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

Image representing Eric Schmidt as depicted in...

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 Mondayattended 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.

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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.

Companies are behaving in precisely the way that our international tax system incentivises them to behave

This is my post published on the LSE Politics and Policy blog last week, written before the corporation tax announcement in the budget. It went down a storm with the UK Independence Party’s Financial Services spokesman:

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Tax in the post 2015 development settlement: opportunities and challenges

This is the short paper I wrote for UNDP based on my presentation last week.

Tax is already the biggest source of public finance in developing countries. African governments, for example, raise over ten times more revenue through taxation than through aid. Even if only the “low hanging fruit” are addressed, the result is likely to be significant increased public resources.

This is borne out by a brief study of recent trends in tax revenue in low and lower-middle income countries. A simple average across those countries for which sufficient data is available during the years 2002-9 shows an average annual increase in the tax/GDP ratio during this time of 0.23 percentage points. In a few countries the ratio fell; if we exclude these, the annual increase rises to 0.44 percentage points. If this latter figure is a reasonable estimate for the potential increase that could be achieved through a concerted effort across all low and lower-middle income countries, the result would be a year-on-year increase in public revenues of $22.5 billion.

The potential of taxation as part of the post-2015 settlement is therefore evident. This paper considers some of the challenges inherent in the implementation of policies to increase the tax/GDP ratio.

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A campaigners’ code of conduct and the ABF story

I see Ben Saunders has taken up the ABF story with two really interesting posts, the first relating it to Bill Dodwell’s call for a campaigners’ code of conduct, and second to what on earth Zambia was doing signing its bonkers treaty with Ireland. As I’m writing this in a break from struggling to put together a PhD chapter on developing countries’ tax treaty policy, let’s have a look at the code of conduct point.

Ben is right that some campaigners have not exactly responded to this suggestion in a very mature way (although with the recent ‘tax prat’ incident I don’t think either side is exactly upholding the standards of decent debate). But I also agree with Chris Jordan (in the comments here) that the way companies respond to allegations is rarely whiter than white as well: this was the gist of my post last week, in which I felt it unfair that ABF’s misrepresentations of the ActionAid allegations and – in some cases – of its own position had been, for the media, the last word on the story.

I remembered that I wrote a post a few months ago that made a couple of suggestions for where campaigners could behave a bit differently. I thought it would be interesting to reflect on ActionAid’s ABF report in the light of this.

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What will BEPS mean for developing countries?

English: The logo of the Organisation for Econ...

(Photo credit: Wikipedia)

“Researchers at the OECD are not free to think the unthinkable. They have to take account of the interests of each and every member state.” Or at least that’s what a recent paper in the Review of International Political Economy concludes from its interviews with civil servants. Yet thinking the unthinkable, or at least “thinking out of the box” is just what the OECD secretariat promised to do in its jargon-tastic paper on “Base Erosion and Profit Shifting” yesterday. (It has clearly already had some governmental approval, judging from the extensive footnotes expressing different countries’ reservations about the legal status of Cyprus).

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Is there anything new in this tax avoidance debate?

Over the break I read Sol Picciotto’s seminal International Business Taxation, published in 1992. It’s not hard to see why this book has acquired the status – in academia at least – of definitive account of the international tax system and its foundation. And it is interesting to see that the current outcry over transfer pricing is hardly new.

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