How does Facebook avoid paying tax, and what will the changes mean?

City editor Jim Armitage explains how the changes will work

It will no longer route sales through Ireland for its largest advertisers. (Getty Images)

Q | How does Facebook currently avoid its UK taxes?

A | Like most US technology companies, it bases its international operations in Ireland, where corporate tax is 12.5 per cent compared with Britain’s 20 per cent. Until now, money made from sales to advertisers in the UK have been routed through Ireland.

Q | So it must pay huge taxes in Ireland?

A | Far from it. While making revenues of €4.83bn last year, Facebook Ireland paid only €3.4m in corporate taxes. That is because corporate tax is based on profit, not revenue, and Facebook Ireland makes very little profit.

Q | Why does Facebook Ireland make so little profit on all those billions of euros in sales?

A | Because it makes huge royalty payments for using Facebook’s technology to yet another Irish company called Facebook Holdings Limited. After paying all those royalties, Facebook Ireland is left making very little profit.

Q | So, is the subsidiary selling Facebook Ireland the royalties paying huge taxes?

A | No. While the subsidiary holding the royalties is based in Ireland, its tax domicile is in the Cayman Islands, which is tax-free. This tax trick is known as the “Double Irish”. In some cases, the royalties are technically held by a third holding company in Holland but funded by the Cayman-Irish business. This is known as the “Dutch sandwich” because the Netherlands entity sits between two Irish firms.

Q | What has Facebook agreed under its new arrangements?

A | Facebook now says it will account for sales made to big advertisers in the UK through its British company rather than funnelling them over to Ireland. That means it will be paying tax on any profits at the UK corporate tax rate of 20 per cent.

Q | So, how much UK tax will it be paying?

A | That’s impossible to say, because Facebook UK may still be making royalty payments offshore. Reports have suggested it will be paying millions of pounds more in UK tax than it was, but we will not know until the relevant UK accounts appear. Given that it is not starting the new system until the 2017 tax year, we will have to wait until 2018 for the accounts. Also, Facebook UK has accrued £21m of tax losses which it is allowed to set against profits in future years. That means it could still be paying no tax for years to come.

Q | What drove it to make the change?

A | Negative publicity is likely to have played a large part, but Facebook may also have been influenced by new UK rules known as the Diverted Profits Tax. Aimed at big companies using international tax avoidance tricks, this effectively means the taxman can make his own estimate of what their UK profits are based on their sales here. This so-called Google tax is levied at a higher-than-normal rate of 25 per cent and is one of the first examples in the world of tax being calculated on sales rather than profit.