The OECD is working to overhaul structures which big multinationals, including many US tech giants, use to shield tens of billions of dollars of income from taxes, writes Tom Bergin.
BIG business was having none of it. In January 2013, a lobby group which represents the largest corporations in the world wrote a letter to the body that drafts the rules on taxing multinationals. The letter focused on a small change to an obscure document, but one that was significant enough to worry Will Morris, director of global tax policy at American industrial giant General Electric.
The letter, which Morris wrote in his capacity as head of the Business and Industry Advisory Committee lobby, was addressed to Pascal Saint-Amans, head of the centre for tax policy at the Organisation for Economic Co-operation and Development (OECD), a group of 34 mainly rich economies, including the US. It expressed concern about the proposed language in an updated tax convention. Morris wrote — 13 times in all — that his group was “concerned” about the proposal, but had been ignored. Submissions on the OECD’s website show that lobbyists, especially those representing tech firms, had been voicing such fears for more than a year.
With some reason. A Reuters examination of hundreds of corporate filings across a dozen countries shows the proposed changes — now part of an even further-reaching review — threaten tax structures that are used by most of the big tech companies in the US to shield tens of billions of dollars of income from taxes each year. As Morris wrote then, the proposals could “have the effect of fundamentally changing” the basis on which multinationals are taxed.
The OECD — a forum in which governments work together to agree how to solve economic problems — is grappling with one of the toughest problems in the global economy. National tax rules are out of date and failing to keep up with multinational companies which split their activities across different markets and base themselves in the lowest-tax jurisdictions. Last week, the G20 group of countries backed an action plan drawn up by the OECD, which issues guidelines that most Western countries follow, to come up with ways to bring firms into the tax net.
A key area of concern is that the current laws on tax residency, known as the “permanent establishment” (PE) rules, allow firms such as Google to fix a tax base in a low-tax country — like Ireland — while generating lots of business in a country where tax rates are higher, like France.
The principle of the system now is that companies often pay tax not on the basis of where they do business, but on where they finalise their business deals with customers. With a contract-stamping operation in a low-tax country such as Ireland as its “permanent establishment”, a company can channel revenue from its major markets to be taxed at a lower rate.
The OECD calls that tactic “artificial avoidance of PE status”, and it wants to change things so the international tax system more closely resembles economic reality. It aims to tweak the guidelines — which countries including France want to change — so that countries where companies make lots of money can claim a commensurate share of tax.
But GE’s Morris told Reuters that governments should be careful about changing a rule that works well “in most cases”.
“We are concerned about wholesale changes to a rule whose certainty has, up to now, promoted cross-border trade and investment,” he said. GE declined to say if it used such tactics; accounts for a dozen of its European subsidiaries show they have a tax residence in their main markets, so do not rely on the tax-cutting structures Morris was helping to defend.
But many firms do, especially in tech, where they can easily operate across borders. Reuters analysed the accounts of the top 50 US software, internet, and computer hardware companies by market capitalisation and found that PE structures that help them avoid tax are currently used by 74% of them.
Of the 37 companies that make use of such systems, those which responded to requests for comment for this article said they follow the tax rules in all countries where they operate; some said their arrangements were driven primarily by a desire to effectively serve customers, rather than tax reasons.
In principle, countries have the right to tax any economic activity that takes place on their turf. For that to happen, though, firms have to be resident for tax purposes within a country’s borders. The main factor determining whether a company has a taxable presence, or “permanent establishment”, in a country, is whether it sells there.
So when does a sale occur? In law, a sale is made not when it is negotiated and agreed, but when it takes on a legal nature with a signed contract. That’s the point some OECD members want to review.
Yet, some companies want the existing system enshrined in law. In its January letter, the Business and Industry Advisory Committee was suggesting draft clauses to add to the updated OECD document, entitled Commentary on the OECD Model Tax Convention. Those clauses would have allowed companies to continue to finalise deals in a low-tax country, and thereby avoid paying taxes in higher-tax markets, even if that’s where most of the business happens.
“They tried to get us to clarify that their [current] deals work,” said Jacques Sasseville, head of the OECD’s tax treaty unit. “Fair enough, but we were not prepared to do that.”
Some EU and US officials said the Reuters analysis shows why the OECD needs to revisit its guidance on tax residence.
Reuters found that for 2012, the average tax charge on non-US earnings published by the big tech companies which used such structures was 6.8% — less than a third of the tax rates in their main markets, and below the headline rate of 12.5% in Ireland, the lowest tax rate in Western Europe.
Much of the attention in the debate about PEs falls on American firms. The United States has tough rules to dissuade companies from using such structures at home, but many tech companies use them abroad, the Reuters analysis found.
Accounts for the 50 biggest US tech firms and their subsidiaries show that only 13 declare the bulk of their income for tax in the main markets where they generate it. The rest use mechanisms to channel some or all of their revenues to a central tax base in a country with a lighter tax regime.
Sixteen of the 20 biggest US software companies by market value, including Microsoft, Adobe and Citrix, do not declare tax residences for their main businesses in their major European markets, their accounts show. Instead, they report software sales in Ireland, Switzerland, and the Netherlands, countries which have smaller populations and offer lower corporate tax rates.
Microsoft said its Irish operation was set up “largely in response to customer demand to consolidate shipments” and it pays all the taxes it should. Adobe said it “pays the lawful amount of tax owed in the countries where we do business”.
US computer hardware makers and internet firms use similar schemes. At least 13 of the 20 biggest hardware firms, including companies such as Dell, and eight of the 10 biggest internet service companies, including Google, Expedia, and Yahoo, reduce their European tax burden by ensuring they do not create PEs in major markets. Companies can create PEs in as many markets as they like.
In Dell’s case, sales and other staff are employed in subsidiaries across Europe but sales are conducted on behalf of an unlimited Irish- registered company. That means it does not have to publish accounts, so it is not possible to see what if any taxes it pays. Dell declined to comment.
Google said it chose Ireland as its Europe, Middle East, and Africa headquarters for a variety of reasons including good logistics, an educated workforce, and low tax.
Some companies that channel cash from their main markets to sales units in Ireland, Luxembourg, and the Netherlands then send it untaxed to countries like Bermuda and the Cayman Islands, which do not levy corporate income tax. Microsoft and Google are among them.
Apple uses companies that are registered in Ireland but say they are tax-resident nowhere. This incongruous mechanism was revealed by a US senate panel in May, which called it the “Holy Grail of tax avoidance”.
Apple declined to comment, but its CEO Tim Cook said in May, Apple pays all the taxes it owes and it did not depend on tax gimmicks.
Like Washington’s tax authority, Europe’s tax collectors can disregard PE schemes contrived to avoid tax. But French, Norwegian and Spanish attempts to exercise these rights have failed in court. Experts say civil law codes make judges reluctant to overrule contractual agreements, such as a sales deal.
This is why governments have asked the OECD to change the guidelines which will then form the basis of future tax laws. If the rules are changed, they hope, more companies will be forced to declare a PE in countries where they generate sales, rather than where the contracts are finalised.
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