Why Aren't Companies Paying Their U.K. Taxes?

In the past year, a number of businesses have come under fire for avoiding their fair share of U.K. taxes, according to legislators.

Apr 9, 2014 at 8:35AM

Caffe Nero, a British coffee chain, has recently come under fire for not paying its fair share of U.K. corporate tax. Specifically, it's been alleged that the company has paid no taxes since 2007. CEO and founder Gerry Ford told the Telegraph that, though the company has been making money, it's had to pay all of its profits back to cover interest charges on its debt. He also said that, though the company is based in Luxembourg -- 84 of its 650 stores are outside the U.K. -- "The whole tax thing is something that's not our story. We're not in the same category as Starbucks."

Ford's reference is to the maelstrom of hate that Starbucks (NASDAQ:SBUX) churned up in 2013 after it was revealed that the company had developed a complex corporate structure that allowed it to avoid the vast majority of its U.K. corporate taxes. Starbucks eventually ponied up, paying tens of millions of pounds in an act of contrition.

Ford said that Caffe Nero isn't that kind of business. He touted the fact that the chain paid 21 million pounds in value-added tax along with over 25 million pounds in payroll taxes. That hasn't impressed British legislators, who have called out Caffe Nero as an unfair competitor, putting smaller businesses at a disadvantage.

That's the same sort of rhetoric that was employed when tax avoidance allegations came out against Amazon.com (NASDAQ:AMZN), which has its European operations based in Luxembourg as well. Chancellor of the Exchequer George Osborne said, "People and companies have to pay the taxes that are due, it's the only way to operate in a fair and competitive society." Some members of Parliament have even gone so far as to call for a boycott of Amazon, which they say is harming British businesses by employing tax avoidance tactics.

How is this even possible?
Caffe Nero's lack of payments has yet to be pinned on malicious activity, and it's possible that the company just spends too much in its expansion to need to pay corporate taxes. However, it is set up in such a way that it could easily avoid taxes in the future, even when it does turn a profit. To understand how it all works, you have to expand beyond the U.K.'s borders.

First, let's think about what we would need to do if we didn't want to pay taxes. The easiest way is to not make any money. That's not a popular idea, though, especially with publicly traded companies. Instead, what if we just made it look like we weren't making any money?

To do that, we could spend it all, like Caffe Nero appears to be doing, or we could "spend it all." Starbucks, for instance, set up a system where it pays a subsidiary in Switzerland for coffee at an comfortable 20% profit margin and then pays out most of its remaining profits to its Netherlands headquarters, which licenses the Starbucks brand to the U.K. chain.

In effect, Starbucks pays different segments of itself in tax-favorable locations in order to avoid paying tax in a tax-heavy location. It's not illegal. The easy flow of cash between European countries makes this an easy move, just as the ease of moving cash between states in the U.S. means that many businesses are "headquartered" in Delaware, where corporate taxes are favorable.

The trading back and forth between business entities makes it easy for many businesses to avoid taxes, and the complex nature of business makes it easy to explain away. Much of the value of Amazon's business is generated out there in The Cloud. Amazon can lean on that when explaining why so much cash is leaving the country that it's generated in. A representative from Deloitte summed up the problem for tax authorities, saying, "What the world wants is a means of taxing Internet businesses more than they can on the basis of where they are located."

In the end, Caffe Nero isn't likely to have much of an issue with U.K. taxes. If the business really is spending that much on its interest payments, then its real problem might be the continued servicing of its debt. No matter how it all turns out, it's unlikely to put a damper on Caffe Nero's plans to expand around the globe, including into the U.S. The company has a planned cafe opening in Boston later this year. 

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Andrew Marder has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Amazon.com and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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