UK government's 'Google Tax' on US tech firms will only tax credibility

Stuart Lauchlan Profile picture for user slauchlan September 29, 2014
Summary:
Political pledges to clamp down on tech tax avoidance plays well to the headline writers, but the UK government's plans need to be seen in a European context.

The luck of the Double Irish may be about to run out for US tech firms as the UK’s finance minister commits to clamping down on hugely unpopular tax avoidance mechanisms deployed by companies trading in the country.

taxes
The Double Irish is one of the (perfectly legal) mechanism by which US firms avoid paying larger amounts of tax in the UK. Basically companies generate revenue in the UK, but collect nearly all of the profits in Ireland.

The Irish government has used low corporate tax rates to stimulate inward investment for decades. Its current rate of 12.5% on company profits makes it one of the lowest in the European Union and this, combined with an English-speaking and skilled workforce, has made Dublin and its environs a magnet for US tech firms setting up on their European adventure.

But the tax advantages go further than that with that headline rate of 12.5% often just a topline theoretical figure. Irish company law and loopholes in US taxation legislation make for very comfortable bed fellows.

Hence, the Double Irish. Let's run through a typical instance in action. You're a US tech company operating in the UK. You trade there and generate sales there, but elect to attribute profits to an Irish subsidiary. You then set up a second Irish subsidiary and manage that  from the British Virgin Islands (BVI), Bermuda or some other tax haven with no corporation tax. Your Irish-based company then makes royalty payments to the second company and claims those payments as tax deductions in Ireland. Et voila - watch that tax bill shrink!

UK anger

It’s all perfectly legal but there has been mounting frustration in the UK about what is popularly percevied as tax evasion rather than legitimate tax avoidance. Facebook for example came under fire when it emerged it paid no corporation tax in the UK last year on declared revenues of £34.6million after it officially made a 2012 loss in the UK.

Facebook is not alone. The Financial Times newspaper this week higlighted seven US tech companies which sold $15 billion of goods and services to UK customers, but only cited £1.7 billion as UK turnover. In addition, those seven firms paid a grand total of £54 million UK corporation tax between them.

This has become a political hot potato in the UK with various executives dragged in front of angry legislators in the House of Commons for a dressing down. Google, for example, was attacked for tax arrangements described as “devious, calculated and ... unethical” while Margaret Hodge, chairman of the Commons Public Accounts Committee, said of Facebook's situation:

This is yet another example of what appears to be deliberate manipulation of accounts of economic activity to deprive the British taxpayer of a rightful tax contribution, according to the profits they make in the UK.

britain-politics-conservatives_lsn3027_45846069
George Osborne

In real terms though, there’s been no real action taken. But with a UK general election looming next May, it’s time for some tough talking by George Osborne, Chancellor of the Exchequer. Yesterday he took to the stage at the Conservative Party’s annual convention to grandstand and declare to the party faithful:

It is this pro-business Conservative Chancellor who says to some of the biggest technology companies in the world this today: you are welcome here in Britain with open arms.

You have the advantages of our skilled population, broadband connections to deliver your services and our NHS to keep your employees healthy. Advantages that have to be paid for, so while we offer some of the lowest business taxes in the world, we expect those taxes to be paid not avoided.

Some technology companies go to extraordinary lengths to pay little or no tax here. If you abuse our tax system, you abuse the trust of the British people and my message to these companies is clear.

We will put a stop to it: low taxes but low taxes that are paid - part of our effort to reduce the deficit.

Oh they loved that in Middle England, the Conservative Party electoral heartland that needs to get out and vote next May if there is to be a Conservative government.

They loved it in the mainstream media as well, where - encouraged off the record by Conservative party flacks - Osborne's announcement was dubbed the Google Tax! (Given the controversially close relationship between the Conservative party and Google in recent years, it'd be interesting to know how that sits with the latter...)

But what does it mean?

So with the front pages of today’s newspapers secured,  what’s actually going to happen?

Well, the answer to that is we don’t know yet. Apparently Osbrone will let us in on the plan in December. (Once he's worked it out, mutter the cynics.)

But for now, business groups warn that just picking on the US tech firms for some ‘tough’ headlines isn’t going to be enough.

Simon Walker, director general of the Institute of Directors, cautioned:

Tackling the perception that multinationals get a sweeter deal than the vast majority of businesses is the right thing to do, but can only be effective when combined with a radical simplification of the UK's sprawling tax code.

irish-tax-holiday
Whether Osborne needs to take action at all is a moot point as other authorities are already making their moves. The Organisation for Economic Co-operation and Development (OECD) has already put proposals on the table to force multinationals to reveal to tax authorities where they make their money and pay their taxes.

Meanwhile the European Union has made it clear that it sees this as a pan-European issue, not a single country matter. French President Francois Hollande said earlier this year:

We cannot accept that a certain number of companies can put themselves in situations where they escape paying taxes in ways that are legal. We must coordinate at a European level, harmonise our rules and come up with strategies to stop this.

France has already stepped up to the mark here. In April, French tax officials delivered to Google a "tax assessment" that could potentially force the company to pay as much as €1 billion ($1.38 billion) in back taxes. in 2012, Google France reported €193 million in sales and paid €6.6 million in corporate tax, at the same time as Google Ireland Ltd reported €15.5 billion in revenue (on which it paid €33 million in corporate tax).

Just this week, the European Commission has weighed in on the Double Irish question publishing a preliminary finding that the Irish government has provided potentially illegal state aid to Apple for more than 20 years as well two ‘sweetheart’ tax deals that the Commission doubts are in line with internal European Union market rules. Apple pays a tax rate of less than 2% in Ireland.

In a statement, the European Commission said:

Accordingly, the commission is of the opinion that through those rulings the Irish authorities confer an advantage on Apple.

That advantage is obtained every year and ongoing.

At this stage, the commission has no indication that the contested measure can be considered compatible with the internal market.

In a statement Apple said: "Apple has received no selective treatment from Irish officials over the years. We're subject to the same tax laws as the countless other companies who do business in Ireland.

For its part, the Irish government states:

Ireland is confident that there is no breach of state aid rules in this case and has already issued a formal response to the commission earlier this month.

My take

Good headline grabbing by George, but it’s all too likely to be nothing more than crowd-pleasing gesture politics for a very simple reason.

It’s a fundamental principle of the European Union’s single market that taxation of profits occurs not where a sale takes place, but where the company doing the selling is domiciled.

If a company sticks to the rules of the EU state in which it is domiciled then it has to be allowed to trade in the UK on the same terms as any other EU company that is also toeing the legistlative line.

In other words, so long as the UK remains part of the EU, there’s really not much Osborne can do other than be seen to do something.

Now, if the UK were to leave the EU, that would be a different matter - but that’s a whole other set of political commitments for the Conservative Party to wrestle with.

Loading
A grey colored placeholder image