Starbucks Tax Scandal UK Case Study

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Starbucks Tax

The United Kingdom is one of the largest markets in the world for Starbucks, with over 700 stores, by far the largest in Europe. The company ran into a scandal, however, when it was revealed that the company was not paying taxes in the UK, but was rather paying the taxes in the Netherlands and Switzerland, which has a much lower tax rate. Some politicians decided to make a name for themselves by attacking the foreign company (Starbucks' major competitors in the UK are local chains Costa and Caffe Nero, both domestic companies). The ensuing negative publicity hurt Starbucks' sales, which fell below ?400 million for the first time since 1998 (Campbell, 2014).

The Case

At issue is the fact that the UK signed into membership with the European Union. The EU established rules that allowed companies to headquarter in one European country and operate subsidiaries in another country from there. So Starbucks set up in Luxembourg, which has very low corporate taxes, and headquartered its European operations there, even though the UK is the largest EU market for the company. Europe's laws were written by Europeans with the intent of providing this benefit to European companies, but when an American company took advantage of the same law, an opportunity for a phony controversy arose. The result, however, has been expensive for Starbucks. The company at first resisted the controversy but when it did not die down, the company was forced to capitulate and relocate its UK headquarters to the UK (Titcomb, 2014). It was recently revealed that the company was still not in a profitable position in the country and therefore would not be making substantial tax payments (Campbell, 2014, 2).

The system by which Starbucks had previously operated was that the company paid royalties on UK operations. Essentially, Starbucks pays licensing royalties on its brand and logo to a subsidiary in the Netherlands, such that for every cup of coffee sold in the UK, 6% goes to this subsidiary. Further, the company runs its beans through Switzerland, and pays an internal transfer price that allows most of the profits to accrue in Switzerland, further lowering its taxes in the UK (Campbell, 2014, 2). The company claims that this model is common throughout the industry, which is quite likely. It stands, however, that this benefit mainly accrues to foreign companies, whereas domestic British companies would have more difficulty setting up this structure, and would likely pay taxes in the UK as a result. Note that the two major competitors of Starbucks are British companies, so it was not exactly coincidence that Starbucks was the target company instead of some other chain.

2.2 Disclosure Vehicle

The company has the option of outlining things like division profits in its annual report, but that has not generally been something Starbucks has done. The UK operations are within the broader EMEA division (Europe, Middle East, Africa), and UK results are not specifically broken out.

The disclosure was therefore not made by the company, but was rather exposed by a third party, Reuters. Investigative reporters had noticed that the company was announcing in its releases and conference calls that its UK business is profitable, despite the fact that it never pays taxes in the UK. This lead to an investigation by Reuters, which revealed that that company had only paid UK taxes once since it entered the country (Bergin, 2012). So there was definitely no voluntary disclosure, and the allegations had caught the company off guard. Reuters had obtained some information from Companies House, which is a government register in the UK that records the financial information for all companies operating in the UK. The Reuters reporter had talked to Starbucks' CFO to find out more information about what the company was doing. As Starbucks was not breaking any laws, it was willing to answer questions, but still did not see to have control over the dialogue on this issue.

2.3 Methodology

Starbucks's public reports, such as its 10-K form filed with the U.S. Securities Exchange Commission, so not break out the company's income by country, just the number of stores and the unit income. This is common practice. The reporter instead looked at transcripts of the company's conference calls to find where it was claiming that its UK operations were profitable, and then the reports from Companies House that showed that Starbucks was posting a loss in the UK The reporter then sought to investigate as to the nature of the discrepancy.

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2.4 Findings

The findings are that the company did not break any laws. The initial report from Reuters pointed this out, and there has been no legal action taken against Starbucks despite the gusts of hot wind emanating from Parliament. Political fulminating has certainly convicted the company in the court of public opinion but by rule of law, Starbucks appears to have followed legal procedures with respect to internal transfer pricing, which is the accounting law at work. It is by no means the only company to do so -- using transfer pricing to lower taxes is a tactic common amongst multinationals

The ethical findings are perhaps a little bit more vague. On the one hand, the argument is made that the company has an obligation to pay UK taxes on earnings made in the UK. There is no particular, universal, ethical principle by which this conclusion can be made. One commentator noted that there appears to be a significant difference between the way that Americans view the ethics of multinational taxation and the way that British people do. In Britain, it was not just politicians in a tizzy, but consumers as well have expressed concern about this, and Starbucks has thus seen a decline in its UK business. Yet, the UK joined the EU of its own volition, and it was the EU's tax structure and taxation law under IFRS that Starbucks was using with respect to transfer pricing.

Starbucks' initial response to the crisis, while legally correct, has resulted in some of the backlash at the consumer level. The story would not die because at the time, there was also controversy with respect to multinational tax-dodging, which combined with a budget crisis to make it a hot issue in the minds of many UK consumers. Starbucks eventually paid some taxes voluntarily, and moved its European operations to London, but then it has also announced that the UK business is in fact not making any money. The latter is the only point that the company's critics have noticed, so the company has still not entirely resolved the issue of the public relations crisis.

The problem is that the criticism is somewhat irrational at this point, and it is difficult to understand exactly what the company can do to appease the critics. It has paid taxes, and relocated, but that is yet not enough. The company has not adopted the tenor of a company that legitimately is concerned about the taxation issue, and that might be a contributing factor the public relations issue, but it might also be driven by other interests.

Starbucks could have taken control over the issue. The company may have been blindsided by the Reuters report, but did not manage the crisis well, and did not seem to read the mood of the public very well. The response for the company was slow and should have taken the concern of the consumers into account more. Legally, being right is important, but the optics were not great. This created a public relations crisis, this low-level response. Clearly, the company did not understand the need for a high-level response for the crisis, and the public saw this as an ethical breach that came about directly from the company's actions.

Burnett (1999) notes that better prescriptive diagnosis would have allowed for the company to understand the seriousness of the crisis, something that the company did not seem to do. By understanding the political/social dimensions of the crisis, Starbucks would have understood the risk it was taking in the first place. A high level response would have seen the company accept responsibility, and recognize the optics of the situation, if not the ethics, which are a little more flexible. The company's response failed to take into account the legs the story might have in the press, and the difference in sentiment in the UK vs. The U.S. In terms of the ethics of the situation.

Conclusion

Starbucks did not handle the UK tax issue well, mainly because it did not understand the depth of the issue. The company felt that because what it was doing was legal, that would be good enough. This was not the case, and a public relations nightmare ensued. It is worth considering, however, that the voluntary taxes the company paid were higher than what the company has lost in profit, but there is definitely a situation where the company could have defended its brand better, and recognized that the.....

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