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As cash piles grow, nations struggle to patch tech industry's tax loopholes

As cash piles grow, nations struggle to patch tech industry's tax loopholes


Transnational tech companies are causing major headaches for tax regulators around the world

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google uk logo stock 1020
google uk logo stock 1020

With all the conflict, competition, and trash talk going on between them, tech companies can often appear to be more different than they are alike. One area where their practices overlap almost completely, however, is in the way they manage their tax bills. Google's chairman, Eric Schmidt, believes his company is aggressive but fair in trying to minimize its liabilities, noting that it pays all "legally required" taxes. That sentiment is echoed by a chorus of fellow tech leaders, with Apple CEO Tim Cook recently assuring the US Senate that Apple pays "every single dollar" of taxes owed.

The unanimity across tech boardrooms has in recent times been countered by an increasing ferment of discontent among both government officials and members of the general public. The UK has been the most vocal among a number of countries that feel US companies like Google are making highly profitable use of their physical and digital infrastructure without returning the favor by paying taxes like upright citizens. Fairness, rather than legality, lies at the root of these objections. That makes for a fragmented argument, as company bosses focus on the legal and regulators emphasize the ethical. Is there a way to determine what if not necessarily who is right in the present circumstances? Let’s look at the facts.

Bending the law but never breaking it

Amazon is one of the UK’s largest retailers, whether online or off, and it generated sales of nearly $5 billion in the country during the fiscal 2011. It paid zero corporation tax on that income, thanks to the fact that is owned and operated by Amazon EU SARL, a limited liability company based in the business-friendly tax regime of Luxembourg. Amazon’s remaining UK arm is purely an order and delivery fulfilment business — which does all the work, but accrues none of the profit.

Google’s no less of a juggernaut in the country, having rung up roughly $4 billion in sales during the same 2011. Its UK tax bill at the end of that prolific year? $2.1 million. That amounts to an effective tax rate of 0.05 percent in a country where the average worker pays over a third of his income in personal tax and health insurance contributions. Google achieves this by booking the profits of its UK ad sales through its Dublin subsidiary and benefiting from the more generous Irish corporate tax system. In effect, what Google is doing is the equivalent of a person working and living in the UK, but receiving his salary in Bulgaria — which charges a flat 10 percent income tax, the lowest in Europe.

Google claims its UK operations only support the company’s sales processes and points to the fact that it has over 3,000 employees in Dublin, which is designated as its international headquarters. And yet, a former company executive has openly contradicted Google’s argument by asserting that advertising deals are habitually done in London, even if the formalities of signing contracts are performed in Ireland. His contention is lent credence by Google’s recent $1 billion investment in an expansive new London HQ — a sizable investment that befits the UK’s importance as the company’s second-biggest revenue source after the United States.

Neither Google nor Amazon is doing anything strictly illegal, yet it’s quite clear that neither Dublin nor Luxembourg are the fulcrums of their respective European businesses. As the UK Public Accounts Committee concludes, these are part of a set of "artificial corporate structures created by multinationals with no other purpose than to avoid tax." Another such construction in popular use goes by the name of a "Dutch sandwich" — whereby a shell company in the Netherlands funnels profits out of high-tax regimes and into tax-free island havens like Bermuda. Repatriating profits to the US or the UK will eventually incur a corporate tax charge for companies, but in the meantime, these structures have allowed them to save billions in taxes they would otherwise have had to pay.

“Offshore tax havens have declared economic war on honest US taxpayers.”

None of these strategies for reducing a transnational company’s overall tax burden are new or unique to the tech industry. Nevertheless, the global economic downturn has sharply increased public sensitivity to tax inequities and consumer tech purveyors are among the most conspicuous beneficiaries of the current system. The combative nature of this mood is best summed up by a 2007 US Senate bill sponsored by Barack Obama, which proclaims that "offshore tax havens have declared economic war on honest US taxpayers." Further incendiary language comes from the UK Treasury Committee, which accuses Facebook of "disingenuous" activity for emulating Google by accounting for its UK income in Ireland.

There’s little in the way of a countervailing moral argument: no company, when prompted by The Verge to provide an ethical justification for its tax practices, is willing to offer one. Facebook "takes its tax obligations seriously," Amazon "pays all applicable taxes," and Google "complies with the tax laws in every country." And that’s as much as they need to do. A Google spokesperson simply notes that "if politicians don’t like those laws, they have the power to change them." Eric Schmidt’s recent op-ed in The Observer expands acerbically on that same point: "When legislators are doing the lobbying and companies are articulating the law as it stands, it's a confusing spectacle for everyone."

Governments are asking companies to exercise gentlemanly restraint

So what practical measures are being taken to close the loopholes that nobody seems willing to defend but everyone is actively exploiting? Obama’s Stop Tax Haven Abuse Act never got anywhere in its initial iteration and, this April, six years after its inception, it’s had to be reintroduced for discussion in Congress. Focusing on tax incentives, the UK is lowering its corporate rate to 20 percent by 2015 and has also introduced a Patent Box reform that taxes profits from UK patents at a lower rate. Still, compared to the extraordinarily low rates companies can achieve with their present arrangements, these incentivization schemes seem unlikely to succeed. More promising is the Netherlands’ plan to root out the Dutch sandwich exploit by taxing the relevant shell companies in a fairer manner.

Whatever steps individual countries take to address the problem of over-aggressive tax avoidance, the ultimate solution will have to have an international flavor. Global accountancy firm EY told The Verge that what’s required is "a multilateral rather than unilateral approach to international tax policy reform" — in other words, countries should be working together to produce a coordinated approach. The European Union is in particular need of this as it already suffers from market distortions brought on by the fact it has one common market but various taxation authorities. The perfect example is Amazon’s ability to sell ebooks in the UK with a 3 percent VAT rate, thanks to its Luxembourg residency, while local competitors have to pay the full 20 percent.

The latest estimates are that $18.5 trillion are stashed away in tax havens

The long track record of efforts to achieve international cooperation on tax has been unfortunately fruitless in terms of tangible outcomes. A G20 meeting in 2009 elicited bullish headlines like "Sun setting on tax havens," however the latest estimate is that $18.5 trillion remains stashed away in places like the Cayman Islands and the Bahamas. More recently, the G8 2013 summit produced the somewhat wistful Lough Erne Declaration, which sets out 10 principles intended "to fight the scourge of tax evasion," though every one of its listed items revolves around the verb "should." In legal terms, the document is as effective as asking multinational companies to exercise some anachronistic form of gentlemanly restraint. The European Commission is employing similar language, but at least it has the enforcement mechanisms to push countries to reform their tax regimes in order to plug some of the present loopholes. Finally, the Organisation for Economic Co-operation and Development (OECD) is expected to soon reveal its latest action plan for tackling the problem. Its tax policy director has already set out what’s required in highly concise terms: "When you don't like some behaviors but they are legal, you need to change the law."

There’s no denying that the giants of the tech industry have been engaged in an ethically dubious game of creative accounting. The implied social contract between these corporations and the states within which they do most of their business is not being fulfilled faithfully. But none of that is news to any of the parties involved — grandstanding accusations of immorality such as those we’ve seen from British parliamentarians have more to do with capturing the zeitgeist of disapprobation than attempting to remedy the ailment. Still, there’s value in having an engaged public on your side when trying to oppose large multinational companies, and the present mood of discontent gives fertile ground for the hope that real reforms can be brought into effect over the coming months.