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As one of many U.S. multinationals that reportedly implemented the Double Irish international tax structure, Starbucks has reportedly paid a U.K. tax rate of 2.8 percent over the last decade. Not satisfied with this levy, last month the British Parliament called Starbucks and other U.S. multinationals before the body to discuss the structure. Last week, in response to Parliament’s pressure, Starbucks announced that it would voluntarily forgo U.K. deductions to ensure it pays £10 million ($16 million) in tax during 2013 and 2014. It remains to be seen whether Starbucks’ announcement will placate Parliament. By making this gesture, however, has Starbucks caused a U.S. tax problem?
Based on publicly available materials, the legal basis by which Starbucks intends to forgo its deductions is not entirely clear. But, some clues can be found in the Double Irish structure itself. Under the structure, a multinational’s foreign operating subsidiary pays a significant portion of its revenue to a related Irish subsidiary as royalty to license the Irish company’s intellectual property. The royalty payment is deductible by the operating subsidiary (and, due to some related structuring, nearly tax free in Ireland). In making its announcement, Starbucks stated that it will refrain from claiming certain deductions that it had previously claimed. Although we are speculating, the sacrificed deductions may be the royalty deductions.
Generally, when a U.S. multinational (such as Starbucks) receives a dividend from a foreign subsidiary, Section 902 provides the multinational a deemed foreign tax credit to the extent of the foreign subsidiary’s earnings and profits. But foreign taxes are only creditable if “compulsory” – voluntary payments to foreign governments do not count. Treas. Reg. § 1.901-2(e)(5)(i). If Starbucks foregoes its U.K. deductions, the resulting tax payment could be voluntary. If treated that way, Starbucks would suffer a double tax on the income attributable to the foregone deductions. It would pay a 23 percent corporate tax rate in the United Kingdom (in contrast to the reported 13 percent tax rate that it currently pays on its international operations). On top of that, it would pay a 35 percent rate on dividends paid to the United States – without reduction for the U.K. tax.
A tax is “compulsory” only to the extent required under a reasonable interpretation of foreign law. Treas. Reg. § 1.901-2(e)(5)(i). Thus, if a taxpayer increases its income in a foreign country by knowingly applying incorrect transfer pricing, the foreign tax attributable to the increased income is not creditable. Treas. Reg. § 1.901-2(e)(5)(ii), ex. 1. Presumably, Starbucks determined the royalty rate paid to its Irish subsidiary through a thorough transfer pricing study. If it increases its U.K. tax by reducing its royalty payment, it may have knowingly increased its U.K. tax in much the same manner as the taxpayer described in the Treasury Regulation.
Regardless of the outcome, Starbucks’ announcement visibly highlights that international tax structuring in one jurisdiction often comes at the expense of another jurisdiction – which will fiercely defend its right to tax. Although tax treaties and competent authority assistance ameliorate some of these issues, they do not save taxpayers from all domestic tax rules. Accordingly, careful taxpayers must examine the domestic consequences of their international activities to ensure they do not run afoul of a trap for the unwary.