Why big American high-tech companies are scared by the Italian Web Tax and…..Europe?

Branches of North American giants rake-in advertising revenue and sales in Italy and the rest of Europe, without paying taxes – except the (few) in Ireland. Rome tries to put a halt to this

Apple is under investigation – Google, Amazon and Facebook are under the tax microscope being accused of having created a perfect system for (and probably legal) tax evasion in half of Europe. Several days ago the news that Milan prosecutors opened a criminal file for tax fraud against the California giant came out (L’Espresso, 2013 in Milan Apple under investigation for tax fraud of more than a billion dollars).

The mechanism is well known: the big North American hi-tech branches rake in advertising revenue and sales in Italy and the rest of Europe, without paying taxes, except the (few) in Ireland, gaining a huge advantage in terms of actual savings on tax burdens.

Google prides itself on having an overseas tax rate, net of U.S. activities, of only 2.4% (source: Bloomberg 2013).

In fact, Google and other internet biggies are not violating any tax laws, but merely exploiting the loopholes of antiquated tax systems, which were designed in the 60s – last century in the pre-computer era – and have not yet adapted to the computer revolution of the last decade.

Indeed, they fight back and claim that it is the states’ fault that they do nothing to change their tax systems; they say that if the states were to eliminate the tax distortions they created, the players in the new economy would adjust and pay more taxes (!).

Here’s a small introduction in order to fully understand the issue.

Companies in the industrialized countries (OECD area) pay corporate tax only in the jurisdictions where they have a permanent settlement e.g. a company, subsidiary or branch (Article 7 of the OECD Model Convention against double taxation). So, for example, if a company has a plant in Italy and a subsidiary in France, they will have to pay taxes both in Italy and in France, but if they are able to export without the support of a transalpine settlement (perhaps using a network of agents), will pay taxes only in Italy and not in France.

It is obvious that this tax system, designed for the ‘old economy’ companies, seems unsuitable to those from the ‘new economy’ that take advantage of the possibilities of exclusion between economic/judicial ownership of intellectual property and of and distance spread of the contents; they can arrange the profits in the cheaper tax jurisdictions.

In this respect Europe also puts its 2 cents forward: the ruling defending the principle of freedom of establishment and freedom to provide cross-border services (Article 43 and 49 of the EC Treaty) allows a non-European company to place itself in EU countries with low tax pressure and to conduct their business in Europe from there without paying any income tax in the national end market.

That’s why Apple and Google take advantage of our European Treaty fundamental freedoms to “freely” bill their sales in Europe from Ireland.

Unlike what is normally held to be true, the choice for Irish jurisdiction does not depend so much on the low Irish tax rate on corporate profits (12.5%) as much as from favorable rules in the calculation of the tax base and privileged relations with certain tax havens.

In jargon the tax scheme used by Apple and Google is called “Double Irish with a Dutch Sandwich.”

The circulation works like this: the American parent company gives the rights to use intellectual property destined for the European market (EU IP) to a primary Irish company (Alfa), which in turn allows the use of a second Irish company (Beta). Beta is the one that invoices the European consumer and in turn receives invoices for royalties from Alfa. In fact Beta does not pay taxes in Ireland, since the payable royalties offset the revenue from sales. But even Alpha does not pay taxes, as this company, being incorporated in Ireland, is operationally managed from Bermuda (or the Caymans) and therefore for the Irish Revenue is not a taxable entity. De facto all revenues invoiced from Beta to European consumers end up in the Caymans/Bermuda in the form of royalties.

This scheme allows, in addition to near tax exemption in Europe (the Irish society’s revenue is canceled by a counter-billing company resident in the Cayman Islands, where you do not pay taxes) and in the USA (the income attributable to an Irish company, more or less tax resident in the Cayman, is outside the U.S. corporate tax).

If on the other hand the income produced could not have been properly “diverted” to these well-known tax havens by virtue of a more restrictive norm in contrast with these jurisdictions from Ireland, the two American giants would have placed their European control room in Italy or France, as well as serving a higher corporate tax rate (31.4% in Italy, 33.33% in France).

The model described above certainly belongs to the phenomena of tax evasion to which the EU and the OECD are trying to react – but slowly and with difficulty.

The solutions announced in some recent documents from the two international organizations (European Commission Communication “An Action Plan to strengthen the fight against tax fraud and tax evasion (Com 2012 n 722) and the Action Plan against the “Base Erosion and Profit Splitting”- BEPS OECD in July 2013) do not appear to be decisive: the aim is the harmonization of domestic legislation, the exchange of information between states (the Foreign Account Tax Compliance Act – FATCA mechanism), the refinement of complex and obsolete regulations (transfer pricing and Controlled Foreign Companies – CFC ) who have not given the desired results so far. Not to mention the fact that it takes a long time: just the compiling of the OECD proposals is not expected until December 2015 (!).

In short, struggling to establish the idea of a Copernican revolution in the tax area, a coherent plan for reform of modern tax systems is needed to adapt to the new networked economy.

In this context, they have attracted attention and headlines even in the international press (Forbes 2013, Italy Proposes An Entirely Illegal Google Tax; Reuters 2013 Italy eyes ‘Google Tax’ to help fix public finances) of the draft law to reform the tax system (a parliamentary plan of initiative approved by the House of Representatives September 25, 2013 and pending in the Senate: Senate act no. 1058), re-proposed in the form of amendments to the Stability Law 2014 which in Article 9, paragraph 1, letter i) provides for a commitment to the government to “predict, in line with the recommendations of international organizations and with eventual decisions at the European level taking into account the international experience, taxation systems on cross-border activities, including those related to advertising, based on appropriate mechanisms for the estimation of portions of assets

attributable to domestic tax jurisdiction. ”

The technical-normative content does not betray the possible underlying tax revolution.

If this rule were implemented, it would mark year zero as the “post-tax computing”, the time when the global world of the internet demolishes the dusty palaces of Ministries of Finance, placed in defense of the national tax base, the birth of a new taxation model is no longer based on the concept that taxes are paid in the country where “they are produced” but to the one that “consumes them” (thus making the convergent field of direct and indirect taxes).

In the futuristic tax system, outlined in the Italian proposal for the web tax, it is easy to imagine in the long run, the progressive convergence of rules for determining the national tax base, the birth of a new supranational order in which, in addition to monetary policy, would be centralized at a European level, including the levers of fiscal policy, the pooling of tax proceeds and their distribution by homogeneous geographical areas, leaving assets available of the national states the sole determining reference for the tax rates they have.

Ultimately the Italian proposal for a Community Web Tax appears “more European” than those who believe in contrast with the economic freedoms of the EU Treaty, but all indications are that it is politically premature and will not see (for decades) the light yet.

Gianluca Marini

gianluca.marini@mazars.it