Taxing Authorities’ Internet Cat-and-Mouse Game

The fact that the Internet has no boundaries of time or geography has changed the way businesses operate forever. One feature of the Internet is that it has allowed creative businesses to avoid, or at least minimize their tax liabilities.

In particular, Google’s business success means that it has to manage its operations if it wants to minimize its tax burden.

How to Manage Tax Obligations

Most readers will be surprised to learn that when the Internal Revenue Code was first considered by the U.S. Supreme Court, Justice Louis Brandeis wrote that it is the duty of each taxpayer to figure out how to pay the least amount of taxes. Fast-forward to today: Doesn’t it make sense that all Internet businesses would do everything possible to reduce their tax liabilities?

Google conducts business in Ireland because the corporate tax rate is 12.5 percent, which is much lower than the rest of the EU, The New York Times reported. Also to reduce Google’s tax bill even more, it makes royalty payments to a unit in Bermuda.

In the meantime, Google reported to the SEC that it generated US$4 billion in sales in Britain in 2011, but reported only $629 million in official filings in Britain. The reason for the reduced sales revenue is that Google reported most of the sales revenue in Ireland, given the lower tax rate.

Then, to reduce profits, the British business unit billed Google Ireland for promotional work, consulting and other activities. Ultimately, Google declared a profit of $49 million in Britain, resulting in a British tax bill of only $9 million.

“We pay the tax we are required to pay in every country in which we operate,” Matt Brittin, Google’s vice president for north and central Europe, told a UK parliamentary panel.

Google was probably complying with the law, acknowledged Margaret Hodge, chairperson of the UK public accounts committee. We “are not accusing you of being illegal, we are accusing you of being immoral,” she told Google.

Most of the economic value it creates is generated in Silicon Valley, where its engineers toil away at the computer algorithms behind its search engine and other services, Google said. So it is fair that most of what it pays in taxes goes to the U.S. Treasury, not its foreign counterparts.

France, Germany Considering Google Tax on Searches

French President Francois Hollande is exploring a tax on Google and other search engines each time they use French media content. Google has threatened to exclude French media websites from search results to avoid paying this new tax. Apparently, the goal of the new tax would be to “reward French media content.” Yahoo also noted that Germany is considering a similar tax or fee. How taxing Google and others for showing French media in results helps French media, may be confusing. Perhaps over time we will learn more about that.

Legally, any such tax plan, to the extent it taxes searches, is not so simple. Each user on Google agrees to the terms of service and privacy policy that control the use of the information search and privacy. So the contract is entered between Google and the user, and the local governments are not a party to those contractual terms unless some valid local law so prescribes.

What legal right does a government have to require any search engine to report search results where no money changes hands between Google and the user? In plain English, there does not appear to be a taxable event, so what tax law could apply to obligate Google to pay a search tax?

Where’s the Taxable Event?

As I have written about Internet taxes in the past, one always has to evaluate exactly where the taxable event took place. Of course determining where a taxable event occurs is not always so easy. For example, when it comes to goods or services, does the taxable event take place where I place an order to buy goods or services on the Internet?

And what is the deciding factor — the location of the Internet business, the server, or the warehouse from which the goods were shipped?

The test from the old catalog world was whether the mail-order business was located in the same state as the purchaser. This test apparently does not work well in the Internet business world.

For example, while at my computer in Texas, I bought a sport coat from Jos. A. Bank, which is in Maryland, where I assume the servers are located. However, the sport coat was shipped from California, and I paid a sales tax since Jos. A. Bank has retail outlets in Texas.

On the other hand, when I bought running shoes from Eastbay in Wisconsin I did not pay any sales taxes since Eastbay is located in Wisconsin, where I assume the servers are located and where the goods shipped from. Eastbay has no retail or any other operations in Texas, so I paid no Texas sales tax.

As governments seek more tax revenue and Internet businesses work hard to avoid paying these taxes we will see more and more efforts to tax transactions, whether on usage or on actual purchases. Stay tuned.