FT: companies find routes to fiscal frugality

"Politicians fret as companies find routes to fiscal frugality"
An article published by Vanessa Houlder in Financial Times (www.ft.com) on July 28 2008.

Last week, a gauntlet was thrown at the feet of business leaders who have fulminated about the complexity of Britain’s tax laws and the frequency with which they change. Lord Wallace, a Liberal Democrat peer, warned that corporate chiefs should offer a “constructive response to the erosion of the national tax base, before some populist politician or press campaigner seizes on the issue to use against them”.

The response from Martin Temple, director-general of EEF, the manufacturers’ organisation, was trenchant. He argued that the “most significant threat to the UK's tax base does not come from aggressive corporate tax avoidance but from the revenue lost owing to companies moving abroad in search of greater consistency and certainty from the tax system”.

In the exchange, on the Financial Times letters page, both men have a point. But the public overwhelmingly believes big companies and wealthy individuals dodge taxes too easily, according to Trades Union Congress research. Many people were shocked last year when official figures showed that almost one-third of the UK’s biggest companies paid no tax in 2005-06.

The US – which collects relatively little revenue in spite of having one of the highest corporate tax rates in the world – has a similar problem. That shows up in Americans’ attitudes to the way they as individuals are taxed. In the decades following the second world war, they considered income tax to be the fairest tax in the nation; since 1980, that opinion has been reversed.


But governments face risks in clamping down on multinationals. In the UK, two big groups moved their holding companies to Ireland earlier this year, amid complaints about Britain’s increasingly onerous restrictions on international tax planning. Michael Devereux, a leading economist, sums up the problem: “The more successful tax collectors are in preventing firms from shifting profit out of Britain, the more they are likely to encourage firms to leave the country.”

One, perhaps unpalatable, conclusion is that governments should learn to live with avoidance. Research by James Hines of the University of Michigan and Mihir Desai of Harvard suggests that companies’ use of tax havens “appears to facilitate economic activity” in neighbouring industrialised countries. Tax dodging by multinationals may let governments collect higher corporate taxes overall by allowing highly mobile companies – which might otherwise invest elsewhere – pay a lower rate of tax than domestic businesses.

But turning a blind eye to international tax avoidance is manifestly unfair. Jeffrey Owens, head of the tax policy group at the Organisation for Economic Co-operation and Development, argues that it is tantamount to stimulating growth at any price: “The same logic could be applied to business run by the Mafia or Colombian drug dealers.”

Yet tackling the issue is easier said than done. The nature of avoidance has changed over the last few years, in a way that has sent a chill through many fiscal authorities. Their focus is no longer on outrageously artificial schemes. Instead, companies are quietly restructuring in a way that is stripping the tax base of large countries.

Over the past decade, as they have become more global, large multinationals have centralised patents, intangibles and other services in low-tax countries. Mr Owens, who calculates that about 20 per cent of US intangibles are now held in Singapore, Switzerland and Ireland, says this sort of restructuring poses real difficulties for governments. “Services are where the potential corporate tax base is, so lose your services and you have lost a significant part of your tax base, and usually in a way where the existing international rules have been respected.”

The shifting of debt around multinational groups is another headache for fiscal authorities, particularly in the UK, which is relatively generous in the tax deductions it allows for interest costs. Over the course of this decade, companies have been engaged in a cat-and-mouse game with the revenue authorities about their use of tax havens as a base for their overseas businesses. This ruse allows them to load up their foreign operations – and sometimes their British activities – with debt via intra-group loans, while paying little tax on interest received.

Governments were slow to wake up to these problems but have recently mounted a rearguard action. At the start of this year, Germany appalled businesses by ratcheting up exit taxes for intellectual property. Britain has also taken a tough stance on transfers of intangibles. One tax director from a company that forms part of the FTSE 100 index compares the Revenue’s attitude to the line in “Hotel California”, a song by the Eagles: “You can check out any time you like. But you can never leave.” Tensions in Britain were exacerbated by a proposal to impose worldwide taxes on passive income – royalties, interest and dividends – which caused such an uproar that it was dropped last week.

The OECD is trying to thrash out a coherent set of rules for taxing business restructurings. But this is proving tricky, because the restructurings are primarily undertaken for business reasons. Pat Ellingsworth, who until this month was in charge of tax at Royal Dutch Shell, is closely involved in the OECD initiative. He says the attempt to define a tax-motivated restructuring proved “spectacularly unsuccessful”. Alternatives are being explored, including a greater emphasis on the location of workers in determining the tax base, though this may prove too radical for some.

Instead, some countries want a formula that will divide tax receipts across states that adopt a common tax base. The European Commission is enthusiastic but technical and political problems are immense. France, one of the strongest advocates, has decided not to push it during its current EU presidency following the Irish No vote on the Lisbon treaty. The idea, according to Christine Lagarde, French finance minister, “is alive, but not kicking very much”.

Meanwhile many businesses – led by the CBI, the UK employers’ group – say the solution is a sharp cut in tax rates. They suggest this would ultimately finance itself by reducing avoidance and boosting economic growth. But despite the success of small countries such as Ireland in going down that route, big nations are reluctant to gamble with corporate tax revenues.

All the while, multinationals are growing ever more restless. Last month, Joel Walters, tax director of Vodafone – a British company that now derives just 4 per cent of its profits from the UK – was blunt about the diminishing relevance of the concept of a “home country”. He recognised that governments were under pressure to raise revenues, he told a conference organised by Tax Journal. But international businesses had no choice but to manage their tax bills, he said.

“It can create an emotional reaction. But the fact of the matter is businesses are under enormous competitive pressure and tax is increasingly something boards are looking for us to manage.”

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