The Most Outrageous Way the US Government Allows Corporations to Dodge Taxes, Part ll.

“First, if Starbucks can organize itself as a successful stateless income generator, any multinational firm can.”

- US tax professor Edward Kleinbard

The predatory wealthy have political control because they have gained excessive wealth. This is the second in a series describing the most outrageous tax dodges that the US government permits for large corporate donors. The first describes how the government allows Internet businesses such as Amazon to do it here. The present post describes how the government allows brick-and-mortar based businesses to do it using Starbucks as an example.

Only when the methods are understood can we see how the proposals to remedy the wrong are calculated to be ineffective and what can be done effectively.

How Brick and Mortar Stores Do It.

It’s not only the huge internet enterprises that get to legally dodge tax. Multinational brick and mortar stores like Starbucks use ingenious methods to achieve the same result.

In his article, Through a Latte, Darkly: Starbucks’s Stateless Income Tax Planning, Professor Kleinbard described the Starbucks tax plan in two parts:

• Shifting its royalty rights for its own intellectual property, such as use of its logo, to a subsidiary in a tax haven and having its other subsidiaries pay royalties to its tax haven subsidiary
• Establishing unnecessary middlemen subsidiaries in a tax haven to buy unroasted coffee beans and then resells them to the locally owned retail outlets that Starbucks franchises.

Royalty Rights

Starbucks USA owned a chain of six subsidiaries through a Netherlands corporation it calls the Amsterdam Structure: 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 complex Amsterdam Structure.

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

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”.

As a result,

● Starbucks charges its own corporate local stores for using its own intellectual property.

● It deducts the royalty payments from the local country’s income tax,including the US, and

● pays no tax on the payments received in the tax haven, the Netherlands.

The Phantom Middleman Companies

Two companies form the basis for the Starbucks Amsterdam structure:

● 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 in the US that does the roasting

● charged a 20% markup

Obviously, the beans were not shipped to land-locked Switzerland but sent directly to the roasters in the US. Starbucks Coffee Trading in Switzerland did nothing but process orders from its related companies on its computer through automatic software programs. There was no need for this middleman. Starbucks Manufacturing could easily have ordered directly. Yet, Starbucks UK pays this fictitious middleman 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 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.

Why It’s Still a Big Deal

In a joint study by the US PIRG Education Fund and Institute on Taxation and Economic Policy entitled,Offshore Shell Games 2017: The Use of Offshore Tax Havens by Fortune 500 Companies, the researchers found:

“Most of America’s largest corporations maintain subsidiaries in offshore tax havens. At least 366 companies, or 73 percent of the Fortune 500, operate one or more subsidiaries in tax haven countries. All told, these 366 companies maintain at least 9,755 tax haven subsidiaries”.

In an article for the Tax Foundation, Professor Kim Clausing observed that many corporations treat their tax department as a profit centre. Now resources that were once devoted to product development are dedicated to taking advantage of tax loopholes.

“The very intellectual abilities that would normally go into generating innovation or figuring out the best way to organize the production process are now at times diverted to the best way to report profit and the best way to arrange the accounting”.

We will look at why the current solutions are completely ineffective and what could be done next.

Acknowledgement:
world Map image by Freepik (www.freepik.com).