The financial statements of Google’s UK operations for the year ended 30 June 2016 show UK turnover of £1.03 billion, profits before tax of £149 million, and a UK corporation tax bill of £36.4 million on those profits. In addition, the financial statements show that Google is owed a £31 million tax refund from HMRC. This has led to much speculation in the media, notably the BBC and The Times, about whether Google is paying enough tax. This article is intended to shed some light on that question. I am a tax consultant of 24 years experience and a specialist in international tax. However, I have no inside knowledge or contact with Google whatsoever. If I did, I would not have written this article. My comments below are based on my general experience of international tax and publicly available information.
How much tax should Google have paid in the UK?
In short, it should have paid 20% of its UK taxable profits in corporation tax. Note that corporation tax is charged on profits. When you hear a journalist or politician comparing tax and turnover, rather than tax and profits, you can guarantee they have no idea what they are talking about.
Although profit before tax in the financial statements is not the same as taxable profits, they are often reasonably similar. In this case, the figures in Google’s UK accounts show an effective tax rate of 24%, or 17% after various deductions. This is fair enough, but not really the point. The controversial question is whether Google actually recognises enough of its profits in the UK.
So, how much profit should Google recognise in the UK?
If we have a look at the financial statements of Google’s parent company, Alphabet Inc, we find that total UK sales are reported as being £6 billion (here). And yet, Google’s UK operations only show turnover of £1 billion. Where has the other £5 billion got to and should it be taxed in the UK?
An analogy might help to explain what is going on here. It is a basic principle of international tax that you pay tax where you have the people and know-how making the profits. You are not taxed where you happen to sell your products. For example, Mercedes sold about 170,000 cars in the UK in 2016, but paid all the tax on the profits from building them in Germany. The exception is the dealer networks, which are UK based (and, in any case, independent franchises). The profits they make buying cars from Germany and selling them to UK customers are UK profits subject to UK tax.
Google’s UK sales operation is not independent of Google, but the same principle applies. It should only pay UK tax on the stuff it actually does in the UK rather than on the basis of its overall sales here. Google says that the turnover attributable to its UK operations, being sales and marketing, is £1billion out of their £6billion UK sales. That is not an unreasonable figure and would be subject to serious scrutiny by HMRC.
Google recognises some of its turnover in Ireland and will make a proportion of its profits there. This should be based on work done by people actually based in Ireland. However, most of its profits will be attributable to the US where the ‘magic’ of Google is created. It is the search engine algorithm itself, not the sales people, which represents the true value of Google. Profits attributable to that should be taxed in the US.
So why does HMRC owe Google £31 million?
My guess is that this could well be Diverted Profits Tax (DPT) aka the Google tax. DPT was introduced in 2015 to catch profits that were being artificially diverted from the UK. Google was alleged to be doing this by booking sales in Ireland and ensuring the related profits were taxed there and not in the UK. It claims that it has changed its procedures and no longer does this.
The way DPT this works is as follows: HMRC gets to guess the tax bill it things a company owes and then the company has to pay the amount HMRC guessed. It is then up to the company to prove to HMRC that the guess is wrong. If, after going through all the documentation, HMRC agrees its guess is wide of the mark, it has to pay back some or all of the DPT to the company. It is possible that the amount HMRC is paying back to Google is the £31million in the accounts.
The UK Government introduced DPT to force international groups to come clean about their structures. That is why HMRC demands payment in advance and makes companies demonstrate that they should get it back. If DPT is a success, no one will actually pay it. Ideally, if all multinationals recognise the correct profits in the UK, they would be subject to corporation tax and not DPT. It is an anti-avoidance measure only.
So is Google avoiding taxes?
I can’t see much evidence that Google is avoiding material amounts of UK tax. That’s not meant as a defence of Google, but rather of HMRC and the UK tax system. We tax consultants spend a lot of time slagging off HMRC but, secretly, we rather admire them. The Government is also serious about fighting avoidance. HMRC asked for DPT to be introduced to give it the tool it needed to force multinationals to pay the right amount of tax in the UK. And the Government gave them exactly what it wanted.
However, Alphabet Inc’s financial statements suggest a very different picture in the US where most of Google’s profits should be taxed. We find that its effective tax rate is only 20%, far lower than the US corporate tax rate of 35%. It looks like it is paying a lot less US tax than expected. It is likely that Google has schemes in place so that the revenue they make outside the US is not remitted to its head office and so is not subject to US tax. These unremitted profits are probably contained in its ‘cash pile’ – a mountainous $86 billion according to Alphabet Inc’s financial statements. Much of this cash is held offshore and is not subject to US tax. The Trump tax reform plan is aimed at getting this money back to the US and taxing it (although at nothing like the full rate).
In summary, my best guess is that Google is not avoiding a material amount of UK taxes because our tax system is now robust enough to stop it. In contrast, there is evidence that it is avoiding vast amounts of US tax.