A possible explainer for Google’s recent tax settlement?

The 2020 accounts for Google Ireland Limited were published last week and showed that the company had a €218 million tax charge that arose from “the resolution of certain tax matters relating to prior years” (and there was a further €127 million of associated interest).  The group’s parent company, Alphabet Inc., had stated in its own 2020 annual report that its “tax years 2011 through 2019 remain subject to examination by the appropriate governmental agencies for Irish tax purposes.”

It’s possible we can get some insight into the nature of this issue from the table of the annual profit and loss statements which were summarised in the previous post which looked at Google’s footprint in Ireland since 2003.  Here is the relevant table. Click to enlarge.

In particular we are drawn to the column for operating profit, which forms the bulk of the company’s profit before tax.  It looks like Google Ireland Limited’s operating profit can be broken down into three time periods:

• 2003-2011
• 2012-2015
• 2016-

A post a number of years ago looked at the determination of Google’s profit in Ireland and looked at the period 2012 to 2014 which ties in with the middle time period above.  As the table shows, in 2012 there was a significant step-up in Google Ireland Limited’s operating profit compared to the previous decade – or at least an increase above that which could be explained by the expansion of the company.

The earlier post reached the conclusion that “Google Ireland’s operating profit has been around 6 per cent of its expenses excluding the license [or royalty] payment.”  Prior to 2012, it seems that the cost-plus arrangement for determining Google Ireland Limited’s operating profit only included the costs incurred in Ireland.  It seems likely that the step-up in 2012 was due to the inclusion of the costs Google Ireland Limited incurs in the payments it makes for the sales and marketing efforts to the local Google subsidiaries in the markets in which it sells.  The earlier post sets this out for a sample of countries. 

The earlier post should have been updated because in 2016 there was another step up in Google Ireland Limited’s operating profit.  It looks like the profit margin is still in the region of six to seven per cent of expenses but it now includes all expenses, most notably the royalty payment.

Here is Google Ireland Limited’s operating profit as a per cent of its administrative expenses since 2005.

The step-ups in 2012 and particularly 2016 are clear.  The outcome for the period 2012 to 2015 would be around 6.5 per cent if the royalty payment is excluded from the base, which is pretty much what it has averaged in the period since 2016 with the royalty payment included.

It is only supposition, but it is possible that the tax issue that Google Ireland Limited revealed in its accounts related to the exclusion of the royalty payment from the base for determining its operating profit using a cost-plus margin in the years before 2016.  The fact that there was €127 million of interest linked to the €217 million tax charges lends credence to the conclusion that it relates to tax due a number of years ago (with Revenue applying an rate of eight per cent per annum to such amounts).   

It is possible that Revenue began this review back in 2015 or 2016 with Google then deciding to include the royalty payments in the base for the cost-plus determination from then on.  Thus what was in dispute was the operating profit figures for Google Ireland Limited for years prior to 2016.  Of course, the change in 2016 also coincides with the time when the cage-rattling by the European Commission using state-aid cases into tax was going strong and that may have influenced the company’s decisions.

So, can we get numbers to fit the hypothesis that the tax settlement is linked to the inclusion of royalties in the case for the cost-plus assessment of Google Ireland Limited’s profit? Perhaps we can.

Looking at the amount of royalties paid, figures for which are available in the accounts of a subsidiary in The Netherlands, Google Netherlands Holding’s BV, shows that these came to €29.7 billion from 2013 to 2015.  While we don’t know the cost-plus margin applied, using 6.5 per cent gives a return of €1.8 billion.  The following table shows what happens if these returns are taxed at 12.5 per cent and the interest that would have accrued if the tax should have been paid seven, six and five years ago.

Maybe it is little more than coincidence that the figures from this scenario are close to “adjustment for corporation tax of prior periods” that Google Ireland Limited disclosed in its 2020 accounts.  These were an additional tax charge of €218.2 million and €127.3 million of related interest.  In fact, the figures are more than just close; they are almost identical.

One fly in the ointment is that the above table only includes the years 2013 to 2015, whereas the note in Alphabet’s 10k said that all years back to 2011 were under review.  But years being under review does not mean there will be a revised tax assessment for them.

We do know there has been a change since 2016 and it is possible that the move to include the royalty expense in the cost-plus calculation has added around €700 million to Google Ireland Limited’s Irish tax bill in the five years since.  The first table above shows a step-up in Google Ireland Limited’s tax charge in 2016. If this change to the cost-plus methodology hadn’t been implemented, and Revenue’s assessment held up, then Google could have been announcing a €1 billion tax settlement last week – assuming the hypothesis here is correct. 

So, as has often been the case the issue was not the tax rate applied to profits but the amount of profit to be subject to Ireland’s 12.5 per cent rate.  The suggestion here is that, up to 2016, the royalty paid by Google’s Irish subsidiary for the right to sell advertising using Google’s platform and technology was excluded from the cost-plus assessment used to calculate its taxable profit in Ireland. 

The Revenue position looks to have been that while the change in 2016 was fine it should also have applied to a number of earlier years leading to an increased tax charge for those years.  Is this a guess? Yes. But probably not a bad one.

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