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Google vs. French taxes

By Alexandre Diehl, Lawyer and IREF research Fellow

For the past few weeks, and as Google has announced “bad” results on the financial markets, the media are gurgling with strange and technical news on a possible tax audit for the company. What is going on? Has Google broken the law, or are the French yet again attacking a success story out of envy? Has the government found another cash-cow?

In order to understand this story and explain future strategic decisions made by US Internet companies in France, we have to review some principles of taxation.

1) Founding principles of corporate taxation

A company based in France pays corporate taxes on her profits. Google France is defined as an advertising agency, representing Google in France and sell its services. It thus acts as sales representatives of sorts for Google in France. In fact, this means that the advertising revenues are collected by Google Ireland which holds exclusive rights to the services Adwords and Adsense in Europe. Therefore, the mission of Google France is to present contracts to advertisers who subsequently pay Google Ireland.

In that sense, Google Ireland’s revenues come out of the proceeds from Adwords/Adsense.

Tax optimisation and tax fraud (tax evasion)

Tax optimisation consists of using existing legislation to reduce one’s taxes, whereas tax fraud implies breaking the law. This applies to individuals as well as to legal entities.

The Maastricht Treaty (signed in February 1992) applies to the entire European Union and takes precedence over national legislation. Although each country retains fiscal sovereignty on its territory in terms of corporate taxation, the other member countries are not considered as being “foreign” territory.

This means that starting a business in Ireland is as legitimate for a French national as doing the same in Britanny or Corsica: this does not amount to tax fraud. Further, this means that it is also legal to establish the corporate headquarters of a US group producing immaterial goods in a low-tax jurisdiction (such as Ireland, Luxembourg, the United Kingdom) in order to do business without having to pay taxes in each of these countries. Again, this is not tax fraud in terms of the Maastricht rules.

However, using vehicles outside of the EU may be considered tax fraud, for instance putting up a shell company in the Bahamas with virtually no taxes.

Taxing immaterial assets

On the Internet and especially for search functions, professionals (including lawyers) sell only intellectual or immaterial services.

When two companies within the same group (say, France and the Bermudas) invoice immaterial services, they have to define a price. If Ireland, a low-tax environment, invoices Google France for a large sum, this amount will leave France, as well as the corresponding tax base. The French tax authorities thus have an incentive to understand and validate this amount. If the service concerns consulting for natural referencing or a lawyer’s fee, the taxman knows the going rate and can form an opinion. But if the service is the license fee for the Google or the e-Bay trademark, there is no means of market comparison. Therefore, these companies can easily set amounts that are “reasonable” but set unilaterally.

2) Fighting tax fraud: the Google case

Governments started cracking down on tax evasion as the crisis struck in 2008, following dwindling public revenues. In this context several bi-partisan working groups were created. A Senate commission was established in early 2012 and a report on digital taxation (authored by Sen. Marini, lawyer and fiscal expert) was presented in June 2012.

These two reports high-lighted a well-known fact: all large corporations use the Maastricht rules to locate each of their business unites in the EU country offering the best tax deal, outside of international outsourcing arrangements (Bahamas, Bermuda, Singapore, China …).

Some figures of reference:

> The telecom sector represents 2 billion dollars globally with a yield of 9 per cent;

> Consumer electronics amount to 1 billion dollars with a yield of 5-6 per cent;

> Advertising comes to 500 billion dollars, of which some 100 billion go to companies like Google, Yahoo or MSN:

> The software industry, making 260 billion dollars, and the music and cinema industries which represent some tens of billions of dollars.

According to France’s National digital council, “the revenues generated by Google, iTunes, Amazon and Facebook varies between 2.5 and 3 billion euros in France, paying 4 million euros in corporate taxes. Whereas if the French law was applied, they would owe some 500 million euros”. (official report, 25 February 2011).

Indeed, most of the US groups with a strong IP portfolio (patents and trademarks) use the “double Irish” method. For Google, this means that:

> Google US Inc. sells its intellectual property (patents and trademarks) to an Irish company based in Bermuda, called Google Ireland Holdings. The latter pays a license fee to Google US Inc. which is set as low as possible to minimize US taxation.

> Google Ireland Holdings is subject to Irish law. Theoretically, it should pay its taxes in Ireland. In fact, the world is divided into two camps: the Anglo-Saxon world that considers that taxes are paid not where the company is based, but where it is managed in effect. If a corporation is based in Bahamas but managed from New York, then taxes are paid in the United States. The rest of the world, including France, considers that taxes should be paid where the company is based (with some rare exceptions). In the case of Google Ireland Holdings, its “effective management location” is in Bermuda, thus no corporate taxes paid in Ireland. However, this is the mother company of a subsidiary called Google Ireland Ltd, based in Dublin and employing almost 2,000 people. The latter then becomes the depository of the IP rights held by the mother company in exchange for a very substantial license fee (some 5.4 billion dollars). Hence, Google Ireland Ltd is in charge of the entire sales proceeds by Google, Europe, the Middle East and Africa; close to 11 billion dollars (or some 88 per cent of the non-US sales).

> Paying the license fee means that the profits may be sent back to the mother company in Bermuda. Google Ireland Holdings is exonerated from corporate taxes and the license fee payment is deductible for Google Ireland Ltd. According to Irish law, licenses linked to the exploitation of an IP right is subject only to a minimal tax in case of transfer outside the country, and totally exempt if transferred within the EU.

> Enters between the two Irish companies a Dutch one, Google Netherlands Holdings BV, a shell company, used to transfer the license fees – hence the name Dutch sandwich. Overall, almost 99.8 per cent of the profits made by Dublin are cashed by Google Ireland Holdings, based in Bermuda … where it is exempt from corporate taxes.

> Last hurdle: the profits transferred to Bermuda cannot be brought back to the United States without paying corporate taxes (35 per cent). In 2005 the US authorities introduced an exceptional tax of 5 per cent for overseas profits brought back, which yielded the return of almost 300 billion dollars (for some 15 billion dollars in tax revenues). Google and other US corporations now await a similar decision to bring home additional profits. According to Bloomberg, approximately 2,000 billion dollars in profits are currently resting in tax havens.

The above arrangement may seem morally questionable to some, but remains legal. However, it is contrary to the interests of countries where Google is present, such as France.

As Google France declared only profits of 2.3 million euros in 2010 for a business estimated at several hundreds of million euros, this caused political reactions. The tax authorities have considered showing that Google France’s business activities go beyond representation to commercial business on French ground, whereas the subsidiary does not file any tax return in this respect. Google is thus subject to an inquiry that could lead to a request for more than 100 million euros in unpaid taxes.

3) Outlook

Unfortunately, from a political perspective, very little will happen in the short term. The schemes outlined above are well known to the political class. Sen. Marini’s commission is set to deliver another report, but it is extremely unlikely to propose large-scale change or concrete solutions.

The legal instruments within the EU will not be modified. And even if one or even several countries wanted to change the rules, a unanimous vote is required on tax issues: several countries (such as Ireland, the United Kingdom and the Netherlands) will always oppose a change to these schemes.

As far as France is concerned, she will quickly find out that the EU will not admit attempts to tax large corporation income flows, as this is contrary to EU rules on free circulation of capital. It is more likely that, after long negotiations the French tax authorities will recover some money, but the flipside will be the prospect of seeing Google employees leaving France for another member country.

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