Watching the Starbucks performance before the Public Accounts Committee (PAC) posed for me a large number of questions about the arms length principle, which I still think is the best method for apportioning taxing rights between countries. To be valid it has to be based on two independent parties acting at arms length and rooted in commercial reality.
Starbucks has allegedly not made taxable profits in most of its 15 years of operations in the UK. In the real world companies can sustain start up losses for a period of time (say 3 to 5 years) but after that one has to question whether they would perservere trading at a loss, or cut their losses? It is questionsable whether a subsidiary which continues loss making beyond start up is operating at arms length as non connected parties do and it would certainly pose questions about its transfer pricing. Advisers I have spoken to use the 3 to 5 year startup time horizon as a sense check on the impact of pricing on profitability.
Starbucks has franchises in the UK. Do they operate at a taxable and commercial loss? If they don’t this calls into question elements of the transfer pricing used.
In its Investor seminars Starbucks in March and May 2012, CFO Troy Alstead talked about “difficult retail conditions have pressured EMEA comps”, but he also showed a Year 1 reurn on investment (cash profit/investment) of 24% for the region. Arms length parties often renegotiate prices in “difficult conditions”. There are no figures on tax in either of his presentations.
The specific issues which emerged at the PAC were the pricing of a royalty, the pricing of coffee and financing. While the pricing of the intangibles for the other businesses before the PAC is more complex, understanding the pricing of coffee and finance is more straightforward.
A number of businesses and business organisations in the UK have called into question whether the impact of transfer pricing on tax payments by inbound investors poses a competition issue? If domestic businesses pay tax on corporate profits but a multinational can structure to avoid that tax, is that the intention of the arms length principle – it seems unlikely. If a domestic company makes a taxable profit in the same business as an inbound who doesn’t make a taxable profit, is the inbound operating at arms length?
What does Starbucks do within the US? Does it make the same charges for coffee roasting and coffee that it does to its international businesses? Does it charge the same royalty for design etc as it does to its international businesses? Some may think this isn’t relevant because the transactions are all within the US, this is true at federal level but not in the calculation of state income taxes.
Finally, in the face of feedback from the PAC hearings, it is reported Starbucks has decided to pay tax in the UK for the next couple of years by not claiming a deduction for the royalty payment, or coffee and by waiving its right to claim capital allowances or brought forward tax losses. While waiving capital allowances is fine, should the other actions be treated as under the arms length standard? If expenses are not deductible in 2012 and 2013, are they tax deductible in other years past or future? Can a company or group decide how much tax it should pay? Is this decision going to be replicated in other EMEA countries?
Have Starbucks (and their advisers) “pushed the envelope” and the arms length standard too far?