Internet Firms and Taxes: Patch-Up Job

Taxmen are doing whatever they can to squeeze more from online businesses.

The international framework for taxing multinationals has been tweaked and refined over several decades under the aegis of the OECD, a club of mostly rich countries. But it remains “a patchwork of national laws and international treaties, frayed by internal and cross-jurisdictional inconsistencies,” laments Ajay Gupta, editor of Tax Notes International.

Internet businesses find it especially easy to exploit the holes in the fabric to shift profits to places with lower taxes. Data on an internet user in one place can be analyzed in another, then used to sell advertising, aimed at that user, to an advertiser in a third place. Taxmen generally cannot get their teeth into a web firm’s profits unless it has a “permanent establishment” — an ill-defined term — on their turf.

All this lets internet giants engage in breathtaking tax gymnastics. In 2011 Google cut its tax bill by $2 billion by routing some sales royalties through units in Ireland, the Netherlands and Bermuda. The OECD aims to produce firm proposals for reform by 2015, and was due to give an update on its progress on January 23, after The Economist went to press. Pascal Saint-Amans, the head of its tax division, says it is proving “complex and contentious.”

[CFO editor's note: The overhaul of international taxation is on schedule, and the first of a series of draft recommendations will be published in March, the OECD announced Thursday.]

The OECD’s big worry is that those European and developing countries that most dislike the present set-up may lose patience and act unilaterally. This, the OECD warns, “could lead to global tax chaos marked by the massive re-emergence of double taxation.”

It is in France that profit-shifting raises the most hackles. In 2011 Apple, Amazon, Facebook, Google and Microsoft paid just €37.5m ($52.1 million ) in corporate income taxes there, rather than the €829m ($1.2 billion) that might have been due had their activities been taxed under domestic rules, reckons Paris-based Greenwich Consulting. The French tax agency is reportedly pursuing Google for €1.7 billion ($2.4 billion) in back taxes and penalties.

France has been buzzing with internet-tax proposals: last year there were no fewer than four officially commissioned reports on the subject. The first, in January, suggested taxing firms on the personal data they collect from online users. In May a former television boss’s report proposed a 1 percent tax on the sale of smartphones and other devices that display content. France already levies a “culture tax” on cinemas, broadcasters and internet-service providers, to subsidize the making of French films and TV shows. In September an independent committee came out against any unilateral taxation of online activities. But in December an official agency, the Superior Audiovisual Council, recommended extending the culture tax to entertainment sites such as YouTube and Facebook.

Egged on by France, EU leaders have blessed a decision by the European Commission to appoint a digital working group, which has until the summer to produce proposals on internet taxation. Prominent among its members is Pierre Collin, an author of the French report that proposed a data-collection tax.

For all the sound and fury in France, Italy is the first big EU member to pass a law to curb profit-shifting by internet firms. Last month its parliament approved a bill requiring Italian companies to buy their internet ads from locally incorporated firms instead of the tax-haven subsidiaries that many transact with today. However, the law probably violates a central EU tenet that companies can buy and sell across national borders. So the government has delayed its implementation until July, while it co-ordinates with other EU countries.

Elsewhere it is the tech giants’ clients that are in the taxman’s crosshairs. In Chile, for instance, the tax authority informed hundreds of local firms last year that they were liable to pay a 35 percent tax for their use of Google’s AdWords service and, worse, would have to pay it retrospectively for 2010-12. Juan Pablo Swett of the Association of Entrepreneurs of Chile estimates that about 100 firms will go out of business if forced to cough up. The companies have sued the tax agency. They may also go after Google, whose American ad-sales operation should not, they say, have handed over their details. Now that they have to pay more for AdWords, a lot of Chilean companies have stopped using it.

With or without such unintended consequences, the OECD could struggle to persuade the countries that count to stick with multilateralism rather than acting alone. It will not be easy to craft solutions that placate the Europeans while not upsetting America, which will fight any proposals that threaten its tech giants’ competitiveness. Those firms, meanwhile, are busily lobbying against anything that would penalize “efficiency” and “innovation.”

© The Economist Newspaper Limited, London (January 24, 2014)

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