We know so much about Google’s tax structure, how is it possible to get the reporting so wrong?
The taxation of US multinationals continues to make headlines. It is right that these companies are subject to intense scrutiny but given how frequently they are reported on it is surprising how frequently significant errors arise in the coverage. A recent case in point arises in this piece from The Irish Times. The piece begins:
Google shifted more than $75.4 billion (€63 billion) in profits out of the Republic using the controversial “double-Irish” tax arrangement in 2019, the last year in which it used the loophole.
The technology giant availed of the tax arrangement to move the money out of Google Ireland Holdings Unlimited Company via interim dividends and other payments. This company was incorporated in Ireland but tax domiciled in Bermuda at the time of the transfer.
It looks like there is headline worthy stuff going on here but in just the opening two paragraphs the piece manages to utterly contradict itself.
Paragraph 1: A Google subsidiary shifted profit out of Ireland.
Paragraph 2: This Google subsidiary was based in Bermuda.
How can a holding company in Bermuda shift profit out of Ireland? Sure, Google Ireland Holdings made substantial dividend payments and distributions in 2019 but it was a payment from a company in Bermuda to its immediate parent. Neither party to the transaction was in Ireland. And this is clearly set out in the company’s accounts.
Note 9 to the accounts tells us “the Company is domiciled and tax resident in Bermuda” while Note 10 tells us that the distributions in 2019 comprised $15 billion of financial assets, $27 billion of debt securities, dividends of $30 billion and other net assets of $3 billion. That is the $75 billion that generated the headline.
Of course, distributions and annual profit are different things. We can use the very same accounts the dividends and distributions figure came from to get the company’s profit. To do that all we have to do is look at its income statement.
Google Ireland Holdings certainly was a profitable company. It had a pre-tax profit of $13.7 billion in 2019 from turnover of $26.5 billion. Of course, as a company resident in Bermuda (which doesn’t have a corporate income tax) pre-tax profit and post-tax profit were the same.
The third paragraph of The Irish Times piece goes:
The move allowed Google Ireland Holdings to escape corporation tax both in the Republic and in the United States where its ultimate parent, Alphabet, is headquartered. The holding company reported a $13 billion pretax profit for 2019, which was effectively tax-free, the accounts show.
Hmmm. Didn’t we have a huge amount of coverage last week, including in The Irish Times itself, of proposed changes to the US minimum tax on the foreign profits of its MNCs – the so-called tax on GILTI, Global Intangible Low-Taxed Income. So, yes you can say that Google Ireland Holdings profit “was effectively tax free” once you ignore the tax that its ultimate parent, Alphabet Inc., is liable to pay on those profits to the US.
Similarly, we could say Ireland is effectively a landlocked country – once you ignore the hundreds of miles of coastline. We can say it but it means nothing.
Moving on to paragraph five:
Google has used the double Irish loophole to funnel billions in global profits through Ireland and on to Bermuda, effectively put them beyond the reach of US tax authorities.
It seems somewhat odd given the above statement, that Google would have included the following note in its 2017 annual accounts:
One-time transition tax
The Tax Act requires us to pay U.S. income taxes on accumulated foreign subsidiary earnings not previously subject to U.S. income tax at a rate of 15.5% to the extent of foreign cash and certain other net current assets and 8% on the remaining earnings. We recorded a provisional amount for our one-time transitional tax liability and income tax expense of $10.2 billion. We have recorded provisional amounts based on estimates of the effects of the Tax Act as the analysis requires significant data from our foreign subsidiaries that is not regularly collected or analyzed.
As permitted by the Tax Act, we intend to pay the one-time transition tax in eight annual interest-free installments beginning in 2018.
This one-time transition tax, or deemed repatriation tax, was levied on the profits that contributed to the dividends and distributions made by Google Ireland Holdings in 2019 and will be paid in annual installments out to 2025.
So, absolutely you can say that for these profits Google was able to “effectively put them beyond the reach of the US tax authorities”, once you ignore the $10 billion of tax that Google will pay on them. And, as noted above, any such profits earned since 2018 have been subject to the tax on GILTI. That tax is in place but as it was introduced in legislation called the Tax Cuts and Jobs Act it is not clear how much revenue is being generated by it.
In overall terms, we can assess Google’s tax payments by looking at its annual financial statements. Here are the company’s income statements for all years from 2010 to 2020, as well as a line about actual tax payments extracted from the company’s cash-flow statements. Click to enlarge.
All told, in the 11 years since 2010 Google has reported a cumulative pre-tax profit of $264 billion. The provision for income taxes sums to $54 billion giving a effective accounting tax rate of just over 20 per cent.
The provision for the one-time transition tax was made in 2017 and it can be seen that the effective tax rate for that year exceeded 50 per cent as the provision for taxes included $10 billion of tax for accumulated foreign profits.
On a cash basis the company paid $41 billion of tax. This will increase to match the provision for income taxes as future installments of the deemed repatriation tax are paid.
We move on to paragraph six
Companies exploiting the double Irish put their intellectual property into an Irish-registered company that is controlled from a tax haven such as Bermuda. Ireland considers the company to be tax-resident in Bermuda, while the US considers it to be tax-resident here. The result is that when royalty payments are sent to the company, they go untaxed – unless or until the money is eventually sent home to the US parent.
Hmmm. Untaxed that is if you ignore the minimum tax that the US has on the foreign income of its subsidiaries. The tax on GILTI was introduced in December 2017 which is surely enough time for the reporting to catch up.
The “double irish” was original designed around the “same country exception” in Subpart F of the US tax code. As this IRS note states passive income, such as royalties, received by the foreign subsidiaries of US MNCs was immediately liable for US tax (under the pre-2018 regime).
Generally, the US shareholder of a foreign corporation is able to defer taxation of the corporation’s income until it has been distributed to the shareholder. However, in the case of a controlled foreign corporation (“CFC”), certain types of income are subject to current inclusion (“subpart F inclusion”) by the US shareholder under IRC 951. One such type of income is Foreign Personal Holding Company Income (FPHCI), which includes income of a CFC such as dividends, interest, rents, and royalties. The FPHCI rules eliminate the deferral of US tax on income earned by certain foreign corporations from portfolio types of investments, i.e., where the company is merely passively receiving investment income rather than earning active business income. Consequently, many of the exceptions to current inclusion of FPHCI focus on the recipients of income (i.e., whether the recipients meet certain criteria).
As the note sets out there are some exceptions to the immediate inclusion of passive income for taxation in the US.
Another exception that looks to the payor of the income for eligibility requirements is the same country exception from FPHCI under IRC 954(c)(3). Under the same country exception, FPHCI does not include dividends and interest received by a CFC from a related CFC payor which is incorporated in the same country as the recipient CFC, and which has a substantial part of its assets used in its trade or business in that same country. Similarly, under this exception, FPHCI does not include rents and royalties received by a CFC from a related CFC for the use or privilege of using property within the same country as the recipient CFC’s country of incorporation. However, the FPHCI implications/treatment of rents/royalties are outside the scope of this Unit and will be covered in a separate Unit.
This is the reason for “double” part of the moniker. The key is to have two companies registered in the same country. Their residence doesn’t matter from a US perspective. So, Google had a Irish-registered trading company operating in Ireland and an Irish-registered holding company based in Bermuda.
The trading company paid for the right to use Google’s technology and because the royalty paid was received by another Irish-registered company, the income was not included when earned but the tax payment could be deferred until the profit was repatriated to the US. The 2017 TCJA abolished the deferral on taxes on this income.
The company in Ireland is Google Ireland Limited and it is the fulcrum of Google’s international operations.
Some big numbers there. Google Ireland Limited had turnover of €45.7 billion in 2019. Of this, around €14.3 billion went on the cost of sales which in this case is fees paid to website owners for hosting ads from Google’s services.
From gross profit if €31.4 billion the company incurred €29.7 billion of administrative expenses. These include staff and premises costs in Ireland but by large the largest component is the royalty it must pay for the license to see advertising using Google’s technology.
After investment and other income, Google Ireland Limited had a pre-tax profit of just under €2 billion and a tax provision of around €250 million (c.12.5 per cent). This, along with its €600 million of wage costs and purchases from Irish suppliers represents its contribution to the Irish economy.
The main supplier for Google in Ireland is the entity that produces the technology it uses. Due to a Irish withholding tax in place at the time the structure was set up the royalties payments make a detour to The Netherlands (the “dutch sandwich”) before finding their way to Bermuda. Under the EU’s Patents and Royalties Directive, Member States can levy a withholding tax on royalties paid to another EU Member State.
At the time, Ireland would have levied this withholding tax if the payments went from Ireland to Bermuda but this was easily circumvented by directing the payments first to The Netherlands and then on to Bermuda.
We have already looked the accounts of the Bermudan company above. It received very significant revenues but we can also saw that it incurred very significant costs. The accounts give a breakdown of some of these.
The largest cost is R&D expenditure. This is a holding company with no employees so it obviously isn’t doing the R&D itself. This is the payment for someone else to undertake the R&D on its behalf. As the accounts note:
Administrative expenses increased from US$11.1 billion in 2018 to US$14.1 billion in 2019, an increase of US$3.0 billion. This increase is primarily due to an increase in research and development (“R&D”) expenses. The Company incurred US$10.4 billion (2018: US$9.6 billion) of R&D expenditure in the year pursuant to a cost sharing agreement with a fellow group undertaking. These expenses increased due to an increase in the worldwide spend on R&D.
Google Ireland Holdings was part of a cost-sharing agreement with Google in the US. The R&D takes place in the US but the cost was split between the US parent and Google Ireland Holdings. Google Ireland Holdings made a contribution to Google worldwide spend on R&D based on the relative size of the market it serves. It look like Google Ireland Holdings paid for around 40 per cent of Google overall spend on R&D.
So while Google Ireland Limited did make a royalty payment of around €26.5 billion that ended up in Bermuda in 2019 around half of that was further transferred to the US to cover the costs of Google technicians, engineers and developers who are behind Google’s technology. The residual that was left in Bermuda was subject to the US GILTI tax.
However, Google does nothing in Bermuda to justify the profits earned by Google Ireland Holdings. In recent years, the OECD, through their ongoing BEPS project, have been proposed updates to transfer pricing guidelines that would ensure that the location where a company’s profit is reported better matches the location of the substance that generates that profit. Google’s structure with $13 billion of profit in Bermuda in 2019 did not align with that.
The changes implemented through the OECD in relation to profits linked to intangible assets such as those produced by R&D are summarised as DEMPE – does a company do sufficient development, enhancement, maintenance, protection or exploitation of the intangible asset do justify the profit allocated to it?
Google Ireland Holdings does nothing so there is no way it had sufficient DEMPE functions to justify the profits allocated to it. This means that payments made to Google Ireland Holdings would not be tax deductible. It is these changes to transfer pricing guidelines that have brought an end to structures like these. For Google this happened at the end of 2019.
Here a paragraph from The Irish Times article that is actually correct. It is a copy and paste of a statement from Google.
“In December 2019, in line with the OECD’s base erosion and profit shifting (BEPS) conclusions and changes to US and Irish tax laws, we simplified our corporate structure and started licensing our IP from the US, not Bermuda. The accounts filed today cover the 2019 financial year, before we made those changes.”
So, the Irish company still has to pay for the rights to use Google’s technology but now those payments go direct to the US instead of ending up in Bermuda. This is as it should be. The US should not have allowed a cost-sharing agreement that allowed the profits from activities undertaken within the US to leak out.
When they did leak out the US wanted their MNCs to “exhaust all remedies” to minimise the amount of foreign tax they paid. Locating the profits in Bermuda was US companies complying with the recommendations of the IRS.
This is from an IRS note that sets out what US MNCs are expected to do if they wished to avoid double taxation:
The United States taxes income on a worldwide basis. To prevent double taxation, under the Internal Revenue Code (IRC) U.S. taxpayers are allowed a credit for foreign income taxes paid. However, the ability to credit foreign income taxes paid is limited. Pursuant to Treasury Reg. § 1.901-2(e)(1) U.S. companies may not obtain credits for foreign taxes paid in which they are not legally compelled to pay. If the U.S. Treasury were to allow foreign tax credits (FTCs) without requiring U.S. taxpayers to effectively and practically reduce their foreign tax payments as legally imposed, taxpayers would have no incentive to challenge any foreign tax, whether or not properly imposed. As a result, foreign tax costs may potentially be improperly shifted to the United States.
As a general rule under Treas. Reg. Section 1.901-2(e)(5)(i), taxpayers cannot claim foreign tax credits for amounts paid to foreign taxing authorities where they have failed to exhaust all effective and practical remedies (including competent authority procedures where applicable).
So what can appear as egregious tax avoidance from, say, a European perspective can be seen as simply ensuring tax payments are maximised from a US perspective. The US wanted their MNCs to locate their foreign profits in no-tax jurisdictions such as Bermuda. This ensured that US payments were maximised, albeit that the US had a terrible record of actually collecting this tax.
The updated transfer pricing rules means that restrictions have rightfully been placed on companies reporting their profits in jurisdictions where they have no substance. Google has responded this need to better align its profit with its substance by licensing its IP from the US and not Bermuda and this has changed how its profit is taxed.
What has been the effect of this in Ireland? In reality, there is very change. The Irish company is still paying for the technology it uses but the destination of those payments has changed. We can see this from balance of payments data.
Whoa! For pretty all of the last decade royalty payments from Ireland to the US were around €2 billion a quarter. They skyrocketed in 2020 and, all told, around €52 billion of royalty payments went from Ireland to the US. It is more than just Google that have moved to licensing their technology for international markets from the US. Facebook have too.
This means that in 2020 the trading companies in Ireland continued to collect tens of billions in revenue from selling advertising on Google’s and Facebook’s platforms. For the rights to sell the advertising, their Irish subsidiaries paid for the technology they are using and these payments are now being directed to the where the DEMPE activities that produce the technologies are located: the United States. These payments may add 0.1 or even 0.2 per cent to 2020 US GDP.
But I wonder how the Irish reports will butcher their “analysis” of Google’s 2020 accounts in Ireland when they are published this time next year? Because all the evidence is that butcher it they will. It seems “most read” or “most likes” is more important than “most accurate”.