Taxation

Brexit Opportunities for Combating Tax Avoidance

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The left just doesn’t know what it wants from Brexit. Some have accepted Brexit as a fait accompli – and their approach now appears to be limiting the damage. Others appear to be dead-set on overturning the result of last year’s referendum at the earliest opportunity. Both approaches are politically risky. The former is wishy-washy, satisfying neither the hard-core Remainers nor the devout Brexiteers; while the latter smacks of elitism and disrespect for democracy.

While “third way” approaches may have fallen out of favour with the left, there is an alternative – and that is to embrace the opportunities that Brexit brings to tackle many of the grave injustices imposed by EU law.

One of the most notable of these injustices is tax avoidance. While the European Commission may be the latest passenger on the tax-justice bandwagon, the reality is that it’s EU treaties that make tax avoidance so particularly easy in Europe. Consequently, the ECJ has a long history of striking down national laws designed to combat tax avoidance.

The Chancellor’s Autumn Statement revealed that his predecessor’s much touted Diverted Profits Tax (the so-called “Google Tax”) – designed to stop companies from limiting their tax liabilities by shifting profits to low-tax jurisdictions (like Ireland) – hasn’t yet raised a penny in revenue. I recently revealed in an article in the leading tax journal “InterTax” that this is because EU law means the tax will almost never work.

Article 49 of the Treaty on the Functioning of the European Union (TFEU) prohibits restrictions upon freedom of establishment of nationals of Member States in the territory of another Member State including establishment of companies. Article 58 TFEU further prohibits any restrictions on the free movement of capital. National laws, including tax laws, which infringe upon those rights are, in almost all circumstances, not permitted. This has resulted in many laws designed to clampdown on tax avoidance being struck down by the ECJ.

The case of Sandoz concerned a provision designed to prevent the arrangement of loans outside of Austria to avoid paying tax. In his opinion on the case, the Advocate General took the view that “[t]he principle of the free movement of capital was introduced inter alia in order to enable Community nationals to enjoy the most favourable conditions for investing their capital available to them in any of the States which make up the Community.”

The Court agreed with the Advocate General’s position, ruling that the measure “deprives residents of a Member State of the possibility of benefiting from the absence of taxation which may be associated with loans obtained outside the national territory. Accordingly, such a measure is likely to deter such residents from obtaining loans from persons established in other Member States.”

If the very purpose of free movement is to ensure the allocation of resources to their most efficient location, it logically follows that “shopping around” for the most favourable environment for those resources is perfectly lawful.

Of even greater relevance is the decision of the ECJ in Cadbury Schweppes. At issue in the case was the UK’s rules designed to prevent companies from shifting profits to related companies outside of the UK to avoid tax. The Court in Cadbury Schweppes reiterated its earlier judgement in Barbier that “a Community national cannot be deprived of the right to rely on the provisions of the Treaty on the ground that he is profiting from tax advantages which are legally provided by the rules in force in a Member State other than his State of residence.”

In other words, under EU Law the fact that a company shifts its operations to another EU state (such as Ireland or the Netherlands) to take advantage of more favourable tax treatment cannot be prohibited. Anti-avoidance rules may not be applied, even where there is an explicit intention to avoid tax, where the taxpayer nonetheless carries on genuine economic activities. Anti-avoidance rules, such as George Osborne’s Google Tax, can only work where arrangements are wholly artificial and have tax avoidance as their sole purpose.

And herein lies the problem. The reality is that these arrangements are almost never wholly artificial, with a reduction in their tax bill seemingly being a happy coincidence. At time of writing Google has over 5,000 employees in Ireland, and Apple approximately 4,000. Under EU law any attempts at taxing profits shifted to these jurisdictions is illegal – notwithstanding the fact that they likely would never have located so many employees there but for their 12.5% corporate tax rate.

Freedom from the application of EU rules on free movement of capital and freedom of establishment would allow the UK to enact a genuinely effective anti-avoidance rule. Rather than being limited to a rule that applies only to arrangements the sole purpose of which is to avoid tax, the UK could adopt a rule that clamp down on arrangements which have as their main purpose the minimisation of tax liabilities.

A favourite method of profit shifting by large multinationals is to make royalty and interest payments from subsidiaries in high-tax jurisdictions to subsidiaries in tax havens. A withholding tax on such payments would seriously clamp-down on this prolific method of tax avoidance, but such a tax is prohibited by a 2003 EU Directive.

Combating tax avoidance is just one opportunity presented by Brexit. There are plenty of others.

The left is undoubtedly suffering from an ideological crisis. Many of the left’s assumptions have been challenged by the discovery that its core vote isn’t what it used to be. But if the left decides to embrace Brexit then there are plenty of opportunities. Ending EU-sanctioned tax avoidance would be a good start.

#AppleTax: The Commission’s bluster shrouds a shaky legal foundation

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apple-taxToday’s sensational, though not entirely unexpected Commission decision, that Apple has been a beneficiary of state aid from Ireland, in breach of Article 107 of the Treaty on the Functioning of the European Union (TFEU) has resulted the bizarre situation where a massive company has been told to pay the state billions in tax, only for the state to say “we don’t want it!” The decision is hailed as a victory by tax justice campaigners, but the reality is that this decision is a travesty for anyone who believes that rulings about tax liabilities should be based upon what the law is, and not what the arbiters wish the law is.

Article 107(1) TFEU provides that:

Save as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.

The classic state aid scenario is one in which a government funnels money or resources towards an undertaking (usually a company) it favours in preference to others. However, in recent decades, it has been commonly accepted that such treatment also includes allowing an undertaking not to pay for something that it otherwise would.

It therefore follows that the Commission has to establish that the state in question granted favourable treatment to Apple specifically. However, rather than doing so, the Commission’s statement today provides little more than a tirade of obfuscation and bluster, containing what could only be deliberate misrepresentations of the nature of international tax law, presumably to distract from the fact that their decision appears to built on an extremely shaky legal foundation.

The Commission repeatedly references the allocation of profits to a “head office” (their quotation marks), claiming that no such “head office” actually exists. Such nomenclature is misleading, as no such terminology exists in either Irish or international tax law. Under both international and Irish tax law, profits are not “allocated” to head offices and subsidiaries. The “first bite of the apple” (as we call it) goes to the source of the income – a jurisdiction in which the enterprise has a fixed place of business through which the business of the enterprise is wholly or partly carried on. Only those profits which arise through the activities of that establishment are attributable there, notwithstanding whether or not profits from other activities are also sourced within that state. In other words, the threshold for attributing profits to a permanent establishment is very high, and that is the sole jurisdiction Ireland has to tax the profits of a non-resident enterprise.

The residuary rule in international taxation is that profits that cannot be explicitly attributed to a permanent establishment are taxable only in the jurisdiction in which the enterprise is resident. Ireland, in common with most common law jurisdictions, uses the De Beers test of corporate residence – which is a company’s “place of effective management”. In other words, as a matter of Irish law, those “head office” profits are being allocated to America – the fact that America employs a different test of corporate residence is America’s problem, and not Ireland’s. Contrary to the Commission’s inferences, it is not Ireland’s concern what happens to the profits that fall beyond its jurisdiction.

A further concern is the following paragraph:

The amount of unpaid taxes to be recovered by the Irish authorities would be reduced if other countries were to require Apple to pay more taxes on the profits recorded by Apple Sales International and Apple Operations Europe for this period. This could be the case if they consider, in view of the information revealed through the Commission’s investigation, that Apple’s commercial risks, sales and other activities should have been recorded in their jurisdictions. This is because the taxable profits of Apple Sales International in Ireland would be reduced if profits were recorded and taxed in other countries instead of being recorded in Ireland.

This is, quite simply, not the case. First, does the Commission seriously think that other EU Member States have simply rolled over and allowed Ireland to tax profits that those Member States think are rightly theirs? Of course not. They have taxed as much of those profits as can be attributed to permanent establishments situated therein – which will primarily be sales from physical Apple Stores. Shifting jurisdiction to tax online sales requires more than simply a unilateral decision to do so by the Comission, the allocation of jurisdiction is enshrined in thousands of tax treaties, which would have to be amended. The European Commission cannot simply decide that the well-established jurisdictional boundaries that are enshrined in international tax law are suddenly not where they’ve always been. In his letter today, Tim Cook claimed that “using the Commission’s theory, every company in Ireland and across Europe is suddenly at risk of being subjected to taxes under laws that never existed.” Tim Cook is right.

All of this is a smokescreen. The Commission has chosen to focus attention on this irrelevant facts and even more irrelevant opinion to disguise the fairly shaky basis upon which they have reached this ruling. There is no question that a tax advantage offered only to a specific undertaking (in this case Apple) is a breach of EU state aid rules. This therefore raises the question of the specificity of Apple’s tax treatment.

There are two possible approaches that can be taken to deciding whether or not an undertaking has been the recipient of special treatment. The first, is reference to whether or not the state intended to confer special treatment on the undertaking. This approach has been roundly rejected by the ECJ and legal scholars. The second approach, which is normally employed by the Court, is an objective one, which compares the treatment of the undertaking with that which would be considered “normal” treatment. Therefore, the only ground on which Ireland could be considered to have provided state aid to Apple is by offering them treatment that materially differed from other large multinationals.

Did the Irish Revenue Commissioners do a deal with Apple? Yes – and in the minds of irate campaigners that would appear to make this an open-and-shut case. Except that almost every multi-national enterprise trading in almost every developed country will strike a deal with the revenue on how to allocate group expenditure to subsidiaries, such as research and development, intellectual property, and management costs. These deals are called Advance Pricing Agreements, and provide enterprises with a degree of certainty as to what their costs will be (i.e. the state in which they’re investing isn’t going to retrospectively tell them that little of their group expenditure can be deducted from their gross profits). The difficulty in determining the value of these costs (pricing) is that they are dependent upon comparable market values, where no such transactions ever actually take place on an open market. Apple would never license the iPhone brand to anyone, so how the heck are we supposed to work out the actual value of the brand?! For technology companies, intangible assets such as these constitute the overwhelming majority of such companies’ cost base. These Advance Pricing Agreements are normally therefore the product of educated guesswork and tough negotiation. Therefore, the “normal” treatment of advance pricing such companies is not a specific set treatment, but a range. Like with all ranges, there will be companies at either end of this range. As the largest company in the world, you would certainly expect Apple to be at the most favourable end of the range.

The Commission’s statement today contains absolutely no references to comparable Advance Pricing Agreements in Ireland in order to determine what is “normal”, nor does their more detailed preliminary decision of 2014. The 2014 preliminary decision focuses almost entirely upon determining whether or not the Revenue Commissioners intended to confer special treatment upon Apple (by focusing on statements about how many people were employed by Apple in Cork, etc.), which has been conclusively established as irrelevant in determining whether or not Article 107 has been breached.

Having failed to demonstrate in any way why the treatment afforded to Apple differed from “normal” practice, the Commission has sought to justify its decision on a tirade of bluster about “factual or economic justification”, as opposed to, y’know, the law.

SNP makes the case for scrapping tax-free personal allowance and imposing a “Flat Tax”

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Sturgeon ParliamentLabour (and the Liberal Democrats) have called the SNP’s bluff, by proposing a 1% tax increase in order to offset cuts to public services. Surely, the left-wing SNP warmly embraces slightly higher income taxes over austerity? It seems not, and the SNP’s spin machine has gone into overdrive, inventing new meanings for words, which hitherto had a commonly understood meaning.

In order to defend themselves against the claim that the SNP, while speaking the language of Syriza, bear a far closer resemblance to the Tories or New Labour when it comes to taxation; the SNP’s spin doctors (another trait they share in common with New Labour) have invented a new definition of “progressive”. Any tax expert will tell you that a progressive tax is one in which the effective rate increases with the value of the base. Income tax is progressive in that respect, because higher earners pay a higher proportion of their income in tax than lower earners; Council Tax, by contrast, is regressive to its base (property values) because the effective tax rate is lower for higher value properties. Simple stuff.

However, in response to Scottish Labour’s proposals to increase the Scottish Rate of Income Tax (SRIT) by 1% in every band, the SNP invented a novel definition of progressivity. The SNP described Labour’s proposals as “regressive” because the relative increase in the proportion of higher earners’ income tax is smaller than the relative increase in lower earners’ tax. In other words, the proportion of the proportion of income.

The SNP’s cyber-warriors went into overdrive, lovingly embracing this new definition of progressivity, seemingly without the slightest clue about what they were actually saying. For example, the first £11,000 of income is tax-free. A certain amount of tax-free income is a feature in almost every tax system and is, surely, progressive? Well, no longer, according to the SNP. Because we pay no tax on the first £11,000, the first penny of income tax is an infinitely higher burden than zero.


As can be seen on the above graph, the rate at which the tax burden increases (green line) is significantly higher at the lower end of income tax, because the tax-free personal allowance represents a much larger share of total income. Because of the withdrawal of the personal allowance above £100,000, the rate at which the tax burden increases in the top brackets approaches zero (the only constant being the weekly National Insurance threshold of £112). Under the SNP’s new definition of progressivity, the personal allowance is regressive, and presumably therefore, has to go.

By contrast, taxing us on every penny we earn at a single rate – a flat tax, without any personal allowance – would be much less regressive under the SNP’s conception of progressivity.

The SNP’s measure of progressivity is what’s called a derivative, and by the SNP’s new definition of progressivity, it’s not just Labour’s proposals that are regressive, but also the whole of income tax itself! In their attempts to spin Labour’s proposals as regressive (which I hope is clear by now, they are not) the SNP’s spin doctors and their online infantry have been making the case for scrapping the personal allowance and imposing a flat tax. And if you believe that’s “progressive” then you really will believe anything.

 

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