The tax arrangements of Google explained. Facebook, Apple and other corporate tax dodgers do similar things.
Treasury official Rob Heferen in a speech entitled Implications of Digitisation for the Australian Tax System argues that such arrangements might undermine the willingness of all of us to pay tax because we might increasingly see tax systems as fundamentally unfair.
I think this is true for a lot of issues wider than tax, including globalisation in general. If economic integration is associated with increasing inequality it is likely that it will be blamed. The benefits of openness need to be spread by appropriate government policies and effective taxation is integral to this. This is of course one reason why we needed to develop an effective mining tax earlier in the boom.
So how does the Double Irish Dutch sandwich work. Heferen explains:
The notion of Base Erosion and Profit shifting or “BEPS”, has recently entered the public policy lexicon around the world. BEPS relates chiefly to instances where the interaction of different tax rules leads to double non-taxation or less than single taxation. It also relates to arrangements that achieve no or low taxation by shifting profits away from the jurisdictions where the activities creating those profits take place. It is squarely on the G20’s agenda and the OECD is well into a two-year work program in this area.
In recent years, intangibles have been the source of some very high profile and sophisticated tax planning techniques. These have significantly elevated concerns about BEPS. I’m sure many of you would have heard of one such technique that has come to worldwide attention called – the Double Irish Dutch Sandwich. A structure reportedly approved by the IRS.
The basic set up goes something like this. We have a US parent company whose employees developed, over many years, some intellectual property. Let’s say it’s the IP used to deliver internet advertising services. The Parent sells the rights to exploit the IP outside the United States, to its subsidiary company Ireland Holdings. Ireland Holdings is managed and controlled from another jurisdiction – say, Bermuda
Ireland Holdings licences all the rights in the IP to a subsidiary company in the Netherlands – for a royalty fee. The Dutch company sub-licences the IP to Ireland Operations, who is the retailer of internet advertising.
Customers wishing to place ads enter into contracts with Ireland Operations on its website. This could be an Australian business wanting to advertise to its local customers.
As a result of this complex arrangement, we ask, where is the tax paid?
The cost of advertising for the customer is reported as income in Ireland Operations. Its taxable income is substantially reduced by the tax deduction it receives on the royalty payment to Dutch Holdings. Under EU law, withholding tax can’t be applied to the royalty payment from Ireland to the Netherlands.
Similarly, the Dutch subsidiary pays a small amount of corporate tax on the difference between royalties received and paid, with no withholding tax on the payment of royalties.
You would think that the royalty payment received by Ireland Holdings would be taxed in that country, but it is not. This is because of the interaction between Ireland’s residency rules, Bermuda’s tax haven status and the US’ check-the-box rules.
But let’s focus on Australia now. Under this arrangement, the profit on sale of advertising into Australia is not taxable in Australia. But should it be?
Some of questions that run through my head include, is the sale of the advertising, in substance, really a service provided by Ireland to Australia. Does it really look like an import? The complex nature of this structure gives the impression that it is artificial; and more generally it doesn’t pass the sniff test.
Are genuine activities and value-add services conducted in Australia? If so, then conceptually some of the profit should be taxed in Australia and current law says it should.Given Australia's reliance on corporate taxation at a much higher rate than the rest of the OECD making these corporations pay tax on Australian operations probably matters a lot.
Some other relevant sources
Digital Economy Chokes on Online Giants’ Low-Tax Sandwiches
To reduce its tax burden, Google expands use of the “Double Irish”