The British Tax State from Waterloo to the Google Tax Settlement

Few people are usually passionate about taxation. Nevertheless, for more than a week now, the tax settlement between HMRC and Google has inflamed the passions of the British public as well as politicians. A number of sparks fuel the debate: There is the question whether the tax settlement is a ​“major success” or ​“fiscal surrender.” There is controversy about the secrecy of the settlement and the relationship between Google and the government. And there is the question whether £130 million is a fair contribution for a company as profitable as Google.

Taxation – are we still in this together?

Underlying these diverse issues is a common theme: does the tax consensus between the government, ordinary citizens and businesses in Britain still hold? The tax consensus is the backbone of the British tax state that the country, as the first in Europe, had developed by 1815 – just in time to have the means to defeat Napoleon. Ever since, the government, individuals (rich and poor) and businesses (big and small) have renegotiated this social contract on taxation in the face of social and economic changes. Each round of negotiations ideally has two outcomes: mutual trust among taxpayers that each group pays its fair share and the confidence of all taxpayers to receive returns for their payments in form of security, public health, education, infrastructure, etc. If these two outcomes are not achievable, the state must come up with a strategy on how else to ensure tax compliance. Such a strategy usually entails surveillance, secrecy about the actual terms of the social contract and coercion. These measures tend to be expensive and can undermine state legitimacy in the long run. A stable tax consensus based on mutual trust and a sense of value for money is hence in any government’s interest.

The fierce public reaction to the Google tax settlement indicates that it is becoming harder to keep the current tax consensus palatable to citizens and smaller businesses. The negative effects of austerity, reducing public goods and services for most people, undermine the sense among taxpayers that they get a fair return for their tax contribution. Moreover, they suspect that firms like Google have become so powerful that they can negotiate their tax rate, essentially leaving the social contract unilaterally. But are Google et al. indeed powerful enough to negotiate a tax rate at their discretion? If so, what are the potential consequences for the British tax state?

Who wears the trousers – Google or the government?

It is not trivial to say who had the power to shape the Google tax settlement. Little is known about the settlement’s details. It is even difficult to judge whether a payment of £130 million is a lot or a little. To help with that question, tax experts put the payment in relation to Google UK’s profits as reported to the company’s US shareholders. It is three percent of that reported profit. The regular corporate tax rate in Britain is 20 percent. Given Google UK’s profitability, £130 million is thus a small contribution to the taxman. There is only one problem with that estimate. It does not tell us whether Google UK’s profits are indeed taxable in Britain. Nevertheless, the three percent tax rate was circulated by the media.

The three percent story in combination with George Osborne insisting that the settlement constituted a ​“major success”, led to the government narrative that taxing a company like Google in itself constitutes a step forward for the tax state. It sounded very much like David vs. Goliath: the powerless but brave British government against the powerful US-American tech giant.

The story of the three percent tax rate and that of the bravery of the government, however, miss the point. Of course Google could not negotiate an especially low rate. The 20 percent corporate income tax rate is determined by the law. Neither an individual company nor HMRC can change it single handedly. After all, in Britain the rule of law applies. The crucial element for understanding Google’s humble tax contribution is not the tax rate but the tax base, i.e. the taxability of its profits. Again, the law is clear about this question. The bilateral treaty between the United States and Britain states that a US firm is liable to pay taxes in Britain if it has a permanent establishment, i.e. a branch or office, here. But there is an important exception to this rule: a branch or office is not considered a permanent establishment if its overall business ​“is of a preparatory or auxiliary character.” Now, Google claims that most of its activities in Britain are services for Google Ireland. It follows that Google UK has no permanent establishment. In its audit HMRC chose not to question this claim, although there are many reasons to challenge it.

The remarkable feature of the tax settlement is that the British tax authorities allowed Google to keep its taxable income low, not that Google succeeded in negotiating a three percent rate. Does it matter, whether the deal between Google and HRMC is about the tax rate or the tax base? After all, it both leads to the same result: a meagre tax bill. Yes, it does matter. The three percent rate argument makes the government look weak. The tax base argument makes it look willing to accommodate the multinational’s tax avoidance strategy.

The stakes are high – the implications for the British tax state

Google isn’t the only multinational corporation using the twist of artificially avoiding a permanent establishment to minimise taxation. To end this practice, the Organisation of Economic Co-operation and Development (OECD) has come up with a new template for bilateral tax treaties. If the government is serious about more strongly taxing multinationals, as it claims, it does not have to project an image of bravery in the face of corporate superpower. It can do so with a dull act of transatlantic diplomacy: amending its tax treaty with the United States according to the OECD’s suggestions.

This would mean for the government to move from competing with other countries in tax matters to cooperating with them to reduce tax avoidance. This move would constitute a significant shift in British international tax politics. It means to stop accommodating tax planning strategies of multinational firms in favour of rebalancing the tax consensus towards the needs of smaller businesses and ordinary taxpayers. The government announced this shift. It has now the chance to move from words to action. Inaction in the face of the crumbling tax consensus, on the other hand, pushes the government further down the road of enforcing tax compliance of the regular taxpayer through surveillance, secrecy and coercion while letting the big fish off the hook. Admittedly, in the short run, the alternative is tempting. Surveillance has become easy and cheap thanks to e‑commerce, automatic information exchange, online tax declarations and electronic pay slips. Yet, in the long run this strategy weakens the tax state – that British institutional innovation which pays for everything from the welfare state to the country’s international influence since Waterloo.

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This commentary was originally published by the Political Studies Association on February 2, 2016.