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January 14, 2013

The Global Tax Climate Is Changing

U.S. Multinational Corporations Could Be Hit With Higher Taxes Abroad

In times of austerity, every dollar counts—and so do uncollected dollars. As belts have tightened across Europe, legislators have begun to consider boosting taxes, asFrancehas already done on its large corporations and high earners and asBritainlooks likely to do on the homes and capital gains of the wealthy.

But, despite the stir caused in September by the French CEO of LVMH seeking to become a Belgian citizen—though he denied acting to avoid French taxation and said he would remain a “fiscal citizen” of France—the trend in many countries is toward higher taxes, and not solely or primarily on wealthy individuals. Corporations, particularly multinationals seeking domiciles with low tax rates, are now in the crosshairs of both regulators and lawmakers for tax-cutting or avoidance strategies in nations where they do business.

Simply avoiding foreign investments won’t safeguard clients’ portfolios from foreign consequences. In fact, U.S. multinational corporations making healthy profits but paying small—or no—tax bills abroad have found their tax strategies currently under scrutiny in the countries where they do business. That’s a trend that looks to continue. While manyU.S.multinationals have been quite efficient at cutting their tax bills, European regulators are not favorably impressed. Regulatory action, whether here or abroad, could have a sizeable effect on client investments. Advisors had best stay alert.

In October, Starbucks made headlines when it was revealed that for years it has been saying one thing to shareholders and analysts, and something entirely different to the tax man inBritain. For the past three years Starbucks has claimed operations in its 735 British outlets to be unprofitable in itsU.K.filings, paying no taxes on proceeds of 1.2 billion pounds ($1.924 billion) raked in by its British stores.

Analysts and investors, however, were told not only that theU.K.outlets were profitable but their operations were models forU.S.outlets to follow. The company has said that its actions regarding taxes were completely legal.

However, the news did not sit well with British authorities, who questioned Starbucks—and Amazon, and Google, which also actively seek to lower their foreign tax bills—about their tax practices, and then issued a report on Dec. 3 that accused companies of “immorally” avoiding taxes and declared their intention to pursue the issue.

France’s fiscal authorities have already billed Amazon for $252 million in back taxes, although the online retail giant has said it will fight.

Not just income taxes are at issue; so are the value added taxes (VAT) a company pays, which are easier to challenge. For example,Luxembourg’s rate is only 15%, compared with theU.K.’s 20% and most other European Union (EU) countries’ rates that range from 19-25%. While it is legal for multinational companies to establish headquarters inLuxembourgto take advantage of the country’s lower VAT rate (non-EU countries must pay VAT to the governments of their customers, and at those governments’ rates), such offices’ validity can be challenged by individual EU countries’ tax authorities in their own domestic courts. Challenged companies must prove that the Luxembourg-based entity is actually the true supplier of goods and services.

BritainandGermanyare currently pursuing eBay for more VAT, after the online auction company chose to locate its European operations headquarters inLuxembourg, thus lowering the VAT it must pay to governments on European customers’ purchases. According to authorities, the total at issue forBritainandGermanyamounts to some $1 billion—hardly small change.

While Amazon and Apple’s iTunes also claimLuxembourgheadquarters for VAT purposes, both companies record ebook and music sales for European customers through theirLuxembourgfacilities. In contrast, eBay’s sales revenues did not go through itsLuxembourgunit; instead, customer funds go to eBay International AG, based inBerne,Switzerland.

The European Commission (EC) is not taking the matter lightly. On Dec. 6, it called for joint action by members of the EU to make sure they don’t lose out on a trillion euros ($1.31 trillion) not paid thanks to tax avoidance strategies. Among the suggestions advanced by the EC were issuance of an EU-wide tax identification number, better sharing of information and common standards for the blacklisting of tax havens.

One country likely to be targeted for its tax policies isSwitzerland. Algirdas Semeta, the EU’s commissioner of taxation policy, singled out the Alpine nation, which does not belong to the EU, as one that actively encourages tax avoidance. So the possibility of companies simply moving to another jurisdiction may be limited.

And even if regulators don’t compel companies to fork over more taxes, public opinion might. A Dec. 6 story from Reuters pointed out that in response to public pressure, Starbucks has agreed to pay more to theU.K.in taxes than required, because “our customers expect us to do more.”

Analyst RJ Hottovy, who covers Starbucks and Amazon for Morningstar, said in an interview that he does not expect much impact on companies despite the possibility of higher taxes.

“Starbucks mentioned [in a call with analysts and others] that it didn’t think it would be a material factor their U.K. operations,” he said, adding that the company said again that its U.K. units “had been struggling and operating at losses, so they shouldn’t have been having much of a tax burden.” Hottovy added that Starbucks also repeated that it brought other benefits to the British economy. “I don’t really look at much of an impact on Starbucks for the long haul.”

Hottovy was sanguine about the fact that there could “occasionally … be a slight negative impression of the brand.” However, he said that “my own due diligence in the U.K. and talking to my contacts that way, it doesn’t sound like there’s much impact on results there—the larger [consideration] is dealing with austerity measures.”

In theU.S.and acrossEurope, he said, both local municipalities and national governments are looking to augment budget shortfalls, and “taxation is one way. More stringent tax laws are a possibility over the next couple of years.” He added, however, that “Starbucks, Google and Amazon are all very large multinational companies, [and they’re] more than able to absorb more stringent losses.”

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