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BEPS and Sustainable Business

25th Feb 2014 | What goes around.....institutional investors can't sit this fight out forever

With G20 finance ministers heading home from Australia after a meeting where BEPS (Base Erosion and Profit Shifting) has been high on the agenda, arm wrestling over Apples $150B cash pot in the run up to the AGM in Cupertino on the 28th February and a little gem of a story from the Australian Financial Review (AFR) illustrate both sides of the BEPS equation.

 

The AFR has given a fascinating window into how multinationals can do it in practice.

 

A long series of paper transactions has allowed News Corp’s Australian subsidiaries to record a $2 billion loss while subsidiaries in tax havens posted a corresponding profit, in turn eventually triggering an $A880m payment from the Australian Tax Office (ATO) to News Corporation after years of legal battles.

 

The story goes back to 1989 as AFR journalist and long time News watcher Neil Chenowyth details:

 

‘Picture a room with four people and one cheque.

The cheque, number 272461, is drawn on News Finance Pty Ltd, made out for $A2, 974,708,426.

 

According to the Australian Federal Court judgment, News Finance director Peter Chegwyn handed the cheque to News Publishers Holdings Pty Ltd director Peter Macourt, who passed it to someone from News Publishers Investments Pty Ltd in exchange for shares; who passed it to News Ltd (now News Corp Australia) to pay for shares in yet another News company.

 

The last step was for News Ltd to hand the cheque back to Mr Chegwyn at News Finance to pay out previous debt. The money was back where it had started. Actually, it hadn’t gone anywhere at all. But each exchange had varied the currency that the Australian-dollar cheque should be repaid in.

 

Further wrinkles in the two years that followed involved a series of promissory notes in US and Australian dollars, Sterling and Deutschemarks.’

 

After a long series of legal tussles the Federal Court of Appeal ruled against the Australian Tax Office (ATO) on July 25 2013 allowing News Corp to claim a $2 billion deduction from the round robin of paper hops between subsidiaries.

 

The ATO made a decision not to appeal the federal court ruling further, the why of which seems to be deeply bound in murky local politics, crystallising what the AFR regards as the largest tax rebate ever made by the Commonwealth of Australia to a corporation.

 

Of even greater concern are additional AFR calculations that all up, various internal paper transactions and shuffling of assets between subsidiaries including the infamous 2005 News Corp incorporation in the US have cost Australia $A3.5b in tax deductions.

 

Meanwhile Apple investors have been arm wrestling over what should be done with the $US153B pot of cash the company is sitting on. While activist investor Carl Icahn has withdrawn his buyback resolution and big players like CalSTRS have made their position clear, the question of how much of the bulging pot ‘o dollars legitimately belongs to the taxman and by extension the people of the countries from where Apple profits are drawn, remains unanswered.

 

The BEPS activities of the digital giants are no small beer in any language. They are making a significant contribution to an even bigger pot. Again the AFR helps with an estimate of $US345 billion in cash held by US corporations Apple, Microsoft, Google and Cisco. The new tech giants are now showing News how it’s really done.

For institutional investors, corporate returns made by global gaming of national and international tax rules cannot be ignored forever.

They come not from productive long term investment, are often hidden behind opaque corporate structures and the contribution to a company’s bottom line - and hence its real financial circumstances, underlying performance and prospects - are not adequately disclosed.

 

Greater transparency and closing of loopholes is now well on the agenda of governments and various economic organisations. Investors have a role to play in encouraging good governance and reforms, just as they have a growing reputational risk from acquiescing to sharp practices that are reaching their sell by date.

 

As the G20 tax cart grinds towards action in September, it is well past time some extra weight was put behind the wheel.

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