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Tax Intelligence

An Open Response to the Evening Standard Re STARBUCKS

Starbucks is once again in the news – this time for predicting it will be profitable (and hence pay corporation tax) within three years…

In yesterday’s Evening Standard (1 December 2014), Starbucks new UK Chief Exec was interviewed and quoted as saying “There is nothing abnormal about the way we are run”. The Standard then ran an editorial piece on the interview that I referred to as “astonishingly ignorant” in a tweet on the way home. The problem with the article, like most mainstream journalism on the tax debate so far, was that it failed to look at the facts and rather went along with the band-wagon rhetoric. Over the coming weeks we will attempt to dispel the misinformation and myths surrounding the tax structures of various US multinationals and get the debate back to first principles.

In the meantime, our bullet point comments (non-exhaustive) on the Standard’s piece are as follows:

  1. The first and most important point is that companies only pay tax on profit, not revenue.  If there is no profit, there won’t be any tax.  The issue with Starbucks is whether the deductions (i.e. expenses that reduce the gross profit) have been wholly and exclusively incurred for the purposes of the trade. This rule applies equally to UK domestic businesses as it does Multinational Enterprises (MNEs).
  2. The second really important point is that MNEs are, by definition, very different to domestic businesses. The constituent parts that make up a MNE are often scattered around the world and divided up into regional hubs with different functions and risks allocated to separate business units. This is critical to any proper analysis of whether Starbucks and other US MNEs are engaged in UK tax avoidance. It is important because the internationally accepted tax rules use what is called the separate entity doctrine – each entity within the corporate group is viewed as separate and distinct from the others. The alternative, which is not an accepted standard, is the enterprise doctrine – where a group of companies is viewed on an amalgamated basis.
  3. The separate entity doctrine is central to Starbucks’ corporate structure. As a US headquartered MNE it can choose how it enters the UK market and has done so via operating subsidiaries and a franchise model. In both cases there are various legitimate expenses that are incurred to allow the business to operate. Central to the debate are the expenses paid in the form of royalties for the use of the Starbucks brand, logo, shop design and so on and the purchasing of the all-important coffee bean.  In both cases the price paid to the Dutch company for the right to use the brand and the price paid to the Swiss company for the coffee bean will be on arm’s length terms (i.e. what would an independent third party pay for the same service / product). The fact that the franchisee pays the same as the subsidiaries is evidence of this.
  4. It is unfair to castigate, pillory and boycott firms such as Starbucks for structuring their affairs in a manner consistent with the basic principles of international tax law. If a royalty payment is deductible for accounting and tax purposes and it is “real” it is immaterial that it might affect the profitability of the company making the payment. Those arguing that Starbucks is gaming the system need to specify what changes they would make to the law to prevent this from happening – perhaps a cap on the overall deductions claimed in respect of payments to related parties (e.g. royalties, interest and business expenditure)?
  5. Google, Amazon and Starbucks all structure their affairs in a manner consistent with the tax laws of the UK (and other jurisdictions).  They all deliver services that are in high demand and at a competitive price – exactly why customers haven’t boycotted them! The role of US tax law and policy in the structures adopted by US MNEs should not be underestimated. If the US changed its own laws much of the structures under examination would not succeed. More on this in the coming weeks…
  6. While politicians love the expression “fair share of tax” this is simply nonsense. It makes for good headlines but who determines what fair is? Whose moral compass are we using? Morality really has no place in tax – the UK has incredibly extensive tax legislation by which MNEs must operate, not the shallow morals of a soapboxing politician.
  7. The article states: “There is a moral case for international corporations paying corporation tax in the countries where they operate”. The reality is that MNEs do page huge amounts of tax in the UK in the form of VAT, social security, PAYE, import duty and business rates. Starbucks hasn’t paid corporation tax (other than the £20mn it was coerced into paying) because it hasn’t made a profit in the UK. However, on £3bn of sales the VAT generated will be very substantial. It is also true that some of the decisions made by Starbucks in relation to its premises have been very costly (a matter that the article does bring out).
  8. While many do not like it, the tax world is a competitive market place with each country competing for MNE business.  This is because corporation tax makes up only a small part of the total tax contribution these MNEs provide to the economy (the total collected through business rates, VAT, PAYE is substantially larger).
  9. The ‘sweet heart’ deal referred to is likely a standard ruling issued by the Dutch Ministry of Finance confirming the “spread” which is to be retained by the Dutch company that is then taxed at ordinary rates. Dutch tax law allows this and such rulings provide certainty for the taxpayer. Whether this amounts to illegal state aid is very hard to say given the lack of information, but we doubt it.
  10. The OECD has recently published a series of papers on Base Erosion and Profit Shifting (BEPS) that focus on the ability of MNEs to use existing transfer pricing legislation and the differences in domestic tax regimes to ensure tax is only paid where they want it to be paid.  The key issue for the UK is whether the practices of the Dutch authorities have undermined the double tax agreement the two states have entered into. The treaty is relied upon by Starbucks to pay a royalty from the UK to the Netherlands (which is both tax deductible and not subject to withholding tax). The treaty permits this on the presumption that the royalty will be taxed in the Netherlands. By allowing a large proportion of the royalty received to be paid out (leaving on a small spread subject to tax) the premise on which the treaty operates has, arguably, been undermined.
  11. As regards the autumn statement and transparency, as we’ve highlighted above, steps are underway to attempt to reduce international tax arbitrage but these will take a long time to agree and implement.  Plus, the loss to the UK Exchequer would be enormous (substantially more than the CT ‘lost’) if it moved unilaterally.

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December 2, 2014

Miles Dean

Posted by Miles

Miles is a founder of Milestone having started his career in international tax in 1994.

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