Calculating Google’s profit in Ireland – it’s not too difficult

Here are the top line figures from Google Ireland Ltd.’s profit and loss accounts for the three years to 2014.

There are two items to be considered in the transition from turnover to operating profit: cost of sales and administrative expenses.

The cost of sales item is relatively straightforward and quoting from Google Ireland’s accounts it is described as:

Cost of sales consists of traffic acquisition costs.  These costs consist of amount ultimately paid to Google Network Members, as well as to partners who directs search queries to Google’s websites.  These amounts are primarily based on revenue share arrangements under which the Company pays its Google Network Members and other partners a portion of the fees it receives from advertisers.

There is little to dispute here.  Google places ad on the websites of third-party hosts and pays them a share of the advertising revenue.  For the three years shown above Google Ireland paid out around 30 per cent of the revenue it received to sites that hosted its advertising.

OK, so now we are as far as gross profit.  The next item is administrative expenses.  There is a little complication here as the actual process is somewhat the reverse of what is shown in the profit and loss account.  The P&L shows operating profit as been the result of the subtraction of administrative expenses from gross profit.  In reality, though, the operating profit figure is determined first and the administrative expenses figure is reverse engineered to give the operating profit figure.

By far the largest component of administrative expenses is the license royalty that Google Ireland Ltd. pays for the rights to sell advertising using Google’s platform and technology.  There are no details on this fee in Google Ireland Ltd.’s accounts but the accounts of the payee, Google  Netherlands Holdings Ltd. do tell us how much is paid by Google Ireland Ltd. each year.   These figures were:

• 2014: €9,221.6m
• 2013: €8,482.5m
• 2012: €8,554.7m

Using these we can get the levels of administrative expenses excluding the royalty payment.

From this we can see that for the past three years Google Ireland’s operating profit has been around 6 per cent of its expenses (excluding the license payment).  And, albeit in rough terms, this is how the profit of Google Ireland is calculated – it is determined on a cost-plus basis.  We don’t know the precise formula used and there are likely to be some non-qualifying items in the “other administrative expenses” figures shown above.  A cost-plus agreement of eight per cent of qualifying expenses may be what is applied but we can’t tell that from the published accounts.

Is there anything untoward about this? Not at all. Cost-plus agreements are a standard feature of transfer-pricing agreements.  Is the cost-plus agreement the appropriate one to use?  Well, there is no right or wrong answer to this.  If you want to argue the toss the OECD have this useful guide to the methods available.

We can get some insight into the expenses incurred by Google Ireland from its accounts.  We that depreciation is around €50 million a year with compensation of employees coming in at around €300 million a year.  But even with the items listed most of the expenses are in the balancing item of “residual expenses” in the table below.

Google Ireland’s accounts don’t tell us what these “residual expenses” (my description) are but we can see them in the revenues of other Google companies such as Google UK, Google France, Google Italy etc.  These are the amounts that Google Ireland pays to subsidiaries in the countries in which it sells advertising for “sales and marketing services”.  A scout around the accounts for the various Google Ireland subsidiaries throws up the following figures for payments received from Google Ireland Ltd. over the past few years.

It can be discerned that these payments make up the bulk of Google Ireland’s expenses (excluding the license fee).  By adding in all the markets which Google Ireland sells into would get us pretty close to the total required. 

Ireland is free to challenge the cost-plus method used to determine the operating profit in Ireland and the other countries can challenge the basis used to determine the basis used to determine the operating profit of the Google subsidiaries in their country or look to see if Google Ireland has a permanent establishment, or taxable presence, in their jurisdiction.  HMRC have just completed a six-year audit on this basis in the UK and both the Italian and French tax authorities are looking at Google’s structure.  See previous discussion of these here.

Google Ireland’s operating profit is a function of its expenses.  These expenses include the staff and other costs that are incurred in Ireland and also possibly the payments made for “sales and marketing services” to subsidiaries in the markets into which Google Ireland sells.  If these expenses go up (i.e. the company gets bigger) then Google Ireland’s operating profit will go up.  Google’s profits in Ireland are not a function of revenue though are continually presented in that fashion.  And Google then pays 12.5 per cent Corporation Tax on those profits. It’s not that difficult.