Starbucks And Tax

The most recent company to attract unfavourable scrutiny of its UK tax profile is Starbucks.

The revelation came courtesy of Reuters, which revealed that despite £3 billion worth of sales in the UK over the last 14 years, Starbucks has paid only £8.6 million in tax.  Further, in the last three years, Starbucks had sales totalling £1.2 billion but reported no profit and paid no corporation tax at all.  How is this possible?

In Starbucks' case, the significant difference between sales and taxable profits arose because a number of payments were made by Starbucks UK to other Starbucks companies located in various countries outside the UK, which completely eliminated any profits.  These payments work in three ways:

1. Starbucks UK pays royalties to another Starbucks company in the Netherlands for the use of its intellectual property, such as the brand and its business processes;
2. payments were also made to a Swiss company for the purchase of coffee beans; and
3. The UK operations are funded by high cost debt, which results in significant payments of interest being made to other group companies.

Starbucks has not broken the law in making these payments, and in fact, inter-company payments of this type are not unusual within multi-national groups.  However, to avoid paying tax in the UK the payments must be tax deductible, which requires the payments to be calculated on a commercial basis, applying a commercial rate which is similar to that which it would pay to an unconnected third party. 

Questions have been raised on the level of these payments – with a suggestion by some commentators that the payments may exceed what might be considered "reasonable" in the circumstances.

The suggestion of excessive inter-company charges was raised particularly in relation to the royalty payments for the use of the intellectual property.  According to Reuters, Starbucks UK paid an amount equal to 6% of the total sales made in the UK in royalties and licence fees for the right to use the Starbucks brand in the UK.    This level of royalty payments does appear somewhat steep, especially given Reuters understanding that McDonalds charges its UK operations a significantly lower rate of royalties (4% – 5%) for the use of its brand.

Questions have also been raised as to the level of interest paid on the inter-company debt – with Reuters reporting that Starbucks UK pays interest at LIBOR plus 4 percentage points, with both KFC (LIBOR plus 2 percentage points) and McDonalds (LIBOR or below LIBOR) charging significantly less interest on their inter-company debt.

Ultimately, the reasonableness of the inter-company payments is a question for the UK tax authorities, and it would appear they are satisfied that the inter-company charges have been made on a commercial basis.

This current debate may force a review of the way in which multi-nationals are subject to tax.  There is a perception that it is too easy for a multi-national to structure its operations to avoid paying tax in high tax jurisdictions, by shifting its income to low tax countries through the use of inter-company charges – such as the inter-company charges used by Starbucks.  A change in the way multi nationals are taxed may be achieved by aligning tax payments with economic activity – perhaps applying a formulaic approach to allocate income to the countries where they do business.  Such an approach will require the agreement of a number of countries, and is unlikely to happen in the immediate future.

In the meantime, it will be left to the individual tax authorities to ensure that multi-nationals pay their "fair amount" of tax in each country – perhaps spurred on by the outrage of the press and the politicians.

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