http://www.youtube.com/watch?v=8wAVAs2h3_Y
On 30 September, the European Commission started an investigation into deals between the government of the Republic of Ireland and Apple that helped the US company avoid tax. If the commission rules the deals are illegal state aid, Apple might be liable to repay billions of dollars it saved in tax in 1991-2007.
The Commission is conducting similar investigations into other deals between European governments and international corporations. They include Fiat, Starbucks and Amazon.
The previous day, UK Chancellor of the Exchequer George Osborne told the annual conference of the Conservative Party, partner in the coalition government with the Liberal Party formed in 2010, that he would use the annual Autumn Statement about British government finances to stop large technology multinationals avoiding tax.
Technology companies “that go to extraordinary lengths” to cut their tax bills will be hit with new anti-avoidance rules, Osborne said.
“My message to those companies is clear: we will put a stop to it,” Osborne said. He said his plans will involve new rules that would produce hundreds of millions of pounds a year in tax for the British government.
Washington has also signalled it wants to act to prevent US corporations using havens like Ireland to avoid American taxes. A US Senate report published last year said Apple avoided $9bn in US taxes in 2012 alone.
Google’s financial statements show the company paid the equivalent of less than 1 per cent of the $5.5bn in sales it generates annually from UK clients.
The way these arrangements work is simple. Companies incorporate a subsidiary in a country with low corporation tax. It then books revenue generated in deals in high-tax jurisdictions with the subsidiary. The final part of the puzzle often involves a further subsidiary in one of several countries that allow offshore banking to which the income is ultimately transferred.
The profits produced can be reported in consolidated profit and loss statements. That will simultaneously lift the market value of the firms benefitting from this process since it is often based on a multiple of net income.
Critics of international corporations as well as those calling for large firms to pay their fair share of taxes have welcomed these moves.
But their effect could be less than anticipated.
The large US IT firms most adept at corporate tax avoidance have in America and elsewhere established close connections with governments that regulate them. Charges that they are tax-avoiding Robber Barons have also failed to strike a chord with the public, many of whom admire Microsoft, Google, Apple and Facebook.
These companies are well-supported by high-flying accountants and lawyers. And they have greater resources than the tax authorities seeking to monitor them.
“The HMRC (HM Revenue & Customs) is completely outgunned,” the Sunday Times quoted one senior tax adviser as saying in a report in the weekly newspaper on 5 October.
Economics2030 has no opinion about the virtues of corporate taxation or its level.
But its analysis of the cat-and-mouse game played by corporations and tax authorities provides a better understanding of why corporate tax avoidance has become both pervasive and easier.
Analysis of the financial statements of the 10 largest companies listed on the London Stock Exchange shows that about 80 per cent of the assets reported on their balance sheets are non-tangible.
For large service corporations, including banks, the proportion is often greater than 90 per cent. The Guardian Media Group Plc, a privately-held media company, reported it had property, plant, equipment and inventories worth just over $30m at the end of 2013. That was less than 2 per cent of its total assets. The rest were intangible assets, including financial instruments.
A factory or a warehouse has to be located somewhere and it’s close to impossible to move it quickly from one country to another. It also needs to be near to sources of labour and markets. That is why most factories are still in or close to major cities.
Intangible assets and financial instruments, in contrast, can be moved instantly and almost costlessly with a couple of strokes of a keyboard. All that is needed is for a company’s finance director to convince its auditors that doing so is legal and in line with a reasonable interpretation of accounting codes and for the jurisdiction in which the intangible assets are registered to be compliant.
There is no need for labour because there is no machinery to operate or warehouses to fill. You don’t have to be near markets either since intangible assets don’t have to be where the services they support are created. So all Starbucks’ intangible assets can be incorporated in the Netherlands while many of the employees those assets support work in the UK.
Luxembourg will do just as well.
This is exactly what Apple and others have achieved for 25 years in Ireland, the Cayman Islands and other offshore tax havens. It’s saved them billions of dollars and is one of the reasons why many have delivered far higher profit rates than makers of tangible goods.
Action by the EU, UK and US to stop the excesses that have been a feature of such arrangements since the late 1980s is now likely. That will be underpinned by measures announced by the OECD in September to crack down on tax avoidance. These become effective in 2017.
But it’s difficult to believe that this will be the end of the corporate tax controversy. The returns on manipulating balance sheets and profit and loss statements are so enticing, it is inconceivable corporations will stop trying to do so.
It’s been said that it is likely that an attempt would be made to set up tax havens on the Moon or Mars in the unlikely circumstances of every jurisdiction on earth imposing and enforcing uniform corporate tax codes.
Are champions of the corporate tax crackdown, therefore, doomed to be disappointed?
We shall see.
But the key to this issue is not strengthening regulations and extending the powers of enforcement agencies so they can act at a regional and global level.
It resides in understanding that the rise of large-scale corporate tax avoidance is entirely due to the growth of intangible assets on the balance sheets of major corporations.
Economics2030 argues that the concept of intangible capital has no valid support either in economic theory or in natural law. Intangible capital is exclusively the product of incremental change in accounting codes, over which large corporations have enormous influence, and laws allowing corporations to manufacture intangible assets that have been passed by legislatures where corporate influence is strong. One example among many is the UK government’s decision – much to Germany’s fury – to cut tax on intellectual property registered in the UK to 10 per cent.
But the rise of corporate tax avoidance is not due to defective laws, enforcement or, even, corporate morality.
It is the inevitable result of the failure of economics to take into account the implications of the growing preponderance of intangibles in advanced economies and their increasing importance everywhere.
For a full account of the origins and implications of the rise of intangible capital, click here.