Sigh

Many businesses aren’t making a full contribution to the country from which they take so much. Starbucks, for example, is a notorious example of this phenomenon”

What phenomenon? Business not making profit does not pay a tax on the profits it isn’t making. This is notorious in what manner?

This was in fact investigated in depth. There were two major claims that Starbucks was sending profits out of the UK by two methods. The first was royalties for the brand to Holland. HMRC had approved their calculation. And a subsequent EU investigation showed that Starbucks UK paid the same royalty as Starbucks franchises in other countries also had to pay. For their not to be doing so would in fact have been a breach of the transfer pricing rules. Something we’ll come to in a moment.

The second was that they paid a 20% margin to Switzerland to the unit that bought the coffee beans. One point is that coffee beans make up perhaps 5 p of that £4 latte. Meaning that it’s unlikely to have much of an effect. However, not to be making such a margin would again be in breach of the transfer pricing rules. For this is how the international tax system works.

If you’ve got various subsidiaries of the one company trading with each other then in order to stop profit shifting they are supposed to price transactions at the “arms length price”. That is, as if they are not co-subsidiaries, but are independent companies. So, Starbucks UK should be buying coffee beans from Starbucks Switzerland Coffee Bean Brokers (whatever they were called) at a similar enough price to what they would buy them from an independent bean broker would demand. And yes, Switzerland is the world’s centre for coffee been brokering and no, none of the independents do offer to trade with you if they make no margin. It would actually be illegal for Starbucks not to pay a margin on such bean purchases because that would not reflect arm’s length pricing. and the same goes for the brand rights and royalties. That they were paying the same amount they charge franchises is right and proper, not to do so is illegal.

Finally, as Vince Cable pointed out, once you added these back in Starbucks was *still* making a loss in the UK. So no tax would have been payable even if.

Companies that don’t make profits don’t get charged a profits tax on the profits they’re not making.

As to why they weren’t making a profit the first chapter of Tim Harford’s “Undercover Economist” gives a lovely explanation. It’s straight Ricardo on rent. Location is everything, so all the profits of the coffee trade go to those who own the properties. And yes, landlords really do pay UK tax on their profits. Starbucks simply paid too much for too many prime properties.

It’s fine for people to have differences on how corporations should be taxed, of course it is, but it does help if people are actually informed. Who knows, next we’ll be told that Vodafone owed £6 billion in UK tax (it didn’t, an invention by Richard Brooks at Private Eye) or that Margaret, Lady Hodge, didn’t use the Luxembourg Disclosure Facility (she did, she’s said she did).

Letter sent to the editor of CapX

32 thoughts on “Sigh”

  1. Bearing in mind that the sole purpose of Starbucks is delivery of coffee and the occasional bun to its customers, the only way it can ‘not make a full contribution’ is if it’s short-filling the lattes.

    Of course, people would argue that Starbucks doesn’t put anywhere near enough coffee in its lattes….

  2. BTW if this dripping wet hand-wringing shit is the best we have to defend capitalism, we might as well fly direct to the fucking gulag.

  3. It may just be a bad attempt at positioning, but Montgomerie always has had a Scooter of Justice parked at the back of his garage.

    With extra mirrors on, so he can look at himself. Like someone else we know.

  4. I thought CapX was supposed to be a capitalist flag-waver? I hadn’t got round to reading it yet; don’t think I’ll bother now.

  5. …once you added these back in Starbucks was *still* making a loss in the UK. So no tax would have been payable even if.

    You’ve repeated this many times Tim, but it’s still not true. Some of the deductions included in Starbucks’ accounting loss are not allowable for corporation tax purposes. (I wrote up the numbers here.)

  6. Some thoughts of mine, posted elsewhere, in January. Not up to Tim’s standards, but it’ll have to do.

    “We have had some discussion of Starbucks before, but an interesting diagram came up in the Times on Jan 27th. Sorry, it’s behind a paywall, so you’ll have to trust me on what it says. For the average cup of cappaccino at £2.27, the breakdown in costs is as follows:

    Coffee 4%
    Milk 4%
    Packaging 8%
    Rent/rates 15%
    Admin/ overheads 15%
    Staff costs 24%
    VAT 17%
    Profit 13%

    Some may say that the fact that the coffee costs less than the packaging tells us all we need to know about Starbucks, but I want to talk tax and such like.

    Taking the items in turn: I hope you’ll accept that they have to buy coffee from abroad! They have been accused of diverting profits by buying through Switzerland. However, apparently some 75% of world coffee is traded through Switzerland. Not because of tax, but because it has established itself as the leading market, in just the same way as London has for marine insurance or fine wine. Secondly, there is vast amounts of tax law concerning “transfer pricing”, ie the artificial transfer of profits overseas. HMRC have all the clout they need to stop this. Indeed, at its simplest , they would disallow an element of the cost. But they don’t. Sure, the Swiss brokers make a profit, but that is for the service they provide, and not to do so would be a reverse form of transfer pricing by the Swiss, wouldn’t it?

    Incidentally, it does show the relative cheapness of them buying “Fairtrade”, especially if they make a virtue of it and can therefore charge more because of it.

    Milk: tax is paid by the milk producers, as well as all their suppliers. A justifiable cost, I’d say.

    Rent: All of which is subject to tax in the hands of the landlords, ultimately at up to 45%.

    Rates: huge, and a direct contribution to the places in which they operate.

    Admin and overheads: more allowable costs, eg telephones, on which their suppliers will pay taxes.

    Staff: Income tax, employees and employers national insurance is due, so around 35% of this is tax.

    VAT: this is very high at 17%. In other words, 85% of the price of a cup of coffee is value added by Starbucks. Effectively the benefit of being able to supply you with a presumably acceptable cup of coffee at a desired location at the right time. So when we hear about Starbucks “paying no tax” on a historical turnover of £3 billion, we can see that that is complete nonsense.

    Profit: This year they have made a profit, by closing loss-making outlets. Note also, that there is a difference between profits and taxable profits, which are always likely to be lower in a younger growing company. We see exactly the same will Ocado, who have only just started to make any profit at all. And, we hear, the swines are then sending profits back to the US. Is that a tax-dodge? Hardly! US corporation tax is a lot higher than in the UK.

    Is Starbucks a good business model? Dunno, but that is up to them.

    Quote:
    In a recent interview with the Evening Standard, Mark Fox, Starbucks’s new UK chief executive, said there was “nothing abnormal about the way Starbucks is run in the UK” and said what he found “abnormal is that we haven’t been making a profit”.

    But does it contribute materially to the tax revenue of the UK? Absolutely!

    But let’s go further. What if Starbucks were to make extra profit, by raising their prices, in order to pay more corporation tax. What would the implications be?

    First, their customers would effectively suffer a loss of income. Secondly, their sales would fall, impacting on VAT, staff and staff taxes, the value, and hence the tax-take from the rents they pay. And there would be a loss of business by those firms with which customers might otherwise have engaged. All small increments, of course, but the direction of travel is clear. And most important of all, it would not be the company which pays for the corporation tax, even if they write the cheque. The tax would be passed on to the drinkers, either in price increases or a reduction of product (shutting marginal outlets, say.)

    So let’s not hear any more nonsense about Starbucks tax status. And, if Hodge the Dodge can’t understand that, she should resign in favour of someone who does.”

  7. Social Justice Warrior wrote: “Some of the deductions included in Starbucks’ accounting loss are not allowable for corporation tax purposes.”

    In which case, they would be added back for corporation tax purposes. So if Starbucks are still not paying Corporation tax, then their accountancy losses are just worse. It doesn’t mean they should somehow, purely by virtue of these non-allowable expenses, be paying tax.

  8. Well, yeah, but given that the editor is Ian (Iain?) Martin they’re never going to pay me. Bit of argy bargy in the history there.

  9. @SJW

    So what you are saying is that your analysis proves that if a company does not claim deductions which are perfectly legitimate, it can end up in profit rather than loss? And owe tax?

    Excellent.

    Can you remind me what you tax qualifications and experience is?

    After the full tech HMIT training and 27 subsequent years in HMIT and private practice I’m finding this new approach to tax a bit confusing and do need some help.

    Thanks

    Remind

  10. Has Tim W ever replied to SJW’s blog on the Starbucks thing? I’ve seen that reposted in pretty much ever Starbucks thread on here, would be interesting to know what the response is.

  11. @SJW

    That’s not a comment I could possibly make or refute without seeing the actual tax return which often bears no resemblance to anything you see in the accounts.

    27 years’ experience has taught me that,

    I assume from your certainty that you have seen the tax return? No?

  12. I mean, yes the accounts say that depreciation was higher than CAs.

    But maybe Starbucks disclaimed CAs?

    As companies making losses often do.

    You know for sure they didn’t?

    You understand the mechanisms if they did?

    I don’t know if they did or not as I wouldn’t be able to tell from just looking at the accounts.

    I’m amazed you can.

  13. Frankly, I’m amazed at times that tax advisers earn any money at all as all you have to do is read a few newspaper articles and you are an expert.

    Can’t think of any other professions like it.

    No-one says they can remove an appendix after reading the Mail on Sunday colour supplement, do they?

  14. @SJW – I doubt Tim’s analysis is any more definitive than yours.

    Still gets us to the point where you don’t know what you are talking about. If Tim doesn’t either, doesn’t mean you do.

    I’ll wait for you to tell us your knowledge of taxation in general and Starbucks’ tax affairs in particular is based on stuff you read in the Sunday papers and something your mate down the pub told you.

  15. Without checking his sources, I can’t see why Paul is not right in principle.

    In this case, Tim is the one makiing the hypthetical assertion that, even without the deductions, tax would still not have been payable.

    And, simply on the face of it from the additional freely available info that Paul has highlighted, that looks to be wrong?

    Hence, there may well be other additional circumstances to take into account, but would Tim not need to know the details of those circumstances for him to continue to make that assertion?

    Nothing to do with the fact that tax wasn’t due (in reality), which is what actually matters, simply the new hypothetical situation Tim put forward?

  16. @SJW
    “I suggest you read the financial statement I linked to.”

    I suggest that from a tax perspective you don’t know how to read the financial statement you linked to.

  17. OK, interesting. This is not adding anything to the certainly, but, Companies House now have a beta service so you can go and look at several year’s accounts without paying.

    Very briefly, and I’ve not gone through lots of detail, but they have circa £40m of deferred tax assets at 2011 available (but not accounted for) and relating mainly to depreciation in excess of CAs, and various other interesting bits prior to that re losses.

    As Andrew says, impossible to know without detailed tax comps (and doesn’t change the fact that one might expect a hypothesis to be justified), but I’m not sure how one can say Tim’s assertion is wrong, standalone in 2011, no matter the add backs?

    ie, Paul, if you go through several years, and given the scale of their P&L numbers (they have circa £240m of cumulative accounting P&L losses by 2011, and yes all after various years’ of royalties charges etc), I can’t see how one can make any reasonable additional claim to what Tim asserted purely in terms of one year, if that makes sense?

    Hence, actually, I’m not sure how useful Tim’s assertion for a single year is in that context. Ie, “would they have paid more tax over the years with those add backs or not” might be hypothetically interesting (or not) but one year means nothing. Any sort of losses available for use in 2011, and as you have already alluded to Paul, renders any negation of Tim meaningless?

    Do we care? To quote the great man, they were “compliant”…:)

  18. If you look at note 3 to the accounts, you find depreciation of £14.9m and impairments of £6.6m. The tax reconciliation in note 7 shows the effect of depreciation in excess of allowances as being £4.4m, which at 27% implies an excess of £16.3m, so CAs claimed are at most £5.2m.

    This is a very low figure for a company with such extensive fixed assets, and bears out the suggestion that Starbucks have disclaimed a lot of allowances.

    If we then look at Note 8, the deferred tax asset has gone up by £5m. That would suggest (if it is all capital allowances) that depreciation exceeds CAs by £18.5m, which seems implausible. What with the £1.6 impact of short-term timing differences too, there must be some other stuff in there – probably share-based payments, possibly something else (pensions?). Share options have notoriously complex effects on the tax position.

    Overall there are two problems in trying to disentangle the tax position:

    1) The tax reconciliation gives little detail;
    2) As deferred tax is not provided, a lot of the impact one might expect to see there is lost.

    Going back to the main contention, however: how could one view this company as being a position of having taxable profits which have been illicitly reduced? With accounting losses of £33m, we need at least that figure in add-backs.

    There are three broad categories of adjustment:

    1) Mandatory adjustments: from the tax reconciliation we get a net £26m of add-backs from depreciation, non-deductible expenses, and STTDs.
    2) Claims for relief: it is clear that capital allowances are not being claimed, so there is an unknown adjustment downwards.
    3) Arbitrary adjustments: we can add back some of the interest and royalties (or indeed anything else we like).

    There can be no firm conclusion here; the best one can say though is that to get Starbucks into a position where there is taxable profit for the year (so, ignoring any losses brought forward etc) we need an arbitrary disallowance of royalties and interest which exceeds the disclaimed capital allowances by £7m or so.

    But if you take the extreme case, which is that all royalties and interest should be disallowed arbitrarily, then we would get Starbucks into profit if the disclaimed capital allowances are less than £20m or so. I really couldn’t say from the accounts whether they are or not: £20m would seem like a high writing-down allowance , but if the company has been disclaiming them for several years than it’s not entirely implausible.

  19. > I suggest you read the financial statement I linked to.

    Is this a financial statement you found hidden away in a top-secret location where HMRC couldn’t find it?

  20. Pellinor

    For info, they analysed their deferred tax asset of £15.1m in 2007 (they accounted for it before writing it off in 2008 – insufficient evidence that it would reverse in the foreseeable future – after both substantial fixed asset additions and an increase in trading losses in 2008), being £12.6m Depn > CA and £2.5m S/T timing diffs.

    A quick scroll through the accounts’ tax recs since then ‘suggests’ that, of that deferred tax asset not accounted for of £40.5m at 2011, over £30m could be Depn > CA, with S/T timing diffs and losses both making up the balance.

    And which is consistent with Note 8 (2011) that states that the deferred tax balance not recognised is “principally in relation to capital allowances and other short term timing differences”.

    The movement of £5.0m for 2011 would presumably include £1.9m losses in addition to the £4.4 Depn > CA less £1.6m other S/T (ie which might help it up to £4.7m)?

  21. PF,

    Thanks for that.

    So what is clear is that the company has been entitled to huge wodges of tax reliefs that it’s been unable to use, due to not making any profits.

    The question then is whether the royalties and interest, which constitute tax reliefs that it has used, should have been disallowed in order to force it to use the other reliefs up; and whether it ought to have paid tax if it did.

    But all this is just mucking about with numbers. It all comes down to whether royalties should be deductible or not. Nothing you can do with these numbers would get you to a taxpaying position unless you disallow a large part, if not all, of the royalties. Is anyone seriously suggesting that this would be arm’s length? Or, if you reject that principle, has anyone suggested a rationale for arbitrarily adjusting royalties to give a “better” UK tax position regardless of the recipient country and the global position?

  22. And in any case – rant mode engaged now 🙂 – all this stuff about here being other adjustments to be made to the accounting profits to get to tax profits. Yes, I know we make these adjustments each year. But there are two sorts of tax adjustment:

    1) Timing differences, that only affect when tax is paid rather than affecting the overall amount, and
    2) Permanent differences, which almost invariably increase the effective tax rate by denying relief for expenses economically incurred.

    By focusing on PCTCT rather than PBT for any given year, you’re either being picky by ignoring other years, or you’re arguing in favour of a concept I really don’t like about tax in general and UK tax in particular, which is that you should be taxed on income you haven’t earnt simply, well, because you can be. Timing differences I can understand, they’re just correcting UK GAAP to a GAAP HMRC would prefer. Permanent differences? Bin the lot, says I: they’re deliberately-introduced unfairness.

  23. PF, Pellinor: Thanks.

    Tim’s claim is that, adding back in royalties etc, Starbucks was still making a loss for corporation tax purposes. Looking at the year in question in isolation (which is what “was making a loss” implies) I think we’re agreeing that that’s not true.

    And yes, I agree that’s an artificial thing to do. I don’t know why Tim bothers repeating this claim.

  24. But all this is just mucking about with numbers. It all comes down to whether royalties should be deductible or not. Nothing you can do with these numbers would get you to a taxpaying position unless you disallow a large part, if not all, of the royalties. Is anyone seriously suggesting that this would be arm’s length?

    I personally wouldn’t, but you know what effect Richard’s fine oratory has on the baying masses…

    And, hence, this is just for a bit of amusement:

    This is the company that, in December 2012, offered £20m over two years as a goodwill gesture?

    I totted up royalties since 2003 and intra group interest payable (1 year LIBOR plus 4%) since 2004, when it appears that they both started being included in the accounts.

    Cumulative (to September 2012), royalties appear to be circa £203.8m and intra group interest payable circa £23.3m.

    Total £227.1m, which at 25% (their 2012 tax rate) is £56.8m. The deferred tax asset not booked at 2012 is £37.4m.

    Am I being creative……

  25. I think that if you add back royalties, Starbucks was still making an accounting loss.

    Whether it would be making a tax loss or not is unclear – it might, or it might not.

    If there are sufficient permanent differences to take it from loss to profit, then I think the big question is why the system taxes a company on profits it hasn’t made. Why isn’t Starbucks a poster boy for egregious imposition of tax? 😉

  26. “Am I being creative”

    I guess, logically, yes (I am being creative), unless they now never intend using those CA’s / other etc in the future (ie that make up the £37m), which I am not sure I can see happening?

    Oh well, it sort of amused me for 5 minutes…:)

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