Unprecedented coverage is being devoted to the perceived low levels of corporate tax being paid in the UK by multinationals, and unfavourable parliamentary and public opinion is becoming more polarised on a daily basis. But how worried should international groups be over any increased risk involved in transfer pricing and tax structures that historically have been considered routine, practical corporate housekeeping?
Matt Brittin, head of Google's Northern European operations, made a particularly salient comment during the public accounts committee grilling of Google, Amazon and Starbucks on Monday 13 November - "I wish we had invented Google in Cambridge, but we didn’t". He was simply acknowledging that if Google’s internal royalties were flowing from the US to the UK rather then the other way around, he may well not have been having to justify his group’s pricing in such a public arena. And this is the crux of the whole current debate. Profit allocations follow a tried, tested and extremely comprehensive set of international transfer pricing principles, which internally allocate group income and costs on the basis of functions, assets and risks maintained in each jurisdiction. This reflects location and ownership of both physical and intangible assets, and with physical substance and location of influential business personnel being a critical driver. Genuine commercial substance is key. The OECD regulations have been carefully developed over many years to identify and disregard artificial corporate arrangements where internal tax structures are not supported by commercial reality. These continue to be adapted and refined as we speak, and clarifying constituent elements which may be considered vague is to be welcomed, so that these guidelines provide a focused adjunct to local anti-avoidance provisions rather than trying to anticipate tax abuse.
In recent years HM Revenue and Customs have been quietly and efficiently increasing their auditing of exactly the types of inter-company structures and pricing that are currently falling under public scrutiny. It collected over £1bn of tax revenues from transfer pricing audits in the year ended March 2012 alone through application of existing pricing standards, including more than treble the previous year’s receipts from the Large Business Service, which audits the UK’s largest corporations. This may explain why the most vociferous and parochial criticism of Starbucks et al is coming from politicians rather than HMRC, with the latter understanding the need for a balanced approach to multi-lateral tax collection procedures.
There is an extremely important caveat to the public outcry which is being largely ignored. The numerous multinationals with intellectual property, headquarters, and management activity that is carried out in the UK are highly likely to have inbound payments from other group companies, generating additional taxable profits in the UK. So in the general condemnation of transfer pricing of centralised commercial functions and asset ownership there is a genuine danger of MPs and others advocating policies that fundamentally conflict with separate initiatives to encourage investment in the UK. At the Global Health Policy Summit in August 2012 David Cameron provided an upbeat commentary on increased capital spend - "For the first time we are creating a Patent Box here in the UK. The Patent Box means that if a company creates intellectual property in the UK, it will pay a corporation tax rate of just 10% on any [worldwide] profits generated by those patents. Let me say that again: 10% corporation tax on patent profits – among the lowest in the developed world." This is a perfect example of the conflict at hand. At first glance initiatives such as the patent box may be fundamentally compromised by the current furore over transfer pricing, given that the calculation of UK profits that benefit from the reduced 10% rate incorporates allocation of international group income to reward centralised ownership of intangibles in the UK. This is exactly the sort of law being taken advantage of by those companies whose principles are currently being branded as "immoral".
"Having your cake and eating it" has never been more in the public domain in terms of the UK international tax agenda, and this conflict will have to be addressed. Regardless of the uncertain outcome of this highly vocal debate, there is no question that transfer pricing remains an emotive topic, and is now of increasing concern to CEOs as well as CFOs and tax directors. It has also never been more important to ensure that internal tax policy and its implementation is flawless.