A WEEK IN ECONOMICS (20/05/13 – 26/05/13) NOT EVERYONE WORKS FOR GOOGLE

, Business

Week-in-Economics

What do Google, Amazon, Starbucks, Microsoft, and Apple have in common aside from being ubiquitous and hugely profitable? They do not like paying taxes (Does anyone?). Tax avoidance by these corporations has caused much consternation with certain UK MPs declaring Google’s practice as “evil”. So how do these multi-billion dollar companies manage to pay so little tax, proportionate to their profits?

Firstly, they have the money to procure the services of intelligent accountants and lawyers who explore gaps in the system. The globalised world now allows companies to be created in one country, sell their products in another country, but be legally incorporated in a third country that offers favourable tax rates. Talented minds are trained to minimise their client’s tax burden. Being aware of arbitrage opportunities is all part of their job description. Thus the system, in some cases, encourages instances of tax avoidance.  It was not with schadenfreude that a perplexed Google chief, Eric Schmidt, justified the actions of Google as “capitalism”, i.e. minimise costs, maximise profits (legally). When the system allows, then what is the problem?

Secondly, these informed, ambitious, creative minds devise complex structures through exploiting loopholes in tax legislation. Offshore jurisdictions, such as Ireland, the Cayman Islands and Bermuda, offer attractive havens for companies to shift their profits and pay little tax. Thirdly, the only thing companies have to do is ensure there is a loophole in domestic legislation in the jurisdiction in which they were set up, allowing the transfer of profits to another jurisdiction.

As an example, what follows is an explanation of the loophole that Apple exploited.According to US Senate Permanent Subcommittee on Investigations, the foreign base company sales (FBCS) income rules regulate the taxation of goods sold by an entity in one country to a related entity for ultimate use in a different country. The rules ensure that parent companies based in the US cannot create an entity in a tax haven that buys finished goods from one country and sell them to related entities in another country. Profits flowing to an entity in a tax haven, and not the parent company, can then be taxed.

However, the Internal Revenue Service (IRS) regulations contain provisions known as check-the-box, which determine how entities should be regarded for tax purposes. A US multinational can ensure that their foreign entities are disregarded as separate legal entities. They would be regarded as subsidiaries of an upper tier subsidiary. By doing this, the revenue generated by a disregarded subsidiary would not be considered for the purpose of tax.

Apple Inc based in the USA created Apple Operations International (AOI) as a non tax resident in Ireland. This entity is a holding company set up in 1980. It does not pay taxes (even to the Irish state) and has no employees. From AOI, a number of subsidiaries were created including Apple Operations Europe (AOE), based in Ireland, and a number of offshore distribution subsidiaries. From AOE, another subsidiary was created based in Ireland, Apple Sales International (ASI). AOE and ASI are also considered as non tax residents.

AOE and ASI holds all the offshore intellectual property rights of Apple Inc. They pay Apple Inc for usage of the intellectual property through a cost sharing agreement. Apple products are manufactured by a third party (usually based in China) but ownership of the products is with ASI. ASI sells the products at a significant profit to Apple affiliates around the world, which are then sold to customers. The profit from the Apple’s foreign transactions is then shifted to Ireland. All subsidiaries under AOI are disregarded for the purpose of US tax meaning that the US tax authority do not account for the profits generated from these subsidiaries.     

The ingenuity in designing this structure to avoid paying tax is impressive. Apple has $145 billion in cash, cash equivalents and marketable securities, of which $102 billion is “offshore.” Between 2009 and 2011, ASI pre tax earnings were $38 billion. It paid $21million! Apple should not have expected anything less than outright disgust.

There are two key reasons for disgust at huge multinationals failure to pay the right level of taxes, but none of them have to do with law breaking. Most individuals and corporations attempt to avoid tax utilising legal means, exploiting loopholes. But the extent conveys the uncomfortable truth that the wealthy can use their position to grow more wealthy. Less affluent do not have that luxury. More importantly, the failure to pay tax shows that the wealthy – the ones that have enough income to contribute to societal welfare – contribute far less than they should. Taxes on the less affluent can be an awful burden, but they do not have the money to find circumventions (if they did have the money, they would attempt to minimise tax).

Taxes are raised in order to look after society. So the question should be whether these multinational giants beneficial to society? Undoubtedly, by the mere fact that demand for their goods is so high, individual consumers are benefiting. The free market is ensuring demand is being met. More so, however, these companies are at the forefront of innovation, cultural change and technological developments. It would be nearly impossible to work without Microsoft Office; Apple has revolutionised the way we use our phones, making it an indispensible extension to organising our lives. Google’s technological wizardry encompasses a whole plethora of products from telecommunications to automobiles. Amazon has granted us easy access to books and services through the click of the button, and Starbucks has brought back the coffee culture in a big way (thank the Arabs first though).

In changing the way we think and the way we live, these companies have contributed to society. They have also given thousands of peoples jobs and have been contributing to philanthropic endeavours (think Bill and Melinda Gates Foundation). So perhaps what they fail to pay in tax is compensated by their sizable monetary and intellectual contribution to society.

At the same time as they grow in power and influence, there are negative spillover effects. Most of these giants are based in Silicon Valley, San Francisco. Many inhabitants are complaining of the elitism and division created by these companies. In the city,  house prices are increasing and infrastructure in the city, including road networks and educational institutions, are withering. In the UK, Amazon has created a factory from which books are shipped. However, while jobs have been created, many employees are describing slave like conditions with no job security. Apple has been condemned for humiliating conditions of manufacturing labour in China.

Governments have a responsibility to their citizens, to ensure living conditions are decent. Tax income is a way in which they can provide the public goods required by citizens. Those who believe in complete laissez faire capitalism think that small government is best: the invisible hand will supply the demanded goods. But when the market fails, the government has to step in. If multinational companies ignore the needs of society, the more active the government has to be. To do this, governments need to tax. Otherwise where is the revenue?

Hence, multinationals have to ask whether their huge profits could benefit society. They probably could, but if they are unable to distribute their income to ensure more people benefit from their largesse, then taxation is the only way to invest in infrastructure, education and upholding employee rights. Failing to pay taxes suggests inconsideration, and for such ‘social’ companies, that is an embarrassing ascription.

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