The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
An outraged U.K. Parliamentary Committee said June 13 that the evidence is clear that London based Google Ltd.'s sales to its major U.K. clients take place in the United Kingdom, and not in Ireland, meaning that H.M. Revenue and Customs should have concluded that Google Ireland had created a U.K. permanent establishment.
In its June 13 report, “Tax Avoidance--Google,” the Commons' Committee of Public Accounts concluded that Google Ltd. was able to avoid U.K. corporation tax on its enormous U.K. profits by successfully making the “deeply unconvincing argument” that Google Ltd.'s advertising sales to its major U.K. clients took place in Ireland.
On May 16, Margaret Hodge, the committee's chairwoman, told Matt Brittin, managing director of Google's operations in Ireland and the United Kingdom, that he was misleading both Parliament and HMRC by asserting that Google U.K.'s sales activity does not take place in the United Kingdom.
During the committee's May 16 hearing, Hodge told Brittin that Google was guilty of manipulating the reality of its business to avoid paying its fair share of tax.
“You are a company that says you 'do no evil,' but I think 'you do do evil' in that you use smoke and mirrors to avoid paying tax,” she said.
During May 16 and November 12 committee hearings, Brittin vigorously maintained that Google U.K.'s staff does not actually sell advertising to the company's high-value U.K. clients, including Amazon, BT, EBay, Argos, Halifax, British Airways, Land Rover, and Lloyds Bank, but only promotes such sales (21 Transfer Pricing Report 741, 11/29/12).
During the May 16 hearing, Hodge said HMRC and Ernst & Young, Google U.K.'s auditor, should have challenged Google Ireland's claim that it had not created a U.K. permanent establishment.
“It is extraordinary that the department did not challenge Google over the complete mismatch between the company's supposed structure and the substance of its activities,” she said.
Following the November committee hearing, some former Google employees blew the whistle, telling the Committee of Public Accounts that Google Ltd. requires its staff to meet sales targets and pays them commissions for sales they achieve with major clients.
Announcing the publication of the committee's report, Hodge said June 13 that despite an $18 billion turnover between 2006 and 2011 in the United Kingdom, Google Ltd. has only paid the equivalent of $16 million in taxes to the U.K. government.
Hodge said June 13 that Google's argument that advertising sales took place in Ireland has been torpedoed by former Google employees who have told the committee that Google Ltd.'s staff are engaged in selling, whereas its staff at Google Ireland simply process the bills.
During the May 16 hearing, Hodge told Brittin that a former senior Google U.K. salesman told the committee he was set sales targets and paid on commission for the sales that he achieved.
His monthly pay slip, Hodge said, showed that he earned a relatively modest basic salary, but then got a success bonus--a commission--of between three and four times his basic salary for selling and closing deals. The commission was triggered by achieving a minimum level of sales in a month, and the reward is accelerated as the sales increase.
Hodge told Brittin that sales personnel are the only employees to get paid this way. “You do not need to incentivize an adviser, or whatever you call them, so highly.”
This senior salesman was making sales in the United Kingdom, Hodge said; the client was signing off or committing to a media plan; and then the invoice--the billing--was in Ireland. “This is a U.K. sale and should be subject to U.K. tax,” she said.
Brittin, however, said “I do not recognize the characterization that you paint.” Google Ltd.'s staff that deal with the high-value clients--comprising one percent of the company's customers in the United Kingdom--are motivated to encourage people to spend money with Google, he said. Therefore, they have targets--not on an individual account basis, “but which include the growth of the business that they are responsible for across a range of customers or industry sectors.”
While Hodge said Google Ltd.'s staff “grow the business by selling advertising space,” Bittin rejected that view. “They grow the business by encouraging people to spend money on Google products,” he said.
In its June 13 report, the Committee of Public Accounts concluded Google Ltd.'s staff sold advertising to the company's major clients, rejecting Brittin's claim that the staff were engaged in promoting advertising sales rather than actually selling advertising.
The Committee found that Google Ltd.'s staff added value in generating revenue in the United Kingdom “from their close working with its high-value clients” from whom Google Ltd. generated 60-70 percent of its revenue.
“It was particularly evident to the Committee that Google Ireland has a very limited role, simply to step in at the end of the process, to carry out the automated billing,” the report said.
The committee said “it made absolutely no sense” to claim that these U.K. sales, as Google U.K. attempts to argue, are actually sales from Google Ireland. “This is especially the case when sales are conducted in sterling and payment can be made to U.K. banks.”
The committee found that Google Ltd.'s staff have a direct relationship with Google's high-value clients, meeting with them regularly to discuss:
• how many people are searching for their products on Google;
• the cost for their name and link to appear when people use search words;
• how to convert appearance on Google searches into sales; and
• how profitable advertising on Google might be.
In addition, Google Ltd. staff used an advertising rate card to negotiate against these prices for different volumes when they discussed prices with their major clients, the report said.
During both the November and May hearings, Brittin was adamant that Google U.K.'s 700 marketing and digital consulting staff do not sell Google products to the company's major U.K. clients, but instead:
• promote Google products to business clients;
• provide the clients with education and training;
• make sure the products work for U.K. consumers;
• explain how the Google system works; and
• show clients the opportunity to spend money profitably with Google.
According to Bittin, the staff are “encouraging people to spend money with Google.”
The trade, he said, “is executed with Ireland.” Advertisers in the United Kingdom, Germany, and France contract with Google Ireland because it has the rights to sell Google advertising. “Nobody in the United Kingdom has had the right to close a transaction with an advertiser.”
According to the committee, Google U.K. recorded revenues of 396 million pounds ($613 million) from Google Ireland in 2011 for the services provided by its 1,300 staff and paid corporation tax of only 6 million pounds ($9 million).
Google Ireland has 3,000 employees, five buildings, and two data centres in Dublin.
Brittin told the committee that Google Ltd.'s staff in the United Kingdom did not have the ability to commit Google Ltd. to any contracts, or to conclude a transaction, and that no money changed hands within the United Kingdom. He said that Google Inc. signed contracts with the company's major U.K. clients prior to the establishment of Google Ireland.
Brittin asserted that job descriptions in Google Ltd.'s recruitment advertising, and the job descriptions given by its U.K. staff on their LinkedIn profiles--both of which give specific details of sales-related responsibilities--did not indicate how Google Ltd. operated in the United Kingdom, and in any event, were irrelevant for tax purposes.
Also testifying before the committee, John Dixon, head of tax at Ernst & Young, said the difference between promotional activity and concluding a sale is a gray area in tax law.
During the May 16 hearing, Dixon said the distinction between the two activities depends on the facts. “One needs to look at all of the facts that exist around the transactions with a particular client.”
Stating that he was unable to discuss Google's case, Dixon explained, on a theoretical basis, how HMRC analyzes whether an Irish resident company is trading in the United Kingdom.
Under Article 5 of the Irish-U.K. tax treaty, an Irish company is subject to U.K. tax on its profits if it is trading in the United Kingdom through a permanent establishment.
Dixon said a U.K. company providing services to the Irish company could be a PE of the Irish company if employees of the U.K. company have the authority to conclude contracts on behalf of the Irish company and habitually exercise that authority.
So the first test, Dixon said, is whether U.K. employees have the authority to conclude contracts and habitually exercise that authority.
If the answer to either of those questions is “no,” Dixon said, the next question is, do they get so close to the point of sale that in substance the sale is being made in the United Kingdom?
Dixon said the answer to this question depends on “all sorts of factors that need to be taken into account.”
A key question is how much of what the employees do lines up with the generation of the profit through the sale, “as opposed to liaising with clients, making sure they are happy, making sure they are supported, and making sure they understand the products,” he said. The issue, according to Dixon, is “that line between liaison, supporting, and making sure clients are happy, and actually getting so close to the point of sale.”
Committee member Ian Swales said Dixon's description of liaison and promotion services “does not fit with people having sales targets and commission-based selling.”
Dixon responded, “You have to look at all of the circumstances and facts from exactly what is happening, what the tone of the communications is, what is occurring, what is being said and how valuable that is.” When a U.K. service company provides services to a related-party Irish company, he said, HMRC would need to look at two tests:
• whether the Irish company is trading in the United Kingdom through a PE, and
• whether the U.K. company is being properly remunerated for the services it provides.
Another facet to the issue, Dixon said, is that if the service company “is providing real services that might get close to a sale but not quite be actually at the point of sale, one would expect its remuneration to be higher than a pure, classic service company.”
Whether, in this particular situation, an Irish company is trading in the United Kingdom through a PE is a difficult factual question, Dixon asserted. The relevant issue is what the employees do on a day-to-day basis; job titles, the currency used for an invoice, and the location of the bank account that receives the funds are irrelevant.
Ernst & Young's audit method are “very much focused so as to check exactly what is actually occurring in fact,” he said.
Hodge, however, said that in the end, “what I am really questioning is your judgment.” A judgment of the facts, not the facts themselves, are what “you have to undertake to come to a view on.”
Hodge said she could not imagine, as an auditor, “looking at the documents that inform what [Google U.K. staff] do day by day, and looking at pay slips, and thinking, 'Actually, these guys aren't selling.' ”
Dixon, however, pointed out that many foreign multinational businesses set up their U.K. operations much like Google has, and that many U.K. multinationals use similar structures when they set up overseas operations.
Hodge said the company's tax avoidance activities “are illustrative of a much wider problem.”
Brittin told the committee that he met with HMRC two or three years ago and that officials asked “a robust and pretty detailed set of questions” about how Google U.K. operates, which he answered transparently and openly. Questions to the company's Irish and U.S. tax teams are answered in a similar fashion, he said.
HMRC also met with Google U.K. staff who were running the company's engineering and marketing teams, Brittin said, as well as employees who were meeting with major clients, and HMRC “looked at the materials that they showed those customers.”
The Committee of Public Accounts report,“Tax Avoidance--Google,” which includes a transcript of the May 16 hearing, may be found at http://www.publications.parliament.uk/pa/cm201314/cmselect/cmpubacc/112/112.pdf.
The transcript of the November 12 hearing is included in HMRC's 2011-12 annual report, which may be found at http://www.publications.parliament.uk/pa/cm201213/cmselect/cmpubacc/716/716.pdf.
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