Google: Don’t Be Evil, Don’t Pay Tax
By Mike SeccombeJune 7, 2012
Double Irish is not a drink order. A Dutch Sandwich is not a snack. These are the names of strategies which keep Google’s tax liabilities minimal as it shifts vast sums of money around the world.
Being a spokesperson for internet giant Google must occasionally be stressful, but surely it doesn't require a lot of independent thought. Most of the time, a trained parrot could do it. Whenever a media representative calls to ask questions about the way your company ducks out of paying tax, you simply recite the script: "Google complies fully with all relevant tax rules in all the countries in which it operates, including ... [insert country details here]."
A couple of weeks ago, Google Australia's spokesman went straight to script when media reports began appearing about Google's latest filing with the Australian Securities and Investments Commission, which showed the company had paid just $74,176 in tax in Australia on last year's estimated revenue of more than $900 million.
The spokesman continued his recitation: "That means that we contribute to all relevant local and national taxation schemes — as well as providing employment for over 650 people in Australia."
Compare this with comments given to Lisa Carroll, writer of The Guardian newspaper's Ireland business blog, when she asked questions about the company's highly efficient tax structure a year ago:
"Google complies fully with all relevant tax legislation in all the countries in which it operates. That means that we contribute to all relevant local and national taxation schemes — as well as providing employment for approaching 2,000 people in Ireland."
Different country, different spokesperson, same line. No doubt the same message goes out in other languages, too — although perhaps not quite so glibly in Hindi, for reasons we'll come to later.
And no doubt it is also true that Google complies with "relevant tax legislation in all the countries in which it operates". It just happens to be the case that the key parts of its operations are in countries such as Ireland, the Netherlands and Bermuda, where the tax legislation is favourable.
Let's start with Ireland, the country which accounts for more than 90 per cent of the company's turnover with third parties outside the United States, according to the investigations of Richard Murphy, the British accountant, economist and tax-policy expert whose work has informed many accounts of Google's tax affairs in various countries.
The attraction, not only for Google, but for many other multinational companies — particularly internet-based firms, which have high-value intellectual property — is Ireland's tax code. "The Google tax position in Ireland is very similar to other internet-based firms which operate here (Paypal, Linkedin, Facebook, etc.)", writes James Stewart, senior lecturer in finance at the School of Business, Trinity College, Dublin, in an email exchange with The Global Mail.
At 12.5 per cent, the Irish corporate tax rate is low, but the real drawcard is that it is flexible, thanks to a network of double tax treaties — particularly with the US — and the ease of incorporation in Ireland.
"The annual Finance Act in Ireland is always introducing amendments to ensure that tax strategies may continue to work," says Stewart.
In spite of the low tax rate, corporate tax payments make up a higher percentage of total revenues in Ireland than in most European countries with much higher rates, Stewart noted last September in a study of the Irish corporate tax system.
The reason is simply that so many multinationals, particularly online companies, use Ireland as a tax haven.
"Data produced by the US Bureau of Economic Analysis (BEA) relating to US companies operating abroad shows … effective tax rates of 4.2% in Ireland compared with 26.8% in France," wrote Stewart.
Depending on the measure used, either the Netherlands and Luxembourg were the largest tax havens in the world for US companies, or Ireland was, according to Stewart.
"Current industrial policy in Ireland is largely thought of in terms of tax reliefs," he wrote.
But such an approach does not encourage innovation or research. It encourages senior management to focus on tax rather than on making and marketing things.
So why is this travesty of governance in Ireland — which as we all know is now something of an economic basket case — relevant to Australia? Because when you buy an ad on Google in Australia, you get billed from Ireland. And those bills add up to an awful lot.
Phil Harpur, senior research manager at Frost and Sullivan, an international business research and consulting firm, says its estimate of the total value of the search advertising market in Australia for 2011 was AUD1.067 billion.
"And we estimate that Google has an 88 per cent share of that market," he says. "That compares with about 89 per cent of an $831 million in 2010."
That works out at close to $940 million Australian revenue for Google in 2011, which is close to a 30 per cent increase in revenue on the previous year.
"That's just search-advertising revenue," Harpur says. "That doesn't include revenue from any other sources within Google, such as video advertising, for example.
"This is only an estimate because there are no official numbers published."
Other estimates place Google's revenue from online ads in Australia even higher, at more than $1 billion.
Google's own spin on its numbers is very different. They say Google Australia paid $781,000 in tax — the lower figure contained in that ASIC filing being just an accounting measure, rather than actual tax paid, they say. And they cite Australian revenue of $201 million, on which they made a loss of $3.9 million.
So where did all the other money go? On a long and winding, stateless journey across the globe.
The journey taken by Google's revenues is something of abiding interest to governments, tax experts and journalists all over the world. We should stress that Google's money is not alone in that journey. According to Richard Murphy, hundreds of multinationals use similar transactions. Google, however is a great case study because (a) we have figures fresh from its recent ASIC filing and, (b) a lot of tax experts in America and elsewhere have studied it because of the sheer size of its tax minimisation efforts. A Bloomberg investigation in 2010 calculated Google had cut its American taxes by USD3.1 billion in the previous three years.
One of the most detailed expositions of Google's tax affairs is contained in a paper entitled Stateless Income by Professor Edward S. Kleinbard, of the Gould School of Law, University of Southern California.
(The paper begins with the rather poignant observation of the difference between stateless people and stateless income: "Stateless persons wander a hostile globe, looking for asylum; by contrast, stateless income takes a bearing for any of a number of zero — or low — tax jurisdictions, where it finds a ready welcome.")
In 2003, Kleinbard explains, just a few months before its initial public offering, Google Inc. set up a wholly-owned subsidiary called Google Ireland Holdings, which then made an undisclosed "buy-in payment" and entered into a "cost sharing agreement" with its parent. As part of the deal — agreed to by the US Internal Revenue Service — Google Inc. licensed the rights to its search and advertising technology outside the US to Google Ireland Holdings.
For Kleinbard, this raised several questions, such as: How could a wholly owned subsidiary negotiate "arm's-length" contractual terms with its parent? And how could capital provided to the subsidiary by the parent somehow become the property of the subsidiary and be treated separately for tax purposes?
Whatever the answers to those questions, Google commenced its Irish operations less than a decade ago with five employees. "Within a few years," Kleinbard writes, "the structure had morphed."
First, Ireland Holdings had become a dual-resident company: that is, for US tax purposes it remained an Irish corporation (because that is its place of incorporation), but for Irish tax purposes Ireland Holdings became a resident of Bermuda, because that is where its "mind and management" are allegedly located.
Second, Ireland Holdings had licensed those core technologies to a Dutch subsidiary, Google BV, which in turn had licensed the rights to another subsidiary, Google Ireland Limited. It is that company which collects the billions of dollars of advertising revenues from the use of those technologies.
And this is what the tax lawyers and accountants — who says such people have no imagination? — call the Double Irish Dutch Sandwich.
As Kleinbard further explains: "Ireland imposes a 12.5 per cent corporate income tax on Irish resident companies; Ireland Limited, therefore, is subject to that tax rate on its net income, but Ireland Limited makes very large deductible royalty payments to Google BV for the use of the core Google intangibles … Google BV in turn makes royalty payments almost exactly as large to Ireland Holdings. The latter is a Bermuda company from an Irish perspective, and Bermuda has no corporate income tax".
The reason for the "Dutch sandwich" part of the deal is that if the royalties were paid directly from Ireland to Bermuda, they would be subject to Irish withholding tax. But that tax does not apply to royalties paid to a company resident in another EU member state, notes Kleinbard, "even one that is an affiliate and that apparently serves no purpose but the elimination of Irish withholding tax."
The Netherlands gets a small amount of tax on the "spread", or difference between the royalties the Dutch subsidiary gets and those it pays out to Ireland Holdings. It is normal in Dutch tax practice, Kleinbard says, to negotiate this sort of spread — really just a fee for the convenience of using its tax system — in advance, with the country's tax authorities.
"Meanwhile, from a US tax point of view, neither Ireland Limited nor Google BV exist at all. The United States sees only an Irish company (Irish Holdings) with a Bermuda branch where most of its net income comes to rest."
You have to admit, it's clever. Google is dudding not only the Australian tax authorities, but also those of all the other countries whose online advertising gets billed out of Ireland; and also the US and, on the face of it, the Irish.
But Ireland does get something out of all this. As Britain's The Sunday Times glowingly reported in February, "a vibrant commercial quarter is emerging from the wreckage of Ireland's economic crash" in Dublin.
"Google employs 2,000 staff there. Soon it will hire another 1,000 after buying Ireland's tallest office block, where the internet search giant plans to install a swimming pool for staff. Twitter is also rumoured to be looking to move into this thriving hub of young talent. And, hottest of them all, Facebook has opened its doors nearby, employing more than 400 at its glass-fronted offices on Hanover Quay."
Oh, puh-lease. It's not Dublin's "young talent" which is attracting them. It's Ireland's tax-haven status.
But let's come back to Australia and the question of why the Australian authorities aren't putting a stop to this rorting of our system.
The federal opposition's communications spokesman, Malcolm Turnbull, has been asking this question since Google's numbers came out. And to his credit Turnbull has, as he said in a blog post on May 21, attempted to raise "an important long-term issue for public policy: the erosion of our tax base due to the growing significance of online commerce and offshore-domiciled service providers in many sectors and markets".
He also says, however: "I am not proposing any specific change to the existing tax laws or flagging a shift in Coalition policy. Nor am I suggesting that the global tax arrangements entered into by global digital businesses, such as Google, are anything but legal. The question is not whether the laws are being complied with (I assume they are) but whether they are adequate in a new, converging digital world."
So, apart from drawing attention to the Google case, and provoking a spirited fight with his government counterpart, Stephen Conroy, Turnbull's involvement has not yielded much.
The government, in response, pretends the issue is close to being solved by new transfer-pricing rules, which are currently in the works. Fond hope.
The truth is, the problem is much bigger than Google and much bigger than Australia. It is a global dilemma: that national and international tax rules have been unable to keep up with multinational corporations, and particularly with multinational corporations which trade in intangible things.
(From an Australian perspective, Google is one of the better multinational tech companies. Google does actually employ significant numbers of staff here, and about half of its Australian workforce is employed in engineering its technology.)
Still, as Edward Kleinbard puts it: "the pervasive presence of stateless income-tax planning changes everything.
"As the example of Google's Double Irish Dutch Sandwich structure implies, it destroys any possible coherence to the concept of the geographic source of income, on which all territorial tax systems rely. It erodes the tax base of high-tax countries in which multinational firms are domiciled through debt-financed tax arbitrage. It privileges multinational firms over domestic ones by offering the former the prospect of capturing … returns derived by moving income from high-tax foreign countries to low-tax ones. And since the costs required to accomplish it create nothing of economic value, it leads to deadweight loss."
They're all doing it, reiterates Richard Vann, Challis Professor of Law, University of Sydney.
"If you go to Amazon, for example, and order products now, you'll see they actually buy them from a Dutch company," he says.
"That's just a sign of the way they're all structuring their operations now. Essentially they locate the selling operation in a country which for one reason or another won't tax them much — Ireland, Holland, Switzerland, countries of that kind."
Furthermore, he says, "it's very hard to work out the revenue from their various operations, and they're not going to help you with that."
As for the Australian Government's assertion that it will address the problem by reforming transfer-pricing laws…
"It's a bunch of nonsense. I doubt it will fix anything. It's essentially a defect in the [international] rules, not anything that Australia can particularly do anything about. They can rewrite the transfer-pricing rules, but it will collect zero revenue in my view," says Vann.
So what are transfer-pricing laws, anyway?
"Transfer-pricing is shifting profits between two related entities by overcharging or undercharging," explains John Passant, tutor at the School of Politics and International Relations at the Australian National University, and a former assistant commissioner at the Australian Tax Office, in charge of ATO input into international tax reform.
Transfer pricing is a perennial problem in the modern world. But it is more vexed in some areas than others. For example, if a multinational company were ducking Australian tax by selling coal cheaply to its offshore parent, it wouldn't be too difficult to compare that company's pricing regime with the normal prices for such coal sales, and to work out what is fair.
But it is much harder with other goods — pharmaceuticals, for example — and services. The more intangibles, such as intellectual property, there are in the picture, the harder it is. And when there are not only large components of intellectual property, but also virtual products, it is very hard indeed.
"How do you tax something that doesn't have a jurisdiction or a source, or at least one that is linked to Australia?" poses Passant.
"This is something that's being wrestled with in countries around the world. In the Google case, we [Australia] are losing maybe $300 million — 30 per cent on a billion — so it's a big issue that needs international cooperation to address. Talks about that international cooperation have been ongoing for about 10 years, but haven't come to any conclusion yet."
That, he suggests, is because a lot of countries have vested interests in making sure discussions don't come to any conclusion.
"If you were Ireland or Lichtenstein or the Netherlands, or some other country which is making a cut on this, you would not want to see an outcome," says Passant.
Nonetheless, the Organisation for Economic Co-operation and Development has made some progress in setting new standards for assessing transfer-pricing.
The changes which the Government refers to would incorporate these standards into Australian law. And it might help in some cases. But Passant, like Vann, doubts they are in any way relevant to cases such as that of Google.
"It's a furphy. They [Communications Minister Conroy and assistant Treasurer David Bradbury] don't understand the issue. The real issue is not transfer pricing but a jurisdictional one," he says.
"You have no intermediation in Australia. You may be paying from Australia and viewing in Australia, but all the activity, presumably, is occurring in Ireland."
In other words, transfer-pricing is not the issue because the transaction is not between Google in Australia and Google in Ireland. It is directly between Australian consumers and an Irish company.
"The profit isn't being shifted out of Australia; it isn't being made in Australia. If you are doing your business direct with Google Ireland, the taxing rights have gone to Ireland.
"It's the nature of the internet that has meant the whole taxing regime has changed. Transfer-pricing is only a minor part of this, at most," says Passant.
"It raises interesting questions about whether our tax treaties are up to addressing this problem."
Tax treaties? What are they and what do they have to do with it?
For this part of the picture, we turn to Michael Dirkis, professor of taxation law at Sydney University Law school. He explains that in theory there are no limitations to how a country can seek to tax, but in practice there have to be some common rules — to prevent double taxation, for example.
And so, he says, countries enter into agreements with each other. These agreements are intended to resolve which country has the primary taxing right. Australia has 44 such treaties, including one with Ireland.
"The problem is, treaties live about 30 years, and you're stuck with them [for the duration]. The treaty with Ireland is really old — 1970s or 1980s. It doesn't have proper exchange of information, there is a whole range of shortcomings," says Dirkis.
When Australia struck its treaty with Ireland, e-commerce didn't exist. Google didn't exist. Of course, treaties get renegotiated. But with Ireland now doing very nicely from its tax-haven status, is it disposed to be helpful in addressing Australia's problem?
Dirkis thinks it's unlikely.
And those treaties can stymie any effort to claw back tax on the online transactions with Ireland.
"You can make whatever laws you want, but if they conflict with relevant treaties, they're not going to be enforced," he says.
As for the OECD, on which the federal government pins its hopes for a solution to its taxing problem? Dirkis says the organisation, in its efforts to update the relevant rules, "fudged it". So it remains that what matters is where the contract for the supply of a service was entered into.
"So if you're set up as a supplier of advertising-type activities and you're using a computer based [in] the Netherlands or Bermuda, which hosts all the software and data that gives rise to these services that you use elsewhere, but those contracts are signed in Ireland, then that's the source of the income. That's the country that has the taxing rights," he says.
"No matter what they do to the transfer-pricing rules, it's not going to fix that problem with Ireland.
"It's not a problem just relating to advertising. It affects retail trade: the profit is going to be where the contracts are entered and the orders are filled. Same as porn and gambling."
The nub of the problem, he says, is this: "We have a tax system based on residency and source, based on concepts developed in the 1930s."
So can't anyone do anything?
Well, yes, and some countries do.
"Developing countries and their courts are a bit more robust," says Dirkis. "India, for example has been very aggressive under its treaties and is basically deeming any degree of involvement in a country to be sufficient to create a permanent establishment, and therefore the profits generated remain in India.
"Most of the major financial institutions and internet companies have currently got big problems in India. They're spending millions and millions in litigation," says Dirkis.
India is churning out court rulings at a rate of about one a month, and the multinationals are very much on the receiving end. Not only are the courts very aggressive, so are the legislators.
Dr Michael Kobetsky, of Melbourne University Law School, now at Wolfson College Cambridge, and recently back from the sub-continent (where he was helping Nepal set up its transfer-pricing laws), says India is the most aggressive country in the world when it comes to asserting its right to tax.
He cites a recent case involving the giant telecommunications company, Vodafone, which is British, but which operates its international division out of the Netherlands.
The Indian Government sought GBP1.4 billion, which it claimed Vodafone owed on a transaction carried out five years ago, in which it took over another telecommunications company.
Vodafone won in the courts. But India has now set about changing the law — retrospectively — to get the money. The company has cried foul and is seeking international arbitration.
The matter still has some distance to run, but, says Kobetsky, it shows the difference between how we operate in this country and other developed countries, and how far some of the rising new economies are prepared to push it.
"In Australia once the [Tax] Commissioner loses a case, that's it, but India is prepared to legislate retrospectively. India is very aggressive, and can do it because it's big, and because these companies need Indian services. Some companies are actually putting up with double taxation because the services are still cheap."
You can bet every big IT company, and every tax-haven country in this wired world is watching that case.
Not that you should expect Australia, or the other high-tax countries of the western world to follow suit; retrospective legislation is anathema to us.
Indeed, we should probably not expect much progress at all in catching all that stateless money. We will stick to our archaic principles of taxation, even as the tech companies and their tax-haven enablers continue to nimbly dance around us.
Let's attempt one prediction, though: A year from now, when Google makes its next statement to ASIC, showing it has paid almost nothing in Australian tax, some reporter will ring some Google flak, who will reach for the script and begin reciting:
"Google complies fully with all relevant tax rules in all the countries in which it operates, including ... [insert country details here]."