Saturday, January 7, 2017

Ikea Transfer Pricing: The EU Green Party v. Tim Worstall

I may be late to the party but I started researching Ikea’s European transfer pricing after Ikea lost a Norwegian Supreme Court decision regarding intercompany interest deduction case. Tim Worstall attacked the EU Green Party for the Green Party’s claims that Ikea has been doing some old fashion income shifting. The title is a bit rough:
The Green Party Doesn't Grasp EU Tax Laws Concerning IKEA
Look – I’ll admit that the Green Party often says any transfer pricing that moves income from a high tax jurisdiction to a low tax jurisdiction is per se transfer pricing manipulation even before they have thought about what the appropriate transfer pricing should be. But as I recount Worstall’s account, it should be clear that he certainly is not proving that Ikea’s transfer pricing policies are consistent with the arm’s length standard:
Here's how bad their assumptions are. They're complaining about the non-taxation of royalties and interest flowing from one EU based company to another. And yet EU Single Market law specifically states that it is illegal for anyone to try to tax royalties and interest flowing from one EU company to another.
Worstall starts off by assuming that these intercompany payments are per se arm’s length, which is a bit premature. To be fair, Worstall does continue with this:
Here's the gist of the complaint. At the top of Ikea there're two tax free foundations. Tax free foundations do not, as the name implies, pay tax. One owns the operation of the stores and network, the other owns the trademark. The one that owns the trademark charges 3% to the other for the use. Those royalties flow around Europe and then into that tax free foundation. Much the same happens with interest payments on the fee that was paid to buy that trademark. And that's pretty much it, there's no more real complexity than this….Which is that we do have transfer pricing laws, laws to make sure that people don't just strip every amount of profit out of a country and stick it where there's no tax to pay. And those transfer pricing rules insist that inter-company transactions must be made at arms length prices. That is, related companies must charge each other an amount of money at least comparable to what they would charge an entirely independent company.
But there are two serious problems with this 3% trademark royalty. One is simply that the tax foundation was not likely the entity that created the trademark value in the first place. Did the tax foundation pay fair market value for any transferred intangibles? Worstall does not even address this. And how would one justify a 3% royalty rate as opposed to only 1%. Worstall’s defense is:
And 3% is actually fairly low by the standards of these things. Starbucks, an unrelated EU investigation found, charges itself 4% and this is considered just fine.
Actually Starbucks charges 3rd parties 6% royalty rates for its entire suit of intangible assets. To presume that this 3rd party royalty rate is a comparable for the Ikea name is beyond absurd. Here is a hint for multinationals that must defend their intercompany pricing – do not hire Worstall as this defense is beyond clueless. While Worstall does not address the intercompany interest rate issue, my understanding is that no one is questioning whether the interest rates are arm’s length but they are questioning whether another affiliate is actually receiving intercompany interest income. It is precisely this kind of debt versus equity hybrid mismatches that the OECD’s Action Plan 2 on Base Erosion and Profit Shifting addresses. May I suggest Mr. Worstall read this document before writing such an utterly embarrassing blog post. Update: While Worstall’s link to the EU report - this should work. Page 23 describes “the notional interest deduction in Belgium”:
Belgium belongs to the list of European countries having a strong tradition of treasury locations (together with Luxembourg, Ireland and Switzerland). The Notional Interest Deduction regime has been conceived as a replacement for the coordination centre measure, deemed illegal according to European competition law by the European Commission in 2003. This new measure, entered into force in 2007, allows Belgian subsidiaries of multinational companies to offset income derived from providing loans or services to affiliated companies around the world, while those affiliates can deduct the expense of these loans or services from their taxable income in their respective countries. This is a classic way for big companies to shift profits to low or no tax jurisdictions at minimal cost. And in cases where the source country imposes withholding tax on interest payments to Belgium, the Belgian entity can generally offset that expense with a foreign tax credit.
Page 21 notes how this works in Luxembourg:
PwC proposed, and Luxembourg accepted, an arrangement which guaranteed that an Inter IKEA Group subsidiary (now called Inter Finance SA) domiciled in Luxembourg would pay almost no tax on an estimated €6 billion in loans funded by subsidiaries in Curacao and Cyprus and funnelled to affiliates through a newly established Swiss branch of Inter Finance SA. In 2014, Inter Finance SA posted a profit of €13.6 million, and paid tax at an effective rate of just 2.4%, as compared with the Luxembourg statutory rate of 29.2%.
But enough about the intercompany loans – what about those trademark royalties? Table 3 on page 16 shows selected income statement information for a few European affiliates such as France. After paying its 3% intercompany royalty, the French profits were only 1.65% of sales. In other words, the trademark royalty captured almost 65% of consolidated profits in France. I’m sorry but that sounds a bit excessive to me.


Tim Worstall said...

That Belgian law has been found to be state aid by the EU Commission already and needs to be reversed. I've covered that before.

Re the 4% Starbucks. HMRC had a look at what Starbucks was charging itself and demurred at that 6% number. Insisted it be reduced to the 4%, which is where that number comes from.

Thus a 3% Ikea royalty rate just doesn't look that far out of line at all.

ProGrowthLiberal said...

Tim - two points here. The 4% is a negotiated settlement with a tax authority. A poor choice for a measure of market rates. Rather it is the 6% rate Starbucks charges independent entities. This is basic transfer pricing.

Also basic transfer pricing - Starbucks is an entirely different business than Ikea with a higher profit potential. So even to even consider the Starbucks entire suite of intangibles as a comparable to the tradename for Ikea is another poor choice for evaluating that the 3% is consistent with arm's length.

Maybe I was not as explicit as I should have been. But your attempt to justify the 3% as arm's length falls horribly short.

Unknown said...

At its base, is this not just another example of why it is vain to tax the income of "businesses?" Income (or better still, consumption) of owners should be taxed. Of course this does not mean that all sorts of rules would not be needed to prevent income to owners from being disguised as expenses.

Owen Paine said...

Pgl really ought to stick to this beat

Here he has a fairly useful grasp of the game

I note
He asks a key question
What did the tax exempt foundation pay for the trade mark

3% of revenue is itself hardly generalizable

Value added varies hugely from firm and industry to firm and industry

Operating net margins vary similarly

Starbucks is not owned by a foundation and it's franchisees
Qualify as " arms length " only because that term of art here
Operates like a hugely elastic O ring

A nation state that does not tacitly conduct a full out cold . War on MNCs
Faces defeat
The courts are a class against class " corporate tilted " battlefield
not halls of justice

Take administrative action

Learn from the abject failure of the Greek electoral left

Make macro navigation independent of MNC actions

Unknowns rational surrender
to the enemy of society aka multi national limited liability corporations
Is understandable
Guys like pgl are chasing a rhino with a nose clipper
Quixotic would be too generous a characterization

Owen Paine said...

Say we start with a "Trade mark " donation to this tax empt outfit

probably created a tax deductible event for the donor entity

Here is an admittedly very specious basis for valuing the trade mark
But a start at any rate

These appraisal events are great fun for clever elves

Once again we see the futility of tax chasers
Yes it's a class struggle front
But not a very promising one long term
Even victories are temporary
Much like regulation.
But with far less short run clout

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Calgacus said...

Learn from the abject failure of the Greek electoral left.

There is an important lesson to learn there, but it is simpler. Do not snatch defeat out of the jaws of victory. Tsipras & Syriza had won. They had the Greek people solidly behind them. Their strategy succeeded, with the best possible outcome - a negotiated Grexit. The "enemy" (who really wasn't an enemy) having shot its wad, was surrendering.

Tsipras, overcome by mindless despair at the prospect of having to behave like a responsible adult, rejected victory and ended up signing an infantilizing plan that was worse than the ones that Schauble, misguided but honest and thus maligned, had told Varoufakis after offering them, that he would not accept if he were in Varoufakis's shoes.

As Bobby Fischer said: "You don't win games by resigning."