On Saturday evening I published a short post on what Google’s tax liability in the UK might look like. You can read it here. It made a number of points, but one in particular has proven controversial.
My post took the revenues that Google Inc, a US entity, reported to its US shareholders as having been made in the UK (£4bn), applied to them the margin that Google Inc makes on its revenues (25%) and to the notional result (£1bn) applied the UK rate of corporation tax 20% to arrive at a notional UK corporation tax liability of £200m. And it compared this figure to the £30m of tax actually paid in the UK, hailed by George Osborne from Davos with more than a little hubris as a “major success”.
Critics have said this analysis is wrong. A number of substantially similar examples have been given in the comments section of that post to illustrate just how wrong it is. But let me take the analogous example given by the Financial Secretary to the Treasury in the House of Commons yesterday. He talked of a manufacturer in the UK which makes cars here, ships half of them to Detroit and sells them there. The point I made above, he says, has as a consequence that the sales are taxed in Detroit. And it is wrong, he said, because:
corporation tax is not calculated on the basis of profits attributed to sales in the United Kingdom, but to economic activity and assets located in the United Kingdom.
But this analogy is less to do with the question whether profits are made in Michigan than the conceptually discrete question ‘to which territory does the corporation tax system choose to attribute profits’. It does not have as its necessary logical consequence a rebuttal of the argument that profits are made in (in David Gauke’s example) Michigan.
We might, in a textbook, predicate a manufacturer in the UK who makes 1,000 widgets here at a cost of 60 each, ships them to Detroit and and sells 300 of them (incurring sales expenses of on average 5) at a cost of 100 per unit. The remainder being sold in the UK. We can hypothesis what his accounts might look like and can construct a sensible argument for attributing different proportions of his profit to the UK and Michigan.
Is his profit in Michigan 300 x 35 (my example above) or 300 x some smaller sum to reflect the fact that we should deem some part of that profit to be attributable to the manufacturing in the UK? An accounting textbook could construct sensible arguments for both.
So I can see the conceptual argument. But what I have more difficulty with its application. Specifically to Google.
Is Google analogous to a car manufacturer?
Not really, it doesn’t make stuff and move it and sell it. You might better think of it as an engine that generates money. Is it situated in the US? I don’t know, but why should that matter – you could put the machine anywhere. Perhaps the better question is where the machine is built and maintained? But that is to attribute profits to where the costs are rather than where the revenues are from. Why is that logically superior to looking at revenues? Few of us would think of a calculation of profits as starting with costs and applying some uplift. Most – if not all – of us would start with the revenues.
But let’s dig a little deeper.
Let’s treat the various Google entities as what they are – part of a single economic monolith – and ask what the Google monolith does in the UK?
We know that revenues are generated here.
That is what my notional profit calculation starts from. But the process of generating those revenues is constructed to look like this: finding and warming up sales leads and then passing them to Ireland for signing. If the signing took place in the United Kingdom the tax consequences would be different – and less attractive to Google. To avoid that Google introduces some artifice.
And obviously costs are incurred in generating and warming up those revenues. But not, apparently, costs of a type that entitle the UK to attribute revenue to it. Costs of a different type: costs to which we accept, apparently, that we should apply only a small uplift on which uplift modest tax is charged here.
But generating revenues here is not the only thing Google does here.
Many of the men and women who build and maintain the Google machine live and work here. And they work on building and maintaining the machine. You can see this in the accounts of Google’s UK entity. Its activities include the provision of research and development services to Google Inc. Surely these are the ‘right’ types of costs? The type that entitle us to attribute to the UK a proportion of Google’s worldwide revenues?
We apparently accept that they are not that type of cost either. They are also the ‘wrong’ type of cost. To them, too, we can only apply a modest uplift to generate a modest UK taxable profit.
So. Revenues less margin is wrong, my critics tell me: we should look to where the work is done, to where the cars are made.
But, in the case of Google, looking at the costs takes us no further. Profits are not taxed where the revenues are earned. Nor on where the costs are incurred. So, where?
To which territory does Google attribute its non US profits?
Not to Ireland. Here’s what the Irish Times reported yesterday:
That’s a profit on a margin of revenues of less than 1%.
And not to the US either.
Although I cannot corroborate it, it is widely understood that Google Inc has no US tax liability on foreign profits until it repatriates them to the US. And it doesn’t.
So although my critics might argue that my calculation of Saturday night fails to respect the textbook norms of international taxation, that argument avails Google only if its affairs do. And they don’t.
So I say to my critics, try again. I’m not throwing in the towel yet.
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I deal with the economics of this issue here
If David Gauke is right that we tax economic substance then the deal agreed fails to do so in any way
Jolyon, some analysts may agree, some may disagree, but this is a simple clear picture of why this is all so difficult. Thank you for writing so clearly, and it is a pity that lay taxpayers will not (in general) have the benefit of your insight. For me – I don’t have a clear idea of the “right” methodology to adopt but what you explain above just cannot be a responsible way to carry on.
Claiming profits in the UK for shareholders but not apparently paying tax on them (anywhere??) brings the childhood cry of “Lair, liar, pants on fire” to my lips.
Determining where economic activity and profit arises is subjective and complex, and I don’t doubt that Google exploits this subjectivity and complexity to its advantage. But If you accept that a blanket application of Google’s global profit margins to its UK revenue is not an appropriate basis for determining UK taxable profits, then the reality is that you don’t have enough information to judge whether and to what extent this exploitation is happening, and therefore to what extent the Google deal is a bad one. More specifically you have no basis for claiming that Google should be paying UK tax on £1bn of profit.
The key question for me, about which we might hear more at the PAC, is whether Google will be paying more UK tax from this point on. As others have said, if the “Google tax” doesn’t impact materially on Google (and I agree that it’s hard to see £130M as material here), then that would put DPT under considerable pressure. I have been wondering whether the Google structure in respect of the UK (as opposed to the Irish aspects) is actually all that aggressive. If you didn’t have all those employees in the UK – and it seems to me that you don’t technically NEED them and Google would still be vastly profitable if they didn’t exist in the UK – would we have an issue with Google deriving much of its profit untaxed in the UK? Is it so different from a bank resident in a jurisdiction that has a zero-rate double tax treaty with the UK not paying UK tax on the UK source interest paid by a UK resident borrower? It seems qualitatively different to selling computers, books or coffee in the UK.
Of course, if the US changed its tax rules so that US multinationals weren’t incentivised to put these low-tax offshore structures in place rather than simply bring the cash back to the US, Google might come to the conclusion that it would be better just to do everything in the UK and pay the UK tax pretty much on the figures you describe above, on the basis that they would end up paying the tax somewhere, so it might as well be in the UK…
Your £200m figure makes several assumptions – such as, for example, that Google’s reported revenues from the UK were necessarily taxable here (why?), and that its profit margin in the UK was the same as its global profitability (why?). But it is at least useful as a starting point. So, why might Google have paid less tax here?
Perhaps Google would not be as successful at selling into the UK market, if it were not for the development of its profit-making machine in the US (in terms of software and hardware – it needs hundreds of thousands of dedicated web servers), and its brand name. Those factors deserve some additional reward, which should ultimately go to the US. Perhaps the UK is a cost centre, not a profit centre, because its UK staff are maintaining the “machine”, not using the machine to make profits.
For the past, no doubt Google has questions to ask as to what activity was really happening in the UK – were its UK staff actually making sales? Were contracts with customers really concluded by rubber-stamping in Ireland, when they are substantially finalised in the UK?
Reading between the lines, it looks to me as if the £160m settlement is probably just an uplift to an existing cost-plus remuneration for the services performed for its affiliates by the UK subsidiary. The more interesting question, as your quote in The Times today suggested, is whether there was a PE in the UK to which sales revenues should be attributed.
For the future, more than the DPT, the BEPS approaches to PE and hybrids are likely to force Google into paying more tax in the UK, but that will involve a change in the law.
Incidentally, the tax system in the US has been a driver for much tax structuring my multinationals over recent years (for example, the check-the-box system creates hybrid entities at will) but I am not convinced by the argument that the UK has the right to tax because the US won’t (or at least offers an indefinite deferral).
As Andrew suggests , I think there is a danger in saying that the UK has a right to tax income that is not being properly taxed elsewhere.
In this structure, moving up the chain we have the UK, Ireland, some intermediate jurisdictions, and the US. The key question for us in the UK is whether we are taxing enough of the profit in the UK. If we are, then I don’t think we should really care whether the US is taxing enough – that’s the IRS’s problem. Ditto Ireland.
To argue that we should grab profit if no-one else does (or because the country which has it isn’t levying enough tax) would be a dangerous precedent, in my view – it makes things too subjective. So long as we get to exercise our taxing rights, we should be happy.
In that regard, I think the key question has always been the that of PE. I am troubled by the report in the Times, though it’s woolly enough not to be terribly reliable.
The second question is whether the question of PE should be enough to determine taxability. I think it makes a lot of sense, or at least it makes more than any alternative I’ve seen – destination-based sales as a measure of profit leaves a lot to be desired from both philosophical and practical bases, for example – but it’s something that should certainly be kept under review. I think that always having distribution relegated to an ancillary activity is going too far, for one thing, especially with shifts in technology.
Picking up Andrew Jackson on PE, I understood G UK has two main activities; the pre sales work and some R&D.
Is it at all possible to say that although remunerated for the pre sales work, G UK was also a PE for the same non-resident company, G Ireland, which paid it for the pre sales work? Is it not more natural to just run the tfr pricing arguments that G UK was undercharging G Ireland? How would a PE argument yield more tax, given there are undoubtedly costs in Ireland.
And if the R&D went outside the UK, and UK pre sales work was all transferred to Ireland and done from there, there would presumably be nothing on which to charge UK Corp Tax, not even a PE.
I would be really interested to hear what Jolyon thinks of the blog post that James linked to above and the calculation there. That seems so persuasive to me – it takes Jolyon’s figure of £200m, treats all worldwide costs as equal value, and comes to a rough estimate of the UK tax take of £32m. Yes it’s a rough and ready estimate, but is there an objection to the method?
I was thinking about what would happen if we taxed on turnover rather than costs and value, and came up with a couple of drawbacks.
Firstly the developing world might be hit quite hard. Taxes would cluster where the consumption is highest, so it seems to me that third world countries that rely on exports of goods and commodities would see tax revenues decline. Of course you might try different rules for different industries, but that seems fearsomely complex and doesn’t deal with…
Secondly, tax competition between nations would be based on increasing consumption. The government that could convince its citizens to spend the most would be the government that could afford high quality services. It doesn’t seem a sustainable model for the planet, nor a stable one for the economy.
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