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The economics of Google’s tax

The economics of Google’s tax

The row over Google’s tax settlement of just £130 million to cover the last ten years has become political.

John McDonnell raised an urgent question on the issue on Monday, arguing that tax experts all think that the likely tax rate paid by Google on its likely UK profits, even after this settlement, may not exceed 5%.
The logic is simple: Google made sales of about £4.5bn into the UK in 2014, according to its global accounts. Those same accounts show an average profit rate worldwide of a little over 25%. There is no reason to think the UK is an abnormal Google market so profits in the UK would be, on this basis, at least £1 billion. It would be entirely reasonable to expect a corporate  tax rate of 20% in that year so I have said at least £200 million should have been due in that year. Tax experts, including myself, think that at most less than £50 million will be paid after the latest tax settlement.

John McDonnell has accepted these estimates.

David Gauke, uncomfortably understudying for George Osborne at the Dispatch Box, decided to deny there was any credibility to such estimates, claiming that tax is paid in the UK on economic activity. The line was repeated by him so often during his nervous appearance that it must have been what he was briefed to say by HMRC (I presume). But what does it mean?

Gauke used an example of cars made in the UK and sold abroad. Where, he asked, should the total profit on sale be taxed? Where the car is sold, or where it was made? The answer, of course, is neither. The whole point of the international tax system that has been in place since the 1930s has been to try to find a fair way to split the profits between the two places since it is obvious that economic activity takes place in both countries.

The trouble for David Gauke is that this was a very poor argument to use in the case of Google. In Google’s case, a technology (undoubtedly developed in the USA in the first instance) which is – beyond doubt – used by UK customers is not recorded as being sold in this country. Instead it is recorded as being sold in Ireland, with the benefit of the sales transaction not going back to the USA, where under Gauke’s logic it should flow, but to Bermuda (untaxed), where – all parties agree – no economic activity giving rise to it took place.

In practice most of the revenue Google earns here is entirely dependent upon people living in the UK clicking on its adverts: that is how the revenue structure works for most of the Google ads sold. So, in fact, the revenue is wholly dependent upon UK activity and without it Google would have no income in this country. The economic substance is, then, that it is only the presence of those adverts for UK based businesses on the web browsers of UK based people that creates value for Google. That is why when you google a local restaurant if you live in Boston, UK you are not offered one in Boston, Massachusetts. The US results are worthless to you and Google knows it.

In that case for Google, David Gauke and HMRC to agree that Google need only be taxed on a bit of profit relating to the cost of selling adverts in the UK is wrong: that is very obviously not subjecting the economic activity that Google undertakes in the UK to the right amount of tax.

So what does this mean politically?

First, because this conclusion can be reached instinctively without having to torture yourself as I have just done, it means that HMRC, and in turn the government, now have a credibility problem on this issue. Their logic is very obviously wrong, and David Gauke just made it a lot worse yesterday.

Second, it may suggest that UK tax strategy on these issues has made not an iota of progress over the last few years, despite what David Gauke has claimed. For all the huff and puff, time expended at international summits and supposed commitment to the OECD process of renegotiating international tax, literally nothing of substance will have changed. Google was paying very little tax before this deal on the economic substance of what it earned in the UK and is still paying very little afterwards. That is a disastrous precedent for UK taxation, and it has happened on David Gauke’s and George Osborne’s watch.
Third, John McDonnell was right in that case to raise the questions he did. He was right to say that this set a dangerous precedent, right to argue that the deal should be on the record, right to say HMRC should explain how it reached this conclusion, right to argue that country-by-country reporting is required on public record so we can see where such abuses are happening, and was right to argue that HMRC need more resources to tackle such issues.

And David Gauke was wrong to ignore all those demands.

In which case, and quite extraordinarily, Google has once again created the necessary conditions for tax reform. But this time that reform has to happen and what is, beyond doubt, clear is that so far that reform has neither happened and is without support in HMRC, which is why John McDonnell was also right to demand its reform.

Tax is back centre stage in UK politics. I can’t see it going away again for a while yet.

This is an edited version of an article that appears on Richard Murphy's blog.