Monday, December 11, 2017


BLOG 184


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?



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