Taxing Amazon: An investigation

Amazon.co.uk is being investigated by the UK tax authorities. This has been revealed in a US Securities and Exchange Commission (SEC) filing by the ultimate parent company, Amazon.com Inc, in 2011. The investigation covers the tax years from 2004 to 2010, which includes the period when ownership of Amazon’s UK business was transferred to
a Luxembourg-based company.

Amazon EU Sarl was established in 2004—the first year covered by the UK investigation—with the expectation of reducing the Amazon group’s tax rate by lawful means. The UK business was transferred to the Luxembourg company in 2006 in a complex transaction which involved four different owners of the shares. Amazon.com Inc said in a 2006 SEC filing: “The effective tax rate in 2006 was higher than the 35% statutory rate resulting from establishing our European headquarters in Luxembourg, which we expect will benefit our effective tax rate over time.”

The impact of the move is apparent from Amazon.com Inc’s filings. In the four years to 2006, the impact of international taxation was to increase the company’s effective tax rate. In 2006, its US rate hit 49.6%. In every subsequent year, the impact of international taxation was to reduce the effective US tax rate by up to 17%; since 2006, the effective US tax rate has been below 35%, falling to 23.5% in 2010.

Asked about the Amazon probe, a spokesman for Her Majesty’s Revenue and Customs said: “Unless it is a criminal investigation I am afraid we are unable to comment on the tax affairs of individual companies”.

Amazon.co.uk also declined to discuss the investigation, its tax structure, and UK tax payments. Instead, a spokesman said: “Amazon EU serves tens of millions of customers and sellers throughout Europe from multiple consumer websites in a number of languages, dispatching products to all 27 countries in the EU. We have a single European headquarters in Luxembourg with hundreds of employees to manage this complex operation.”

Accounts for Amazon EU Sarl show that it employed 134 people in 2010, generating €7.5bn (£6.5bn) in turnover. In the same year, Amazon.co.uk employed 2,265 people, but reported a turnover of just £147m.

This is because the British company is now only a fulfillment business. According to the US master company, Amazon.co.uk generated sales of anywhere between £2.4bn and £3.2bn in 2010. But because the company is owned in Luxembourg, that is where the sales are recorded and tax levied accordingly. Despite its €7.5bn turnover, Amazon EU Sarl declared just €5.5m by way of a tax charge for 2010.

Amazon.co.uk would not offer any explanation for the switch to Luxembourg ownership. However, Richard Murphy, an accountant turned tax specialist and campaigner for stricter anti-avoidance rules with Tax Justice, says the structure appeared to be designed to make it easier for Amazon to minimise its tax liability."

Superficially, there is not much difference in corporation tax rates between the UK and Luxembourg,” Murphy says. “However, there is little doubt in my mind that the Luxembourg authorities are likely to take a more benign approach to scrutiny of the costs which can be offset against income in order to reduce taxable profit."

Murphy’s argument appears to be supported by analysis of the latest accounts, for the 12 months to December 2010, filed by Amazon EU Sarl in Luxembourg. The company is exempt from producing consolidated accounts, so the figures relate only to the Luxembourg company itself. Although it reported €7.5bn of income, this was largely off set by €7.4bn of what are called “other external charges”. These are described as including “cost of product sales and other ongoing costs related to the operations of the company”.

Had the Luxembourg company earned the income at the average operations margin of 4.1%—as reported by Amazon.com Inc across the group’s entire operation for the year to December 2010—then it would have reported a €307m profit. Instead, the Luxembourg company reported a profit of just €14m.
 
Owning Amazon for a day

In the five years since the company began operating as Amazon’s European holding company in 2006, it has reported cumulative sales of €23bn, but combined profits of only €55m, on which it has declared net tax of €15m.

"This looks to me like a transfer pricing structure,” Murphy says. “The ways these structures work is that one Luxembourg company acquires the rights to the brand, the website technology, the marketing expertise and any other intangible assets. It then charges another Luxembourg company a royalty fee for use of these intangible assets, which reduces the profits accordingly."

Again Murphy appears to have a point. A Luxembourg company called Amazon Europe Holding Technologies SCS, which owned Amazon.co.uk for a day in February 2006, appears to do a lot of business with Amazon EU Sarl, which bought the shares in the British company for €62m just 24 hours after its affiliate (Amazon Europe Holding Technologies SCS) had acquired them from a company called  Amazon.com International Sales Inc—which itself had become the only shareholder when Amazon.com Inc transferred its holding in December 2005.

According to the Amazon Eu Sarl accounts in 2010, it owed Amazon Europe Holding Technologies SCS over €1.5bn, by way of a loan which has risen steadily from €387m in 2006, and which is now regarded as a liability due for repayment in more than 12 months’ time.
 
€4bn assets
Despite its low profitability, Amazon EU Sarl has grown to be a business of considerable
substance. Net assets were approaching €4bn at the end of 2010—almost four times 2006’s figure. The company has amassed more than €2bn in cash and high-quality investments (“transferable securities”), which include government bonds. The
company has also been the vehicle which has financed several group acquisitions. It
financed the purchase of LOVEFiLM; is a 50% investor in the Joyo Chinese joint venture;
and bought Joyo.com, a British Virgin Islands company, for €105m in 2010.

There is no such glamour for the British business. It boasts net assets of £53m—largely represented by its fixed assets—and had only £520,000 in the bank at the end of 2010. It has not made a profit since 2006, when it recorded an after-tax surplus of £508,000. Since then, after-tax losses have steadily increased each year, reaching over £3m in 2010.

However, despite generating billions of pounds-worth of sales in the UK, there appears to have been little paid in the way of corporation tax. In the eight years between 2003 and 2010, the UK company has reported a cumulative net tax bill of just £1.1m—of which half was incurred in 2010. This is not necessarily the tax actually paid to HMRC—that information is not available because the UK company is not required to produce a cashflow statement.

Without HMRC’s assistance, it is impossible to know what the investigation into Amazon.co. uk’s tax affairs is about. But it is unlikely to involve VAT. Christopher North, Amazon’s UK managing director, told the BBC’s “Today” programme on 1st February that
VAT on UK sales was paid in the UK at the UK rate. “On the products we sell and ship to
customers we pay the UK VAT rate. We collect that from customers at the UK rate, we
remit that to the UK government. We collect and remit hundreds of millions of pounds of VAT in the UK,” he said.

However, he admitted that there was a tax difference in the treatment of e-books, an important element of Amazon’s strategy to promote its Kindle e-reader. “E-books, under EU rules, are considered a service,” he said. As such, VAT is added at the rate charged by the supplier, not at the rate applicable to the buyer. Luxembourg, which has the lowest VAT rate in Europe (15%), has just cut the rate charged on e-books to 3%, to bring it into line with traditional paper books, which, as reported in The Bookseller in December, could give Amazon a significant competitive advantage.

Meanwhile the Channel Islands loophole, which allowed mail-order companies based on
the islands to send products worth less than £18 to the UK free of VAT, is being closed.
 
Four-country investigation

The HMRC investigation could be a routine audit of Amazon.co.uk’s tax affairs. There has been no suggestion that Amazon has broken any laws in the steps it has taken to minimise its tax liabilities.

However, it could equally involve transfer pricing issues. The company refused to discuss these issues, but in a recent SEC filing Amazon.com Inc said: “In addition, while we have not yet received a Revenue Agent’s Report [which is] generally issued at the conclusion of an IRS examination, we have received Notices of Proposed Adjustment from the IRS for the 2005 and 2006 calendar years relating to transfer pricing with our foreign subsidiaries.“

The notices propose an increase to our US taxable income that would result in additional federal tax expense over a seven-year period beginning in 2005, totalling approximately $1.5 billion, subject to interest. We disagree with the proposed adjustments and intend to vigorously contest them. If we are not able to resolve these proposed adjustments at the IRS examination level, we plan to pursue all available administrative and, if necessary, judicial remedies.”

That “Notice of Proposed Adjustment” is for a period which is covered by the UK investigation. UK assets were transferred around the group in the period leading up to 2006, when ownership passed to Luxembourg. Eagle-eyed readers of the accounts might have noticed that the word “fulfilment” was added to the description of the business in 2006; it had previously read: “The principal activity of the company during the year was the provision of marketing and services to other group undertakings.”
 
Job fulfilment

The business’ description now reads: “The principal activity of the company during the year was the provision of fulfilment, marketing and services to other group undertakings.” Otherwise the UK accounts remained silent on the issue. The ownership by Amazon EU Sarl was not revealed until the 2007 accounts.

It may also be that the UK authorities are troubled that net sales generated in the UK avoided the UK tax system. In the most recent financial year (to December 2011), net sales generated in the UK were between £3.3bn and £4.6bn, all of which are avoiding exposure to UK corporation tax. That could yield, using the Amazon group 1.8% margin reported in 2011, a profit of anywhere between £59m and £83m, which could produce a UK tax bill of up to £23m, given that UK corporation tax is 28%.

As things stand, Amazon’s UK business remains a discrete fulfilment operation with relatively low levels of public scrutiny. The real action takes place in Luxembourg, where it is altogether more difficult to access the complete picture about Amazon’s financial position. With such a complex structure it is not surprising that Amazon (and this is according to its own SEC filings) has been under investigation by tax authorities in Germany, France and even Luxembourg as well as the UK. Amazon.co.uk may not want to explain why it moved its ownership to Luxembourg, but Richard Murphy has his own view: “Luxembourg is a place where it is much easier to secure some privacy from prying eyes.”

This feature was first published in The Bookseller in March 2012.