On Monday I discussed how I think most of the real debate about corporate tax scandals is about people’s normative interpretations of the tax system, not the technicalities of the particular structures. Then I read this:
Another day, another report of an internet company avoiding taxes in the UK. This time it’s eBay, to follow the earlier stories about Facebook, Google, Apple and so on. What’s really rather sad about these stories is that they ignore the very structure of the law. This isn’t an aberration, some corporation bending the rules to dodge taxes. This is the very point and purpose of the legal structure around taxation itself.
Here’s the thing. Based on his tone, I really want to disagree with this article by Tim Worstall…but he seems to have reached the right conclusion, all be it for possibly the wrong reasons.
Let’s start at the top. All of these internet giant tax avoidance stories seem to begin from an intuitive point: if a significant chunk of the sales that generate your profits take place in the UK, shouldn’t you pay a share of your corporation tax there? As Michael Devereux pointed out in the Financial Times last week [£], the answer at present is ‘not necessarily’.
Our international tax system says that you pay corporation tax on your profits wherever you generate the value-added that results in those profits. If you can make the case that your sales are from abroad, and that what infrastructure you have in a particular country isn’t adding any significant value, then there is no corporate income tax to be paid, no matter how much you sell. It may be an intuitively perverse outcome, but it applies to all these companies.
The practicalities of the internet cases all work slightly differently, but in this case I’m using eBay, to follow Worstall’s logic. EBay makes its money through the fees that it charges retailers for the use of its services. On paper, those services are provided by eBay’s Luxembourg subsidiary. It has a UK company too, but this just provides ‘marketing services’ and, assuming that it meets certain criteria under tax law, it isn’t liable for tax in the UK – certainly not for tax on a significant share of the profits.
Here’s where I think Worstall got it wrong:
They are in fact a result of the way in which the European Union has simplified matters for corporations within the EU.
The EU’s ‘freedom of establishment’ rule may be a part of the issue, but it’s not the most significant part. The idea that eBay’s local subsidiaries are just marketing agents that aren’t liable for tax has been tested, not in the EU, but in India, where eBay won its case at a tax tribunal:
The tribunal concluded that eBay International had no permanent establishment (PE) in India and, therefore, the ‘business profits’ earned here were not taxable.
That the same situation arises in a transaction between India and Switzerland implies that the EU law highlighted by Worstall is not the heart of the matter.
But here’s where I think he does have a point:
As a result none of this is tax avoidance: it’s actually tax compliance, exactly and precisely what our rulers desire and intend that such companies do.
Well, almost. It seems a stretch to say that governments ‘desired’ eBay to adopt this tax-efficient structure, certainly when it ended up as a dispute at India’s tax tribunal. But it’s not technically tax avoidance in the UK, where the government certainly considered this kind of situation when developing the law as it stands. Here’s how the UK explains its own position on e-commerce:
The development of e-commerce places a strain on the traditional definition of a PE [‘Permanent Establishment’, the definition of a taxable business presence] in cases where the computer equipment is positioned in one territory whilst the enterprise has no personnel active in the business in that territory. […]
In the UK, we take the view that a server either alone or together with web sites could not as such constitute a PE of a business that is conducting e-commerce through a web site on the server. We take that view regardless of whether the server is owned, rented or otherwise at the disposal of the business.
Other OECD Member States take the view that a server, as distinct from mere web sites (which cannot fulfil the geographic situs condition) could constitute a PE where the equipment is in fact fixed.
That’s the point about taxing sales from a website covered; as for the fact that eBay is providing a technical service to its sellers, I wrote last week about how the UK and US oppose a new provision in the UN model treaty that might allow countries to tax fees for services provided online from abroad.
This is a story, not about EU law, but about an international tax system under which the starting point for tax liability is still the existence of a physical presence in a country. That principle seems increasingly irrelevant in a digital age. Some standard-setters and law-makers are starting to revise it, while others are want to retain it. Meanwhile, companies like eBay will have more options than most to structure their businesses in a tax-efficient way, of which, naturally, they’ll continue to avail themselves.
I do wonder about the sustainability of a tax system that continues to produce such intuitively perverse outcomes.