Ben Chu: Let's not get bamboozled by Google in the global tax avoidance debate

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The Independent Online

Outlook Who says politics is boring? There was another entertaining session of the Public Accounts Committee today as Google's Matt Brittin received a fresh savaging from the chair Margaret Hodge over the internet giant's tax avoidance. The climax came when Ms Hodge told Mr Brittin: "I think you do do evil". The spanking followed revelations about Amazon's minuscule corporation tax bill earlier in the week. How Ms Hodge must have wished she'd been able to give Jeff Bezos a tongue lashing too.

The temperature of the tax avoidance debate is rising. But there's a danger. We seem to be getting sidetracked. The PAC committee meeting was dominated by a row about how much of Google's sales activity actually takes place in the UK, rather than in Ireland, where revenues are officially booked. This seems off the point since corporation tax is levied on profits, not sales.

We need to take a step back and identify the main problem. Multinational firms, especially those whose businesses are based on monetising profitable intellectual property such as a search engine algorithm, are able to move profits out of a country in which they operate and into tax havens.

Here's how it works. A firm's management registers the rights to its intellectual property in a subsidiary in one country (let's say Bermuda) and requires a subsidiary in another country (let's say the UK) to pay a charge for the use of that intellectual property. Thus trading profits in a subsidiary serving a big market such as the UK can be offset by fees paid to a subsidiary in a tax haven. The profits then pile up in the latter.

There are some complexities. Profits often get shifted through places such as Ireland, the Netherlands and Luxembourg on their way to the tax havens. But this basic framework is, essentially, the reason multinationals are able to report a very high turnover in a country yet also record low profits and thus pay negligible local tax.

So-called "arm's length" accounting rules, created by the OECD, are supposed to prevent this kind of artificial profit shifting. It is called "arm's length" because those fees are meant to be no higher than the firm would charge a third party business for the same transaction. The snag is that determining an arm's length price for intellectual property is immensely difficult, since IP is not traded in the same way that a piece of capital machinery, for instance, is. There is thus no market price for the tax authorities to use as a benchmark for detecting abuses. The upshot is that multinationals, aided by phalanxes of clever accountants and lawyers, end up getting away it.

Exposing and shaming individual corporations who engage in aggressive tax avoidance will only get us so far. The fact is that no country can address profit shifting unilaterally. These footloose leviathans are exploiting a loophole in the global tax regime. To close it, two things are necessary jobs. First, governments need to agree to drive the tax havens –those sunny places full of shady people – out of business. Second, governments need to establish a new international tax framework for taxing multinationals. Should these firms pay a proportion of their worldwide profits to national treasuries? And, if so, how should this proportion be determined? By staffing levels in each nation perhaps? Turnover?

George Osborne and David Cameron say brokering a new deal on tackling multinational tax avoidance is the priority for the UK's G8 presidency. Yet what has emerged so far is just tinkering. Vastly more is needed, otherwise things are going to get steadily hotter – not only for the multinationals but also national politicians. The redoubtable Ms Hodge will no doubt see to that.