Corporate tax posturing should stop

When David Cameron flew to Davos last week to tell companies that reduce their tax bills by dividing activities among countries to “wake up and smell the coffee”, his target was clear. Starbucks now faces a consumer boycott and has been publicly accused of acting unethically.

The only problem is that it is not true. Starbucks’ supposed immoral act is not to pay UK corporation tax that it does not owe, and would not owe even if it did not license its brand from the Netherlands. It obeys both the letter and the spirit of global tax law, which governments could reform if they wished.

A better target for the UK prime minister would be countries, such as the Netherlands and Ireland, that lure businesses with low tax rates. Oh, yes – and his own government, which has cut corporation tax and introduced a “patent box”, similar to the Netherlands’ “innovation box”, giving relief on intellectual property.

I look forward to Mr Cameron naming and shaming companies such as Google (also a target of British politicians) if they are drawn from Ireland to the UK by his tax arbitrage. Perhaps that is too much to expect of a politician’s intellectual consistency.

The division of responsibilities in regard to tax is clear, despite the wave of political rhetoric designed to obscure it. Governments must decide which regime is fair, and companies and individuals must comply. The latter ought not be blackmailed into carrying out the former’s job.

As Lord Tomlin put it in a tax case involving the then Duke of Westminster in 1936 (quoting a 17th century chief justice), governments should not substitute “the uncertain and crooked cord of discretion” for the “golden and straight mete wand of the law”.

Plenty of tax avoidance by individuals and companies relies on exploiting legal loopholes. UK authorities estimate that £5bn a year is sheltered by “contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage”. Such structures obey the letter of the law rather than its spirit.

However, most companies that place operations or intellectual property in low-tax countries – or even in tax havens such as Bermuda – are not breaching the spirit of global tax law. They comply with a structure established under the League of Nations in the 1920s.

This allows – indeed, encourages – multinationals to split their operations among countries, paying taxes as if they were separate entities, in order to avoid double taxation. They have to make transactions at “arm’s length” – as they would deal with others.

It worked for a long time but is under strain because of the growing value of brands, intellectual property and intangibles to global corporations. “Ideas are their biggest asset, and what generate profits, and it is far easier to shift intangibles than factories,” says Jeffrey Owens, of the Institute for Austrian and International Tax Law.

Most of the outrage relates to US companies placing brands and IP in low-tax shelters. Carl Levin, chairman of a US Senate subcommittee accused Microsoft of “tax shams and gimmicks” last year. Margaret Hodge, who chairs the UK public accounts committee, fiercely assailed Starbucks, Google and Amazon.

Ms Hodge was particularly tendentious, claiming not to believe that Starbucks would have operated at a loss in the UK for most of the past 15 years, or that its brand is worth 4.7 per cent of its sales – the licence fee that its UK operations pay. “I do not find your business model very compelling,” she told its chief financial officer loftily.

Since Starbucks is among the world’s best-known brands and has a market capitalisation of $41bn, this says little for Ms Hodge’s potential as a business executive. Luckily, she instead has a job that puts her in a good position to change the law if she can achieve consensus.

That, however, would be harder than sounding off against companies for lacking morals. It would require governments to take responsibility for dividing corporate taxes, rather than telling companies to do so and then criticising them.

There are clearly flaws in any regime that permits companies to shield high-value intangibles from tax. “The global tax regime is pretty arbitrary. If you started with a clean sheet of paper, you would not do it like this,” says Michael Devereux, professor of business taxation at Oxford university.

The much-hailed alternative is unitary taxation of global companies, under which profits would be split according to where the substance of their activities took place, and then taxed in those countries. This would require governments to agree a formula for dividing taxable profits “fairly” – for example by assets, workforce and turnover.

The difficulty is obvious – who says what is fair? Should intellectual property count for more or less than employees or assets? Which countries should gain tax revenues and which lose? The European Commission has suggested unitary tax for the EU but the chances of achieving consensus within Europe, let alone the rest of the world, are slim.

Most countries tend to assume they would gain from changing the current set-up, but it is questionable. One US study found that unitary taxation would not generate any more tax globally, once companies adjusted behaviour by, for example, shifting staff rather than intellectual property to low-tax countries. It would be a zero sum game.

Politicians thus have the choice of indulging in easy rhetoric against companies that obey the laws they have passed or struggling to reform the tax regime for little reward, with lots of disruption. In their position, I might posture too.

john.gapper@ft.com