Tax planning by multinational companies has caught the attention of the public in the Anglo-Saxon capitalist world. Here is a quick look at the tax travails of some global technology giants.
The ‘iConic’ gadget maker has been accused of being too smart with its tax planning.
Using inter-company cost-sharing agreements — a well-accepted concept in transfer pricing rules that deal with joint development and exploitation of resultant intellectual property rights — Apple captures almost all of its non-US revenue in certain Irish ‘ghost’ companies.
These companies are claimed to be residents of neither Ireland nor the US. This is possible due to the way tax residency is defined in Ireland’s and the US’s tax laws.
Ireland does not consider these companies to be resident in that country because they are not controlled and managed from Ireland. American law does not consider them to be resident in the US because they are not incorporated there.
In effect, a very large chunk of Apple’s non-US profits escape the tax tentacles of both Ireland and the US. Ireland is not complaining, as it probably values the ancillary benefits that Apple brings to its economy more than the direct tax revenue foregone.
But the US Senate Permanent Committee on Investigations feels Uncle Sam is getting a raw deal.
Now, there were some provisions in the US tax law (called Subpart F) that were supposed to tax the offshore passive income of corporate ghosts in the hands of the US-based ultimate owner.
However, these provisions have been rendered redundant due to the gaping loophole called “check-the-box”, inadvertently opened by the US Treasury Department in the 1990s to deal with the problem of hybrid entity classification.
Although about 85 per cent of Microsoft’s research and development (R&D) is said to take place in the US, it manages to park about 67 per cent of the global revenues from certain intellectual property (IP) rights in Ireland and Singapore through a clever use of transfer pricing norms.
While Apple has not yet been accused of avoiding tax on its US-sourced profits, Microsoft is being considered guilty of that very sin.
Through an ingenious sale and buyback of distribution rights of IP with its Puerto Rican subsidiary, Microsoft is alleged to have avoided US taxes on about half of its sales in the US. Puerto Rico is a US territory in the Caribbean.
Microsoft, the original developer and owner of such IP rights, sold those to the subsidiary, only to get them back under an arrangement that makes Microsoft US pay to Microsoft Puerto Rico for marketing rights in the US.
Notwithstanding elaborate guidance and rules about arm’s length pricing between associated enterprises, the valuation exercise of IP and its distribution rights can be extremely complex, and, therefore, subjectivity can creep in.
This legally facilitates tax planning schemes, such as the one used by Microsoft.
While US lawmakers have turned up the heat on Apple and Microsoft, UK parliamentarians are grilling Google. Again, it is the use of Irish structures that has incurred the wrath of the Public Accounts Committee (PAC) of the House of Commons. The question involved is whether Google is selling its services (which essentially constitute a use of technology platform) to UK customers through the large local presence of its marketing workforce in the country, or directly from Ireland where the technology platform is actually legally owned/ licensed for its economic exploitation.
This is a classic permanent establishment issue that frequently arises in the case of cross-border business transactions.
It is a widely accepted taxation principle that business profits are to be taxed in a jurisdiction only if the entity earning the profits has a permanent establishment in that jurisdiction.
Google believes its Irish company does not constitute a PE within the UK’s legal framework and also in accordance with the OECD’s model tax convention.
Its auditor (and tax advisor) is a Big 4 accounting firm that swears by Google’s position.
The PAC, however, seems convinced that there is a huge gap between the form and the substance, and that Google’s UK arrangement is an eyewash to cheat Her Majesty’s Revenue and Customs of their rightful share of tax.
The PAC also questioned the UK tax officers who went on record saying that international tax law has not kept pace with the digital economy, and, until politicians change laws, the taxman is helpless in his fight against companies that take advantage of the grey areas in e-commerce taxation.
The kind of tax planning resorted to by this internet retailer is largely similar to that used by Google except that Ireland is replaced by Luxembourg as the country to which UK profits are diverted.
In its deposition before the PAC, Amazon claimed that all the strategic functions for its business in UK were based in Luxembourg.
Apparently, the staff in UK only offered “support” to these activities. Since the ultimate customers were directly invoiced from Luxembourg and the UK staff only supported the transaction, the low profitability in UK was said to be justified.
The author is a chartered accountant