My editorial from the latest issue of International Tax Review
Contrary to the tin-hat theories on Mayan prophecy, 2012 is over and the world has not ended. But the year brought great change for multinationals and how they conduct their corporate tax affairs.
Tax avoidance has dogged companies in the mainstream press like never before. What was once at best an issue for the business sections has become front page news as governments desperately search for means to plug gaping budget deficits and the public feels the pinch of service cuts and cries unfair.
Rightly or wrongly, household corporate names are being denounced as poor citizens because of the tax planning they have employed for years that has suddenly become unacceptable in the eyes of the media and the public. Most notably of all are Google, Amazon and Starbucks, hauled before the UK Parliament’s Public Accounts Committee and its unforgiving chairwoman Margaret Hodge last month where their inability to make a compelling business case for their corporate structures only sharpened the public perception that they have been too aggressive in avoiding tax.
France has also demanded that Amazon pay more tax, while the Australian government referred to Google Australia directly in November when it unveiled draft revisions to transfer pricing laws.
The companies have done nothing illegal. And they are keen to trumpet that the amount of corporate tax they pay is not their only contribution to society. But from the hostile reaction they have received, it is clear that these kinds of arguments no longer wash with public – and customer – opinion. Now the argument comes down not simply to whether businesses are acting legally, but whether they are acting morally.
Starbucks, whose highly visible brand-orientated business has perhaps been hit hardest by customer revolt, has agreed to pay £20 million ($32 million) in UK corporate tax over the next two years. This is more than it has ever paid in its 15 years operating in the country.
Its most strident critics are unlikely to be satisfied by this move, but it is a start and a sensible one. Other companies would be wise to take note and learn from Starbucks’ misjudgements and how it is attempting to rectify them.
It is high time that tax became more of a boardroom concern. Starbucks has gone to great pains in recent years to improve its reputation by promoting fair-trade products and environmentally sustainable practices, but all that good work on CSR has been undone by one tax scandal hitting the press.
Companies planning their tax affairs can no longer afford to think only about their exposure to risk, but also their reputations. Governments around the world are closing loopholes, while transparency is shooting up the agenda with the proliferation of FATCA-like legislation promoting automatic information exchange. But tax authorities are not the only ones watching. The media and the public will be looking on too.
The world may not be over. But companies must face the fact that it has changed. Tax planning will never be the same again.
So it seems a mystery as to why Starbucks decided to pay more tax then legally required, while Google declined to do the same. Let me explain it to you.
When looking at this whole issue, its worth understanding some history and background. The current system of tax treaties and international structuring arose from a desire by many national governments to try and maximize the tax revenue they collect. They did this by recognizing that there are constantly situations where an international corporation may be obligated to pay tax to several jurisdictions on the same revenue (aka double taxation). Of course, this would result in no net revenue and the corporation going bankrupt.
Therefore in order to attract the good or service to their jurisdiction; try to get as much tax revenue as possible; and try to encourage the corporation to set up some of its physical structure and work force in their jurisdictions, countries like the US, UK and Ireland set up tax treaties between themselves and other countries. It is key to understanding this underlying motivation for the current system. This system arose not out of some noble desire to relieve taxpayers of the “unfairness” of double taxation or even at the bequest of the lobbyists of those taxpayers. It came out of a logical self-interest of various governments.
With this background in mind, let’s look at Twitter, Apple, Google and Starbucks (which are all under fire in the international media for their tax planning).
-Many US politicians and citizens want these companies to pay US tax on its WORLDWIDE income, including income earned from foreign customers. They argue that while this may not be legally correct, it is MORALLY correct because all three companies were a) Founded, IPOed (or will in the case of Twitter) and has their headquarters in the US; AND b) The citizens of the US are suffering in a financial downturn and “deserve” this money;
-Many foreign politicians and citizens want these companies to pay more tax on the revenue generated from customers in their country. They argue that while this may not be legally correct, it is MORALLY correct because a) The company is deriving income from tax resident individuals and corporations; AND b) The citizens of these countries are suffering in a financial downturn and “deserve” this money;
-All four companies want to maximize their net revenues (“gross revenues” minus “expenses including tax” equals “net revenue”). Each company used the tax treaty network and international structuring regime to minimize their global tax burden. As part of this structure they may have to set up operations in places like Ireland; or assigned intellectual property rights to places like the Netherlands. However there are important differences between these companies;
-Starbucks needed to respond to this “Moral but not legal” obligation demand because a) It has physical facilities which could be picketed or damaged reducing sales; and b) There are many competitors who could easily service customer needs and decrease gross revenues. As a result, it was logical that Starbucks chose to pay more tax in the UK than legally obligated in order to maintain gross revenues and thereby maximize net revenue.
-Twitter and Google are different in that a) They do not have or need physical facilities in a given country to deliver its service; b) You can’t picket everyone’s smartphone, tablet and computer to ensure that no one is not boycotting their services; and c) With all due respect to other search engines, Google is not really realistically worried today about losing customers to its competitors. Same thing with Twitter’s lock on “tweets”. Therefore, the current controversy is unlikely to significantly reduce people from using their products and services. As a result, it is logical that they will not consider paying more tax anywhere than legally obligated;
-Apple derives gross revenues from various products (hardware and software) which has competitors. Some of the sales of their products and services derive from physical retail outlets and some does not. The big question is whether Apple products (with their hardware and software integrated) is unique enough to avoid a drop in revenues. Obviously, Mr. Cook has decided that for the time being Apple will NOT pay more than legally obligated in taxes. I am sure the people at Apple are watching their sales very closely to determine if consumer anger with their tax planning is having any significant effect on revenues.
In summary, Starbucks sells a standard physical commodity which is readily available from other competitors and is clearly subject to pressure. “Search” and “Tweeting” are not a standard physical commodities today and whether through perception or reality, both are far and away market leaders. As a result, neither Twitter or Google are motivated by self interest to pay more tax to maintain gross revenues. Where Apple considers itself (closer to a standard replaceable commodity or a unique product) in the long run will determine where they will respond and volunteer to pay more tax anywhere than they are legally obligated.
It is also worth understanding that revising the current international legal tax planning regime for individuals and corporations is not simple. First it requires that each country think about all of the possible/ probable reactions of corporations and individuals to any changes that come into being. Increasing a tax rate or taxable amount could result in the individual or corporation moving all or part of its operations/holdings outside of that jurisdiction. This means that not only is the anticipated additional tax revenue never materializing but jobs, VAT, and other economic activity associated with that taxpayer also disappear.
Second, as explained above, the current matrix of tax treaties and domestic laws was developed over the better part of a century. Domestic tax policy was put in place by local politicians acting in what they thought was the best interest of that country. Tax treaties were negotiated, signed, updated when both countries perceived a win-win for each of their countries.
The major problem in trying to achieve achieve changes that will increase tax revenue (that groups like Oxfam, Tax Justice Network and ActionAid are calling for) is that you need to change not only domestic rules but also the intertwining tax treaty network for each and every country in the world. Given the “Prisoner’s Dilemma”, it is HIGHLY unlikely that we will ever see a global “tax level playing field”. Each country will continually claim special circumstances or financial emergencies as to why they are not immediately changing current policies.
In addition, as explained above taxing regimes do not have the same “leverage” over all corporations or individuals. With “global citizens” (i.e. Golden Geese who do not need to be in the country of their birth to make and maintain their wealth/income), cloud computing, and the pending revolution in 3D printers (which will turn more current tangible goods into intangible services/programs delivered on-line direct to the consumer), you will see more and more taxpayers who are more like Google than Starbucks.