STARBUCKS AND AMAZON FACE TAX FURY

Poor old Starbucks and Amazon (and we can add a few other notable heavyweights to that list) are getting it in the neck. The two cases are very different. Both are accused of aggressive or “unfair” tax avoidance. Unfair seem to be a term used by commentators when they can’t think of anything specific to complain about. The main complaint seems to be that both companies generate revenues in the UK and don’t pay much UK corporation tax. They do both contribute to the UK plc by employing people in the UK who pay tax, by paying VAT and National Insurance and by spending money with providers of goods and services. They do contribute but do they contribute enough or a “fair amount”? Importantly neither are UK companies. They are both headquartered in the US.

Starbucks extract royalties out of the UK which reduce or eliminate most of its profits. Many of the Starbucks coffee shops in the UK are franchises- joint ventures with a local corporate partner (apparently they won’t grant franchises to individual entrepreneurs). The franchise agreement would typically provide that Starbucks will provide expertise, systems, know-how and the use of the Starbucks name in return for a royalty. A royalty is charged on turnover and is an expense to the operator which, obviously, reduces local taxable profit as do its other overheads such as rent and wages. Starbucks also operates its own coffee shops in the UK and is allowed to charge the same royalty, but no more, as it would charge a franchisee. Apparently the royalty is 4.7% of turnover. Tax agreements, normal practice and logic all dictate that it is reasonable for a company that has spent millions, probably billions, advertising and marketing its brand to be able to charge for the use of that brand. Starbucks in the

US has made the brand valuable by aggressively promoting it as a sign of quality. All big brands do the same. People visit the Starbucks coffee shops because they are called Starbucks. Without the Starbucks name business would probably reduce. Certainly the franchisees value the use of the name and for Starbucks expertise etc and are prepared to pay for that use. It is a condition of the franchise agreement. If you don’t value what Starbucks provide don’t sign the agreement.

International tax agreements, which override local tax legislation, dictate how royalties are treated and give companies tax certainty. The UK and the US have signed a tax treaty which provides that royalties can be paid gross and without withholding tax. The receipt of the royalty in the US would add to the profits, made by Starbucks in the US and be subject to US corporation tax. In theory the royalty will not escape taxation – it will just be taxed in the US rather than the UK. What seems to have offended here is that the royalties are not being sent to the US but rather to the Netherlands. The UK and Netherlands have concluded a similar tax treaty. Royalties can be sent to the Netherlands tax free. Those royalties are subject to tax in the Netherlands but the Netherlands allows royalties and interest to be paid onwards and deducted as an expense without tax being withheld on either. We don’t know what happens to the to the income received in the Netherlands but standard planning is for the Netherlands company to be paying away most of the royalty income it receives to a zero tax company. This would leave little or no taxable profit in the Netherlands so the royalty being paid out of the UK escapes tax in both the UK and the Netherlands.
 
These arrangements may be obnoxious to the UK but it doesn’t cost the UK any tax. If the royalty was paid directly to the US, no UK tax would be payable on that amount. The US might well complain if it is not getting tax on the royalties sent to the Netherlands but that is a matter for the US IRS. The US have rules designed to capture and tax the profits of offshore companies used by Starbucks. They can bring those rules to bear if they can and wish. It is not clear whether anybody has ascertained whether or not the royalty payments going out of the UK are being taxed in the US. All we know is that they are not being taxed in the UK which is both logical and legal. An UK company doing business in the US would receive similar treatment and can extract royalty payments without suffering US. It could receive the royalties in the Netherlands if it wished.
 
The Amazon case is quite different. Amazon trades with the UK and not in the UK. It sells books, CDs and other items in the UK but has not set up a taxable entity in the UK. Generally if an US company sends goods to the UK, payment is sent to the US and is revenue belonging to and taxable only in the US after expenses. Tax is not payable on revenue only on profit. International tax treaties contain a “permanent establishment article”. That article clearly states what you are allowed to do within a country without being subject to tax in that country. Typically the treaty will state that a treaty partner company can maintain “facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise” without creating a taxable presence. On the other hand it may not maintain a place of management; a branch; an office; a factory; a workshop; without creating a Permanent Establishment and thereby becoming taxable.

Amazon has set up a subsidiary in Luxembourg. It is the Luxembourg company which sells the goods to UK residents. If a customer logs on to Amazon.co.uk and buys something that transaction is processed through a Luxembourg server owned by a Luxembourg company and managed by persons resident in Luxembourg. The sales process is automated so does not require much by way of personnel. The warehousing and distribution of the goods in the UK probably requires many more people. That is not particularly unusual. If the US and Luxembourg treaties signed by the UK provided that UK tax had to be paid if the foreign company had a warehouse and distribution centre in the UK, Amazon would probably move that facility out of the UK. Delivery of goods would be slower but it could easily fulfill orders through a server in Luxembourg and a warehouse in, for example, Ireland. If the Luxembourg company was removed from the equation there would still be no UK tax payable as sales would be made to UK persons by the US company and any and all profits made from those sales would be taxed in the US, not in the UK. Again the UK is not losing revenue because of the Luxembourg arrangements.

The tax treaties which allow Starbucks and Amazon to avoid tax in the UK were signed to encourage trade between the tax treaty partners and give certainty as to which country was able to tax the revenue. They have achieved that. Advisors are using these treaties creatively to try and reduce the overall tax burden by parking profits in a third country. It could be argued that Amazon and Starbucks are “borrowing” the Luxembourg and Netherland treaties respectively and shouldn’t be allowed to use those treaties because their main and head office is not located there. But they do have companies in those countries and it would seem unrealistic to deny them the use of the treaty because they have less personnel in those countries then they do in others. Perhaps if they couldn’t plan like this they would just move their company to a lower tax country instead. We saw quite a number of companies exiting the UK and now individuals exiting France to escape tax hikes. Countries compete to attract business and investment. Tax is one factor. Expertise, living standards, infrastructure and even the weather also play a part in attracting people and businesses.

The UK could increase taxable profit by denying a deduction for the royalty payable to Starbucks. That would discourage big companies from doing business with the UK unless all other countries in the world did the same.

Amazon employ a large number of people in the UK. Amazon are different to Starbucks in that they probably don’t need an operation in the UK and would not have one if it led to having to pay large amounts of tax which they could otherwise avoid. Starbucks cannot sell and deliver hot coffee over the internet. Starbucks need shops in the UK which must pay UK tax on profits made in the UK so the only question is how that profit is taxable and who gets the right to tax profits. I think the reality is, and politicians and HMRC know this, that businesses are very mobile and it does not pay to kill the golden goose by increasing tax rates or denying reasonable deductions against taxable profit. It makes great headlines for newspapers and politicians to knock the greedy corporate who has huge revenues but little tax (in the UK) but the reality is a bit different.

It is interesting to note that the Guardian- which seems to have been the main critic of both these companies- has a turnover of £195 million but pays no tax. Its accounts show it is making a loss. It would probably argue that there is nothing “artificial” about these accounts but if it was advocating a tax on turnover, it may no longer be in existence due to its losses being greatly increased by that tax.

Partnerships in today’s world

We keep hearing governments across Europe tell us that “we’re all in this together”. British newspapers in particular seem to take great delight in reporting examples of how some of the more wealthy members of the current cabinet are “out of touch” with ordinary people. The recent story about whether or not to charge VAT on hot “pasties” was just one example. But in general, it seems that most people in the UK realise that by working together – in partnership if you will – things will eventually get better. Certainly the huge deficit is being reined in although there is a long way to go.

Since the last edition, I have had the pleasure of attending the long awaited wedding of two good friends. It was a lovely affair; my partner and I had a very jolly time and we wish the newlyweds a long and above all, a very happy, marriage.

Going to the ceremony got me thinking – weddings do that, don’t they? – and all the talk of partnerships led me down several paths. What constitutes a partnership anyway? And when we hear the term in a business context, is it based on the same principles as two people who call themselves “partners”?

A simple definition of partnership is that it is an arrangement where parties agree to cooperate to advance their mutual interests. But let’s go back a little to explore the term used by individuals in their personal lives, rather than the business context.

Years ago, if one was neither married nor engaged but still committed to another person in a steady relationship, the words “boyfriend” or “girlfriend” seemed to do perfectly well (although I accept it sounded rather odd when describing people old enough to be one’s parents). The term “common law marriage” was one taught to me by my mother although I used to get alarmed at the level of vitriol in her voice when she said “common” – as if there were something dreadfully wrong about it all.

Fast forward 25 years and the word “partner” seems now to be the in-phrase. Time was, just a few years ago in fact, that if I had referred to my partner in polite company, there’d be a short intake of breath for it was taken as read that I had to be referring to another man. In these days when so many people maintain a relationship without ever entering into marriage, the term partner could just as well refer to a girlfriend of several years’ standing. It’s all become rather confusing.

In the UK, it was the Labour government that took the politically brave and potentially risky decision to enact civil partnership legislation in 2004. Possibly soon to be extended to Gibraltar, the legislation set out clear guidelines for the first time relating to the responsibilities of partners and the benefits to be gained from entering into such an arrangement. Aimed at same-sex couples, there have been complaints of discrimination ever since from straight couples who do not wish to enter into marriage but seek the financial and legal benefits of a partnership arrangement. So far the government has maintained that such people can simply get married but sometimes it’s more complicated than that.

The civil partnership legislation is very clear. In exchange for a series of undertakings and legal definitions of what constitutes the partnership between two people, several important benefits arise. The most important implications from a financial perspective are probably those dealing with succession issues and inheritance tax in the UK and the setting out of new rules relating to next of kin and a lot more besides. Sadly – but inevitably – it also goes into considerable detail about how such partnerships should be dissolved.

These new rules in effect brought into force for individuals important aspects of legislation that had previously only been available in a corporate setting. Business partnerships, as we shall see, are nothing new. Legal partnerships come in several shapes and sizes but they all follow a similar pattern. It is also now very common to see the initials LP (standing for limited partnership) or LLP (limited liability partnership) appended to the name of many of our large firms, legal and accountancy in particular.

But hang on. Surely partnerships – law firms, doctors and so on – were not supposed to be able to limit their liability. Wasn’t that the whole point? In exchange for the comforting knowledge that the partners in question, whether they were drafting a contract or diagnosing a condition, were putting not just their professional reputations on the line but also their assets. Of course, insurance was used to mitigate some of this risk but ultimately their judgment, and that of their colleagues, was backed by individual partners’ wealth.

In several jurisdictions, many of them based on English law, partnerships as a separate legal entity have become far more popular in recent years. Essentially the intention was to retain the benefits of partnership whilst allowing at least some protection associated with limited liability. But this concept is not restricted to English law and is certainly nothing new.

In the third Century BC, Roman societates publicanorum exhibited many similarities to the company structures we see today – but at least one partner had to be included who was fully liable for the entity’s debts. Across the Islamic world too, such arrangements became common. In Europe, the Italian commenda of the tenth Century were the forerunners of the LPs and LLPs we see today.

As always there are differences across the various jurisdictions where such structures can be established but the general principles are similar enough. A limited partnership may typically have up to 20 members, at least one of which is a “general” partner. This general partner has the power to bind the partnership by entering into contracts and so on and also assumes unlimited liability for the debts and obligations of the partnership. This potential liability can itself be mitigated if the general partner is itself established as a limited company.

In these circumstances, the other partners could enjoy “limited” liability in respect of the partnership in much the same way that shareholders in a company know that their financial risk is limited to the amount of capital that they have invested into the company. It follows that these limited partners may not take part in the management of the company nor are they able to bind it contractually. The limited liability partnership differs in that there are limitations in liability for all partners.

Assuming such partnerships are properly structured from the outset, limited partnerships can be extremely flexible. Within reason, they are able to do anything a “natural person” – that is someone like you or me acting in an individual capacity – can do. A partnership can enter into contracts, own assets and, importantly, it can carry on in existence despite any changes in the status of the individual partners. In other words, in many ways such partnership “entities” are much more closely related to companies than a traditional partnership of old.

Tax advantages are likely to result because, generally speaking, these types of structures are established so that profits are taxable in the hands of the partners rather than the partnership itself – in the US, this is often referred to as “look-through treatment” because the taxman will “look-through” the partnership structure to assess the individual partners. Additionally, limited partnerships allow for the issue of shares in cases where other corporate facilities may not be desirable.

In summary, partnerships can offer the managers of businesses a more flexible, modern approach to liability and risk management in general. Their benefits were there for the Romans more than 2,000 years ago and I imagine the law relating to partnerships will continue to develop further in millennia to come. They are not necessarily simple to establish so, as always, professional advice should be sought at the earliest stage.

And so back to those friends whose marriage we have just celebrated. I happen to know that they read The Gibraltar Magazine – at least I hope they do for the lady in question happens to be the magazine’s editor. From my own partner and me and on behalf of my colleagues at Sovereign too, I say congratulations and we wish you a long and happy partnership.

Cyprus lowers VAT for Yacht Leasing Scheme

Under the Scheme, a Cypriot company can purchase a pleasure yacht and enter into a lease-sale agreement for the yacht with a third-party lessee - an individual or company irrespective of their location. Since this is a service deemed to be supplied in Cyprus, VAT is due on the lease at the normal rates of VAT in Cyprus - currently 17% - but is payable only on that portion of the lease which the yacht spends in EU waters.

To avoid the difficulty of establishing the exact length of stays in EU waters, the VAT Service has issued its own percentage scales based upon "presumed" lengths of stay for different types and lengths of yacht. Motor and sailing boats over 24-metres in length are deemed to spend only 20% of their time in EU waters (compared to 30% under the Malta equivalent scheme) to give an effective VAT rate of 3.4%, while motor boats below 8-metres and sailing boats below 10-metres are deemed to spend 60%, giving an effective VAT rate of 10.2%.

The yacht, which can be registered anywhere within the EU, must arrive in Cyprus within one month of the date of inception of the lease agreement and the initial lease payment must amount to at least 40% of the value of the yacht. Further lease payments are payable on a monthly basis, and the lease period must under no circumstances exceed the period of 48 months (36 months in Malta).

The lessee may purchase the yacht at the end of the lease period, for a final consideration of not less than 5% of the initial value of the yacht. The VAT authorities will then issue a certificate to the lessee confirming full payment of the total VAT liability. The lessor is expected to make a total profit from the leasing agreement of at least 10% on the initial value of the yacht.

Prior approval from the VAT Commissioner is required for every application of the Yacht Leasing Guidelines.

Comparing Gibraltar is one thing – but can it compete?

In recent columns, I have written about the reasons one might consider Gibraltar as a good place to invest, work and live. I have covered issues such as the legal framework in the jurisdiction itself, regulation and, perhaps most importantly, the new corporate tax legislation that came into force in January of this year.

Then what happened? After the last column a lady reader stopped me in the street to say: “That’s all very well, but do you really have such rose-tinted spectacles?” She went on to ask if I was so enamoured of Gibraltar that I could simply ignore the competing jurisdictions. The conversation made me think.

As you can see from my mug shot overleaf, I obviously do wear “specs” – and have done since the age of five. But honestly, they’re not rose tinted. Of course everything isn’t perfect in Gibraltar but then who can show me a jurisdiction where such a utopia exists? Life would be pretty boring wouldn’t it?

So in answer to my lady critic, I thought I might take a quick look at one or two “competing” jurisdictions to see how Gibraltar measures up. What follows is necessarily a general view of just a couple of places that I genuinely consider to be our “competitors”. As always these are just my own personal thoughts so don’t shoot the messenger. If you disagree with anything that follows, do get in touch and let me know.

I decided to limit myself to considering the most obvious places against which Gibraltar is most often compared. Bring on my first problem. Being involved in the corporate services and trust business, the Channel Islands and Isle of Man were my first choices.

Other finance professionals in Gibraltar will differ; those more closely involved with the funds or insurance industries might consider Luxembourg or Switzerland. The Chief Minister is likely to say London. And to an extent we’re all right. What I wanted to consider though were the places that are already close to each other in other ways – legal system, language, etc. In that way I felt we could make a more accurate “comparison”. After all, how does one match tiny Gibraltar with a country such as Switzerland with a population of several million?

So for this article I decided to consider only the Channel Islands and the Isle of Man. After all, I can always look at other places in Europe or further afield in future columns.

First though, a word about my personal position in all this. As my surname suggests, I am not from around these parts. I am instead a proud Jerseyman although I left the island over 25 years ago. I rolled up on Gibraltar’s shores when I took up my appointment with Sovereign in November 2004 so am still considered by some, no doubt, as very much a new boy.

Having said all that, my first visit here was almost 30 years ago and during my time as a banker I was here very frequently. So I’ve seen a few changes. I am settled here and celebrated National Day last month with everyone else so, of course, I am a keen fan of what one might call “Gibraltar plc” and everything the territory and its people stand for.

When considering the Channel Islands and Isle of Man, how do we compare and can we compete? Is it realistic for us in the finance industry to make such bold claims? Naturally I think we can and now I’ll try to answer why that is.

Firstly of course, Gibraltar is not an island – that much is obvious. As in the cases of the other three, we suffer our fair share of weather related issues at the airport. However, it’s rare for Gibraltar to be totally cut off and there are always options such as using Málaga. You can’t leave the islands so easily in bad weather so being joined to mainland Europe can certainly be an advantage.

I then considered some bare facts. For sheer size and population, Gibraltar is by a very long way the smallest of the four – although remember what they say about good things coming in small packages. Gibraltar’s population of almost 30,000 is half that of Guernsey and not much more than a third of the totals in both Jersey and the Isle of Man. Covering around 220 square miles the Isle of Man is many times the size of Gibraltar, and at 46 and 25 square miles respectively, Jersey and Guernsey also dwarf our small country in terms of size.

For all four jurisdictions, financial services are vital parts of the local economy. The percentage of the workforce employed in the industry varies but is significant in each place. The Channel Islands were first off the block in terms of providing what became known as “offshore” services in the ‘sixties although both the Isle of Man and Gibraltar soon followed. It’s when one considers the broader financial infrastructure and legislative framework that have evolved subsequently that one begins to appreciate how close Gibraltar now comes to the other three in almost all respects. Let’s look at a few concrete examples.

We may not have as many banks as the islands, but a number of Europe’s finest banks are represented here, not to mention a growing number of hedge funds and investment firms. We host most of the major accounting firms and although the large City law firms may be absent, many of our local lawyers have built world class reputations in such diverse areas as Experienced Investor Funds and maritime law, to name just two.

Moreover, in recent years, financial services have played an important role in the creation of a Gibraltar gaming sector that has left its competitors in Guernsey, the Isle of Man and indeed elsewhere far behind.

Looking at corporate and trust services, our firm has important offices in Guernsey and the Isle of Man, as well as here in Gib where we employ more than 60 staff. Each jurisdiction has its own specialities – for example Guernsey is particularly well regarded as a QROPS jurisdiction. But in general, Gibraltar can claim to compete across the board.

I have written about corporate taxation in recent columns. Gibraltar companies pay 10% corporation tax on the accrued and derived principle; this has been accepted at EU level and our new system is now operational. At present, with just a few exceptions, Channel Island and Isle of Man companies pay no corporate tax at all. This option is being challenged in some quarters so it may be that those rules might need to change.

There is one area, however, where Gibraltar not only competes with its peers but can also be considered to have a serious competitive advantage. Gibraltar is a full member of the European Union, although not part of the Customs Union – there is therefore no VAT. This presents unique opportunities for EU companies that benefit from operating in a VAT-free environment. There is no VAT in Guernsey either, while Jersey levies a Goods & Services Tax (GST) – the present rate being 5% – and the Isle of Man VAT is charged at the UK rate, currently 20%. But none are part of the EU.

The second unique advantage that Gibraltar offers by dint of its EU membership is the ability for licensed, regulated firms to “passport” that status to other EU countries. This means that firms regulated here may offer services to clients in any one of the 27 EU states. Passporting is enormously valuable to banks, insurance and investment companies. This is simply not an option in the other three jurisdictions.

So in conclusion, with or without my “rose tinted specs”, can we really compare ourselves with the Channel Islands and the Isle of Man? You bet. More importantly, is it realistic for Gibraltar to claim that it can compete effectively with these places? Again, the answer is a resounding “yes”.

Clearly, there is enough good quality, international business to keep the good practitioners busy in all four jurisdictions. I believe that we should always be aiming to grab a larger slice of the pie here. Gibraltar-based professionals are travelling ever further afield in order to spread that message. Let’s hope that this trend continues and that we develop our offering still further, to the benefit of all of us who live and work here.