A new game with no rules: Part 2, Where are the brand values?

January 9, 2013 | Banks, Capital markets, Global news, HSBC, Nations, Regulation, Speculation, Standard Chartered, Starbucks, Taxation

[Continued from yesterday’s Part 1.]


By:David A. Smith                                                         


You’re unstable, you
I’ll enable you
I’m codependent

Codependent, by John Forster


You want that protest grande?


Yesterday’s post on the new century’s new games with no rules, using two stories from the same issue of the December 15, 2012 Economist: Too big to jail in black font, and Wake up and smell the coffee in blue font, focused on one part of the game:  the slippery wrestling where corporations skirt or flout global rules on capital flows.  But there’s another game – legal tax minimization – and its counter-game – tu quoque public shaming of corporations for punctiliously complying with the very rules competing governments establish to lure them to immigrate:


You see, we pour the income from one country to another


“This is an unprecedented commitment,” said Kris Engskov, the boss of Starbucks in Britain and Ireland, on December 6th, announcing that the coffee retailer will volunteer to the British taxman around £10m ($16m) a year more in 2013-14 than it is required to pay by law.


Mr. Engskov is right; it is unprecedented; when does a company voluntarily offer up taxes it need not pay?


It is doing so not under any pressure from the authorities –


This is disingenuous, as we’ll see in a moment.


– which had not been party to the firm’s decision to donate an extra shot of cash to the exchequer, but to please British consumers furious not, as you might expect, at the high price of a latte, but at how little tax the firm pays in their country. “We’ve heard that loud and clear from our customers,” said Mr Engskov.


Pay more taxes and raise our coffee prices to cover them!


The consumers, one should note, were whipped into a frenzy by journalists loving the opportunity to sell newspapers by bashing a foreigner and being fed red meat headlines by a Parliamentary committee where cameras and bottles of water serve as the modern-day stocks.


So kick me around like a dog at the pound
I will still fetch your slippers on cue

Isn’t it enough to fetch your coffee on cue?


Alas, this pioneering effort to transform tax into a marketing expense did not elicit the hoped-for gratitude. On December 8th UK Uncut, a group which campaigns against government austerity and corporate tax avoidance, staged protests at dozens of British Starbucks stores.


At least UK Uncut is consistent, as both its protests boil down to Give us more things for free.


Campaigners point out that since first opening its doors in Britain in 1998 Starbucks has paid only £8.6m in corporate income taxes there. In testimony last month before a parliamentary committee, Starbucks had said this was because it had made a profit in only one year in Britain, though it also admitted that its British business had made large payments for coffee to a profitable Starbucks subsidiary in Switzerland and large royalty payments to another profitable subsidiary in the Netherlands for use of the brand and intellectual property.


Obviously Starbucks is arbitraging the respective national tax systems, and that’s fine as long as the nations have different tax rules.  Remember, in the waltz between capital and property, governments try to attract capital to locate itself on their property, and then to tax it.


Starbucks is not thought to be using the “Dutch Sandwich” and “Double Irish”, even if these sound like items on its menu.  They are legal tax-avoidance techniques believed to have been used by, among others, Google, which was also called to testify before Parliament.


Tasty tax treats


Though the names are hilarious, the structures are revealing:


The Double Irish arrangement is a tax avoidance strategy that U.S.-based multinational corporations use to lower their corporate tax liability. The idea is to use payments between related entities in a corporate structure to shift income from a higher-tax country to a lower-tax country. It relies on the fact that Irish tax law does not include U.S. transfer pricing rules. 


None of this should be surprising to the slightest degree.  All countries have their own tax systems – it’s one of the prerogatives of sovereignty, like controlling the money supply and deciding who is or can be a citizen – and naturally enough, companies choose where they do business based on the tax rules in each country.  Nor is it borderline behavior to buy goods in one place and transport them to another; these are just natural edge effects.

Your life was screwed up
Now mine is too
‘Cause I’m so codependent with you


When there are multiple countries, there can be a cascade of edge effects:


The addition of a Dutch Sandwich to the Double Irish scheme further reduces tax liabilities. Ireland does not levy withholding tax on certain receipts from European Union member states.


Presumably Ireland introduced this law to encourage European companies to establish call centers or sales offices in Ireland.


Revenues from income of sales of the products shipped by the second Irish company are first booked by a shell company in the Netherlands, taking advantage of generous tax laws there. Funds needed for production costs incurred in Ireland are transferred there, the remaining profits are transferred to the first Irish company in the Cayman Islands or Bermuda. If the two Irish holding companies are thought of as “bread” and the Netherlands company as “cheese,” this scheme is referred to as the “Dutch Sandwich.”


The original Dutch sandwich: a kaas broodje


Of course, as legislators add rules, the rules-upon-rules create the potential for games-within-games, and the result can be tax minimization by the companies.  Here’s how Australia’s Assistant Treasurer and Minister Assisting for Deregulation described it:


While the day-to-day dealings of Australian firms advertising on Google might be with Google Australia, under the fine print of contracts Australian firms sign with Google, they are actually buying their advertising from an Irish subsidiary of Google.


It is then argued that the source of this income – and therefore the taxing rights under our tax treaty – would be with Ireland rather than Australia. Despite Ireland’s relatively low company tax rate of 12.5%, we have just started to build the sandwich.


The next step is to route a royalty payment from the Irish operating subsidiary of Google to a Dutch subsidiary of Google, which is then paid back to a second Irish holding company subsidiary of Google that is controlled in Bermuda, which has no corporate tax.


The first Irish subsidiary receives a tax deduction for the royalty payment to the Dutch subsidiary, substantially reducing the income subject to the 12.5% Irish company tax rate.


Under Dutch law, and because EU member countries do not charge withholding taxes on transfers within the EU, the transfers to and from the Netherlands are essentially tax free.


And under Irish tax law, the second Irish resident subsidiary is not taxed on the royalty payment because it is controlled by managers elsewhere.


The profits from the sale of advertising to an Australian firm then sit in a tax-free jurisdiction – possibly indefinitely.”


You’re a bit crook, mate


Google, like every other intelligent company, is minimizing its taxes across multiple tax jurisdictions.  Wouldn’t you?


Most of Google’s revenues in Europe are booked in Dublin, then shifted via royalty payments to a Dutch subsidiary, before whatever is left is recognised as profits by a subsidiary in Bermuda, which levies no income tax.


Why wouldn’t you do this?  Google chairman Eric Schmidt put his foot into his tin ear when he said:


“We pay lots of taxes; we pay them in the legally prescribed ways,” he told Bloomberg. “I am very proud of the structure that we set up. We did it based on the incentives that the governments offered us to operate.”


“It’s called capitalism,” he said. “We are proudly capitalistic. I’m not confused about this.”


Maybe I could have said that better


Mr. Schmidt’s commentary may be ham-fisted, but it’s the logical consequence of the various nations’ tax laws.  If they don’t like companies tax shopping, they have it in their power to stop it, by changing whichever laws they enacted to attract those companies in the first place.


Why aren’t you marching on Parliament?


Another online giant, Amazon, told parliamentarians that its low British corporate-tax bill—£1.8m in 2011—was due to its British operations merely providing back-office services to its main Europe-wide business, which is based in low-tax Luxembourg.


Have you noticed the common element among tax-haven jurisdictions?  They’re all mini-nations or micro-nations.  Such little bolt holes for capital have been popping up ever since the Swiss pioneered the idea.


You just never know what’s going to be in the boxes


In the twenty-first century, where warfare is no longer between armies of infantry but has evolved into tiny pockets of madmen hiding in society to assault it, the classical reasons for nations being large have been devalued, and the benefits of micro-independence are appreciating.  To the incumbents of Monte Carlo, Bermuda, the Netherlands Antilles and the Caymans, we can now add post-meltdown newcomers like Ireland and Holland, nations whose friendliness, English fluency, and tax flexibility have encouraged them to innovate a twenty-first century business model – cleansing global income earned elsewhere with a low rate booked in the taxation way station. 


Punching above their weight?


Although Starbucks denies using tax havens, it admits to having negotiated a secret low rate of tax with the Dutch taxman for its subsidiary in Amsterdam.


And who’s to blame for this – Starbucks?  Or the Dutch government, which decided to undercut its trading and tax partners, and to keep secret its side deal?


Vind je hier


Worldwide, Starbucks says it pays out over 30% of its profits in tax.


For Starbucks, this should be not a point of pride but a rueful admission, the more so as America’s corporate tax rates are among the highest.


Many other firms are making extensive use of havens.


Nations are not a membership group, they compete like anything else.  As the world creates more nations, it creates ever more opportunity for tax arbitrage.


A study published last year by ActionAid, an activist charity, said 98 of the firms in the FTSE 100 index have at least one subsidiary in a haven.


Tax arbitrage accelerates when property becomes intangible and intellectual, because it can be shifted to other tax jurisdictions, and as the property shifts, so too do the profits.


An increasingly popular strategy is to transfer ownership of the multinational’s main intellectual property to a subsidiary in a tax haven, then charge other subsidiaries in higher-tax countries for use of it. Data compiled by the OECD, a rich-country think-tank, highlight how many patents are owned by outfits in such unlikely innovation hubs as Barbados, the Cayman Islands and Bermuda.


Obviously, the micro-states are competing quite well indeed.  Why else would you locate your business in Mauritius or the Maldives?  (Or, if you’re Indian, in Dubai?)  Unless the larger nations are willing to invade and conquer the smaller ones, they’re going to have to accept haven-shopping.


They asked us to invade, in English no less


Or they could take the more radical step, and cut their own tax rates.


Anything but that


In both Britain and America, businesses have been lobbying for cuts in marginal corporate-tax rates, even if this meant losing a few small loopholes, and had started to get somewhere. Their arguments were bolstered by a study in June from the Centre for Business Taxation at Oxford University, which found that the two countries had among the world’s highest effective tax rates (ie, after allowances).


These two countries are cornered; they’re already raising as much as they can from their corporations, and they’ve reached the point where they’ve made it worth companies’ while to shift revenues elsewhere, and it’s worth the micro-nations’ while to attract the shifted revenue. 


We’re doing okay on taxes


Now, though, the public outrage being whipped up over the most lucrative avoidance strategies may cause politicians to shift their focus from making taxes more business-friendly to shoring up the tax base.


However shortsighted, this is extremely tempting, for publicly flogging a foreign company is the political gift that keeps on giving.


George Osborne, Britain’s chancellor of the exchequer, has responded to the furore over Starbucks, Google and Amazon by promising to use the country’s imminent chairmanship of the G8 club of rich countries to wage war on tax havens.


I have tax plans up my sleeve


That’s brave talk; how will you do it, Ms. Osborne?  You can’t pass laws governing Bermuda.


Politicians elsewhere, also facing swelling deficits, may join him in that.


Despite their inability to legislate, the elected officials are on to something – if you cannot tax, perhaps you can shame?  Brand value is global, and as we’ve just seen, companies will pay tribute to protect it.


The [regulator settlement] agreements put an end to uncertainty over the banks’ ability to operate within America, a key link in their global networks; their share prices both rose on the day the fines were announced.


Now we can start rising again


Though neither of them likes the idea, national governments and global corporations have become co-dependent. 


Companies need national governments to maintain enabling environments for capital and business, and to protect property and assets via laws.  Nations need companies to create jobs and profits. 


In Britain Vince Cable was unimpressed by Mr Schmidt’s views. The Business Secretary told The Daily Telegraph: “It may well be [capitalism] but it’s certainly not the job of governments to accommodate it.”


Google this, Google


Actually, it is the job of governments to accommodate profit-making.   Each needs the other, much though they wish not.


Indeed, at a news conference this week Lanny Breuer, head of the Justice Department’s criminal division, suggested that an outright prosecution of HSBC was considered and rejected because of how damaging the impact could be on the bank’s viability, and thus on jobs and the American economy.


For companies, the way out may be genuine, authentic corporate social responsibility.  If they fund authentic non-profits, those who do good work in every country they do business, and in every income segment of their customer base, then the companies will always have some good works and ongoing commitment to which they can point.  And we need the eggs.


You’re my Albatross
But you’re still the boss
I’m codependent with you


That’s not what we wrote