No longer a question of paying taxes

This article was contributed and first published in the Business Times on 8 February 2013.

The recent Starbucks tax story in the UK has been interesting in so many ways. Who would have thought that so many people from different walks of life could become overnight experts in taxation, well versed and skilled in the intricacies of cross border transfer pricing, issuing forth in their blogs or through their Twitter accounts to all that might read their sage words?

And I had been under the misapprehension that transfer pricing was a specialist area in the world of tax, requiring some years of learning and experience to master.

I jest of course. The public's hostile reaction to the disclosure that Starbucks had paid very little tax in the UK for a number of years as a result of adopting aggressive transfer pricing was somewhat uninformed and borne of a sense of moral outrage. "It's not fair, we pay tax, so should companies" was the cry, regardless of whether Starbucks' transfer pricing was in accordance with the rules. And on balance one would expect that it was and that Starbucks acted within the law.

Further, it is difficult to believe that the UK tax authorities would not have reviewed Starbucks transfer pricing over the years and challenged it where appropriate. One upshot of the whole saga was that various people made it known publicly, again through Facebook, Twitter or other such media, that they would henceforth be taking their coffee business elsewhere.

In a number of cases the sentiment was expressed in the following terms: "From now on I will be buying my coffee at X, because at least they pay tax." Again, who would have thought? People determining their preferred barista on the basis of how much tax they pay; you could not make it up!

One irony in all of this is that should Starbucks lose any significant portion of its market share in the UK as a result of the public's anger, as some commentators are predicting, this could plunge it into losses for some years to come, in which case . . . it won't have any corporate tax to pay!

Except that, in an attempt to appease the public and the UK government, Starbucks has announced that it will voluntarily deny tax deductions to the extent necessary so that its tax bill will be £10 million (S$19.5 million) for each of the next two years. There are some important messages and lessons coming out of this affair.

First, a recognition that tax may become, if it has not already become, part of the corporate social responsibility (CSR) agenda. If you go into any Starbucks and read some of the literature on the walls or counters, you will see that they are very active and do a great deal of good work in their local communities, as well as regionally and globally.

Like many leading organisations, Starbucks, it seems to me, has a worthy CSR programme. It appears that paying enough tax (whatever that may mean) will now have to be part of that programme, but some potential pitfalls need to be borne in mind.

Many organisations are now seeking to disclose voluntarily their total tax contribution as part of their efforts to demonstrate good corporate citizenship and in defending itself against the recent public backlash in the UK, Starbucks pointed to, among others, the amount of value added tax (VAT) that it accounted for to the UK tax authorities each year.

However, people were quick to point out that it was they that were paying the VAT and that Starbucks was merely handing it over to the government. Some people went as far as to suggest that they would ask Starbucks to deduct the VAT from the price of their coffee purchases, and only then could the company claim to be contributing the tax on its own account.

The total tax contribution debate could take up several pages, so I will leave it at this: organisations are going to have to be much more mindful of the tax that they pay, if and how they report this (recognising the possibility of mandatory country-by-country reporting of taxes in the future), and how this will be perceived by governments and the public.

Second - and this is nothing new - organisations have to be very careful about their PR. It is often the case that CEOs will be keen to highlight positive results in a particular area, be it product, business segment or geography related. Starbucks made claims that its UK business was profitable and this is probably what antagonised people the most. "How can a company claim to be profitable and yet pay no tax?" was the basic question to which people wanted an answer.

The lesson here: make sure that any public statements that you make about your business activities take into account all relevant issues, including taxation. Tax authorities can and do read and listen to the news, and if they see a company's announcement that it is performing strongly in their jurisdiction, they will look to see how this compares with the tax that the company is paying. It's simple, really, but organisations can get it wrong and overlook the importance of tax, in its widest context, in PR.

Third, the pressure on tax havens will continue, if not increase, and in the wake of the Starbucks furore, the UK government has continued to re-affirm its commitment to the fight against tax evasion and aggressive avoidance, in which tax havens are invariably named as culprits.

The US, the EU, the Organisation for Economic Co-operation and Development (OECD), and many other countries and organisations are stepping up their efforts to curb the use of tax havens by multinational corporations (MNCs).

Measures like America's Foreign Account Tax Compliance Act are designed to tackle tax evasion by targeting the secrecy and opacity of some of these jurisdictions, but it is worth noting that although the Starbucks episode may have fanned the flames of the debate about the use of tax havens; in the Starbucks case, the jurisdictions in play were not the Cayman Islands or Bermuda, but Switzerland and the Netherlands (a member of the EU no less!).

Basically, governments are tired of losing money through evasion or avoidance that involves the use of tax havens and they believe that more has to be done. Expect more measures in the coming years.

Fourth, and as a related matter, the Starbucks case has cast the spotlight on the arm's length principle, the generally accepted standard governing pricing between related parties, and at the heart of why Starbucks paid so little UK tax for so many years. The case has reopened the debate as to whether the arm's length standard is the best way to achieve the "right" result in terms of revenues (and therefore tax liabilities) between related parties dealing with each other, or whether an alternative system is needed.

The most commonly proposed alternative is formulary apportionment, a system under which the profits of an MNC are divided by entity (and so in effect geographically) according to pre-determined keys - eg headcount, assets, etc. The theory is that under such a system it should not be possible for the profits of MNCs to end up in low tax jurisdictions where little or no commercial activity is taking place.

At the detailed level the debate is complex. The OECD continues to espouse the arm's length standard as the only reasonable basis for achieving the correct outcome, but this ignores the possibility that the will of people and governments to see a "fairer" outcome could point to a different result.

The OECD continues to work on developing its transfer pricing framework to achieve rules which are acceptable to businesses and governments alike, but patience may be wearing thin and there may be more pressure on the arm's length standard in the coming years; alternatively governments may adopt different rules on a unilateral basis, which would only be bad for business and potentially result in increasing amounts of double taxation for MNCs.

Some final observations. Popular activism will continue to play a role in how governments react to these sorts of incidents and in turn how they might come to shape tax (and other) policy; the power of Twitter and other social media in this context cannot now be ignored.

Companies need to recognise that the press and social pressure groups are actively scouring their accounts and news to uncover anything that might be seen as less than impeccable behaviour - even if within the rules - and often how and when this is reported may come as a surprise and shock.

The Starbucks case raises questions about the fundamentals of capitalism: Starbucks was - one has to assume - seeking to maximise shareholder return through legitimate tax planning and structuring, but increasingly it seems that people are not prepared to accept this, they want responsible capitalism, going beyond the requirement for organisations to act legally, and looking to the moral dimension and the concept of fairness, both of which can be very difficult to define, rationalise or reconcile in the context of taxation.

The debate about abolishing corporate taxes altogether one day may receive more air time, but in the current climate that is unlikely to be a realistic option. I could go on, but I have run out of space, and I'm in need of a coffee. As I say, so interesting in so many ways.