It’s Very Difficult To See How George Osborne’s Google Tax Could Possibly Be Legal

George Osborne, the Chancellor of the Exchequer over here in the UK, has just announced at the Conservative party conference that he’ll be changing the tax laws to make sure that Google GOOGL +0.16% and other tech multinationals (Facebook, Microsoft MSFT -0.17%, possibly Apple AAPL +0.64%, among them) end up paying more tax to the UK Treasury. It’s being termed the “Google Tax”, and being termed that by people doing the media briefings on his behalf. The problem is that it is extraordinarily difficult to see how any such scheme could possibly be legal. And having a Chancellor proposing taxation schemes that aren’t going to be legal doesn’t sound like very good public policy really. We could, of course, make the point that the UK is a sovereign country and can make whatever tax laws it likes: but that isn’t true. The tax treatment of intra-European Union trade is in fact a matter of European Union law, not of law domestic to the UK.  And that’s the fence at which attempts to change the taxation of Google, or the other tech giants, are going to fall.

Here’s one report on what he’s suggesting:

In order to do so, he will introduce at the Autumn Statement in December a plan designed to stop multinationals from diverting profits offshore in order to avoid corporation tax. The measure is estimated to raise hundreds of millions of pounds for the Exchequer, as part of wider anti-avoidance plans.

The new legislation will prevent global technology firms from doing what is known as a ‘double Irish’ – in short, using artificial arrangements to divert profits to offshore tax havens that have been earned in the UK.

The taxation of profits earned in the UK: the Chancellor obviously has the power to tax those. But the problem that he’s got in trying to do this is that under EU law those profits that he’s trying to tax are not in fact “made” in the UK. Therefore they don’t fall into his taxing power. Another report:

Osborne’s “Google tax” – Details

Obviously no one in government would ever dream of naming a company being targeted by George Osborne’s new clampdown on tax avoidance. But a senior source has been telling journalists in Birmingham that they might like to know that some people are referring to it as the “Google tax”.

That’s where the phrase itself is coming from, the horse’s mouth.

The new measure will specifically target the “Double Irish” – a transfer pricing scheme used by companies like Google. This involves transferring profits internally, first to Ireland (which does not have US transfer pricing rules), and then to another low-tax jurisdiction, to limit a firm’s tax liability. According to the Wikipedia Double Irish page (which our source is encouraging us to read), other companies using this include Facebook, Apple, Microsoft, Yahoo YHOO +0.57% and Starbucks SBUX +0.25%.

Companies using this strategy will be made to pay tax on profits as if they were incurred in the UK, and not in the foreign jurisdiction chosen through the tax avoidance scheme.

The problem here being that it’s not immediately apparent how on earth such a scheme could work given the realities of how EU law influences matters here. And over and above EU law there’s the little matter of the double taxation treaties that have been signed with countries around the world over the past 70 years.

Here’s the background to the situation. Google (and Facebook and Yahoo do very much the same thing) sell their advertising into Britain from Ireland. Yes, the companies have companies within the UK but they are training, support, research outfits: the claim is that they do not actually sell anything inside the UK. So, in terms of revenue, and of course any profits made from that advertising revenue, all of it is booked in Ireland. That’s what has people enraged: but, but, they’re selling ads to Brits and therefore those sales should be taxed in Britain! But the EU tax system just doesn’t work that way. Any company, in any of the 28 member nations, has an absolute right to sell to any company or person in any of the other 28 nations. This is what the “single market” part of the Single Market means. And it’s absolutely fundamental to that single market idea that taxation of profits takes place where the company doing the selling is domiciled. That is, not where the sale takes place: where the brass nameplate of the company doing the selling is situated.

The situation with Apple and Microsoft, because they’re often selling hardware, is subtly different but by and large the same.

The end point of all of this is that Osborne, the UK Treasury, has no power whatsoever over the tax treatment of companies based in other EU countries. It’s not just that they’re not allowed to tax companies from other countries: they’re not allowed to discriminate either. And that’s exactly what they’re suggesting that they’re going to do. Once those revenues/profits are in Ireland then yes, these companies do have some quite lovely arrangements known as that Double Irish with Dutch and so on. Apple, famously, had a company that didn’t seem to have a tax domicile anywhere at all. But these are all arrangements in another EU state: and Osborne and the UK Treasury simply aren’t allowed to have any say over such arrangements.

As long as a company is legally abiding by the laws of the EU state that it is based in then the UK must allow it to trade in the UK on the same terms as any other EU company that also obeys the laws of its EU state of domicile. And that really is it, this is over-riding law.

We have, of course, been here before in a slightly different manner. That’s what the Cadbury and Vodafone cases were all about. There the UK Treasury was insisting that profits made in another EU country were subject to UK taxation. Everyone agreed that as and when a UK based company brought back into the UK profits from a subsidiary elsewhere in the EU then UK corporation tax was righteously payable. But there was a further set of laws, the Controlled Foreign Company laws, that said that if those profits remained offshore then they were still taxable in the UK. Again, everyone agreed if those foreign subsidiaries were in Cayman, or Bermuda. But not if those subsidiaries were in the EU: and that was fought all the way up and down the chain of courts until we got the answer. The CFC rules do not apply to EU subsidiaries, the UK Treasury cannot tax the profits of EU companies outside the UK. A different set up, yes, but the implication for the current proposal is obvious.

An alternative strategy for Osborne would be to change the definition of “permanent establishment”. For if our “based in another EU country” company has a permanent establishment in the UK then the business that is done from that establishment is taxable in the UK. Change the definition so that, say, Google’s big new London office is regarded as being such and that brings Google Ireland’s sales into the UK tax net. The problem there being that the definition of a permanent establishment is not something that is in the power of the UK government to change unilaterally. It’s defined by treaty and has been since the draft treaties were set up by the League of Nations (which died on the creation of the UN in 1944 so you can see how old they are). And there are treaties with a couple of hundred other countries that the UK has signed. It’s only possible to change those definitions if you go around and renegotiate all of those. Which could, of course, be done, but not quickly. And everyone else has to agree. And whatever the new rules are they will be just as binding upon UK companies trading elsewhere as they will be on Irish companies trading in the UK. It’s not obvious or even apparent that this would be of net benefit to the UK.

That a campaigning politician pulls a rabbit out of the hat at the last party conference before a General Election isn’t really all that much of a surprise. But it is very difficult indeed to see how Osborne could actually bring in what he’s promising to do and still remain inside either or both the current EU rules on corporate taxation and the double taxation treaties.