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Corporation Tax

We need to talk about Corporation Tax

26th July 2022 by Alex Dunnagan

Corporation Tax (CT) has been in the headlines again after several candidates in the Conservative Party leadership race promised to cut the rate. Liz Truss has promised to reverse the planned increase to 25 per cent, while Jeremy Hunt and Sajid Javid, set out plans to cut the rate to 15 per cent before they were eliminated from the contest. [1]15 per cent is the lowest permitted under Pillar Two of the Global Anti-Base Erosion (GloBE) rules

This note sets out what the UK’s current plans regarding CT are, who the tax affects, how much it contributes to the treasury, and how the UK compares internationally.

Changes in the Corporation Tax rate

UK Corporation Tax rates over time

When the Coalition government came to power in 2010 the headline rate of CT stood at 28 per cent. Since then it has been gradually cut to an all time low of 19 per cent. It was initially planned that the rate would be reduced to 17 per cent from April 2020, but that was reversed, and in 2021 the then Chancellor Rishi Sunak announced that it would be increased to 25 per cent from April 2023. Should Sunak become the next Conservative Party leader, and with that the UK’s next Prime Minister, there are no indications that the proposed rate increase would change.

It should be noted that the planned rate increase affects companies differently dependent on how much profit they make. Companies with profits under £50,000 will continue to pay 19 per cent in what’s known as the “small profits rate”. Businesses with profits between £50,000 and £250,000 will pay a “marginal rate” somewhere between 19 and 25 per cent. [2]Corporation Tax Rates, HMRC, 01 April 2022, https://www.gov.uk/government/publications/rates-and-allowances-corporation-tax/rates-and-allowances-corporation-tax

Who pays Corporation Tax?

The key thing to remember when looking at CT is that it is a tax on profits, not on revenues. There is also a difference between the statutory tax rate, be it 19% or 25%, and the effective tax rate, which is the amount of corporate tax a company actually pays on its pre-tax profits. There are various reasons for this difference. Companies are able to claim various tax reliefs, for example if they invest in Research and Development. There is an Annual Investment Allowance which allows businesses to claim tax relief on certain assets. A “super-deduction” on purchases of capital goods was introduced in the 2021 Spring Budget, allowing companies to deduct 130 per cent of the cost of “main rate assets” – more than the cost of the equipment itself – from their taxable profits in the year they purchase it. These are just a few of the reasons why companies often pay an effective rate lower than the statutory rate.

Of the three main legal forms of businesses in the private sector (sole proprietorships, ordinary partnerships, and companies) only companies are liable to Corporation Tax. There were 2 million actively trading companies at the start of 2021, almost half of which had no employees. [3]Business population estimates for the UK and the regions 2021, Department for Business, Energy & Industrial Strategy, 07 October 2021, … Continue reading

Over two thirds of the companies that paid CT in 2019-20, approximately 1.1 million companies, had liabilities of less than £10,000. A further 27 per cent of companies had liabilities between £10,000 and £49,999. While it is not clear from the data exactly how much profits these companies turned in order to have these liabilities, it would be reasonable to assume the vast majority of these companies – some 94 per cent of those with liabilities – would have profits of under £250,000, and thus would not be subject to the increased 25 per cent CT rate.

Number of companies and their CT liabilities by liability band, 2019-20 [4]Corporation Tax statistics commentary 2021, HMRC, 23 September 2021, https://www.gov.uk/government/statistics/corporation-tax-statistics-2021/corporation-tax-statistics-commentary-2021

How much does Corporation Tax contribute to the Treasury?

Total revenues reported by HM Revenue & Customs (HMRC) from 2017-18 to 2021-22 [5]‘Other’ includes, for example, Stamp Taxes, Inheritance Tax, alcohol and tobacco duties, Insurance Premium Tax, Capital Gains Tax, student loan recoveries, environmental taxes, customs duties and … Continue reading [6]HMRC Annual Report 2021 to 2022,Corporation tax is the fourth largest contributor to HMRC’s revenues, yielding £68.3bn in 2020-21. This is compared to £233.4bn for income tax, £158.3bn for … Continue reading

How does the UK Corporation Tax rate compare internationally?

Average Corporate Tax Rate by Region or Group 2021 [7]https://files.taxfoundation.org/20211207171421/Corporate-Tax-Rates-around-the-World-2021.pdf

The European average rate is 19.84 per cent, but this includes a number of very small economies with very low rates. The average European rate when weighted by GDP is 23.97 per cent. The G7 average rate is 26.69 per cent (26.41 per cent weighted by GDP). The OECD average rate is 23.04 per cent (25.81 per cent weighted by GDP) [8]https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1091378/HMRC_Annual_Report_and_Accounts_2021_to_2022_Web.pdf

Jeremy Hunt, who is no longer in the race, stated recently that “We’re scheduled to increase corporation tax to be higher than Japan, America, France or Germany.” This is half true at best. [9]Conservative leadership contest: four early claims fact checked, Full Fact, 11 July 2022, https://fullfact.org/news/conservative-leadership-2022-fact-checked/

The countries listed charge CT at both a central and a sub-central level, i.e. at a state, regional, or municipal level. The UK only charges a central CT. While the UK’s central rate may be higher than some of these countries when it increases to 25%, the total rate will not.

Take Japan for example. In 2021 Japan’s central CT rate was 23.2 per cent. However, Japan also has a sub-central rate that averages 7.4 per cent. Once deductions are factored in, the total CT rate in Japan is 29.7 per cent. Germany’s total rate is 29.9 per cent, the US is 25.8 per cent. France does not levy a sub-central CT, but the CT rate alone is 28.4 per cent. The OECD provides a useful dataset that show the central, sub-central, and combined CT rates for countries. [10]Statutory Corporate Income Tax Rates, https://stats.oecd.org/Index.aspx?DataSetCode=CTS_CIT

Conclusions

In discussing CT it is important to remember that raising the UK’s rate to 25 per cent as planned will not affect the vast majority of businesses, nor will it turn the UK into a high-tax outlier. In fact, the only companies set to pay 25 per cent will be those that are turning profits of over £250,000, and even then, they will likely pay a lower effective rate as a result of various reliefs. An increase from 19 per cent will move the UK to a rate closer to that of other large developed economies, and will still be lower than the rate the UK had in 2010.

TaxWatch discussed some of these issues recently with the New Statesman.

References[+]

References
↑1 15 per cent is the lowest permitted under Pillar Two of the Global Anti-Base Erosion (GloBE) rules
↑2 Corporation Tax Rates, HMRC, 01 April 2022, https://www.gov.uk/government/publications/rates-and-allowances-corporation-tax/rates-and-allowances-corporation-tax
↑3 Business population estimates for the UK and the regions 2021, Department for Business, Energy & Industrial Strategy, 07 October 2021, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1019907/2021_Business_Population_Estimates_for_the_UK_and_regions_Statistical_Release.pdf
↑4 Corporation Tax statistics commentary 2021, HMRC, 23 September 2021, https://www.gov.uk/government/statistics/corporation-tax-statistics-2021/corporation-tax-statistics-commentary-2021
↑5 ‘Other’ includes, for example, Stamp Taxes, Inheritance Tax, alcohol and tobacco duties, Insurance Premium Tax, Capital Gains Tax, student loan recoveries, environmental taxes, customs duties and fines and penalties.
↑6 HMRC Annual Report 2021 to 2022,Corporation tax is the fourth largest contributor to HMRC’s revenues, yielding £68.3bn in 2020-21. This is compared to £233.4bn for income tax, £158.3bn for National Insurance Contributions, and £148.8bn for VAT.
↑7 https://files.taxfoundation.org/20211207171421/Corporate-Tax-Rates-around-the-World-2021.pdf
↑8 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1091378/HMRC_Annual_Report_and_Accounts_2021_to_2022_Web.pdf
↑9 Conservative leadership contest: four early claims fact checked, Full Fact, 11 July 2022, https://fullfact.org/news/conservative-leadership-2022-fact-checked/
↑10 Statutory Corporate Income Tax Rates, https://stats.oecd.org/Index.aspx?DataSetCode=CTS_CIT

A fair distribution?

7th October 2021 by Alex Dunnagan

7th October 2021

US Government set to raise 3x more than rest of the world combined in tax payments from four tech companies after Global Tax Deal

Raising Global Minimum Tax to 21% would see US Government raise an extra $2.5bn in tax from Apple alone

Summary and introduction

In June 2021 finance ministers of the G7 group of nations agreed on proposals to reform the way in which multinational enterprises are taxed. The agreement was the product of over 10 years of negotiations hosted by the OECD under the auspices of the Base Erosion and Profit Shifting (BEPS) programme.

When the deal was announced, the UK Government, which hosted this year’s G7, trumpeted it as a “seismic agreement on global tax reform that will mean the largest multinational tech giants will pay their fair share of tax in the countries in which they operate.”1

This paper presents an analysis of the deal, looking at the accounts of individual tech companies to demonstrate that the United States, where almost all major tech companies are headquartered, stands to gain billions of extra tax dollars from global tech giants as a result of the deal, whilst “the countries in which [tech companies] operate” stand to gain relatively little.

To do this we look at the gains that the US government can expect from imposing a global minimum tax of 21% on Facebook, Google, Apple and Microsoft. This would result in an extra $5.4bn in taxes from just these four companies, whereas we estimate the total additional tax these companies would pay in all other countries in the world under the terms of the G7 deal would be $2.5bn.

The figure of 21% is used because the stated intention of the US Government is to impose a global minimum of 21% on companies headquartered in the US, regardless of the minimum level set through the OECD led process.

Furthermore, we find that the US Government would further benefit from the removal of tax incentives on royalties received by US parents from overseas operating companies (the Foreign Derived Intangible Income incentive, or FDII). The introduction of the FDII in 2017 had already led to tech giants substantially restructuring their tax affairs. US companies have moved vast amounts of profits arising from sales outside of the US out of tax havens and back to the United States. This had expanded the US tax base at the expense of market jurisdictions in advance of the G7 deal. The removal of the FDII incentive is facilitated by the increase in global minimum taxation and therefore should be seen as a benefit of it.

We estimate that just four tech companies will see taxes increase in the US by $3bn per year as a result of the removal of the FDII.

Taken together, this means that the package of reforms will mean a yearly increase in US Tax of $8.4bn, as against a benefit of $2.5bn shared between all other countries arising from just four companies. What is significant is that both the global minimum tax and the FDII only impact profits that arise from revenues made overseas, in countries like the United Kingdom where sales are made. The analysis therefore demonstrates that the G7 / OECD deal resolves the question of who gets to tax the offshore billions of tech companies decidedly in favour of the United States.

This was not necessarily the outcome expected from the OECD led BEPS process.

Tax avoidance and the multinational

The problem that the BEPS programme set out to resolve was clear. Large multinational enterprises had accumulated trillions of dollars offshore by shifting profits out of “market jurisdictions” – the countries in which their customers or users were based, and into tax havens.

These tax haven entities were often an accounting fiction, generating billions in profits every year but with no staff, no offices and no discernable economic activity.

Although companies in all sectors have engaged in profit shifting, perhaps due to the particularly high profile of these companies, and the particularly aggressive stance they took towards the tax system, the behaviour of the tech industry has been a particular concern. In fact, the activities of tech giants warranted their own action point within the BEPS action plan.

The structure of the US tax system, where almost most global tech giants are headquartered, provided huge incentives for US based multinational corporations to move cash out of their international (non-US) markets and hoard it offshore, avoiding taxes on profits made in foreign jurisdictions and a US corporation tax charge that would accrue if they brought the cash home to the US.

A classic tax avoidance structure used by a US company would see intellectual property (i.e. trademarks, patents or software aka IP) developed in the United States sold to an offshore company in Bermuda, which would then licence the use of the IP to companies in Europe and other non-US markets. Companies in these international markets would pay the offshore company high fees for the use of the IP leading to an accumulation of wealth offshore and the elimination of profit elsewhere.

According to the US research institute ITEP, fortune 500 companies alone had accumulated $2.6 trillion in profits offshore by 2017, when the Trump administration enacted far-reaching tax reform.2

The tax proxy wars

A key question facing tax policy makers was therefore whether or not the tax haven profits of US based multinationals and tech companies in particular should have been properly accounted for and taxed in the US, where the IP was developed, or in the “market jurisdictions” where services were sold to (predominantly European and other developed countries). All governments appeared to agree at least that shell companies with no staff and no physical operations should not have been considered to have “earned” any profits themselves.

The OECD’s report which kicked off the Base Erosion and Profit Shifting programme that sought to reform the global tax system raised the question of whether more profit needed to be allocated to countries where sales are made. Under the heading “Jurisdiction to tax” the report contained the following passage:

“In an era where non-resident taxpayers can derive substantial profits from transactions with customers located in another country, questions are being raised as to whether the current rules ensure a fair allocation of taxing rights on business profits, especially where the profits from such transactions go untaxed anywhere.”3

However, perhaps unsurprisingly given the amounts of money at stake, neither the US nor Europe saw eye to eye on how profits accumulated offshore should be divided.

In the US, the IRS has attacked the way in which costs are divided between US entities and offshore entities. It has argued that the subsidiaries of US corporations based offshore, which typically have no staff and no costs, should contribute a greater amount to the costs incurred by their US based parents. In effect, bringing profits onshore to compensate the US entities for their role in developing IP.

In 2020, a US federal appeals court resolved a dispute that had been going on for years between the IRS and Altera, a US based chip maker. The court upheld an IRS regulation from 2003 that offshore companies owned by US multinationals should contribute to the cost of share options granted to employees in the US. As a result of this case, Google and Facebook alone set aside $2bn to comply with the ruling.4

In Europe, the European Commission launched a number of cases against governments, claiming that the favourable tax treatment which allowed multinationals to move money to low-tax jurisdictions breached state aid rules, and compelled European tax havens to levy taxes on profits either accumulated or passing through their jurisdiction.

Although from a European perspective, this has been seen as an albeit imperfect mechanism to claw back some tax which should have been due in Europe, US politicians have viewed EC action against tax avoidance as a raid on US profits.

When Apple was fined €13bn Euros by the European Commission for unpaid taxes arising from a scheme which saw profits transferred out of profitable European markets to a headquarters company that “only existed on paper”,5 Charles Schumer, one of the highest-ranking Democratic senators, said:

“This is a cheap money grab by the European Commission, targeting US businesses and the US tax base.

By forcing their member states to retroactively impose taxes on US companies, the EU is unfairly undermining our ability to compete economically in Europe while grabbing tax revenues that should go toward investment here in the United States”

This fundamental disagreement on who should have the right to tax held up progress on the digital economy workstream of the BEPS programme for years and in the interim, governments sought to enact unilateral reforms.

A number of countries sought to impose digital services taxes on the revenues of some tech companies. The UK’s diverted profits tax sought to impose a higher tax rate on profits diverted using artificial structures.

Eventually an agreement was reached at the 2021 G7 Summit in Cornwall to co-ordinate tax policy. As we will explore later in this paper, this essentially resolves the question of who gets to tax big tech profits in favour of the US.

Tax Cuts and Jobs Act 2017

The most significant unilateral policy change enacted before the G7 agreement was introduced by the US government. The Trump administration’s Tax Cuts and Jobs Act of 2017 (TCJA) fundamentally altered the incentives in place for US corporations to keep their cash offshore and paved the way for the G7 agreement.

These reforms came in several parts. A one off tax on accumulated offshore holdings, a new tax on profits allocated to intangible assets in tax havens (global intangible low-taxed income, or GILTI) and a tax incentive on revenues from overseas accruing to intangible assets in the United States (foreign-derived intangible income, or FDII). By targeting foreign derived income, the United States was laying claim to the offshore profits accumulated by its multinationals.

Profits from outside the US accruing to intellectual property based in tax havens would be taxed for the first time under the GILTI regime, whereas, if that IP was brought back to the US, the FDII provided a discount on the tax paid on the profits accruing from revenues earned by that IP. The GILTI and the FDII are both set at a rate of 13.125% (assuming a 21% corporate rate) ensuring that there was no longer an incentive to keep IP offshore. Being set at the same rate means they also work together. If the FDII incentive was removed without also increasing the GILTI rate, then US corporations would simply move their IP offshore, as they had under the previous incentive structure.

As will be explored in more detail later in this paper, in the years following the introduction of the TCJA, US companies responded to the new incentive structure by repatriating intellectual property from offshore jurisdictions to the US.

This clearly shows up in macroeconomic data. A study published on behalf of the Irish Finance Ministry showed royalty payments from Irish companies to the US jumping from €8bn a year on average between 2014-2019 to €52bn in 2020.6 Ireland is a key conduit used by US tech companies to move profits out of Europe.

The G7 deal

The current proposals endorsed by the G7 come in two parts. A new Global Minimum Tax, Pillar Two acts as an expanded GILTI charge, with jurisdictions that host the headquarters of multinational corporations placing a charge on the profits they accrue in tax havens.

The G7 has agreed that this should be set at a minimum 15%, however, as we have seen with the GILTI, countries can go it alone and tax the offshore profits of their corporations without international agreement. The US has said it will adopt a 21% rate and has encouraged others to do the same.

If raising taxes on profits accumulated offshore encourages companies to shift profits onshore, then jurisdictions also have more freedom to tax onshore profits.

As part of the Made in America tax plan President Biden has said that the US will scrap the FDII incentive which had already been declared a “harmful tax practice” by the OECD,7 replacing it with a new, as yet unspecified, R&D subsidy.

The removal of the FDII will mean large increases in US taxation on royalties paid from market economies to the US.

On the other side of the coin, the limited actions by market jurisdictions to claw back some income from digital services companies through digital services taxes are replaced by a limited redistribution of income from large multinational enterprises (MNEs) via the second part of the G7 deal, the so called Pillar I proposals.

Under Pillar One, the world’s largest companies see a portion of their global profits re-allocated to countries where they have a market which are then charged at the local corporate tax rate. Pillar One is limited to roughly the 100 largest corporations in the world.8

Under analysis undertaken by the OECD around the time of the publication of their blueprint for reform, the gains of the new system are weighted massively in favour of Pillar Two, with total gains from both pillars comprising between 2.3%-4% of global corporate income tax revenues and Pillar One accounting for between 0.2-0.5%.9

This is confirmed by our analysis in this paper, which shows that the real effect on four tech companies from the US plan to raise the GILTI rate to 21% and remove FDII is more than three times the additional tax those companies will see from Pillar One.

For companies subject to digital services taxes, the replacement of DSTs by Pillar One represents an effective tax cut.10 11

The impact on US based multinationals of the TJCA the G7 deal and the Made in America tax plan

Now that several years have passed since the Tax Cuts and Jobs Act, the impact of the new incentive structure on US based corporations can be seen very clearly in corporate accounts. In this part of the paper, we look at several companies and see how they have responded to the changing incentive structures they face after TCJA. The analysis shows that although some companies have chosen to repatriate the majority or all of their IP to the US, causing large and dramatic changes in their profitability overseas, some appear to have hedged, keeping some intellectual property offshore.

These companies will be impacted differently by the removal of the FDII and the increase in Global Minimum Taxation.

Shifting profits onshore

Google

In 2019 Google announced that it would no longer be licencing its IP from a Bermuda registered company, Google Ireland Holdings Unlimited Company, and instead would move its IP back to the United States.

The impact of this change on Google accounts was dramatic and immediate. The amount of profit Google declared in the United States (their US tax base) moved from $16.4bn to $37.6bn whereas the amount of profit Google declared outside of the US more than halved, from $23.2bn to $10.5bn.12

Figure 1: Alphabet (Google) 2020 10K, showing US and non-US profits.

Google explains this saying “as of December 31 2019, we have simplified our corporate legal entity structure and now license intellectual property from the U.S. that was previously licensed from Bermuda resulting in an increase in the portion of our income earned in the U.S.”

As a result of this shifting of profit to the United States, the amount of taxes paid to the United States Federal Government doubled, whereas the taxes paid to non-US governments saw a significant decline.

Figure 2: Alphabet (Google) 2020 10K, showing effective tax rates

The tradeoff that Google has made between a discount on its tax bill through the use of offshore companies, with the discount on the FDII shows up in Google’s tax reconciliation. In 2019, Google saw a 5% decrease in its effective tax rate through declaring income outside the US. In 2020, this almost disappeared, and instead the company saw a 3% reduction in its effective tax rate as a result of the FDII. This 3% is worth over $1.4bn.

In comparison, we calculate that under Pillar One, Google is likely to face an additional tax charge of just $307m.

Facebook

Turning our attention to Facebook, we see the same story again, with US profits increasing almost five fold from 2019 to 2020, while non-US profits more than halve.

Figure 3: Facebook 2020 10K, showing US and non-US profits.

In 2020 Facebook saw a 1.9% reduction in its effective tax rate resulting from “foreign-derived intangible income”, a tax break worth some $630m, whilst at the same time the effect of “non-US operations” fell from 5.8% to 2.4%.

Figure 4: Facebook 2020 10K, showing effective tax rates

It is also remarkable that the dramatic changes in where these companies locate their profits, is almost tax neutral, with Facebook’s effective tax rate being 12.8% in 2018, before their IP was repatriated, falling to 12.2% in 2020. The larger payment in 2019 can largely be attributed to a one-off increase in costs associated with “share based compensation” likely to be the impact of the Altera ruling.

Nike

For completeness, we can see that the impacts of the TCJA extend beyond the tech industry by looking at sports brand Nike, where US profits increased by almost 400%, from $593m in 2019 to almost $3bn in 2020. As this is happening, Nike’s previously profitable non-US business goes from a profit of $4.2bn in 2019 to a loss $67m in 2020.13

Figure 5: Nike 2020 10K, showing US and non-US profits

While US profits increase, we see an 8.1% reduction in the effective income tax rate as a result of “Foreign-derived intangible income benefit related to the Tax Act”. Nike state in their accounts that “This benefit became available to the Company as a result of a restructuring of its intellectual property interests”. What this means is that as a result of Nike bringing its IP back to the US, rather than sitting offshore. This 8.1% reduction is worth some $234m to Nike.14

Figure 6: Nike 2020 10K, showing effective tax rates

Remaining offshore

Although it is clear that there has been a very significant shift of profits from offshore back to the US, it appears that some US companies are hedging their bets and either only repatriating a portion of their IP, or continuing to keep all of their IP overseas.

Microsoft

Microsoft’s latest 10-K form contains the following statement:

“In the fourth quarter of fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. GILTI tax.”

The reference to the one off tax benefit show that Microsoft expect that moving their IP to Ireland and the US will result in a lower tax bill in the future.

As a result of this, whereas Micrsoft’s non-US profits made up 68% of their total profits in 2018, by 2020, this had fallen to 55%.

The Microsoft tax reconciliation shows that in 2021, the company still had a substantial tax benefit arising from earnings taxed offshore of 2.7%, whilst also claiming a 1.3% deduction on their effective tax rate due to the FDII.

Figure 7: Microsoft 2020 10K, showing effective tax rates

This reconciliation table suggests that if the global minimum rate is raised to 21%, then Microsoft will have to pay an additional $1.9bn in taxation. The removal of the FDII would mean an additional $900m to pay.

Apple

Apple is another company that has seen some shift in profits to the US, but appears to be continuing to keep a substantial amount of IP offshore. In 2018, the company earned $48bn in pre-tax profit overseas (66% of total profit), this fell to $38.1bn in 2020 (57% of total profit).

The current tax rate on Apple’s non-US profits was just 8.3% in 2020.

The company stated that as a result of declaring earnings overseas, it saw a reduction in its tax bill of $2.5bn against the standard US corporation tax rate. This fell from $5.6bn in 2018 (which included a period US corporation tax rates were higher). The company does not appear to claim anything under the FDII.

Figure 8: Apple 2020 10K, showing effective tax rates

Where now?

For years multinational companies accumulated trillions of dollars in tax havens at minimal or zero tax rates. Although multinationals from all jurisdictions and in all sectors have been to some extent guilty of these practices, it was always the digital disruptors, almost all of which are headquartered in the United States, that attracted the most attention. This is recognised in the fact that the current proposals put forward by the OECD have been framed as dealing with the challenges of the digital economy, when in reality the proposals will impact a wide range of multinationals regardless of the sector they are in.

In 2017, the US government laid claim to the offshore dollars of US headquartered multinationals, directly taxing the profits they had accumulated overseas and changing their policy framework to encourage them to bring their IP onshore. This has already raised billions from the offshore cash piles of US based multinationals and seen tens of billions of dollars of profit shifted to the US from overseas, substantially increasing the US tax base.

The G7 deal reached on global tax reform largely accepts this position. Countries that host multinationals get to tax the tax haven profits of companies in their jurisdiction, with a small amount of profit from larger companies redistributed to “market” jurisdictions.

For global tech giants, almost all of which are headquartered in the US, this will mean billions of extra tax dollars for the US government – all of which arises from profits on the sales of goods and services overseas.

We calculate that an increase in the global tax rate to 21% would mean that Microsoft would pay an additional $1.9bn in taxation to the US Federal Government, Apple an additional $2.5bn, Google an extra $144m and Facebook an additional $796m based on their latest annual accounts.

The removal of the FDII, which would also see the profits arising from royalties paid from overseas taxed at the current US tax rate of 21%, would mean an additional $1.4bn in tax paid by Google to the US Federal Government, an additional $630m in taxes from Facebook and $924m from Microsoft.

In total, this means that the US will see an increase in tax on profits derived from overseas sales of $8.4bn from just these four companies. By comparison, we would expect all other jurisdictions in the world receive an additional $2.7bn combined from these companies under the Pillar One agreement.

Given the history of the debate around tax avoidance over the last 10 years, which has focused on tech companies in particular removing profits from market jurisdictions, it is remarkable that the response from Finance Ministries in other developed economies to this obvious inequality has been muted. The US appears to have won the argument that the profits arising from from the customers of US companies overseas should largely be taxed in the US.

It is the case that G7 countries will also be able to raise more from multinationals based in their home countries. For example, in the UK, the new proposals would prevent the kinds of controversial profit shifting arrangements that have been used by British companies like Vodafone to keep non-UK profits offshore, and this may well be why developed nations have accepted the Biden proposals.

However, they have done so at the expense of other market jurisdictions. Developing countries, which host very few multinationals, will see relatively little benefit from the deal. As Nigeria’s ambassador to the OECD has said “What I understand, with the . . . rules as currently being developed, is that developing countries may get next to nothing.”15

Data for Facebook, Google, Apple, and Microsoft based on 2020/21 10-K filings

Notes

  1. ‘Income’ refers to what is in US 10-K filings as ‘income before provision for income taxes’. In UK company accounts this often referred to as something along the lines of ‘profit on ordinary activities before taxation’. This is simply taxable profit.

This report is also available as a PDF here. This research was featured in The Guardian as an op-ed by our Executive Director George Turner, available here.

Photo by NASA on Unsplash

1G7 Finance Ministers Agree Historic Global Tax Agreement, G7, 05 June 2021, https://www.g7uk.org/g7-finance-ministers-agree-historic-global-tax-agreement/

2Fortune 500 Companies Hold a Record $2.6 Trillion Offshore, ITEP, 28 March 2017, https://itep.org/fortune-500-companies-hold-a-record-26-trillion-offshore/

3OECD, Key tax principles and opportunities for base erosion and profit shifting, February 2013, p.36

4An obscure court ruling could play havoc with tech companies’ earnings, Marketwatch, 18 July 2020, https://www.marketwatch.com/story/an-obscure-court-ruling-could-play-havoc-with-tech-companies-earnings-2020-07-16

5Comment: ECJ decision should not let Apple off the hook, TaxWatch, 15 July 2020, http://13.40.187.124/apple_ecj_ruling/

6Seamus Coffey, The changing nature of outbound royalties from Ireland and their impact on the taxation of the profits of US multinationals, Irish Department of Finance, https://www.gov.ie/en/publication/fbe28-the-changing-nature-of-outbound-royalties-from-ireland-and-their-impact-on-the-taxation-of-the-profits-of-us-multinationals-may-2021/

7Harmful Tax Practices, OECD, August 2021, https://www.oecd.org/tax/beps/harmful-tax-practices-peer-review-results-on-preferential-regimes.pdf

8The OECD state that “In-scope companies are the multinational enterprises (MNEs) with global turnover above 20 billion euros and profitability above 10%”. A full explanation of which companies Pillar One applies to is available in the Statement on a Two-Pillar Solution to Address the Tax Challenges Arising From the Digitalisation of the Economy, OECD, 01 July 2021, https://www.oecd.org/tax/beps/statement-on-a-two-pillar-solution-to-address-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-july-2021.pdf

9OECD, Tax Challenges Arising from Digitalisation – Economic Impact Assessment, (Paris, 2020) see table 1.1 available from: https://www.oecd-ilibrary.org/docserver/0e3cc2d4-en.pdf?expires=1633339704&id=id&accname=guest&checksum=BB2899422231BC934DA03A1778EE8C89

10This is also likely the case for other countries with their own respective digital services taxes. We have not however carried out an analysis on the effect for countries other than the UK.

11Will the OECD’s global tax deal raise more from tech companies in the UK?, TaxWatch, 27 September 2021, http://13.40.187.124/oecd_pillar1_analysis/

12Alphabet Inc. 10-K 2020, SEC.gov, https://www.sec.gov/ix?doc=/Archives/edgar/data/1652044/000165204421000010/goog-20201231.htm

13Nike 10-K 2020, SEC.gov, https://s1.q4cdn.com/806093406/files/doc_financials/2020/ar/NKE-FY20-10K.pdf

14 The increase of 43.3% to the effective tax rate in 2018 is a result of the one-time mandatory transition tax on deemed repatriation of undistributed foreign earnings, part of the Tax Cuts and Jobs Act 2017.

15Biden’s global tax plan could leave developing nations ‘next to nothing’, Financial Times, 10 May 2021, https://www.ft.com/content/9f8304c5-5aad-4064-9218-54070981fb4d

“Amazon Tax Cut” features in Parliamentary debate

29th April 2021 by Alex Dunnagan

On Monday 19 April MPs met to scrutinise the Finance (No. 2) Bill in a committee of the whole house. In the debate, TaxWatch’s research into “super-deductions” featured prominently, as MPs sought to amend the legislation to ensure some companies were excluded from the benefit of the super-deduction.

The new policy, at a cost of £12bn for this financial year, allows companies to deduct 130% of the cost of “main rate” assets from their taxable profits in the year that they purchase it. We calculated that many large companies with significant expenditures would be able to reduce and perhaps even extinguish their tax bills as a result of this policy. Logistics companies, energy, infrastructure, Amazon, would all likely gain significantly as a result of super expensing.

More details can be found in our report, “The Amazon Tax-Cut”, which was published in March following the announcement of the policy in the Budget.

Speaking in support of these amendments, James Murray MP, speaking on behalf of HM Opposition, raised the issue of the super-deduction benefiting companies who have seen business increase throughout the pandemic, saying:

“The super deduction that we are debating now is designed to help companies such as Amazon, which do not need any help with their investment. It is important that we see this in the context of those companies that have done well throughout the outbreak and are already avoiding much of the tax they should be paying. It is no wonder that TaxWatch has nicknamed this the “Amazon Tax Cut”. This giveaway from the Chancellor could wipe out Amazon’s UK tax bill entirely.”

Dame Margaret Hodge MP highlighted how small Amazon’s tax bill was, and the fact that the super-deduction could see it wiped out altogether, saying:

“In 2019, Amazon’s UK turnover was £13.7 billion, but by claiming that its UK sales took place in Luxembourg it exported its profits and avoided corporation tax. It declared only a bit of profit in the UK, as the shadow Minister said, on its warehousing and logistics activities. Its corporation tax contribution was less than 0.1% of its turnover. Analysis by TaxWatch shows that even that miserly contribution would be wiped out with super deductions. It would write off its investment in IT equipment and machinery against its deliberately understated profits.”

Rebecca Long-Bailey MP reiterated the fact that due to the amount Amazon spend on plant and equipment, they stand to see their tax bill wiped out entirely while the super-deduction remains, saying:

“I would have no problem if such businesses desperately required the relief in order to protect jobs or to invest in our local economies, but let us look at some of the potential beneficiaries. Amazon has benefited from the pandemic, seeing its sales jump by 50%. According to TaxWatch, the company’s latest accounts show that they spent £66.8 million on plant and machinery, £80.4 million on office equipment and £15.3 million on computer equipment in the same year, so the 130% super deduction could entirely account for the pre-tax profits of the company even before any deductions of staff pay awards.”

Responding to the debate on behalf of the government, Rt Hon Jesse Norman MP, the Financial Secretary to the Treasury said that the deduction had been deliberately broadly drawn to ensure that a range of companies could benefit from this “very generous policy” and that avoidance was best dealt with via other means. He said:

“the deduction has been very carefully assessed and includes important exclusions, including as to related party transactions and second-hand assets. It also includes a new anti-avoidance provision, which is designed to give it additional protections….

It is true that this is a country that takes the question of tax avoidance and tax manipulation extremely seriously. The right hon. Member for Barking (Dame Margaret Hodge), who has been a great campaigner in this area, focused on that. Of course I cannot discuss individual taxpayers. No one knows what an individual company’s taxpaying arrangements are. She purported to know—that is her privilege—but I am not in a position to discuss that. None the less, I can tell her that it would be very bad policy indeed for any Government to base tax policy on a single employer or taxpayer. If she thinks that this country has been soft in any respect on tax, let me remind her that we have led the international charge on base erosion and profit shifting, on diverted profits taxes, and on the corporate interest tax restriction. We have put into law a digital services tax and are consulting on an online service tax. That is not the action of a Government who take these things in any way other than very seriously.”

The debate is available on Parliament Live here, and on Hansard here.

Photo by Deniz Fuchidzhiev on Unsplash

Amazon’s ballooning revenues demonstrate the need for transparency in tax affairs

4th February 2021 by Alex Dunnagan

The news that Amazon’s sales in the UK have ballooned over the last year have sparked the traditional headlines about Amazon’s tax bill (or lack of it).

This article looks to tease out some of the complex issues that arise from Amazon’s tax structure in the UK.

There is no doubt that Amazon has engaged in tax avoidance in Europe and the UK. Its structure, with a European hub in Luxembourg and satellite companies in the UK and other markets, was originally designed to exploit Luxembourg’s low VAT rate on books and other tax benefits.1 The way that the company divided profits between the UK and Luxembourg (with very little profit being declared in the UK) was based on the fiction that Amazon’s European companies were separate entities operating independently of each other.2

Much of this changed in 2015. Ahead of the UK’s introduction of a “diverted profits tax” which was designed to attack structures such this, Amazon established a UK “branch” of its main European HQ in Luxembourg.3

Its UK company, Amazon UK Services, which delivers goods on behalf of its Luxembourg parent, continues to operate, making a small amount of profit and paying a little corporation tax each year. However, the branch structure means that the company would also start reporting the sales made to UK customers from Luxembourg to HMRC and pay corporation tax on those profits.

So was that the end of the story with regards to Amazon’s corporation tax in the UK? No.

The branch structure means that Amazon does not publish any public accounts that detail the sales and profits it makes from UK customers or the taxes paid on them. All that is there is the company’s Luxembourg accounts, which show that as a whole, the company had no net tax liability and instead receives tax credits.4 It is possible that there was some corporation tax paid in the UK, which was offset elsewhere, but we just don’t know.

Amazon’s global accounts state that the Luxembourg entity did make a profit in 2020 as a whole, but that this was was offset by deferred tax assets.

Deferred tax assets are often the result of losses a company has made in previous years that it can offset against profits made today or in the future. Interestingly, the company also said that it still believes that its earnings in Luxembourg are uncertain, and as such, has written off some of their deferred tax assets on the basis that it will be unlikely to generate enough profit to offset previous losses against future profits.5

So whilst business across the world is booming (and has been booming for years), and the company is recording its highest ever profits, the accountants appear to believe that its European operations may continue to be loss making (or at least not make much profit) for a significant time to come.

For a company that was built partly on tax avoidance all of this is hardly reassuring, and Amazon’s attempts to obfuscate the issue raises even more concern.

Specifically, Amazon publish what they call their annual economic impact in the UK.6 This attempt at assuaging criticism of the company’s historic tax dodging seeks to set out the company’s total contribution to the UK economy, including the total amount of taxes it pays. This includes direct taxes the company pays, like corporation tax, as well as taxes it pays on behalf of consumers, such as VAT. The company states that in 2019 it paid £293m in direct taxes.

The problem with this is that the figure for direct taxes includes Employer’s National Insurance, which is a large bill for a significant employer like Amazon and will dwarf any corporation tax liability they have. The comparisons of this figure that some media outlets have made with other UK retailers’ corporation tax bills are grossly misleading.

Looking at Amazon’s global accounts, it must be said that the company does state that it pays taxes overseas. The latest annual report for 2020 published on February 3rd shows that the company had a current tax liability of close to $1bn outside the United States on profits of $4bn.7 However, although this tax rate of around 25% is more than the UK’s statutory tax rate, there is no indication whatsoever as to where this is paid, it might all be paid on Amazon’s operations in Asia or anywhere else. We just don’t know.

The UK government could easily rectify this lacuna. Every major multinational needs to report their economic activity, including their profits and taxes on a country by country basis. This report is then given to tax authorities on a confidential basis.

In 2016 MPs voted to give the power to ministers to compel the publication of these reports (for all major companies, not to single out any individual one). However, the government has yet to take up the offer.8

If the government were to do this, or Amazon were to publish their country-by-country report themselves, this would go a long way to establishing the reality of Amazon’s tax position in the UK and other jurisdictions around the world.

Two final things worth noting. Amazon’s published figures for how much profit it makes outside of the United States may well be significantly deflated by royalty payments paid by its overseas operations to the US.

Amazon’s latest corporate accounts show an adjustment in their tax liability against the US headline corporation tax rate of $372 for Foreign income deduction.9 This is the Foreign-Derived Intangible Income (FDII) provisions of the US tax code which gives US based corporations a discount of 7.75 per cent on royalty income on intellectual property they bring in from overseas. This suggests that Amazon’s international operations sent back almost $5bn in royalties from overseas, vastly more than the total profit they made outside the US.

Secondly, Amazon’s global accounts also show that the company received $639m in tax credits.10 These appear to be primarily related to US government subsidies on research and development. The use of tax credits to help subsidise things like research and development has become increasingly popular with governments around the world in recent years. As we have previously pointed out in our work on the creative industry tax credits in the UK, by design, much of these credits end up subsidising very large profitable corporations. It seems that the US is no different in this regard.

Our Director discussed some of the issues raised in this blog on Times Radio on 04 February 2021.

Photo by Christian Wiediger on Unsplash

1 David Pegg, From Seattle to Luxembourg: how tax schemes shaped Amazon, The Guardian, 25 April 2018, https://www.theguardian.com/technology/2018/apr/25/from-seattle-to-luxembourg-how-tax-schemes-shaped-amazon

2 Clair Quentin, Risk-Mining the Public Exchequer, Journal of Tax Administration Vo. 3, No 2 (2017), http://jota.website/article/view/142

3 Simon Bowers, Amazon to begin paying corporation tax on UK retail sales, The Guardian, 23 May 2015 https://www.theguardian.com/technology/2015/may/23/amazon-to-begin-paying-corporation-tax-on-uk-retail-sales

4 Mark Sweney, Amazon given €294m in tax credits as European revenues jump to €32bn, The Guardian, 21 April 2020, https://www.theguardian.com/technology/2020/apr/21/amazon-given-294m-in-tax-credits-as-european-revenues-jump-to-32bn

5 Amazon 10-K 2020, p.63 available from: https://d18rn0p25nwr6d.cloudfront.net/CIK-0001018724/336d8745-ea82-40a5-9acc-1a89df23d0f3.pdf

6 Dayone Blog, 2019:Amazon’s Economic Impact in the UK, https://blog.aboutamazon.co.uk/jobs-and-investment/2019-amazons-economic-impact-in-the-uk

7 Amazon Inc 2020 10-K p.62

8 Out-Law News, UK MPs back power to make multinationals’ country-by-country tax reporting public, https://www.pinsentmasons.com/out-law/news/uk-mps-back-power-to-make-multinationals-country-by-country-tax-reporting-public

9 Amazon Inc 2020 10-K p.62

10 Amazon Inc 2020 10-K p.63

James Bond goes on furlough

26th January 2021 by Alex Dunnagan

The news that the latest James Bond Film, No Time to Die, has been delayed for the third time1 comes soon after the companies responsible for producing the film published their latest set of accounts. These reveal that in 2020 the company behind the latest James Bond Film increased its tax credit claims by over £4m and claimed support under the Coronavirus Job Retention Scheme, commonly known as the Furlough Scheme.

As is common in the film industry, each James Bond film is produced by a special purpose vehicle (an SPV), a company specifically set up to make the film. In the case of No Time to Die the company is called B25 Limited. These SPVs are owned by a parent company EON productions based in the UK, which in turn is owned by Barbara Broccoli and Michael Wilson.

The latest accounts of EON were published on January 12, made up to the end of 2019. B25’s accounts are a little more up to date. The latest set covers the period to 30 June 2020 and was published at the beginning of December.

As we noted in our report, No Time to Pay Tax, the Bond franchise generates substantial UK government tax credits which results in the British taxpayer subsidising each Bond film to the tune of tens of millions of pounds.

Film tax credits are based on production costs, and with the bulk of production happening in 2019, most of the subsidy generated by No Time to Die was generated in that period. However, the latest accounts from B25 show that the company appears to have earned an additional £4.7m in tax credits in the 2020 financial year. This takes the total amount of tax credit the company is eligible for to £51.5m for the production of No Time to Die.

On top of that direct production subsidy, B25 also qualified for the Coronavirus Job Retention Scheme, and claimed £96,487 between March and June 2020.

Of course, EON and their subsidiaries are perfectly entitled to claim tax credits and furlough payments. We are not suggesting that they are doing anything untoward in doing so.

However, the case raises another example of how the creative industry tax credit system, which is based on the amount of spend, benefits higher value productions. With the British taxpayer already on the hook for over £50m, many may well start to wonder when they might get to see the product of their investment.

1 Covid: James Bond film No Time To Die delayed for third time, BBC News, 22 January, https://www.bbc.co.uk/news/entertainment-arts-55761211

Tax avoidance, bailouts and bribery – The UK government’s Corona Corporate Finance Facility

6th June 2020 by George Turner

On 04 June the Bank of England published the names of 53 companies that had outstanding loans under the UK government’s Covid Corporate Financing Facility.

The list contains a number of companies that have had links to tax havens, or have seen controversy regarding their financial affairs.

The publication of the list follows growing calls for the government to place more conditions on companies receiving state support, and the Scottish and Welsh Governments have legislated to prevent companies incorporated in tax havens from accessing funds.

We covered the issue of bailout conditionality in our recent report, Paying in Equally?, in which we suggested that conditions could be based on future tax behaviour. Others have made similar suggestions, including Glyn Fullelove, President of the Chartered Institute of Taxation, who has suggested that support to companies could be predicated on businesses committing to lower their risk rating with HMRC.

HMRC already reviews the “tax risk” of large businesses and includes use of tax avoidance schemes in that assessment. Eligibility for help could be linked to not being judged “high risk” due to such behaviour. 2/11

— Glyn Fullelove (@glyn12gh) May 11, 2020

Dame Margaret Hodge MP, chair of the All Party Group on Responsible Taxation, has taken up this idea and written to the Chancellor suggesting that the government implement it.

Following the publication of the list of companies receiving support under the Covid Corporate Finance Facility, we went through the list to identify companies with links to tax havens, or that have seen other allegations poor financial conduct.

Companies with links to tax havens or tax avoidance

Overall we found 13 companies with links to tax havens, which made up 29% of the loans given.

Company Value of CCFF (£m) Domicile Parent / Owner jurisdiction Notes
ABB Finance B.V. £400 Netherlands Switzerland Companies house not up to date
Baker Hughes UK Funding Company PLC £600 UK Bermuda Ultimate holding company GE, currently in litigation with HMRC over alleged tax fraud. Immediate parent in Bermuda
Carnival plc £25 UK UK Ships registered in Panama. Carnival is two companies, one British, one Panamian.
Chanel Limited £600 UK Cayman Islands Ultimate parent company is Litor Limited, based in the Cayman Islands
CNH Industrial N.V. £600 Netherlands US/Italian corporation, incorporated in Netherlands but resident in the UK for tax purposes
Easyjet PLC £600 UK Cayman Islands Easygroup who are owned by a Cayman Islands based trust, have a 34% stake.
J.C.B. Service £600 UK Netherlands JCB parent company located in the Netherlands.
Johnson Controls International plc £370 Ireland Ireland American multinational domiciled in Ireland. Was subject of second largest corporate inversion in history
PACCAR Financial PLC £170 UK Netherlands,USA Immediate parent is in the Netherlands, and ultimate parent is in the USA
Schlumberger Plc £150 UK Netherlands Parent incorporated in Curacao
Telefónica Europe B.V. £200 Netherlands Netherlands Spanish telephone network company, registered in the Netherlands
Tottenham Hotspur Stadium Limited £175 UK Bahamas Owned by billionaire tax exile
Wizz Air £300 Hungary Jersey Hungarian airline with a holding company in Jersey
Total £4,790
All 53 companies receiving CCFF £16,250
Per cent of money going to tax-haven linked companies 29.48%

We have defined companies as having links to tax havens if they are owned by a tax haven company or a tax exile, or are incorporated themselves in a tax haven.
One of the more interesting companies on this list this is Baker Hughes, which is a subsidiary of General Electric (via a Bermuda holding company). GE is embroiled in a £1bn tax dispute with HMRC over unpaid taxes going back to 2004. The case is currently being litigated, and it was recently revealed that HMRC had changed their case to allege fraud on the part of GE. The company denies the allegation.

A number of companies are owned by parent companies in the Netherlands, or are incorporated in the Netherlands themselves. The Netherlands is both a well-known tax haven, and a major economy in itself. We counted the company if the Netherlands was being used as a conduit, with substantial operations or the headquarters of the company elsewhere.

So, for example, ABB Finance, a Dutch subsidiary of a Swiss multi-national and Telefonica, a Spanish company applying for UK government funding via subsidiary in the Netherlands, make the list, whilst AkzoNobel, which is headquartered in the Netherlands, does not.

A number of companies used tax havens as vehicles for personal holdings, or are owned by tax exiles.
For example, Chanel Limited, is owned by Litor Limited, a company based in the Cayman Islands. The Cayman Islands is also used for the vehicle to hold Sir Stelios Haji-Ioannou’s Easygroup, which in turn owns a substantial shareholding in EasyJet.

Tax haven UK costs the taxpayer

The list demonstrates that companies can qualify for UK government support, even though they have relatively little activity in the UK.

In recent years the UK has increasingly sought to set itself up as a tax haven for multinational companies. The primary attraction for companies becoming tax resident in the UK is that our controlled foreign company rules mean that UK tax resident corporations are not usually liable for UK corporation taxes on profits made outside of the UK.

This can be a particular advantage if the multinational can put profits into more traditional tax havens which don’t charge any corporation tax. Profits end up being taxed nowhere. This is not the case in other countries (such as Italy) where companies can be liable for taxes on their global profits.

CNH Industrial Limited, a US-Italian company formed as a merger between Fiat Industrial, and Case New Holland, appears to be a company that has taken advantage of the UK’s business friendly tax regime. The company is incorporated in the Netherlands but tax resident in the UK, because its Dutch parent locates its office in London.

CNH International BV does own a manufacturing plant in Essex, but it is a relatively small operation in comparison to its global footprint. In total, CNH International BV employs just over 1,000 people in the UK, out of a total of 64,000 worldwide.

According to the annual accounts of CNH International BV, and a number of subsidiary companies it has in the UK, its UK operations are loss making. As a result the company faces no tax liability in the UK on any income from either the UK or abroad.

However, its presence in the UK allows the company to access support from the UK taxpayer, and CNH International BV has borrowed £600m from the UK government, which is more than 50% of the company’s £1.1bn turnover at its Basildon plant.

Financial impropriety

Two companies stuck out as having had serious non-tax related financial issues.

ABB

ABB, a Swiss multi-national, received a £400m loan via a Dutch holding company – ABB Finance B.V.. In the UK, ABB has a company, ABB Holdings, which as of 04 July is 9 months late with filing its latest annual accounts.
ABB Holdings in turn owns ABB Limited in the UK, which reports that it had a turnover of £700m in 2018, the latest accounts that are available. This means that the UK government facility accounts for 57% of the turnover of ABB Limited. Another ABB company in the UK, ABB combined Heat and Power, is in voluntary liquidation.

Chemring Group

Chemring is a UK company operating in the defense sector. According to a press release on its website https://www.chemring.co.uk/media/press-releases/2018/18-01-2018a Chemring referred itself to the Serious Fraud Office in 2018, triggering a criminal investigation into bribery, corruption and money laundering. As confirmed by the SFO website, this is still a live investigation.

This research has been featured in the Financial Times, Daily Mail, Vice, The Telegraph, and The Times among others.

Correction – 06 June 2020

An earlier version of this article included British Airways in table of companies above. British Airways (BA) Limited is owned by a Jersey holding company – British Airways Number Two Limited, which is why we included the company on the list.

However, the entity receiving the government loan was British Airways PLC and not British Airways (BA) Limited. British Airways PLC is directly owned by IAG in Spain.

The proportion of loans going to tax haven linked companies was also updated to reflect this change.

Wars, taxes, and excess profits

1st May 2020 by Alex Dunnagan

“The profiteering that cannot be got at by the restraints of conscience and love of country can be got at by taxation.” – US President Woodrow Wilson, 1918.1

World leaders are using wartime rhetoric in describing the current crisis. Emmanuel Macron has declared that “we are at war”, Donald Trump has referred to the virus as an “invisible enemy”, and Boris Johnson has declared that “we must act like any wartime government and do whatever it takes to support our economy”. This language is not hyperbole.

But what does a wartime government do to support its economy? History shows us that wartime economies often bring with them radical tax innovations. Income tax was first introduced in the Napoleonic Wars, and the PAYE system (pay as you earn) was introduced in the Second World War. In this crisis we have already seen the tax system thrown into reverse to create the Furlough scheme.2

One tax that has featured in previous wars is the excess profits tax, which economists Emmanuel Saez and Gabriel Zucman have argued should be imposed by the US Federal Government as part of the response to the current pandemic.3 They rightly note that while many businesses will suffer, some will see profits increase.

In this article we take a look at what governments did in the past in relation to excess profits taxes – and how these taxes operated in practice.

In the First World War the British government saw that certain industries were doing well out of the conflict, particularly the arms manufacturers, and introduced an excess profits tax of 50 per cent of profits above the normal pre-war level. The rate was raised to 80 per cent in 1917. In 1921, the then Chancellor of the Exchequer Austen Chamberlain terminated the excess profits duty.

An excess profits tax is a tax levied on profits in excess of what is considered “normal”. While every iteration of this form of tax has been slightly different, the general rule is that an average from a pre-war period is taken. For example, Canada’s World War Two excess profits tax exempted “normal” profits taken as an average between 1936 and 1939.4 Administered under what is known as the “war-profits principle”, this tax is designed to recapture wartime increases over normal peacetime profits.

Various different rules and exemptions have been made in the past, for matters such as the size of the business, if the income is derived from investments, or to allow for depreciation of assets. In the First World War, in the UK a deduction of £200 per annum was allowed in the case of every business, which was subsequently increased in the case of small businesses. Administration of this tax went without serious friction, with taxpayers considering it part of their patriotic duty.

The UK wasn’t alone in introducing an excess profits tax during the Great War. Australia, Canada, New Zealand, South Africa, France, Italy, and the United States of America all introduced similar taxes. The goal was the same – to help pay for the war, and to ensure that no one outrageously benefited from a situation in which the country at large suffered.

Throughout the Second World War the excess profits tax was reintroduced. The debate in Parliament throughout the war was not over whether there should be an excess profits tax, but if the tax should stand at 100 per cent or not.

During his 1941 Budget speech, the then Chancellor of the Exchequer, Sir Kingsley Wood, stated that “The yield of National Defence Contribution and Excess Profits Tax exceeded the estimate of £70m by no less than £26m”, and that “The large surplus is due mainly to the public-spirited manner in which many firms and companies have paid over the estimated tax due from them without waiting for the figures to be finally agreed.”5

Wood went on to explain that the measure “is directed primarily to taking the profit out of war and ensuring that in war-time, when the whole nation has to bear sacrifices, the increased production which the war requires will not become the means of enrichment that it did in the last war.”6

Taxation to pay for war has been fairly popular so long as the war in question is popular too. Once you unite the people in a common cause, they have historically been quite happy to pay for it. Covid-19 is not a war of choice. If governments wanted to introduce measures such as excess profits taxes, it is likely that they would face little opposition from the public.

Photo by A Perry on Unsplash

1US President Woodrow Wilson, Session of 65th Congress, 27 May 1918.

2Coronavirus: Employment Support, House of Commons, 19 March 2020, https://hansard.parliament.uk/Commons/2020-03-19/debates/A72357FF-0207-4CE1-A3EF-B5F2D5AE5089/CoronavirusEmploymentSupport

3Jobs Aren’t Being Destroyed This Fast Elsewhere. Why Is That?, Emmanuel Saez and Gabriel Zucman, The New York Times, 20 March 2020, https://www.nytimes.com/2020/03/30/opinion/coronavirus-economy-saez-zucman.html?action=click&module=Opinion&pgtype=Homepage

4Canadian Economist Alex Hemingway has recently called for an excess profits tax – Excess profits tax needed to prevent profiteering amid COVID-19, Policy Note, 09 April 2020, https://www.policynote.ca/profits-tax/

5Budget speech, 07 April 1941, https://hansard.parliament.uk/Commons/1941-04-07/debates/047d6100-7faf-4924-bfba-2152f9a19d7b/ReviewOf1940%E2%80%9341

6Ibid

Top five tech companies in the UK avoided an estimated £1.3bn in tax in 2018 – new analysis

10th February 2020 by George Turner

The top five tech companies operating in the UK managed to generate profits estimated at £8.1bn from UK customers in 2018, a new analysis by TaxWatch shows.

However, due to these companies implementing complex financial structures to take these profits offshore, these companies only paid a combined total of £237m in taxes on these profits in the UK, an effective tax rate of just 2.9%. That puts the total amount of tax avoided by the companies in the UK at an estimated £1.3bn in 2018, the latest year where figures exist.

 

  Google Cisco Facebook Microsoft Apple Total
Current UK Tax Charge £72,895,000 £40,101,583 £30,372,000 £24,729,000 £70,877,000 £238,974,583
UK Estimated Revenues £9,358,419,600 £1,677,303,280 £2,289,953,250 £2,885,251,840 £12,270,489,000 £28,481,416,970
Estimated Profits on UK Revenues £2,433,189,096 £443,311,257 £1,030,478,963 £952,133,107 £3,313,032,030 £8,172,144,453
UK Estimated Tax Liability £462,305,928 £84,229,139 £195,791,003 £180,905,290 £629,476,086 £1,552,707,446
Estimated UK Tax Avoided £389,410,928 £44,127,556 £165,419,003 £156,176,290 £558,599,086 £1,313,732,863

The latest figures are an update on TaxWatch’s 2018 study, Still Crazy After All These Years, which looked at the activities of Google, Cisco, Facebook, Microsoft and Apple, five of the largest technology companies in the world, over the period 2013-2017. The latest figures use the same methodology applied to the companies’ 2018 financial accounts.

Methodology

Corporation tax is a tax on corporate profits. Under international principles of taxation a country has the right to tax companies on the profits that arise in their jurisdiction, even if the company is headquartered overseas.

However, it has become common practice for many multinational companies to move profits from higher tax countries to lower tax countries via a series of complex financial transactions. For that reason, the accounting profit declared in the UK accounts of many multinational companies is not an accurate reflection of the real economic profit made by the company from its activities in the UK.

For example, up until 2019 Google booked sales from UK customers in Ireland. The Irish company which recorded sales of Google products then made large royalty payments for the use of Google intellectual property to a Dutch company, money which then eventually ended up in Bermuda. In 2018, the company moved $22.7bn from its worldwide operations to Bermuda in this way.

The result of this is that Google made a relatively small amount of profit in the UK, Ireland, and other countries, and an enormous profit in Bermuda, which has a zero % tax rate. However, given that Google’s Bermuda subsidiary appears to have no employees, whereas the company employs over 3600 people in the UK, are the vast profits made by its offshore shell company an accurate reflection of the real economic profit of the company? We think not.

In order to get a better understanding of the real profit that the companies in our study made in the UK, TaxWatch estimated the total revenue made by these companies in the UK, and applied the company’s global pre-tax profit margin to that revenue. The pre-tax profit margin is the proportion of revenues that is declared as profit before taxes.

From an economic point of view this assumes that the UK market has an average level of profitability vis-a-vis all of the other markets these companies operate in, including their domestic market, the US.

It also assumes that the costs of the company, from research and development to manufacturing and other functions are allocated equally between different markets.

There are some who argue that the approach we have taken overestimates the real profits that these companies make in markets such as the UK because, under international tax rules, profits should be allocated based on where value is created, which is not the same as the location of customers. The argument goes that as much of the research and development conducted by these companies happens outside of the UK, the UK market should receive less profit.

This is an argument also put forward by the companies themselves. Responding to the 2017 Paradise Papers leaks from the International Consortium of Investigative Journalists Apple made the following statement on their website:

Under the current international tax system, profits are taxed based on where the value is created. The taxes Apple pays to countries around the world are based on that principle. The vast majority of the value in our products is indisputably created in the United States — where we do our design, development, engineering work and much more — so the majority of our taxes are owed to the US.

This could be a reasonable argument for Apple to make if in fact the company allocated most of its profit to its operations in the United States (where it says that the vast majority of its value is created). The fact is that it does not.

Apple’s latest annual financial statements state clearly that the company’s pre-tax profits outside of the United States were $44.3bn in the year until November 2019 and $48bn in 2018. That accounted for 67% and 66% of the company’s entire pre-tax profit. As far as Apple’s financial accounts are concerned, the majority of the company’s profit is made outside of the US.

In fact, according to Apple’s accounts, the distribution of the company’s pre-tax profit is much more closely aligned with the distribution of its net sales. In 2019 the US market accounted for 39% of sales and 33% of the profits made by the company.

Other companies also report that their operations outside of the US are more profitable than their US operations, suggesting that our approach in fact underestimates the amount of profit that these companies really make in countries such as the UK.

For example, the latest Microsoft annual report shows that worldwide the company made revenues of $126bn in 2019. Of this, 51% was received from customers in the USA and 49% from customers in the rest of the world.

Microsoft also declares the pre-tax profit the company makes in its US domestic segment as against its non-domestic segment. This suggests that the pre-tax profit margin of Microsoft is 24.6% in the USA, but 45.2% in the rest of the world.

At no point do we pretend that the figures presented here are an exact answer to how much profit these companies make in the United Kingdom. That would be impossible to determine without access to detailed figures from inside these companies. However, we do argue that our approach gives a much more realistic estimate of the real profits made by these companies in the UK market as opposed to the profits declared in the accounts of their UK based subsidiaries.

Google

Until 2016 Google reported the revenues it made from the UK in its US 10-K filing. On average, around 9% of Google’s global revenues came from the UK between 2014 and 2016. We applied this average figure to Google’s 2018 global revenues to estimate the revenues generated from the UK in 2018.

Over the last five years Google has consistently made a profit margin of over 25% on all of its worldwide sales. In 2018, Alphabet, the parent company of Google reported profits of $34.9bn, on revenues of $136.8bn. The same profit margin applied to the UK revenues of Google would yield a profit of £2.4bn, and a tax bill of £462m.
Google UK had a current tax charge of £72.9m in 2018.

In January 2019 it was revealed that Google had changed its corporate structure, moving its intellectual property from Bermuda back to the United States. This does not impact our study (which only covers 2018) and is unlikely to impact profits declared in the UK in the future. This is because rather than paying royalties to Bermuda, the company will simply make the same payments to the US where under the new FDII rules these payments will be subject to a substantial tax break.

Cisco

Cisco Systems has a subsidiary based in the UK called Cisco International Limited. It is responsible for the majority of Cisco’s sales in the Europe, Middle East, and Africa region.  The accounts of Cisco Systems International report separately on the revenues the company makes from UK sales, which were £1.7bn in 2018.

Cisco Systems made a profit margin of 26% in 2018 on all of its global sales. Applied to its UK sales this would yield a profit of £443m, and a tax bill of £84m. However, in 2017, Cisco International Limited and another UK subsidiary, Cisco Systems Limited, were charged £40m in tax between them.

Facebook

Facebook’s global accounts do not break down their revenues by geography at all, whilst the accounts of the company’s UK subsidiary do not reflect the real UK revenues.
Until 2016, Facebook booked all of its UK revenue in a subsidiary in Ireland. Following public pressure about the company’s tax affairs, it started booking revenue from its largest customers through Facebook UK rather than an Irish subsidiary. However, smaller customers would still receive invoices from Ireland, meaning that Facebook UK’s accounts are not a true reflection of the revenue the company makes from UK customers.

In order to estimate Facebook’s real revenues in the UK, we looked at Facebook’s average revenue per user (APRU), which is published in a chart, broken down by region, appended to the company’s US stock market filings. We then took the mid-point between the US APRU and European APRU basing this calculation on the assumption that the UK would be at the top end of the European APRU range, but less than the US. Recent market research puts Facebook’s userbase in the UK at 39 million users, an increase on previous estimates of 32 million. To get an estimate for UK revenue we then multiplied the APRU by 32 million.

In 2018, the company had a tax charge of £30.3m – substantially more than the £16m tax charge they recorded in 2017.

Our estimate based on how much Facebook makes per user puts revenues in the region of £2.29bn in 2018 from UK customers.

In 2018, Facebook globally had a profit margin of 45%. If we assume that the UK market is no less profitable than any other market the company operates in, then the company should have generated a profit of around £1bn in 2018.

A profit of £1.03bn would yield a tax charge of £195.8m.

Microsoft

Microsoft UK appears to have made a significant accounting change since 2017, with significantly more revenue from customers from the UK being recorded in its UK accounts. Between 2017 to 2018 Microsoft UK’s sales to 3rd parties increased by more than £1bn.

However, this increase in sales to 3rd parties does not seem to have been at the expense of Microsoft’s Irish subsidiary, Microsoft Ireland Operations Limited, which saw its revenues increase from $22.8bn in 2017 to $27.5bn in 2018. Microsoft Ireland Operations Limited makes sales to customers throughout the EMEA region.

Previous editions of Microsoft Ireland Operation’s accounts provided a figure for revenues earned from the UK. Between 2013 and 2015 the proportion of the company’s global revenues that came from the UK ranged between 3.12% and 3.6%.

To estimate revenues that Microsoft gained from the UK in 2018 we applied an average of 3.44% to the global revenue of Microsoft in that year.
Overall, Microsoft made a pre-tax profit of 33% on its revenues in 2018.

In total, we estimate that Microsoft generated revenues of £2.9bn in 2018 from UK customers. This would yield an estimated profit of £952m and a tax bill of £181m in 2018. Microsoft Limited in the UK had a tax bill of £24.7m in 2018.

Apple

Apple is one of the most opaque of all of the companies we looked at, and so most difficult to analyse.

In order to estimate how much revenue Apple makes from the UK market, we looked at the amount of money spent by UK customers on iPhones in the UK which was constructed from data on smart-phone penetration and market research. This shows that £6.3bn was spent on iPhones in the UK in 2017. This accounts for 6% of Apple’s global iPhone sales. We were not able to obtain updated figures for 2018, and so to estimate Apple’s 2018 revenue in the UK, we applied the same figure, 6% to the company’s global revenues.

Assuming that Apple makes 6% of its revenues in the UK, it would have generated £12.3bn from UK customers in 2018.

Applying Apple’s global pre-tax profit margin of 27% to these revenues implies an estimated profit of £3.3bn and a tax bill of £629m in 2018. Apple’s three UK subsidiaries had a UK tax charge of £70.8m in 2018.

This research was featured in the Daily Mirror, The Telegraph, and the Mail on Sunday among others.

The Sunday Times Tax List and the argument for corporation tax

28th January 2020 by George Turner

The Sunday Times published their second annual tax list over the weekend. The list, which uses publicly available data to showcase the “individuals and families who contribute most to the public purse” is pitched as a celebration of the contribution that the wealthy make to the Treasury.

Coming at the end of a week that saw the release of a letter from the Millionaires Against Pitch Forks, a call for higher taxes on the wealthy coming from a group of millionaires and billionaires, it is important to remember that there are many wealthy people who value the contribution they make to public services and do not just slip off to Monaco at the first whiff of fortune. The Sunday Times list contains a number of such people, such as Denise Coates, owner of Bet 365, who chooses to put her extraordinary £276.6m salary through the payroll, and J.K. Rowling, who The Sunday Times reports puts her £100m+ in royalties on her self-assessment form.

However, the list also contains people, such as Philip and Tina Green, and Stelios Haji-Ionnou, who have moved to Monaco, as well as the Perkins family (owners of Specsavers) of Guernsey. Although these individuals could have moved for reasons unconnected with tax – for example, Douglas and Dame Mary Perkins said they’d moved to Guernsey some 40 years ago to be closer to Dame Mary’s parents – it remains important to ask how people resident in such well known tax havens made it onto the list of top UK taxpayers? That is because The Sunday Times ranking probably tells us more about the effectiveness of wealth taxation in the UK rather than giving us an indication of the ethical conduct of taxpayers, and explains why corporation tax is such an important tax for capturing income arising from wealth.

Calculating the Tax List

Unlike some Scandinavian countries, where individuals’ tax payments are a matter of public record, the tax affairs of individuals in the UK are subject to strict secrecy laws. As a result, rather than looking at the tax paid by people, in most cases the Sunday Times has looked at taxes paid by the the businesses they own where records are available via Companies House. Primarily the ranking looks at Employers National Insurance Contributions and Corporation Tax apportioning these taxes to individuals based on their stake in the company. The list also looks at dividends paid by these companies and then assumes that UK resident individuals will pay income tax on these payments at the higher rate. As a result, the list favours people who own large UK businesses employing staff in the UK.

Who pays corporation tax?

There is a large, lively and important debate as to who really ends up paying corporation tax, a tax on the profits of companies. A number of people, particularly those who argue for cutting corporate taxes, assert that corporation tax is in the end paid for by the workers of a company. They argue that lower corporation tax will lead to higher wages for employees.

The Sunday Times entirely rejects that view, explicitly, and assumes that 100% of corporation tax is borne by the shareholders. The paper argues that this is because shareholders could choose to move operations overseas if they wanted to, but instead choose to locate their business in the UK and therefore make it liable to UK corporation tax.

Another argument of course is that if corporation tax is reduced, this leaves more profit in the company available for distribution to shareholders. Some empirical analysis has shown that any excess distributable profits overwhelmingly goes to shareholders.

Corporation tax – A withholding tax on wealth?

This debate is important for how, why, and how much we tax profits arising from business activity. If a shareholder is a UK resident, then the money they receive from corporate profits goes though two tax gateways. Corporate profits are first taxed at the corporate level through the corporation tax, and then again as income once the profits have been paid out as a dividend and are in the hands of the shareholder.

The income tax rate that individuals pay on dividends is lower than the amount paid on income from work, partly to account for the fact that corporation tax has already been paid on the distribution. If a UK resident were to move offshore to a place like Monaco, which does not charge income tax, then that corporate profit would only be subject to corporation tax, and not income tax.

Now consider what would happen if corporation tax were to be cut, as some argue it should be. If we are to accept the argument of The Sunday Times, then 100% of that benefit would accrue to the shareholder. If that shareholder was a UK resident then the impact on government revenue would be limited because the government would recoup some additional tax from the shareholder via increases in income taxes on the dividends they receive. If the shareholder was offshore, or tax exempt (e.g. a pension fund), then the UK government would lose all of the amount of the cut.

If we assume that the corporation tax primarily falls on shareholders, then The Sunday Times Tax List demonstrates its importance in ensuring that when companies generate profits in the UK at least some of that profit is taxed in the UK even if the shareholders live in Monaco, Guernsey, Bermuda or anywhere else. Following the same argument, cuts to corporation tax would disproportionately benefit those who choose to move to tax havens, as it allows them to move more profit generated from UK activities offshore and outside of the UK tax net.

A letter from our Director to the Editor of The Sunday Times was published on the issue.

Photo by Colin Watts on Unsplash

Global Video Games Giants: Playing the system or paying their fair share?

20th November 2019 by Alex Dunnagan

20th November 2019

Global Video Games Giants: Playing the system or paying their fair share?

A report from The Guardian, Revealed: global video games giants avoiding millions in UK tax, has shown that four large companies have claimed close to half of all Video Games Tax Relief (VGTR) since the scheme’s inception. The cost of Video Games Tax Relief has spiralled to over £100m a year, and since 2014 has seen WarnerMedia claim £60m, Sony £30m, and Sega £20m.

We have dug further into the accounts, and seen that not only are multinational companies claiming millions in relief, many are also engaging in tax avoidance, specifically profit shifting. This involves moving profits out of the UK so that no taxes are paid on UK generated profits. The effect of the shifting is that the UK accounts of the game developers show little or no profit being made. As many of these games are critically acclaimed best-sellers, and often part of long-running franchises, this claim is rather dubious.

Profit shifting by games companies was highlighted in our World Of TaxCraft investigation, which showed Activision Blizzard moved €5bn to sit with Dutch companies resident in Bermuda and Barbados that owned the intellectual property to the games. The Guardian study highlights that there are many more companies involved in this practice, and those companies in addition to moving profits out of the country, are claiming large sums of money in subsidy from the British taxpayer.

VGTR is a government scheme that allows UK developers to apply for tax relief from HMRC, subject to qualifying as “culturally British” under rather questionable BFI testing criteria. The relief is part of the wider Creative Sector Tax Relief, which also includes film production, animation, and high-end television.

Video Games Tax Relief is worth up to 20% of the core production costs of a game. Profitable games development companies are issued this as a relief, meaning a deduction from their corporation tax bill, with loss-making games companies are able to claim a payable tax credit at a rate of 25% of their total losses up to the total amount of qualifying expenditure.

We have studied two companies highlighted in the Guardian report to look at how the VGTR system is being used. These examples highlight both how generous the relief is and how it can be open to abuse by companies which engage in tax avoidance.

Example 1. Creative Assembly (Sega)

Japanese video game company Sega Games Co is an organisation which prides itself on the fact that it “does not take part in tax avoidance schemes”.1 In 2018, Sega had revenues of ¥250bn (£1.9bn) and owned subsidiaries across the world.

One of these subsidiaries is Creative Assembly, a UK based games development company, responsible for the long running Total War series, which has sold over 22 million copies2.

Creative Assembly
  2015 2016 2017 2018 Total
Turnover £30,285,066 £30,501,799 £45,804,938 £47,139,851 £153,731,654
Cost of Sales -£22,922,198 -£17,558,135 -£27,560,548 -£33,679,193 -£101,720,074
Gross Profit £7,362,868 £12,943,664 £18,244,390 £13,460,658 £52,011,580
Gross Margin 24.31% 42.44% 39.83% 28.55% n/a
Admin Expenses -£4,103,109 -£4,690,134 -£4,941,792 -£13,735,035
Operating Profit £7,362,868 £8,840,555 £13,554,256 £8,518,866 £38,276,545
Operating Margin 24.31% 28.98% 29.59% 18.07% n/a
Profit before Tax £6,244,494 £8,891,387 £13,554,256 £8,455,866 £37,146,003
Video Games Tax Relief £2,779,435 £1,828,352 £2,501,996 £3,567,481 £10,677,264
Tax £1,658,862 £92,595 £703,372 £3,239,757 £5,694,586
Profit for the year £7,903,356 £8,983,982 £14,257,628 £11,695,623 £42,840,589

Figure 1. Creative Assembly Accounts, 2015-2018.

On the face of it, Creative Assembly does not seem to be engaging in profit shifting, or at least, it does not have a particularly aggressive approach with regard to its transfer pricing structure. The company, unlike some other UK based developers owned by large multi-nationals, declares a pre-tax profit in the UK of around 25% of its revenue. Creative Assembly’s operating profit margin was 18% in 2018, which is considerably larger than its Japanese parent company which had an operating margin of 5.5%.

In the absence of any subsidy the company would normally pay corporation tax on these profits. However, VGTR allows Creative Assembly to wipe out its corporation tax bill entirely, and to increase its post-tax profits, through a tax credit. This presumably can be used to deduct from any future corporation tax liability.

Figure 2. Rome Total War II, a game in which you can set your own tax-rates.

Figure 3 shows how this works. In 2018, Creative Assembly had a pre-tax profit of just under £8.5m. Once various tax adjustments are made, including a backdated tax relief of £1.5m, and a 2018 relief of £3.5m – a total £5m in VGTR – Creative Assembly are able to eliminate any corporation tax they might have owed, ultimately increasing their post-tax profits by £3.2m.

Figure 3. Creative Assembly accounts 2018, taxation bill.

Example 2. Rocksteady Games (Warner Bros.)

Rocksteady Studios is a London based games developer, and subsidiary of Warner Bros. Interactive Entertainment, responsible for the “culturally British” Batman games. The studio made Batman Arkham Knight, the fastest selling game of 2015, which shifted some 5 million copies in its first 3 months. You would expect that a company behind a game as successful as this would make a profit, but scrutiny of Rocksteady’s accounts show that its only after government subsidy that this loss making enterprise turns a profit.

Rocksteady Studios
  2014 2015 2016 2017 Total
Turnover £11,271,000 £12,725,000 £13,251,000 £14,592,000 £51,839,000
Cost of Sales -£7,159,000 -£10,047,000 -£14,050,000 -£15,740,000 -£46,996,000
Gross Profit £4,112,000 £2,678,000 -£799,000 -£1,148,000 £4,843,000
Gross Margin 36.48% 21.05% -6.03% -7.87% n/a
Admin Expenses -£4,360,000 -£5,503,000 -£126,000 -£160,000 -£10,149,000
Operating Profit -£248,000 -£2,825,000 -£925,000 -£1,308,000 -£5,306,000
Operating Margin -2.20% -22.20% -6.98% -8.96% n/a
Profit before Tax -£232,000 -£2,791,000 -£897,000 -£1,292,000 -£5,212,000
Video Games Tax Relief £1,566,000 £3,234,000 £2,396,000 £2,783,000 £9,979,000
Tax £1,215,000 £3,511,000 £2,397,000 £3,011,000 £10,134,000
Profit for the year £983,000 £720,000 £1,500,000 £1,719,000 £4,922,000

Figure 4. Rocksteady Studios Accounts, 2014-2017.

The accounts of Rocksteady show the company making a pre-tax loss for every year between 2014 and 2017, despite creating a highly successful game. How can that be? According to the annual accounts of Rocksteady, rather than getting a share in the profits of the game, the company receives payments from its parent companies based on the total cost of production. This payment is not, according to the accounts, enough to pay for the total costs incurred by the company. As a result Rocksteady Studio appears to be permanently loss making.

These losses mean that the company can claim back almost £10m in VGTR as a credit, which pushes the company into a post-tax profit – all the while paying £0 in corporation tax. The result of this is that Rocksteady is being subsidised by the British tax payer to produce highly lucrative games for its American parent company. The company pays no tax on the profits derived from the production of those games in the UK.

Figure 5. Rocksteady Studios accounts 2017, taxation bill (Creative tax credits is VGTR).

Conclusions

British studios that actually create highly successful games are essentially subsidised by the British taxpayer – however, what is the British tax payer getting back?

The two companies which we have studied here demonstrate that the VGTR scheme is almost bound to ensure that the UK games industry will not pay corporation tax – regardless of how successful the industry becomes.

In the case of Sega, the company does not appear to be engaged in any obvious profit shifting, however, video games tax relief still manages to wipe out the taxable profit of the company.

Add in profit shifting and games companies can even claim money back. It is implausible that the games produced by Rocksteady are loss making, and the losses in the Rocksteady accounts appear to be the result of profit shifting by the company. The perversity of the VGTR regime is that it rewards this aggressive behaviour with more subsidy.

Video Games Tax Relief is a poorly executed scheme. The intent is to promote British culture, and to foster innovation amongst small independent games developers through subsidies. The reality is that this scheme is being used as state-aid, acting as corporate welfare for multi-national companies worth billions.

The relief is set to run until at least 2023, by which point it is expected to have cost well over half a billion pounds. We want to know why companies engaging in profit shifting are still able to claim VGTR? TaxWatch is calling for a comprehensive review of this scheme – the UK Government should investigate the matter before any more subsidy is given to multi-national organisations involved in profit shifting.

We have approached the studios for comment. A spokesperson for Creative Assembly said: “The amount of Corporation Tax paid by Creative Assembly is publicly available information”. Rocksteady Studios did not respond.

Photo by Marcin Lukasik on Unsplash

1https://www.sega.co.uk/uk-tax-strategy

2https://www.segasammy.co.jp/english/ir/library/pdf/printing_annual/2018/ssh_ar18e_web.pdf

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