Bloomberg News

Ortega’s Zara Fashions Tax Avoidance by Shifting Profits to Alps

February 26, 2014

Ortega’s Zara Fashions Tax

In part because of this profit shifting, Zara reports narrow margins in many high-tax countries, trimming its taxes in some of its biggest European markets. In Italy, Germany, France and the U.K., Zara has recorded average profit margins from 3 percent to 5 percent since 2009, corporate filings show. Photographer: Antonio Heredia/Bloomberg

Zara’s celebrity chic helps make its Spanish parent company, Inditex SA, the world’s biggest fashion retailer. Singer Taylor Swift, reality-television personality Kim Kardashian and Kate Middleton, Prince William’s wife, have all been spotted wearing the stylish, low-cost brand.

Another reason for Inditex’s industry-best profit margins of almost 15 percent: the company uses the kind of tax loopholes coming under increasing scrutiny from international regulators.

In the past five years, Inditex has shifted almost $2 billion in profits to a tiny unit operating in the Netherlands and Switzerland, records show. Although that subsidiary employs only about 0.1 percent of Inditex’s worldwide workforce, it reported almost 20 percent of the parent company’s global profits last year, according to company filings.

In part because of this profit shifting, Zara reports narrow margins in many high-tax countries, trimming its taxes in some of its biggest European markets. In Italy, Germany, France and the U.K., Zara has recorded average profit margins from 3 percent to 5 percent since 2009, corporate filings show.

This arrangement legally reduced Inditex’s taxes by as much as $325 million since 2009 -- $100 million last year alone -- and boosted the company’s net income by more than 3 percent. Thanks to Inditex’s soaring stock price, the company’s founder and majority owner, Amancio Ortega Gaona, last year became Europe’s wealthiest person and the third richest in the world.

Political Ire

Multinational tax avoidance has risen to the top of the international political agenda, with the Group of 20 nations and the European Commission both overseeing efforts to crack down. The political ire, though, is focused on U.S. technology companies such as Google Inc. (GOOG:US) and Apple Inc., which shift valuable software patent rights into offshore units. Inditex shows that a retail company can also cut its taxes by moving rights to know-how such as designing a store window display into low-tax units.

“Policymakers need to go well beyond looking at online and tech companies,” said Alex Cobham, a research fellow in London at the Center for Global Development in Europe, a think tank. “This is a systemic issue across industry after industry.”

Inditex reports the profits of its units appropriately, said Jesus Echevarria Hernandez, a spokesman for the company. Their profit margins comply with domestic and international regulations governing transactions between subsidiaries, he said. The company’s units are “audited and frequently reviewed by the local fiscal authorities in each market to assess the fairness of the profitability levels,” he said.

The Dutch subsidiary is “an entity of significant importance within Inditex’s business model,” and is not related to “tax savings,” said Echevarria. It has not had a “significant” impact on fluctuations in the company’s effective tax rate, he said.

Value Added

Inditex says its contribution to Europe is greater than its corporate income tax expenses, which amounted to 764 million euros ($1.05 billion) in the fiscal year ending January 31, 2013. A two-page section in the annual report breaks out the value added tax, or VAT, collected on behalf of local governments from shoppers, as well as tariffs and property taxes. That added up to 4.1 billion euros in 2012, the company said.

“The economic activity generated by Inditex worldwide helps to collect taxes in a very significant amount,” the report states.

Dutch Unit

With almost $21 billion in sales and $3 billion in profits last fiscal year, Inditex is larger than competitors like Hennes & Mauritz AB (HMB) and Gap Inc. Yet those profits can be hard to find in Italy, France, Germany and the U.K.: the small Dutch unit posted more profit just last year than Inditex’s Zara subsidiaries in those markets combined over the past five years.

The Dutch unit has reported an effective tax rate in recent years of about 16 percent, approximately half the corporate income tax rate in Italy, France and Germany. So far in fiscal year 2014, Inditex has reported an effective tax rate of 21.7 percent overall.

Inditex’s strategy of moving income to its Dutch unit has cut its Zara unit’s profit in Italy by more than half. Since 2009, the Italian Zara subsidiary has paid out more in royalties to its Dutch sister unit than it reported income in Italy.

Echevarria called it “misleading” to compare the margins of Zara’s retail subsidiaries to the higher profits of the Dutch unit. Such a comparison, he wrote in an e-mail, “disregards all functions performed by each specific entity (design, manufacturing, distribution and sale of fashion items, mainly clothing, footwear and accessories).”

Regulators’ Scrutiny

Disparities between where companies generate sales and where they report their profits have drawn the attention of tax regulators.

Beginning in July, European financial institutions will be required to submit information to the European Commission disclosing revenue, taxes paid, profitability and the number of employees in each country where they operate. The European Council has said this approach should be expanded to cover all industries.

The Group of 20 nations has also endorsed this so-called country-by-country reporting. At the behest of the G20, the Organization for Economic Cooperation and Development is developing a plan that would require companies to disclose such information in a single source, although only to tax administrators, not the public.

Public Pressure

“Multinational companies know that once this kind of information becomes public, tax dodges that are legal today may not be legal tomorrow because there will be so much public pressure,” said Tove Maria Ryding, tax coordinator at the European Network on Debt and Development, a Brussels-based watchdog organization. She was addressing tax avoidance in general, rather than Zara specifically.

In the past year, companies including Starbucks Corp. (SBUX:US), McDonald’s Corp. (MCD:US), Dolce & Gabbana Srl and Bulgari SpA have come under scrutiny by regulators and tax authorities in France, the U.K. and Italy for moving profits into tax havens. Tax practitioners say fashion retailers have been using such profit-shifting techniques since the early 1990s, following on the heels of pharmaceutical, chemical and technology companies.

Budget Deficit

The spotlight on tax avoidance comes at a time when the EU’s combined budget deficit was 483.2 billion euros in the third quarter, or 3.7 percent of the region’s GDP. Europe’s labor underutilization rate, which includes a broader swath of jobless people than the basic unemployment rate, was 17.1 percent in the third quarter, up half a percentage point from a year earlier.

While Inditex’s subsidiaries file reports in many of its biggest markets, there are gaps. In the U.S., where Inditex has 49 stores, including in New York, Los Angeles and Chicago, the company isn’t required to file a separate report breaking out revenue and profit. Echevarria, the Inditex spokesman, said its units in the U.S. and Canada have “posted double-digit margins on a sustained basis.”

Inditex’s founder, Ortega, opened his first Zara store in La Coruña, near his hometown on the Galician coast in northern Spain, in 1975. The retailer now has its headquarters in the nearby town of Arteixo, and has grown to operate more than 6,200 stores in 86 countries -- about as many as Gap and H&M combined. It employs more than 120,000 people and opens a new store somewhere in the world, on average, every single day.

Ortega stepped down as chairman in 2011, but still owns 59 percent of the company, making up most of his $59.2 billion net worth, according to the Bloomberg Billionaires Index.

Although Ortega is well known in Spain, he is famously press shy, contributing to his low profile internationally. The company is also press shy: It virtually never advertises, except to announce the opening of new stores.

Low Prices

Zara has made its name offering clothing at low prices, often based on high end brands. On a recent weekday afternoon, Italian fashion student Maria Chiara Totti joined a throng of customers at Zara’s biggest store in Rome, a converted 19th century palazzo on the main shopping street, Via del Corso, a few minutes’ walk from the famed Trevi Fountain.

It’s her favorite place to shop, she explains after buying a pair of 12 euro casual pants: “You can find an outfit for classes at the university and one for nightclubbing.”

Bershka, Pull & Bear

Inditex has expanded beyond Zara. The company sells inexpensive, Italian-style apparel under the Massimo Dutti brand and caters to younger shoppers with Bershka and Pull & Bear. Zara clothing and accessories still make up the majority of Inditex’s sales -- $13.6 billion out of $20.6 billion in fiscal year 2013. The value of the Zara brand rose 14 percent last year to 8.6 billion euros, Echevarria said.

The company is in the forefront of what is known as “fast fashion.” Store managers transmit detail about shoppers’ habits to headquarters in Spain on a daily basis. Office employees in Arteixo, a hilly, industrial town near the coast, analyze the data and share their findings with seamstresses sitting nearby. New clothes can be shipped out to stores twice a week -- a quick turnaround and a key to Zara’s success.

Amsterdam Office

The tax-avoidance strategy can be traced to a small office in the heart of Amsterdam.

On Kalverstraat, one of the city’s busiest shopping streets, two Inditex stores sit across from each other: a Bershka and a four-story Zara. Around the corner, down an alleyway, there is a door with an intercom, marked only by a handmade label that says “Inditex.”

This is the entrance to a subsidiary called ITX (ITX) Merken BV, established by the company in 1996: ITX is Inditex’s ticker symbol and “Merken” is the Dutch word for brands. Inditex’s other subsidiaries and its franchisees around the world pay royalties for the right to use the company’s commercial trade-name, Dutch filings show.

The unit’s 173 employees also identify new shop locations and consult on interior design and window display, services for which the subsidiaries and franchisees pay, said Echevarria, the company spokesman. They provide the “know-how and technical assistance relating to the layout and physical appearance of stores,” he said.

“ITX Merken plays a crucial role within the Inditex Group because it is essential that our store concepts are transmitted in an entirely consistent way around the world,” Echevarria said.

Since 2009, the unit has collected about $4.3 billion and reported about $1.9 billion in net income, records show, a profit margin of 45 percent. Reflecting its outsized income, the Dutch subsidiary earned $3.1 million per employee last year, making it seven times more profitable by that measure than Apple Inc. (AAPL:US), the most valuable company in the world.

‘Very Valuable’

Carlo Alberto Carnevale-Maffe, a professor of strategy at Bocconi University’s school of Management in Milan, said Inditex could argue that it is justified in attributing significant profit to ITX Merken because the company’s brand names are “very valuable.”

Units in the Netherlands are popular with companies seeking to pare tax bills because Dutch authorities make it easy to move profits through the country to low-tax destinations.

ITX Merken’s profits don’t all stop in Amsterdam. The subsidiary splits the income with a branch in Fribourg, Switzerland, a small town with spectacular views of the Swiss Prealps -- the north-western Alps -- and well-preserved gothic architecture.

Swiss Cantons

Switzerland is attractive to multinationals in part because cantons, the Swiss equivalent of states, hand out multiyear tax holidays. The Canton of Fribourg, for example, grants corporate income tax holidays of as many as ten years, according to the Fribourg Development Agency.

Six other Inditex subsidiaries are also located in the same office in the seven-story building there, which shares space with a health club and a supermarket, just a few yards from the train tracks that lead in and out of town. The company declined to say if it had received a tax holiday there or how its profits are divvied up between Switzerland and the Netherlands.

The bottom line: Profits attributed to ITX Merken have been climbing, and last year reached almost 18 percent of Inditex’s worldwide net income.

Tax Savings

Bloomberg News calculated Inditex’s tax savings two different ways. The first approach compares the effective tax rate that a public company reports globally to the statutory rate in its home country, based on a method required by accounting standards in many countries. If all of the Dutch unit’s profits since 2009 had been taxed at the 30 percent Spanish corporate income tax rate, Inditex would have paid $325 million more in tax.

The second method calculates Inditex’s effective tax rate reported by Inditex for all of its profits other than the ones reported by the Dutch unit. It then applies that rate to the Dutch unit’s income. Using that approach, the arrangement has saved Inditex $215 million since 2009.

Based on that first method of tax savings, the Dutch unit added 3 percent to Inditex’s net income last year.

“If you can increase a company’s net income by 3 percent by shifting income to a lower tax jurisdiction, my God, it’s considered a gold mine,” said Robert Willens, an independent accounting analyst who advised companies on tax strategies at Lehman Brothers Holdings Inc. for 18 years.

Popular Technique

Echevarria, the company spokesman, declined to estimate the tax savings attributable to the arrangement in the Netherlands and Switzerland or explain why the unit’s 16 percent rate lags the Dutch corporate rate of 25 percent.

ITX Merken “is well known by the tax authorities and its activity has been audited in a large number of countries where Inditex Group is operating stores,” he said.

Splitting profits between a Dutch subsidiary and its Swiss branch is a popular technique among multinationals, according to Francis Weyzig, a financial researcher at Utrecht University. Other companies that have used such a structure include Nokia OYJ, the European mobile-phone maker that’s being bought by Microsoft Corp., filings show. Most of Nokia’s treasury staff and management are in Switzerland, a company spokesman said in an e-mail.

In Italy, anger over corporate tax avoidance prompted a law passed in December to prevent profit shifting offshore by requiring Web advertisers to purchase from Italian companies. The law, though, would have no impact on fashion retailers. Inditex now has about 300 stores in Italy, the third most of any European Union market, behind Spain and Portugal.

Via del Corso

In the heart of Rome’s historic center, there are three Zara stores within a seven-block walk on Via del Corso alone, as well as a Massimo Dutti.

By moving $200 million in royalties to the Dutch subsidiary in the past five years, Zara’s Italian unit may have deprived Italy of about $60 million in corporate income taxes. That assumes the Zara profits would have been taxed at Italy’s corporate rate of 31.4 percent. It does not include royalties paid by Inditex’s other Italian units.

Echevarria, the Inditex spokesman, disputed the analysis. Without the Dutch subsidiary, “Zara Italia would have paid no taxes at all, as Zara Italia would not have existed,” he said in an e-mail. “Zara Italia would not have been able to benefit from the unique and exclusive Zara store concept and to use Zara’s distinctive sign as a commercial name.”

Inditex’s strategy places a larger tax burden on “smaller companies that don’t have the power and don’t have subsidiaries in the Netherlands and Switzerland,” said Giuseppe Ragusa, an economist at Luiss University in Rome. “This creates a false playing field.”

To contact the reporter on this story: Jesse Drucker in New York at jdrucker4@bloomberg.net

To contact the editor responsible for this story: Daniel Golden at dlgolden@bloomberg.net


Best LBO Ever
LIMITED-TIME OFFER SUBSCRIBE NOW

Companies Mentioned

  • GOOG
    (Google Inc)
    • $589.27 USD
    • 4.50
    • 0.76%
  • SBUX
    (Starbucks Corp)
    • $75.73 USD
    • 0.39
    • 0.51%
Market data is delayed at least 15 minutes.
 
blog comments powered by Disqus