The Raging 2020s

by Alec Ross

  This is essentially how multinational firms abuse transfer pricing. They make payments from one subsidiary to another to shift their profits toward countries with low tax rates and raise their costs in countries with high tax rates. The difference is that multinationals have the accountants, lawyers, and international footprints to build paper trails that span oceans, and you can only draft invoices across town. If you are a pizza delivery driver, the offshore world is out of your reach.

  With that in mind, we will go back to Google.

  THE DOUBLE IRISH WITH A DUTCH SANDWICH

  Between 2004 and 2019, Google used a pair of profit-shifting maneuvers—the “Double Irish” and “Dutch Sandwich”—to move the vast majority of its global earnings into Bermuda. Different versions of the Double Irish were also used by Facebook, Pfizer, Coca-Cola, Cisco, and other American multinationals. The maneuver follows the same basic logic as your pizza delivery scheme: raise costs in high-tax jurisdictions and move profits to low-tax jurisdictions. However, instead of a car lease, Google used licenses for its own intellectual property. Its Bermuda-based division was given ownership of Google’s search algorithms and essential technology, and other divisions of the company had to lease out the intellectual property.

  Google was forced to abandon this specific practice in 2020, after Ireland closed one of the necessary tax loopholes, but for fifteen years it used the Double Irish with a Dutch Sandwich to reduce its tax bill by tens of billions of dollars. In 2016 alone, the arrangement helped Google keep an estimated $3.7 billion away from European tax authorities.

  We will say Marco bought his belt in the summer of 2018, while Google was still using the setup. This is how it would have worked.

  When Marco (and the thirty-five people who did not make a purchase) clicked on the ad for the Italian leather belt, the Ascani family was charged €3.96 by a Google subsidiary called Google Ireland Limited. Created in 2003, this Irish company acts as the hub of Google’s ad business across Europe, Africa, and the Middle East.

  Google maintains corporate offices in dozens of countries including Italy, but the company argues these outposts are not full-fledged businesses but rather satellites of its European headquarters in Dublin. This semantic maneuver helps the company justify funneling revenue to its Irish subsidiary, where Google can take advantage of Ireland’s comparatively lax tax structure.

  Ireland’s low tax rates and permissive corporate laws have made it something of a mecca for American technology companies looking to expand their presence across the Atlantic. Google’s glassy European headquarters (where Google Ireland Limited is based) ranks among the tallest buildings in Dublin, towering over the city’s Grand Canal. The surrounding neighborhood, a former industrial yard turned tech-bro hot spot, is also home to the European headquarters of Twitter, Facebook, LinkedIn, and Airbnb. Apple set up shop in Cork, where it is the city’s largest private employer. According to the most recent data, American companies booked more revenue in Ireland than in the sixteen largest European countries, combined.

  Had the transaction between Google and the Ascani family taken place in Italy, the profit it generated would have been subject to the country’s 24 percent corporate tax rate. Instead, Google immediately shifted the revenue to Ireland, where the corporate tax rate is only 12.5 percent.

  That does not mean Google pays no tax in Italy—the company’s total tax bill is just much lower than it would be otherwise. In 2018, Google’s Italian subsidiary—Google Italy s.r.l.—brought in €107 million in revenue, recorded €15.4 million in pretax profit, and paid €4.7 million in taxes to the Italian government. The catch is that almost all of that revenue came from “sales and services” in Ireland, not Italy. In other words, Google’s Italian subsidiary makes almost all its money by helping Google’s Irish subsidiary sell ads in Italy, not by selling the ads itself. Again, this is an instance of transfer pricing.

  By shifting the €3.96 in ad revenue from Italy to Ireland, Google effectively cut its tax rate in half. If the buck stopped there, Google Ireland Limited would have deducted its expenses, paid the Irish government its 12.5 percent corporate tax, and called it a day. But the journey is far from over—Google does not pay anything close to the Irish rate either.

  Technically, Google Ireland Limited makes its money by using the technologies and services developed by Alphabet Inc., the parent company of Google and its dozens of subsidiaries. Alphabet owns the intellectual property for software that powers Google Ads, Google Search, Google Maps, and other technologies. In order to use that software, subsidiaries must obtain the right to use that intellectual property.

  But Google Ireland Limited does not lease the right to use this intellectual property directly from Alphabet. Instead, it obtains the license through another subsidiary, called Google Netherlands Holdings B.V.

  In 2018, Google Ireland Limited generated about €38.1 billion in total revenue. The company logged €1.4 billion as profit and paid €272 million in taxes to the Irish government.

  The company claimed that the other €36.4 billion got eaten up by operating costs, which are not subject to taxes in most jurisdictions. That included the usual expenses like employee salaries and office rent, but it also included a €16.1 billion royalty payment to Google Netherlands Holdings B.V. You read that correctly: Google used more than 40 percent of its earnings in Europe, Africa, and the Middle East to buy the rights to use its own software.

  This Dutch subsidiary does not actually own this software either, but rather leases it from another Google subsidiary. It is a shell company in the purest sense, a conduit for distributing intellectual property licenses and transporting the profits they generate around the globe. In 2018, Google Netherlands Holdings B.V. did not employ a single person, yet it received a multibillion-dollar royalty fee from the Irish subsidiary in exchange for a software license.

  But Google Netherlands Holdings B.V. then needed to pay for its own software license. Where did it receive that license? Another Alphabet subsidiary called Google Ireland Holdings. This company is officially incorporated in Dublin, at an address just a short walk along the canal from Google Ireland Limited. But thanks to a loophole in Irish tax law, the company is not required to be managed in Ireland. In this case, it legally operates out of Bermuda.

  Here we have another game of semantics: the company is “incorporated” in Ireland, where it benefits from the European Union’s trade policies, but it is “domiciled” in Bermuda, where the corporate tax rate is 0 percent.

  In 2018, Google Netherlands Holdings B.V. paid this Irish-incorporated, Bermuda-based holding company a €21.8 billion royalty fee for the right to use its software. This entire sum came from the Dutch company’s own royalty fees—the €16.1 billion from Google Ireland Limited and another €5.7 billion from Google Asia Pacific Pte. Ltd., a Singapore-based entity with which it has a similar arrangement.

  The Netherlands did not tax royalty payments at the time, so those billions were routed from Ireland and Singapore to the Netherlands and then back to Ireland (but actually Bermuda) without losing a penny to taxes. From Ireland to the Netherlands to Ireland—a Double Irish with a Dutch Sandwich.

  Like its Dutch counterpart, Google Ireland Holdings (which is domiciled in Bermuda) does not employ a single person. The company shares its registered address—70 Sir John Rogerson’s Quay, Dublin 2—with nearly a thousand other businesses. Yet in 2018, Google Ireland Holdings took in more than $25.7 billion (€22.4 billion) in revenue and recorded profits of more than $15.5 billion (€13.5 billion). Of the remaining $10.2 billion, nearly 95 percent was spent on Google’s own R&D and the rest went to cover other costs.

  Because the company is technically based in Bermuda, it paid no taxes to either the Irish government or the Bermudan government.

  Google Ireland Holdings is where the buck finally stopped. Through an agreement with Alphabet, the company held the rights to license all of Google’s intellectual property outside the United States. And while on paper
it “generated” billions of dollars in annual revenue, the company’s only physical presence on the island of Bermuda was a post office box in a nondescript four-story office building in the capital city of Hamilton. The number of the PO Box is 666.

  To summarize:

  Marco clicked on the Google ad for Pelletteria Artigianale Firenze della Famiglia Ascani, and he bought one of the company’s belts. Thirty-five other people clicked the same ad but did not buy the belt. Each of those thirty-six clicks cost the Ascani family about €0.11, for a total bill of €3.96. For the sale of Marco’s belt, the Italian government also received €8.80 in sales tax paid by the Ascani family. Italy would have collected that tax regardless of whether the sale took place online or in person.

  Google Ireland Limited received €3.96 from the Ascani family. From there, the company spent €3.78 on what was classified as operating expenses, kept €0.15 in profits, and paid roughly €0.03 in Irish taxes. The Italian government received no taxes from this transaction, which involved an Italian citizen and an Italian business and took place entirely within the borders of Italy.

  Of the €3.78 that Google Ireland Limited spent on operating expenses, €1.67 was wrapped up in a royalty payment to Google Netherlands Holdings B.V. and €2.11 went to other costs.

  Google Netherlands Holdings B.V. took that €1.67 and funneled virtually all of it to Google Ireland Holdings, withholding only a tenth of a penny to cover its own costs. The Dutch subsidiary paid about €0.0003 in taxes.

  Finally, Google Ireland Holdings, an ostensibly Irish company with a PO Box in Bermuda, received the €1.67. From there, about €1.01 was recorded as profit and the rest was mostly used to fund Google’s own research. Google Ireland Holdings paid no taxes.

  In total, of the €3.96 that Google received from the Ascani family, only €0.0284 was paid in taxes. That is an effective tax rate of roughly 0.7 percent. Instead of going to Italy, where the transaction occurred, that paltry sum was split between Ireland and the Netherlands. Keep in mind that Italy’s corporate tax rate is 24 percent, Ireland’s is 12.5 percent, and the Netherlands’ is 25 percent. Yet—like magic, and with the help of Bermuda—Google found its way to 0.7 percent.

  THE COST OF TAX AVOIDANCE

  When companies get to pick and choose among the laws of hundreds of jurisdictions, their money will flow to wherever it is offered the most tax breaks. This is a choice that the pizza delivery driver does not get to make. As convoluted as it sounds, the financial wizardry employed by Google and other multinational companies is not overtly against the law. Such tax avoidance contrasts with tax evasion, where wealthy individuals hide money that is due by law as tax—though both make use of the same tax havens and follow the same labyrinthine process of disguising money flows, relying on bank secrecy to avoid detection and turn profits.

  The technical legality of tax avoidance is used by many business leaders to justify their strategies. Eric Schmidt, CEO of Google at the time it adopted the Double Irish, pointed out that it was commonplace among major companies to use such techniques. “We were following the global tax regime in the same sense that European companies follow the things that benefit them when they operate in the U.S.”

  In a later interview, he noted that of course “businesses will respond to the tax stimulus made available to them.” He has a clear point. He’s not wrong. If countries are putting money on the table, why should a company just leave it there? “Europe did this to itself,” Schmidt stated, noting that the Europeans themselves created the “race to the bottom” tax treatment for a then-struggling Ireland to stimulate investment there. “The global tax system is incredibly complicated, and we are required to follow the tax rules,” he continued. “When the tax rules change, of course we would adopt them. But there was a presumption that somehow we were doing something wrong here.”

  Schmidt is correct. For whatever finger wagging may be directed against him and Google, the culpability rests principally with the countries that enable these activities by making them legal in the first place in the race to the bottom.

  Still, just because something is legal does not make it right. “Where there is an income tax, the just man will pay more and the unjust less on the same amount of income,” Plato wrote more than two thousand years ago. An argument rooted in moral philosophy is difficult to make successfully in a world of shareholder capitalism, though. Harm has to be demonstrated to win the moral argument, which Columbia University Law School professor Tim Wu makes by pointing out that “if everyone just does what’s legal in their marriages or families or even their conduct as a consumer, you pretty quickly turn into Hobbesian chaos. I think ethics have long been the oil that lubricates the social contract. When you have a dedication to doing that which is legal and nothing else, that I do not think makes for a very cohesive society.”

  Many times, corporate tax avoidance schemes are considered legitimate only because they have not been challenged, said John Christensen, director of the Tax Justice Network. “So much of what [multinational corporations] do in terms of tax planning falls into an untested grey zone, with many avoidance schemes, claimed to be perfectly legal, falling apart under investigation.”

  In other words, when it comes to tax avoidance, companies are innocent until proven guilty. They are more than happy to take advantage of these shades of gray. Unpacking the intricate, global tax structures of multinational corporations requires a significant amount of time and expertise. Some governments have the resources to devote to these investigations, but many others do not.

  “In countries where the fiscal authorities are powerful, multinational companies and their tax planners are likely to be more conscious of risk and therefore more likely to steer towards safer tax planning,” Christensen told me. “In countries where the tax authorities have weaker transfer pricing investigation capability, multinationals are much, much more aggressive.”

  Nations offering major tax breaks are in a tough spot themselves. To attract capital in a globalized world, countries have been sucked into a race to the bottom, neutering their laws to compete for investment. The result is that both individuals and companies have figured out how to operate beyond the reach of any government. “Companies and capital migrate not to where they are most productive but to where they can get the best tax break,” Nicholas Shaxson, a journalist and tax justice advocate, wrote in his book Treasure Islands. This process undermines the ability of governments to make sovereign economic policy decisions, as well as the efficiency of free markets. “There is nothing ‘efficient’ about any of this,” said Shaxson.

  Indeed, every dollar that they keep from tax authorities is a dollar that is not being spent on infrastructure, health care, education, public safety, and other government programs that benefit not only society but the companies themselves.

  Given the complexity of these tax structures, it is difficult to know exactly how much tax revenue governments are losing. Companies are not exactly lining up to share those figures either. But looking at the data, researchers estimate that governments around the globe lose between $500 billion and $600 billion each year due to tax avoidance by corporations, and another $200 billion to tax evasion by individuals.

  The United States and European Union each lose about $190 billion in taxes every year thanks to the offshore system, but countries in the developing world are hit even harder. Developing countries in Latin America, South Asia, and Africa have much more to gain from corporate tax—it typically comprises 15 percent of their total tax intake, versus 10 percent in developed countries, and is more reliable when it can be collected. But tax evasion and avoidance costs these countries drastically more, since they have fewer resources to plug leaks. When wealthy individuals and multinational corporations make money in developing countries and then send it to a tax haven, it cuts economic growth off at the knees. It quashes real investment in infrastructure and health care, undermines democracy, magnifies inequality, and destroys public trust. And while the cost to
developed countries might seem like a steady leak, in much of the world the loss is an outright flood. One think tank estimated that developing countries in 2008 lost as much as $1.2 trillion in illicit financial flows—a figure that dwarfs the $100 billion in total annual foreign aid to these same countries.

  Fixing the global tax system would have a greater impact on the developing world than any acts of philanthropy or foreign aid.

  The reason we know about Google and its Double Irish with a Dutch Sandwich is largely because the company continued to use the setup for years after it had been exposed. It sparked outrage, but it was still technically legal.

  In 2014, under heavy pressure from the EU, Ireland stopped letting multinationals domicile Irish subsidiaries in a different country. No longer could an Irish company be managed out of Bermuda. However, businesses that already used the setup—like Google Ireland Holdings—were allowed to continue doing so until 2020. It was only on December 31, 2019, that Google’s parent company confirmed it would abandon the structure. And by then, similar maneuvers had already started cropping up to replace the banned scheme.

  A further reason the Double Irish, Dutch Sandwich got so much attention in the first place was that Google and the other multinationals that used it were among the highest-profile and most closely scrutinized companies in the world. This one avenue for tax avoidance was filled with streetlights and neon signs, but the vast majority are not as well lit. Even so, it took years for journalists, the public, and policy makers to pressure the Irish government to close the loophole.

  The coverage of Google’s tax strategies prompted a crackdown from other European governments as well. Italy and France both implemented a digital services tax, which gives the government a small cut of the profits generated by digital advertising and other online transactions. The two countries also launched tax fraud investigations against Google, which led to the company paying more than a billion euros in back taxes for tax strategies that apparently did not pass the legal test in addition to the laugh test. The Netherlands also introduced a 21.7 percent tax on royalties and other payments that flow to low-tax jurisdictions like Bermuda, effectively taking the Dutch Sandwich off the menu.