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Tech

Developers of Grand Theft Auto claim millions in tax credits

28th July 2019 by George Turner
  • Rockstar Games, the creator of Grand Theft Auto, has made an estimated $5bn in operating profit since the release of Grand Theft Auto V in 2013.

  • The game was designed and developed in the UK by Rockstar North Limited based in Edinburgh, but TaxWatch can reveal that the company has paid £0 in UK corporation tax over the last ten years.

  • In fact, Rockstar North Limited has managed to claim £42m in subsidy from the taxpayer over the last three years, whilst senior managers and developers at Rockstar shared in a bonus pool worth billions of dollars.

  • TaxWatch is calling on HMRC to urgently investigate the tax structure of Rockstar Games and Take-Two in the UK.

A new report from TaxWatch has revealed that the makers of Grand Theft Auto have not paid any UK corporation tax in 10 years, despite the game being made in the UK and generating billions in profit for its US based parent company.

  • The full report can be viewed online here: https://www.taxwatchuk.org/reports/gaming-the-tax-system/
  • A PDF version can be downloaded here.
  • The press release accompanying the report can be downloaded here.

Instead of paying taxes on profits made by sales of the game, the company has been able to claim tax credits from the government under the Video Games Tax Relief scheme. Over the last three years, Rockstar North Limited, the company which led the development of the game, has claimed £42m in tax credits.

Video Games Tax Relief was designed to help smaller producers of “culturally British” games not designed for the international market.

Grand Theft Auto V, based on a fictional depiction of gangland California, was granted certification as a culturally British video game by the British Film Institute in September 2015, after the game had already recorded more than $3bn in sales. The certification allowed the producers of the game to claim tax relief on production costs.

Research from TaxWatch has found that the amount of tax credits claimed by the makers of Grand Theft Auto in the last three years is the equivalent of 19% of all tax credits granted to the video games industry since the relief was introduced in 2014.

Commenting on the release of the report, George Turner, Director of TaxWatch said:

“It is outrageous that the UK taxpayer is being asked to shell out tens of millions of pounds in subsidy to the developers of Grand Theft Auto, when at the time that the game’s developers put in their tax credit application Grand Theft Auto V had already generated several billion dollars in sales and profits.

“This is a drive-by assault on the British taxpayer and corporate welfare scrounging at its very worst.

“The Video Games Tax Relief was designed to help developers of games with a cultural content that would struggle to sell in the international market. The fact that such a large amount of that relief is going to the developers of Grand Theft Auto clearly shows that the relief is not working as intended.”

Key facts and figures from the report:

  • $6bn – estimated total sales of Grand Theft Auto V since 2013
  • $5bn – estimated operating profit of Rockstar Games 2013-2019
  • £42m – total Video Games Tax Credits claimed by Rockstar North Ltd between 2015-2017. Equivalent to 19% of all tax credits paid by government to the industry
  • $3.4bn – total bonus pool available to top managers at Rockstar games from 2009-2019
  • £0 – total combined corporation tax bill of Rockstar companies in the UK between 2009 and 2018

This report was covered extensively in the UK and international media. In the UK, the report featured in The Sunday Times and The Guardian among others. TaxWatch’s Director was interviewed by BBC News on this research.

Report: Gaming the System

26th July 2019 by admin

How the makers of Grand Theft Auto managed to pay £0 UK corporation tax and claim millions in government subsidies whilst making $$$ billions in profit

Key Facts and Figures:

$5bn

Estimated operating profit of Rockstar games 2013-2019

£42m

Total Video Games Tax Credits claimed by Rockstar North Ltd, developer of Grand Theft Auto V, between 2015-2017 - 19% of all tax credits paid by government to the industry.

£0

Total corporation tax liability of Rockstar companies in the UK between 2009 and 2018

$800m – sales of Grand Theft Auto V in first 24 hours of release

$6bn – estimated total sales of Grand Theft Auto V since 2013

$3.4bn – total bonus pool available to top managers and staff at Rockstar Games 2009-2019

 

Key dates:

2008 – Rockstar North, a UK based company starts development of Grand Theft Auto V (GTA V)

2013 – GTA V released to the public

2015 – GTA V certified as “culturally British” by the British Film Institute, allowing Rockstar North to apply for Video Games Tax Credits from HMRC

Gaming the Tax System

A PDF version of this report can be downloaded here.

Summary and Introduction

Grand Theft Auto V is the most commercially successful product in the history of the entertainment industry, with total revenues estimated to be $6bn since the game’s release in 2013.

The game is published by Take-Two Interactive Inc. under their Rockstar brand. Take-Two is a US listed multinational company.

Grand Theft Auto I was first developed in the UK by DMA Design in the late 1990s. After DMA was bought by Take-Two, game development continued in the UK at a company called Rockstar North Limited based in Edinburgh.

Despite the huge success of the title, our analysis shows that Rockstar and Take-Two companies based in the UK have not paid any corporation tax over the last ten years. Rockstar North Ltd, which led the game’s development, has in fact claimed £42m in subsidies from the taxpayer over the last three years in the form of credits through the Video Games Tax Relief regime.

Video Games Tax Relief was introduced by the UK government in 2014 to provide targeted support for games that were “culturally British”, with a particular focus on support for small and medium sized businesses.

Our analysis shows that the amount claimed by Rockstar North is the equivalent of 19% of the total relief paid to the entire video games industry in the UK since the programme came into effect. This raises serious questions as to whether the relief is being properly targeted, at a time when the industry is lobbying for the relief to be expanded and made more generous.

This report also raises questions as to whether an appropriate amount of profit has been allocated to the UK companies involved in the game’s development. Seven active companies based in the UK, using the Take-Two and Rockstar names, declared a total profit before tax of £47.3m in the UK between 2013 and 2018. However, over the same period we estimated the operating profit of games published by Rockstar to be in the region of $5bn.

Despite the minimal allocation of profits to the UK, Take Two interactive placed a substantial amount of value on the work of Rockstar employees, including those based in the UK. These key employees were given the rights to substantial amounts of the profit generated by the company in relation to games released under the Rockstar label.

It is our opinion that a more appropriate allocation of profit between the US and UK would have resulted in substantially more profit being allocated to the UK. This would have meant that Rockstar North would not be eligible for a payable tax credit. Instead, Take-Two and the Rockstar companies should have had a substantial tax liability in the UK.

Video Games Tax Relief

Video Games Tax Relief was first announced in Alistair Darling’s budget in 2010, the last budget of the Labour administration. However, with an election very soon afterwards, it was never implemented, with plans for the relief being cancelled by the incoming Coalition government.

After lobbying from the video games industry, a more modest relief was announced in the 2012 budget.

Video Games Tax Relief works by reducing the taxable profit of a video game developer. Developers can deduct an extra 25% of qualifying expenditure from their taxable profit. If a game is loss-making then the developer can claim a cash credit from HMRC.

After it was confirmed that the UK government would be going ahead with the scheme, the European Commission announced that it would hold an investigation into the proposed relief to determine whether the subsidy was permissible under state aid rules.1 The Commission was concerned that the measure represented an unnecessary intervention, seeing no need to subsidise an industry that was thriving and making profits.

The UK Government’s argument in support of the relief was that specific, targeted intervention was required to preserve the cultural character of the UK and European games industry. The government raised a concern that video games producers could make much more money creating games that were tailored towards the international market, because they could achieve huge economies of scale from targeting a larger community of gamers. As a result, producers were stripping out cultural references relevant to British and European gamers from the storylines of their games, and this was having an impact on British culture.

The Video Games Tax Credit would therefore be available only to games that were culturally British, under a test administered by the British Film Institute. The government argued that this targeting would mean that “The proposed tax relief should promote the production of video games with a cultural content as opposed to games that are purely for entertainment.”2

In order to qualify as being culturally British, games are scored against a number of criteria, including being set in the UK, having British lead characters, or being produced in the UK.

When introducing the relief, the government estimated that only around 25% of games produced in the UK would qualify, and that the major beneficiaries would be small games producers interested in the local market. The government expected only 10% of games that qualified for the relief would have a budget of more than £5m. A press release put out by the government at the time stated that 95% of video games development in the UK was performed by SMEs.3

The government estimated that the new relief would cost £35m a year, and committed to reviewing the relief after three years of operation to determine whether it had been effective.

There is no evidence that this review has taken place. If it had, the government would have seen that the programme is significantly over-budget, having cost £108m in 2017/18, and that a significant amount of the tax credit is being claimed by just one company.

Grand Theft Auto’s Tax Credits

A year after the scheme came into effect, Grand Theft Auto V was granted certification as “culturally British” by the British Film Institute. The certification has allowed the game’s developer, Rockstar North Ltd, to access substantial amounts of tax credits.

That Grand Theft Auto should receive any tax credits at all may seem bizarre to some. One of the criteria of the BFI Cultural Test for video games is how the game represents diversity. The guidance note for the cultural test states:

“Cultural diversity can directly influence the content and tone of a video game; its sensibility and authority. For example, much has been written on a lack of female video game developers, and the differing perspectives and sensibilities that women bring to video game productions.

 

Encouraging cultural diversity implies challenging preconceptions, assumptions and ways of working. It goes beyond simple equal opportunities and recognition of difference and emphasises the potential creative connections that can be forged across different perspectives through access, inclusion, and collaboration –and the direct impact of these on the video game as a cultural product….

 

Points will be awarded based on the following determinants of diversity:

 

a. subject/portrayal: exploring contemporary social and cultural issues of disability, ethnic diversity and social exclusion on screen; promoting and increasing visual, on-screen diversity; and

 

b. other cultural diversity factors which can be shown to have an impact on the final content.”

It is unlikely that the drafters of that guidance had in mind a game which allows the player to murder prostitutes when formulating the cultural test.

For most observers, the controversial game would probably fall under the category of a game produced purely for entertainment rather than a game with significant cultural content. The game was made famous by its free-wheeling game play which allows players to car-jack, carry out random killings and blow up things whilst progressing through the ranks of organised crime. None of the lead characters are British, and the 5th instalment in the series is set in Los Santos, a fictional representation of Los Angeles. Previous editions had been set in New York, Florida and California. The only part of the game set in the UK was an expansion pack to the second edition of the franchise, GTA II.

Made in Britain

The game was however largely developed in the UK. The first two editions of the game, GTA and GTA 2, were developed by DMA Design Ltd, a UK based developer.

DMA was bought by Take-Two Interactive Inc, a US-based multinational, in 1999. The US company had already acted as the publisher of GTA 2 under their “Rockstar” label, which has been the publisher of all subsequent editions of the GTA franchise.4 Game development continued in the UK at Rockstar North Ltd, a design studio based in Edinburgh. This connection with the UK is apparently enough to secure the culturally British test for Grand Theft Auto V.

Having been certified as culturally British in 2015, Rockstar North starting receiving Video Games Tax Credits in the financial year ending March 2016. The amount it claimed was substantial. The annual accounts of Rockstar North Ltd show that over the last three years the company has claimed £42m in Video Games Tax Credits. This is equivalent to 19% of the £227m that the government has granted to the entire industry since the relief was introduced in 2014.5

In 2016 the company also recorded a large retrospective adjustment for tax paid in previous years. The effect of tax credits and previous year adjustments means that over 10 years the company recorded a net loss for tax purposes, paid nothing in corporation tax, and claimed £70m in credits from HMRC. The amount of credit claimed by Rockstar North from HMRC was almost 6 times its operating profit over the period.

Table 1: Key Financial Data Rockstar North Limited 2009-2018

(Year to March 31st) 2009 2011 (17 Months) 2012 2013 2014 2015 2016 2017 2018 Totals
Turnover £14,853,498 £25,828,898 £18,054,810 £20,127,149 £32,252,221 £42,909,043 £53,446,092 £57,089,880 £79,158,894 £343,720,485
Cost of Sales -£9,079,562 -£14,218,633 -£11,789,637 -£12,404,764 -£16,111,491 -£26,501,031 -£26,641,448 -£29,087,405 -£40,799,868 -£186,633,839
Gross Profit £5,773,936 £11,610,265 £6,265,173 £7,722,385 £16,140,730 £16,408,012 £26,804,644 £28,002,475 £38,359,026 £157,086,646
Admin Expenses -£8,288,372 -£11,368,142 -£7,423,997 -£6,413,329 -£13,986,232 -£13,600,894 -£23,308,165 -£24,257,130 -£30,116,236 -£138,762,497
Operating Profit -£2,514,436 £5,415,849 -£12,681,786 £1,309,056 £2,154,498 £2,807,118 £3,496,479 £3,745,345 £8,242,790 £11,974,913
Operating Margin -16.93% 20.97% -70.24% 6.50% 6.68% 6.54% 6.54% 6.56% 10.41% 3.48%
Profit before Tax -£2,507,040 £5,419,081 -£12,679,587 £1,136,416 £2,162,491 £2,819,685 £3,515,268 £3,763,815 £8,300,782 £11,930,911
Tax £202,688 £135,510 £46,992 -£2,461,467 -£887,635 -£718,156 £33,416,310 £13,121,157 £26,915,315 £69,770,714
Profit for the year -£2,304,352 £5,554,591 -£12,632,595 -£1,325,051 £1,274,856 £2,101,529 £36,931,578 £16,884,972 £35,216,097 £81,701,625
Video Games Tax Relief £0 £0 £0 £0 £0 £0 £11,278,530 £11,918,339 £19,116,178 £42,313,047

Grand Theft Auto Profits

Although the statutory accounts of Rockstar North, the maker of Grand Theft Auto V, state that the company is hardly making any profit, the game is widely reported to be the most profitable media product in history. The game broke several world records for the speed of its sales, and generated $800,000,000 in revenue for Take-Two within the first 24 hours of its release. Within three days the game had hit $1bn in sales, making it the fastest selling entertainment product in history. Within one year, the game had hit $3bn in sales, making it the biggest selling game of all time.6 The game continues to sell, and in May 2019, Take-Two disclosed that they had sold over 110m copies.7

Alongside GTA V, the company developed an add-on GTA Online, which created a new virtual world where gamers could interact with other players over the internet. GTA Online generates revenue for Take-Two as players can buy virtual currency to purchase new items in the game.

In 2015, two years after the release of the game, 8 million people were still playing GTA every week, and the add-on had generated an additional $500m for the company.8 The huge sales of GTA V and the popularity of GTA Online has generated an estimated $6bn in sales for Take-Two over the current lifetime of the product.9

These sales have translated into vast profits for the company and its senior management. Between 2009, when development on GTA V is known to have started, and the 2014 financial year in which the game was released, Rockstar North had total costs of £110m. In 2013, the Scotsman reported that the game had a total development and marketing budget of £170m.10 Adding in distribution costs and other ongoing development costs, Take-Two should have generated gross profits in the region of $5bn from the game. This figure is corroborated by data on internal royalties paid by the company.

Under a profit sharing agreement signed with senior staff at Rockstar Games, three “Principals” and other unnamed Rockstar employees were entitled to a profit share worth 50% of the operating profit made on Rockstar titles.

Take-Two’s annual reports in the United States disclose a cost which it calls “internal royalties”. It describes these as allowing “selected employees to each participate in the success of software titles that they assist in developing.” Between 2009 and 2019 Take-Two paid out $3.4bn in “internal royalties”, 22% of the total revenues of the company over that period. Between the financial year ending in 2014 (the year Grand Theft Auto V was released) and 2019, internal royalties stood at $2.5bn.

The success of the Grand Theft Auto franchise would suggest that the vast majority, if not all of the cash being allocated to internal royalties by Take-Two is being used to fund the Rockstar royalty plan. That would also put the total operating profit (which also includes deductions for head office costs and contributions from other games) generated by Rockstar at $5bn over the last 5 years.

How is it possible that a game made in the UK, generating billions of dollars in profit for its parent companies and senior management, makes a loss for tax purposes in the UK and is able to claim tax back from the government?

Rockstar North is one cog in the Take-Two machine, but an important one. Given that the game is not set in the UK, and does not feature British characters, in order to meet the BFI’s culturally British test the game makers will have had to argue that a substantial amount of creative input for the game came from the UK, and would have signed a statutory declaration to this effect.11

In return for creating this intellectual property, Rockstar North would presumably have had a contract with Take-Two to remunerate it for its work. The contract would appear to have been constructed so that Rockstar North receives not much more than the cost of its work. Between 2009 and 2018 the company made an average operating profit of just 3.5%; between 2013 and 2017 operating profit kept stable at around 6.5%, whilst sales of the product it created were beating all expectations.

Other Rockstar companies based in the UK show even less profit. Rockstar Lincoln Ltd, which was involved in testing the game, declared a total profit before tax of £1.2m between 2009 and 2018, and a total tax bill of £226k over the same period.

In order to work out the taxable profits of a business, revenue authorities around the world do not look at a multinational company as a whole, but treat each subsidiary as an independent entity. In the case of Rockstar North Ltd, the question they will be asking themselves is whether the contract Rockstar North had with its parent company was one that independent companies would negotiate in the real world.

On the facts that we have been able to determine, we believe the answer is no.

Profit share

Given the importance of the games produced by the Rockstar label to Take-Two’s business, Take-Two entered into a royalty agreement with certain key people in the Rockstar team as early as 2002.

Following the success of GTA 3 and GTA 4, the Rockstar principals, as they were called, felt they had the leverage to increase their profit share and renegotiated a new deal: the 2009 Royalty Plan. The Plan named three people as Rockstar Principals: Sam Hauser, Dan Hauser, and Leslie Benzies.12 Sam and Dan Hauser created the original Grand Theft Auto. Sam Hauser is the President of Rockstar Games and Dan Hauser, his brother, is Vice President of Creativity.

Leslie Benzies is largely credited with the technical advances in game playing which led to the popularity of Grand Theft Auto exploding with the release of GTA V.13 At the time of the development of GTA V he was President of Rockstar North Limited.

Although the Hauser brothers are based in New York, it was part of Leslie Benzies’s contract that he was to be employed in Edinburgh, and any requirement for him to move from Edinburgh could be cited as cause for termination of the contract.14

The 2009 Royalty Plan, which in reality was not a royalty payment but a profit share agreement, gave the Rockstar Principals and unnamed qualifying Rockstar employees entitlement to a bonus pool of 50% of the operating profits of games produced under the Rockstar label. Under the plan, the principals were entitled to no more than 60% of the total pool, with no individual able to receive more than 25% of the pool.

When setting up the incentive schemes for the principals, lawyers agreed a side letter setting out the tax treatment of the payments the principals would receive.15 This letter makes clear that the remuneration would be paid as a service for employment, and that in the case of Leslie Benzies his employment was with Rockstar North Limited. The reason for this stipulation was likely to prevent the imposition of US employment taxes on his income, as part of the royalty plan involved assigning certain intellectual rights to a Delaware LLP which the three principals were partners of. However, despite this stipulation, the remuneration does not appear to be included in the Rockstar North accounts. It is not known whether and how much UK income tax has been paid by the principals on these profit shares.

The significance of all of these arrangements is that they demonstrate that had Rockstar been an independent company, then the management would clearly not have been satisfied with selling the rights to their work for the cost of production plus a small margin. In fact, the reality of the relationship between Rockstar and Take-Two was that the management of Rockstar demanded huge sums in compensation for their contribution. After the release of GTA V, Leslie Benzies left the company following a dispute with the other Rockstar Principals. However, the existence of a profit sharing agreement in 2009 which included Mr Benzies suggests that Take-Two placed a substantial amount of value on work carried out on its behalf in the UK.

All of this stands in stark contrast to the tiny profits allocated to Rockstar North and other Rockstar companies in their UK accounts, suggesting that profits allocated to the company should have been much higher than stated. It is impossible to say how much higher, although it is not unreasonable to believe that that profit should have been in the hundreds of millions if not billions. At this level, HMRC would not be paying tax credits to Rockstar North. Instead, the tax collected from Rockstar in the UK would likely be enough to pay for the entire Video Games Tax Credit Programme.

Conclusions and recommendations

Grand Theft Auto has been referred to by some as a “Great British Export”.16 However, a brief look at the accounts of the UK based developer of the game, with its slender profits, would not lead one to that conclusion. Rather than a picture of success, the accounts of the developers of the game, Rockstar North, show that the company has earned so little that they have been eligible to claim tax credits from the government.

The situation is absurd. The large amounts of subsidy that Rockstar North has been able to claim from the UK government demonstrates that the Video Games Tax Credit system is not working as intended. The government should hold an immediate review into its effectiveness.

Furthermore there are serious questions over how the company has been treated for tax purposes in the UK.

Take-Two appears to believe that it is reasonable that close to 100% of the profit should flow to their US based parent companies and senior management, whilst almost no profit flows back to the UK companies involved in either making or selling the game. We do not believe that this division of profits can be justified under the so-called “arm’s length” standard found in international tax law.

There is no evidence that HMRC have challenged this set-up or that Take-Two or any of the individuals named in this report has acted illegally. However, it is open for HMRC to challenge the allocation of profit under the transfer
pricing system and we urge them to investigate this case urgently.

 

Notes

1Documents relating to the European Commission investigation into Video Games Tax Relief are available from the European Commission website – http://ec.europa.eu/competition/elojade/isef/case_details.cfm?proc_code=3_SA_36139

2See European Commission Decision SA.36139 (13/C) (ex 13/N) – https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv:OJ.L_.2014.323.01.0001.01.ENG

3HM Treasury, Video Games Companies to Begin Claiming Tax Relief, https://www.gov.uk/government/news/video-games-companies-to-begin-claiming-tax-relief

4A short history of the development of the game is set out in the statement of case of Leslie Benzies in Leslie Benzies vs Take-Two Interactive Software Inc., Supreme Court of the State of New York, Index No. 651920/2016

5HMRC, Creative Industry Statistics July 2018, Published April 2019

6See Statement of Case of Leslie Benzies in Benzies vs Take-Two Interactive Software

7Rockstar Intel, Take-Two Q4 Earnings Report, https://rockstarintel.com/take-two-q4-2019-earnings-report-red-dead-redemption-2-has-sold-over-24-million-copies-worldwide

8See Statement of Case of Leslie Benzies in Benzies vs Take-Two Interactive Software, paragraph 42

9Sky News, Grand Theft Auto V grosses more than any movie ever, available from: https://news.sky.com/story/grand-theft-auto-v-grosses-more-than-any-movie-ever-11326135

10The Scotsman, New GTA release tipped to rake in £1bn in sales, available from: https://www.scotsman.com/lifestyle/gadgets-gaming/new-gta-v-release-tipped-to-rake-in-1bn-in-sales-1-3081943

11The cultural test administered by the BFI awards points if the lead programmers and developers work in the UK or the European Economic Area, and if more than 50% of the design or development of the game is carried out in the EEA.

12A copy of the 2009 Royalty Agreement is available from the the Supreme Court of the State of New York on the docket of Leslie Benzies vs Take-Two Interactive.

13Connor Sheridan, One of the Fathers of Grand Theft Auto has left Rockstar, Gamesradar January 12 2016, https://www.gamesradar.com/uk/gta-leslie-benzies-leaves-rockstar/

14Paragraph 6 (d) 2012 Employment Contract of Leslie Benzies.

15Tax Side Letter between Take-Two Interactive, Another Game Company and the Rockstar Principals, available on the docket on the Leslie Benzies vs Take-Two Interactive Inc.

16Sophie Curtis, GTA 5: a Great British export, The Telegraph 18 September 2013, https://www.telegraph.co.uk/technology/video-games/10316267/GTA-5-a-Great-British-export.html

European Commission responds to TaxWatch call to investigate Google

5th June 2019 by George Turner

The European Commission has replied to TaxWatch’s call to launch an investigation into the tax structure of Google. The Commission has said it will consider the information provided by TaxWatch as part of its ongoing investigation into tax agreements in Ireland and the Netherlands.

TaxWatch wrote to the European Commission on 26 April to highlight the structure that Google has put in place to avoid paying taxes in Europe. Google charges all of its European customers via a subsidiary in Ireland, Google Ireland Limited. That company pays out large royalty payments for the use of Google’s intellectual property to a company in the Netherlands, which in turn pays out almost all of the revenue it receives as a royalty to a company registered in Ireland but tax resident in Bermuda.

The royalty payments are substantial, comprising 46% of Google Ireland’s revenues in 2017, the last year where accounts are available. The structure minimises profits and tax liabilities in Europe, whilst making sure that profits appear in Bermuda, which has a 0% corporation tax rate.

TaxWatch questioned whether the scale of royalty payments made by Google to its Bermuda subsidiary was in line with the arms-length principle. This principle is used by tax authorities to establish whether a company is artificially shifting profits to tax havens, and whether the government of the Netherlands and Ireland had come to any special arrangements with Google to allow them to make such payments.

Responding to TaxWatch’s letter, Max Lienemeyer, Head of the State Aid: General Enforcement and Scrutiny Unit of the European Commission’s Competition DG, told TaxWatch that the Commission had an ongoing investigation into tax rulings granted by Ireland and the Netherlands, and was seeking to establish whether certain tax agreements had resulted in a selective advantage being given to particular companies.

Mr Lienemeyer thanked TaxWatch for the information provided, and said it would be considered as market information in the light of their ongoing investigation into transfer pricing deals.

In addition to raising this issue with the commission, TaxWatch has put forward a proposal on how countries could change domestic legislation to ensure that royalty payments made by large multinational companies to tax haven subsidiaries are subject to income tax.

Photo by Sara Kurfeß on Unsplash

Tax Treaties, the source of the problem

2nd May 2019 by George Turner

Mel Stride, the Financial Secretary to the Treasury, recently confirmed concerns raised in the latest TaxWatch report, that the UK’s tax treaties will render the government’s latest attempt to tax the tech giants ineffective.

In our report we analysed the government’s recent policy announcements related to their attempts to tax major technology companies. We highlighted how its most significant measure, Offshore receipts in respect of intangible property, was not only expected to recoup only a fraction of the likely lost tax from such receipts but to collapse dramatically after just a couple of years of the measure coming into effect.

The measure imposes an income tax charge on UK royalty payments paid by companies to their subsidiaries in low tax jurisdictions. Royalties are a common mechanism by which companies divert profits from countries like the UK to tax havens.

Under the government’s impact analysis, the policy will raise just £475m in total in its first year of application (2020/21) – and dwindle to only £165m a year by 2023/24. Yet TaxWatch estimated that the lost tax from UK royalties paid to tax haven subsidiaries could be as much as £8bn a year.

Although the government did not explain either why this measure would recoup only a fraction of the likely lost tax or why it would so quickly become ineffective, we suggested that this collapse in revenue was most likely due to the government choosing not to apply the measure to countries where the UK had a tax treaty.

In response to this, companies would simply restructure their tax avoidance schemes to take advantage of this loophole. Indeed, with the long lead in before the policy was implemented, and the relatively small amount of tax the government forecast the measure would raise even in its first year of operation, it is clear that the government anticipated that many companies would restructure their affairs before it came into effect and that more would follow thereafter.

Following our report, Labour Shadow Treasury Minister Anneliese Dodds MP put down a couple of questions probing the government on how their new policy would be implemented.

In a response dated, 23 April, Mel Stride confirmed TaxWatch’s concerns, stating:

The Offshore receipts in respect of intangible property measure targets multinational groups that realise intangible property income from UK sales in low or no-tax jurisdictions.

The government has been clear that this measure will be applied in compliance with the UK’s international obligations. This means that the measure will only apply to low-tax jurisdictions with which the UK does not have a full tax treaty.

In a later response dated April 29, Mr Stride provided a list of countries which have a full tax treaty with the UK, by which they mean a treaty containing “an appropriate non-discrimination article”.

The list, which can be found here: https://www.gov.uk/hmrc-internal-manuals/international-manual/intm412090 is revealing

On the list provided can be seen some classic tax haven jurisdictions including, Ireland, The Netherlands, the UAE, Luxembourg, Switzerland, Malta, Mauritius, Panama and Liechtenstein.

What’s more, the UK has recently signed new treaties with Jersey, Guernsey and the Isle of Man and it is not clear why they would not also qualify for the government’s exemption to this measure.

With the UK refusing to apply its anti-tax avoidance measures to tax havens, it is easy to see why their efforts to crack down on tax avoidance will ultimately be ineffective.

As we argued in our recent report, contrary to the position stated by Mr Stride, there is no international obligation for the UK to not apply such measures to countries where it has a treaty relationship. Tax treaties were established with the purpose of stopping companies and individuals from being taxed on the same income twice. They were never designed to allow taxable income to escape tax anywhere.

Indeed, as we noted in our report, the measure is specifically designed to apply in certain circumstances even where there is a tax treaty. The problem is that it is deliberately designed in such a way that it will hardly ever so apply. What is not clear is why. The courts have been supportive of the UK in the past when it has sought to close down tax avoidance schemes that use the UK’s tax treaty network to escape taxation. The government choosing not to apply this measure to treaty countries is a policy choice, not an obligation. Why it has made that choice, remains a mystery.

If the government wants its attempts to tax the tech giants to have real impact, it must now move to apply its income tax charge on royalties to countries which do have a tax treaty with the UK. A good start would be to apply the measure to Ireland, a country which has been actively encouraging companies to move their IP to its jurisdiction in order to help them avoid tax in countries around the world.

Photo by James Newcombe on Unsplash

TaxWatch calls on the European Commission to open an investigation into Google’s European Tax Avoidance Scheme

26th April 2019 by George Turner

TaxWatch has today written to Commissioner Vestager requesting that the European Commission open an investigation into Google’s European Tax Avoidance scheme, the Double Irish Dutch Sandwich, and specifically whether the Dutch and Irish Governments have provided state aid to the company.

Google’s tax avoidance scheme, which uses Irish and Dutch companies to funnel profits from their European operations to Bermuda tax free has been in operation since 2004, since when tens of billions of Euros a have flowed though the scheme.

As highlighted in the letter TaxWatch has sent to the Commission the scheme relies on very large royalty payments being paid from Google’s European hub, Google Ireland Limited, to a Dutch company, Google Netherlands Holdings. This company then pays another royalty to a company registered in Dublin but tax resident in Bermuda, Google Ireland Holdings.

In 2017, Google Ireland Limited transferred €14.9bn in revenues from its European, Middle Eastern and African operations to Bermuda under this scheme. This royalty payment was equivalent to 46% of Google Ireland Limited’s revenues, 65% of its gross profits. TaxWatch is asking the Commission to investigate whether these large royalty payments are the result of any special arrangement between the Dutch and Irish government and Google.

TaxWatch’s letter was featured in Law360.

A Question of Royalties – Taxing International Technology Companies in the UK

21st March 2019 by George Turner
Google logo in Dublin

A Question of Royalties

- A practical solution to taxing tech companies

A Question of Royalties

Tax avoidance and profit-shifting by multinational companies has been high up the economic policy agenda for a decade. Yet, despite an unprecedented global initiative1 and a series of loudly-trumpeted domestic measures to counter the problem2, TaxWatch’s first report3 recently estimated that what we called the “Tech 5” companies4 alone paid £1bn less UK tax than they would have if the UK share of their global profits corresponded to the UK share of their global sales.

In this paper, we propose a radical but achievable solution to the problem. Given the inclusion of a curiously watered-down version of the solution in Finance Act 2019 (which we have called “Google Tax III”)5, the government is clearly already aware of it but not, it would seem, of its full potential. We think its full potential could be realised simply by ensuring it prevented the likes of the Tech 5 from misusing a few of the UK’s double tax treaties (particularly that with Ireland) to avoid its effect.

UK Budget – 29 October 2018

In his Budget on 29 October 2018, the Chancellor, Phillip Hammond, announced two measures aimed specifically at the kind of avoidance in which the likes of the Tech 5, in particular, have indulged: the much-heralded “Digital Services Tax” (DST)6 (that, as we note below, might arguably be called Google Tax II) and the less-noticed extension of income tax to include “offshore receipts in respect of intangible property” (that, as noted above, we have called “Google Tax III”).

Each measure seems to seek to address precisely the kind of exaggerated divergence between the UK sales and UK profits of the likes of the Tech 5 that we highlighted in our first report – by imposing UK tax by reference to the UK sales of such companies in addition to the existing tax on their UK profits.

But, while the government forecasts that the measures will raise considerable amounts of revenue (between £600m-£750m a year between them), as we explain below, the evidence suggests that the government could raise billions of pounds a year from them (perhaps as much as £8bn). The measures required are similar to those it has taken. They simply require a bolder, though entirely legitimate, approach to the possibilities provided by the international tax system.

In this report, we firstly consider the two measures, explain why they are half-hearted (and, arguably, cosmetic) and how they allow Ireland (these days, probably the world’s foremost facilitator of corporate tax avoidance) to frustrate their effectiveness. We then show what the government could do if it genuinely had a mind to tackle the problem.

Digital Services Tax (DST)

According to the government7, the DST will be a 2% tax on revenues generated by providers of “social media platforms, search engines and online marketplaces” to the extent that such revenues are linked to “the participation of a UK user base”. So, while it will presumably apply to the search engine-providing Google (perhaps making it “Google Tax II”) and the social media platform-providing Facebook, it will not, presumably, apply to Apple’s hardware business, Microsoft or Cisco (none of whose businesses involve social media platforms, search engines or online marketplaces).

The government forecasts that the DST will raise £275m in its first year of effective operation (2020-21 since its introduction is delayed until April 2020) rising to £440m a year by 2023-248.

As a tax on turnover rather than income or profits, the DST falls outside internationally-agreed principles for dividing taxing rights between countries. As such, it faced immediate opposition from the US government9. The UK government itself made it clear that the DST is, in any event, merely temporary and will only apply “until an appropriate long-term solution is in place”10.

On 29 January 2019, the OECD published a policy note11 outlining the bare bones of a new approach to allocating taxing rights on international trading profits among sovereign states – explicitly to address the problems posed by the likes of the Tech 5. Although the note includes some interesting and potentially radical ideas, it is very vague and only time will tell whether it heralds the long-term solution the UK government has in mind.

Either way, notwithstanding the fanfare accompanying its introduction, it does not seem that the DST is likely to provide any kind of effective answer to the problems the government faces in tackling the likes of the Tech 5.

Offshore receipts in respect of intangible property (Google Tax III)

This measure extends the scope of income tax to include certain UK royalties that are arguably not currently within its scope – essentially those paid by non-UK companies to other non-UK companies in respect of intangible property (IP) relating to trademarks and brand names.12

Like the DST, the measure seeks to impose tax not so much by reference to the net UK profits of the likes of the Tech 5 but by reference to their UK sales. But, unlike the DST, it does not seek to do so through a turnover tax that falls outside internationally-agreed principles for dividing taxing rights between countries.

Rather, as an extension to income tax, this measure falls squarely within international tax principles by seeking to tax income– in this case, the internal royalties generated by the likes of the Tech 5 (to the extent that such royalties relate to UK sales).

Role of royalties in Tech 5 avoidance schemes

Royalties are fees paid to the owners of legally-protected IP by those who exploit such IP in their businesses. So, for example, radio stations are legally required to pay songwriters copyright royalties when they play their music on the radio.

Royalties are especially pertinent to the taxation of tech companies because they are at the heart of the tax avoidance we highlighted in our first report. As we explained, like many 21st century multinational groups, the Tech 5 have adopted a variety of counter-intuitive, tax-driven business models. Their basic premise is that, although the multinational makes its profits from selling its products and services around the world for more than it costs it to develop, make, market and sell them, most of the profits are attributable to various types of IP it has developed.

On this basis, the profits of the subsidiaries that sell the multinational’s products and services in, for example, the UK are reduced (often to little or nothing) by internal royalty payments they are required to make to fellow subsidiaries for the use of IP, in which its legal ownership has been artificially located.

IP transfer pricing

A typical IP transfer pricing scheme

By artificially locating the intermediate legal ownership of the IP in avoidance-facilitating jurisdictions such as Ireland, the Netherlands, Luxembourg and Switzerland, the multinational can avoid UK tax on UK royalties. Even though such royalties are within the scope of UK income tax, the UK has agreed double tax treaties with these jurisdictions. Under these, only the avoidance facilitating country may tax them.

By artificially locating the ultimate legal ownership of the IP in a tax haven like Bermuda, the multinational can avoid tax on the UK royalties in the avoidance-facilitating jurisdictions because the profits of the subsidiaries receiving the intermediate royalties are, in turn, reduced or eliminated by royalty payments to the ultimate legal owner of the IP. The avoidance-facilitating jurisdictions of course do not seek to tax those royalties on their way to the place of ultimate ownership. Since Bermuda has no tax regime, none of the royalties is taxed anywhere.

Under these kinds of business models, most, if not all, of the multinational’s profits are said to belong not to the subsidiaries who develop or make or market or sell the group’s products and services, but to the tax haven-based subsidiaries in which the ultimate legal ownership of the IP has artificially been placed.

Taking Google as an example, nearly all its income comes from selling advertising space through a mixture of on-line “auctions” and old-fashioned salesmanship. In an effort to avoid UK tax on its profits from UK sales, the advertising is sold by an Irish subsidiary of Google13 which (arguably) has insufficient physical presence in the UK to be taxable here.

In any event, in line with the business model summarised above, the Irish subsidiary has little in the way of taxable profits because it is required to pay substantial royalties to a Dutch fellow subsidiary14. This, in turn, is required to pay equally substantial royalties to a Bermudan fellow subsidiary15.

The accounts of Google’s Bermudan subsidiary show that, in 2017, it received around $20bn in royalties from (undisclosed) fellow Google subsidiaries. Reuters recently reported16 that most (if not all) of these royalties were from its Dutch fellow subsidiary (whose 2017 accounts show that it, in turn, received nearly €15bn (around $13bn) in royalties from its Irish fellow subsidiary – along with a further €5bn (around $4.5bn) from a fellow subsidiary17 based in another avoidance-facilitating jurisdiction (Singapore)).

Google Royalties

Google’s Royalty Payments from UK source

It is arguable both whether the vast majority of the profits of multinationals like the Tech 5 really is derived from IP and whether the royalties in relation to UK sales that are ultimately paid to Bermuda are outside the current scope of UK income tax. But most tax authorities seem to accept the premise of these business models and HMRC seems resigned to not taxing the royalties.

Taxing UK royalties

The proposed extension of income tax (Google Tax III?) seems, on its face, to be the UK government saying to the likes of the Tech 5: “OK, if you’re right that most of your profits are attributable to IP, we’ll tax the UK’s share of those profits by putting it beyond doubt that UK royalties paid in respect of such IP are liable to UK income tax”.

So, where, for example, Google’s Irish subsidiary sells advertising space to a UK customer in respect of which it is required to pay royalties to its fellow Dutch subsidiary which is, in turn, required to pay royalties to its fellow Bermudan subsidiary, there should, under Google Tax III, be an income tax charge on those UK royalties.

On the face of it, that should give rise to a substantial increase in UK tax. As noted above, Google’s Irish subsidiary (that not only sells Google’s advertising space in the UK but in the rest of Europe and in the Middle East and Africa (EMEA)) paid €15bn in royalties in 2017 to its Bermudan fellow subsidiary.

Given Google’s lack of transparency, it’s not possible to say with any precision how much of that €15bn was in respect of UK royalties. But Google’s public filings in the US suggest that around 27% of Google’s EMEA sales are UK sales18. If UK royalties were similarly around 27% of the royalties paid by Google Ireland Ltd via Google Holdings Netherlands BV to Google Ireland Holdings Unlimited Company in Bermuda, it would suggest that, in 2017, around €4bn (around £3.5bn) was paid in UK royalties.

With UK income tax at 20%, that would suggest that Google Tax III could potentially raise £700m a year from Google alone, which, in turn, would suggest that it could potentially raise around £2bn a year from the Tech 519 and anything up to £8bn a year overall20. Yet the government forecasts that Google Tax III will raise only £475m in total in its first year of application (2020/21) – and to dwindle to only £165m a year by 2023/2421.

It seems odd that the government estimates that a measure that, on its face, would seem to be capable of raising anything up to £8bn a year, will not only raise a considerably lower amount in its first year of application but will dwindle dramatically thereafter.

Either this is yet another Google Tax that doesn’t tax Google ( because, for example, it has been drafted in such a way that it does not include royalties paid by the likes of the Tech 5) or it anticipates that they (and other multinational groups) will take increasingly successful steps to try to avoid the effect of the measure. It also evidently has no plans to effectively counter such steps.

Treaty shopping

It is to be hoped that the government has learned from its mistakes with Google Tax I and has ensured that Google Tax III has been drafted in such a way that it includes royalties paid by the likes of the Tech 5. There are some fairly widely-drawn exemptions that could possibly be exploited by the likes of the Tech 5 but the most likely way in which Google and others will seek to avoid the effect of Google Tax III is through some kind of “treaty shopping” scheme.

As noted above, bilateral double tax treaties form an integral part of the avoidance schemes employed by the likes of the Tech 5. The UK (in common with the other main countries in which these multinationals operate) has made bilateral double tax treaties with its trading partners under which, to avoid double taxation, they mutually cede to each other their right to tax income such as royalties where they arise within their territories to residents of their treaty partners.

So, for example, although Google Tax III will put it beyond doubt that the part of the royalties paid by Google Ireland Ltd to Google Holdings Netherlands BV that relates to UK sales is liable to UK tax, the double tax treaty between the UK and the Netherlands provides that only the Netherlands may actually tax them.

On the other hand, there is no double tax treaty between the UK and Bermuda so, unless Google takes steps to avoid its effect, Google Tax III should ensure that the UK is able to tax that part of the royalties paid by Google Holdings Netherlands BV to Google Ireland Holdings Unlimited Company in Bermuda that relates to UK sales.

The government understandably thinks that groups like Google will try to take steps to ensure they do not have to pay UK tax on their UK royalties. The most likely means would probably involve restructuring operations such that UK royalties are paid only to subsidiaries resident in countries with which the UK has made a double tax treaty under which only the UK’s treaty partner may tax such UK royalties. The selection of countries through which to route transactions in this way is colloquially known as “treaty shopping”.

Google could, for example, simply make its Irish-registered, Bermudan-based subsidiary, Google Ireland Holdings Unlimited Company, tax resident in Ireland (as Irish law will shortly require it to do in any event). The UK has a double tax treaty with Ireland under which only Ireland may tax UK royalties paid to Irish residents so, unless the UK took action to ensure Google Tax III applies notwithstanding the UK/Ireland double tax treaty, it would not apply to any of Google’s UK royalties.

Ireland

This would be especially attractive to Google given that, in 2009, the Irish government introduced a new tax regime for IP22 (which it further enhanced in 201423). This may well afford the Tech 5 and other many or all of the tax advantages they enjoy through the use of Bermudan subsidiaries, without the hassle of having to devise structures to cater for the inconvenience of Bermuda having no double tax treaties.

Successive Irish governments have a long history of actively facilitating this kind of international corporate tax avoidance with specially-designed measures like these. From the “Double Irish” to the “Single Malt” through myriad other iterations, Ireland has been at the forefront of facilitating eye-watering amounts of tax avoidance over the last 40-50 years.

Given the lack of transparency involved, it is impossible to be precise about figures but it is undisputed that, over the years, the Irish Government has actively enabled multinational groups to avoid many, many billions of dollars in tax (tax that, without Ireland’s active facilitation, would largely have been paid to its fellow European Union partner states). And, of course, the Irish Government has recently been forced by the European Commission (the EC) to demand more than €14bn in back taxes from Apple to whom, the EC say, the Irish Government gave illegal State Aid24.

So many multinationals moved their IP to Ireland in 2015 (presumably to take advantage of the enhancement to the regime) that Ireland’s GDP increased by more than a third25. While in most countries royalty payments account for less than 1% of their GDP, for Ireland it has exceeded 20% in recent years26.

Apple seems to have been one of those multinationals that has already restructured its avoidance schemes to take advantage of the latest tax avoidance facilitation offered by the Irish government27. Others in the Tech 5 may well have since followed suit – especially as the UK government gave warning in December 201728 of its plans to tax these kinds of royalties and that those paid to companies resident in countries with which the UK had a double tax treaty would be excluded.

Applying the measure despite a double tax treaty

The government seems to have anticipated the possibility of treaty shopping since it has included an anti-treaty shopping clause29 that provides that, where there is a certain kind of treaty shopping, Google Tax III will apply despite anything in a double tax treaty. But the fact that the government nonetheless forecasts that the measure will raise only £475m in its first year of operation and dwindle dramatically thereafter suggests that the likes of the Tech 5 will be free to use other types of treaty shopping to avoid Google Tax III.

Given that the measure is presumably aimed at the very tax avoidance that sparked the OECD’s BEPS project and given the sheer scale of the amount of tax being avoided, it is hard to understand why the government would make only superficial attempts to ensure Google Tax III works effectively.

The government did make it clear in the consultation document that it issued in December 2017 that it “intends to respect all of its international obligations in the application of the measure”30. It did not specify what it meant by its “international obligations” but the context suggests that it had in mind the 100+ double tax treaties it has made with other countries31.

It is unclear why the government considers that including a partially effective anti-treaty-shopping clause within Google Tax III would fulfill its international obligations while including a fully effective one would somehow contravene them. But all the evidence suggests that the UK’s “international obligations” do not prevent it from taxing these kinds of UK royalties.

While the UK has made many treaties in which it has ostensibly ceded to its treaty partners its right to tax UK royalties, it does not follow that it is precluded from taxing them where, as is so clearly the case with the likes of the Tech 5, the royalties are a fundamental aspect of tax avoidance structure. The main purpose of Double Taxation Treaties is to avoid double taxation.

Tax treaties are not designed to facilitate the avoidance of taxation – notwithstanding their persistent use by a small number of governments (the Irish in particular) to do precisely that. Most of the UK’s treaties are based on the OECD Model Tax Convention on Income and on Capital, the Commentary to which makes it clear that, in light of their clear purpose, governments are perfectly entitled to ensure that any anti-avoidance legislation they enact applies notwithstanding the terms of a treaty – especially if the avoidance at which it is aimed involves the misuse of the treaty32.

One of the main action points of the OECD’s BEPS project was to prevent the misuse of tax treaties. Action Point 6 (Treaty Abuse) suggests the inclusion of a general anti-abuse provision in all double tax treaties.33

Google Tax III is clearly anti-avoidance legislation and the avoidance at which it is aimed equally clearly involves the use (or misuse) of certain treaties. Given the clear purpose of tax treaties and the unequivocal support of the OECD Commentary and the BEPS project, it is unclear why the UK government thinks taxing UK royalties of companies involved in avoidance and misuse of a tax treaty (in particular that with Ireland) would contravene the UK’s international obligations.

Applying any legislation that is in tension with the specific provisions of an international treaty is (and should be) rare. But now would seem to be the time and this would seem to be the issue when it would be fully justified– especially as, in practice, such action could be focused on the very small number of treaties where abuse is taking place.

Previous cases of the UK applying anti-avoidance law despite a tax treaty

It is not as if there is no clear precedent for applying anti-avoidance legislation despite a tax treaty where it is deemed necessary in the national interest to do so. Indeed, when it was done in 2008 to counter an avoidance scheme involving considerably less tax than the Tech 5 alone are avoiding, the legislation34 was even drafted to deem that it had always applied (i.e. it had retrospective effect). Crucially, both the UK courts35 and the European Court of Human Rights36 deemed the measure to have been proportionate in the circumstances.

A quote from the ECHR’s decision in that case is perhaps pertinent here:

“The Court notes that in the present case the object of the legislative amendments in issue was to prevent the DTA tax relief provisions from being misused for a purpose different from their originally intended use, that is relieving taxpayers from double taxation. The Court considers that it is a legitimate and important aim of public policy in fiscal affairs that a DTA should do no more than relieve double taxation and should not be permitted to become an instrument by which persons residing in the United Kingdom avoid, or substantially reduce, the income tax that they would ordinarily pay on their income. Moreover, it is in the general interest of the community to prevent taxpayers resident in the United Kingdom from exploiting the DTA in a way which would enable them to substantially reduce their income tax and secure a competitive advantage over those who chose not to use such a scheme.”37

Given that the circumstances regarding the Tech 5 and their ilk are far more serious than those which the 2008 legislation sought to tackle, it is puzzling why the government seems to have chosen to take such a soft line.

Double taxation

It may be that the government is concerned that, if it applies the new legislation despite anything in one or more of its double tax treaties, royalties will end up being taxed both in the UK (where the royalties arise – the “source state”) and one of its treaty partners (where the company receiving the royalties is resident – the “residence state”).

Given the alacrity with which the world’s multinationals have moved their IP to Ireland over the last few years, it seems unlikely that they are required to pay any significant Irish tax on their royalties. But, if that is the government’s concern, there does not seem to be any reason why Google Tax III could not include some kind of provision under which any company that could prove that it had paid tax on its UK royalties in the country in which it is resident could claim a credit for any such tax against the UK tax it has to pay on those royalties.

Double tax treaties made under international tax principles often provide for taxing rights on certain items of income to be shared. Indeed, royalties are a prime example of such income under many treaties – with the residence state traditionally being responsible for relieving any double taxation that arises as a result of both countries taxing the same income.

UK law therefore already includes provisions enabling UK residents who have received income arising in other countries to claim credit against UK tax for any foreign tax they have paid there38. There does not seem to be any obvious reason why such provisions could not be adapted for inclusion in Google Tax III to provide for the UK as source state to take responsibility for relieving any double taxation that arises when Google Tax III is applied despite a double tax treaty.

In such circumstances, it would not seem to be all that difficult to devise rules to allow non-resident recipients of UK royalties to claim credit against UK tax for any foreign tax they have paid in the country in which they are resident.

Conclusion

The problems posed by the business models used by the likes of the Tech 5 are not easy to solve. The proposed Google Tax III is by no means the perfect solution but it seems to us to be the best attempt yet put forward.

But the self-imposed restrictions the government has attached to it ensure that it is no solution at all. If we are right that the reason the government estimates that so little tax will be raised by Google Tax III is that double tax treaties prevent the government raising any more, we would recommend that the government takes more effective steps to ensure that it applies when it should, despite any specific treaty provisions.

All the evidence suggests that the OECD, the UK courts and the European Court of Human Rights would all support such a move. The billions of pounds of tax at stake demand it.

Notes

1 The G20/OECD Base Erosion and Profit Shifting (BEPS) project http://www.oecd.org/tax/beps) was an unprecedented attempt by the world’s major governments to collectively identify and tackle the main areas of corporate tax avoidance. 15 Actions were identified, on all but one of which (Action 1 on the so-called digital economy dominated by the Tech 5) detailed reforms were proposed. It is early days but, 5 years since the project ended, none of the Actions appears to have got to the heart of the problems that triggered the project

 

2 Eg the Diverted Profits Tax (Part 3 Finance Act 2015 – the so-called “Google Tax” aimed at addressing BEPS Actions 7-10); Hybrid mismatches (section 66 and schedule 10 Finance Act 2017 aimed at addressing BEPS Action 2); Corporate Interest Restriction (section 29 and schedule 5 Finance (No 2) Act 2017 aimed at addressing BEPS Action 4).
3 Corporate Tax and Tech companies in the UK: Still Crazy after all these years

 

4 Apple, Google, Microsoft, Facebook and Cisco

 

5 The so-called “offshore receipts in respect of intangible property”: Schedule 3 Finance Act 2019 – enacting new Chapter 2A Income Tax (Trading and Other Income) Act (ITTOIA) 2005

 

6 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/754975/Digital_Services_Tax_-_Consultation_Document_FINAL_PDF.pdf

 

7 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/754975/Digital_Services_Tax_-_Consultation_Document_FINAL_PDF.pdf

 

8 The Office for Budget Responsibility “judge these estimates to be subject to high uncertainty due to the data, modelling and behavioural complexities involved” and forecast that it will apply to just 30 groups of companies -https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/752208/Budget_2018_policy_costings_PDF.pdf

 

9 https://home.treasury.gov/news/press-releases/sm534

 

10 https://www.gov.uk/government/publications/budget-2018-documents/budget-2018#tax

 

11 http://www.oecd.org/tax/beps/policy-note-beps-inclusive-framework-addressing-tax-challenges-digitalisation.pdf

 

12 A version of which was originally proposed in the 2016 Budget as a withholding tax on royalties (https://www.gov.uk/government/publications/income-tax-royalty-withholding-tax) and amended in the 2017 Autumn Statement (https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/663889/Royalties_Withholding_Tax_-_consultation.pdf)

 

13 Google Ireland Ltd

 

14 Google Holdings Netherlands BV

 

15 Google Ireland Holdings Unlimited Company

 

16 https://mobile.reuters.com/article/amp/idUSKCN1OX1G9?__twitter_impression=true

 

17 Google Asia Pacific Pte Ltd

 

18 Google’s public financial filings in the US show that, in 2017, a third of its global sales were in EMEA countries. It did not separately report what proportion of its sales were UK sales but from 2010-2016, it reported them as 10%-11% of its global sales. As US law requires them to identify all countries in which the group makes 10% or more of its global sales, that figure must have fallen below 10%. Assuming, UK sales are now, say, 9%, that would, in turn, suggest that UK sales are around 27% of Google’s EMEA sales.

 

19 In our first report, we estimated that Google’s 2017 sales were around 1/3 of the Tech 5’s 2017 UK sales

 

20 A study in 2014 by Citizens for Tax Justice on the offshore cash mountains being accumulated by US multinationals (a number of whom built them employing similar tax-driven business models to the Tech 5) suggested that 4 of the Tech 5 (all but Facebook which was not as profitable then as it has since become) accounted for a little under a quarter of the then $2.1trn cash mountain held offshore by US multinationals.

 

21 https://www.gov.uk/government/publications/offshore-receipts-from-intangible-property/income-tax-offshore-receipts-in-respect-of-intangible-property

 

22 Capital Allowances Scheme – Intangible Assets: Finance Act 2009

 

23 The Knowledge Development Box: Finance Act 2015

 

24 https://www.bbc.co.uk/news/business-45566364. It is perhaps a rich irony that the tax that Apple avoided has been paid not to the countries whose tax was avoided but to the country whose government actively facilitated such avoidance.

 

25 Ireland’s Central Statistical Office Statistical Release (12 July 2016). “National Income and Expenditure Annual Results 2015”

 

26 https://www.ft.com/content/d6a75b56-215b-11e8-a895-1ba1f72c2c11

 

27 https://www.icij.org/investigations/paradise-papers/apples-secret-offshore-island-hop-revealed-by-paradise-papers-leak-icij/

 

28 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/663889/Royalties_Withholding_Tax_-_consultation.pdf

 

29 Proposed new section 608T ITTOIA 2005

 

30 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/663889/Royalties_Withholding_Tax_-_consultation.pdf

 

31 It may also include undertakings regarding the taxation of IP that its officials may have given to their counterparts in other OECD countries during the recent BEPS project. The UK was one of the main architects of the BEPS IP proposals that the Irish government so effectively exploited in the enhancements it made to its IP regime in 2014 – https://www.oecd.org/ctp/beps-action-5-agreement-on-modified-nexus-approach-for-ip-regimes.pdf

 

32 See, in particular, the section on the Commentary on Article 1 headed Improper Use of the Convention (paragraphs 7-26)

 

33 These can be based either on a provision that the UK seeks to include (where its treaty partners agree) in the dividend, interest and/or royalty articles of as many of its treaties as possible or the Limitation of Benefits restriction that the US requires to be included in all its treaties.

 

34 Section 58 Finance Act 2008 now incorporated into Section 858 Income Tax Act 2005 – enacted to counter a disguised remuneration tax avoidance scheme that sought to exploit an unexpected interpretation of double tax treaties reached by the UK courts (Padmore v Inland Revenue Commissioners. [1989] BTC 221) that had been overturned by retrospective legislation (section 62 (No. 2) Finance Act 1987).

 

35 R (Huitson) v HMRC [2011] EWCA Civ 89; R (Shiner & Sheinman) v HMRC [2011] EWCA Civ 89 – cases brought to challenge (unsuccessfully) the legality of section 58 Finance Act 2008

 

36 UK: ECtHR, 13 Jan. 2015, Application no. 50131/12, Robert Huitson v. United Kingdom.

 

37 Paragraph 30 of the decision

 

38 Chapter 2, Part 2 Taxation (International and Other Provisions) Act (TIOPA) 2010

CONTACTS

George Turner

Director

email: george@taxwatchuk.org

Tel: +44 7540 252 850

If you would like to download a Pdf of this report – you can do so here.

French tax authority’s Apple bill shows up weakness of HMRC

16th February 2019 by George Turner

Reports from France tell us that the French tax authorities have reached a settlement with Apple after an investigation into Apple’s tax payments in the country going back 10 years. Although the accounts of Apple’s French subsidiaries have not yet been published, the French newspaper L’Express reports that the settlement reached is in the order of £500m.

In 2016/17, according to Apple’s UK accounts the company reached a similar settlement with HMRC. In that year the Apple companies paid a total of £324.8m – in the previous year the company had paid £16.8m. The 2016/17 accounts of Apple in the UK covered a longer period than usual, as Apple changed their accounting year. The notes to the accounts disclose that between them the Apple companies in the UK paid an additional £218m, less than half of the amount that the company has settled with the French government.

The accounts of Apple (UK) Limited disclose that he increase in tax was due to an adjustment for “prior years” up to 2015 following an ‘extensive investigation’ by HMRC, although it does not say how far back the HMRC investigation went. The majority of the adjustment was attributed to Apple Europe Limited – a UK based company which supports sales activity for the whole of the European, Middle Eastern and African region for Apple.

Apple does not publish a breakdown of figures for its activities in various countries around the world, however, there is data on the market share of Apple vs Android phones published by market research organisations. We used the figures provided by Kantar.

These show that the UK is a much bigger market for Apple, where iPhones had 41% of the smartphone market in 2018, whereas in France they accounted for just 25%.

Apple have paid more than twice the amount to French authorities in their settlement for tax avoided in the past, than they have to HMRC, in a country which has a smaller market for Apple products.

There could be a number of reasons that account for some of the difference. French tax rates are higher than UK corporation taxes, so the effect of any avoidance is greater – although for many of the years covered by the adjustments the difference in the UK and French rate would have been smaller.

It could be that the HMRC investigation covered a shorter period, but that is unlikely. The HMRC investigation led to permanent changes in the way that Apple calculated its taxable income in the UK. The first year following the adjustment Apple had a UK tax charge of £30m, up from £16.8m in the year before the adjustment. This suggests that the adjustment covered a long period.

Until we have more transparency on the settlements between HMRC and the companies they investigate, we will never know how on what basis these deals are done – but on the face of it, the settlement with the French Authorities makes the UK settlement with Apple look pretty weak.

Photo by Marcin Nowak on Unsplash

How much profit are Google, Apple, Facebook, Cisco and Microsoft making in the UK?

6th November 2018 by George Turner

How should profit be distributed within the modern multinational corporation? That is the key question at the heart of the debate on international tax avoidance, and one touched on by Taxwatch’s first report.

The aspiration of the OECD reforms to the international corporate tax system is to better align taxable profits to where value is created. However, what itself constitutes ‘value’ is a disputed concept, which is being discussed between international negotiators at this very moment. The UK government for example, feels that a significant amount of ‘value creation’ comes from the users of social media sites, which is the position they are currently taking in OECD negotiations.

Some argue that the “value” of products sold by large American technology companies is made in the United States, where the engineers and designers create the product. For that reason, under international tax rules profit is properly allocated to the US. The operations of these multinational companies in the UK are limited to less profitable activities such as sales and marketing. That is why so little profit shows up in the UK accounts of the subsidiaries of these companies and why so little tax is due. The scale of tax avoidance, they argue, is far lower than has been claimed, if it exists at all.

This is an argument which is shared by the corporate interests themselves.

Apple wrote to Taxwatch in advance of the publication of our first report to say that it is “indisputable” that the vast majority of the value of their products is created in the United States of America – and for that reason, most of the company’s tax bill arises in the United States of America.

This argument may appear logical – but does it correspond to the facts?

Current tax rules are not concerned with a measure of value, but with profits. Are US corporations allocating the profits of their business activities to the US, where all that design, product development and entrepreneurial innovation takes place?

No they are not. Indisputably.

As part of their US corporate filings, Apple, Google, Cisco and Facebook all declare how much of their pre-tax profit they say is made overseas, and how much is made in the US. These figures appear as part of their tax note in order to help investors better understand their tax bill.

If you analyse those figures, you find that these companies are telling investors that the majority of their pre-tax (and post tax for that matter) profit is made outside the US.

In Apple’s case their US filings show that 70% of their pre-tax profit is made outside the US. In 2017, Cisco reported that a staggering 81% of their pre-tax profit was made overseas.

Below are two tables showing how much profit Google, Cisco, Facebook and Apple declared in their accounts as being earned outside the United States, and the percentage that number represents of their global pre-tax profit.

Google, Apple, Facebook and Cisco non US profits

Why aren’t the profits in the US? It appears from the accounts that these companies are not recharging any of their group costs to their non-US subsidiaries, as they are entitled to do. The companies pay for all of their R&D costs, all of their product design, and all of their group administrative costs from their US revenues. This results in lower profit margins for the US business. Their overseas businesses, freed from any obligation to pay for the product design and innovation that are a significant part of the business, see their profits rocket (before zooming offshore).

Why are they set up like this? Probably because it is harder to avoid tax in the US, so why not get as much cost on the income statement as possible, and make all your profit overseas where those profits can be kept offshore and tax free.

Now all that is fine if the companies want to do that, but it then becomes very difficult to argue that these companies should face barely any tax charge in Europe.

After the publication of our first report, which sought to estimate how much profit was being made by 5 US tech companies from UK customers, and compared those estimates to the (very low) profits being declared in the accounts of their UK subsidiaries, there were some who criticised the report by arguing that the numbers we produced failed to recognise the reality of current tax rules, which rewarded the product designers and the innovators. The same argument of course made by Apple.

The irony of this argument is that the methodology in the Tax Watch report, which used the global average profit margins of companies, allocates more R&D and administrative costs to the European operations of Apple, Google, Microsoft, Cisco and Facebook than the companies themselves do!

The final question this raises is this. If these companies are not charging their European subsidiaries for R&D etc, and if they claim that the majority of their pre-tax profit is made outside the US, then how are they paying so little in Europe?

This confirms that most of the profit being made outside the US is being shifted towards tax havens. Indeed the companies themselves admit this. Microsoft’s 10-K contains the following statement:

Our foreign regional operating centres in Ireland, Singapore and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 87%, 76%, and 91% of our foreign income before tax in fiscal years 2018, 2017, and 2016, respectively.

Google say:

“Substantially all of the income from foreign operations was earned by an Irish subsidiary.”

Could it really be that he majority of the value of Google’s business is generated in Ireland? What on earth are all those people in California doing? Time for a restructuring perhaps?

What the accounts of these five tech companies confirm is what many of us of course already know. Companies arrange their affairs to move profit out of European countries and into tax havens, often though the use of royalties on intellectual property.

The perversity of this structure is that companies in our study are “paying” for the use of IP, but they are not paying it to the creators of the IP, but to another entity within the group – an entity which appears not to have incurred any significant costs for creating that IP in the first place. It is impossible to argue that this structure rewards the creators and the makers in any way (unless of course you count the creative lawyers and accountants who would have constructed such schemes).

How value creation is rewarded by the tax system is an important issue, and one which in the end will require a political rather than a technical answer. But when we have that debate, lets first start with an honest conversation about what is really going on.

Photo by Marvin Meyer on Unsplash

TaxWatch report estimates UK is losing £1bn a year in taxes to profit shifting by just 5 companies

28th October 2018 by George Turner

A new report released today by TaxWatch, finds that profit shifting by just five tech companies could be costing the UK up to £1bn a year in lost revenues.

The data, which is being released the day before the Chancellor gives his budget on Monday, shows that despite a supposed crackdown on international tax avoidance, government is still failing to grapple with the problem.

The report, seeks to estimate the amount of profits made by Facebook, Google, Apple, Cisco Systems and Microsoft on their sales from UK customers. This figure is then compared to the profit declared by the companies in their main UK subsidiaries.

In total Taxwatch estimates that in 2017 these five companies earned revenues of £23.4 bn from UK customers. TaxWatch further estimate that profit attributable to these sales was £6.6bn, which at the prevailing rates would have given a tax liability of £1.26bn.

The profits declared in the accounts of the UK subsidiaries of these companies, and their tax liabilities, were far less. In total, the accounts of the main UK subsidiaries of the companies in the Taxwatch study suggested a combined tax liability of £191m. This is more than one billion pounds less than we calculate would have been due if the accounts of the UK subsidiaries more accurately reflected the revenues and profits made from UK customers.

Commenting on the release of the report – George Turner – Director of Taxwatch said:

“The fact that tech companies have been engaged in industrial scale tax avoidance has been well known for a long time. Our study shows that the attempts by government both on an international and domestic level to tackle the issue have barely scratched the surface of the problem.

“HMRC estimates that corporate tax avoidance costs the UK just £700m a year. Although it freely admits that it does not count avoidance via profit shifting in its estimate of the ‘tax gap’, our study shows that the government is vastly underestimating the scale of tax avoidance by multinationals operating in the UK.

“At £1bn a year, the tax losses to the UK from profit shifting by just five companies are enormous. But the tech five are not the only companies doing this. The total losses to the UK from profit shifting will be much higher.

“Government must do much better to ensure that taxes on profits made in this country, are paid in this country. What is needed is a rethink by government and international bodies of how multinationals are taxed, and an acceptance that the current approach just isn’t working.”

The full report can be viewed on the TaxWatch website here.

This research featured in The Telegraph, The Financial Times, and The Guardian among others.

Title image background – by Mathew Schwartz on Unsplash

TaxWatch comments on Facebook UK’s 2017 accounts

24th October 2018 by admin

Facebook published its 2017 accounts in the UK, showing that its tax bill had risen to £17m after it had changed its structure to book more revenues onshore. However, as Taxwatch director George Turner told the Independent, Facebook’s real profits in the UK are likely to be much higher.

Read the full article here…

 

Photo by Tim Bennett on Unsplash
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