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‘Starbucks vs the people’

Prof. dr Hans van den Hurk

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The world is changing....

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https://www.youtube.com/watch?v=alcKsti_8QQ

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Where to start?

• International tax planning will be influenced by:

– OECD-modeltreaties and softlaw

– UN-modeltreaty

– Emerging countries and upcoming economies

• BRIC

• Taiwan etc

• Ghana

– EU

– NGO’s

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What role play EU MS’s in this?

• Best way to illustrate this is with an example

– In this situation: Google

• Why Google?

• Well:

– Use of Ireland

– Use of Netherlands

– Thus.. Standard tax planning and challenged by NGO’s

• What is wrong with it?

– Let us see....

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Google

• Some facts: – Annual revenues (2011): $ 37.905.000.000

• (2012: $ 50.170.000.000)

– Incorporated 1998 in California

– Effective Tax Rate: 2,4%

– Regular US Tax Rate: 35%

• To be discussed:

– US legal framework in a nutshell

– Google’s Tax Planning Toolkit

• Step 1: IP shifting

• Step 2: The Double Irish

• Step 3: The Dutch Sandwich

• Step 4: H(e)avely Bermuda

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To be created…

GIL

Netherlands

Ireland

Bermuda

US

IP income

EMEA subsidiaries

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Few words on US system

• Principle one – Worldwide Taxation for companies incorporated in the US

– Credit system

– Overseas profits are taxed when brought to the US

• Principle two – Avoidance of Double Taxation, two systems

• (Deduct foreign taxes from their domestic US taxable base)

• Ordinary foreign tax credit

– Most companies use the latter

• No foreign tax credit for ‘Voluntary’ taxes

– Companies have to exhaust remedies to reduce foreign income taxes

– Or companies have to have an at least should opinion from a respected firm

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US Legal Framework (2)

• Principle three – Anti-avoidance legislation

• Subpart F Regulations – Passive Income

– Income derived from inter-company dealings

• Intention

– protect US Tax Base by inhibiting artificial shifting abroad of profits and the subsequent use of tax havens

• Principle four

– Transfer Pricing • According to OECD criteria ‘at arms length’

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Google’s Tax Planning Toolkit

• Step 1: IP shifting – Google did foresee a raise in value of the IP

– IP was shifted oversea based on a Cost Sharing Agreement (§1.482-7 FTR)

• CSA: agreement that parties share costs to develop IP in proportion to their shares of reasonable exploitation of the interest in the IP

• Allocation of costs should be at arms length

– In case of existing IP to be brought in the CSA, other participants are required to effect a so-called ‘buy in’ payment at arms length

– If IRS agrees there will be no TP adjustments

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How did Google do this?

• Google creates in 2003 subsidiary in Ireland, called Ireland Holdings

• Through CSA the latter obtained rights to Google’s IP for EMEA

• Since Google owned pre-existing IP Ireland Holding effected a buy-in payment to comply with the US rules

• In 2006 Google created legal certainty by obtaining an APA – It is expected that the buy-in payment was at arms length

• EMEA revenues are now attributable to Ireland Holdings

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Step 2: The Double Irish

• Google Ireland Limited – Establishment of second Irish subsidiary in 2003

– Functions of GIL:

• Generation of passive income through collection of royalties

• But mostly coordination of activities in EMEA

– Google Ireland Limited (GIL) was created by a Dutch intermediary company

• Ireland Holdings (IH) licenses IP to GIL via Netherlands

• EMEA countries pay fees to GIL

– Deductible in these countries

– Margin of fees taxable in Ireland at 12.5%

– Press: 88% of Google’s overseas profits flow to GIL

– But are these profits taxable in GIL?

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Google checked the box?

• Assumingly they did... – Irish Ltd is not on ‘per se’ list

– Subsidiary (GIL) is clearly a separate legal entity

– GIL can therefore choose to be treated as disregarded entity

• What does it mean? – IH could be caught by Subpart F legislation

– IH merely receives royalties and has no active income

– Under Subpart F IH would be qualified as follows: • Wholly owned subsidiary of Google US and only generates passive income

• This triggers US CFC legislation and profits would be deemed to be distributed to the US

– By checking the Box • GIL becomes division of IH for US tax purposes

• Since GIL is predominantly active its business income will be attributed to IH

• There it will outweigh the passive character of IH’s income

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Creation of a Hybrid

• IH’s effective place of management (mind and management) is in Bermuda, although almost 2000 people work in HQ in Dublin

– Tax Rate 0%

– Irish tax rate as said 12.5%

– So any IP income that is received via the GIL/EMEA will be taxed at 0%

• No Permanent Establishment risk since most of the more than 2000 employees work for GIL

• Hybrid classification

– US still sees IH as a Irish corporation

– Ireland looks at IH as a Bermuda corporation

• One problem:

– No tax treaty between Ireland an Bermuda, therefore WHT 20%

– How to solve this? .... Use a Dutch intermediary

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Using the Netherlands

• Dutch Sandwich looks as follows:

GIL

Netherlands

Ireland

Bermuda

US

IP income

EMEA subsidiaries

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How does the condensed P&L look?

• Suppose income 1000 GIL receives 1000

Suppose 2% remains in Ireland 20

-/- ____

Netherlands receives 980

Due to Dutch tax ruling 0.2% is payable 1.96

-/- ____

To be distributed to Bermuda 978.04

Effective tax rate in chain: 21,96/1000 = 2.2%

In reality it is 2.4% whereby only 88% flows through GIL

• How does the Dutch sandwich work?

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Dutch Sandwich

• Dutch BV is called Holding BV – Private limited liability company

– The box is checked • From US tax perspective it does not exist

• Other countries see it as a separate legal entity

– Holding BV acts as conduit company • Holding BV has an exploitation license from IH for IP

• Holding BV sublicenses this IP to GIL

– In the Netherlands a small taxable spread will be reported, provided that

• Substance

• Real risk incurred

– Company’s equity is 50% of average anticipated yearly gross royalty income

– Or € 2M, whatever criterion has been met first

• Since Annual revenues: $ 37.905 Billion, the latter criterion is easily met

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Tax aspects Ireland-Netherlands

• Yes, there is a treaty • Art.10, par.1 Treaty between Ireland and the Netherlands

• And the Interest & Royalty directive • No withholding tax between Ireland and the Netherlands with respect to Royalty payments

• ‘Beneficial owner’ versus ‘Ultimate Beneficial Owner’

• And back to the IH? • Netherlands do not levy withholding taxes on outbound royalty payments

• So net royalty’s arrive ‘tax free’ in Bermuda

• And the Dutch spread?

– This is taxed in the Netherlands • Dutch position contributes in total €1.5 Billion to the Dutch Economy

– But this taxation can be credited in the US

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And Bermuda?

• Bermuda’s directors are two attorney’s at a Hamilton based law firm

• It is not fully clear but it is expected that Google Bermuda is nothing more than a letter box company

• Dividends have to remain in Bermuda in order to avoid US Taxation

• In order to ‘optimize’ IH was transferred from LLC to Unlimited Liability Company in order to prevent publication of IH accounts – IH is still checkable so this step does not harm the structure

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Uncork the champagne?

• Well, better wait a while... – ‘Locked Out Profits’

• Repatriation leads to US CIT

• This is the main problem of the structure

• It is expected that companies like Google, Pfizer, Apple, Cisco etc. have $1.375 trillion accumulated profits in overseas tax havens

– $ 1.375.000.000.000!

– Lobbying for Repatriation Tax Holiday

• First time in 2004

– 5.25% tax rate provided that corporations would invest this money in job creation, R&D etc. In the US

– However many loopholes where found to not having to do so

• Can US challenge this behavior?

– Not sure: multinationals spend alone $3.5Billion on lobbying!!!

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And Google shareholders?

• Two ways to get a dividend

– First alternative:

• selling their shares and realizing the dividends via a capital gain

– Second alternative • Google Holding US acquires a lone to finance the buy back of shares

• Possibly (I am not sure in this) from the Bermuda company

• Interest deductible in US

– Taxed at 0% in Bermuda

• See: http:/www.nytimes.com/2013/05/03/business/how-apple-and-other-corporations-

move-profit-to-avoid-taxes.html?_/r=1&

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Is Google to blame?

• Tax strategy is commonly used

– Other companies take comparable approaches

• Questionable is probably whether Bermuda is a letterbox

– If so, the dual resident status should be ignored

– Ireland has to fully tax IH in that situation

• A little bit of hypocrisy is the request for a ‘tax repatriation holiday’

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What do other companies use?

• Other companies use either comparable structures or structures based on the following elements:

– Profit participating loans

– Tax treaties • Substance

• Withholding taxes

– Participation Exemption

– Beneficial tax treatment for certain areas • Swiss holding regime

• Luxembourg ruling regime

• Hungary

– Etc.

• But are all of these elements responsible for tax avoidance?

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Bad boys... And governments?

• For example the UK... – On the one hand:

• George Osborne: In 2014 the UK will have lowest CIT rate for any Western economy!

• Several new tax arrangements which will increase the position of the UK as the country to invest in

– Innovation tax breaks, etc.

– On the other hand: • Thousands of new hires to become tax inspectors

• See his ‘justification’ in Wall Street Journal, April 13, 2013

• Another example from yesterday’s papers – France’s EDF, state owned for 84% uses a Dutch financial holding

– As do many other French companies

• And the Netherlands? – Discussion going on is merely about letterbox companies

– And we lease our trains from an Irish company

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Conclusion.... Deadlock!

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And now? • Three main influences, OECD, UN and EU

– OECD • OECD Report on Harmful Taxation

• OECD Harmful Tax Project 2004 Progress Report

• Several other reports like:

– Tackling Aggressive Tax Planning through Improved Transparency and Disclosure

– Corporate Loss Utilization through Aggressive Tax Planning

– Hybrid Mismatch Arrangements: Tax Policy and Compliance Issues

• Will OECD help solving tax competition? – Probably not. Politically too complicated

– However in 2013:

» Report Base Erosion and Profit Shifting

» After Tax Hedging

• Recent report to G20: – April 2013-OECD-SG-Report-to-G20-Heads-of-Governments

» Part I, developments on exchange of information (Progress Report).

» Part II is report by OECD on current work that is relevant to tackle offshore tax evasion and tax avoidance

• Decision G7, May 2013: http://www.bbc.co.uk/news/business-22476233

• G8, June 2013

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United Nations

– UN

• Main difference to OECD: ‘more source state based’

• Relevance of UN strongly underestimated

– See problems with BRIC Countries

– UN Model Treaty is more focused on the (developing) state » Sometimes due to lack of knowledge free interpretation by some states which will

normally not lead to a more favorable position for companies

• Some countries go even beyond UN basis – See e.g. TP-discussions with India

• Also coordinated initiatives for further development, one example: – Resolution from March 20, 2013: Promoting transparency, participation and

accountability

» http://www.un.org/ga/search/view_doc.asp?symbol=A/RES/67/218&Lang=E

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European Union

• In 1997 the first Code of Conduct Group was established – From a legal point of view the so-called Primarolo-report is softlaw

– However the results have been widely accepted • See: http://ec.europa.eu/taxation_customs/resources/documents/primarolo_en.pdf

• New list of Code of Conduct Group (June 2012)

– List contains:

• Rollback measures

• Standstill Discussion – UK: Guernsey, Gibraltar

» Progress has been made recently

• Anti-Abuse measures – Profit Participating Loans

– Mismatches Hybrids and PE’s

– Beneficial treatment of Interest, Royalty’s etc.

• Some specifics regarding third countries like Liechtenstein

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New EU Tax developments

• Communication December 2012: ‘An Action Plan to strengthen the fight against tax fraud and tax evasion’

– Will it be successful? • After the result of the 1999 report it is expected that it will be partially successful

• Commissioner Algirdas Semeta is pushing this Action Plan

• Commission Decision of April 23, 2013

– A Platform for Tax Good Governance, Aggressive Tax Planning and Double Taxation will be created

– Support of MS, NGO’s and Industry is being requested

• May 22, 2013: Country leaders have discussed tax evasion in EU

– Van Rompuy: a trillion euro's is lost every year by tax planning

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Once ignored, now important

• NGO’s – Action Aid

– Christian Aid

– Robinhoodtaxes.org

– Tax Justice Network

– War on Want

– UK Uncut

• You really think it has no impact on YOUR tax practice? – Forget it, every tax director is concerned for

• Getting information in the press (Reputation)

• Not being able to deliver information requested by ‘the people’

– E.g. What did you pay in which country based on what profit?

– Country by country reporting with respect to taxes is what NGO’s want

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How will they impact Tax Planning?

• From ‘blame to shame’ – It is perhaps correct what you do but you shouldn’t

• Tax Planning often based on legal concepts – Profit allocation PE: functions, risks

– But that legal approach is not always strong • See video called ‘Vodafone Swiss Swizz’ http://www.youtube.com/watch?v=XAenlYsV7A4

• NGO’s expect from companies to behave as ‘good tax paying citizens’

• NGO’s are also fighting against Governments which retain their competitive laws

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Conclusion

• The world is changing – Due to modern media the world turns smaller

– People use these media to impose change

• Governments seem to act passively – Simply because they have their financial interest

• Companies retain their traditional tax planning schemes – Since shareholders see tax as costs

• In the end the weakest position seems to be for the companies – ‘Corporate Social Responsibility’ influences ‘Shareholders Value’

• But the battle just begun!

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Want to be ‘up to date’?

@Hansvandenhurk Hans.vandenhurk@maastrichtuniversity.nl Hvandenhurk@deloitte.nl

http://www.deloitte.com/view/nl_NL/nl/diensten/belastingadvies/fiscale-informatie/fiscale-expertisegroep/hans-vanden-hurk/

Some recent publications can be downloaded via:

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Thank you!