WHAT HAVE STARBUCKS DONE WRONG?

WHAT HAVE STARBUCKS DONE WRONG?

Tax avoidance is in the news again.  What puzzles me is that tax avoidance in the eyes of the public seems to be simply a perception.  X is not paying as much tax as we would like him to.  Ergo, he is avoiding tax.  But that cannot be right.

Take Starbucks, for example.  Why do people perceive that it is avoiding tax?  The answer is because it pays no tax in the UK.  But there could be lots of reasons to explain that.  Starbucks say that they are not making profits in the UK.  If by that they mean taxable profits, I can believe that.  It is a retail business.  Such businesses spend a lot of money on fitting out their shops and in many cases regularly refitting them to refresh their impact.  These costs attract tax relief in the form of capital allowances.  Starbucks is as much entitled to that relief as the corner shop at the end of the street.  It is still expanding in the UK.  With an expanding business, the capital allowances on new shops are available to set against the taxable profits on existing ones.

Some months ago, Costa Coffee complained that because it pays no tax, Starbucks outbids Costa for good sites.  It seems to be more likely that because it is competing with Costa and others for sites, Starbucks has to pay top dollar to get the sites it wants.  That might well mean that because it is overpaying for sites, it does not make a profit. 

Would anyone pay so much in rent that it cannot make a profit?  Isn’t business all about profits?  Yes of course it is, but with a global business there may well be reasons why it does not need to make a profit or even to try to make one.  The Evening Standard engages people to stand outside railway stations and give away copies of the publication.  It clearly does not make a profit by printing the paper and paying people to give it away.  It makes a loss. Why should it do that?  I don’t know.  It may be that giving it away attracts advertising; it may be that it drives readers to the Independent; it may be that the proprietor simply wants a mouthpiece to propagate his views.  But no-one is saying that because retailing the paper creates a loss, Mr Lebedev is somehow avoiding tax.

What is the business of Starbucks?  Obviously selling coffee?  I don’t know.  If I make a cup of coffee at home, it costs me virtually nothing, perhaps a few pence, if that.  If I go to a local cafe I will pay between 90p and £1.50 for a cup of coffee.  So why should I instead pay Starbucks £3?  Perhaps it is because it is not selling coffee; it is selling something else such as relaxation, a meeting place, somewhere quiet to do ones homework or even run ones business, and the price of the coffee is the entry fee to obtain that product.  When I go to Chicago every year, I often visit Oak Park, which is one of the suburbs.  It is hard to get a seat in Oak Park Starbucks.  It is full of youngsters with laptops who seem to stay there for long periods nursing their cup of coffee, which has undoubtedly long gone cold.  I can understand why it might well not make a profit; it has become a study venue.  People studying do not drink coffee with the same rapidity as those who simply want to be refreshed.  Starbucks are not looking for the rapid turnover that, say, Macdonalds want.  They are content for customers to sit and relax, so their business model may not rely on selling lots of coffee.  They might for example believe that if there is a Starbucks everywhere that people are likely to congregate, customers will choose Starbucks over its competitors and that the resultant volume of traffic will compensate for slow turnover.  It is rare to see an empty Starbucks!

And what is profit from Starbucks UK operation?  Suppose I set up a shop to concentrate on tea.  I sell my tea at £1 a cup.  While in America I meet someone who says that he can show me a way to sell tea at £5 a cup and still attract the same number of customers, but he wants a royalty of £2 a cup for explaining his idea.  That sounds a good business deal to me.  I would be amazed if anyone were to say that the royalty should not be deductible in calculating my profits.  The idea is so good that I expand globally.  Each of my shops is paying 50p a cup for tea because I only sell high quality tea.  Someone in Holland comes to me and says that if I buy in bulk from him, he will only charge me 48p a cup.  That looks a good deal to me.  It takes a lot of work off of me and makes commercial sense.

Now let’s look at the man in America.  He lives in America.  He came up with his idea in America.  I exploit it throughout the world.  If he is paying tax on his £2 in America, is he nevertheless avoiding UK tax?  Surely not.  The UK government has agreed with the US government that we won’t tax him simply because I use his idea in the UK; it is a US idea and should attract US tax.  What about the man in Holland?  He is presumably going to India and negotiating better prices than I did and is making a profit in doing so.  He never sets foot in England.  So surely he is not avoiding UK tax either.

Suppose now the US government has said to the man in America (as it has done), “If you keep your profits in a non-US subsidiary, we won’t tax them until you bring them into the UK, because by encouraging US businesses to spread globally we can spread American ideas internationally.  So the man puts his idea into a Bermudan company.  Is he now avoiding US tax?  I don’t think so.  If I buy shares in Marks & Spencer, I have to pay UK tax on the dividends and on the gain on sale.  The UK government wishes to encourage people to save, so if I instead buy exactly the same shares through an ISA, I won’t have to pay any tax.  If I use an ISA, am I avoiding tax?  No, say both HMRC and the UK government.  “We have created a tax-free environment for you provided that you invest through the wrapper of an ISA.  It is sensible to take the benefit we are offering you because we want you to save and not become a burden on the State”.  But if I am not avoiding tax by saving through a tax-free wrapper, surely the man in America is not doing so either by trading through a wrapper that is specifically designated to enable US tax to be deferred.

Suppose next that I buy the Bermudan and Dutch companies.  They continue exactly as before.  I pay them exactly the same fees as before.  Am I somehow avoiding UK tax even though the previous owners were not doing so?  That would seem to me to defy common sense.  But suppose that having bought the companies I increase the amounts they charge me.  That might be trying to avoid UK tax.  But the UK laws say that what I pay myself is irrelevant.  I can only deduct the proper commercial rate – which is likely to be what the company was paying the previous owner.  Indeed, the law goes further.  It says that if I am paying out money partly to acquire coffee and partly to avoid tax, I cannot deduct even the commercial amount.

Sadly I don’t think I would make any money from a chain of tea-shops that allows people to relax in comfort.  Starbucks have already created that environment with coffee and I doubt I can entice enough people away to make it worth my while.  But my business model bears an uncanny resemblance to that of Starbucks, and if I and my friend in America and the guy in Holland were not avoiding UK tax, how can Starbucks be doing so? 

ROBERT MAAS