Starbucks UK Tax Scandal: Legal Compliance and PR Crisis

Introduction and Background

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 faced a significant scandal, however, when it was revealed that Starbucks was not paying taxes in the UK but was instead routing tax payments to the Netherlands and Switzerland, which have much lower tax rates. Some politicians seized on the opportunity to attack the foreign company (Starbucks' major competitors in the UK are local chains Costa and Caffe Nero, both domestic companies). The ensuing negative publicity severely hurt Starbucks' sales, which fell below £400 million for the first time since 1998 (Campbell, 2014).

At the core of the controversy was the fact that the UK had 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. Starbucks took advantage of this structure by setting up operations in Luxembourg, which has very low corporate tax rates, and headquartering its European operations there—despite the UK being the company's largest EU market. Europe's laws were designed with the intent of providing this benefit to European companies, but when an American company took advantage of the same law, it created an opportunity for public controversy.

The Tax Structure and Legal Framework

The result, however, proved expensive for Starbucks. The company initially resisted the controversy, but when the issue 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).

The system by which Starbucks had previously operated involved the company paying 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 percent goes to this subsidiary. Further, the company routes 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). 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 coincidence that Starbucks was the target company instead of some other chain.

Starbucks had the option of outlining details such as division profits in its annual report, but had not generally done so. The UK operations are within the broader EMEA division (Europe, Middle East, Africa), and UK results are not specifically broken out in public filings.

The disclosure was therefore not made by the company voluntarily, but was rather exposed by investigative journalists at Reuters. 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 paid taxes in the UK. This discrepancy led to an investigation by Reuters, which revealed that the company had only paid UK taxes once since it entered the country (Bergin, 2012). There was no voluntary disclosure, and the allegations caught the company off guard.

Disclosure and Investigation

Reuters obtained information from Companies House, a government register in the UK that records the financial information for all companies operating in the UK. The Reuters reporter spoke with Starbucks' CFO to find out more information about what the company was doing. Because Starbucks was not breaking any laws, it was willing to answer questions, but still did not seem to have control over the dialogue on this issue.

The reporter's methodology relied on comparing statements from Starbucks' public reports and conference call transcripts—where the company claimed UK operations were profitable—with official reports from Companies House showing that Starbucks was posting a loss in the UK. This allowed the reporter to investigate the nature of the discrepancy without relying on company disclosure of detailed income by country, which is not standard practice.

The findings revealed that Starbucks did not break any laws. The initial report from Reuters pointed this out explicitly, and there has been no legal action taken against Starbucks despite heated criticism in Parliament. Political pressure certainly convicted the company in the court of public opinion, but under the rule of law, Starbucks appears to have followed legal procedures with respect to internal transfer pricing, the accounting law at work. Using transfer pricing to lower taxes is a tactic common amongst multinationals, making Starbucks far from alone in this practice.

Crisis Response and Ethical Analysis

The ethical findings are perhaps less clear-cut. On 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 Americans view the ethics of multinational taxation and the way British people do. In Britain, it was not just politicians expressing concern, but consumers as well, resulting in a decline in Starbucks' 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, resulted in significant consumer backlash. The story did not fade because it coincided with broader controversy over multinational tax-dodging, which combined with the UK's 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 announced that the UK business was in fact not making any money. Critics seized on the latter point, so the company had still not entirely resolved its public relations crisis.

The criticism was somewhat irrational at this stage, making it difficult to understand exactly what the company could do to appease the critics. It had paid taxes and relocated, yet this was still not enough. The company had not adopted the tone of a business legitimately concerned about the taxation issue, which may have been a contributing factor to the public relations problem, though it might also be driven by other interests.

Starbucks could have taken control over the issue more effectively. Although the company may have been blindsided by the Reuters report, it did not manage the crisis well and did not seem to read the mood of the public. The response was slow and failed to take consumer concerns adequately into account. While being legally right is important, the optics were not great, and this created a public relations nightmare. Clearly, the company did not understand the need for a high-level response to the crisis, and the public saw this as an ethical breach resulting directly from the company's actions.

Burnett (1999) notes that better prescriptive diagnosis would have allowed the company to understand the seriousness of the crisis—something Starbucks failed to do. By understanding the political and social dimensions, Starbucks would have grasped the risk it was taking. A high-level response would have seen the company accept responsibility and recognize the optics of the situation, if not the strict ethics, which are somewhat more flexible. The company's response failed to account for the story's potential in the press and the difference in sentiment between the UK and the US regarding 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 sufficient. 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 the profits the company lost. Nevertheless, there was definitely a situation where the company could have defended its brand better and recognized that the letter of the law and public sentiment are two different things.