High-Level Tax Avoidance: How Apple, Amazon, And Starbucks Do It.
This is the third in a series of articles on offshore tax avoidance. For the first and second click here.
In the parallel universe of tax havens, there are two methods to axe tax: one is illegal called, evasion (My article on that here); while the other is provided by governments through tax loopholes and so is called, avoidance. What you are about to read is all legal thanks to our politicians.
Corporations keep their tax schemes as closely guarded a secret as CocaCola does its blending formulas. However, law professors and investigative journalists have pieced together some of the schemes. From their work and a Senate Committee’s, we can get a glimpse of how it’s done. We often have to look to Europe where it has been better exposed. But we can be certain if it’s done there, it’s done here.
First, the simple underlying pattern. The game is played by pretending to earn income that is actually earned in one country as if it had been earned in a low tax jurisdiction in Europe. In addition, the corporations use artificial expenses in a foreign country to set off against that income.
Amazon made headlines in the UK in 2012 for its astonishing sales pattern. The Guardian noted that Amazon reported sales in Britain of $213 million, while its sales in Luxembourg were $11 billion.
What? Where? Luxembourg? It’s the last Grand Duchy of Europe — a country smaller than an average American city with a population under 500,000. It’s also one of the world’s leading financial centers and recognized as being in the big leagues with New York, London, and Hong Kong. How can little Luxembourg be so amazing? It sells something everyone wants — tax avoidance at a very affordable price.
What’s the trick? In the fine print on an Amazon contract, you will see that a Brit buying a book is ordering from Amazon Luxembourg, not Amazon UK.
Only a few Amazon employees are needed to keep up the façade of running a business in Luxembourg. The UK is left on the hook to provide the thousands of Amazon employees with healthcare, education for their children, etc. etc. Relieved of this burden, Luxembourg can give Amazon a very special tax deal and still reap a huge gain.
Europe is aggressively pursuing corporations that abuse the tax avoidance schemes. The European Competition Commission fined Amazon $259 million in October of this year on another of its tax dodges. The Competition Commission commented:
“Luxembourg gave illegal tax benefits to Amazon. As a result, almost three-quarters of Amazon’s profits were not taxed.”
This scheme (called Goldcrest in honor of Luxembourg’s national bird perhaps because Luxembourg does not tax intellectual property royalties) permitted Amazon to shift its intellectual property rights held by its US parent company, in part, to a Luxembourg subsidiary which then collected royalties tax-free on international sales.
Although the Senate recommended changes to the US tax code in 2013— especially regarding the transfer of IP rights—nothing was, or is, being done about it. Thus, a US court upheld the Goldcrest scheme shifting of IP rights to Luxembourg as in accordance with the present US tax law.
The amount of tax evasion raises the question as to whether Amazon’s ability to squeeze out small retail bookstores is due to its superior business system or superior ability to dodge taxes that locals cannot.
Starbucks Brewed A Tax Storm
Starbucks’ secret sauce for tax avoidance gives us an excellent example of how to create phony expenses out of nothing by mere transfers on paper between a parent company and a subsidiary.
In one gambit described by law professor Edward Kleinbard, Starbucks formed a company in Switzerland called Starbucks Trading. Starbucks Trading Switzerland bought raw coffee beans from, say, South America and resold them to the Starbuck subs that do the roasting at say a 20% markup. Obviously, the beans were not shipped to land-locked Switzerland but sent directly to the roasters. Starbucks Switzerland does nothing but process transactions on its computer. There is no need for this middle-man; Starbucks UK could easily have ordered direct. Yet, Starbucks UK pays this 20% and gets to deduct it from its UK tax.
So how does the tax man allow this obvious dodge? There is a tax rule called ‘transfer pricing.’ It permits a company to charge for internal services what it would pay if it had bought these services from an outside business. Starbucks could show that small coffee shops had to order through a broker paying about 20% (a figure I’m using for discussion purposes).
To this point we have an example of how to shift income from a high tax to a low tax country and how to create artificial expenses to deduct from it. This goes by the name of profit shifting. Any doubt as to what some of the most creative minds on the planet can do with that opportunity? Thanks to a Senate investigation, we have a glimpse.
But first another peculiarity of the tax laws. The US taxes a corporation on where it was incorporated. Ireland taxes a corporation on where it is controlled and managed.
A Company Without A Country
It seems Apple gets the credit for conjuring up the idea of a ghost corporation. Professor Kleinbard dubbed them ‘ stateless corporations.’ This example of Apple’s genius at work is detailed in a 2013 Senate report. Here’s a quick rundown of one.
Apple Incorporated a subsidiary in Ireland called Apple Operations International (AOI) that was managed in Cupertino. Since it was not incorporated in the US and not managed in Ireland, it fit the bill as a company without a country and not taxed in either country.
Apple admitted that five years prior to the Senate hearing AOI had not filed a tax return in any country. In that period, Apple told the Senate Committee that AOI had received $29.2 billion in dividends from lower tier offshore Apple affiliates (p22). It did not pay a cent of tax to the US or Ireland on this income.
Apple had a bushel full of other subsidiaries. Note how many had ‘no tax residence’:
AOI had a subsidiary, Apple Operations Europe (AOE), that had 40 employees in Ireland who supposedly generated $42 billion in income. AOE paid tax voluntarily (it wasn’t managed in Ireland) of tax of $7 million. That was at a rate of 0.005% and not Ireland’s corporate tax rate of 12.5% (Note the US rate is 35%).
Politicians did nothing about it…yet.
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Europe Shocked Awake
In 2014 one Luxembourg PwC employee of conscience, Antoine Deltour, grew so upset at what he saw, and with the political dithering, that he felt he had to do something about it. He knew that what he was going to do was a career breaker. He would never again get a job with a large accounting firm; would be put through an expensive criminal trial to break him financially; possibly get a jail term and after being released, could look forward to a future working on the second floor of a strip mall for the rest of his life.
His leak would benefit the citizens of many countries. Few, if any, would come to his aid. No government would assist him with whistle-blower protection, and most media barons would do their best to ensure the public knew little or nothing of his sacrifice and persecution.
A familiar scene emerged from the leak that became known as the Luxleaks: a small office building in Luxembourg with a long list of large multinationals on its door. There were 340 large MNCs on the list. Think of the names of all the big corporations you know until you are too tired to continue: Microsoft, Amazon, Koch Industries and so on and so on. Most will be on a door in Luxemburg. Of course, as one would expect, the name “Disney” appears in this fairyland of dreamy tax rates.
Deltour did not ask for any money for the leak but said he acted out of conviction.
That didn’t stop the government of Luxembourg and the tax avoidance industry from claiming he was a thief and should be prosecuted as a criminal, which he was — fined and convicted. That conviction is under appeal.
However, the genie was out of the bottle. The billions of dollars of tax avoidance, and the willful blindness of all governments and that they did nothing about them was exposed. Politicians had to act.
Closing The Loopholes
Governments, including the US, are enacting the requirement that businesses report their profit on a country-by-country basis. It’s a small start.
Governments will recover billions of dollars in tax revenue as a result of Deltour’s sacrifice. Deltour will not get a cent, his criminal conviction and fine will likely stand, but he will soon be forgotten. That has already happened in the US.
Additionally, the European (Union) Commission found that Apple had used the contract dodge. Sales to customers in Europe were ‘made’ with AOI in Ireland and not with the Apple corporation in their country.
The EU directed Ireland to charge Apple its normal rate of 12.5%, which amounted to $15 billion. Apple agreed to pay. However, the recent Paradise Papers revealed emails showing this world-class innovator has asked for legal advice on where to move its business now that it will be taxed in Ireland. It seems like the Channel Island of Jersey is its next destination.
The Deferred Income Quandary
The US taxes corporations on world income (net of foreign taxes paid) while some other countries only tax on income within the country. US corporations claimed that they needed a tax break to be competitive with other multinational corporations. So the US government gave its corporations a great break. They are only taxed on income earned in other countries, if, as and when, they bring that money into the US.
So, of course, they don’t. They hoard it offshore. Apple has an estimated $200 billion such untaxed profit invested in foreign counties.
The new tax bill passed by the Senate on this past December 11th reduces the tax on this foreign earned income from the normal 35% to 14%. This is the same rate that Obama proposed in his 2016 budget. Obama planned to earmark the recovered billions to repair the crumbling national highway system, but the Republicans blocked him.
The Pressure Is Working
Despite the government’s best efforts to suppress whistleblowers like Deltour by ruthless criminal prosecutions (see my article on other whistleblower prosecutions here), leaks are increasing.
The International Consortium of Independent Journalists (the ICIJ)has found a way to protect future whistleblowers like Deltour. Notice how it has protected the sources of the Panama Papers and the Paradise Papers. So more leaks, not only about banks but also about enablers like the accounting and law firms that profit from these tactics, are likely in the next few years.
From the time of the Deltour revelations, internet campaigns began keeping the issue alive in the EU. A Committee of Inquiry by the EU Parliament has released a scathing report criticizing its own government for its inaction in permitting these tax avoidance strategies.
The US Senate Investigative Committee made several effective recommendations for changes to the US tax code to end the most flagrant abuses— so far ignored.
It has now been 10 years since the US government jailed Bradley Birkenfeld who leaked information about American citizens using a Swiss bank to evade US taxes. Since that time, investigative journalists and tax fairness groups have fought back.
The tide of the battle is turning. The pressure is on. Just this week Facebook announced it would stop diverting advertising income ($14.8 billion in 2016) to Ireland and book it in the country where it originates.
The more voters who understand these gambits, the more likely corporations will be forced to pay their fair share of the cost of running the country in which their executives enjoy such a privileged lifestyle.
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