France Hits McDonald’s With $341 Million Tax Demand : Possibly Unfairly

The French taxman, Le Fisc, has apparently decided to send McDonald’s MCD -0.24% France a tax bill for €300 million ($341 million). It’s not entirely obvious that this is a correct demand: nor, in fact, necessarily a legal one. If there were no European Union and no rules about the Single Market then there wouldn’t really be an argument about it. But of course there is a European Union and there are those Single Market rules. Those rules try to make the corporate tax system as it should be (assuming that we’re going to have a corporate tax system at all that is), which is taxing economic activity where that economic activity takes place. This is not, at all, the same as saying that the tax should be applied where the sales take place. And therein lies the argument that’s going on: how much of the economic activity of McDonald’s France is actually taking place in France, and thus is justly taxable there, and how much isn’t and is not? In the end we end up with the transfer pricing rules, those things that have underlaid the entirety of the international corporate tax system since the days of the League of Nations.

Here’s the news itself:

French authorities have sent McDonald’s France a €300 million ($341 million) bill for unpaid taxes on profits believed to have been funnelled through Luxembourg and Switzerland, business magazine L’Expansion reported on Tuesday.

Depending on how good your French is, or possibly how well Google GOOGL -0.12%Translate is behaving, that original is here:

Bercy claiming € 300 million in the burger king for his anti-tax montages that pass through Luxembourg and Switzerland. Hard to swallow when, at the same time, social unrest is growing in the group against such practices.

Umm, yes, looks like online translation might not be wholly ready for prime time just yet. Reuters is here:

It said tax officials had accused the giant U.S. burger chain of using a Luxembourg-based entity, McD Europe Franchising, to shift profits to lower-tax jurisdictions by billing the French division excessively for use of the company brand and other services.

And that’s what’s at issue. So, to the basic underlying economic and public policy issue. Governments claim the right to tax economic activity happening within their jurisdiction. The problem is not over that, it’s over defining what is economic activity happening within a jurisdiction. The buying of beef (almost all McDonald’s products are everywhere made from local ingredients) in France to make hamburgers to sell in France is obviously French economic activity. Tax it Daniel. But that brand “McDonald’s” obviously has some economic value. Try setting up a hamburger stall next to a McDonald’s and test your sales. It’s also equally obvious that the value of that brand hasn’t been created in France. Thus whatever part of McDonald’s France’s turnover or profits are created by that brand is not righteously taxable within France. That’s all well known and long understood.

What is irking Le Fisc is that McDonald’s is, as it has every right to, sending that brand value out of France to some variety of low tax jurisdictions. No taxman likes to see potential revenue flowing away but flowing away to a lower tax place is adding insult to injury. Which brings us to two things. Firstly, the relevant EU law on this matter:

The I+R Directive is designed to eliminate withholding tax obstacles in the area of cross-border interest and royalty payments within a group of companies by abolishing:

withholding taxes on royalty payments arising in a Member State, and

withholding taxes on interest payments arising in a Member State.

These interest and royalty payments shall be exempt from any taxes in that State provided that the beneficial owner of the payment is a company or permanent establishment in another Member State.

So, France cannot try taxing royalties for brands going to another EU state, something which Luxembourg is, another EU state.

However, that’s not quite the end of the matter. Because it is possible to argue about the royalty rate. If we said that Ronald was worth 50% of French Maccy D sales then we’d expect more than just a quizzically raised eyebrow. It is, the brand, the character, worth something but that much? Which brings us to the older rules about such things, transfer pricing. As far as it is possible to check, these internal prices between subsidiaries should be the same as those that would be or are charged to non-related companies. So called “arms length” transactions therefore.

As an example, consider Starbucks SBUX -0.02%. There was some kerfluffle a couple of years back when it was revealed that they hadn’t been making a profit in the UK for years. Tax fraud! was the cry and when people found out that they paid royalties abroad then this was just taken as proof. However, HMRC had looked at those royalties of (from memory) some 6% and demurred. That’s a bit high isn’t it? 4% was settled upon as being a more realistic number. The basic idea that royalties could, even should, be paid was not seriously challenged, the amount though was. A later EU investigation into the company collecting those royalties showed that Starbucks was charging its own subsidiaries the same royalty rate as it charged to franchisees: it was charging the arms length rate (at that lower rate agreed with HMRC I believe). Thus it was obeying all three parts of the correct set up. The brand was created outside the UK so that brand value should be taxed outside the UK. The royalty transfer was to another EU company and so was untaxed in the UK and finally, the price agreed with the transfer pricing rules. Everything is hunky dory.

And so it is with McDonald’s. The brand value was obviously not created in France. Thus whatever portion of turnover or profits that are represented by the brand should not be taxed in France. The royalties are going to another EU company and must not have tax applied to them before they leave France. The only remaining question is whether McDonald’s are charging their own subsidiary the same royalty rate that they charge a franchisee? That’s the part that we don’t know. But that is the part that the French tax claim rests upon.

My own opinion of this is that Le Fisc is trying it on. There’s a certain background here of unions and others making complaints for their own reasons, complaints that at least in part appear to have led to this latest action. Perhaps a certain amount of theatre and politics creeping in.

And my more general opinion about these difficulties of taxing international corporations is that it is becoming very much more difficult, yes. Precisely because more business is international and also because more of the value of business rests in those intangibles, patents, copyrights, trademarks, things which aren’t created locally and thus shouldn’t be taxed locally. It’s also true that we only ever taxed companies directly because they were convenient places to tax. We all know that only real live human beings (no, companies are legal persons, not real persons) really bear the burden of any corporate or other tax. But for decades we’ve accepted the fiction that we will tax the companies as a proxy for those people because it’s easier. This no longer seems to be the case: so let’s not accept the fiction. Simply abolish corporation tax altogether and tax individuals on their income at whatever rate we tax income at. Make no differentiation between tax rates for dividends, capital gains or labour income: but only after we’ve abolished corporate taxation.

If it’s actually true that it’s the capitalists who really pay corporate taxes then the end result will be exactly the same, won’t it? So, why not gain the same result and make the system simpler and cheaper to run at the same time?