This election has ratcheted up the calls for Starbucks and other multinationals to pay more taxes on their British revenues.  Politicians give no indication of how they will achieve that; one suspects their silence is based on ignorance.

This blog is a brief explanation of why multinationals are fully entitled, under present laws, to push profits into lower tax regimes.  If the UK wants to change, it may need multinational legislation.

If a brand owner in one country sells to a distributor in another, they split the total profit between them.  If the companies are independent, the presumption is that the split is “arm’s length” and that is accepted by the tax authorities in both countries.  The game gets tricky when both companies are owned by the same group and the brand ownership is switched from one country to another.

The practice began with Bailey’s Irish Cream which was launched in 1972 to accept the Irish Finance Minister’s offer that any export profits for a new Irish agriculture-based brand would be free of tax for 10 years.  The brand became a huge global success and, come 1982, the ultimate brand owner, Grand Metropolitan, was about to be hit by a sharp jump in taxes.

By coincidence, the concept of “brand equity” as a marketing asset which could go on a balance sheet was also being developed in the 1980s.  Why not move the brand equity from Dublin to the Netherlands which was, then anyway, offering low taxes on Dutch earnings by foreign-owned assets? Why not indeed?

As you can imagine, the British and Irish tax authorities were less that thrilled with that and Grand Metropolitan had to justify that the Netherlands company really was marketing the brand globally.  In effect, the distributor company is renting the use of the brand equity asset from the brand owner and has to pay for that.  If the transfer price is “arm’s length” it is all perfectly legitimate so, for two companies both parts of the same group, what exactly is “arm’s length”?

The multinational can count on the support of the tax authorities in the brand owning country.  Their take decreases by the amount of profits switched to the distributor (or franchisee) country.  And if the brand owning company can show it sells, on the same terms, to (or franchises) companies which are not part of the same group, the case for “arm’s length” is strengthened.

HMRC has spent a huge amount of time and money on this issue.  Whilst it is possible they have not been tough enough, it is much more likely that the law is not on their side.  It is also likely that any unilateral action by the British government would lead to even more expensive legal costs on appeal.

With corporation tax down to 20% the UK is closing the low tax gap, but unless politicians can show they understand the game, and come up with a credible big stick, HMRC is going to have to settle for goodwill payments by the multinationals.

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