Tax Avoidance Alive and Well in Europe

Tax Avoidance Alive and Well in Europe

The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS) marks the culmination of a project that began some five years ago to save between $100bn-$240bn of taxes currently estimated to be avoided by multi-national corporations such as Apple, Amazon and Alphabet.


The FT recently reminded its readers that the project of defending the European tax base against the planning schemes of large US corporates is thriving.

The range of tools available to these companies is broad and includes the creative use of hybrid entities, interest expense allocation, royalty payments in respect of intellectual property and the location of strategically structured corporate entities in low-tax jurisdictions such as Ireland, Luxembourg and Singapore.


The BEPS report, agreed in 2015, contains some fifteen action items that will keep its project team and external tax advisors busy for some time and provide a roadmap for Margrethe Vestager, European Commissioner for Competition, to continue the good fight.
It is worth looking at a few of these action items – they are frequently discussed in the financial press.



The Opportunities of a Digital Economy

 



The emergence of the digital economy and the ability of companies to deliver products of value online have created dislocations that current systems of taxation are not well suited to deal with. Collecting sales tax on items sold by Amazon was an early example. Before Amazon itself agreed to collect sales tax at source, enforcement was virtually impossible.


Cryptocurrencies are another example. Without the banking system to supervise reporting thresholds, the ability to track and therefore tax transactions involving payment in cryptocurrencies is challenging.


Netflix reports approximately 6.5m subscribers in the UK. At an average of £7.99 per month, this suggests revenues should be over £500m. Netflix reported just under £20m of revenues in the UK in 2016 and just under £19m in costs based on 14 employees. In other words, the value generated for Netflix in the UK is not even close to being reflected in the taxable income it reports to the Inland Revenue.



Creative Use of Hybrid Entities

 



The term is not as mysterious as it sounds at first. A limited liability company (LLC) sounds as if it is a corporation and, therefore, subject to a corporate tax regime. It may not be. In the US, taxpayers may elect to treat such a corporation as a partnership for tax purposes. It is possible to arbitrage those arrangements by setting up a company that, for example, is treated as a corporation in France, is owned by a Dutch intermediate holding company and, for US purposes, is treated as a flow-through entity.


The Dutch company may lend money to the French subsidiary that may use the interest expense to reduce its liability to French tax. The interest income will not be currently taxable in the hands of the Dutch intermediate company (it will enjoy beneficial classification as a dividend under EU treaty law) and, because the Dutch company will qualify for an exception to the US rules for current inclusion of income, the ultimate US parent will achieve deferral of tax on the underlying earnings.


The net effect of such an arrangement is to deprive France of current taxation on the earnings of the local subsidiary and to deny current taxation in the US of the earnings of the Dutch intermediate holding company. This is one of many creative, disregarded entity structures designed to achieve double non-taxation of income, double deduction of expenses and long-term deferral of taxation.



Royalties, IP and Bricks and Mortar

 


The press has often reported on the ability of multi-nationals to avoid local country taxation by exploiting outdated aspects of various tax regimes to minimise income in high-tax jurisdictions and maximise earnings in low-tax jurisdictions.


The historical assumption of many tax regimes is that taxation follows local revenue generation attached to a physical presence in the country in question. As the Netflix example shows, the digital economy has significantly undermined this assumption.
Another ‘abuse’ is the use of royalty and intellectual property payments to reduce revenue in high-tax jurisdictions and move it to low tax jurisdictions. Jurisdictions such as Ireland and Luxembourg have been complicit in this.


Amazon has recently been ordered by the European Commission to pay €250m in back taxes on untaxed profits of €2bn held in Luxembourg. Amazon structured its European operations around a Luxembourg partnership – a non-taxable holding structure in Luxembourg – and moved its intellectual property into this holding partnership.


The Luxembourg entity collected royalties – about €4bn over a ten-year period – and reduced the taxable profits of its EU operations to around €10m on revenue of €60bn over the same ten-year period. The Luxembourg entity paid only €2bn of those royalties to the US over this same period and retained the remaining €2bn in Luxembourg, essentially free of tax. Amazon is battling both European and US tax authorities on this scheme.



A Global Problem

 


The facts of the Amazon case are not unique. Similar techniques used in the US have resulted in royalty payments extracting taxable revenues of around $2.6trn and accumulating them in jurisdictions such as Ireland and Singapore. The structures used to accomplish these results are known to all the major law and accounting firms advising well-resourced multi-national companies. They constitute the basic block and tackling needed to keep pace with these companies’ peer groups and ensure that their effective tax rates are not out of line with those peer groups. Lower effective tax rates lead to higher stock valuations.


The BEPS project correctly identified the need to approach this problem on a global basis. It has made great progress. Although it may not, in its implementation, provide an equivalent amount of high-value work for tax advisors to that provided by the multi-nationals, it will soften the blow. In the meantime, pre-implementation, these advisors can play on both sides of the fence.

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  • Danny Rosenberg

    The middle class are paying an even higher level of tax because the super rich and multinationals do not pay. The working class are losing because of cuts to welfare, schools, hospitals, etc are being slashed. The wealth of nations is being syphoned off into tax havens. There is now $32 trillion dollars stashed away in tax havens. The massive national debts are because of tax avoidance/evasion. Shut down the tax havens. Make tax laundering in the form of aggressive tax avoidance illegal. People become non-dom to avoid paying taxes yet are still living in the country they owe taxes. Enforce these laws.Things can be done and should be done, because it is killing our economy making us poorer and poorer.

  • Kirill Kondrachov

    Well to be honest, corporate tax avoidance is immoral and anti-social but not illegal. Ideally, I would like to live in a world where every company pay fair share of tax. A substantial revenue that would hopefully be used to improve education, housing and infrastructure we can all rely on. Clearly this is not going to happen without persuasion so what do we do? As each company is identified as one that does not want to make a fare financial contribution to the society in which they operate and make their billions we should have the courage to boycott that companies products. The continued purchase of their products is the only green light these companies need to continue with their anti-social behaviour.

  • Lee Yung Shun

    Unfortunately, rich multinational companies can benefit from tax avoidance because they are generating a lot of value in the countries in which they operate. Their status afford them to get away. It's crystal clear.... The rest of us have to pay tax, and governments make sure we pay every single penny. Without tax, there is no public spending and without public spending, there will be no more schools and hospitals.

  • Peter

    If the governments want to do anything they should close loopholes in the law.

  • John Lingel

    We should stop buying from tax avoiding companies such as Apple and Amazon. Let them go bankrupt !!!! We are bringing high taxes on ourselves by letting them pay lower taxes.

  • Guillaume Bourgault

    While some practises to avoid paying taxes may sound controversial, taxation policies just like law must be understood and analysed carefully to ensure maximum savings for companies. Multinational firms are the backbone of any economy, they can promote and sustain financial growth. It is therefore necessary that they are not unduly burdened with taxation.

  • Wade Danielson

    Boycot Starbucks, Apple, Alphabet and Amazon, and you will notice changes ;)

  • Paul MacDonalds

    Big corporations must pay their taxes, the money collected should be used to fund public environmental or technological research.

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Neil Winward

Company Guru

Neil is the CEO of Sevara Capital Advisors. He is passionate about solving tax, accounting and regulatory problems for institutions that have invested billions of dollars of capital in multiple jurisdictions. His company provides solutions for banks, insurance companies and hedge funds to tackle their problems related to tax returns, financial statements, accounting and internal finance matters. Neil holds a master’s degree in Law from the University of Cambridge. 

   

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