The report by Neil Chenoweth in the Australian Financial Review about Apple shifting $9 billion of profit out of Australia makes for interesting reading. (Neil Chenoweth, ‘Apple’s $9bn profit shift‘ Australian Financial Review, Thursday 6 March, page 1.)
Let me give a simple example of profit shifting before I go a little into the detail Chenoweth has revealed. Let’s assume a US company (US Co) sets up a wholly owned Australian subsidiary company (Aus Co) to sell its US manufactured goods in Australia. In the time honoured law lecturer tradition we’ll call these goods widgets.
The US company sells the widgets it has made to its Australian company for a market price of say $100 each and the Australian company on-sells them to consumers here in a competitive market for say $150. In other words the Australian company (ignoring its very small costs in doing this) makes a profit of $50 on each widget it sells and is taxed on that profit.
A not so clever tax adviser interposes a company, which we will call Van Co, again wholly owned by US Co, in Vanuatu. Now what happens is that US Co sells its widgets to Van Co for $100 and van Co sells the widgets to Aus Co for $150. Aus Co then sells the widgets at market price of $150 to Australian consumers.
Aus Co has made zero profit – it sells the widgets at $150 after purchasing them for $150. So the tax payable in Australia is zero. However because of this artificial arrangement the vanuatu company, Van Co, has made the $50 profit. There is no company tax in Vanuatu. The arrangement has shifted the profit from Australia to Vanuatu, and saved the group the tax that would have been paid in Australia (30% of $50).
There are a whole raft of laws in place in Australia to deal with pretty obvious profit shifting, also known as transfer pricing. Basically the Commissioner of Taxation would deem Aus Co to to have sold the widgets at market price, ie $150, and tax them on the notional $50 profit that arises.
So what has Apple done? Much the same thing by the look of it. Its Australian arm had sales revenue according to Chenoweth of $26.7 billion between 2002 and 2013. Over that time it paid $193 million in tax to the Australian Tax Office, or 0.7% of turnover.
Turnover of course is not taxable profit, but with sales of $26.7 billion over a decade there must be some huge costs in there to make Apple in Australia pay so little tax here. And there are.
Apple in Australia pays huge amounts for ‘intangibles’, in this case the intellectual property rights. Chenoweth estimates this amount to have been about $8.9 billion over the period from 2002 to 2013. If a more reasonable market price for the intellectual property were set (note however that Apple claim their mark up on these rights is a market one), some if not most of that $8.9 billion may have been taxable in Australia.
However it looks as if the pricing arrangements have the approval of the ATO under what are called Advanced Pricing Arrangements (APAs). In other words the prices Irish Apple charges Apple in Australia for intellectual property are legitimate approximations of arm’s length, market prices. All I will say is that the skinny Australian margins tend to belie that. Perhaps the ATO might check to see if Apple is in fact complying with the APA?
This $8.9 billion has been paid in the main to an Irish company owned by Apple. This Irish Apple is the international sales point for non-US sales of intellectual property.
There are two reasons for this. Ireland’s company tax rate is 12.5% for active businesses.
However even better Irish Apple is not taxable in either Ireland or the US. This is because Irish Apple is run from California but under the tax laws of the two countries this means it is not taxed in Ireland or the US. In fact Irish Apple is not a resident of any country for tax purposes. This is being fixed, supposedly, by Ireland.
There is another complication. For the last few years these intellectual property rights payments have been going to Singapore Apple, perhaps in anticipation of Ireland changing its tax laws to possibly tax the Irish Apple.
Apple has a ten year development and expansion incentive deal, according to Chenoweth, with Singapore making it subject not to the normal 17% company tax rate but to a rate of 5%. On top of that, and again this comes from Chenoweth, that deal gives further concessions to Singapore Apple so its effective tax rate there appears on recent figures to be close to 1%. Singapore is a conduit on the way to Ireland, at the moment.
The end result is that in 2009 the Irish Apple said its worldwide average tax rate was 4%. The real figures appear to be, according to Chenoweth, about 0.1% ($3.65 million on pre-tax earnings of $4 billion on non-US sales.)
Chenoweth also says that in the last five years Irish Apple made US $100 billion of profits but paid 0.05% tax worldwide (excluding the US), or 50 cents tax for every $1000 profit.
It is not only Apple that doesn’t pay its fair share to use the hackneyed phrase of bourgeois commentators. Google for example has not only an Australian arm that doesn’t do very much but also an arm in Ireland, and one in Singapore. It doesn’t need to use profit shifting to move its Australian sourced revenue offshore.
This is the problem known as base erosion and it is related but distinct from profit shifting. You may have seen reports about the G20 and OECD talking about base erosion and profit shifting, or BEPS. I’ve explained profit shifting; now for base erosion.
When you as an Australian resident contract with Google to put an advertisement on their site, you are contracting with Google Ireland, or more recently perhaps Google Singapore. Under all our tax treaties, treaties which use 19th and 20th century concepts no longer relevant for capturing the tax on revenue of digital companies and transactions, Singapore and Ireland respectively have the taxing rights over the income of companies resident in those countries.(Note too that just because they have the taxing rights doesn’t necessarily mean they exercise them. It just means Australia can’t.)
Using Google Ireland as an example, you, the Australian resident, contract with Google Ireland to put an advertisement on their site, perhaps limited to Australian readers, depending on the nature of the product. You pay Google Ireland for that. Under the tax treaty Ireland has taxing rights over that income from Australian sources, assuming that income is not earnt through a branch in Australia of Google Ireland or Google Singapore, which it isn’t.
Estimates are that on revenue from Australia of up to $2 billion a year Google paid $74000 tax. Others estimate the figure at $740,000. The latter figure is less than 0.5% tax on revenue of $2 billion.
Unlike Apple, because Google Ireland is a resident of Ireland it will be taxable in Ireland on that income unless it can arrange to make it non-taxable. Enter the Double Irish Dutch Sandwich.
Under this neat little arrangement income flowing into Ireland on its way to another EU country isn’t taxed in Ireland. So the Australian sourced income is routed from Ireland to The Netherlands. It isn’t taxed there because it is then routed back to Ireland on the way to say Bermuda. So it becomes untaxed flow through income in Ireland and Holland and then Ireland on the way to the tax haven of Bermuda.
Nice work if you can get it.
Other companies that come to mind include Starbucks which has not made any profit since it set up its franchise arrangements in Australia in 2000. In the UK Starbucks paid no income tax because it paid huge amounts to an Irish subsidiary company – think Double Irish Dutch sandwich after that – for intellectual property, for example the name.
Twiggy Forrest’s company, Fortescue Minerals Group, has paid no income tax in Australia in the last 18 years and accumulated losses mean it will pay none for the next couple of years even if it has no more exploration costs.
A few years ago ATO Deputy Commissioner Jim Killaly pointed out that 40% of big business between 2005 and 2008 paid no income tax. The figure after the GFC is likely to be much higher.
We now have a Commissioner of Taxation who is a former tax partner in KPMG, a major international accountancy firm specialising in tax advice to the rich and capital. So we won’t find out from the ATO today what the more recent figures for big business income tax are.
The previous Labor government had in train legislation to make transparent the amount of tax the big companies pay. The Abbott government does not support this.
This is also the Commissioner getting rid of 900 tax officer jobs. If you couple that with the ongoing destruction of international tax capability over the last decade in the ATO and the ‘open for business’ (sound familiar?) attitude of the top rungs of the ATO now under the business friendly former KPMG tax partner and the further erosion of Australia’s company tax base is likely to accelerate.
Of course all the countries of the world could sit around the revenue campfire and chant Kumbaya to address the problem but tax cooperation won’t happen to address either base erosion or transfer pricing. Why not?
Who benefits from the current arrangements? Well Singapore and Ireland obviously; the Netherlands too; various tax havens. But to take Apple as an example Chenoweth says the company ‘… has noted that it is one of the largest taxpayers in the US. In 2013 it provided for US $12 billion in US federal and state taxes and $US 1.1 billion in foreign tax provisions.’ Good luck bringing the US on board.
What can we do? The cooperation of all the countries of the world in combatting this, let alone the US, won’t happen. All the spin about automatic exchange of information is precisely that – spin. It will have no impact on addressing BEPS.
Imposing wealth taxes and higher taxes on the rich and capital will possibly drive some of them offshore even more or maybe make Australia a less attractive investment destination. I couch this in terms of possibilities because a lot of the ‘we are too highly taxed’ screeching is BS. Australia is a low tax country, on a par with Turkey and the US in terms of tax as a percentage of GDP, and 7% below the OECD average tax take.
That is not an argument for not trying to tax the rich and capital, or for abolishing the tens of billions of tax concessions the rich and powerful receive, but an argument for saying the problem of getting companies and the rich to pay tax is a deep-seated one. For example the Tax Justice Network has estimated that between $US 21 trillion and US$ 32 trillion is hidden in tax havens and bank secrecy countries. US GDP is about $16 trillion a year.
Corporate tax avoidance is systemic.
Google as we have seen has tax avoidance arrangements around the globe. Its Chairman Eric Schmidt defended his company’s tax avoidance activities around the globe, activities which have seen it funnel almost $10 billion into Bermuda, saving $2 billion in taxes. He said:
“I am very proud of the structure that we set up. We did it based on the incentives that the governments offered us to operate.”
The company isn’t about to turn down big savings in taxes, he said.
“It’s called capitalism,” he said. “We are proudly capitalistic. I’m not confused about this.”
And that is the point. Competition forces them to seek legal and sometimes not so legal ways to reduce tax. If one is doing it all its competitors will be forced to cut their costs too and one way is tax avoidance.
Company tax avoidance is not a failing of capitalism: it is its logical expression.
There are two ways to really tax the rich. The first is for workers to win bigger pay increases to stop the bosses getting their hands on more of our money before they can play funny buggers with it. The second is to overthrow the capitalist system which produces corporate tax avoidance.