If you ever want to see the tax version of a wrestle-mania “beat down” watch the English Parliament’s Committee on Public Accounts administering a properly British wallop upon Amazon’s European director of policy, Mr. Andrew Cecil. It’s a few years old, but demonstrates the tax structures that Amazon and others have used to reduce their global tax bills for years. Mr. Cecil stammers through an explanation of how Amazon can earn 9.1 Billion Euros in Europe in tax year 2011, yet pay only GBP 1.2 million of income tax to the UK. A ridiculously low figure. You can see the video at https://www.youtube.com/watch?v=21Xf8ADFvdc&t=1580s.
Why does Amazon pay such a low income tax rate in the UK, the US, Germany and many others? Thank the international tax lawyers who have found ways to shift a lot of the company’s profits away from those pesky “high tax” countries to the “heavily discounted” tax havens like Luxembourg. And it’s making a lot of people upset in the “high tax” countries, including the Members of Parliament who formed the Committee on Public Accounts’ interrogation of Amazon.
Consider the exasperated Mr. Austin Mitchell, a Labour M.P. on the Committee, asking Amazon’s representative about the reason that the majority of Amazon’s European revenues are taxed in tiny Luxembourg, rather than the countries in which the revenues are generated.
Mitchell: “I don’t get…why Luxembourg is so lucky?! The books are here[in the UK], the warehouses are here, the business is here, the customers are here. Why don’t you pay tax in the UK??”
The answer to Mr. Mitchell’s question lies in the Two Fictions. Remember those? 1. Related corporations are treated as economically independent even if they are owned by the same ultimate parent; and 2. Related corporations can sell each other goods and services at a hypothetical “arms-length transfer price.”
Here’s where the ultra-secret international tax shell game comes into play. When the UK Committee on Public Accounts had the audacity to ask Amazon’s representative for UK specific financial information he told them he’d get back to them later, if Amazon felt like releasing that information!
The truth is that governments everywhere, including the United States find it very difficult to peel back the opaque layers of the onion that is international tax planning for multinational corporations. And when governments do manage to bring multinational corporations to account, armies of smart tax lawyers descend on the government like pigs to pancakes.
Just look at Amazon’s homerun victory over the IRS in the United States Tax Court on March 23, 2017. For my European friends who don’t know what a “homerun” in baseball is—it’s like scoring a goal between the goalie’s legs in a soccer match (fútbol, football, voetbal, fußball). The IRS argued that Amazon shifted over $3 billion of profits from the U.S. to Luxembourg during tax years 2005 and 2006. The Tax Court rejected the IRS’ position and handed Amazon a victory, confirming as legal the same tax structure that was at issue in the English Parliament’s Committee on Public Accounts hearing that we talked about above.
How did Amazon get away with this? The Tax Court’s opinion in the Amazon case provides glimpses into the remarkable story behind one of the most valuable companies in human history. You remember when Amazon just sold books right? Back then, in the late 90’s and early 2000s, Amazon challenged the bricks-and-mortar book industry and performed very well. Amazon then turned its attention to challenging bricks-and-mortar retailers of all kinds of goods.
In order to sell millions of dollars of merchandise every second, Amazon’s parent company in silicon valley had smart people developing technology that would provide customers with a seamless online shopping experience. All of this “intellectual property” took a lot of time, effort and money to develop. Especially money! Amazon US incurred great expense to pay programmers a salary, pay for office space, pay for huge amounts of pizza deliveries, all to develop the intellectual property necessary to operate the most sophisticated online retail business in the world.
By 2005 Amazon’s business had expanded to Amazon Europe, which consisted of its various businesses in France, the UK, Germany, Spain, Italy, etc. Amazon paid a huge income tax bill to each of those countries. Amazon didn’t like the hefty price tag and it settled on this solution: Amazon moved its intellectual property to different entities within its corporate family just to drastically reduce its global tax bill.
Now enter the Rock Star International Tax Lawyers (“RSITL”):
Secret Amazon Executive (“Number 1”): “Are you telling me we can reduce our global tax bill by billions of dollars in all of these “high tax” countries like the US, UK, Germany, France, etc. all by shifting our income out of there? We can do that??”
RSITL: “Why yes sir. And a lot of the plan just calls for you signing a bunch of agreements to transfer intellectual property between your companies, it doesn’t really cost you a lot of money. Except for my fee, he, he, he.”
Number 1: “But where would we shift the income to and why would they tax us less than what we are already paying?”
RSITL: “Well we’ve already worked out a special sweetheart deal with Luxembourg where they promised they are only going to tax us at a rate of _____%.”
Number 1: “Luxembourg? Where is that?”
RSITL: “It’s in Europe sir. We can form a Luxembourg subsidiary, send a few hundred jobs there, send Amazon’s intellectual property there with the stroke of a pen, and call it our “European Headquarters.” A customer in the UK, or France, or Germany that buys something on Amazon.com, will actually be buying it from our Amazon Luxembourg company. And so, voilá, that customer’s purchase will be income to the Luxembourg company, and won’t be taxed in the UK, or France, or Germany or wherever that customer is located.”
Number 1: “Seriously? We can do that?”
RSITL: “Yes sir. And the best part is that it will also greatly reduce our US tax bill!”
Number 1: “Wait, where is Luxembourg again?”
And so an Amazon subsidiary was born and it was christened the Amazon European Headquarters. Now, Amazon’s intellectual property legally resides in Luxembourg, and with it came hundreds of jobs. Thanks to this plan, any customer anywhere in Europe who clicks on Amzaon’s website pays the purchase price to Amazon Luxembourg. This last point is important because the European customer pays Amazon LUXEMBOURG, the customer DOES NOT pay the purchase price to Amazon’s UK, or German, or French businesses, therefore those countries cannot tax the purchase. This is the point that made Mr. Austin Mitchell so angry when he interrogated Amazon’s representative in the UK Committee on Public Accounts hearing.
Put this into perspective. Amazon has 15,000 workers in the UK. It has many more workers in Germany and France and Spain, and Italy. Yet tiny Luxembourg (population 500,000) is home to a few hundred workers at the European headquarters of what is now the 5th most valuable company on earth and Amazon’s billions of Euros of annual European revenues are primarily taxed there, in Luxembourg, not in the UK, Germany, France, Spain or Italy. And while my Luxembourgish friend is a nice guy, the country is known more for its ___?___ than for its technology industry.
Remember Mr. Mitchell’s question at the hearing: “Why is Luxembourg so lucky?”….
It’s not luck, its fiction. Two fictions, actually. Let’s focus on Amazon’s structure from a U.S. perspective. How did Amazon shift $3.3 billion of US tax liability (according to the IRS) away from the U.S. and to Luxembourg? That’s where The Two Fictions come into play. Amazon transferred its intellectual property to its Luxembourg corporate subsidiary for a fee, called a “transfer price.” Amazon was able to do this because of The First Fiction that says it’s Luxembourg subsidiary is separate and independent from its US parent in the silicon valley.
Amazon was also able to do this because of The Second Fiction that says the “transfer price” that Amazon Luxembourg paid to Amazon US for the transfer of intellectual property has to be at “arms length.” In other words, the transfer price that Amazon Luxembourg pays for the intellectual property must be for an amount of money that two hypothetically unrelated companies would pay for that intellectual property.
This is the part the IRS challenged. The IRS argued that the value of the intellectual property that was transferred to Amazon Luxembourg was over USD $3 billion that should have been taxed in the United States. Amazon’s lawyers argued, with straight faces, that the “real” value of the intellectual property was a couple of hundred million dollars—payable over several years. And the Tax Court agreed with Amazon!
So the United States treasury lost this latest round of the fight against gaming the international tax system. From the United States’ perspective it’s a zero sum game. A Euro of income that is now revenue taxable in the tax haven of Luxembourg, is one less dollar of income subject to tax in the United States. Germany, France, Italy, the UK, etc. are none too happy about this arrangement either as indicated by the UK’s Committee on Public Accounts hearing.
Things may soon change. Two branches of the US government are now controlled by the Republican party. US President Trump has introduced a tax plan that lacks detail but which promises, among other things, cuts to the corporate income tax rate from the current 35% to 15%. The US Congress has not introduced tax legislation at the time of this writing, but several plans have been discussed by members of Congress, all of which advocate some reduction of the corporate income tax rate.
A significant reduction in the US corporate income tax rate would reduce the incentive that US companies have to engage in the type of tax planning that leads to substantial investment and jobs in Europe.
A change to the corporate income tax rate is only part of the story. The proposed Border Adjustment Tax and changes to Subpart F could have far reaching consequences for any businesses globally. But that is the subject of my next post…