by Alec Ross
These measures addressed the specific techniques used for a particular type of tax avoidance but did not solve the underlying problem. For every Double Irish with a Dutch Sandwich, there are dozens of equally tricky maneuvers that are known only to the lawyers and accountants who dream them up, as well as the companies that put them to use. The offshore world is like an iceberg, with the vast majority out of sight. Even right in Ireland, just as the Double Irish was phasing out, a replacement quietly entered stage left. When one Irish lawmaker, Matt Carthy, pointed out to the finance minister that revised legislation still left major loopholes wide open, he was told to “wear the green jersey.” That is, he should quiet down and do what’s best for Ireland. Ironically, that meant catering to the tax bills of US multinationals.
Without building a cohesive framework for taxing companies that operate across the globe, money will continue to flow to the jurisdictions with the lowest tax rates. Paul Monaghan, CEO of Fair Tax Mark, compares the existing system to a leaky dam. “The water’s spilling through the holes and … as [you] plug some holes, other holes appear,” he said. “As we close loopholes and create new legislation, other loopholes will open up.”
To see this leak in action, look no further than the iPhone.
For years, Apple saved billions on its tax bill through its own Irish arrangement. By the early 2010s, Apple had achieved what economist Brad Setser calls “the nirvana of global tax planning.” Its main Irish subsidiary was considered Irish for US tax purposes and American for Irish tax purposes—thus, it lived nowhere. Other offshore affiliates were so well disguised they did not need to file tax returns in any country. In 2014, the company paid a tax rate of roughly 0.005 percent on its global profits. This was not a Double Irish arrangement, but a close cousin that was later ruled to be an inappropriate sweetheart deal that Irish authorities had granted. Apple and Ireland won an appeal of that decision, but remain entangled in further litigation.
When a US Senate investigation shined a light on the company’s practices and European tax authorities prepared to crack down, Apple started looking for a way to reshuffle its tax structure. After reaching out to lawyers in six different low-tax jurisdictions, Apple decided to take its business to Jersey, a speck of land in the English Channel with a hundred thousand residents and zero taxes on corporate profits.
From the outside, Jersey does not seem like a place a major tech company would set up shop. The island is forty-six square miles of lush, hilly pasture bordered by some of the best beaches north of the Mediterranean. You can drive to the ocean from any point on the island in ten minutes or less. The fishing villages and resort towns that line its coast are home to more shopkeepers than coders. Prior to the 1980s, Jersey had the sleepy, self-reliant economy typical of a small island. But today, Jersey is among the world’s most popular tax havens.
In late 2014, Apple had two of its three “stateless” Irish subsidiaries claim tax residence in Jersey, and then a third Irish subsidiary claimed residence in Ireland. Around the time of this restructuring, nearly $270 billion of intangible assets suddenly appeared in Ireland. This influx of wealth—more than the value of all the residential property on the island—was so significant that it boosted Ireland’s GDP by 26 percent that year.
At the time, nobody was sure what had caused this economic spike. Eventually, tax experts recognized it as a sign that one of the world’s biggest companies had landed on the shores of the Emerald Isle.
Upon organizing its corporate structure, Apple had its Irish subsidiary borrow more than $200 billion from one of its Jersey affiliates, and then use the loan to buy the intellectual property owned by the other Jersey company. The Irish subsidiary was then able to deduct both the interest on the loan and the depreciation of the intellectual property from its taxes.
In effect, Apple lent itself money to buy its own intellectual property, and then generated billions of dollars in tax credits as the loan accumulated interest and the intellectual property became less valuable. Economist Brad Setser, who covered these issues at the White House and Treasury Department, told me it was a “classic paper transaction,” and it left Apple with an effective tax rate in Ireland that likely sits between 1 and 3 percent.
This new tax avoidance maneuver was one of the very loopholes that Irish lawmakers had quietly left open when reforming the Double Irish. Fittingly, the scheme has been dubbed the “Green Jersey,” and it is gaining popularity among companies that trade in intellectual property. It lets companies knock billions of dollars off their tax bills, just like the Double Irish, but now their profits and intellectual property never have to leave Europe. The Green Jersey does not rely on an Irish company based in a tax haven, the now-outlawed arrangement that underpinned the Double Irish. Instead, the Irish company is borrowing money and buying intellectual property from separate tax haven subsidiaries. The 2014 reform does not apply.
Like other tax avoidance strategies, the Green Jersey was not publicized by the companies that used it. It came to light only after journalists received a trove of leaked documents from a law firm that advised Apple on the restructuring.
Technology platforms like Apple and Google are not the only companies that engage in tax avoidance, but they do present especially difficult targets for tax collectors. There are a few reasons for this. For one, their products are ubiquitous. Unless the government blocks the site, you can become a customer of Google or Facebook or any other consumer internet company from anywhere in the world with an internet connection. When a company can operate in virtually every jurisdiction without a physical footprint, figuring out where to tax it is difficult.
At the same time, technology companies derive most of their revenue from intellectual property. Unlike corn, oil, and other commodities, intellectual property is often intangible. It is a creation of the mind—the patent, trademark, copyright, or other special sauce that differentiates your product from all the others. For Coca-Cola, it is the recipe for its signature soft drink. For Walt Disney, it is the copyrights for Mickey Mouse and Donald Duck. For tech companies, it is the code that makes their software tick. Intellectual property is incorporeal, easy to move from one country to another, and hard to pin down in terms of value. This makes it an ideal product for transfer pricing abuse.
By hiking up the licensing fees—in Google’s case, €16.1 billion for a single year—tech companies can shift huge amounts of profit to the offshore havens where their intellectual property legally resides.
Just how much does this intellectual property offshoring cost the world’s governments? Fair Tax Mark estimated that between 2010 and 2019, the big American technology platforms used transfer pricing and other strategies to collectively shave between $100 billion and $155 billion off their international tax bills.
Though the big tech companies get a lot of attention for their low tax bills, they are far from the only perpetrators of international tax avoidance. In large part, they are simply putting their own spin on the strategies that other multinationals have used for decades.
In 2017, the Institute on Taxation and Economic Policy found that nearly three-quarters of Fortune 500 companies operated at least one subsidiary in an offshore tax haven. At the time, 293 Fortune 500 firms used those subsidiaries to store more than $2.6 trillion in profits offshore. On average, those profits were taxed at only 6.1 percent. At the time, the US corporate tax rate was 35 percent.
Had the 293 companies brought those earnings back to the US before Congress changed the tax code in 2017, they would have owed the government a combined $752 billion. Even after the new tax law reduced the repatriation rate (the taxes companies pay when they move assets back to the US), the government would have received more than $200 billion in corporate tax revenue if that $2.6 trillion had come back to the States. And that is just from the Fortune 500.
This does not even begin to address the tax optimization strategies of companies headquartered throughout much of Africa, East Asia, and the Middle East. The reason we kn
ow about the Fortune 500’s tax maneuvers is that the US government requires a certain amount of transparency and disclosure from its publicly traded companies. The same thing happens in every other part of the world. We just do not have the view into their financial activity.
While American companies get much of the attention, some European multinationals have recently come under fire for their own aggressive tax practices. The European Commission launched an investigation into IKEA over allegations that the company had avoided €1 billion in Dutch taxes. Similarly, German journalists found that Volkswagen stashed billions of euros in Luxembourg-based subsidiaries to avoid paying taxes back home.
As of this writing, among the Fortune 500 firms, Apple had the most profit stored in tax havens, with about $246 billion scattered across its three offshore subsidiaries. However, US financial institutions were by far the tax havens’ most prolific customers.
America’s largest banks and investment banks operated more than two thousand offshore entities and held about $149 billion offshore. That is nearly as much as they received in government bailouts after the global financial crisis.
Like technology platforms, pharmaceutical companies derive most of their value from intellectual property, and their patents have a similar tendency to wind up in tax havens. The four largest pharmaceutical companies in the US—Abbott Laboratories, Johnson & Johnson, Merck, and Pfizer—held a combined $352 billion across their 443 tax haven subsidiaries. According to Oxfam International, the companies use their offshore structures to avoid more than $3.8 billion in global taxes every year, including $112 million in taxes to developing countries.
While bashing tech platforms, banks, and pharmaceuticals is very much in vogue, it is important to realize that the offshore world plays host to firms in virtually every sector. Even companies that are inextricably linked to the US and its national identity—brands like Coca-Cola, Nike, and General Motors—used offshore subsidiaries to avoid paying billions of dollars in taxes to the US government. But as with Google and its tax practices, none of these companies is breaking the law. The behavior may be objectionable, but it is still legal, so the only solution is to change the law. Period.
When they avoid paying taxes, multinationals not only avoid paying their fair share into government programs, but they also gain an unfair edge on small businesses. Hiring accountants, lawyers, and bankers to optimize your offshore tax structure is not cheap. Only the biggest companies can afford to do so, and those that cannot are left at a significant disadvantage.
If a local coffee roaster is forced to hand over 21 percent of its profit to the US government, while a globally tax-optimized competitor like Starbucks receives a $75 million tax rebate, the playing field is tilted at a 45-degree angle.
“It’s the big players that get rewarded on a fact that has nothing to do with productivity or entrepreneurship or real, genuine stuff,” said journalist and tax expert Nicholas Shaxson. “It’s just about transferring wealth offshore,” where even the most powerful nations can’t touch it.
THE RACE TO THE BOTTOM
But if nations are roundly hurt by tax abuse, then why does the web of tax havens still have so much influence? It siphons billions per year away from developed and developing countries alike, weakening their ability to serve their citizens and granting free passes to the world’s largest companies and wealthiest individuals. Yet even as the enormous costs have come to light, and even as regional powerhouses like the European Union have made serious efforts to plug major loopholes, the offshore system has suffered hardly a scratch. If anything, it continues to grow bigger and stronger.
To understand why, and to begin to approach solutions to the problem, we need to look at how the modern offshore system came to exist. Over the course of the last half century, tax havens have gone from peripheral actors to central hubs in the global economy. Many nations have tried to take a stand against them in one decade or another, but no efforts have made a lasting impact. And the constant slipperiness of the offshore world is best understood by two themes that keep recurring: a country becomes captured—or even simply influenced just enough—by outside interests. And it is then pulled into the global race to the bottom, where it competes against other nations to see who can offer the most enticing tax policies.
It has become increasingly difficult to find countries that are saintly actors. If you’re looking for a villain, it’s difficult to finger just the tax havens themselves or the corporate lobbyists or accountants. Two of the most prominent players in establishing the offshore world as we know it are major countries that are now losing billions to it every year: the United Kingdom and the United States. These would seem to be two of the few countries that would be powerful enough to start fixing the leak, and perhaps they still can do just that.
The starting gun for the global race to the bottom, if we are seeking its beginnings, was fired in London during the aftermath of World War II. Tax havens certainly existed before then; Switzerland, for instance, was a mecca for tax evasion from the late 19th century on. But, prior to the 1950s, tax havens largely catered to wealthy individuals and organized crime. They held plenty of money, but it was illicit money—which limited these countries’ global economic power. That is, until the City of London helped tax havens go mainstream.
A common theme among tax havens is that they rarely choose to become havens. They tend to make the shift at the behest of a powerful outsider. And while the City of London might not sound in the slightest like an outside interest, it’s worth making a clear distinction. The City of London should not be confused with London, the city.
London is the capital of the United Kingdom, and the City of London is a square-mile district inside the capital that houses much of the country’s financial industry. And it is something else entirely.
The City of London has a peculiar history, tracing its roots to the Roman Empire. It has been a powerful force in British politics since the Normans invaded the island in the 11th century. And as the United Kingdom grew up around it, the City of London used its financial clout to maintain a degree of autonomy from the rest of the country. It elects its own government (the City of London Corporation), maintains its own police force, and remains exempt from certain laws of the UK Parliament.
In addition to the geographic area, “the City” is also used as a shorthand for the UK financial industry, similar to “Wall Street” in the United States. Not all British banks fall within the City of London’s geographic limits, but the City and its officials act as the banks’ chief representatives in the UK and abroad.
The official responsibility of the City’s top executive—the Right Honorable Lord Mayor—is to serve as “an international ambassador for the UK’s financial and professional services sector.” The Lord Mayor is also the president of the leadership council of TheCityUK, an industry group established in 2010 to “champion and support the success” of the British financial sector. The organization, which represents dozens of global financial services firms, acts as a “fusion of the City of London Corporation and the private financial sector,” according to Nicholas Shaxson.
Reuters called TheCityUK “Britain’s most powerful financial lobby group.” The organization proudly displays the assertion on its website.
The City of London Corporation also appoints an official called the Remembrancer to serve as a lobbyist in the House of Commons—he has a special seat across from the Speaker. Members who raise questions about financial services and other matters related to the City can expect a call from the Remembrancer within hours. It’s also important to note that the businesses residing in the City have a hand in electing its local government, the City of London Corporation. In municipal elections, the City’s eight thousand human residents each get a single vote, but the businesses that reside there get thirty-two thousand votes. That means international banks like Barclays, JP Morgan Chase, Central Bank of China, Bank Sepah International, and Moscow Narodny Bank can directly participate in one of the U
K’s most important local elections.
Though the City has assimilated into the greater UK in many respects, its loyalties reside with the financial industry. Given its constituents, the City is perhaps the most powerful special interest organization in the UK, if not the world. Shaxson calls it a lobbying organization “so deeply embedded in the fabric of the British nation-state that it has made it very hard for Britain … to confront or even seriously check the power of finance.”
This is partly a result of the City’s aggressive lobbying efforts. John Christensen, director of the Tax Justice Network, said that when compared to TheCityUK, the US National Rifle Association “seems quite shy and timid.” The City’s sway over British politics also stems from its importance to the national economy.
“Most [members of Parliament] … think that the City of London is the goose that lays the golden egg,” Christensen said. “It’s a sector that generates … the most wealth in the UK economy, and if we were to take action against it, our economy would tank because it’s that weak. It’s the sense that there is no option other than to continue to kowtow to financial services. It’s almost complete state capture.”
This influence extends beyond domestic politics as well.
“On the list of things most important to the United Kingdom in its relationship with the European Union—number one on the government’s list, I suspect—was to protect the City of London,” said Jonathan Luff, a former top aide to UK prime minister David Cameron. “At the top of the list of any British prime minister, any chancellor of the exchequer, any diplomat representing the United Kingdom in Brussels, would have been ‘how is this going to affect the British financial services industry?’”