Google under indictment: Internal Revenue Service demands 1 billion in taxes

The agreement had thus marked a watershed between the before and after. A case destined to set the standard, in Italy and abroad. The new fact that had changed the cards on the table was the loss of centrality of the man in identifying a concealed permanent establishment.

In the case of Netflix, an innovative approach had been followed, which had relied on the existence of an exclusive technological network. Investigations by the Guardia di Finanza in Milan had shown that the platform used by the streaming giant consisted of over 350 servers distributed throughout Italy through which 100% of video traffic passed.

Fiamme Gialle, Agenzia delle Entrate and the Milan Public Prosecutor's Office had thus decided to classify the infrastructure present in Italy as a 'material permanent establishment', succeeding in demonstrating how the server network - although formally immaterial - was essential for Netflix to broadcast the videos purchased by subscription by Italian customers.

The investigation by the judiciary and the Gdf had started in 2019. The prosecutors claimed that, although the company Netflix International BV resided in the Netherlands, it had a 'fixed place of business' in Italy. The assets that the American company used in Italy, the prosecutors added, were cables, optical fibres, computers, servers and algorithms, which would have made Netflix fall under the concept of a 'material permanent establishment'.

And so it had been. The tax audit carried out for the years 2015 to 2019 had found the existence of undeclared IRES and IRAP taxable bases and the presence of unpaid withholding taxes on royalties paid to the Cayman Islands-based foreign subsidiary, owner of the group's worldwide intellectual property rights.

With the payment of the EUR 55.8 million to the Italian tax authorities, Netflix had also decided to have the subscription revenues no longer invoiced to the Dutch company, but to the Italian Netflix Services Italy, registered as early as 2021.

Today, the reasoning is almost identical for Google. Which finds itself for the second time under the IRS's lens.

The first case had broken out in 2016. The two Irish holding companies of the group (Google Ireland Ltd and Google Ireland Holdings) and a Dutch company that also belonged to the search engine (Google Netherland Holding BV) were in the investigators' sights. The money paid to Google by Italian advertisers ended up in Bermuda after having passed through the Irish and Dutch companies. The violations alleged against the search engine for setting up a concealed permanent establishment were from 2009 to 2013. There was no room to challenge the conclusions of the Internal Revenue Agency and the web company ended up settling with the tax authorities by paying the EUR 306.6 million.

The magic wand that had allowed the American multinational to accumulate almost USD 50 billion in tax-free profits in Bermuda, an archipelago of 300 islets to the north of the Caribbean, had been a scheme called 'Double Irish with a Dutch Sandwich' that created a kind of 'corporate fiction' in which Google's Italian subsidiary had a specific role.

Google Italy was a Milanese limited company controlled by Google International Llc, a company domiciled in Wilmington, Delaware, a US tax haven. The Italian branch had as its corporate purpose 'the provision of consultancy and assistance services in sales support activities, in the marketing and advertising sector', but according to the Fiamme Gialle it operated with quite different roles and, above all, with 'a permanent establishment'.

Contracts with Italian customers, formally finalised in Ireland, were instead prepared and edited by employees of the Milan company, according to the investigators' findings. The documents were then sent to the Irish company Google Ireland Ltd, where they were signed and sent back to Italy. The Dublin company, therefore, had operated for years in Italy with an 'undeclared' and not formally constituted permanent establishment.

It was at this point that the 'Double Irish with a Dutch Sandwich' system came into play, a mechanism - used by Google not only for Italy - involving two Irish companies (Google Ireland and Google Ireland Holdings) and a Dutch entity (Google Netherlands Holdings Bv).

Google Ireland, which was based in a building in the centre of Dublin, was not just any company: it sold advertising on the search engine for all countries outside the United States and generated more than 80% of the American multinational's foreign turnover. Revenues from advertising contracts signed in Italy and other countries in Europe, Asia, Africa and the Pacific ended up in Dublin. And this was the first step in the system that allowed Google to pay a derisory percentage of taxes.

There was another detail that had to be kept in mind to understand how the 'Double Irish with a Dutch Sandwich' worked. Google Ireland Ltd, which collected the money from Italy and other countries, in turn had to pay royalties to the second Irish company, Google Ireland Holdings, because it was the latter that owned the intellectual property of the search engine algorithm.

Thus, the first Irish subsidiary paid royalties to the second, generating expenses that reduced its tax base and allowed it to pay less tax in Ireland. The second company diverted profits to Bermuda where it paid no tax. That is why in the Overseas Territory of the United Kingdom Google had amassed some $50 billion tax-free.

However, the mechanism was not so simple. To avoid payment of the Irish withholding tax (12.5%), Google's revenues did not pass directly from the first to the second Irish subsidiary. Instead, they made a diversion of almost a thousand kilometres to the Netherlands, to Google Netherlands Holdings (a company that, according to the Gdf, was an empty box). And it was Netherlands Holdings that turned the money over to the second Dublin company.

Why such a complicated slalom? Because Irish tax law stipulated that if a company paid royalties to companies in other EU countries, it paid no tax. And so the Dutch company - which had no function other than to allow this further tax reduction - paid 99.8% of the royalties it received from Google Ireland to Google Ireland Holdings, which turned them over to Bermuda. The Irish holding company, in fact, was controlled by Motorola Mobility International Ltd and Google Bermuda Unlimited, both domiciled in the archipelago off the US.

The money route was, in short, a round-the-world trip: from Italy to Ireland, from there to Holland, then back to Ireland and finally to Bermuda. Thousands of kilometres with the sole function of reducing Google's overall taxation to telephone prefix levels.

After the Italian investigation, which was followed by investigations in other countries, that structure was dismantled. But evidently the optimisation mechanisms to pay less tax are by no means finished.