Original URL: http://www.theregister.co.uk/2013/08/07/tax_avoidance_for_beginners/

Tax dodging? It's harder to do - and rarer - than you think

What are Amazon and Apple really getting away with?

By Tim Worstall

Posted in Policy, 7th August 2013 09:04 GMT

Video So you'd like to know how to avoid tax. After all, everyone else seems to be doing it, so why end up as the Muggins who has to pay while everyone else mugs the Treasury?

The simplest and most obvious method of not paying taxes is simply to avoid doing anything. If you're not taking part in economic activity then no one will be able to tax you. This does have a downside to it as starvation is a likely outcome.

This is what famously occurs towards the second end of the famous Laffer Curve: a taxpayer decides to do a little bit less of something - whether it be running a business or working for someone else - if tax rates become insupportably high.

At the one extreme – 100 per cent taxation – the government receives zero revenues as no one is prepared to work for "free", while at the other extreme – 0 per cent taxation – the government receives zero revenues for obvious reasons (see video below for a back-of-the-napkin – yes, literally – explanation from former Reagan White House economic adviser Arthur Laffer himself).

Laffer draws his famous curve on a napkin and explains how it works.

Yes, it's really true. The argument is about the shape of the curve, not its existence. If you push tax rates too high, a sufficiently large number of people will do sufficiently less such that overall tax collections will fall.

There are Laffer effects at any level of taxation. A decent guess is that what we call the "deadweight" loss of taxation is 20 per cent. Raise £1 in tax and 20p of economic activity doesn't happen purely and solely as a result of that tax.

At the margin, where we already take 40 per cent of GDP in tax, that deadweight might rise to one-third or so. Given that at least some of what the government does is worth more than 130 per cent of what the taxpayers themselves would do with the money, this is fine.

Allowances - governments make them, so use them

You still want to save on your taxes but don't want to give up on the work? The next step is to use all of the allowances that are made available to you. Stick your savings into an ISA (a 401k, sorta, for our friends over the Pond); maximise your pensions contributions; make sure you claim absolutely everything you can as a work allowance (if you're wearing a boiler suit to work in a dirty environment make sure to claim for cleaning it) and so on.

So far no one is going to accuse you of tax dodging in any manner: this is just some combination of the usual human response to incentives plus things specifically put into law to persuade you to act in certain ways.

Call in the contractor... or be one

After this though it becomes a tad more tricky. Because there will be those who insist that this next stage is tax avoidance, not good old tax compliance. For example, you could, if you were a contractor, incorporate yourself as a company. Put the husband on as 49 per cent shareholder too. Earnings go into the company and you pay yourself £3k a year each or so.

This is enough for you to be credited with paying national insurance (and so earning your state pension) but not enough for you to be actually paying any NI. You then pay corporation tax out of profits and you pay what's left as a dividend. Corporation tax plus individual income tax on dividends is pretty much the same rate (not quite, but close). However, crucially, dividends attract no NI. So you save both the employer and employee NI costs.

The actual saving isn't all that large because the alternative to incorporation would be to be self-employed, where you pay lower NI anyway. But it's still a cute scheme. For you have now also moved some of the income over to hubby who, being the stay-at-home look-after-the-kids sort, has an unused personal allowance and a further standard rate allowance to use up before hitting your exalted income tax levels.

It's so cute in fact that Gordon Brown tried to ban many from doing this (leaving a company as an employee and returning as a contractor to avoid NI) with the IR 35 legislation, but it didn't work all that well. As an aside I know a certain tax campaigner who rants and raves against this “misuse” of incorporation, calling it tax abuse. He did pipe down after one wag checked at Companies House and proved that this was the scheme that he and his own wife used.

But these of course aren't the sort of schemes that are making the recent headlines. There's all those complex, completely legal Jimmy Carr-type schemes out there but they don't last long and don't, usually, save any tax either.

As soon as HMRC finds out about them (and they must be disclosed in advance now), they close them down, pass a nice bit of retroactive legislation and everyone has to cough up the tax and still lose the fees they paid to the scheme promoters. Shame, eh?

Then there's all the other stories, all those tech companies adhering to the just and righteous law but nevertheless not coughing up a bean. The Googles, Apples, Dell, Microsoft and all the rest are dancing around the edge of the law and the grannies die of starvation while corporate execs heap the profits high.

Except, actually, in those large corporations there's almost no one at all in the know who suspects any dancing at the edge of the law. What they're doing is clearly established in the relevant tax law: it's just that times have changed since the laws were written.

Tech giants: 'So what're you going to do to stop us, huh?'

There's an interesting little leak here explaining what the OECD is trying to do to make sure that taxes are indeed paid on those profits.

For example:

Also up for possible revision are long-standing "specific activity exemptions" which have been used by Amazon to enable it operate major retail businesses in countries like Britain and Germany without creating tax residences for these businesses.

Subject to tax...BUT not sold here.

This isn't quite true. Amazon's warehouses are indeed subject to the usual taxes. They're just in a separate company from the one that actually makes the sales. And one of those long-standing exemptions (it's in the standard double-taxation treaty that's been in use by everyone for well over 50 years) is that if you sell your goods into a country then using a bit of warehouse space or some logistics in that country doesn't give rise to your having a “permanent establishment” (PE) in that country. And it's that PE that creates the liability to corporation tax.

Double-Dutch-Irish sandwiches and other tasty treats

Why the exemption is there should be obvious. As an example, much of the trade in minor metals takes place in warehouses in Rotterdam. That's where the actual legal transfer of title takes place. But it would be mad for the Netherlands to get all the tax from that global trade. So what gets taxed by the Dutch is the cash from the warehouse services while all the traders pay tax on their profits back home.

But you can see how simple it is for a multinational retailer like Amazon to sell everything from, say, Luxembourg, put all the warehouses in another company and thus run away screaming maniacally with oodles of cash. Well, except for the fact that Amazon seems to operate a policy of not actually trying to make a profit at all.

The OECD draft also said it would target arrangements where treaties designed to avoid double taxation of corporate profits are abused through the use of "dual resident entities" to ensure no taxation whatsoever is paid.

Now that's a stab at Apple which does something slightly different. It has a company in Ireland that buys all the kit from China then resells it to Apple UK (and DE, FR and so on). All the profit ends up with the Irish company, the retailers left just enough margin to cover the costs of the Genius Bar.

The point here is that Ireland does have a low corporate tax rate of 12.5 per cent, yes. But it only applies it to business that really, really, happened in Ireland. Buying something in China and selling it in the UK did not so it doesn't even try to tax this: that's the secret of Apple's incredible 2 per cent overseas tax rate.

Here's Reuters again:

The OECD also has its sights set on arrangements where companies allocate profits to tax haven units on the basis these units funded research or bore business risks related to transactions elsewhere in the group. Microsoft uses such arrangements to allocate profits derived from research conducted in the United States to a unit in Ireland, a U.S. Senate investigation last year showed.

Apple also has a similar arrangement. Clearly there's some value to the research: in the tech space that is really what is being bought by the consumer. So, make some guess as to how much of the value of the kit is the research then assign that to a company. The other parts of the company then should pay that new one for use of the research.

Or, if you prefer, the Starbucks brand has a value, people should pay for using the value of that brand. Certainly, you're going to get more sales as a Starbuck's than you would as “Cafe Fred”. Which is exactly what Starbuck's was doing, the UK arm sending 5 per cent or so of sales off to the Netherlands. Not only isn't this illegal, there's actually an EU rule that says that it would be illegal to tax royalty payments from one EU country to another. We are after all in a knowledge economy and royalties do come with that territory.

The action plan said the OECD would also examine the avoidance of tax residence, or permanent establishment (PE) "through the use of commissionaire arrangements" – a mechanism used by companies including Dell to avoid reporting revenues in markets where they have major sales.

That's just a variation of Apple's dodge: sell to an intermediary in the country, make sure that broker only gets enough margin to cover costs and keep all the profit elsewhere.

There's one avoidance method that's more commonly complained about that the OECD isn't addressing. That's loading the company up with debt. This decreases taxable profits because the interest you've got to pay is tax-deductible. It's a bit of an odd one to complain about (although UKUncut did with Boots) because the interest is taxable to the people it is paid to. It can actually end up with a higher tax bill.

After all of these cute tricks we come to the final way of dodging taxes: lie. This is also known as tax evasion and it's a criminal offence and no one, no one at all, thinks that any of these large companies (nor many small ones come to that) is actually doing this. There is most certainly tax evasion going on but it's largely the province of individuals and the grey economy: no VAT receipts and the like.

It's the tax laws, stupid

The real point of all of this is that the current system of taxing large companies is completely borked. It grew up post-war, largely, when currencies were fixed, when there were capital controls, when companies rarely sold over national boundaries.

The rules set up for that world just don't work in today's. Where we've got, as one example, the European Union insisting that we must have perfect freedom of movement of capital, goods and companies. Thus reform is going to have to happen and as Google's Eric Schmidt has pointed out, the politicians set the rules and companies will obey them.

I am an extremist on this matter of course. Companies don't actually bear the economic burden of corporate taxes: shareholders and workers do. Companies used to be, in the old world, a convenient place to get the cash, but now they're obviously not. So, don't try to tax the companies: just sting the shareholders and workers as it's them that really pay anyway.

And one final point about the amount of such dodging that's going on. Various NGOs and campaigners have been insisting for years that inside those secretive Swiss banks there's billions upon billions hidden away from HMRC. So a deal was signed and the Swiss banks combed through their books, identified the UK citizens and worked out whether they should, righteously, have been paying UK tax. British Chancellor of the Exchequer George Osborne was so confident about this that he booked £4bn and change as a receipt for the cash that was about to come rolling in.

Unfortunately, once they combed the books, they found only a few hundred million that was due. For most of the Brits with Swiss accounts are either non-doms (who don't pay UK tax on their foreign earnings they keep in foreign bank accounts - for example, the UK does not tax Abramovitch's earnings in Russia, as long as they stay outside the UK) or Brits working abroad like, umm, me, who also do not pay UK tax on earnings as we're not actually resident in the UK. We cough up elsewhere.

There's something of a difference between the £4bn the government expected, the much larger squillions that tax campaigners were claiming and the few hundred million actually due. There's a great deal less tax evasion going on than the current zeitgeist might lead you to think. ®