A number of international e-commerce and other business-to-consumer businesses have been in the media spotlight recently. Google, Amazon and Starbucks executives have received the most attention in the UK, following appearances by them to give oral evidence to the House of Commons Public Accounts Committee (PAC) investigation into tax avoidance. Google was asked to return to the PAC to clarify issues concerning its taxable status in the UK.
These three companies appear not to have paid similar amounts of corporation tax to those of other UK-based companies with a similar turnover, even though they appear highly profitable. This has led to criticism of their ethics as well as to the tax system itself that enables them to appear to get away with paying little or no tax.
Starbucks is reported not to have paid much tax as its UK subsidiary is not, on paper, a profitable company. It appears to pay significant sums for its supplies and branding rights to other companies in the Starbucks’ group of companies. This raises the issue of the real value of these transactions and what is known as transfer pricing. Starbucks has weathered the PR storm by ‘volunteering’ to pay £20 million in corporation tax for 2013/2014.
Here, I look at the situation where business is said to be conducted by foreign companies without a taxable presence (or, in tax jargon, a permanent establishment) in the UK. Google, in particular, is quite up front about its tax affairs, stating that all of its UK business is concluded by its Irish company, which pays 12.5% corporation tax in Ireland instead of the UK’s 20%+ tax rate.
The reason that these tax arrangements are legal is that for many jurisdictions’ tax laws, the mere carrying out of certain activities by representatives of a foreign company in a jurisdiction does not created a ‘permanent establishment’ for the foreign company in that jurisdiction. It is only companies with a permanent establishment that are taxable.
‘Permanent establishment’ is defined in the UK by Chapter 2 of Part 24 of the Corporation Taxes Act 2010. In summary, if the activities of a foreign company carried out in the UK by its employees or agents are only for preparatory or auxiliary purposes, then no place of permanent establishment is created. This closely follows the OECD Model Tax Convention on Income and on Capital 2010, Article 5. If the place of management, ie where the companies’ transactions are concluded, is outside of the UK, then no UK corporation tax is payable. As has been demonstrated by the Google case, this appears to be a surprise to many, despite this being long established international tax law and practice.
The obvious answer is not to vilify the executives of companies, who naturally seek legitimate ways to reduce their tax burden, but to change the relevant tax laws.
If I were to do this, I’d go for the definition of ‘permanent establishment’. I suggest that if a significant proportion (say 75%) of the total costs of sale or delivery of a service are physically incurred in a the same jurisdiction where the goods or services are delivered, then despite the fact that the relevant company’s HQ (place of management) may be elsewhere, the company should be deemed to have a permanent establishment in that jurisdiction.
Secondly, I support the idea already considered by the OECD Technical Advisory Group of amending the OECD Model Tax Convention (and the definition of ‘permanent establishment’ in the Corporation Taxes Act) to include virtual permanent establishment.
The TAG suggested in its report Are the Current Treaty Rules for Taxing Business Profits Appropriate for E-Commerce?:
323. The “Virtual Fixed Place of Business PE” would create a permanent establishment when the enterprise maintains a web site on a server of another enterprise located in a jurisdiction and carries on business through that web site. The place of business is the web site, which is virtual. This alternative would effectively remove the need for the enterprise to have at its disposal tangible property or premises within the jurisdiction. It would nevertheless retain some or all of the other characteristics of a traditional PE, i.e. the need for a “place” (whether physical or electronic) within a jurisdiction having the necessary degree of permanence through which the enterprise carries on business. Thus, for example, a commercial web site, through which the enterprise conducts its business and which exists at a fixed location within a jurisdiction (i.e. on a server located within that jurisdiction) is regarded as a fixed place of business.
I would go further than the TAG and not get fixated on the idea that virtual permanent establishment be tied to the physical location of the e-commerce website server. In addition to the server location, I’d also consider that where a website was clearly targeted at consumers in a particular jurisdiction, as shown by evidence such as use of language, billing currency, local contact details or the applicable law that would apply to the consumer transaction effected by the web site, then this, too, would create a virtual permanent establishment.
Note that the TAG report referred to above was published in November 2002, following work started in 1999. Any recent outrage and questions about the ethics and morality of tax avoidance from politicians of any party must therefore be taken with a pinch of salt. It is a shame that it has only taken the worst recession the UK has suffered for a generation for these same politicians to begin to wake up to tax avoidance.