Last week Google appeared before the UK’s Public Accounts Committee for the third time in four years. Once again it was a wasted opportunity. The Committee Members were more interested in point scoring then in getting to the heart of the matter in hand.
The first topic addressed to the Google executives was that of Matt Brittin’s and the first issue for the staff of HMRC was the cost of the audit into Google’e tax affairs. Google’s pay rates is not a public accounts issue and HMRC undertook the detailed investigation that the PAC Members had been loudly clamouring for.
There are some nuggets of information in the transcript but all in all it makes for frustrating reading with lots of weak questions and the Google executives cut off whenever they seemed set to give a useful answer to the few good questions asked. The supplementary written evidence from HMRC on the Google audit is helpful.
When the results of the audit were published there were numerous claims that Google was engineering a 3% corporation tax rate in the UK. The crude calculations usually go something like this:
- Google has worldwide revenues of $70 billion or £40 billion
- Ten per cent, £4 billion, of Google’s revenue comes from UK customers
- Google makes an annual profit of around £10 billion
- Thus, Google profit margin is around 25% of revenue
- Therefore, Google’s profit from sales to UK customers is £1 billion
- Google pays £30 million of UK Corporation Tax a year
- Ergo, Google pays 3% tax on its UK profits.
This is all well and good and the arithmetic is correct but it is not how the current system of Corporation Tax works. Maybe it is how it should work but arguing that the amount of Corporation Tax that Google pays in the UK is “wrong” based on such a calculation can only be the result of ignorance of how Corporation Tax works or dishonesty. Neither reflects well on those making the claims. Here is a good reply.
Corporation Tax is not paid based on the location of sales or customers; it is paid based on the value-added of the activities a company has in a country. If a company has no presence in a country and makes sales to customers in that country it will face no liability for corporate income tax in that country.
Of course, the problems arise when a company has a presence in lots of countries. The first problem is determining whether that presence is significant enough to be deemed a taxable presence. This is the concept of permanent establishment. A storage facility will not be a permanent establishment whereas a manufacturing facility will be. The next problem is determining how to allocate a company’s taxable income across these permanent establishments. The current approach is to try and resolve this using transfer pricing based on the arm’s-length principle. This allocates profits to permanent establishments based on the risks, functions and assets that they have.
The staff of HMRC tried to explain this to the Committee Members but they weren’t fully for listening. They heard what was being said but didn’t follow through on it. Below the fold are some extracts from the hearings.
Here is a selection of answers from Jim Harra, Director General Business Tax, HMRC.
Jim Harra: I think the two key areas in an inquiry like this are, first, establishing the facts of what goes on in the different jurisdictions—the activities that are carried on and the assets that are located there year by year—then looking for comparable data using the different methodologies—
Jim Harra: Once you’ve established the facts, the kind of discussion that you have is about what value-add is created by activities, what remuneration those activities get on an arm’s length basis in the market and which transfer pricing methodologies are the relevant methodologies to apply. If you look at several of them, what ranges do they give? As was mentioned in this case also, while there is clearly a UK company to which we can attach a tax charge, is there a permanent establishment of some other Google company in the UK?
Jim Harra: The previous witnesses gave an answer to that, which I agree with. The starting point that we take is, what are the activities that are carried on in the UK or what are the assets that are held in the UK? What value do those create in the group’s profitability, and are we getting sufficient profits returned to reflect that value? So if they have an asset held in Bermuda that, as they said, is designed to make sure that profits do not get back to the US and get taxed in the US, that is not material to the UK. The key thing that I have to do is make sure that all UK activities get taxed at the full value that they bring.
Jim Harra: For the future, what we will have to do is wait and see what Google self-assess. We will obviously monitor that, we will risk-assess it, and we will inquire as we would with any business if we have concerns about it. When you look at how activity should get rewarded, there are a number of methodologies approved by the OECD. Some of them can be like a cost-plus methodology, but you can also look, particularly in activities that are marketing-related, at what is a commission on sales that you would expect that kind of activity to get. Those are the kinds of methodologies that we have looked at in this case and would look at in similar cases, but what Google do in the future we will have to wait and see.
Jim Harra: In our case, yes, first of all we do look at and investigate the wider arrangements, so that we understand how the whole global group sees its profits allocated to its different functions and assets; but, when it comes to looking at what is subject to UK tax, what we focus on is what are the activities carried on in the UK, and what are the assets carried on in the UK, and what should the value be that attaches to those? Relevant to that is an understanding of what are all the different components of the group that produce value.
I think one or other of the two witnesses that were here before said that in their view the big value in Google that generates a sort of economic rent is the intellectual property rights that that group has developed through its engineering work; but that is what we do. We look into all of that.
Jim Harra: When we deal with groups they will often try to constrain the information that we look at, and, indeed, the information they will give us, by saying “That is not relevant to what you have to look at, which is the activities that we carry on in your country.” We do have other means of getting that information from other tax authorities, under our double taxation agreements, and, shortly, through country-by-country reports under the OECD BEPS project. So we do not allow ourselves to be constrained by the information that the group will give us; but ultimately what we are looking to do is tax at full value the activities carried on here and not, for example, police their global tax compliance.
Jim Harra: I can’t disclose details of this specific case, but the UK does have a tax information exchange agreement with Bermuda, whereby they commit to giving us information that we need to conduct our inquiries. They do provide information to the UK under that agreement. So whilst multinationals may place assets there because it is a tax-efficient thing to do, it is not a hidden or non-transparent thing from our point of view.
Jim Harra: You are right that in the case of transfer pricing in particular there is often a range within which the answer can fall, because what you are looking at here is a judgment about what is the value of something. I know you did not like the analogy of a car dealer, but in a very simplistic way, if you were building an extension to your house and you took a quote from four builders, you are unlikely to get exactly the same quote from them all, and you cannot say that one of those is right.
What we have in transfer pricing OECD guidelines is a number of different methodologies that you can apply in determining the transfer price. One of the things that we do is to look at what transfer price you might get applying those different methodologies and see where those cross, so that we narrow the range and make it as specific as we possibly can to the facts of the particular case. But ultimately in transfer pricing there will be a range within which a transfer price will fall.
Jim Harra: I go back to what it is we are here to do. We are here to identify the activities that are carried on in the UK that are taxable in the UK, understand their value and make sure that we get the full amount of corporation tax on them. You have heard from the previous witnesses that they have tax structures in place designed to make sure that they are tax-efficient in relation to the US tax system in particular. That is not something that I would like my very expensive resource to be spending quite a lot of time looking at.
The exchanges with the two Google executives who attended the committee were not hugely enlightening. They were asked poor questions and were cut-off a number of times during contributions that may have been useful if allowed to continue. Here are the more interesting exchanges.
Q27 Chair: Mr Brittin, I know the way you operate. Can I just ask some questions, then we will get into more details about that? Your UK operation is 10% of your business.
Matt Brittin: 10% of sales are to UK customers. That is correct.
Q28 Chair: Right, and yet your UK profits generate a fraction of your overall tax bill.
Matt Brittin: Yes, it is important to understand this—and I think the Committee raised this last time. You wrote a Report after we appeared last time suggesting two things: first, we should look at our tax structures, which is what HMRC has done, and secondly, that we should pay tax proportionate to our UK sales. If those were the rules, that’s what we would do, but those are not the rules. The rules are that you should pay taxes on the profit on the economic activity. This is at the heart of what HMRC looked at, and Tom can explain more. On the application of the complex tax rules, which are 17,000-plus pages long in the UK, they spent six years understanding exactly what we do. You asked me when I appeared previously what people do in the UK and what people do in Ireland. They interviewed our staff here and our staff in Ireland. They looked at the systems and processes and all the legal contracts and they applied the laws to the facts.
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Q32 Mr Jackson: No, let me come back to you. Why didn’t you mention Bermuda in this article? That seems to be an integral part of your business model vis-à-vis your tax obligation.
Matt Brittin: Bermuda has no impact on the tax that we pay in the UK. Having a tax expert here, it might be helpful to hear from him about that, because I know it sounds strange to UK ears, but it is actually a commonplace arrangement for American companies—
Mr Jackson: What happens in Bermuda, then?
Matt Brittin: It is a commonplace arrangement for American companies, and Tom can explain, because he is our global head of tax.
Mr Jackson: Okay, well before we get on to—
Matt Brittin: If you would like to hear the answer, he would be the person to answer it.
Q33 Mr Jackson: No, I will decide who I ask questions; thank you very much for the guidance.
Where is the value created in your business?
Matt Brittin: That is at the heart of how corporation tax works—the question of where value is created. If you are a company in the UK selling cosmetics you might go to an event that Google runs, saying “Here’s how to use our services”. You might speak to somebody in Dublin who can guide you in using our services; but the value for you is created when somebody in Japan searches on their phone for cosmetics and connects with you, and you sell cosmetics.
If you think about that, most of the value is created by the product search, which is developed and built in the US. Some of the value is created by the marketing person and the activity that has alerted you to this opportunity, some by the person in Dublin who guides you, but most of the value is created by the search, and that was something which was founded and created in the US—20,000 engineers-plus in the US and 1,000 in the UK. I would like that 1,000 to be bigger and bigger, and as that gets bigger the proportion of our profits that we earn in the UK will become bigger, but the rules require you to pay your taxes based on the economic value creation.
We paid £3.3 billion taxes last year—an average rate of around 20% over the last few years, the same as the rate of tax in the UK. So that’s how the corporation tax system works and we pay where the value is created.
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Q36 Mr Jackson: Can I specifically come back to the diverted profits tax regime, which came in last year? I was going on to say, in fairness, you have intimated in your press release that things have changed now—that you have accepted a more robust tax regime. Does that mean you are fully cognisant of the diverted tax regime and that you will be caught by that, and therefore are willing to pay the proper amount in a timely way, going forward?
Tom Hutchinson: Can I answer that question? The diverted profit tax was a system that was set up—a separate tax system, basically. If you are not paying the right amount of tax under the normal tax system, that’s when it kicks in. Because of our settlement, as Matt described—the settlement with HMRC—we are paying the right amount of taxes, so therefore we are not paying any additional taxes for DPT.
Q37 Mr Jackson: At least for back taxes. I am talking about going forward, not back taxes. This is a deal you have made because for whatever reason, which we may get to the bottom of by the conclusion of this Committee, you chose not to pay, in the period between 2005 and 2015, the proper amount of tax to the Treasury. I am talking about going forward. Are you going to be caught by the diverted tax regime going forward?
Tom Hutchinson: Again, let me just explain some of the details. It was only for one quarter of that settlement—so a very small part of that settlement—where the DPT came into effect, and the conclusion was it did not apply to us. Going forward, if we are paying the right amount of tax according to the normal rules in the UK then DPT would not apply, again. The DPT is making sure you are paying the right amount of taxes based on the existing system.
Q38 Mr Jackson: But what has changed about your business model? What has changed since 2012? You are still using this model—this interaction between creation of value, and a debate about creation of value between the UK, Ireland and Bermuda, which is commonplace, as you say, among big companies. What has changed that will make you pay more tax, effectively, and go to the heart of the Chair’s point that there is a massive discrepancy between your sales and your profit that’s declared, and what you’re actually paying in tax?
Tom Hutchinson: That’s right. As Matt described, the way the tax system works—the corporate tax system, the income tax system—is that it taxes you based on the value of your activities. So, a lot of the value that is attributable to the profits from UK customers is value created outside of the UK. It’s relating to the technology that’s been developed outside the UK.
You look at the value of the substance or the services provided in the UK, and you look at comparables. What would you pay a third party to provide those same services? And that’s what we did in doing our tax returns. We were audited, as you know, by HMRC. They came back and argued that it should be a higher amount, and that’s the amount we ended up paying and settling for at the end.
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Q39 Mr Jackson: Okay. The Comptroller and Auditor General will come in in a minute, but I will ask a final question. It has been reported that you’ve had some pretty involved discussions with the tax regimes of Italy and France. Can you tell us a bit about that?
Tom Hutchinson: As a large company—Google is obviously a very large company—tax audits are very commonplace. All large companies are going through audits. I’m not going to comment on some of the press reports; there are a lot of rumours out there in those articles. We will wait and see how those turn out; it’s just hard to say.
Q40 Mr Jackson: Will you confirm that the sales and profits in those jurisdictions—France and Italy—are substantially lower than they are in the United Kingdom?
Tom Hutchinson: Again, I will say that we look at those activities just like we do—
Q41 Mr Jackson: Answer the question: are they smaller as a proportion of Google’s worldwide income, sales and profits in France and Italy than they are in the UK?
Matt Brittin: Sales to customers in the UK are 10% of Google’s sales, and that’s the highest percentage of sales for any country outside the US. Obviously, taxes are paid on profits on economic activity and not in proportion to sales in each country, so that’s a different matter, because that’s how corporation tax works.
Q42 Mr Jackson: I understand that, but then why are you being asked to pay substantially more—hundreds of millions of euros or dollars—
Matt Brittin: Just like in the UK, there have been a whole range of statements that are based on what people—politicians and others—might like to see large companies pay, but they are not related to a tax demand or an audit. They are just statements by politicians asking us to pay more money—politicians in many cases who, like the Committee, would like to see a system where taxes are paid in proportion to sales, and that’s not the system that we have to deal with.
Q43 Mr Jackson: Just for the benefit of the Committee, are you specifically refuting the quoted figures that those tax jurisdictions say they are going to ask you to pay? My final, final question is: what stage are you at in terms of your negotiation with the French and Italian tax authorities then?
Tom Hutchinson: What I am saying is that we’re not confirming those rumours of what’s happening. Those are articles that are not based on facts. But I can say, the information that I can provide is that we have never paid, as part of an audit settlement outside the US, a larger settlement than the one we just agreed to.
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Q88 Chair: Mr Hutchinson, it is your choice to have part of your company based in Bermuda, a tax haven. That is a choice you have made.
Tom Hutchinson: As Matt mentioned, Bermuda has no impact at all on the amount of taxes we are paying in the UK. That is because of the US system; it’s very common—
Chair: You use the rules to good advantage.
Matt Brittin: Can we just deal with that question, Chair, because—
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Matt Brittin: We would like to be recognised for paying the right amount of tax where we operate, but also for us to be clearer on the value we create in each country we operate in. Obviously, part of the value is paying corporation taxes and we pay the right amount exactly to the penny that the tax authority here has asked us to do, but we also create value through the use of products and services, through hiring people—we have 1,000 more people in the UK since the last time I appeared. So companies create value far in excess of the tax that they pay. We want to pay the right amount of tax but we also want products and services that help hundreds of thousands of British companies to grow, export and create jobs. The UK has been successful at that and we want to continue to invest here and to do more of that.
Q91 David Mowat: You make quite a play, Mr Brittin, of your desire, which is laudable, for a simpler tax system—if only all the politicians in all the different countries could get together and give you one, how much easier it would be. But it was not us who decided to ensure all our sales were booked in Dublin, it was not us who decided that the way you were going to choose to operate was utilising a technique called the double Irish, which I mentioned earlier. That is nothing to do with your apparently passionate requirement or desire for a more transparent system. You tell us you want a transparent system, yet with the system here you use the double Irish, you use the Dutch sandwich and you use Bermuda, which we will come on to. Your argument so far is, “Everyone else does it, so we do.” It does not seem to stack up.
Matt Brittin: Can I deal with your operational question and then ask Tom to deal directly with Bermuda, because that has come up a number of times? Operationally, we set up in a way we think can best serve our customers and the markets. We set up our headquarters in Dublin. We have people speaking over 14 languages there, serving customers across the region. The reason we do that is that we believe we can provide a better service by having expertise that is concentrated and shared. Many of our UK customers export to multiple markets and they have that resource that can speak multiple languages and help them to reach those customers. We set up our operations for business reasons, not for tax reasons.
Q92 David Mowat: To be clear on that point, because it is important, the evidence you have given us today is that you have set up in Dublin because of the ability to get lots of linguistic skills in Dublin. [Laughter.] It is nothing to do with the tax rates.
Matt Brittin: No, I said—
Q93 David Mowat: That’s what you just said.
Matt Brittin: No, I said that—
Q94 Chair: You’ve said that three times now, I think. We haven’t got that in London?
Matt Brittin: We love being in London and we have hired 1,000 more staff since I last appeared.
Chair: Multilingual, I hope.
Matt Brittin: What I said was—[Interruption.]
Chair: Can we let Mr Brittin answer?
Matt Brittin: Let’s be fair. There are two questions I want to come to—the operational question and the use of Bermuda and other issues, which you have raised a couple of times. We set up in Dublin to operate across the whole of Europe, the Middle East and Africa. We could have set up that operation in a range of different countries. We chose to be in Dublin. I mentioned to the Committee before that a lower tax rate was one of the factors in operating there. So were lower property costs, so was the access to high-speed internet connection across the Atlantic. There was a range of factors. Once you have a scale operation across multiple countries, it is a benefit to customers in the UK to be able to access export skills, whether in Dublin or elsewhere. That is the operational reality. We set up our operations. In terms of the question you raised, I would really like to address that.
Q95 Chair: Mr Hutchinson, do you want to talk to us about why you have a set-up in Bermuda? Some of us know but it would be good to have it on record.
Tom Hutchinson: Sure. I have already made this comment but it is important to point out that the Bermuda structure does not impact the taxes we pay in the UK. The Bermuda structure is related to the peculiar tax regime we have in the US. It is a worldwide tax system and that tax system encourages companies such as Google to keep their funds overseas. Once they bring that back, they are taxed at the very high US rates, so that is one piece of that pie, but the most important point is that it does not affect the amount of taxes paid in the UK.
Q96 David Mowat: Since you are answering my question, I would just like to—
Tom Hutchinson: Sorry, if I could just finish—just one more point.
Q97 David Mowat: Could I just come back on that? What you have just said is right, clearly. It does not affect UK tax per se because you have already moved that through Ireland. But I was using it as an example in reply to Mr Brittin’s point that all that Google wants is a simpler tax regime so you can get on with building search engines and do not have to worry about all this stuff. What I am saying is that your use of these structures, albeit it is not uncommon, is not indicative of that desire.
Tom Hutchinson: Again I understand that concern, but if you look at the fact that we were paying a 19% rate for the last five years, I would say that is a very fair rate. It is the rate in the UK, so I have to assume that that is a fair rate to pay on your profits. The question is, where do we show? It is not that we are not paying enough taxes. It is which country do we pay those taxes in. That is determined by Governments.
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Q123 Chair: So did they investigate the London operation—
Tom Hutchinson: A big part of their inquiry was asking questions about whether the activities that were done in the UK, by our employees in the UK, would rise to the level of a permanent establishment. But it is also important to point out that whether there was a permanent establishment or not—there has been a lot of discussion, not as much today, but in prior hearings, about that and what sales activities are happening in the UK versus Ireland—that would not change, like the statement I made about the Bermuda structure, the amount of taxes we would pay in the UK, because what was not talked about last time was that there are two steps in the process when you are dealing with PE. First, if you prove there is a PE—again, the facts did not support that, but even if you did prove a PE—the next step in that process is what is the value of that PE, which gets right back to the transfer pricing discussion, which is what is the value of the services provided in country. So it does not result in a change to the corporate income taxes you owe at the end of the day.
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Q135 David Mowat: How many employees—? You mentioned earlier—I didn’t write it down—How many do you have in Ireland?
Matt Brittin: Well over 5,000.
Q136 David Mowat: And in the UK?
Matt Brittin: Just around 4,000 now.
Q137 David Mowat: And in Bermuda?
Matt Brittin: None.
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Tom Hutchinson: A large part of our employees are based in the US. That’s where most of our IT—
Q142 David Mowat: I understand that, and accept it.
Tom Hutchinson: And your comment earlier was that—you say that we feel good about ourselves that we have set up this complicated structure and then maybe we’re paying the right tax under that complicated structure. I think it’s important to point out—I’ve said this a few times, so I know you may not want to hear it again—that those complicated structures that keep getting talked about are not affecting the amount of taxes we pay in the UK. So, it’s not that we set up these complicated structures and now the HMRC has said, “Well, with that complicated structure, here’s the amount of taxes you pay”—[Interruption.]
David Mowat: Just on that point—
Tom Hutchinson: We would pay the same amount of taxes even if we didn’t have that complicated structure.
Q143 David Mowat: What affects the amount of tax that you pay in the UK is the first part of your complicated structure, which is you book the sales through Ireland. So that affects the tax you pay—
Matt Brittin: We do that—[Interruption.]
Q144 David Mowat: But if, as you say, you’re paying a fair amount of tax—I think I’ve heard you say 19% on global profits; fair enough, or it may be fair enough—why go through it all? Why go through the Dutch sandwich? Why do the double Irish? Why have the Cayman Islands? Why have Bermuda as part of your set-up, if the result of all that is you end up paying the right amount of tax anyway?
Tom Hutchinson: Exactly. So we end up paying the amount of tax that we think is a reasonable amount—19%. Again, that’s very close to the UK rate.
Q145 David Mowat: But my question isn’t that. My question is—fine, the 19% is right. I don’t know; maybe it is right. You’re the tax guy. If, then, your objective—laudably—is that you’re going to pay the right amount of tax, why do you put yourselves through all this stuff about booking sales in Ireland, moving profits through the Dutch sandwich, and why do you have the Cayman Islands stuff and Bermuda? Because then you have to answer questions from people like us, and it seems a lot to have to put yourselves through if the result of it all is you’re paying the right amount of tax.
Tom Hutchinson: Let me make an important point. If we set up differently and we had our UK office selling directly to UK customers, that would be a change in our structure and it’s one of the things that’s been talked about. Again, that would not change the fact that the tax rules require you to show profit in the UK attributable to the value of those services in the UK—
Q146 David Mowat: No, that’s a different point. You’re right. That point goes to my other question about whether your UK employees—many of whom will have parents who use care homes and doctors, and relatives who use teachers, and all of that—goes to whether or not the way you’ve chosen to set yourselves up is cognisant of your UK employees being proud of working for a company that may well pay the right global amount of tax but appears to go to great lengths so that it’s not in the UK.
Matt Brittin: We are paying the amount of tax in the UK that—