’, providing tax incentives for investment, reducing regulations, simplifying tax, cutting corporation tax financed by tax increases elsewhere, creating 21 ‘enterprise zones’ and funding extra apprenticeships and work experience placements.
The links below give details of the measures and consider their likely effectiveness. Crucially, the Budget will be much more successful in encouraging investment if people think it will be successful. In other words, its success depends on how it affects people’s expectations. Will it help confidence to return – or will the impending tax increases and cuts on government expenditure only make people more pessimistic?
Webcasts
Budget: Chancellor George Osborne opens speech BBC News (23/3/11)
Budget: Osborne wants to ‘simplify taxes’ BBC News (23/3/11)
Budget: Osborne lowers corporation tax BBC News (23/3/11)
Budget: BBC Economics editor Stephanie Flanders BBC News (23/3/11)
Budget: BBC business editor Robert Peston BBC News (23/3/11)
Enterprise Zones on the way back Channel 4 News, Siobhan Kennedy (22/3/11)
Articles
Osborne’s Budget ‘to fuel growth’ BBC News (23/3/11)
A budget for big business BBC News blogs, Peston’s Picks, Robert Peston (23/3/11)
Budget 2011: tax grab is the real story Guardian, Patrick Collinson (23/3/11)
Budget 2011 – full details Independent (23/3/11)
Osborne shakes up corporation tax Financial Times, Vanessa Houlder (23/3/11)
Osborne unveils ‘Budget for growth’ Financial Times, Daniel Pimlott and Chris Giles (23/3/11)
Budget 2011: Guardian columnists’ verdict Guardian, Jackie Ashley, Martin Kettle, George Monbiot, Julian Glover (23/3/11)
Budget 2011: a million low-paid people escape tax but fiscal drag catches others The Telegraph, Ian Cowie (23/3/11)
Budget 2011: some good news and lots of micro-management The Telegraph, Janet Daley (23/3/11)
Micro trumps macro BBC News Blogs: Stephanomics, Stephanie Flanders (23/3/11)
George Osborne, growing giant of the Tory party, launches ‘slow burn’ Budget Guardian, Nicholas Watt (23/3/11)
Budget documents
2011 Budget, HM Treasury (23/3/11)
Budget 2011 press notice, HM Treasury (23/3/11)
2011 Budget documents, HM Treasury (23/3/11)
Questions
- What supply-side policies were included in the Budget?
- What will be the impact of the Budget measures on aggregate demand?
- What are the major factors that are likely to influence the rate of economic growth over the coming months?
- What would have been the advantages and disadvantages of a more expansionary (or less contractionary) Budget?
- What will be the effects of the Budget measures on the distribution of income (after taxes and benefits)?
Google may be the first in a line of companies making such changes to its accounting practices following a global drive to tackle the low levels of taxes paid by these large companies. This change in tax rules may bring welcome relief to government coffers, though criticisms remain about the ‘real’ figure that Google owes. As an example of this: in 2013, Google’s UK revenues were $5.6bn. Yet it only paid £20.5m in tax on its UK profits. The Head of Google Europe, Matt Brittin said:
