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Taxing big tech is starting to change

Taxing big tech is starting to change

Big Tech’s relationship with regulation and government scrutiny has rarely been plain sailing. It is now getting to the crunch point

And you can see why.  Finance ministers see spectacularly profitable international behemoths making billions from their citizens while paying taxes more akin to a smallish domestic company. 

The EU estimates that digital businesses pay on average 9.5 per cent corporation tax, compared to an average of 23 per cent for traditional businesses. 

Of course the politicians have themselves to blame. Finance ministries around the world have allowed their tax codes to become overlong, bafflingly complex and nationalistic. 

Tax convergence across the finance departments of different states is rarer than a budget surplus.

This opens the door to some top class, but broadly legal, tax manipulation in the shape of pricing of products or services across territories.

We have always had a fair amount of this from major industrial and energy businesses. 

But big tech is so vast, so fast growing, profitable and visible with all those consumer brands, that governments are sure to start ringing the changes.

So how is this tax manipulation done and what can governments do to counter it?

Transfer pricing

Transfer pricing is the main culprit. 

It allows a company’s finance director to maintain low levels of taxation regardless of how much profit is being made.

Since (for now) revenues are not taxed but profits are, the price of inputs is arranged so that most of the profit is booked in the lowest tax area in which that company operates. 

You order a book on Amazon.co.uk.  It is sourced in the UK, is despatched from Amazon’s UK warehouse and delivered to you in the UK.  But the invoice is from Amazon in the Netherlands. Easy. 

Big tech operates across most of the developed world so that leaves plenty of flexibility, especially as most of the value of these companies is in their intellectual property, not factories, offices and other hard assets. 

The ownership of this intellectual property can be shifted to a subsidiary in a low-tax country, which then invoices operations in higher-tax ones for the use of that know-how, transferring profits from higher-tax to lower-tax regimes.

This is only possible because tax authorities fail to enforce the requirement for companies to adequately justify the transfer pricing they are using: how can intellectual property actually reside in Ireland when there is no material headcount there either creating or maintaining it? 

If Google employs thousands of highly-paid engineers in California and none in Ireland, then it should be impossible to argue that its intellectual property, its most vital asset, exists in Ireland and not in the US. 

The US (and other governments) are failing to use their power to look through clearly fictitious transfer-pricing and tax the underlying reality of the business.