COLUMN-Business, taxes and responsibility-Chrystia Freeland

Thu May 2, 2013 1:14pm EDT

By Chrystia Freeland

NEW YORK May 2 (Reuters) - In recent months, people and their politicians around the world have been astonished to learn that big companies and billionaires will go to extraordinary lengths to pay lower taxes.

Thanks to the work of the International Consortium of Investigative Journalists, based in Washington, we have discovered that some of the most prominent public figures in the world have banked their fortunes in international tax havens, beyond the scrutiny of their national treasuries.

Meanwhile, Tom Bergin, my Reuters colleague, has become the scourge of the top U.S. multinationals by revealing their low effective tax rate in Britain. Mr. Bergin has found that between 1998 and 2012, Starbucks paid less than 9 million pounds, or about $14 million, in British taxes while registering sales of more than 3 billion pounds. According to statutory filings, Google made $18 billion in revenue in Britain from 2006 to 2011, and paid just $16 million in taxes.

Open the door to the top executives' suite and you will hear howls of rage over the backlash these revelations have provoked. There is, from the corporate point of view, something a little disingenuous happening here. After all, countries, states and cities have spent the past several decades openly competing to set the lowest corporate tax rates in an effort to attract business. The fact that multinationals would respond to these incentives and turbocharge them with some international tax arbitrage is about as shocking as the discovery of gambling in Casablanca.

After all, as Lord Clyde observed, in a 1929 British tax case: "No man in the country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or property as to enable the Inland Revenue to put the largest possible shovel in his stores."

This principle - that you should seek to make the most money you can, provided you do not break the law - is the operating software of modern capitalism. As Milton Friedman put it: "There is one and only one social responsibility of business - to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."

In the hypercompetitive 21st century, where every Apple is only one algorithm away from becoming a BlackBerry, paying the lowest possible taxes is not the exceptional policy of one particularly greedy chief executive - it is what every executive seeks to do to keep his job. That was what Andrew Kassoy, a former private equity investor, explained at a recent panel discussion at the Stern School of Business at New York University (Disclosure alert: I was the moderator).

Kassoy, who now leads a nongovernmental organization working to transform corporate behavior, argued that current publicly traded U.S. companies were "actually obliged to maximize their externalities" - economist-speak for behavior that harms the wider community - if that would increase their bottom line. Kassoy does not think that is a good thing, and, increasingly, neither do a lot of other people - the grim title of the session was "Can American Capitalism be Saved?"

He's not the only one who is worried. In a recent interview, I asked Mark Carney, the governor of the Bank of Canada, about the ability of rich people and big companies to avoid taxes in a world of global capital flows.

"It is demonstrably a problem," said Carney, who will take over as the governor of the Bank of England on July 1. "If there's an ability to fundamentally, whether on a personal or a corporate level, persistently avoid tax, the consequence of that is that the burden of fiscal adjustments that are happening in virtually every advanced economy falls more heavily on those who pay their fair share. And they end up paying more than their fair share as a consequence."

Closing the tax loopholes or tightening the lax tax enforcement that have deprived European treasuries of so much multinational corporate tax revenue is politically difficult and technically complicated. But what is even harder is figuring out how to better align the behaviors of the business titans with the greater good of the community as a whole.

After all, the companies that have been minimizing their European tax bills are ones we are accustomed to thinking of as the good guys. These are not the bailed-out fat cats of Wall Street or the crony capitalists of the emerging markets. These are the inventive entrepreneurs of the West Coast, who brought cappuccinos and search capabilities to the global masses. Starbucks energetically associates its brand with all manner of ethical causes, and Google's motto is "Don't be evil."

In a new book, a University of Michigan business professor, Mark S. Mizruchi, contends that the forsaking of responsibility for the wider community is a big shift in the behavior of U.S. business and a central reason for the country's political and economic malaise.

"The current American corporate elite seems to be leading us toward the fate of the earlier Roman, Dutch and Hapsburg Spanish empires, starving the treasury and accumulating vast resources for itself," Mizruchi writes. He concludes his book with the hope that the corporate elite will rediscover "enlightened self-interest" and reform themselves.

Speaking at the New York University conference, Clay Christensen, one of the leading thinkers about the disruptive impact of the technology revolution, suggested that belief in a God who holds us accountable in the afterlife would make captains of industry more civically responsible today.

Christensen is right that to change behaviors we need to change incentives. Hellfire and damnation is one option; another is rewriting the rules of engagement between companies, countries and shareholders.

(Chrystia Freeland is the managing director and editor, Consumer News at Thomson Reuters. Prior, she was U.S. managing editor of the Financial Times. Before that, Freeland was deputy editor of the Financial Times, in London, editor of the FT's Weekend edition, editor of FT.com, UK News editor, Moscow bureau chief and Eastern Europe correspondent. From 1999 to 2001, Freeland served as deputy editor of The Globe and Mail, Canada's national newspaper. Freeland began her career working as a stringer in Ukraine, writing for the FT, The Washington Post and The Economist.

She is the author of two books: "Plutocrats: The Rise of the New Global Super-rich and the Fall of Everyone Else," published by Penguin in 2012 and "Sale of the Century: The Inside Story of the Second Russian Revolution," published by Crown Publishing books in 2000.)

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Comments (2)
When looking at this whole issue, its worth understanding some history and background. The current system of tax treaties and international structuring arose from a desire by many national governments to try and maximize the tax revenue they collect. They did this by recognizing that there are constant situations where an international corporation may be obligated to pay tax on the same revenue but numerous times. Of course this would result in no net revenue and the corporation going bankrupt.

Therefore in order to attract the good or service to their jurisdiction; get as much tax revenue as possible; and encourage the corporation to set up some of its physical structure and work force in their jurisdiction, countries like the UK and US set up tax treaties between themselves and other countries (such as Ireland).

It is key to understand this underlying motivation for the current system. This system arose and continues to exist not out of some noble desire to relieve taxpayers of the “unfairness” of double taxation or even at the bequest of the lobbyists of those taxpayers. It came out of a logical self-interest of various governments. For what its worth, the UK tax treaties with both the US and Ireland were signed into being by the Labour government of Harold Wilson.

With this background in mind, let’s look at the Google situation.

-Many US politicians and citizens want Google to pay US tax on its WORLDWIDE income, including income earned from UK customers. They argue that while this may not be legally correct, it is MORALLY correct because a) Google was founded, IPOed and has its headquarters in the US; AND b) The citizens of the US are suffering in a financial downturn and “deserve” this money;

-Many UK politicians and citizens want Google to pay UK tax on the revenue generated from UK customers. They argue that while this may not be legally correct, it is MORALLY correct because a) Google is deriving income from UK tax resident individuals and corporations; AND b) The citizens of the UK are suffering in a financial downturn and “deserve” this money;

-You could insert “Starbucks” for “Google” in this fact situation. Both companies want to maximize their net revenues (“gross revenues” minus “expenses including tax” equals “net revenue”). Both companies used the tax treaty network and international structuring regime to minimize their global tax burden. As part of this structure they may have to set up operations in places like Ireland; or assigned intellectual property rights to places like the Netherlands. However there are important differences between the two companies;

-Starbucks needs to respond to this “Moral but not legal” obligation demand because a) it has physical facilities in the UK which could be picketed or damaged reducing sales; and b) There are many UK competitors who could service UK customer needs and decrease gross revenues. As a result, it is logical that they may consider paying more tax than legally obligated in order to maintain gross revenues and thereby maximize net revenue.

-Google is different in that a) it does not have or need physical facilities in the UK to deliver its service; b) With all due respect to other search engines, it is not really realistically worried today about losing customers to its competitors. Therefore, the current controversy is unlikely to significantly reduce people from using its products and services. As a result, it is logical that they will not consider paying more tax than legally obligated;

The end result is that the UK push to have Google pay more UK tax is probably doomed to failure UNLESS the UK can show that Google did not properly operate the tax structure they set up. Whether the Reuter uncovered “UK sales team” is sufficient to undermine the Google tax structure is a legal question, not one that will be settled in Parliament or the courts of public opinion.

As a tax lawyer, I can tell you that the Reuters revelations about UK employees is interesting enough to warrant further investigation but hardly a slam dunk that Google was offside. Investigation and adjudication will tell.

If Google is currently tax-compliant then you have to look at the practical levers to force Google to pay more tax than they are legally obligated. Starbucks which sells a standard physical commodity which is readily available from other competitors was clearly subject to pressure. “Search” is not a standard physical commodity today and whether through perception or reality, it is a far and away market leader. As a result Google is not motivated by self interest to pay more tax to maintain gross revenues.

May 03, 2013 12:54pm EDT  --  Report as abuse
When looking at this whole issue, its worth understanding some history and background. The current system of tax treaties and international structuring arose from a desire by many national governments to try and maximize the tax revenue they collect. They did this by recognizing that there are constant situations where an international corporation may be obligated to pay tax on the same revenue but numerous times. Of course this would result in no net revenue and the corporation going bankrupt.

Therefore in order to attract the good or service to their jurisdiction; get as much tax revenue as possible; and encourage the corporation to set up some of its physical structure and work force in their jurisdiction, countries like the UK and US set up tax treaties between themselves and other countries (such as Ireland).

It is key to understand this underlying motivation for the current system. This system arose and continues to exist not out of some noble desire to relieve taxpayers of the “unfairness” of double taxation or even at the bequest of the lobbyists of those taxpayers. It came out of a logical self-interest of various governments. For what its worth, the UK tax treaties with both the US and Ireland were signed into being by the Labour government of Harold Wilson.

With this background in mind, let’s look at the Google situation.

-Many US politicians and citizens want Google to pay US tax on its WORLDWIDE income, including income earned from UK customers. They argue that while this may not be legally correct, it is MORALLY correct because a) Google was founded, IPOed and has its headquarters in the US; AND b) The citizens of the US are suffering in a financial downturn and “deserve” this money;

-Many UK politicians and citizens want Google to pay UK tax on the revenue generated from UK customers. They argue that while this may not be legally correct, it is MORALLY correct because a) Google is deriving income from UK tax resident individuals and corporations; AND b) The citizens of the UK are suffering in a financial downturn and “deserve” this money;

-You could insert “Starbucks” for “Google” in this fact situation. Both companies want to maximize their net revenues (“gross revenues” minus “expenses including tax” equals “net revenue”). Both companies used the tax treaty network and international structuring regime to minimize their global tax burden. As part of this structure they may have to set up operations in places like Ireland; or assigned intellectual property rights to places like the Netherlands. However there are important differences between the two companies;

-Starbucks needs to respond to this “Moral but not legal” obligation demand because a) it has physical facilities in the UK which could be picketed or damaged reducing sales; and b) There are many UK competitors who could service UK customer needs and decrease gross revenues. As a result, it is logical that they may consider paying more tax than legally obligated in order to maintain gross revenues and thereby maximize net revenue.

-Google is different in that a) it does not have or need physical facilities in the UK to deliver its service; b) With all due respect to other search engines, it is not really realistically worried today about losing customers to its competitors. Therefore, the current controversy is unlikely to significantly reduce people from using its products and services. As a result, it is logical that they will not consider paying more tax than legally obligated;

The end result is that the UK push to have Google pay more UK tax is probably doomed to failure UNLESS the UK can show that Google did not properly operate the tax structure they set up. Whether the Reuter uncovered “UK sales team” is sufficient to undermine the Google tax structure is a legal question, not one that will be settled in Parliament or the courts of public opinion.

As a tax lawyer, I can tell you that the Reuters revelations about UK employees is interesting enough to warrant further investigation but hardly a slam dunk that Google was offside. Investigation and adjudication will tell.

If Google is currently tax-compliant then you have to look at the practical levers to force Google to pay more tax than they are legally obligated. Starbucks which sells a standard physical commodity which is readily available from other competitors was clearly subject to pressure. “Search” is not a standard physical commodity today and whether through perception or reality, it is a far and away market leader. As a result Google is not motivated by self interest to pay more tax to maintain gross revenues.

May 03, 2013 12:54pm EDT  --  Report as abuse
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