Tax Avoidance: Starbucks Brewed a Tax Storm

In my last post, I explained how high-tech companies like Amazon shift their profits to avoid tax. In this post, I explain how brick and mortar stores like Starbucks use ingenious methods to achieve the same result.

While all corporations are permitted to keep their complex corporate structures and tax planning strategies secret, investigative journalists unearthed enough of Amazon’s and Starbucks’ tax avoidance schemes to cause a Parliamentary inquiry in the UK, giving us a rare look at how it’s done.

From the Amazon inquiry, we learned how high-tech corporations are permitted under tax laws to shift sales in a high tax country, where the sales were actually made, to a low tax country where they will pay little or no taxes. From the Starbucks inquiry we will see that a multinational brick and mortar corporation is permitted, through a chain of subsidiaries, to create unnecessary expenses and deduct them from their income tax by.

* Charging itself royalties and deducting those expenses from its income for tax purposes

* Creating unnecessary service expenses in a subsidiary in a tax haven and deducting those expenses from income tax paid in high tax countries like the US and UK

* Lending money to itself and deducting the interest from income

All of these schemes are permitted by the relevant tax codes.

It is equally difficult to estimate how much tax loss this is causing the US government. However, US tax law Professor Kimberly Clausen in her 2016 paper, The Effect of Profit Shifting on The Corporate Tax Base In The United States and Beyond found:

“…that profit shifting is likely costing the US government between $77 and $111 billion in corporate tax revenue by 2012, and these revenue losses have increased substantially in recent years.”

Economists Ludvig Wier and Gabriel Zucman in their 2022 paper, New Global Estimates on Profits in Tax Havens Suggest The Tax Loss Continues To Rise, confirmed Clausen’s prediction, finding that tax losses have increased to $250 billion each year.

How Starbucks Does It

US tax professor Edward Kleinbard reviewed Starbucks’ tax plans in an article, Through A Latte Darkly: Starbucks Stateless Income Planning. He summarized findings by a Reuters investigative reporter, Tom Bergin, on how little UK tax Starbucks paid despite its huge market share of the coffee shop market:

“Starbucks has operated in the United Kingdom since 1998. In October 2012 Reuters reported that Starbucks had claimed losses in 14 of the first 15 years of its existence in the United Kingdom and as a result paid virtually no UK company tax, despite a 31 percent market share and shareholder reports indicating solid profitability for the Starbucks group attributable to its UK operations”.

In the opening of his paper, Kleinbard noted: “First, if Starbucks can organize itself as a successful stateless income generator, any multinational firm can.”

Kleinbard described the Starbucks tax plan in three parts:

* Shifting its royalty rights for intellectual property, such as use of its logo, to a subsidiary in a tax haven and having its other subsidiaries pay royalties to it.

* Establishing unnecessary middlemen subsidiaries in a tax haven to buy and roast coffee beans and then resell to the local Starbucks owned retail outlets.

• Having the US parent company lend money to the UK subsidiary on which it pays interest.

It’s all perfectly legal.

Royalty Rights

Starbucks USA owned a chain of six subsidiaries through a Netherlands corporation: five in Holland and one in Switzerland. Its financial public information revealed that its other subsidiaries, which ran the local coffee shops, paid royalties to the vague “Amsterdam structure”.

Kleinberg constructed a Corporate Flow Chart of the Amsterdam structure from the available public documents.

Starbuck UK’s royalty payments to the Amsterdam structure are about £20 million to £25 million annually.

According to Kleinberg, there is a Dutch tax ruling that is the key to understanding how much tax Starbucks actually paid on its royalty income in the Netherlands. But Starbucks refused to disclose it “on the grounds that to do so would have violated its understanding of mutual confidentiality with its Dutch tax inspector”.

However, the Financial Times reported that the Dutch deputy finance minister said that Starbucks’ statement was untrue and that ‘’the Netherlands never asked companies to keep their tax arrangements secret”.

Starbucks maintained that it paid a somewhat lower tax in the Netherlands on these royalties. Kleinberg reviewed the evidence and commented that this lower rate was indistinguishable from zero.

Starbucks is charging its own corporate local stores for using its intellectual property. It deducts the royalty payments from the local country’s income tax liability e.g., the UK; and pays no tax on the payments received in the tax haven, the Netherlands.

Unnecessary Middleman Companies

At the bottom of the diagram of the Amsterdam structure above are two companies:

* Starbucks Coffee Trading, a Swiss company
* Starbucks Manufacturing, a Netherlands company

Starbucks Coffee Trading:

* bought raw coffee beans from South America

* resold them to Starbucks Manufacturing that does the roasting

* charged a 20% markup

Obviously, the beans were not shipped to land-locked Switzerland but sent directly to the roaster Starbucks Manufacturing in the Netherlands. Starbucks Coffee Trading in Switzerland did nothing but process orders from its related companies on its computer. There was no need for this middleman. Starbucks Manufacturing could easily have ordered directly. Yet, Starbucks UK pays this 20% and gets to deduct it from its UK tax.

So how does the tax man allow this rate of 20%? There is a tax rule called ‘transfer pricing.’ It permits a company to charge for internal services among its subsidiaries what it would pay if they had bought these services from an outside business. Starbucks could show that small local coffee shops had to order through a broker paying about 20%.

Additionally, Starbucks Manufacturing, the roasting company, is there to add a profit on the roasting that would not happen if it was done internally and not by the fiction of being allowed to treat this wholly owned subsidy as an arm’s-length entity. The amount of the charge is determined by transfer pricing, i.e., at the same rate as local coffee shops would buy from an independent roaster.

Transparency is the Key

Kleinbard explains that we cannot forge an effective solution to profit shifting without a rule that requires complete disclosure of the tax plan and the documentation supporting it. The companies say, ‘just trust us’, and oppose complete disclosure, claiming it would reveal trade secrets. But in his commentary, Kleinbard gives a method for disclosure that would preserve trade secrets.

The Organization for Economic Cooperation and Development (OECD) has drafted a convention to reduce profit shifting. Will it be effective? We look at that next.

Image by sahinsezerdincer on pixelbay

Originally published at https://jandweir.substack.com.