US set to raise $8.5bn from four tech companies following global tax deal

7th October 2021 by Alex Dunnagan

New analysis from TaxWatch reveals how the US Government is set to be the big winner from increases in taxes on big tech arising from the global tax negotiations currently underway under the auspices of the G20/OECD.

In our latest research, we have analysed 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 under Pillar One would be $2.5bn under the terms of the G7 agreement set out earlier this year.

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 also 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 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 from just four companies, as against a benefit of $2.5bn shared between all other countries.

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, with relatively little being distributed to the countries where these companies operate. This was not necessarily the outcome expected from the OECD led BEPS process, which had a stated goal of making tech companies pay a fair share in the countries where they operate.

The full report, ‘A Fair Distribution’, is available as a web page here, and as a PDF here. This research was featured in The Guardian as an op-ed by our Executive Director George Turner, available here.

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.

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

‘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, h ttps://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

G7 tax deal represents a tax cut for big tech in the UK – new analysis

27th September 2021 by George Turner

In June 2021 the G7 announced that it had reached an agreement on proposals to change the way that the largest multinational companies are taxed. This included a mechanism to redistribute profits to countries where sales are made (such as the UK), often referred to as “market jurisdictions” . The final agreement is due to be signed off in October 2021 at the OECD.

A new analysis from TaxWatch has demonstrated that tech giants will almost certainly end up paying less tax under the proposals put forward by the G7 than they are currently liable for under the digital services tax.

Scrapping digital services taxes was a key demand of the United States in the negotiations for a new global tax deal, which is expected to be finalised next month at the OECD.

TaxWatch has undertaken an analysis of the formulae used to calculate the DST and the potential future tax liabilities under the G7 proposals, and concludes that with a digital services tax rate of 2%, the current UK DST rate, and a corporation tax rate of 19%, the current UK corporation tax rate, a company would have to have a profit margin of 62% in order to pay more in tax under the G7 proposals than under the DST. Historically tech companies have never achieved these profit margins.

If the UK tax rate rises to 25%, as it is currently scheduled to do, then the profit margin required before a company ends up paying more than under the DST falls to 48%, a margin rarely seen historically.

The paper also analyses the proposals that have recently been put forward by the G24 group of countries, which advocate for more profit to be reallocated to countries where revenues are made (such as the UK) under the OECD formula. If these proposals were adopted, then tech companies would be likely to end up paying more in tax in market jurisdictions, with the result that profit margin required before a company pays more dropping to 44% assuming a 19% corporate tax rate or 36% assuming a 25% corporate tax rate.

The full report can be found as a web page here and as a PDF here.

Will the OECD’s global tax deal raise more from tech companies in the UK?

27th September 2021 by George Turner

27th September 2021

Analysis shows that tech giants would pay less in taxation in market jurisdictions under G7 global tax deal than under current digital services taxes.

Proposals put forward by the G24 group of nations ahead of next month’s crucial meeting of the OECD would lead to tech companies paying more.

Making tech companies pay their fair share?

In June 2021 the G7 reached an agreement on a new system of taxation for the world’s largest companies.

The deal unlocked ongoing negotiations at the OECD and was billed as a way of confronting the “tax challenges that arise from the global digital economy” and a way of making sure multinationals pay “their fair share in the countries they do business”.¹ Final sign off on a deal at the OECD is expected in October.

The agreement was the product of years of negotiations at the OECD following public outcry at the low levels of taxation being paid by large tech companies – some of which had seen their effective tax rates fall to single digits.

Although tech companies have insisted that the low tax rates they have achieved have been a result of government incentives, the reality is that the industry was a heavy user of tax avoidance schemes.

Talks aimed at addressing the problem had been taking place at the OECD for many years. In the interim, many countries around the world grew increasingly frustrated with a lack of progress and started to implement their own unilateral measures to tax digital companies and “make them pay their fair share”.

These so called “digital services taxes” (DSTs) were a controversial measure that sparked trade disputes between the United States and European countries that adopted them.

One particular aspect that aggravated tech companies was that DSTs operate as a tax on the turnover in jurisdictions where services were sold. This meant that they did not come under tax treaties and therefore could not be credited against taxes paid in a company’s home jurisdiction in the say way that corporate taxes can be offset against liabilities at home. They were a tax that came on top of any corporate tax liability.

From the point of view of tech companies, a new global system of allocating taxable profit to jurisdictions to replace a patchwork of DSTs would be easier for tech companies to administer, allow them to manage their tax liabilities on a global level, and have the added benefit of wiping the slate clean following years of tax avoidance.

For this reason, tech companies have long argued for tax reform and were supportive of the G7 deal when it was announced. A spokesperson for Google told Reuters: “We strongly support the work being done to update international tax rules. We hope countries continue to work together to ensure a balanced and durable agreement will be finalised soon.”²

Nick Clegg, Global Vice President of Public Affairs for Facebook Tweeted: “Facebook has long called for reform of the global tax rules and we welcome the important progress made at the G7. Today’s agreement is a significant first step towards certainty for businesses and strengthening public confidence in the global tax system. We want the international tax reform process to succeed and recognize this could mean Facebook paying more tax, and in different places.”³

But will companies like Facebook end up paying more tax in market jurisdictions like the UK?

In this paper, we demonstrate that for companies subject to the DST rate of 2%, the DST rate in the UK, it is a near certainty that they will end up paying less in tax in “market jurisdictions” such as the UK under the G7 proposals than under existing digital services taxes. If the UK supported the position of the G24 group of nations, more profit would be allocated to the UK, with the result that profit margin required before a company pays out more tax under the OECD formula than the current DST being closer to the profit margins observed at large tech companies.

We come to this conclusion based on a mathematical analysis of the formulas used to calculate the DST and the new tax base under the OECD proposals.

The effective tax cut that the G7 deal represents is even larger for countries with higher DSTs like France.

The G7 deal

The agreement reached at the G7 was based on a blueprint put together by the OECD.

The new proposals come in two parts, Pillar 1 and Pillar 2. Pillar 1 is a mechanism to re-distribute profits made by some of the world’s largest multinational companies to countries where they make revenues (such as the UK). Pillar 2 is a mechanism to stop companies from moving their profits into low tax jurisdictions. In this paper we focus on the Pillar 1 proposals. Under Pillar 2 all of the benefit goes to the country where the multinational is headquartered, and as such it is not relevant to the distribution of profit to market jurisdictions.

The OECD blueprint outlines a three step process to find the “allocation amount” under Pillar 1, which is the amount of profit that will be available to market jurisdictions to tax.

The G7 deal largely adopted the blueprint, and agreed the various percentages required to determine the allocation amount, which had been left as an open question.

Following the G7 agreement, we can now see what the impact will be on the tax base of large corporations using the blueprint process and the allocation percentages set by the G7.⁴

Step 1 – Allowance for “routine” profit

The first step in the OECD process is to isolate what the OECD call “routine profits”. This applies a simple percentage to the profit before tax of a multinational as an allowance that will excluded from any reallocation. The G7 agreement set this as 10%.

Step 2 – Global Reallocation

The next step in the process is to create a pool of profits that will be available for reallocation to market jurisdictions. This is a simple percentage of the remainder of a company’s profit before tax after step one. The G7 set this reallocation percentage at 20%.

Step 3 – Redistribution

The reallocation pool arrived at after step two is then carved up amongst market jurisdictions who can then apply tax the profits allocated to them.

The G7 agreement did not give any details on how this would work, however, the OECD blueprint states that the key will be based on the revenues a Multinational Enterprise(MNE) makes in any in-scope country.

For the purposes of this paper, we have assumed that the allocation is based on a simple proportion of total revenue made in any country.

The three steps can be expressed as a formula as follows

Local tax base = Global revenues x (profit margin – 10%) x 20% x local market share

This local tax base can then be multiplied by the local corporation tax rate to find the amount of additional taxation raised by the pillar 1 process.

Digital Services Taxes

As part of the G7 agreement reached on the new global tax deal, countries should dismantle domestic digital services taxes. The rational for this is that the DST was a stop gap to ensure that some tax was paid in market jurisdictions until a global agreement of the kind proposed by the OECD was agreed.

Digital services taxes are crude and simple taxes that place a flat rate of taxation of the revenues of a company derived from the provision of certain digital services in the country.

In the UK, the DST is a tax of 2% on the revenues derived from search engines, social networks and online marketplaces with a tax free allowance of £25,000,000

The UK DST can also therefore be expressed as follows:

DST revenues = (Global revenues x local market share) -£25m x 2%

Comparing DST revenues with Pillar 1 revenues

For companies subject to the DST, i.e. those that derive their income from in-scope activities, we can easily compare the amount of tax raised by the DST against the new pillar 1 formula. We have already done this exercise using the real corporate accounts of several global tech giants and our estimates of revenues in the UK here.

However, we can also determine under what conditions the DST will equal tax revenues raised under pillar 1 because by putting the two equations together we get:

(Global revenues x local market share) -£25m x 2% = Global revenues x (profit margin – 10%) x 20% x local market share x local tax rate

We can see here that for any given company, their global revenues and local market share will be the same on each side of the equation, meaning that the only two variables that will change whether or not the DST raises more than Pillar 1 for any company subject to the DST will be determined by the profit margin of the company and the local tax rate.

This equation can therefore be rearranged to isolate profit margin, allowing us to answer the question, what profit margin would a company need to achieve in order to end up paying more under the pillar 1 than the DST at a given local corporate tax rate?

Profit margin = ( (Global revenues x local market share) -£25m) x 2%/ (Global revenues x 20% x local market share x local tax rate) + 0.1

If we take a company that has global revenues of £10bn, and a market share in the UK of 10% of global sales, and a UK corporate tax rate of 19% we get the following:

Profit margin = ( (£10bn x 0.1) -£25m) x 0.02 / (£10bn x 0.2 x 0.1 x 0.19) +0.1

Which gives us

Profit margin = 62%

So, under the current UK corporation tax rate of 19%, a corporation would have to achieve a pre-tax margin of 62% before it started paying more under the pillar one agreement than under the digital services tax.

The UK corporation tax is currently scheduled to increase to 25%, so we can re-run the exercise at that tax rate with the same notional £10bn company.

Profit margin = ^[1]£10bn x 0.1) -£25m x 0.02 / (£10bn x 0.2 x 0.1 x 0.25) +0.1

This gives us

Profit margin = 49%

The equation is highly sensitive to increases in the DST rate. If we look at the same company, and apply the French DST rate of 3% and the French Corporate tax rate of 28%, then the profit margin required is 68%.

Real profit margins of tech giants

Of course in theory, a company could end up paying more under the pillar one process than under the digital services tax if it achieved very high profit levels.

However, a quick glance at the real historical profit margins seen by tech giants demonstrates that the kinds of profit levels required before a company ends up paying more under pillar one are rare. As such, it is a near mathematical certainty that companies will end up benefiting from a deal that removes digital services taxes and replaces them with a Pillar 1 allocation under the deal announced at the G7. This is a highly significant finding, given that the purpose of the G7 deal was to come to a more equitable taxation of the digital economy.

The following chart gives us the historic pre-tax margin of Google, which has never risen above 37%.

The following chart is the pre-tax profit margin of Facebook. Facebook’s profit margins have been as high as 53% in the past, but more recently have hovered around the 40% mark.

Source: macrotrends.net

The G24 proposals

The fact that the G7 proposals involve very little distribution of profits away from the home jurisdiction of multinational companies (most of which are headquartered in G7 countries) has not gone unnoticed.

The G-24 group of developing nations has put forward alternative proposals to those adopted by the G7.⁵

The most signifiant change to pillar 1 is to the allocation percentage, the percentage of a multinational’s profits (above the 10% hurdle) that would be available for reallocation to market jurisdictions. Under the G24 proposals this should be at least 30%.

If we rerun our formula above, substituting an allocation percentage of 20% to 30%, we find that assuming a 2% DST and a 19% corporate tax rate, a company would only have to have a profit margin of 44% before Pillar 1 started to raise more revenues than the DST. With a corporate tax rate of 25% that falls to 36%.

It is therefore in the best interests of the UK to support the proposals put forward by the G24 group and seek a higher allocation percentage.

This report is also available as a PDF here.

This article was amended on 27th September to correct a mistake in the calculation of the impact of the G24 proposals.

1G7 Finance Ministers Agree Historic Global Tax Agreement, HM Treasury, 05 June 2021, https://www.gov.uk/government/news/g7-finance-ministers-agree-historic-global-tax-agreement

2Reaction to the G7 minimum tax agreement, Reuters, 05 June 2021, https://www.reuters.com/business/reaction-g7-minimum-tax-agreement-2021-06-05/

3Nick Clegg, Twitter, 1437hrs 05 June 2021, – https://twitter.com/nickclegg/status/1401171338358714374?lang=en

4HM Treasury, G7 Finance Ministers and Central Bank Governors Communique, 05 June 2021, https://www.gov.uk/government/publications/g7-finance-ministers-meeting-june-2021-communique/g7-finance-ministers-and-central-bank-governors-communique

5Comments of the G-24 on the Statement on a Two-Pillar Solution, G24, 19 September 2021, https://www.g24.org/wp-content/uploads/2021/09/Comments-of-the-G24-on-the-IF-July-Statement.pdf

References[+]

References
↑1	£10bn x 0.1) -£25m x 0.02

Will Facebook, Google, eBay and Amazon pay more in UK tax under the new global tax deal?

8th June 2021 by Alex Dunnagan

TaxWatch analysis shows that package agreed at the G7 would lead to a tax cut for tech companies subject to the Digital Services Tax

On Saturday 5th June G7 finance ministers announced an agreement on changing the tax rules for global multinational companies. The deal was a significant change to the current global tax rules, introducing unprecedented restrictions on the use of tax havens, and a new system of apportioning profit made by large multinationals between countries.

Talks on reforming the global tax system started almost 10 years ago in the UK at the Loch Erne G8 conference. The process was set up in response to a number of scandals that had broken about the use of tax havens by global tech companies in particular. For that reason much of the focus of reform has looked at the tax affairs of global technology giants such as Facebook, Amazon and Google.

In this note we set out our analysis of the consequences of the deal for the UK Tax liabilities of the largest global technology companies that would be covered by the Digital Services Tax (DST).

Our analysis is based on the known shape of the deal as announced by the G7 on Saturday 5th of June. The terms of the deal may still change, and some details still need to be negotiated and are as yet unknown.

In order to analyse the position of the companies in our study we have relied on historical data and had to use some estimates of revenues generated in the UK. For these reasons the figures we have produced should not be taken as the definitive answers to how much tax liabilities will increase under the deal. However, we believe our research provides a strong foundation for an analysis.

We have used data from 2019, as that is the latest year that UK accounts are available for the companies in our study.

We find that the tax liabilities for Amazon, Facebook, Google and eBay in the UK arising from the so called Pillar One proposals are below or at the same level as their current UK tax liabilities. This means that if the new liabilities from Pillar One are additional to current tax liabilities these companies will see their tax liabilities increase. If the Pillar One allocation is not additional, but offset against existing liabilities, there will be very little change to the tax liabilities of these companies in the UK.

However, when looked at as a whole, the package of reforms announced in the G7 Finance Ministers and Central Bank Governors Communiqué could result in very substantial tax cuts for some digital companies due to agreement to remove the Digital Services Tax, which would raise significantly more from these companies than any new liabilities faced under the Pillar One proposals.

No additional revenues would be raised from tech companies in the UK under the Pillar Two proposals.

Pillar Two

The element of the deal that has attracted the most attention is the so-called Global Minimum Tax Rate. This will see countries impose a minimum 15% tax rate on the profits of multinational enterprises. The global minimum will be imposed by the home nation of a multi-national enterprise. This means that if there were any liabilities arising from Pillar Two on tech companies, they would be paid to the United States Government.

Pillar One

Under the Pillar One proposals companies see a portion of their global profits re-allocated to countries where they have a market where they are charged at the local rate.

The allocation formula set out is that a company gets an allowance of 10% of their revenues. Any profit above this is considered to be a “super-profit” and 20% of these super profits are reallocated to countries where they operate.

Currently the proposal is that Pillar One would only apply to one hundred of the largest companies in the world.

We have sought to analyse what this would mean for the companies in our study based on their 2019 accounts, the latest year for which we have full data. We have then allocated the distributable super profit to the UK based on the UK market share these companies have from our estimates undertaken for previous analysis.

We have then compared the tax charge that would arise in the UK from these allocations to the current tax charge these companies have in their UK companies. Again this figure is taken from our analysis of profit shifting by big technology companies.

For Amazon, we have limited the analysis to Amazon Web Services. This is because Amazon as a whole falls out of Pillar One due to its profit margin being below 10%. However, there is an idea being considered to apply Pillar One to particular business segments within large companies. Amazon Web Services, which in 2019 had revenues of $35bn and accounted for over 50% of Amazon’s global profits would likely qualify for Pillar One in itself if it was agreed to apply Pillar One to individual business segments.

Pillar One proposals 2019 analysis	eBay	Amazon (AWS only)	Google	Facebook
Global revenue	$8,636,000,000	$35,026,000,000	$161,857,000,000	$70,697,000,000
Global profit margin	20.25%	26.27%	24.48%	35.10%
“super profit” (margin -10%)	$885,400,000	$5,698,400,000	$23,439,300,000	$17,742,300,000
20% of super profit	$177,080,000	$1,139,680,000	$4,687,860,000	$3,548,460,000
UK portion of total sales	15.00%	6.25%	9.00%	5.45%
UK portion of super profit	$26,562,000	$71,207,147	$421,907,400	$193,406,303
Exchange rate on balance sheet date	0.75	0.75	0.75	0.75
UK Pillar One charge (@19%)	£3,803,864.07	£10,197,361.22	£60,420,088.81	£27,697,134.56
UK current tax charge	£5,260,000	£14,582,000	£58,987,000	£40,049,000

The Digital Services Tax

The UK Digital Services tax was first announced in 2018 and came into effect in April 2020. The tax applies to the UK sourced revenues of large multi-national companies providing social media services, search engines or online market places. The tax is levied at the rate of 2% on revenues above £25m, with a discount for any corporation tax paid.The tax is counted as a business expense, and so deductible against revenues for the purpose of working out profit for corporation tax liabilities. This means that if a company books their revenue in the UK, they will see a reduction in their corporation tax bill as a result of the DST.

The purpose of the DST was to target companies that the government determined were not paying a fair share of tax in the UK. The then Chancellor Phillip Hammond said of the DST in his Budget 2018 speech – “It is only right that these global giants, with profitable businesses in the UK, pay their fair share towards supporting our public services.”¹ It was always intended as a stop-gap ahead of a global deal on international tax reform.

The communiqué released by the G7 Finance Ministers and Central Bank Governors states that “We will provide for appropriate coordination between the application of the new international tax rules and the removal of all Digital Services Taxes [emphasis added], and other relevant similar measures, on all companies.”²

The removal of the UK DST is therefore part of the package of reforms announced by G7 ministers. The impact of removing the DST must therefore be considered when analysing the proposals.

We have tried to estimate the UK DST that would be placed on eBay, Amazon, Google and Facebook, using our previous work on looking at the sales these companies make in the UK.

For Amazon, the DST would only apply to the fees generated from sellers on the Amazon Marketplace. The Amazon 10-K disclosed that in 2019 Amazon made $54bn in fees to third party sellers. To estimate the UK portion of these fees, we have applied the percentage of Amazon’s total revenues that come from the UK which can be derived from their 10-K form to their disclosed figures for third party seller services.

Both Facebook and eBay book a substantial amount or all of their fees through a UK company. This means that the DST would be an allowable expense to deduct from their pre-tax profits and they would get a discount against their corporation tax liability arising from the DST. We have tried to account for this in our calculations of the total tax liability arising from the DST.

Our analysis shows that for every company that is subject to the DST, the Pillar One proposals would lead to substantially less money being raised in taxation in the UK. If the UK therefore goes forward with the removal of the DST, as the G7 communiqué strongly suggests it will, the package of reforms will lead to a net loss of tax in the UK from eBay, Amazon, Google and Facebook. While not the only companies likely to see a UK tax reduction as a result of the removal of the DST, these four are almost certainly the largest. Between them, based on 2019 revenues, these multinationals look set to pay £232.5m less in tax than they would under the DST.

DST 2019 analysis	eBay	Amazon (Marketplace only)	Google	Facebook
UK Revenues	$1,323,000,000	$3,359,046,970	$14,567,130,000	$3,853,290,000
£/$ rate	0.75	0.75	0.75	0.75
UK DST @2%	£19,443,458	£50,135,685	£219,091,036	£58,086,111.84
Discount on CT for UK booked sales	-£3,789,257	£0	£0	-£8,213,543
Total DST	£15,654,201	£50,135,685	£219,091,036	£49,372,568
UK Pillar One charge	£3,803,864	£10,197,361	£60,420,089	£27,697,135
Benefit from removing DST	£11,850,336.64	£39,938,323.60	£158,670,947.00	£22,175,433.80
Reduction from removing DST	75.70%	79.66%	72.42%	43.90%

Conclusions

The removal of the digital services tax as part of the agreement reached by the G7 creates significant winners and losers. Companies that are subject to the DST will all see a substantial taxcut arising from the G7 proposals.

This is because in all cases the DST liability is more than any increase in taxes under the Pillar One proposals.

There are some companies that will receive a particular benefit, being companies that are too small to fall under Pillar One, but would have been subject to the DST. This includes smaller social media platforms and online marketplaces.

However, the UK DST is narrowly defined and there will also be companies that do end up paying more in UK tax if they fall under the new Pillar One rules and were not part of the DST regime.

One key issue that needs to be addressed by negotiators is whether corporation tax currently being paid in a jurisdiction will count towards any liability arising under Pillar one. If it does, then all of the companies in our study will not see any significant change in their corporation tax liability in the UK arising from the agreement.

Detailed methodologies

Facebook

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. Using the online tool Napoleon Cat, we calculated an average of 42,000,000 Facebook users in the UK for 2019.

On the basis of these numbers we estimate Facebook’s revenues from the UK to be £2.9bn in 2019.

Facebook’s US 10-K shows a pre-tax margin of 35%.

Facebook bills larger UK clients via its UK company. As a result it can deduct a portion of its DST from its revenues before corporation tax is applied. We calculated that this would have led to a £8.2m discount on 2019 corporation tax liabilities at Facebook UK. This results in a total DST impact of £49.4m.

With the new Pillar One proposals, the amount owed would be £27.7m. The removal of the DST therefore results in a net tax cut of of £22.2m based on 2019 figures.

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 2019 global revenues to estimate the revenues generated from the UK in 2019.

Based on 2019’s revenues, Google would stand to pay £219m in DST.

With the new Pillar One proposals, the amount owed would be £60.4m – a tax cut of £158.7m.

Should the percentage of Google’s global revenues arising from the UK have decreased since 2016, the result would be the same. The DST would remain higher than the pillar one charge. The proposals represent a tax cut for Google.

eBay

The online marketplace eBay launched in the UK back in 1999. eBay’s 10-K shows a global pre-tax margin of 20%, and UK revenues of £997,172,883 for 2019.

All of eBay’s fees are earned via a UK company, which means they would be able to deduct the DST from their taxable profit. This would result in a £3.8m discount leading to a total DST impact of £15.7m based on 2019’s revenues.

With the new Pillar One proposals, the amount owed would be £3.8m – a taxcut £11.9m.

However, it is possible that eBay would not fall into Pillar One, as it is much smaller than Facebook, Google and Amazon, and may not end up being one of the world’s largest, most profitable companies. If that was the case than the package of reforms would be of even greater benefit to the company.

Amazon

Amazon’s 10-K shows a global pre-tax margin of 5%. As such, it would not qualify for Pillar One, which only bites when a company has a profit margin of more than 10%.

However, Amazon Web Services, which accounts for more than 50% of Amazon’s pre-tax profits, has a margin of 25%, and so could qualify if the proposals applied to business segments within companies.

With regards to the DST, this would only apply to Amazon’s fees to third party sellers using its platforms.

Amazon publishes its total revenues from the UK market in its 10-K. It also publishes the total fees it generates from 3rd party sellers, and total revenues and profits at AWS.

We applied the proportion of Amazon’s business that takes place in the UK (6.25%) to AWS’s profits and fees generated from 3rd party sellers to calculate the DST liability and the pillar one liability for the UK.

Based on 2019’s revenues, Amazon would stand to pay £50.1m in DST.

With the new Pillar One proposals, the amount owed would be £10.2m – a taxcut of £39.9m.

This analysis is available as a PDF here.

1 Budget 2018: Philip Hammond’s speech, Gov.uk, 29 October 2018, https://www.gov.uk/government/speeches/budget-2018-philip-hammonds-speech

2 G7 Finance Ministers and Central Bank Governors Communiqué, Gov.uk, 05 June 2021, https://www.gov.uk/government/publications/g7-finance-ministers-meeting-june-2021-communique/g7-finance-ministers-and-central-bank-governors-communique

Financial services lobbyists request EU delay anti-avoidance measures

23rd April 2020 by Alex Dunnagan

A consortium of financial services lobbyists has written to the European Commission calling for a delay to the implementation of anti-avoidance measures due to be rolled out on 01 July.¹ As first reported in Law360,² the letter – also sent to the OECD and to Finance Ministers in the EU and the UK – claims that due to the unfolding Covid-19 pandemic, businesses are unable to devote enough time to complete their preparations for the reporting required.

In a separate letter seen by TaxWatch, the European Banking Federation (EBF) requested a three-month postponement of the requirement to provide information on customer bank accounts to tax authorities.

The sixth version of the EU Directive on administrative cooperation, or DAC6, aims to provide the tax authorities of EU Member States and the UK with additional information to assist in closing tax loopholes. DAC6 requires EU and UK intermediaries to file information on “reportable cross-border arrangements” to their home tax authorities. One test of whether an arrangement must be reported is if its “main benefit” is to gain a tax advantage. The definition of what an intermediary includes is broad, and includes any individual or company who sells cross-border tax arrangements, i.e. accountants, tax advisers, lawyers, banks.³ ⁴

The implementation of DAC6 has already been challenging. The way EU directives work is that they set out an objective, and give EU states a choice of how to achieve it.⁵ DAC6 was passed by the European Commission in June 2018, though individual member states were slow to implement the Directive as domestic legislation, with almost half of the EU member states missing the 31 December 2019 deadline to implement DAC6. However, should a member state fail to implement an EU Directive as domestic legislation, the Directive itself acts as a backstop – effectively meaning that regardless of action taken at a national level, businesses should have been aware that DAC6 would be coming into effect.

This is reflected by Big Four accountancy firms that have been recommending for over a year that affected institutions should begin their implementation efforts, even before member states have transported the EU Directive into local law.⁶ ⁷ Despite the two years that relevant parties have had to prepare for DAC6, lobbyists are suggesting that as some people are off work due to having the coronavirus illness, or have childcare duties as a result of school closures, that the intermediaries affected by DAC6 will be unable to comply with the requirements.

The request asks for a postponement of reporting deadlines until 2021, with a review at the end of September 2020 to see if a further extension is required.

The EBF, one of the groups lobbying for a delay of DAC6, wrote separately last week to both the European Commission and the OECD, requesting a three month postponement of the deadline for information exchange under the Common Reporting Standard (CRS). This requirement, based on the US Foreign Account Tax Compliance Act, is a global initiative to combat tax evasion, and was implemented in the UK on 01 October 2018. The CRS is used to determine the personal financial information that must be shared regarding assets, income, and taxable amounts across international borders, and is reported annually. The added transparency on a global basis provided by the CRS should allow for enhanced enforcement actions, not only against tax evaders, but also against those involved in money laundering and terrorist financing.⁸

Again, the reason given was that workforces are struggling with technology constraints due to working from home. This request is more controversial, given the fact that the CRS has been in place for several years, and is global in its scope. The other nine signatories of the 20 April request have not put their names to this letter.

This is not the first time that interest groups have sought to use the coronavirus to delay tax measures. Earlier this month we reported on how TechUK, the industry group that represents Facebook and Google amongst others, had asked the UK government for a delay to the start of the Digital Services Tax, saying that companies will be unable to cope with the burden of extra compliance during the crisis. A similar campaign is being waged to defer the Indian digital tax.⁹

The coronavirus pandemic is undoubtedly having an effect on the ability of companies to conduct business. However, given the huge amount of resources required by governments fighting the impacts of the virus, is now really the time to delay measures designed to combat corporate tax avoidance, tax evasion, and money laundering?

The full letter requesting a delay to DAC6 can be found here – Request to European Commission to recommend/endorse the deferral of EU DAC6 reporting obligations

Photo by Calvin Hanson on Unsplash

1The associations who signed the letter, dated 20 April 2020, are ACC, AFME, AIMA, EACB, EBF, EFAMA, EFSA, ESBG, Insurance Europe and Invest Europe.

2EU Should Suspend New Anti-Avoidance Rules, Lobbyists Say, Law360, 21 April 2020, https://www.law360.com/financial-services-uk/articles/1265736/eu-should-suspend-new-anti-avoidance-rules-lobbyists-say?about=financial-services-uk

3Council Directive 2018/822/EU of 25 May 2018, https://ec.europa.eu/taxation_customs/sites/taxation/files/dac-6-council-directive-2018_en.pdf

4DAC6: EU Mandatory Disclosure Regime, Deloitte, https://www2.deloitte.com/uk/en/pages/tax/articles/dac6-eu-mandatory-disclosure-regime.html

5A good explainer of how EU Directives work has been produced by Full Fact, How the EU works: EU law and the UK, Full Fact, 11 March 2016, https://fullfact.org/europe/eu-law-and-uk/

6EU Mandatory Disclosure Requirements – Update, KPMG, 08 February 2019, https://home.kpmg/xx/en/home/insights/2019/02/etf-394-eu-mandatory-disclosure-requirements-update.html

7DAC6: The clock is ticking… Less than 1 year until go-live, Deloitte, 02 July 2019, https://blogs.deloitte.ch/tax/2019/07/dac6-the-clock-is-ticking.html

8The OECD common reporting standard (CRS): FATCA is going global, Gibson Dunn, 11 June 2015, https://www.gibsondunn.com/wp-content/uploads/documents/publications/Schmid-Grunert-OECD-common-reporting-standard-BLM-02.2015.pdf

9Tech giants such as Google, Facebook seek to defer Indian digital tax – sources, Reuters, 31 March 2020, https://uk.reuters.com/article/uk-india-tax-digital/tech-giants-such-as-google-facebook-seek-to-defer-indian-digital-tax-sources-idUKKBN21I1XY

Unitary taxation – the new approach to corporate taxation and its critics

15th November 2019 by George Turner

There is widespread international consensus that the current system for taxing multinational companies is broken beyond repair. The OECD is currently negotiating a new system, with the organisation aiming to come to an agreement early in 2020. The current OECD proposals move away from the traditional approach of taxing (or attempting to tax) multinationals, and introduce an element of unitary taxation. The position of the UK government in the negotiations over the OECD proposal has become an election issue, with the Labour party announcing that it wants to go much further and introduce a fully unitary system, taking unilateral action to deliver it if necessary.

What is unitary taxation and how do the OECD’s proposals work? In this article we set out some of the issues confronting politicians as they seek a solution to the problem of tax dodging by multinational enterprises and why the OECD’s only partial adoption of the unitary principal is unlikely to solve the issue. The article then goes onto deal with some of the criticisms of the unitary approach, arguing that it is possible for the UK to take action on a unilateral basis which would move us towards a unitary system, even if international agreement on a fully comprehensive global reform was not reached.

A broken system

In 2016 Google made almost exactly 50% of its pre-tax profits in the United States and 50% in the rest of the world ($12bn and 12.1bn).¹ On that profit, it paid $3.8bn in US federal and state taxes, and a further $966m was divided between every other government in the world where Google operates.

The reason for this extreme inequality is that in 2016 Google Ireland Holdings Unlimited, a company with an address in Dublin but tax resident in Bermuda, declared a profit of $8.9bn which was subject to a 0% corporation tax rate.² As stated in the Google 10-K form, this was most of the profit that the company made outside of the United States (although the 10-K uses the term “substantially all”). Google Ireland Holdings Unlimited appears to have no employees, and all of its income derives from the ownership of intellectual property rights.

For 8 years governments at the OECD have been trying to agree how to reshape the rules around international tax. A number of reforms have already been put in place under the BEPS process, but as the OECD itself accepts, these have failed to grasp the kinds of structures put in place by Google and others.

This is confirmed by our own research, which found that the effective tax rates in the UK of five of the largest tech corporations in the UK had barely changed following the last round of BEPS reforms.³

The choice facing governments

Governments are now facing a choice. Do they defend the individual entity principle, often called the arm’s-length principle, the current foundation of the international tax rules? This states that the hundreds of thousands of individual companies that make up multinational corporations should all be taxed as independent businesses. This approach has facilitated the current tax structures of multinational companies, which rely on trading between group companies to move profit from one jurisdiction (such as the UK) to another (such as Bermuda).

The alternative approach is unitary taxation, which treats multinational corporations as one single enterprise, dividing the right to tax their total global profits between the nations where they operate based on a formula. This formula could be based on sales and employees for example, ensuring that companies only face tax liabilities in countries where they have substantial operations. The system already exists in the US, where it is used to divide taxable profit between different state governments which levy their own corporation tax rates. The Labour party have announced they will implement a unitary system as part of their platform in the 2019 election.

As a matter of pure principle, the unitary principle must surely be the correct approach. As was set out long ago by Lord Carnwath LJ, tax statutes ‘draw their life-blood from real world transactions with real world economic effects’. In the real world, multinational groups are single businesses rather than a set of loosely affiliated, separate entities.

However, there are many who still cling to the individual entity myth. Why? We can only speculate. However, it cannot go unnoticed that the individual entity approach generates mountains of paperwork for each multinational corporation, as each individual subsidiary must file its own accounts and justify the transactions it makes with companies within the group. This creates large amounts of work for accountants and tax advisors, all of whom are paid hefty fees for their work. These firms of accountants are often the same people acting as the voice of business when it comes to international tax reform.

The OECD’s hybrid approach

The current proposals from the OECD manage to avoid taking a decisive position on the choice between the arm’s-length system and the unitary system. Instead of throwing out the individual entity approach, the OECD have proposed a hybrid system. The arm’s-length principal stays, but a new right to tax a “residual” profit is added to the international tax system. The residual is apportioned to countries on the basis of where a company makes sales. What comprises the “residual” is not made clear and is the subject of ongoing negotiations.

Whilst the willingness of the OECD to consider moving away from the current tangled mess created by the arm’s-length principle is to be commended, putting a unitary system on top of it will only add difficulties rather than solve them.

The first issue is who will be subject to the new tax. Under the OECD proposals, the new taxing right will not be targeted at all multinational businesses, only “consumer facing” businesses will be in scope.

A test which only included purely consumer facing businesses would exclude companies like Google and Facebook, who derive the majority of their revenues from advertising. Overwhelmingly the purchasers of advertising are other businesses and not consumers.

The OECD accepts this and talks about consumer facing elements, which would encompass online advertising businesses. To stretch the definition of consumer facing in this way could end up creating significant grey areas which could be open to exploitation. The private equity industry has demonstrated very well that the profits of almost any industry can be easily converted to finance income for example.

It is also the case that most big tech companies are no longer purely tech companies. Their sheer size is seeing them expand into driverless cars, banking, and other industries. Is the proposal to separate out the ‘digital consumer facing’ parts of these companies? Where and how will that line be drawn?

It would be better to broaden the unitary principle to a wider set of companies rather than simply seeking to place companies or parts of companies into an artificial consumer facing category.

The second question is what will be taxed?

In order to defend their maintenance of the arm’s-length approach within their proposed hybrid system, the OECD states that arm’s-length remains a good foundation for the division of taxing rights with regard to most transactions. The new unitary approach will only apply to the “residual”.

The evidence we have seen demonstrates that currently businesses are able to eliminate not just a residual but most if not all of their profit in market jurisdictions using the arm’s-length approach.

As demonstrated by the Google example given above, despite substantial marketing and research operations in the UK, the outcome of the arm’s-length approach is, by Google’s own admission, substantially all of their non-US profit being moved to tax havens. If the purpose of the new system is to plug the gaps in the current system, is it really credible that substantially all of the profits a company makes in Europe could be considered a ‘residual’?

TaxWatch has also studied the video games industry in the UK. Our work discovered that the makers of Grand Theft Auto have not declared any profit in the UK over the last ten years, despite producing the most popular entertainment product in history.⁴

This perverse outcome was achieved because Take-Two Interactive, the US headquartered multinational which publishes Grand Theft Auto, reimburses the UK based developer of the game at a rate which means that it does not make a taxable profit in the UK.

Under the arm’s-length principle the contract between Take-Two and its own UK based developer, Rockstar North, should be the same as if Take-Two had commissioned an independent developer to do the work for them. It does not seem credible that an independent contractor would accept such a bad deal for creating such a cash cow for its employer. As we found, the real pay agreements entered into between Take-Two and senior staff at Rockstar confirm this. Under the agreements, senior staff at Rockstar Games received a bonus based on the profits made by the games they developed (on the basis of the profits made by the Rockstar group as a whole), an arrangement which was not available to the company they worked for. Many other companies operating in the UK have a similar structure, where employees are compensated on the basis of the performance of the entire multinational enterprise, but the company they work for is not.

Despite this, as far as we are aware, Take-Two’s business model has not been challenged under any existing rules.

Further evidence of how the arm’s-length principle is not working is provided by HMRC. In February 2019 the UK government announced a new Diverted Profits Tax Compliance Facility.⁵

The background note published alongside the facility noted:

“HMRC has found that some Multinational Enterprises (MNEs) have adopted cross border pricing arrangements which are based on an incorrect fact pattern and/or are not consistent with the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines (TPG)”

(TPGs set out how the arm’s length principal should be applied)

Although HMRC will not say how many companies they are targeting with this scheme, the fact that the UK government created a new compliance facility to deal with such MNEs suggests that the problem was significant, and not isolated to a few companies. It also suggests that even in cases where companies can be challenged under the existing rules, tax authorities are struggling to deal with the issue.

Again, it is not clear how the introduction of a unitary element will solve the inherent problems with the arm’s-length principle, or why it would not be better to subject the entire tax base of a multinational corporation to the unitary approach.

Can unitary taxation be introduced without international agreement?

Those that oppose the introduction of a unitary system claim that the solution is an overly simplistic answer to a complex problem.

In particular, they argue that such an approach conflicts with existing tax treaties, all of which would need to be renegotiated. To implement a unitary system would require global agreement, something which would be impossible to achieve.

Of course, the ideal outcome would be for governments to agree on a comprehensive solution. But that does not mean that nothing can be done until that happens. As has been set out in the recent paper by Professor Sol Picciotto (Taxing multinationals: a new approach), many tax treaties already in force already permit the use of a profit split methodology to determine taxable profit attributable to permanent establishments. This allows countries to attribute the global profits of a multinational to offices located in their jurisdiction on the basis of a formula. The OECD accepts that this could provide a ready made legal basis for countries adopting an apportionment method. In addition to this, there are new and long standing anti-avoidance initiatives which move towards a unitary approach. Full inclusion CFC rules are one example, as are the much newer US GILTI provisions.

It could also be argued that in order to stem the clearly abusive schemes that are commonplace today, more drastic action is required. It is possible for Parliament to legislate to unilaterally disapply the provisions of tax treaties. This last happened in the UK in 2008, when the government legislated to unilaterally override all of their tax treaties to close down a disguised remuneration scheme (FA 2008 ss 58 and 59, which amended ICTA 1988).

The action by the UK government was subsequently upheld by the European Court of Human Rights, which noted that double tax treaties should do no more than seek to relieve double taxation, and should not be permitted to become an instrument of avoidance.⁶

We have proposed that the UK government take this approach with regard to the taxation of royalty payments, a measure which would attack the current profit-shifting models of the tech companies and bring in a potential revenue of £8bn a year.

One of the drivers of the OECD talks has been the willingness of governments around the world to consider unilateral action such as new digital services taxes. It is thought by many that these new taxes are problematic under the current international tax rules. This is one reason why the UK only announced a DST as a backstop if the OECD talks fail.

In this context it makes sense for the UK to continue to make the argument that if the OECD cannot find agreement on how to end tax dodging, it will take action itself. This may not mean a global comprehensive system of unitary taxation, however, there are many tried and tested anti-avoidance mechanisms which could be brought introduced by any government under the rules that exist today. These would move us towards a unitary approach even if none was agreed at the OECD and would be an effective means of closing down avenues to profit shifting by multinational companies.

This article is partially based on TaxWatch’s submission to the OECD consultation on their proposed tax reforms. The full consultation response can be found here. The response to critics of unitary taxation was published in the Tax Journal here. This research was also featured in Funding Real Change, part of The Labour Party 2019 election manifesto (see page 32).

Photo by Sean Pollock on Unsplash

1 Google’s 10-K form states pre-tax earnings in the US and International divisions, the 2016 results are used as 2017 was an anomalous year due to one-off charges associated with the US tax reforms.

2 The annual report of Google Ireland Holdings Unlimited Company for 2017 is available from the Irish Corporate Records Office

3 http://13.40.187.124/corporate-tax-and-tech-companies-in-the-uk-2/

4 http://13.40.187.124/reports/gaming-the-tax-system/

5 https://www.gov.uk/government/publications/hmrc-profit-diversion-compliance-facility/profit-diversion-compliance-facility

6 Huitson vs United Kingdom

TaxWatch comments on new OECD proposals to tax multinationals

10th October 2019 by George Turner

The OECD has published new proposals which seek to deal with the problem of profit shifting by multinational companies.

The proposals set out principles on how large multinational companies should be taxed in the future. At the core of the proposals is a new approach to how the profit of companies should be allocated to different countries in which they operate.

These proposals are a starting point. There will now be a period of negotiation with the OECD seeking to get agreement early next year.

As highlighted in research by TaxWatch, the current system allows multinational companies to easily shift profit out of the countries which they operate and into tax havens where no real economic activities take place.

Our research found that just five companies dodged £1bn a year in UK corporation tax through profit shifting between 2012-2017.

The proposals from the OECD would redistribute just a fraction of that profit back to the UK.

Commenting, TaxWatch director George Turner said:

“The proposals from the OECD move away from the absurd system where a multinational company is treated as if it is a network of independently trading companies. That is a good thing.

“However, the proposals set out yesterday are limited in scope and analysis has shown that they will only redistribute a small amount of the profit multinationals currently shift offshore.

“The fact of the matter is that the UK government could immediately tackle the issue of profit shifting by tech companies if it wanted to. All it needs to do is to change existing legislation which exempts tax havens like Ireland, Switzerland and the Bahamas from income tax on royalties. TaxWatch has estimated that such a move would allow the UK to raise an extra £8bn in taxes a year.

“With consultation on the plans now open, there is still a lot to play for and it is important that civil society and other groups engage with the process in order make the argument for a system that ensures that governments see a real benefit from the profits made by multinationals in their jurisdiction.”