In the beginning of May 2017 the Dutch Railways (further: NS) were again in the news for tax avoidance. The new scandal focuses on a German Subsidiary of NS which leases trains to be used in Germany. The lease company is an Irish subsidiary of NS. What is it about?
Well, like a couple of years ago, the issue is that this lease company of NS operates from Dublin where the corporate income tax rate is just 12,5%. Only a couple of years NS was for the first time a head liner in the news when it appeared that trains being used in the Netherlands where also leased from this Irish subsidiary. This has as consequence that the lease payments are deductible in the Netherlands against 25% while the pick-up is only taxed at 12,5%. So, by using an Irish subsidiary the tax bill of NS is lowered with approximately 12,5% of the lease payments diminished with the costs of maintaining the Irish subsidiary.
Was it a wrong decision from NS to walk this way? Well, legally not. As long is the Irish subsidiary provides the servicing which any group may expect from a professional lease company, nothing is wrong. And this is not just a judgment based on tax rules but this is also based on EU-law rules. It was in the end of the last century that the European Court of Justice decided that German airliner Germanwings was allowed to lease planes from an Irish group company even when this led to a leakage of German Taxes (Gewerbesteuer). So legally nothing is wrong.
The next question is whether this is morally wrong. Reputation plays a role here. If NS would be perceived as a tax dodger the clients of NS can choose to take the car, another train company (if available) or alternative ways of transportation. So, there is always a risk that clients say they don’t want to spend their money with a company which avoids paying taxes in its own country. But does this mean that what NS is doing, is also morally wrong?
And this is a difficult discussion. I always make the distinction between ethics and reputation. Ethics as being discussed here is based on what is called deontology. This refers to the intention of persons and why they act as they act. A person acts, simply said, morally well when his intention matches with a correct ethical motive. Reputation is different since it deals with how a person wants to be valued. In practice this can have as the consequence that a company acts (objectively speaking) unethical but still seems to be able to safeguard its reputation. As an example I refer to Starbucks (see my previous blog) which did not act in conformity with the correct ethical motives being formulated by NGO’s (and supported by the public opinion) and therefore voluntarily paid millions to UK’s HMRC in order to safeguard its reputation.
Then the next question is of course whether this means that other US MNE’s which did not pay voluntarily a comparable amount of money to the UK’s HMRC act unethical. According to NGO’s, they do. This is however only based on what they perceive to be the correct ethical motive. But in practice there is no single correct ethical motive. It is the UN’s UNCTAD which published in 2015 that eliminating fancy tax planning structures for multinationals, may be beneficial for western states but in the end the developing countries pay the price for this. So, where NGO’s preach that multinationals should pay more taxes in for example the Netherlands, this is fair for the Netherlands but not automatically for developing countries where subsidiaries of the group reside in.
Back to the Dutch railways. NS’ German subsidiary (Abellio) has won a tender in Germany and leases trains which are owned by its Irish lease company. The difference with the previous NS situation, is that it is not about a Dutch state owned company avoiding taxation in the Netherlands, but about a German subsidiary of the Dutch company avoiding German taxes. The German corporate income tax rate (including local Gewerbesteuer) is between 30 and 33%. By leasing trains from Ireland at an arm’s length price, a margin is deductible in Germany at 30-33% which is only picked up in Ireland at 12,5%. The discussions in the newspaper deal with the question whether NS should principally reject this structure and just pay German taxes over its full German profit. NS has responded to these questions by explaining that they have discussed with the grantor in Germany whether it would be a problem when the trains will be leased from Ireland. The grantor apparently has answered that opposing these structures would be in conflict with primary EU-law (freedom of establishment) and therefore NS is allowed to act as NS did.
So, what would have been the correct way to act in accordance with the ethical motive as being upheld by NGO’s and many others? If the company would lease from the Dutch entity, the lease margin will be taxed in the Netherlands which means a tax rate of 25%. Just buying the trains directly from the factory leads to comparable effects. As a consequence the ‘tax element’ in Abellio’s price at least doubles which means that for Abellio it will be hardly possible to compete with others. Clearly the only alternative is to withdraw from Germany since NS can never be a serious contender in the German market. This would only be different if all passengers are willing to pay more for a train ticket with Abellio knowing that Abellio pays all of its taxes in Germany. I am afraid this is not a rational alternative.
The next question is whether the element of NS being state owned makes a difference in condemning NS’s morality. In other words, is being able to compete a factor which is more relevant than the ethical motive as discussed above? People seem to have different opinions here. On the one hand many say that, accepting that NS avoids paying Dutch taxation, sounds like Coca Cola owning a chain of restaurants which only sells Pepsi Cola. And this seems to be a little awkward so this should be changed.
On the other hand people say that by using the Irish structure, the total global revenues increase and the profits accordingly which is again in the interest of the Dutch state. I assume that the Ministry of Finance will benefit of NS’s behavior of using the Irish lease company for their global expansion when bottom line this increases NS’s global presence, total revenues and profitability. Passengers of NS will also benefit of a more profitable railway transportation company since more global scale means lower prices for the cost of the main assets and therefore lower prices for a comparable train ticket or the same prices for better services. But, as in many cases with taxation, one could uphold a different truth, condemn NS and start using the car again.
The discussion with state owned companies is therefore principally more complex than with privately owned companies. If not just for the fact that many clients of NS believe that this corporation should not strive to a profitability of 7%. But they forget that a company which continuously has to invest in its products, needs to be profitable. Still, when you cannot see or will not see the rationale behind this company, you will just condemn the company. Which is to my opinion just unjust.
Hans van den Hurk