The Reasons To Be Skeptical About The UK’s Google Tax

Two things should be said about the UK’s new Google GOOGL -2.7% Tax as proposed in the Autumn Statement by George Osborne, the Chancellor of the Exchequer. The first is that there really is a certain amount of public anger about the manner in which the big tech companies (here is usually meant Facebook, Google, Apple AAPL -0.41%, Microsoft MSFT -0.86% and Amazon) are not paying much, if any, corporation tax on the profits that they make from selling their wares in Britain. That this anger has been whipped up by certain campaigners is also true but a politician must deal with what the populace believes, not with what might actually be objective reality. The second thing is that it’s really extraordinarily difficult to work out how Osborne is going to manage to impose this new level of taxation. Unless he’s decided to entirely tear up the standard treaties and laws on international taxation of business it’s very difficult to see how he’s going to impose it at all.

Of course, I’ve been saying this since Wednesday when he first announced it but we’re now getting other people (and more senior, more sensible and even more believable than I) saying it. As we find here in the WSJ:

The British government hasn’t disclosed many details about a new 25% tax announced Wednesday that it intends to levy on companies it accuses of dodging taxes. But tax experts and attorneys here are already saying it could conflict with international tax treaties, some of which date back to the 1920s.

That would make the new measures difficult to enforce—and easy for companies to challenge. The move is already drawing criticism for being more political rhetoric than sound economic policy.

Yup.

Those agreements—many drafted generations before e-commerce existed—now may get in the way of the new tax, experts said. According to some of these conventions, things like warehouses and sales representatives—the backbone of many brick-and-mortar businesses, not to mention modern e-commerce companies—don’t necessarily mean a company is resident in the country hosting those assets, when it comes to tax purposes.

It’s worth taking a step back and seeing how Osborne, and the UK tax system, is hemmed in by those previous agreements.

What is being suggested is that if you sell stuff in the UK then the profits you make from those sales should be taxed in the UK. And this “diverted profits tax” will have some mechanism (we find out what it will be next week) to determine what those profits might have been on those sales and whether you’ve diverted them. The problem with this is that it’s simply not the way in which liability for corporation tax is currently defined. Here’s HMRC (the UK equivalent of the IRS) on this matter:

Non-resident trading companies which do not have a branch in the UK, but have UK customers, will therefore pay tax on the profits arising from those customers in the country where the company is resident, according to the tax law in that country. The profits will not be taxed in the UK. This is not tax avoidance: it is simply the way that corporation tax works.

Most major economies operate corporation tax in the same way as the UK, so UK-resident companies are treated in a similar way in other countries. In other words, UK companies do not pay corporation tax to another country on the profits from sales in that country, unless they trade through a branch based there. Instead, they pay corporation tax in the UK

The reason for this is obvious. Imagine my little company that deals with weird metals. I have a customer in Japan who every year or two makes a small purchase. It would clearly be entirely nuts to have my little one man company liable to file a Japanese corporation tax return on the basis of that. We generally allow that to just rub along, on the basis that there’s probably some Japanese company with the occasional sale in the UK and it all balances out, roughly enough, over time.

So then we need some basis of working out when a company is large enough that we’re going to say that it does have a branch, or a “real” base in another country. At which point we think it’s big enough and important enough that it ought to be part of the local company taxation scheme. This comes under the rubric of a “permanent establishment”. Pretty much, although not exactly, having a permanent establishment means you pay the local corporation tax, not means you don’t. The rules on this were drawn up by the League of Nations between the two wars and now form the basis of the OECD standard taxation treaties. Here’s the one between Luxembourg and the UK for example. The one that covers Amazon and its activities in the UK.

(1) For the purposes of this Convention, the term `permanent establishment` means a fixed place of business in which the business of the enterprise is wholly or partly carried on.

(2) The term `permanent establishment` shall include especially:

(a) a place of management; (b) a branch; (c) an office; (d) a factory; (e) a workshop; (f) a mine, quarry or other place of extraction of natural resources; (g) a building site or construction or assembly project which exists for more than six months.