The Week Explained: Tax Avoidance

PUBLISHED : Monday, 29 October, 2012, 12:00am
UPDATED : Monday, 29 October, 2012, 2:22am


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Those of us who assumed that there was something dubious about the world's most famous purveyor of milky hot drinks (it calls itself a coffee specialist) have discovered that there is also something dubious about Starbucks' tax arrangements.

Starbucks is under fire in Britain for paying no corporate tax in the past three years despite sales of £1.2 billion (HK$15 billion). Starbucks says it paid no tax because it made no money. Yet it has consistently told shareholders its British operations are profitable.

The "losses" stem from complex intra-company arrangements where very high charges are levied against earnings in the form of royalties and the parent company receives high loan repayment fees from the British operations.

It is not alleged it has engaged in tax avoidance, which is illegal, but that it has focused the efforts of its accountants on tax avoidance.

Donald Johnston, ex-head of economic watchdog OECD says tax avoidance is harder to identify, but draws a distinction between "unacceptable tax avoidance" and "acceptable tax planning". However, this is far from a precise definition.

Some people argue that paying taxes is a social responsibility - the price citizens pay to keep policemen on the streets, schools open, roads built and so on.

But the more extreme advocates of the free market believe that all taxation is theft, and contributes to excess government and controls.

Hong Kong is often cited as a paragon of tax virtue because it has a low and relatively simple tax system. This regime is simple for individual taxpayers who, unlike Americans, don't need to employ accountants to fill in their tax forms and ensure that they are compliant.

Yet the richer you are the more likely it is you will pay a smaller proportion of your income in tax. This is because there is no dividend or capital gains tax in Hong Kong.

Seriously rich people, who do indeed employ accountants to deal with their tax affairs, know how to manage the system. This also applies to many other people who own companies and arrange their affairs so that the bulk of their earnings comes from dividends.

Hong Kong seems the epitome of the declaration by the convicted tax cheat Leona "Queen of Mean" Helmsley who said, "only the little people pay taxes". Although the rich slide out of income tax liability, Hong Kong still generates some 60 per cent of its revenue from direct taxation. Much of the rest is from stamp duty on property and shareholding transactions.

Hong Kong is a poster boy for the anti-tax brigade but the system can cause distortions that can damage business. Because dividends are not taxed, many owners of listed companies divert profits into dividends. Because they are the majority shareholders they are the biggest beneficiaries of this, but it can also mean that companies are starved of investment resources.

Moreover the absence of capital gains tax encourages the kind of speculative activity that puts the property market out of reach for even middle-class people.

Property trading is a favourite pastime of both individuals and companies, not least because the profits are untaxed.

In response to the furore in Britain, Starbucks has said its tax payments are consistent with its value system: "balancing our need to operate a profitable business with a social conscience". But, then again, it also claims its drinks are synonymous with coffee.