Google will pay 130 Million GBP in back taxes to the UK Government, in settlement of any potential dispute as to whether it should have paid more in the past. Whether Google has thereby established a new tax rate for the future I’m not sure. But if it has, it amounts to a derisory rate – about 3% on the real profit it obtains from its UK sales, some say.

Large multinationals, especially those providing software or services, take enormous and conscious advantage of the lack of clarity surrounding concepts that we too easily take for granted – such as the concept of a sale.

I am no tax expert, but I would presume that the idea of corporation tax, the tax on a company’s profits, is to tax economic activity in the country where that activity is carried out. This is fair recompense for the physical infrastructure, legal protection, and military protection that the taxing government provides.

But how do you define economic activity and its location?

In determining profit, there is on the one side revenue (usually a company’s sales) and on the other side there is cost. In general a company will want to record its revenue in the most lenient tax jurisdiction it can find.

So that’s why, if you’re a British entity you may well find that when you buy services from Google, you are actually buying them from Ireland. You will receive an invoice from an Irish company, and you will pay to an Irish company (let’s put aside the issue of whether an Irish company can run a bank account in the UK – that’s probably another complex matter, but we won’t go into it here). Your contract for the provision of services (an agreement that services will be supplied in return for money) is with an Irish company. This means that revenue is booked in Ireland. Google will then subtract costs and pay tax at a relatively lenient corporation tax rate on the difference.

In some circumstances you can imagine that Google needn’t even run a company in the UK. It might operate entirely in Ireland, and its forays into the UK might be confined to the occasional salesman’s visit. Indeed some companies operate in this way. They simply provide goods or services from another country. If you buy contact lenses, for example, from a Czech company and receive them in the UK, the Czech company’s costs will amount only to delivery costs, but even these would be contracted with a logistics firm in the Czech Republic. Fair enough? Possibly.

But of course Google does incur costs in the UK, and some of these, one might argue, are related to the services it ‘sells’ from Ireland. There may be a marketing, or sales department based in the UK, whose job is to cajole British companies into using Google’s services. And I would imagine that Google does indeed offset these costs against Irish revenue, by subcontracting ‘marketing and sales’ services from the Irish entity to the UK one, with a mark up on costs for the UK company. Thus a small profit is made in the UK on services provided by the UK entity to the Irish one. But the main profit is made in Ireland where customer revenues are booked, and where tax is lower.

But I also know for a fact that Google does incur other costs, such as marketing costs, in Ireland. I regularly receive calls from Czech (and also English) speakers based in Ireland who explain to me that by spending more on Google’s Adwords services I will sell more of my own company’s software and services.

The conceptual difficulty lies in the definition of a sale and where it takes place.

The Shorter Oxford English Dictionary (the 8,000 page version) defines a sale as:

1. the action or an act of giving or agreeing to give something to a person in exchange for money

Putting aside ‘agreeing to give’, a stage in the process (signing a contract) which doesn’t allow a company to book revenue, this definition is woefully inadequate for our purposes. Whilst it does cover the giving of goods (as in a shop), services (‘giving’ consulting, whether at a client’s offices or remotely) and the granting of a right to use software, it doesn’t help us to clarify where the ‘act’ takes place.

Many companies regard the ‘act’ as simply that of printing a bill (an invoice). Even if vast costs are incurred in the UK by sales representatives, in marketing, and so on, the ‘act of sale’ happens in another country because that is where the bills are created (and you could even imagine that these bills might be created by accounting clerks in the UK using software running on UK-based servers). In the end what it comes down to is that the ‘act’ is often generously defined solely in terms of the legal location of the company into whose accounts the bill will be booked.

If you broaden the concept of the ‘act’ to include all the surrounding precursor activities, such as marketing, business management, warehousing, even manufacture, then you might go a long way, with some kinds of company, towards capturing a larger taxable profit.

But take Amazon. Amazon does, indeed, do many of these things in the UK, but it’s one of those large international companies currently under scrutiny for its low taxable profit.

In any case, this approach doesn’t work well with software companies such as Google or Microsoft, or any of those whose marketing, products and delivery mechanisms are all digital. It isn’t easy to say where the ‘acts’ of sale occur. Underlying software (including its development), databases, support teams, even marketing teams, may be located outside the jurisdiction of the companies that are buying the company’s services. So, where should profit be taxed?

It’s not easy. If you go so far as to say that a company should be taxed in the country where its customers are you open up a Pandora’s box of complexity. My companies, LLP Group and systems@work, sell software and consulting services in seventy or so countries around the world. How would we go about declaring profits in each of these?

Some of these countries, it is true, charge a withholding tax on invoices we send to our customers. So, if we bill 100 to Albania, we might receive only 80. This mechanism, I suppose, is designed to prevent the movement of profit from Albania to the Czech Republic, and if we furnish proof of this payment to the Czech tax authorities, we can reduce the profits we pay here. But this mechanism is generally and rightly regarded as obstructive and most countries abandon it when they are fully integrated into the global economy. It is a huge disincentive to business, and more often than not simply results in fees being uplifted by the selling company to compensate for the frequent failure to make all the paperwork work.

It isn’t easy to set policy, but certainly something needs to be done. It seems obvious to the man in the street that Google ‘acts out’ its invoices in Ireland to reduce its tax bill in the UK.

But does the solution lie in the harmonisation of tax policy, or in taxing sales activity using a broader definition, one that reaches as far as the location of the customer?

Sorry, it is a dull topic, but it’s a hugely important and difficult one, and it concerns billions in taxes.