The taxation of Google’s activities are capturing the attention this week. Although a party to what is going the attention isn’t really on Ireland – the attention is rightly on the taxation by countries of activities that take place within their jurisdiction.
Closest to home we had the conclusion in late January of the six-year audit of Google’s activities in the UK by HMRC. By and large HMRC seem to have accepted the premise of Google’s structure as it is generally understood and the rough position is outlined in the Supplementary Written Evidence that HMRC provided for the House of Commons Public Accounts Committee when they convened a hearing on this matter a few weeks ago.
Under the structure Google’s sales are booked by Google Ireland Ltd in Dublin. Google Ireland contracts with a subsidiary, Google UK Ltd, which provides “marketing services” to Google Ireland and liaises with Google’s largest customers in the UK.
A critical part of the audit was whether the activities of Google’s staff in the UK are close enough to the sales to mean that Google Ireland had a permanent establishment or branch in the UK. This would accept that the sales are booked by Google Ireland but that this activity actually happens in the UK rather than Ireland.
HMRC have concluded that Google Ireland does not have a permanent establishment in the UK and therefore Google Ireland does not owe UK Corporation Tax on sales made to the UK. The parent company’s most recent 10-K filing for 2015 in the US shows that based on the billing address of customers Google generated $7.1 billion of sales from the UK.
Another part of the audit involved analysing the remuneration of Google UK for the activities it undertakes. The 2006 accounts of Google UK include the following note:
Turnover represents the total intercompany cost plus at 8% charged to Google Ireland Limited for sales and marketing and cost plus 10% for research and development charged to Google Inc. during the year, excluding value added tax.
The most recent accounts show that in the 18 months to June 2015 Google UK had revenue of £1,178 million with £890 million coming from Google Ireland and £288 million from Google Inc. The reported operating profit of £123.7 million suggests there has been a small uplift in the margins used in the transfer pricing arrangement but not significantly so. Although not broken out it seems that part of the outcome of the HMRC audit relates to the treatment and deductibility for Corporation Tax purposes of share-based staff remuneration rather than the remuneration of the activities of Google UK per se.
Anyway the political reaction has been as expected. The PAC state that:
The lack of transparency about tax settlements makes it impossible to judge whether HMRC has settled this case for the right amount of tax.
before going on to declare that:
The sum paid by Google seems disproportionately small when compared with the size of Google’s business in the UK, reinforcing our concerns that the rules governing where corporation tax is paid by multinational companies do not produce a fair outcome.
A crucial aspect was whether Google Ireland had a de facto branch in the UK and HMRC have determined that it does not. But the PAC are sure to be interested in how this is being viewed by other tax authorities – namely in France and Italy.
In essence, the French and Italian tax authorities are following the same approach as that undertaken by HMRC in the UK. In a similar fashion Google Ireland has subsidiaries in France and Italy, Google France and Google Italy, and these also provide “marketing services” to Google Ireland and get their revenues from Google Ireland.
In 2014, Google Italy had revenue of €54 million and reported a profit of €4 million. Over 60 per cent of expenses were personnel costs. For 2013, Google France had revenue of €225 million with a profit of €20 million. Again personnel costs made up over 60 per cent of expenses. Given the profit levels the (relatively small) amount of tax paid can be roughly discerned.
France and Italy might quibble with the remuneration by Google Ireland for the “marketing services” provided by Google France and Google Italy respectively but that is not where the pot of gold is.
France and Italy are also looking at whether Google Ireland has a permanent establishment in their countries. Again what is at issue is whether the activities of the staff are sufficiently close to the sales of Google Ireland that they constitute a branch of Google Ireland in those countries. We don’t have figures for Google’s revenue from customers with billing addresses in France or Italy but the suggested figures are that it is around €1 billion per annum in France with a somewhat smaller figure originating from Italy.
Although final assessments have yet to be made the tax amounts involved are significant – apparently €1.6 billion in the case of France and €227 million in the case of Italy. It appears around one-third of the €1.6 billion figure for France arises from interest and penalties for not declaring a tax presence but the potential tax sum is large.
However, there does appear to be a bit of leap here to arrive at these tax figures. As it stands the sales are booked in Ireland but this doesn’t result in massive taxes falling due in Ireland. How are Italy and France (allegedly) determining much higher tax bills by claiming the sales of Google Ireland are booked in branches the company has in their jurisdictions?
Google Ireland’s accounts for 2013 show revenue of €17 billion. The companies main expenses were “cost of sales” of €5.1 billion and an “administrative expense” of €11.7 billion. The cost of sales is the money to third-party websites which host ads from Google and this is around 30 per cent of the ad revenue. “Administrative expense” includes around €0.4 billion of costs in Ireland and also the fees paid to the subsidiaries of Google Ireland in the various countries for “marketing services” but the main component of this expense is the royalty paid for the license to sell advertising on the Google platform. This fee was €8.5 billion of Google Ireland’s “administrative expense” in 2013. The deduction of the cost of sales and the administrative expense from revenues leaves a profit in Ireland of around €200 million and Corporation Tax due in Ireland of around €25 million for sales in all of Google’s European markets.
So how can the tax due in France, in particular, and Italy be a multiple of this? One avenue could be that they are challenging the royalty fee paid by Google Ireland. Even if they determine that Google Ireland has a branch in their country the taxable income remaining could be negligible after the royalty fee is deducted. For the company as whole Google Ireland’s costs are almost 99 per cent of revenue. What reason is there to believe that this would not be similar for a branch of the company undertaking the same activity?
The size of the royalty fee can be challenged but it is possible that they are not going down the route but looking at the tax treatment of it and, in particular, whether it is subject to a withholding tax. The report on the Italian audit says:
In addition, some 600 million euros of royalties should have been revealed to the tax authorities and would have faced a tax demand for some 200 million euros.
Google Ireland does report that it pays some “foreign withholding tax” but the amounts are small with €8.5 million paid in 2013 and €17.5 million in 2012.
As we know the royalty fee incurred by Google Ireland is paid to The Netherlands. The most recent accounts for Google Netherlands Holding show that it received €9.2 billion of royalty income from Google Ireland in 2014. This payment, or a variation thereof, would still be due if sales are not booked in Dublin but are booked by branches of Google Ireland in the various countries.
At present, the Revenue Commissioners do not subject this outbound payment from Ireland to a withholding tax. One justification for this is that the payment is made to a company in another EU Member State and such payments are exempted from withholding tax under the EU directive on the taxation of interest and royalties. Besides those arising from the EU directive there can also be exemptions from a withholding tax in other provisions of domestic law.
However, even if the provisions of the EU directive have been transcribed into domestic law there are a few bases on which it can be argued that the royalty payment could be subject to a withholding tax. It could be said that Google Netherlands Holding does not qualify as a “beneficial owner” per article 1(4) given that it transfers 99.9 per cent of the royalty it receives to Google Ireland Holdings in Bermuda (or apparently it does). Alternatively it could be argued that the withholding tax should apply so as to prevent “fraud or abuse” under article 5 of the directive.
These are possibilities but it is not clear that any them would actually apply. And for these countries to impose a withholding tax it first of all requires the determination that Google Ireland does actually have a permanent establishment in their jurisdiction. In the only known audit concluded to date on this matter HMRC have determined that Google Ireland does not have a permanent establishment in the UK. But that doesn’t mean that France or Italy can’t determine that Google Ireland has permanent establishments in their jurisdictions – this can be through a difference of facts or, maybe more likely, a difference of interpretation. And just because HMRC have concluded their audit doesn’t mean they are right. Truth be told there is no “right” but let’s not go there.
Even if other countries can show permanent establishment they would further need to establish that a withholding tax can be applied to the outbound royalty payments of that permanent establishment (with the possibility of challenging the size of the royalty also an option – again a matter of interpretation). If the royalty payment was paid direct to Google Inc. in the US (as it possibly should) then it is likely that no withholding tax would apply. But the payment isn’t made to the US so there doesn’t seem any leeway for someone from the US Treasury to try and intervene by arguing that EU Member States have no right to tax these monies. This is about countries exercising their right to tax activities that take place within their jurisdiction and because of the countries involved US tax treaties do not apply.
Anyway, one first-round statistical implication of attributing the sales of Google Ireland to branches in the various countries is that the flows would no longer be recorded as imports and exports in Ireland’s Balance of Payments. And for these countries there would be a reclassification of the current computer services import as a patent royalty import. The GDP effects in both cases would be negligible (provided the royalty paid by the branch is of a similar magnitude to that currently paid by Google Ireland).
How will the Revenue Commissioners react? Will they be passive and say “after you” to countries who deem Irish-resident companies to have permanent establishments within their jurisdiction? If such branches are deemed to exist would they argue that the royalty fee should be paid from the branch to the parent here without being subject to a withholding tax? Would they be prepared to challenge the transfer pricing parameters of such arrangements? Do they have the resources to do any of this? Should they be charging a withholding tax?
And what of the implications for Google? Well the implications in the UK seem slight in comparison to the (alleged) potential outcomes in France and Italy. What about the implications for the infamous “double-irish” structure that Google uses? In essence, this is not a relevant feature of the various audits being undertaken. What the tax authorities are concerned with is establishing the activities that take place within their jurisdictions and the remuneration and taxation of same. The place of incorporation of the companies is a bit of a side-show – except, that is, for US tax reasons.
The main reason for putting in place a “double-irish” structure is to engineer a deferral until repatriation of the US corporate income tax that would be due on these profits. The US has a general deferral for sales company profits but if there are profits from royalties, rents, interest or dividends the anti-avoidance measures in Subpart F of the US tax code for passive income kick in and the US tax becomes due for payments regardless of whether such profits have been repatriated or not.
Well, that was the original intention of Subpart F when it was introduced in the early 1960s but it has been significantly watered down since then with various provisions and exemptions. The structures are all multi-layered and include many methods through which a deferral of the US tax due on passive income can be achieved. Even if one fails there will be another to step in.
The principle exemption that a “double-irish” structure is designed to avail of is the “same-country exemption”. That is, the transfer of passive income between two companies in the same country does not trigger a payment of the US corporate income tax due under Subpart F.
Of course, the US judges “same country” on the basis of place of incorporation so we have two Irish-registered companies, Google Ireland Limited and Google Ireland Holdings, being classed as being in the same country even though one is in Dublin 2 and the other in Hamilton, Bermuda. [Google uses “check the box” to have Google Netherlands Holdings assessed a disregarded entity in this instance. The royalty payment does not go direct from Ireland to Bermuda as Ireland would have levied a withholding tax on such transfers to a non-treaty country.]
What would happen to the “same country exemption” if the royalty payments originate in branches of Google Ireland in other countries? From this remove it is impossible to tell. And with provisions like the “look-through rule”, “check the box”, and others there are multiple ways of achieving the same deferral outcome.
And we don’t know if all of this is just idle speculation. HMRC have completed their audit and concluded that Google Ireland does not have a permanent establishment in the UK under the Irish-UK tax treaty. There isn’t anything sufficiently different in our tax treaties with France and Italy to suggest that the definition of permanent establishment used will lead to a different outcome. Of course, the facts may be different or, even if the same, France and Italy may apply a different interpretation to the PE provisions. And it is also the case that this tax risk has been obvious to Google for some time – one would imagine from the time the structure was put in place - but knowing the risks and avoiding them are not the same.
Is there any take-out point from all of this. Maybe not! But it does show that countries are not trying to unravel the “double-irish”. It is a part of the story but they are not hugely interested in what goes on in Ireland – or more precisely they are interested in what does not go on in Ireland. They are interested in the activities that are carried out in their countries. What they are doing is looking at the structure and wondering if the nature of the activities that happens is such that they can dip into the flows that begin with customers in their jurisdictions and capture some tax revenue from them. All sides are generally acting as they should; let’s see how it plays out.
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