International tax avoidance is at the top of the agenda for world leaders attending the G8 Leaders Summit in Northern Ireland this week.
There is also considerable international political pressure for measures to counter aggressive tax avoidance. In Australia, the Gillard government plans to introduce legislation that would publicly disclose the amount of tax large companies pay.
The US Senate Permanent Committee on Investigations and the UK House of Commons are looking at avoidance by multinationals, while the UK’s Committee of Public Accounts has recently published a highly critical report on the behaviour of Google, which has generated US$18 billion in revenue between 2006 and 2011, but paid only $US16 million in tax.
The report follows a threatened consumer boycott of Starbucks in the UK, after its very low levels of tax paid were revealed. The company has been embarrassed into promising it would make voluntary company tax payments of £10 million in UK for the next two years.
University of Melbourne’s international taxation law specialist Associate Professor Michael Kobetsky explains why tax avoidance tactics such as profit-shifting may comply with the letter of the law, but ignore the moral dimensions of paying your “fair share”.
TC: Is there a moral argument for multinationals to pay more tax?
MK: Multinationals operating in Australia, like other taxpayers, are only required to pay the minimum amount of tax imposed under Australian law. One criteria of an effective tax system is tax equity. That is, taxpayers in a similar economic position should pay similar amounts of tax. So if some multinationals are able to engage in international tax avoidance arrangements that result in them paying little or no tax in Australia, whilst domestic companies are paying tax, we have an inequity in the tax system.
This international tax avoidance deprives Australia of tax revenue and it undermines voluntary compliance, as it may encourage other taxpayers to engage in tax avoidance as well. There is no moral amount of tax that multinationals should be paying, they should simply be paying tax according to tax law. Press reports claim that Google only paid a small amount of income tax.
If some multinationals are avoiding tax in Australia, Parliament should enact measures to stop profit-shifting. And they should liaise with the OECD on exploring which measures to enact as unilateral measures are unlikely to be effective. The key principle is that multinationals should pay tax in the countries in which they conduct business. However, the multinationals engaged in aggressive tax avoidance respond with the defence that they are complying with the tax laws in the countries in which they operate.
TC: So this includes what Google have done - and possibly Starbucks and Apple?
MK: The colourful name given to the arrangement is the “Double Irish and Dutch Sandwich” which is used to shift a multinational’s profits to a tax haven. A tax haven may be defined as a jurisdiction which imposes very low income tax or no income tax at all. The underlying feature of the arrangement is that a multinational’s intellectual property is located in a tax haven and the intellectual property costs are able to absorb most of the income of the multinational derived in the countries in which it operates.
A multinational’s intellectual property is claimed to be owned by a subsidiary in a tax haven. The company may be a company incorporated in Ireland but is managed in a tax haven like the Bahamas and is not subject to tax in Ireland.
It is treated as a Bahaman company and there is no company tax in the Bahamas. The company then provides a licence to a Dutch subsidiary to use the intellectual property. In turn, the Dutch subsidiary then provides a licence to an Irish company to use the intellectual property.
My understanding is that if an Australian individual or company wants to advertise on Google, the customer will have to deal with Google Ireland. The invoice is issued by Google Ireland. What that means is that the Australian customer is paying Google Ireland, and the income will probably have an Irish source. Australia has jurisdiction to tax non-residents on income which has a source in Australia. If the income has an Irish source and is derived by Google Ireland which is a resident of Ireland, Australia has no taxing right over the advertising income.
Even if the advertising income has an Australian source, under the Irish-Australian tax treaty, if Google Ireland doesn’t have a permanent establishment in Australia, such as a branch office, involved in selling advertising, Google Ireland is only subject to tax in Ireland. In this situation, Australia gives up its source country taxing right under the treaty.
After Google Ireland receives advertising income from around the world, it then claims a deduction in Ireland for a royalty paid for the right to use Google intellectual property. The deduction covers most of Google Ireland’s income and results in minimal tax being paid in Ireland. The royalty payment by Google Ireland is made to a Google subsidiary in the Netherlands.
The reason for this step is that under the Ireland-Netherlands tax treaty there is no royalty withholding tax. This allows the royalty payment to move from Google Ireland to Google Netherlands tax-free. The final step is that the Netherlands entity pays a royalty to the second Irish company which is incorporated in Ireland but is managed in the Bahamas. The royalty payment moves out of the Netherlands tax-free as well. A small amount of income will be left in Google Netherlands after subtracting its licence fee from its royalty income.
So the end result is that the operating profit ends up in a tax haven, having avoided taxation in Australia, Ireland and the Netherlands. There are a number of multinationals that are using a similar sort of technique. For US multinationals the profits will only be subject to US tax when they are repatriated to the US. But the US multinationals are allowed to indefinitely defer making a dividend payment to the US parent.
TC: Now this is a legal structure, under international jurisdictions isn’t it? It’s not like they’re breaking the law?
MK: Tax evasion - not declaring income, or claiming false deductions - is illegal. But tax avoidance may be defined as complying with the letter of the law but not the spirit of the law. The “Double Irish and Dutch Sandwich” is tax avoidance, so as multinationals claim, they are complying with the law. The way to counter this avoidance is to amend the law in Australia and other countries. Another option is to attempt to embarrass multinationals by disclosing the amount of tax they are paying, which Australia is proposing to do.
The Google arrangement uses Ireland’s tax treaties to avoid taxation in countries such as Australia. One measure, which is drastic, would be for countries with tax treaties with Ireland to threaten to terminate their tax treaties. Tax treaties are designed to prevent double taxation but some tax treaties are being used to avoid taxation. If Australia were to terminate the Irish treaty and to enact a source rule that treats payments by customers in Australia for goods or services from an entity abroad as having an Australian source, this would give Australia the right to tax payments to Google.
TC: How effective would this be if Australia did this? Would it be a lone voice?
MK: Multilateral measures coordinated by the OECD are more likely to be effective. The OECD is looking at this issue with the base erosion and profit shifting report that it issued earlier this year. Another technique that they can look at is how the intellectual property is being migrated into the tax haven, which is a transfer pricing issue. The Double Irish and Dutch Sandwich scheme manipulates a whole range of tax laws in various countries to end up with this overall result.