Wednesday, 26 December 2012

Off to Starbucks for a Coffee

Starbucks didn't do themselves any favours in front of the Commons (UK's most important parliamentary chamber) select committee investigating low levels of Corporation Tax.  Like most taxes, CT is avoidable if you know how.  Most large multinationals with multiple overseas operations attempt to minimise their liability in individual countries (a) to simplify the recovery of tax through the patchy double tax agreements that exist and (b) to ensure, as far as possible that their investors do not suffer tax twice on any given income stream.

The system varies from country to country but in essence any company is liable in their home economy for tax on their earnings.  That tax will form the basis of a credit against the shareholders' liability for tax usually at a basic rate.  The shareholder only becomes liable for tax on their dividends in excess of that basic rate.  So, in the UK, a higher rate tax payer would only pay tax on their dividends at the difference between the basic rate and the prevailing higher rate of tax.   In effect, corporation tax is a payment of tax on an earnings stream in advance for the shareholder.  So, the tax gets paid somewhere.

If a US company, operating in the UK, pays CT here it can claim that CT payment against its US liability through the prevailing double tax agreement.  The problem with this system is that Starbucks, trades in a very large number of countries.  To avoid the problem of having to reclaim under the double tax rules in every country it tries to minimise its liability in each country but, make no mistake, ultimately the tax will be paid.

So why, giving that proportionately the UK benefits from the way the system works more than virtually any country in the world, are British politicians getting into such a lather about Starbucks, amazon, google and all the rest?   Three possible reasons: (i) they are simply ignorant (highly likely) or (ii) they are endeavouring to find a scapegoat for the country's ills or my favourite - both.


Investor88 said...

Bob - I agree with your reasoning as to why this has become a big issue - the scapegoat and ignorance arguments are valid. The number of times 'sales' are referred to in the same sentence as corporation tax is particularly irritating.

It is important to point out however that double tax relief really isnt the issue with the companies you have mentioned. Most double tax regimes are favourable these days and allow a company full relief on the tax it has suffered abroad. The issue is more to do with WHERE the corporation tax is suffered. If a company has significant operations in the UK - should it not be paying its 'fair share' of UK CT. Although the companies in question will suffer the tax somewhere, it is often in a tax haven. The UK exchequer loses out on the cash.

Another key point to note is that UK SMEs which sell similar products/offer similar services are unable to structure their tax affairs in such a favourable way - simply because they arent multinationals. They have to pay their CT in the UK. Is that fair? It then becomes a question of - do we need these multinationals in the UK or not? Surely if the demand for coffee (for example) was so high, and Starbucks was ousted from the UK, a UK coffee chain could grow to meet the demand - and pay the 'fair' amount of CT.

But of course, business isnt 'fair' and the morality argument is rather weak. What the big multinationals have done is perfectly reasonable from their perspective and it is LEGAL.

The cases do differ significantly however:

In the case of Starbucks the issue was with regards to the 'arm's length' nature of its royalty payments to corporations based in countries with favourable tax regimes (which is perfectly legal if executed correctly). HMRC are able to challenge the rate of royalties paid and have done so in the past.If the company is paying at a reasonably commercial rate then Starbucks have done nothing wrong.

With Amazon, the company operates from a server outside the UK and therefore doesnt have a taxable base in the UK - again this is perfectly reasonable and will become a frequent arrangement with alot of companies with the increased popularity of internet sales.

Google operates as an agency in the UK, obtaining a cut of the advertising commission google generates in the UK. In this case the intellectual property is held abroad (in Ireland) and it is the Irish company which invoices UK clients. Again, if HMRC believes that the UK agency isnt making a commercially acceptable profit from this arrangement and thereby not suffering enough CT then a transfer pricing adjustment may be imputed to uplift its profits for CT purposes.

It is clear that HMRC do have alot more power than what most people believe. It is also clear the Multinationals are able to adopt favourable tax arrangements purely by virtue of being able to operate internationally - and to in effect choose where they suffer the tax. But this is hardly a new story- multinationals have benefited from their internalisation for years - whether it be by employing people in countries with weak employment laws/ low labour costs or otherwise. I dont know why everyone is so surprised- and nothing will change unless the UK Corporation tax system is radically overhauled!

Professor Bob Ryan said...

Thanks for an excellent reply Investor 88. I don't actually think we differ much - if at all. You're right - the real argument is where the incidence of CT should fall. I take what I suppose is a rather old fashioned view that CT is a tax on an income stream accruing to the equity investor and after all other claims have been settled. In that sense it is where the shareholder is resident which is important rather than where the operating activity happens to be.

Anyway, thanks for commenting and as a matter of interest I have been reading 'Treasure Islands' by Nichlos Shaxson. Perhaps not a good idea if you happen to have a blood pressure problem but it does have some interesting historical insights that are worth a read