Craig Elliffe: Multinational internet businesses adept at minimising tax

Multinationals can choose a location for its best tax advantage. Photo / AP

In the first of a three-part series Craig Elliffe looks at how much corporate tax these companies are paying.

Business is changing. Sitting in a Starbucks in San Francisco reinforced the point. The cafe was crowded with people taking advantage of free Wi-Fi, reading downloaded books (from Amazon), or searching for jobs, travel, services and products using Google. This scene could be replicated in any New Zealand city.

Many have written about the impact of the internet and e-commerce on business. Bookshops and travel agents will disappear from New Zealand shopping malls. It seems likely that smaller retailers will struggle against larger competitors and all will suffer from foreign retailers selling their products and services over the internet and importation directly to the customer.

This cafe scene is a frightening one to an Inland Revenue tax inspector, the New Zealand Government and therefore to you and me (as members of the New Zealand public). If there is any parallel between the way Starbucks, Google and Amazon carry on their business in New Zealand and Britain, very little corporate tax will be paid by the multinational corporations involved in the above cafe scene.

Most of the economic activity involved in these transactions takes place in New Zealand. The coffee is made and consumed in New Zealand, the book downloaded (or ordered via the Amazon website) and read here, and the sale of advertising services consumed by a New Zealand company using a New Zealand-specific search engine. There is still a risk that, despite the economic connection with New Zealand, little corporate tax is paid here.

Traditional taxation regimes are largely based on the recognition of profits determined by arm's-length legal transactions and upon the physical presence of the business.

There is no suggestion of any illegality in the low level of corporate tax paid. It's just that multinational corporations are sophisticated organisations.

They often have a plethora of business structures and rationalise the functions for efficiency. For example, all the worldwide purchasing for a product may take place in one jurisdiction. If you were a multinational where would you locate that company - a high- or low-tax jurisdiction?

Multinationals often use intellectual property. It is common for such intellectual property to be held in a single entity and licensed to worldwide subsidiaries. This arguably protects intellectual property and gives recognition to the value of expenditure incurred in developing the intellectual property. Again, if you were a multinational would you locate your intellectual property company in a high- or low-tax jurisdiction?

Part of the change to both business and taxation is due to the dramatic increase in e-commerce. The person (or company) that you are transacting with can be located anywhere. This has meant that some multinationals choose where profits can be located. In that sense they can locate the seller of the product in any jurisdiction around the world.

Furthermore, under most double tax agreements business profits are taxed only where the profit-making enterprise has a "permanent establishment" in the country. It is generally accepted that most sales of goods and services over the internet will not lead to the vendor having a permanent establishment in the country where the consumer makes the purchase.

Tax regimes seem to be struggling to keep up. New Zealand collects a relatively high percentage of its total tax revenue from corporate tax. In 2010 New Zealand ranked fourth-highest of 35 OECD countries in this respect. Does New Zealand have a multinational tax problem?

David Clark, Labour's revenue spokesman, thinks so. He has raised questions about Facebook's tax bill in New Zealand. Facebook paid $14,497 in New Zealand corporate tax in 2011. He pointed out that with 2.2 million users in New Zealand and billions of dollars of worldwide turnover the amount of corporate tax paid in New Zealand was "tiny"and "barely believable".

He has also questioned whether Google New Zealand was funnelling revenue through its low-tax Irish company. Google New Zealand paid $109,038 in tax on revenue of $4,447,898 (its profit before tax was $56,803).

On the other hand Alan Tsoi, the Hong Kong-based Deloitte Asia Pacific regional managing director for tax and legal, sees governments becoming too aggressive in their attacks on transfer pricing.

Facebook and Google may be structured differently in New Zealand from their overseas counterparts. By themselves the numbers mean very little and the full picture of how a business is structured is necessary to make informed comment. There is concern, however, that the amount of tax, by itself, is low. There may be many different reasons for that.

Craig Elliffe is Professor of Taxation Law and Policy, University of Auckland Business School.

Coming up
The next column examines exactly how multinationals reduce their taxes and the particular techniques and strategies they use to do so. The third column discusses the possible governmental and OECD response to these tax problems.