TAXING THE DIGITAL ECONOMY
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TAXING THE DIGITAL ECONOMY
One of the documents the government
published on Budget day was a Treasury Position Paper on “Corporate tax and the
digital economy”. I have just finished
reading it. To be honest, I did not find
it at all convincing or, indeed, very logical.
However I think it important because it sets out the Treasury’s
justification for the Chancellor’s new withholding tax on royalty payments and
its thinking on taxation in the digital world.
It starts with a statement of
principles. “The important question when
applying corporation tax to a multinational group is what amount of profits
should be taxed in the UK compared with the other countries in which the group
operates. The answer to that question is
currently determined by an international tax framework which was developed in
the early 20th century … The
overall principle underlying that framework is to tax a multinational group’s
profits in the countries in which it undertakes its value-generating
activities. That is a principle that the
government continues to support. It does
not, for example, believe that another country should have a general right to
tax profits that a UK business generates from a product that is designed in the
UK, manufactured in the UK, marketed in the UK and then sold remotely to that
country’s customers … Instead countries
should have the right to tax business profits derived from productive
activities, enterprise and human innovation in their jurisdiction, irrespective
of where shareholders and customers are located”.
So far, so uncontroversial – or, at
least, nearly so! The international tax
framework actually is that a country can tax the profits generated worldwide by
its own companies (but in doing so should give credit for tax paid on those
profits elsewhere) and can also tax profits made in its country by foreign
entities that have some form of business organisation in its country (such as a
branch). Even then it should only tax
the profits derived from that branch. In
determining what profits are derived from a branch, the host country will take
account of productive activities, enterprise and human innovation of that
branch. So, nearly right, but that is
not what worries me.
The Treasury goes on to assert that
“while the government continues to support the principle of aligning profits
with value creation, there is a clear need to consider the situations in which
that principle is not being delivered by the existing international tax
framework. In particular, it is important
to consider how the international tax framework is being stressed by
digitalisation and whether it is flexible enough to take account of the
differences in how certain digital business models operate and generate value”.
“Why”, you may ask. It is certainly not clear to me how the
international tax framework is being stressed.
Take, for example, Amazon. As far
as I am aware, Amazon does not have a branch in the UK. It has warehouses here but the international
tax rules exclude warehouse from being a branch – sensibly, because a warehouse
does not create value or by itself generate profits. It simply fulfils international contracts
created in another country. How does
digitalisation make Amazon any different from, say, Marks & Spencer? I do not know if Marks & Spencer has
warehouses in the USA, but if it does, I suspect that the Treasury would be
pretty upset if the USA were to want to seek to attribute a US profit-earning
element to sales made by Marks & Spencer in the USA.
Indeed, the Treasury emphasises that
“the mere consumption of a good or service in a country should not, by itself,
entitle that country to tax the profits of the business providing that good or
service”. But the bottom line is that,
while conceptually it believes that the US, not the UK, should have the right
to tax profits on sales made in the UK by Amazon and Google and Facebook and
other large US corporations, it recognises “the growing public dissatisfaction
that the corporation tax payments of digital businesses are not commensurate
with the value that they derive from the UK markets”.
I am a bit puzzled by this. I have never heard anyone say that they
believe Google or Facebook or whatever “derive value” from the UK market. I read quite a lot but have never read an
article suggesting that such companies “derive value” from the UK market. There is certainly an irrational public
dissatisfaction that they appear to pay very little tax anywhere. Irrational, because under the international
tax framework they ought to pay their tax in the USA, so the US public have the
right to be dissatisfied but it should be no business of the British public how
the USA wishes to tax American corporations.
Indeed, the creation of the USA derives from the fact that its citizenry
in 1776 felt strongly that the UK had no right to charge its corporations to UK
tax unless it integrated the US colonies more firmly into the UK.
The US policy is based on the premise
that the US wishes US corporations to reinvest overseas profits overseas in
order to expand US influence throughout the world. Accordingly it does not seek to tax such
profits until they are brought into the USA.
That is not an unreasonable system; indeed it is the system that the UK
itself decided to adopt a few years ago (with an exception, like the USA, for
passive income such as interest and dividends).
Different countries adopt different tax policies. It is no more unreasonable for the USA to
decide not to tax profits of US groups which are retained overseas than for the
UK to have adopted “one of the most competitive tax systems in the world” by
imposing corporation tax at 19% in the hope that, say, a US company wishing to
establish a branch in Europe would prefer to pay UK tax at 19% in preference to
basing its branch in France and paying French tax at 33.3% instead. No one would suggest that a US company that
is enticed to establish its branch in the UK should have to pay extra taxes on
sales in France because it is “avoiding” French taxes by having its branch in
the UK. Yet that is the logic of the UK
public’s – and I suspect the UK Treasury’s – gripe that the USA chooses not to
tax Google or Facebook.
The Treasury has however come up with an
ingenious argument to justify its desire to tax Google and Facebook. It says that in reality you and I work for
Google and Facebook, so it is our activities in the UK that enable Google to
make money from UK sales, so the UK should tax that money.
So how do we work for Google? I’ll give you an example. I follow baseball. I am a fan of the Chicago Cubs. For a modest annual subscription I can watch
all of the Cub’s games live on my computer by signing in to the website of MLB
(Major League Baseball) who run baseball in the US. I access the Chicago Cubs website via Bing
(which is part of Microsoft) because Lenovo (a Chinese company) installed it on
my computer before I bought it. (I do
not actually use Bing to go to the MLB website because Microsoft Edge refuses
to let me watch baseball, so I use Firefox to do this and Firefox uses Yahoo. However they are all US companies so it does
not affect the principle). When I access
the Cub’s website, it includes a number of adverts, some from US companies and
some from UK ones. Why should Fortnum
& Mason (on the website today) advertise on the Cub’s website? I doubt they can sell much in Chicago. The answer is that they don’t. They advertise on the version of the website
that Microsoft puts in front of me. They
advertise to me because I bought something on line from them a couple of months
ago. Microsoft has incorporated software
in Bing that records what websites I browse.
This software was probably devised in Seattle and I imagine is operated
by Bing from Seattle.
You probably know that already. So how do I work for Microsoft? The UK Treasury’s argument is that
Microsoft’s software enables them to tell Fortnum & Mason that I view the
Chicago Cubs website every day during the baseball season and for a fee that
they will put Fortnum’s advert in front of me every time I do so. Of course Fortnum’s are not interested in
me. But if Microsoft tells them that
100,000 UK people go on baseball websites every day during the baseball season
and they will put Fortnum’s advert in front of them all, Fortnum’s may decide
to advertise these. So, say the
Treasury, every click I make on my browser earns Microsoft the ability to
generate advertising revenue. Because it
is my work clicking that does this, the UK ought to be able to tax the profit
Microsoft makes from Fortnum’s through putting Fortnum’s advert in front of me
(using their US developed software monitored from the USA).
Personally I find this wholly
unconvincing. It is a bit like saying
that Sainsbury’s know what I like to buy because they track this through my
Nectar card. Accordingly if Sainsbury’s
were to open a shop in Chicago, the UK would be entitled to tax part of the
profits that they would make when I shop in Chicago because they have the
ability to target special offers at me when I shop in Chicago in the same way
as they do when I shop in the UK.
The other obvious fallacy is that when I
visit Chicago (as I do every year) I access the Cubs’ website as much as I do
here. Why should the UK be entitled to
tax Microsoft based on clicks that I make in Chicago? I very much doubt that Microsoft
differentiates my Chicago clicks from my London ones when both are made on my
i-Pad. I also doubt that either
Microsoft or Fortnum’s care where I click, so my clicking cannot provide a
rational basis of taxation.
The Treasury also have another odd
concept. Again starting “from the
position that profits are taxed in the countries in which a business has
genuine economic activities” it concludes that “to maintain confidence in the
international tax framework and avoid competitive distortion in local markets,
it is crucial that multinational groups are prevented from being able to
realise profits in low-tax entities that are not justified by local economic
substance. That is partly about ensuring
a robust international transfer pricing framework and pursuing multinational
reforms to address the limitations of that framework in aligning taxable
profits with value created”. Let’s
examine that conclusion. Let’s take
Starbucks. Starbucks does not make much
profit in the UK. The head of Costa
complained a few years ago that Starbucks overpays for its sites, which
probably explains why it makes little profit here. What is profit? It is the difference between sales and
costs. What are Starbucks main
costs? The purchase of coffee, rent and
rates, staff costs, and a payment to use the Starbucks brand and marketing
concepts that were created in Seattle.
Any reasonable definition of profits requires the deduction of all of
those costs. Starbucks purchases its
coffee from an overseas related company.
HMRC need to be vigilant to ensure that it does not overpay for that
coffee. HMRC also needs to be vigilant
to ensure that the price Starbucks in the UK pays to access the Starbucks
intellectual property created in Seattle is not excessive. Its transfer pricing specialists are adept at
meeting both of those challenges. If
Starbucks UK makes a payment to Starbucks US and HMRC are satisfied that the
payment is at the right level, are the UK entitled to nevertheless tax those
payments to the US because, say, the payment is based on the number of coffees
you and I buy in the UK? Most people,
including the Treasury, would say, “Of course not”. So, why should the UK
suddenly be entitled to tax that profit simply because Starbucks USA decides to
sell its intellectual property to Starbucks BVI or whoever? Provided that the UK company is paying the
right price, it is surely irrelevant to UK tax who that price is paid to. How can what Seattle chooses to do internally
damage confidence in the international tax system? It surely can’t!
Of course it is not easy for HMRC to
check whether the price paid for use of the intellectual property is a market
price. But it is no more difficult to do
so if that price is paid to Starbucks BVI than if it is paid to Starbucks
USA. It may be that the Treasury
questions the competence of HMRC. But,
if so, it is HMRC’s paymaster. If the
management of Marks & Spencer was felt by its shareholders to be
incompetent, they wouldn’t say, “We must find a different way to sell our socks
and undies that by-passes the Marks & Spencer stores”. They would tell the Board to replace the CEO
with someone with greater competence to sort out the problem.
I am a bit surprised that the Treasury
do not equate my purchases of coffee from Starbucks with my clicks on
Bing. They look very similar to me. I can only conclude that the Treasury feels
that my coffee purchases are a ridiculous basis for a system of international
taxation. If so, great, but surely my
clicks form an equally ridiculous one?
ROBERT
MAAS
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