Clamping down on Google’s tax avoidance: don’t hold your breath

Eric Schmidt. Image by Charles Haynes via CrunchBase

This is a post I wrote for the LSE Policy & Politics blog.

Google’s executive chairman Eric Schmidt will stand up to give a talk at the LSE this evening after a week of unprecedented criticism of the search giant. I wonder if he still feels the same way today as he did last October, when he told journalists:

“I am very proud of the [tax] structure that we set up. We did it based on the incentives that the governments offered us to operate…It’s called capitalism. We are proudly capitalistic. I’m not confused about this.“

Last Thursday Matt Brittin, the company’s vice president, was told “I think you do evil” by the chair of parliament’s Public Accounts Committee when he made a second appearance to defend what he had openly admitted were the company’s tax avoidance activities.

Coverage of a pre-G8 summit meeting for business leaders at 10 Downing Street on Monday, attended by Schmidt, focused on the tax avoidance questions, and whether the company’s tax practices had been discussed. David Cameron and Nick Clegg did indeed claim to have challenged Schmidt for his aggressive tax position. Just yesterday, Ed Miliband took the fight to the belly of the beast, throwing the company’s own words back at it. He said:

“I can’t be the only person here who feels disappointed that such a great company as Google, with such great founding principles, will be reduced to arguing that when it employs thousands of people in Britain, makes billions of pounds of revenue in Britain, it’s fair that it should pay just a fraction of one per cent of that in tax.”

The political consensus appears to be that the international tax system is broken and needs to be fixed by governments – to change those incentives identified by Schmidt – but also that, in Miliband’s words, responsible companies should “do more than obey the letter of the law.”

Here’s the problem with this analysis: the reason that Google (and Amazon, Apple and Starbucks for that matter) pay so little tax in the UK is not simply a matter of exploiting weaknesses in the system. It’s also because that’s how the system is designed. We’ve built a set of global rules that define a company’s tax liability not by how much stuff it sells in Britain, but by where it locates the business functions that add most value to the things it sells.

And the reason we did this is because we thought it suited us. On the global stage, Britain is a reasonably sized, but not huge, consumer market. But British businesses have a lot of customers overseas. So we figured that we would be better off with a system that’s biased towards – in the language of international tax – a multinational company’s place of residence, rather than the source of its revenue. It’s that bias that allows US companies to sell billions in Britain while incurring a relatively small tax liability here – a liability that they can reduce further through tax avoidance.

What our political leaders rarely mention is that the difficulties that e-commerce would create for our tax system were foreseen as early as 1997, and supposedly resolved as early as 2001 (pdf). The crucial agreement here was that the sale of a product over the internet would be treated just like the sale of its physical equivalent. If I stand on the other side of the UK-French border, stretch my arms across it and sell you a book, I’m running a business in France and my profits are taxed in France, even though you, my customer, are in the UK. The same would be true no matter how many books I sold. Under the rules agreed in 2001, exactly the same rule applies if I sit in an office in Luxembourg and transfer a book to your Amazon Kindle, no matter how far away I am.

At a meeting debating international tax rules last year, the UK and US opposed efforts by India and other developing countries to change precisely this kind of rule. They wanted to be able to tax the profits of foreign companies that sell services into their huge and growing markets without needing a physical presence. The UK said no, outright, because it would be a “fundamental change in the balance of source and residence taxation.” The OECD, which is in charge of the current review of international tax rules, says it isn’t aiming to change this balance.

The system as it stands suits countries like the US and UK, which are home to large multinationals that sell services abroad without needing a big physical presence.  Many companies selling services into developing countries are either British or providing the services from Britain, and our government doesn’t want to surrender the right to tax these companies. A side-effect of this decision is that it also means getting less tax from the foreign companies with the biggest consumer presence and visibility here.

David Cameron says he’s going to sort the system out, and no doubt there will be some changes that tighten up some of the areas most exploited for tax avoidance. But untangling the costs and benefits of international tax reform is complex, and it’s unlikely that the outcome will put an end to all of the counter-intuitive tax results.

Putting a price on the reputation risk from tax avoidance

What are the reputational consequences of perceived corporate tax avoidance? That’s the question that introduces today’s “Tax and Reputation Forum,” organised by the Oxford Centre for Business Taxation and friends. (It’s at King’s College London, so after the High Court the other week, I’m beginning to think that Aldwych is the centre of tax news!)

The event could not be better timed, and I’m hoping to see the tax profession’s criticisms of the UK parliament’s Public Accounts Committee debated directly with its Chair, Margaret Hodge. It will also be interested to observe where Treasury minister David Gauke positions himself: in front of a mostly business audience, will he be closer to his pre-Starbucks “government and business have to work together to combat the public’s misunderstanding about tax avoidance” messaging, or his bosses’ more recent “this is outrageous and we won’t stand for it” tone?

The conference blurb talks about “perceived tax avoidance”, which is understandable. You’d expect that a risk assessment for potential media coverage would be based on how people might interpret the information in the public domain, not on the underlying tax structure, which may be obscured in the accounts. But what if companies also had to contend with private information from within the tax function coming into the public domain?

Last week the Public Accounts Committee talked about evidence from “whistleblowers”, people from outside the tax function who felt that their day to day experience contradicted how the company’s affairs were described for tax purposes. That doesn’t move us beyond the issue of “perceived” versus “actual” tax avoidance.

But what about a whistleblower from inside the tax function? That appears to be what’s happened in today’s Guardian story about Marks & Spencer. The quote below, form a leaked email, is interesting in two regards. First, because it shows correspondence in a company about the value of a tax saving versus the potential cost of reputational damage from it. Second, because the email appears to have been leaked by someone within M&S:

Given that it was developed as a means to avoid UK corporation tax when it stood at 26% it now seems appropriate to reassess this. Corporation tax will be 21% by next year. Does this not render many of the advantages of having an Irish company obsolete?

From a tax management perspective there may have been advantages in avoiding the UK 26% tax rate but the process and IT overhead with the additional VAT complexity may negate these advantages. Needless to say there is also the reputational damage to M&S should it be seen to be avoiding UK tax in the current climate, as seen with recent examples such as Starbucks [and] Amazon.

I wonder if this phenomenon could really narrow the gap between the public debate on “perceived” tax avoidance, and the internal discussions about “real” avoidance.

The recent ActionAid survey [pdf] gives a nod to G4S for its “explicit reference to [internal] whistle-blowing over tax concerns.” Maybe more companies will choose to put in place a safety valve like this for employees, to try to prevent information spilling out into the public domain.

“Tax, Law and Development”: recommended reading for campaigners

This spring, two academic books have come out that offer an opportunity to look at tax and development from different perspectives. “Critical Issues in Taxation and Development” edited by Clemens Fuest and George Zodrow is going to be the economists’ take, using “modern empirical methods” to answer a lot of “what is the effect of X on Y” questions. I haven’t got my hands on it yet, but in the meantime I’ve been reading “Tax, Law and Development” edited by Yariv Brauner and Miranda Stewart.

The contributors to Tax, Law and Development don’t follow a strict empirical approach, rather they give their own reasoned opinions on how various laws, policies and institutions in international tax affect developing countries, and how they might be changed for the better. This is a work of critical legal scholarship, a position staked out by its editors in the book’s introduction, which argues that “we cannot avoid the challenge of tax competition by calls to end taxation of mobile capital, even if this may be perceived to be a theoretical economic inevitability.”

The book covers “on the ground” issues such as tax expenditure reporting in India and fiscal federalism in China, as well as international tax justice topics such as tax treaties, information exchange and country-by-country reporting. Each reader will find different parts interesting, and so here I’m going to pick out a few chapters that were the most useful for me.

Quite a large chunk of the book covers tax incentives, reflecting how big an issue this is for tax and development policy. Brauner and Luis Eduardo Schoueri’s chapters demolish the idea that tax incentives are purely a domestic policy issue for developing countries, by looking at how they interact with tax treaties and national policy in developed countries.

A controversial mechanism through which this can occur is tax sparing, through which a developed country offers its tax residents a credit against its tax bill for the tax they would have paid in a developing country, even if that country waives the tax to encourage investment. This way the taxpayer gets to keep the benefit from the tax incentive, rather than it being captured by their home state. As Brauner points out, policy advice from developed country-dominated organisations such as the IMF and OECD has for some time been that tax incentives are a poor use of the money, yet by continuing to give tax sparing agreements in their treaties, these governments keep on encouraging it.

Schoueri’s paper also discusses matching credit, a quasi-incentive included in some tax treaties whereby a developing country agrees to lower its withholding taxes on inward investment, but the developed country at the other side continues to offer a credit as if withholding taxes were still levied at higher non-treaty rate. A mainstay of Brazil’s tax treaty network in the 1970s, this mechanism ensures that inward investors, rather than the treaty partner’s fisc, benefit from the lower rate.

Many countries – including, increasingly, the UK – exempt their residents’ overseas profits altogether, in which case tax sparing and matching credit may be less relevant considerations. Here Schoueri argues that the system currently has inbuilt a kind of distorting reverse tax sparing: when the residence country decides not to tax some of its residents by exempting their foreign income from taxation, the source country is prevented by tax treaties from claiming this untaxed income for itself. As described above, when it’s the source country that foregoes revenue, it can be captured by the residence state. Schoueri argues for a more symmetrical arrangement.

Tracy Gutuza’s chapter on the South African headquarters regime is also about the impact of a tax incentive on developing countries. This one was created by the South African government to compete with the tax haven of Mauritius as the base for multinationals’ holding companies when investing into the rest of Africa. Who can blame them, I wondered, when even the UK is joining in the race to the bottom? Nonetheless, it’s a cautionary tale about the need to look at the BRICS with a critical eye. The regime twice fell afoul of the OECD’s 1998 definition of harmful tax practices, and Gutuza argues that the resulting social pressure was enough for it to be withdrawn or modified in both cases…except that as of 2011 it’s back.

Towards the end of the book comes a series of chapters preoccupied with this kind of social pressure. Pasqual Pistone is concerned about the solidification of “a kind of global norm concerning the exercise of taxing jurisdiction” as legal fact, Heather Stewart the “hybrid mode of global tax governance” emerging from tax information exchange cooperation, and Allison Christians “whether awakening public attention to multinational tax planning will provoke sufficient political attention to compel paradigmatic change.”

The latter paper was an interesting read for me, because it devoted quite a bit of space to the drafting of a report within the OECD tax and development task force [pdf] in which I was a participant. It’s interesting that to the outside observer, basing her analysis on published documents, certain events in the process took on a much greater significance than they did to those of us involved at the time, while other occurrences that felt much more significant don’t get a mention because they took place in private. One could say that this demonstrates the limits of desk-based research, but actually it made me rethink my own understanding of what happened at the time, as well as of the importance of the written record.

This is another good reason for campaigners to read this book. Not just to expand their hinterland, but also to see how their movement and the issues they work on are seen from a different, and largely sympathetic, perspective.

Why FATCA might be good for developing countries

Recently I wrote a post explaining that I feel cautious about the burden that compliance with an automatic tax information exchange standard would place on developing countries. Since then a new paper by Itai Grinberg has popped up called Emerging Countries and the Taxation of Offshore Accounts.

This amused me. I encountered Grinberg a couple of times when I was an NGO tax justice policy adviser and he a US Treasury official who was, in general, dead set against the NGO policy prescriptions I was advocating. Now both of us are academics and, freed from our respective party lines, it turns out that I’m sceptical of this one, while he is a rabid enthusiast! Here’s what Grinberg says that has challenged my thinking a little.

First, he restates the argument made by Tax Justice Network and many other NGOs, as follows:

Under pressure from the G-20, an international standard requiring governments to exchange tax information upon request emerged. On its own, however, information exchange upon request is inadequate to combat offshore tax evasion because it requires the requesting tax administration to know which foreign jurisdiction to ask for information about which taxpayer, and to have other details that prove a credible suspicion of tax evasion.

That makes complete sense, but as I wrote last week, my concern is about whether developing countries are yet ready to engage in anything more sophisticated. Automatic information exchange would require a lot of effort on their part to compile and send information, let alone use what they receive. Here Grinberg has a number of strong arguments, given that large multinational banks will in any event have to compile information from overseas in order to comply with the US’ Foreign Account Tax Compliance Act (FATCA) rules:

1. There is a narrow window of opportunity

Grinberg sketches out the current dynamics created by FATCA. The original legislation obliged overseas banks to report directly to the US government on the financial affairs of US citizens, but this would often breach their domestic legal obligations. The US government’s agreements with European countries have instead created a model in which banks report to their own governments, who then exchange the information with the US. (Bizarrely, at present domestic US law prevents it from supplying the same information that it expects to receive from these governments, but plans are afoot to change this so that the exchange is reciprocal).

The US-EU approach is similar to the automatic exchange model within the EU, and it could therefore be a suitable basis for a multilateral regime to develop. This would be preferable on a number of levels, says Grinberg, including reduced compliance burdens for governments and financial institutions from a standardised approach, and the possibility that developing countries could benefit by participating.

But there isn’t much time to transform the current piecemeal approach into a global, multilateral one. The information exchange system develops through “punctuated equilibrium” such that its current rapid evolution will not continue indefinitely, and will give way to a period of stasis.

Furthermore, Switzerland has pursued a different approach to comply with FATCA,in which banks do send information directly to the US in the manner envisioned by the original FATCA legislation (and not entirely automatically). That’s in addition to its secrecy-preserving agreement with the UK. So there is a risk of divergent standards becoming consolidated, which would make any move to one global standard harder.

I can accept the idea that, while this might not be the ideal time for developing countries to move to automatic exchange on their own terms, they may need to consider their options from a “now or never” perspective. It’s for this reason that Grinberg’s paper is framed with a sense of pressing urgency.

2. Banks are likely to put in place the systems anyway

According to Grinberg, large multinational financial institutions would,

likely implement standardized processes for obtaining proof of residency and tax identification numbers (or dates of birth) as part of their account-opening procedures across jurisdictional boundaries. They would similarly have incentives to undertake firm-wide IT projects aimed at enabling information reporting on dividends, interest, other income, and account balances to governments in a standardized way, with respect to all accounts the financial institution manages.

In other words, this is an opportunity for developing countries to start gathering better data on taxpayers within their borders at minimal cost:

Coercing financial institutions by means of FATCA to use a simple, standardized system for reporting on income from capital,intended to facilitate automatic record-matching, may function like a program for upgrading the capacity of some domestic tax administrations.

3. Automatic exchange may strengthen tax authority independence

Grinberg argues that it might be easier for a tax authority to challenge a powerful taxpayer based on information received automatically from abroad than purely on its own initiative:

In a country struggling with corruption or fears those in power may abuse that power, an automatic information exchange system may reduce the pressures on a semi-autonomous tax administration because, unlike information exchange upon request, investigations begun as a result of automatic information exchange are less likely to be perceived as politically motivated. Similarly, a tax administration may find it less difficult to open an audit of politically connected persons when information that suggests such an audit should be conducted is provided from abroad.

It’s easy for tax and development commentators to forget that the tax policymaking and administration apparatus in developing countries is not one uniform lump, but rather different people and institutions with different preferences and facing different incentives. A prod from the outside might be just what one set of people in a country needs to achieve its own objectives.

But I’m not wholly convinced yet. A cost-benefit analysis to test these theories, especially the third, against the compliance cost for developing countries seems important. And this is still a case of policy developed outside developing countries with little input from their side. That’s not a reason to rule it out as such, but it is a reason to think long and hard and, maybe, ask some developing country tax officials themselves..

Tax, law and morality: the IF campaign debate

Last night’s debate at St Martin’s in the Fields church, between politicians from what we used to call the three main parties, was quite interesting. Notable that all three were well aware of what the campaign is demanding, and after a bit of work I think we managed to tease some policy differences out of them. There was quite a lot of tweeting, so rather than blogging about what happened I’ve made a Storify with most of them tweets in them. Enjoy!

[See also here for my previous post about the "Enough food for everyone if..." campaign]

Secondments, democratic scrutiny and corporate tax

I’ve just been next door to the high court (a perk of being at the LSE!) to watch the UK Uncut Goldman Sachs judicial review. For all those who lament the quality of public debate on questions of corporate taxation, this is surely a desirable outcome: a painstaking debate through which the judiciary will decide who is right. Maybe it makes the case for putting corporate tax settlements in the public domain…but that’s another blog altogether.

What’s really reflected by the Goldman case is a debate about the integrity of the UK’s corporate tax policymaking and administration. At senior levels in both the Treasury and HMRC, civil servants mix with individuals from the top accounting firms and large businesses – on Treasury working groups, on the HMRC board, through secondments, not to mention Dave Hartnett’s acceptance of more corporate hospitality than any other civil servant. All these arrangements have been criticised by people outside the tax profession, while it seems Ministers, civil servants and tax practitioners – the ‘tax elite’ if you like – have closed ranks in defence.

All this sounds very much like what international relations theorists call an ‘epistemic community’. In the classic text on the subject, Peter Haas in 1992 defined epistemic communities based on the following criteria:

1. a shared set of normative and principled beliefs which provide a value-based rationale for the social action of community members;
2. shared causal beliefs, which are derived from their analysis of practices leading or contributing to a central set of problems in their domain and which then serve as the basis for elucidating the multiples linkages between possible policy actions and desired outcomes;
3. shared notions of validity – that is, intersubjective, internally defined criteria for weighting and validating knowledge in the domain of their expertise; and
4. a common policy enterprise – that is, a set of common practices associated with a set of problems to which their professional competence is directed, presumably out of the conviction that human welfare will be enhanced as a consequence.

I think it would be quite easy to identify all four for our ‘tax elite’ – although I’ll have to leave that for yet another blog post. The key point from the definition, however, is that an epistemic community is bound together by more than shared knowledge or profession: it also includes shared values and a worldview through which knowledge is filtered.

Epistemic communities are associated with the increasing influence that technical experts have in some areas of policymaking  (“consolidating bureaucratic power” as Haas has it). This is sometimes seen as undesirable, as it detaches policymaking from democratic accountability. And that hypothesis is my interest here.

Because the community’s self-perception is founded on ‘expertise’, any criticism of its actions – even by legislators themselves – is put down to ‘lack of understanding’. It becomes self-reinforcing. The most vocal members of the ‘tax elite’ regard most criticism as the product of commentators with a lack of understanding and/or an inherent anti-establishment, anti-corporate bias. Well yes, those elements do exist in many cases, but that doesn’t mean that there isn’t a grain of truth to anything the “tax muggles” say.

Un-PACking the secondments debate

For example, I don’t think the recent Public Accounts Committee report on the accountancy firms did a good job of analysing the issue of secondments from the Big 4 into government. Ben Saunders has quite a reasonable rant about it here. But I wonder if the tax elite would have been any more willing to accept the content of the PAC’s conclusions had they listened carefully to their witnesses, and then respectfully disagreed with them nonetheless.

In dismissing the PAC report, Mike Truman says that “[secondees'] role was to advise on the commercial implications of the proposals.” How can he be so sure? Maybe he took the word of his fellow ‘tax experts’ at KPMG on trust. I encountered a Treasury secondee from KPMG when I was lobbying on behalf of ActionAid, and I’m quite confident that he was much more implicated in the policymaking process than that, consistent with the claims on his LinkedIn page.

Also reflecting on the PAC report, Wendy Bradley argues that:

the accountancy and tax professions…think of themselves as professionals…that they are more like the barrister who can give objective advice to a party to a court case whether the person is innocent or guilty.  They certainly do not recognise themselves in the “poacher turned gamekeeper” that PAC perceives.

For me, the secondments issue is not about the Big 4 gaining inside knowledge of HMRC, but about information flow in the other direction. It turns on whether you think that there is a clear boundary between technical advice and lobbying. In the epistemic communities framework, no such boundary exists. According to Haas:

It is the political infiltration of an epistemic community into governing institutions which lays the groundwork for a broader acceptance of the community’s beliefs and ideas about the proper construction of social reality.

Richard Brooks’ new book argues that just such an infiltration has occurred in HMRC and the Treasury. If so, it’s not at all unreasonable to think that the beliefs, ideas and values that have emerged within a community that is paid for its ability to keep corporate tax bills low might diverge from those of the general public and of the legislature.

For example, here are Canadian tax professionals Brian Arnold and Larry Chapman, in an article that criticises much of the campaigning on Starbucks:

The role of tax professionals in assisting multinationals to avoid tax may require some serious soul-searching. Without our “creative” talents in manipulating legal relationships, complex legislation and tax treaties, this type of international tax avoidance would not be possible.

Wendy Bradley offers another example, the supposedly neutral value of tax “competitivity”:

Meanwhile the big glaring elephant in the room is the [government's] commitment to a tax system which is “more competitive, simpler, greener and fairer”.  In Taxworld, a “competitive” tax rate is a lower tax rate – a rate which competes for business with other tax jurisdictions. Yes, it’s official coalition policy that, in the great multinational tax race, the UK should do its best to win the race to the bottom.

So what now?

I absolutely agree with all those bloggers who point the finger for much of this at parliament. As Wendy says:

The responsibility for the existence of tax legislation and for the quality of that legislation lies with the people who make it, with Parliament.

[...] each Budget [the Government] publish their proposals, consult on them, and then bring the legislation to Parliament along with a TIIN which tells you what the legislation does and why, how much it will raise and how much it will cost, and who will be affected.

Does Parliament ever look at them?

Do MPs ever challenge the legislation, and if they do, are any changes ever made?

That would make an interesting study, although I think we already know that on complex areas of corporate taxation the answer is no.

To help achieve a better political debate, Mike Truman and Heather Self advocate an “adopt an MP” scheme whereby tax professionals would provide “clear, dispassionate advice on the tax system”. Sounds great in theory, but the epistemic communities framework challenges the notion that such advice exists.

What I think is really needed is an open, honest exchange between the tax elite and the tax muggles. Yes it would help for the former to educate the latter on technical matters, but that should go hand in hand with discussion on the level of “normative and principled beliefs” about corporate tax. And on that, the tax profession might do well to adopt a little more humility.

Unitary taxation, Barclays and Africa

I just read the Tax Justice Network briefing which is explained in Richard Murphy’s blog title “Barclays and HSBC make the case for unitary tax in the UK – because we’d have collected £2.6 billion more in 4 years.” Now I haven’t checked out the UK figures at all, but the inclusion of Barclays piqued my interest, because by some measures it has a bigger operation in Africa than it does in the UK.

Unitary taxation makes me nervous, because while the idea is to draw the tax base away from tax havens and towards economic substance, I worry that under most formulae – certainly those acceptable to the G20 – it may also suck the tax base away from developing countries.

The segmental analysis in Barclay’s accounts means that it’s possible to conduct a hypothetical case study to help answer this: would Africa be better or worse off under a simple unitary tax formula as compared to the current system?

I’ve quickly cobbled together a spreadsheet to do that for the last three years. I reproduced the TJN figures to make sure it’s comparable. I couldn’t find a tax figure for Africa, but that’s fine, the best comparison is anyway the tax base, that is, the pre-tax profits. So I applied the same two-factor formula as the TJN report proposes, which divides up the group profits on the basis of staff numbers and turnover. TJN wanted to use fixed assets as a third factor well, but couldn’t find any data. I’ve had a go at it, by using the number of distribution points (branches and sales centres), although this doesn’t change the overall distribution very much.

The result is interesting. When the group as a whole is profitable, Africa does better from this simple unitary approach than it does from the status quo. But because the African operations are not subject to the same shocks as other parts of the business have been, in 2012 Africa is much more profitable than the group overall, and so it does a lot worse under the unitary approach that takes the overall group profits as its starting point. The net effect of the unitary approach over three years is still positive, though: the African tax base is £2.9bn-£3.3bn as compared to £2.0bn under the status quo.

Link to Google spreadsheet

There are of course caveats. The staffing and profit figures I used are for the Africa segment, which doesn’t quite include all the African operations (though the turnover figure does). According to the ActionAid tax haven tracker, Barclays has six subsidiaries in the tax haven of Mauritius, which might distort the Africa figures.

Most importantly, though, Barclays is a big service provider in Africa. It has a lot of sales, a lot of staff, and a lot of branches in Africa. So it’s not a typical case study. I don’t think Africa would do so well out of unitary taxation of a company that was primarily extracting minerals or growing agricultural commodities for export.