Looking at Amazon's Tax Affairs in the U.K.

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Andrew Murray Rozi Ellis

Andrew Murray and Rozi Ellis, Milestone International Tax Partners LLP, U.K.

Andrew Murray is a Partner and Rozi Ellis is an Associate at Milestone International Tax Partners LLP, U.K.

Amazon has been accused of tax avoidance in the U.K., but the emphasis solely on corporation tax shows a lack of understanding of how MNEs operate. Allowing the debate to focus on Amazon's corporation tax is also at odds with the government's stated agenda on alleviating the corporate tax burden.

Amazon's tax affairs are never far from the scrutiny of tax justice campaigners and the media. The recent release of its U.K. logistic and customer service company's financial accounts revealed a lower corporation tax liability (7.4 million pounds corporation tax on profits of 24.3 million pounds), despite a healthy increase in turnover. The commentators' response was to wield accusations of tax avoidance and allow the unfortunate phrase “fair share of tax” to once again reach media headlines.

However, allowing the tax avoidance debate to focus solely on corporation tax illustrates a lack of understanding:

  •  of a basic tax calculation;
  •  of how multinational enterprises (“MNEs”) operate generally;
  •  that the U.K.’s Diverted Profits Tax (“DPT”) has been largely effective in creating a behavioral shift; and
  •  that corporation tax is only a small portion of Amazon's total U.K. tax contribution.

The Tax Calculation

Revenue versus profit is an unfortunate but common error loudly played out in the media. As all readers will know, tax is only paid on profits, not revenues. Thus, it's a misnomer to contend that Amazon's U.K. operations avoid tax merely because corporation tax has fallen while revenues have increased. So, what's going on?

Amazon UK Services Limited is Amazon's U.K. fulfilment and corporate support services business. Essentially, it provides employees to the distribution center and administrative staff for Amazon's U.K. operations. It's a high volume, low margin business. 2016 revenues were 1.46 billion pounds, up from 0.95 billion pounds in 2015. Yet, profits fell. The reason? Amazon employed an additional 5,000 people in the U.K. Hardly actions that deserve to be pilloried.

However, to focus solely on Amazon UK Services Limited when drawing a conclusion regarding Amazon's total U.K. tax contribution, is to ignore how Amazon now operates in the U.K.

MNEs’ Global Operations

But first, we need to go back to basics. A foundation of international tax is that a company will only be subject to foreign corporation tax to the extent that the company has a taxable presence (permanent establishment (“PE”)) in that foreign jurisdiction or is managed and controlled from there. The math is relatively simple: no foreign taxable presence equals no foreign corporation tax.

In today's globalized world, a non-U.K. digital business with little need for a U.K.-based sales company to sell to U.K. customers will mean limited exposure, under general rules, to U.K. corporation tax. Similarly, U.K. companies entering foreign markets have the same ability to operate through a no or low touch domestic presence, thereby limiting their exposure to foreign corporate tax. But times are changing.

BEPS, DPT and Behavioral Change

The OECD's BEPS (base erosion and profit shifting) project was a result of concerns that the current PE definition and transfer pricing rules were inadequate in protecting the domestic tax base. Frustrated with the lack of immediate implementation and, six months before the OECD released its final papers, the U.K. moved unilaterally to introduce the DPT, an entirely new tax aimed at perceived multinational tax avoidance (to capture the likes of Google, Amazon and Starbucks).

The DPT levies a 25 percent charge if a company:

  •  designs its activities to avoid creating a PE in the U.K. by moving profits out of the U.K. to a low tax jurisdiction; or
  •  creates a tax advantage by using entities or transactions that lack economic substance.

The DPT was designed to send a message to the U.K. public that something was being done to rein in “evil” MNEs. However, the rate has been set at a level that, perhaps more than a direct revenue raise, is designed to encourage a behavior change for MNEs operating in the U.K. while also seeking to ensure the U.K. is kept sufficiently attractive for inward investment.

Amazon's U.K. Structure

Amazon's U.K. operations are headquartered in Luxembourg (Amazon EU Sarl). Before the introduction of the DPT, all U.K. sales were booked through Amazon EU Sarl. The distribution of products to the U.K. customers was then contracted to Amazon UK Services by Amazon EU Sarl for a fee on which any profit would then be subject to U.K. corporation tax.

These arrangements, while historically tax efficient (and legal) were clearly within the scope of the penal 25 percent DPT charge. To mitigate DPT (which seemed to be the government's intention), Amazon could incorporate a U.K. subsidiary or establish a U.K. branch and allocate profits to that U.K. PE: the latter option was chosen two months before the legislation would bite.

However, how has the DPT had the desired effect? Pushing MNEs to restructure in this way throws them directly back into transfer pricing, the source of many current international tax inadequacies. The level of profits allocated to the U.K. branch is now determined by the arm's length principle based on comparable market transactions calculated by internationally agreed methodologies. The difficulty is that if all MNEs are tested on similar comparables, a “new normal” is created, somewhat nullifying the full impact of the rules. Thus, while Amazon EU Sarl and its U.K. branch are treated as if they are transacting as distinct and separate enterprises, it's likely that very little is actually allocated to the U.K. due to the limited staff (separate from the Amazon UK Services' 14,000 employees), risk, functions and assets located here.

Interestingly, the size of the Amazon group means that HM Revenue & Customs (“HMRC”) will have reviewed and agreed the allocation of profit to the U.K. branch in accordance with internationally accepted transfer pricing practices. The branch structure also means that the public are not privy to this information as the figures are aggregated with those of Amazon EU Sarl.

Looking at the possible alternative arrangements, however, Amazon made a wise decision. HMRC claimed its first DPT victim, Diageo, earlier this year, announcing a 107 million pound DPT assessment. Perhaps even HMRC were surprised by the lack of encouragement Diageo took from the penal 25 percent DPT. The Budget Statement estimated the DPT would raise 270 million pounds (rising from 25 million pounds in the 2015–2016 tax year), meaning Diageo's assessment covers a large portion of the expected revenue from the DPT. Clearly, all is not as clear as it seems.

Perception is Key

The attacks on Amazon's contribution to the U.K.’s corporate tax take are ill-founded and lack understanding. Any government that wants to incentivize investment, growth and innovation in a highly competitive global market place cannot be completely out of step with its neighbors. The U.K. took a significant risk with the DPT but, in the end, likely got the result it wanted: additional U.K. tax.

Amazon's business model means far more tax is paid through the investment it makes into the U.K. The additional 5,000 people Amazon employed during 2016 will provide additional income tax, national insurance contributions and VAT, amounts likely to far outweigh the corporation tax perceived to be lost.

Indeed, allowing the MNE tax avoidance debate to center solely on corporation tax is at odds with the U.K. Government's stated agenda (on both sides of Parliament). The U.K. has moved to alleviate the corporate tax burden by repeatedly dropping the rate (from 28 percent in 2008 to 17 percent by 2020). Labelling MNEs as evil corporations who do not pay their “fair share” distorts the argument. No legislation we have ever reviewed focuses on fairness or morality. To do so would introduce a moral element that could not survive legislative or judicial scrutiny. Instead of soapbox politics, we should actively encourage MNEs like Amazon to establish a presence here in the U.K. and reap the tax rewards of their success.

Andrew Murray is a Partner and Rozi Ellis is an Associate at Milestone International Tax Partners LLP, U.K.They may be contacted at: andrew@milestonetax.com; rozi@milestonetax.comwww.milestonetax.com

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