The false economy

The false economy

Facebook looks set to pay more UK tax but it might not be as much as you think

dolphfyn /

Facebook has said it will pay more in UK taxes from 2017. The news comes hot on the heels of the much-derided settlement of Google’s decade-long tax dispute with the UK tax authority. It also comes a day after it emerged that Facebook is paid more by HMRC for adverts than it pays in tax.

Facebook has encountered heavy criticism for its tax dealings – not for their legality, but for how fair they are. In 2014 the company’s UK operations, Facebook UK Limited, reported a corporation tax payment of only £4,327. The company’s UK subsidiary reported a turnover of £105m and a gross profit of £103m, but this was wiped out by a massive administrative expense of £131m, leaving a pre-tax operating loss of £28m.

Companies trade with a view to making a profit, but since 2011 Facebook has been reporting accounting losses. Its audited UK accounts for 2014 do not provide any information about the composition of the administrative expenses, a key element in its reported losses and a possible reason for low tax.

Facebook has promised to change its business model and the way it records its sales revenues from advertising. Currently, Facebook books a number of its sales to UK customers through its Irish subsidiary, Facebook Ireland Limited. But it is set to pay millions more in taxes after a decision to allow profits from major advertisers initiated in the UK to be taxed in the UK. Facebook executives said in an internal post reported by the BBC that “UK sales made directly by our UK team will be booked in the UK, not Ireland. Facebook UK will then record the revenue from these sales”.

Change of heart?

Facebook’s 2014 global accounts do not show the proportion of UK sales that are booked in Ireland. So it is difficult to predict how much additional tax it will end up paying in the UK from the change.

Facebook is a global company, but some 47% of its US$12.46 billion global revenues are logged in Ireland (where it bases its international operations). This allows it to take advantage of the country’s 12.5% corporation tax rate and generous tax breaks for research and development. The UK’s current corporation tax rate is 20%.

The making of a Double Irish Dutch Sandwich. IMF Fiscal Monitor 2013

The profits relating to the sales booked in Ireland do not entirely remain there. Facebook was one of the companies questioned by European lawmakers about tax arrangements that have been described as the “Double Irish Dutch Sandwich” (the key elements of which are explained in the IMF’s Fiscal Monitor 2013). This allows companies to declare income in lower tax or no-tax jurisdictions to reduce the overall tax it pays.

These arrangements have been construed as state-aid by the European Union and have been under investigation. Ireland, meanwhile, has been under pressure to abolish, or seriously modify its Double Irish schemes. So Facebook’s change of business model is not entirely voluntary.

No guarantees

The mere booking of sales revenues in the UK will not necessarily lead to a higher tax bill, as Ireland can testify. Corporate tax is levied on taxable profits, which can be shifted through transfer pricing practices, for example. The key to this is the unpacking of the administrative expense which is likely to contain intra-group transactions – for example royalty payments and fees to other Facebook entities around the world.

Under the transfer pricing rules developed by the Organisation for Economic Cooperation and Development for ensuring fair dealings in intra-group transactions, companies should use independent market prices. The difficulty is that there is only one Facebook, so normal market rules that apply to numerous active buyer or sellers engaging in independent transactions are not in operation. Facebook will continue to have considerable discretion in the amount of royalty, management and other fees that it can charge to its UK operations and shift profits to low or no-tax jurisdictions.

The change in Facebook’s business model does not necessarily signal a new era in which Facebook will pay millions in tax that some might assume. One way to prevent Facebook and other big multinational companies from minimising their taxes would be to implement a system known as unitary taxation, which can eliminate the tax advantages of all intra-group transactions. But unitary taxation has received virtually no attention from the OECD’s recent Base Erosion Profit Shifting (BEPS) project, which was geared toward reforming the international system for taxing companies.