‘Starbucks vs the people’

1. ‘Starbucks vs the people’ Prof. dr Hans van den Hurk

2. The world is changing....

3. https://www.youtube.com/watch?v=alcKsti_8QQ

4. First of all, some principles • How to deal with: • Corporation versus Permanent Establishment • Double taxation • Capital Import Neutrality versus Capital Export Neutrality • Seat of a corporation • Withholding Taxes • Beneficial Owner • Influence of tax treaties • Intragroup pricing • Tax competition • Patent boxes etc.

5. Where to start? • International tax planning will be influenced by: • OECD-modeltreaties and softlaw • UN-modeltreaty • Emerging countries and upcoming economies • BRIC • Taiwan etc • Ghana • EU • NGO’s

6. What role play states in this? • Best way to illustrate this is with an example • In this situation: Google • Why Google? • Well: • Use of Ireland • Use of Netherlands • Thus.. Standard tax planning and challenged by NGO’s • What is wrong with it? • Let us see....

7. Google • Some facts: • Annual revenues (2011): $ 37.905.000.000 • (2012: $ 50.170.000.000) • Incorporated 1998 in California • Effective Tax Rate: 2,4% • Regular US Tax Rate: 35% • To be discussed: • US legal framework in a nutshell • Google’s Tax Planning Toolkit • Step 1: IP shifting • Step 2: The Double Irish • Step 3: The Dutch Sandwich • Step 4: H(e)avely Bermuda

8. To be created… US Bermuda Ireland Netherlands GIL IP income EMEA subsidiaries

9. Few words on US system • Principle one • Worldwide Taxation for companies incorporated in the US • Credit system • Overseas profits are taxed when brought to the US • Principle two • Avoidance of Double Taxation, two systems • (Deduct foreign taxes from their domestic US taxable base) • Ordinary foreign tax credit • Most companies use the latter • No foreign tax credit for ‘Voluntary’ taxes • Companies have to exhaust remedies to reduce foreign income taxes • Or companies have to have an at least should opinion from a respected firm

10. US Legal Framework (2) • Principle three • Anti-avoidance legislation • Subpart F Regulations • Passive Income • Income derived from inter-company dealings • Intention • protect US Tax Base by inhibiting artificial shifting abroad of profits and the subsequent use of tax havens • Principle four • Transfer Pricing • According to OECD criteria ‘at arms length’

11. Google’s Tax Planning Toolkit • Step 1: IP shifting • Google did foresee a raise in value of the IP • IP was shifted oversea based on a Cost Sharing Agreement (§1.482-7 FTR) • CSA: agreement that parties share costs to develop IP in proportion to their shares of reasonable exploitation of the interest in the IP • Allocation of costs should be at arms length • In case of existing IP to be brought in the CSA, other participants are required to effect a so-called ‘buy in’ payment at arms length • If IRS agrees there will be no TP adjustments

12. How did Google do this? • Google creates in 2003 subsidiary in Ireland, called Ireland Holdings • Through CSA the latter obtained rights to Google’s IP for EMEA • Since Google owned pre-existing IP, Ireland Holding effected a buy-in payment to comply with the US rules • In 2006 Google created legal certainty by obtaining an APA • It is expected that the buy-in payment was at arms length • EMEA revenues are now attributable to Ireland Holdings

13. Step 2: The Double Irish • Google Ireland Limited • Establishment of second Irish subsidiary in 2003 • Functions of GIL: • Generation of passive income through collection of royalties • But mostly coordination of activities in EMEA • Google Ireland Limited (GIL) was created by a Dutch intermediary company • Ireland Holdings (IH) licenses IP to GIL via Netherlands • EMEA countries pay fees to GIL • Deductible in these countries • Margin of fees taxable in Ireland at 12.5% • Press: 88% of Google’s overseas profits flow to GIL • But are these profits taxable in GIL?

14. Google checked the box? • Assumingly they did... • Irish Ltd is not on ‘per se’ list • Subsidiary (GIL) is clearly a separate legal entity • GIL can therefore choose to be treated as disregarded entity • What does it mean? • IH could be caught by Subpart F legislation • IH merely receives royalties and has no active income • Under Subpart F IH would be qualified as follows: • Wholly owned subsidiary of Google US and only generates passive income • This triggers US CFC legislation and profits would be deemed to be distributed to the US • By checking the Box • GIL becomes division of IH for US tax purposes • Since GIL is predominantly active its business income will be attributed to IH • There it will outweigh the passive character of IH’s income

15. Creation of a Hybrid • IH’s effective place of management (mind and management) is in Bermuda, although almost 2000 people work in HQ in Dublin • Tax Rate 0% • Irish tax rate as said 12.5% • So any IP income that is received via the GIL/EMEA will be taxed at 0% • No Permanent Establishment risk since most of the more than 2000 employees work for GIL • Hybrid classification • US still sees IH as a Irish corporation • Ireland looks at IH as a Bermuda corporation • One problem: • No tax treaty between Ireland an Bermuda, therefore WHT 20% • How to solve this? .... Use a Dutch intermediary

16. Using the Netherlands US • Dutch Sandwich looks as follows: Bermuda Ireland Netherlands GIL IP income EMEA subsidiaries

17. How does the condensed P&L look? • Suppose income 1000 GIL receives 1000 Suppose 2% remains in Ireland 20 -/- ____ Netherlands receives 980 Due to Dutch tax ruling 0.2% is payable 1.96 -/- ____ To be distributed to Bermuda 978.04 Effective tax rate in chain: 21,96/1000 = 2.2% In reality it is 2.4% whereby only 88% flows through GIL • How does the Dutch sandwich work?

18. Dutch Sandwich • Dutch BV is called Holding BV • Private limited liability company • The box is checked • From US tax perspective it does not exist • Other countries see it as a separate legal entity • Holding BV acts as conduit company • Holding BV has an exploitation license from IH for IP • Holding BV sublicenses this IP to GIL • In the Netherlands a small taxable spread will be reported, provided that • Substance • Real risk incurred • Company’s equity is 50% of average anticipated yearly gross royalty income • Or € 2M, whatever criterion has been met first • Since Annual revenues: $ 37.905 Billion, the latter criterion is easily met

19. Tax aspects Ireland-Netherlands • Yes, there is a treaty • Art.10, par.1 Treaty between Ireland and the Netherlands • And the Interest & Royalty directive • No withholding tax between Ireland and the Netherlands with respect to Royalty payments • ‘Beneficial owner’ versus ‘Ultimate Beneficial Owner’ • More and more countries take different view (Denmark) • And back to the IH? • Netherlands do not levy withholding taxes on outbound royalty payments • So net royalty’s arrive ‘tax free’ in Bermuda • And the Dutch spread? • This is taxed in the Netherlands • Dutch position contributes in total €1.5 Billion to the Dutch Economy • But this taxation can (in principle) be credited in the US

20. And Bermuda? • Bermuda’s directors are two attorney’s at a Hamilton based law firm • It is not fully clear but it is expected that Google Bermuda is nothing more than a letter box company • Dividends have to remain in Bermuda in order to avoid US Taxation • In order to ‘optimize’ IH was transferred from LLC to Unlimited Liability Company in order to prevent publication of IH accounts • IH is still checkable so this step does not harm the structure

21. Uncork the champagne? • Well, better wait a while... • ‘Locked Out Profits’ • Repatriation leads to US CIT • This is the main problem of the structure • It is expected that companies like Google, Pfizer, Apple, Cisco etc. have $1.375 trillion accumulated profits in overseas tax havens • $ 1.375.000.000.000! • Lobbying for Repatriation Tax Holiday • First time in 2004 • 5.25% tax rate provided that corporations would invest this money in job creation, R&D etc. in the US • However many loopholes where found to not having to do so • Can US challenge this behavior? • Not sure: multinationals have spent alone more than $1Billion on lobbying!!!

22. And Google shareholders? • Two ways to get a dividend • First alternative: • selling their shares and realizing the dividends via a capital gain • Second alternative • Google Holding US acquires a lone to finance the buy back of shares • Possibly (I am not sure in this) from the Bermuda company • Interest deductible in US • Taxed at 0% in Bermuda • See: http:/www.nytimes.com/2013/05/03/business/how-apple-and-other-corporations-move-profit-to-avoid-taxes.html?_/r=1&

23. Is Google to blame? • Tax strategy is commonly used • Other companies take comparable approaches • Questionable is probably whether Bermuda is a letterbox • If so, the dual resident status should be ignored • Ireland has to fully tax IH in that situation • A little bit of hypocrisy is the request for a ‘tax repatriation holiday’

24. What do other companies use? • Other companies use either comparable structures or structures based on the following elements: • Profit participating loans • Tax treaties • Substance • Withholding taxes • Participation Exemption • Beneficial tax treatment for certain areas • Swiss holding regime • Luxembourg ruling regime • Hungary • Etc. • But are all of these elements responsible for tax avoidance?

25. Bad boys... And governments? • For example the UK... • On the one hand: • George Osborne: In 2014 the UK will have lowest CIT rate for any Western economy! • Several new tax arrangements which will increase the position of the UK as the country to invest in • Innovation tax breaks, etc. • On the other hand: • Thousands of new hires to become tax inspectors • See his ‘justification’ in Wall Street Journal, April 13, 2013 • US • The following 4 minute movie says it all: • http://www.youtube.com/watch?v=yN96cFnnguE

26. Another example… • Another example from yesterday’s papers • France’s EDF, state owned for 84% uses a Dutch financial holding • As do many other French companies • And the Netherlands? • Discussion going on is merely about letterbox companies • And we lease our trains from an Irish company

27. Conclusion.... Deadlock!

28. And now? • Three main influences, OECD, UN and EU • OECD, in the beginning… • OECD Report on Harmful Taxation • OECD Harmful Tax Project 2004 Progress Report • Several other reports like: • Tackling Aggressive Tax Planning through Improved Transparency and Disclosure • Corporate Loss Utilization through Aggressive Tax Planning • Hybrid Mismatch Arrangements: Tax Policy and Compliance Issues • Will this OECD help solving tax competition? • Probably not. Politically too complicated • However since 2012: • 2012……….. • Quite a start with ‘Base Erosion and Profit Shifting’ (January and July 2013) • ‘After Tax Hedging’ • Brilliant initiative, also for non-OECD countries

29. The G’s….. • Recent report to G20: • April 2013-OECD-SG-Report-to-G20-Heads-of-Governments • Part I, developments on exchange of information (Progress Report). • Part II is report by OECD on current work that is relevant to tackle offshore tax evasion and tax avoidance • Decision G7, May 2013: http://www.bbc.co.uk/news/business-22476233 • G8, June 2013 • G20, St Petersburg • Statements Obama and Poetin

30. United Nations • UN • Main difference to OECD: ‘more source state based’ • Relevance of UN strongly underestimated • See problems with BRICS Countries • UN Model Treaty is more focused on the (developing) state • Sometimes due to lack of knowledge free interpretation by some states which will normally not lead to a more favorable position for companies • Some countries go even beyond UN basis • See e.g. discussions with India, Brazil etc. • Also coordinated initiatives for further development, one example: • Resolution from March 20, 2013: Promoting transparency, participation and accountability • http://www.un.org/ga/search/view_doc.asp?symbol=A/RES/67/218&Lang=E

31. European Union • In 1997 the first Code of Conduct Group was established • From a legal point of view the so-called Primarolo-report is softlaw • However the results have been widely accepted • See: http://ec.europa.eu/taxation_customs/resources/documents/primarolo_en.pdf • New list of Code of Conduct Group • List contains: • Rollback measures • Standstill Discussion • UK: Guernsey, Gibraltar • Progress has been made recently • Anti-Abuse measures • Profit Participating Loans • Mismatches Hybrids and PE’s • Beneficial treatment of Interest, Royalty’s etc. • Some specifics regarding third countries like Liechtenstein

32. Other EU Tax developments • Communication December 2012: ‘An Action Plan to strengthen the fight against tax fraud and tax evasion’ • Will it be successful? • After the result of the 1999 report it is expected that it will be partially successful • Commissioner Algirdas Šemeta is pushing this Action Plan • Commission Decision of April 23, 2013 • A Platform for Tax Good Governance, Aggressive Tax Planning and Double Taxation is created • Participation of amongst others NGO’s • May 22, 2013: Country leaders have discussed tax evasion in EU • Van Rompuy: a trillion euro's is lost every year by tax planning

33. And also….. • EU and OECD agree in developing a global standard in automatic exchange of information • See memo September 16th • http://www.eu2013.lt/en/news/pressreleases/european-union-and-oecd-agreed-to-foster-the-progress-in-developing-global-standard-of-automatic-exchange-of-tax-information

34. Once ignored, now important • NGO’s • Action Aid • Christian Aid • Robinhoodtaxes.org • http://www.youtube.com/watch?v=qYtNwmXKIvM • Tax Justice Network • War on Want • UK Uncut • You really think it has no impact on YOUR tax practice? • Forget it, every tax director is concerned for • Getting information in the press (Reputation) • Not being able to deliver information requested by ‘the people’ • E.g. What did you pay in which country based on what profit? • Country by country reporting with respect to taxes is what NGO’s want

35. How will they impact Tax Planning? • From ‘blame to shame’ • It is perhaps correct what you do but you shouldn’t • Tax Planning often based on legal concepts • Profit allocation PE: functions, risks • But that legal approach is not always strong • See video called ‘Vodafone Swiss Swizz’ http://www.youtube.com/watch?v=XAenlYsV7A4 • NGO’s expect from companies to behave as ‘good tax paying citizens’ • NGO’s are also fighting against Governments which retain their competitive laws

36. What are the real problems? • Well, often the main problem is US tax system • In an ordinary tax credit system a rate of 35% kills all competitiveness • A bad system which is economically not defendable urges companies to go beyond this • So in a way a tax holiday is necessary • But what about the ‘arms length principle’? • Stems from the old colonial days • Adidas example clearly shows the shortcomings • Many states offend this principle or go easily beyond this

37. Solutions for ALP • In a way there are many solutions • The vary between: • Old fashioned ALP • OECD’s prefered ALP • Prices are determined by real added value • Difficult with a.o. intangibles • Problem: how will this be determined? • Formulary Apportionment • A way to go around difficult discussions like OECD’s ALP approach • See Brazil and also India

38. Conclusion • The world is changing • Due to modern media the world turns smaller • People use these media to impose change • Governments seem to act passively • Simply because they have their financial interest • Companies tend to retain their traditional tax planning schemes • Since shareholders see tax as costs • In the end the weakest position seems to be for the companies • ‘Corporate Social Responsibility’ influences ‘Shareholders Value’ • More and more MNE’s report tax in their CSR though still less than 20% • But the battle just begun!

40. Contact details Hans van den Hurk @Hansvandenhurk Hans.vandenhurk@maastrichtuniversity.nl

41. Thank you!