Homeless multinationals and taxing decisions

The digital economy has generated many changes in how we shop, stay in touch with friends, and manage our daily routines. Despite this, it seems that politicians around the world are only just starting to realise that the digital world has truly changed the economy.

The recent Australian federal budget was the usual mix of promises and projections. One of the more interesting facts presented was the Treasury estimate that since the 2008/2009 budget, federal government revenues from tax receipts have fallen by $170 billion dollars.

When it comes to tax revenue and government budgets, there will always be some level of political debate. It is now pretty obvious that traditional sources of government revenue are now insufficient, even when the Australian economy is powering ahead strongly. Particularly when you look at the backlog of infrastructure investments needed to keep the economy productive.

Painting by Carl Barks
Painting by Carl Barks

Whichever politicians end up running the country after the September federal election, there will be some very tough decisions to make on taxation.

In an interesting coincidence, the announcement of the shortfall in tax revenue has coincided with Treasury bureaucrats kicking off consultations regarding the tax treatment of multinationals doing business with Australians.

At first blush, the multinational taxation consultation process seems to be a rather belated reaction to major political rumblings aired in the G20 and OECD. The issue that is generating the angst is “base erosion and profit shifting” (BEPS), a rather dull way of saying tax avoidance.

BEPS is seen as a global issue worthy of the attention of the G20 for one simple reason – it is entirely legal, and can be used to avoid almost all corporate income taxes.

Businesses that are able to transact with clients online across international borders are the most likely to be able to profit from BEPS, but it is certainly not the only way corporate leaders minimise tax bills.

The UK parliament has recently been examining in minute detail how Google’s internal employee workflows have been structured to shift the legal location of a business transaction. The inquiry heard that despite employees, clients, and work occurring in the UK, Google has successfully claimed that business transactions are legally based in a foreign country.

Amazon has also recently received a huge amount of negative media attention for their UK tax affairs, which seem at face value to be far less adventurous than Google’s. Amazon is reported to have paid just £2.4m in UK corporate taxes last year on sales of £4.3b, while also receiving £2.5m in UK government grants.

But the biggest revelations to date have been thrown up by the US Senate, which recently grilled Apple CEO Tim Cook. The inquiry heard claims that a single Apple owned entity reported profits of USD $30 billion between 2009 and 2012, with no country receiving any tax on that income. Another separate Apple entity managed to pay a tax rate of 0.05% on $22 billion in revenue for 2011.

Perhaps the most important revelation has been that major entities used by Apple to conduct their worldwide business were described as “homeless” for tax purposes, with no country able to collect tax on their corporate income. This “homeless” status undermines some of the most fundamental principles underpinning the international tax and trade treaties relied upon by OECD and G20 nations.

Now business leaders are of course supposed to focus their attention on generating profits and pleasing shareholders. Minimising corporate tax bills can be an effective way to boost cash flows, profits and shareholder returns.

CEO bonuses usually depend entirely on achieving profitability targets and increasing shareholder returns. So it should be obvious that corporate leaders will structure business workflows and organisational design to maximise their bonus.

The result can be bizarre workflows spanning multiple international corporate entities and legal jurisdictions. When tax considerations trump customer service in decision making, it can make high quality customer service very difficult to deliver, and consumer rights unclear. In this digital age, corporate reputations can be quickly tarnished, and very expensive to repair. It has never been easier for the public to learn the financial affairs of large corporations.

Multinationals usually base major operational centres in locations which offer high quality infrastructure and workforces, all of which depend on a stable social environment with sophisticated government services.

If there is no government funding for infrastructure, crime prevention, education, or healthcare, then someone else will end up paying the price. There is a very good reason why there are so few successful multinationals headquartered in third world countries.

While BEPS is currently attracting media scrutiny, it remains to be seen how much impact that attention will have on actual corporate behaviour. While executive KPIs reward elaborate tax avoidance strategies, there will be little chance of corporate driven change.

On the other hand, politicians can always change the rules of the tax game. The international scale of the BEPS problem is already monumental, and politicians of all stripes are going to need corporate scapegoats to deflect inevitable community anger. Now is the time for corporate leaders to rebalance the risks they are taking with their tax affairs.


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