Following yesterday’s lament about the untimely death of the Progressive Tax Blog, I now have most of its blogs available. Special thanks to Guy Templeton (who went to the cached versions of the blog and put together a bunch of them, representing most of them, I think) and forwarded them to me in a tidy document.
I have never been able to find out who wrote the original blogs, so I have no way of asking copyright permissions, but since they were put there in the spirit of public service, I can’t imagine there’s a copyright issue here. I am therefore taking the liberty of posting these all up on the web. See below.
Unfortunately, the original links don’t work, and the pictures aren’t available, and the word ‘tax’ is in bold font all over the place. Still, in the spirit of public service, I will now paste these blogs right here. If anybody sees or can access ones that we’ve missed, please let me know.
Thanks for all the suggestions that came in response to my original request yesterday.
This blog aims to provide an insider’s view on tax issues from a progressive perspective.
It has been started out of frustration that public debate on tax issues is often polarised between those on the one hand who think all tax is theft, and others who think any form of tax avoidance is immoral. In your blogger’s view, the reality falls somewhere in between.
This blog therefore aims to bring to life UK tax issues including tax planning techniques in order to better inform public debate. Only by understanding the detail of how the tax regime works can progressives take a view on what tax planning is unacceptable, and therefore what policies should be argued for.
If progressives do not understand tax, then policy will be made by those that do – i.e. rich individuals, large companies and their tax advisors.
Over the course of the next few months I intend to address a number of topics which I believe the public needs to understand better to inform debate on tax policy. These are likely to include:
- Vodafone and how the EU enables tax avoidance
- How to solve a tax problem like Philip Green
- Corporate tax reform and the move to offshore tax avoidance
- A primer in corporate tax avoidance techniques
I will of course comment on topical issues as and when they arise.
If you have any comments please feel free to add these to the blog. Other contact means will be available shortly.
Written by admin
February 12th, 2011 at 11:26 am
By now many people are familiar with the fact that in 2010, Vodafone settled a long outstanding tax case with HM Revenue & Customs (HMRC) which resulted in the group paying tax of £1.25bn to HMRC. Campaigners including UK Uncut claim that Vodafone owed up to £6bn in unpaid tax prior to settlement with HMRC, although this is likely overstated if Vodafone otherwise had UK tax losses. In any case, Vodafone itself provided for a UK tax liability of £2.2bn in its group accounts meaning that the settlement resulted in Vodafone saving almost £1bn in UK tax compared to the amount that it forecast to pay (and convinced its auditors of being a reasonable estimate at the time).
What hasn’t been reported so widely is exactly how Vodafone managed to save so much tax. You might think that this is confidential information, but in fact the details of Vodafone’s tax planning strategy are very much in the public domain. This is because Vodafone, like Cadbury-Schweppes (as then known), took HMRC to court and challenged that the whole basis on which UK tax would have been levied on its foreign subsidiary was contrary to EU law. Anybody can read the judgements of the Special Commissioners (tax tribunal), High Court and Court of Appeal online, and discover the facts for themselves.
This post therefore seeks to explain:
- How Vodafone planned to save so much tax
- Why Vodafone was liable to tax under UK Controlled Foreign Companies (CFC) rules
- How the EU let Vodafone (and others) ignore UK tax law
How Vodafone planned to save so much tax
At the height of the dotcom boom in 2000, Vodafone acquired the German telecoms operator Mannesmann. For any multinational group, an acquisition is the perfect tax planning opportunity as it can whitewash a transaction for a myriad of anti-avoidance rules based on a transaction having a good business purpose.
As is common with acquisitions, Vodafone decided that Mannesmann should take on debt of €35bn from another group company (this is called a ‘debt pushdown’). Vodafone could have decided that the loan to Mannesmann be made by a UK company, but instead Vodafone structured the transaction so that a Luxembourg subsidiary (VIL Sarl) was funded with extra equity used to finance the loan to Mannesmann. The net result is that Mannesmann would pay mammoth amounts of interest to VIL Sarl on its €35bn of debt, which may be expected to significantly reduce its taxable profits (and therefore tax bill) in Germany. Meanwhile Vodafone did not receive any interest income in the UK, and therefore subject to Controlled Foreign Company rules (explained below), no UK tax would be due.
Of course, the missing piece in this jigsaw is how much tax Vodafone paid in Luxembourg, as after all VIL Sarl was earning significant amounts of interest from its loan to Mannesmann. A critique of Luxembourg’s role in facilitating tax avoidance is a post for another day, but suffice to say that it is well known jibe within the industry that favourable low-tax deals with the Luxembourg tax authorities can be reached over dinner (Michelin starred of course).
So far so good for Vodafone. Except under a provision in UK tax law called the Controlled Foreign Companies (CFC) rules, Vodafone should have been technically paid UK tax on the profits of its low-tax Luxembourg subsidiary.
Why Vodafone was liable to tax under UK Controlled Foreign Companies (CFC) rules
As far back as 1984, the UK realised that abolishing exchange controls would provide opportunities for multinational groups to move taxable income offshore and avoid UK tax. The UK therefore introduced CFC rules designed to levy UK tax on low-tax subsidiaries which could be viewed as not having good commercial reasons for existing, or otherwise helped to avoid UK tax. Many other countries have followed suit.
The CFC rules are some of the most complicated provisions in UK tax law (and therefore advising on them is a lucrative field for tax advisers). Suffice to say that the rules are only designed to apply where overseas subsidiaries pay a low amount of tax compared to UK tax (less than 75%) or the subsidiaries do not undertake trading or other good activities. The rules do apply where a subsidiary is low tax and merely undertakes non-trading activities (e.g. lending) which could have been done in the UK. Where the rules apply, UK tax is payable on the profits of the foreign company.
It is pretty clear from the various court judgements that in Vodafone’s case, UK tax should have been due on the profits of its Luxembourg subsidiary in full as a matter of UK tax statute under the CFC rules. Note that this is only because somehow Vodafone was not paying tax in Luxembourg of 75% or more than the UK tax that would be payable (otherwise it would have not been subject to CFC rules). You might think this is odd given that for 2001, Luxembourg’s corporate income tax rate was 37.45%.
Given that it was technically subject to CFC rules, you might therefore ask how Vodafone managed to avoid paying UK tax for so long and pay significantly less tax in the end than it expected itself. The answer lies in the application of EU law.
How the EU let Vodafone (and others) ignore UK tax law
As a member of the EU, the UK has subscribed to various ‘fundamental freedoms’ in the various EU treaties, notably the EC Treaty which provides for the right to ‘freedom of establishment’. The application of these treaty freedoms is interpreted by the European Court of Justice, which decided in the Cadbury-Schweppes case that CFC or other anti-avoidance rules in tax law of EU member states can only be applied to establishments in other EU member states (including subsidiaries) where they involve ‘wholly artificial arrangements’, i.e. those where no ‘genuine economic activities’ are undertaken.
You might think that in cases where most of a group’s people including its board of directors and treasury function are based in the UK, it is difficult to argue that ‘genuine economic activities’ would be undertaken by a subsidiary in Luxembourg, particularly in relation to €35bn of debt which it is fair to say would have been critical to the group’s financial position and monitored closely in the UK. However, this is exactly what Vodafone and others have argued. What is extraordinary is that after the Court of Appeal confirmed that the CFC rules were capable of applying in principle to Vodafone (subject to there being ‘wholly artificial arrangements’), the Government decided to settle with Vodafone on more favourable terms than the group itself expected, and leave the application of EU law to UK tax law unclear for not only Vodafone, but all other multinational groups.
The consequence of this decision is that Vodafone and other multinational groups which have undertaken tax planning in friendly EU member states (e.g. Ireland, Luxembourg, Netherlands, Cyprus) have and will pay less tax than due under UK tax statute by negotiating the position away with HMRC. In effect, the ‘EU defence’ is a convenient fall back position in case the chosen tax planning (which in some cases may be more aggressive than Vodafone) is challenged. In fact, HMRC is currently actively seeking such settlements rather than challenging aggressive tax planning in the courts because of this uncertainty (more on this in a subsequent blog post).
All this means that there is now a de facto (partial) EU exemption from the UK CFC rules on the basis that HMRC has no appetite to take a case to court and risk having a judgement against it as binding precedent. Instead, multinational groups undertake tax planning in tax friendly EU member states, and then plan for a favourable settlement with HMRC later.
Against this background the Government is changing the CFC rules to make the position even more attractive for multinational groups. We will discuss the pros and cons of this in a later blog post. However, the fundamental point remains that whatever rules the UK comes up with to prevent tax-avoidance, the EU and the principle of freedom of establishment to a certain extent gives multinational groups a licence to ignore these rules and locate taxable income in low-tax EU member states.
EDIT 16 Feb 2011 – Richard Brooks (the journalist who raised the Vodafone case in Private Eye) commented on our other post that Vodafone’s Luxembourg subsidiary, VIL Sarl, only had staff costs of €50,000 per year up to 2008 (based on accounts he has accessed from the Luxembourg commercial registrar). This would seem to suggest that the company did indeed have minimal substance in Luxembourg, making the settlement offered by HMRC even more surprising (as there would be very strong arguments that the arrangements were ‘wholly artificial’). Why did HMRC not feel they could win this case based on the facts? Would any court accept that employees being paid €50,000 are consistent with responsibility for managing a loan portfolio of €35bn?
Written by admin
February 13th, 2011 at 10:05 am
In our previous post we explained how Vodafone structured its acquisition of Mannesmann in 2000 to avoid UK tax, and the favourable settlement that it was able to reach with HMRC due to uncertainty on the application of EU law.
It is common knowledge among tax professionals that HMRC is actively seeking similar settlements with other UK multinational groups who have entered into perceived offshore tax avoidance structures. In fact, the process was covered in Tax Journal (subscription only) as far back as April 2010.
While tax professionals understand the basis on which settlement may be reached, HMRC has not explained the process to the wider public or indeed to Parliament. This led the Public Accounts Committee in the House of Commons to state in it’s annual review of HMRC’s accounts:
“There is little transparency for the taxpayer over the way that tax disputes with large companies are resolved. While we recognise the Department’s obligation to ensure taxpayer confidentiality, the Department should consider the scope for increasing transparency in the area of large and complex tax cases and for assuring Parliament and the public that due process in the resolution of these cases is being followed. We look to the Department to cooperate fully with a National Audit Office review of its procedures for resolving tax disputes.”
To at least partially rectify this, we explain the process below.
HMRC’s proposed basis of settlement
As we explained in our article on Vodafone, UK groups with low tax subsidiaries overseas are in general subject to UK tax on those profits under ‘Controlled Foreign Companies’ rules unless they carry on trading activities or satisfy a ‘motive’ exemption. The latter requires that the overseas subsidiary has good commercial reasons for existing and is not involved in any UK tax avoidance transactions.
Many groups do not meet these requirements where they have effectively transferred financing profits out of the UK to low-tax territories (similar to Vodafone), or have otherwise undertaken tax planning of various degrees of aggressiveness to fall within the strict letter of the law. Some of these groups have deliberately structured though low-tax EU subsidiaries so they can claim (like Vodafone) that EU law means they are not subject to UK tax.
Rather than take these cases to court, HMRC is in the process of agreeing to make settlements as long as a certain percentage of the potential tax due is paid. The mechanism for these settlements is that the group pays a dividend of an agreed amount from its low tax subsidiary to the UK and taxes this dividend in the UK. HMRC will then agree that ‘motive’ exemption applied (as an agreed proportion of the low-tax profits will then have been taxed in the UK).
The process and percentages of potential tax to be paid is meant to be consistent across all taxpayers (including Vodafone). Higher percentages will be due where aggressive tax planning has been undertaken, with lower percentages where the subsidiary otherwise has some commercial ‘substance’. Vodafone settled its outstanding tax position by paying UK tax of £1.25bn compared to £2.2bn it provided in its group accounts. It is therefore not unreasonable to assume that HMRC is applying a benchmark of approximately 55% to 60% of potential tax to be paid in these discussions.
However, less commonly understood is that HMRC is offering to waive interest on late paid tax in these settlements. The interest rate HMRC applied from 2000 through to 2008 typically varied between 6% and 8%. If you were to calculate the compound interest due on tax not yet paid for a year ended 31 December 2006, the interest could be worth approximately 25% of the tax. Tax due in earlier years would carry more interest, whereas tax due in later years would carry less. Using 2006 as an average year, the effect is that HMRC is effectively offering to settle enquiries for less than 50% of the tax and interest due.
Lack of transparency is the main issue
All of this may on balance be a good deal for the public if the relevant taxpayer has good arguments to defend its position. This is particularly true if the perceived tax avoidance structure involves a low-tax EU company (as there is uncertainty if the EU rules could apply). However, many (including MPs) will feel entitled to know more about how HMRC is assessing these cases given that HMRC’s own Litigation and Settlement strategy states that, where its legal advice is strong, it should not accept settlements for less than 100% of the tax and interest due.
David Gauke is Exchequer Secretary to the Treasury, and therefore minister responsible for HMRC. We believe he should answer the following questions:
- Why hasn’t the Government provided MPs, when requested, with details of the general framework under which settlements with multinational groups are being reached, given these details are known by tax professionals?
- How did HMRC determine the percentages of tax required to be paid for reaching settlement, and why is late payment interest not being charged?
- Has the Government taken legal advice on all significant settlements confirming that it does not have a strong case for litigation?
Answering the above questions may not change the overall amount of tax that HMRC collects. However, it will give the public greater confidence that due process is being followed, at a time when VAT and other taxes on ordinary people are being raised.
Written by admin
February 15th, 2011 at 4:33 pm
The Daily Telegraph today published a shameful error about the amount of tax paid by UK non-domiciled individuals. We can only question whether their intention was to put pressure on George Osborne to relax the regime by publishing misleading statements, or whether it was just plain incompetence.
As a reminder, individuals who do not have a permanent connection with the UK may claim ‘non-domiciled’ status and avoid UK tax on income which arises to them from non-UK sources (including offshore bank accounts, amongst others). This is different to individuals from the UK who are taxed on their worldwide income wherever it arises (so offshore bank accounts on which UK tax is not paid are ‘tax evasion’ rather than ‘tax avoidance’).
Under rules introduced by the Labour Government, any non-domiciled individuals who have been present in the UK for more than seven years must pay tax on their worldwide income or opt to pay a fixed levy of £30,000. Clearly individuals who have millions (or billions) in offshore bank accounts will choose to pay the fixed levy rather than the significantly greater amounts of tax that would be due under general taxation.
The headline published today by the Telegraph, with tagline attributed to Deputy Political Editor, Robert Winnett was:
Non-doms are paying £1 million a year each in tax
This was based on a parliamentary answer provided by David Gauke, Exchequer Secretary which we have copied verbatim below (via Tax Research UK):
The number of individuals who filed a self-assessment (SA) tax return and indicated that they were non-domiciled was as follows:
2008-09 is the most recent tax year for which data are available.
The figures above include both individuals who were UK resident and individuals who were not UK resident.
Individuals who complete a SA return are only required to indicate that they are non-domiciled if this affects their tax liability. Therefore the actual number of non-domiciled individuals who complete a return will be greater than the number who indicate their non-domicile status on their SA return.
The annual £30,000 remittance basis charge was introduced with effect from the 2008-09 tax year. The number of non-domiciled individuals who paid the charge in 2008-09 was 5,400. This is a provisional figure rounded to the nearest hundred and may be updated once all returns for the tax year have been received and analysed.
Figures are not available for the total amount of UK tax paid by non domiciled individuals. However, it is possible to calculate the total amount of UK income tax and capital gains tax (CGT) paid by individuals who completed an SA return and indicated that they were non-domiciled. These amounts for the past five tax years were as follows:
Several taxes are not accounted for via the SA system and some non-domiciled individuals are not required to complete an SA return at all.
The Telegraph article implies that all of the £5.9bn referred to by David Gauke was paid by the 5,400 individuals opting to pay the £30,000 levy. The truth is therefore that the £5.9bn includes income tax and capital gains tax paid by all non-domiciled individuals (whether cleaner, investment banker or multi-billionaire). This represents an average of £48,000 in income tax and CGT for each non-domiciled individual, clearly higher than for UK domiciled individuals, but miles away from the £1 million figure the Telegraph quotes.
Will the Telegraph retract their article and publish a correction?
We will publish our views on the tax treatment of non-domiciles in a later post.
Written by admin
February 16th, 2011 at 7:25 pm
It has been well documented that Philip Green has structured the ownership of the Arcadia group (which owns Topshop and Dorothy Perkins) so that neither he nor his wife pay UK income tax on profits paid out by the group as dividends.
Based on information already in the public domain (including the Guardian and the Daily Telegraph among others), it is understood that the Arcadia group is owned by a Jersey resident company called Taveta Investments Ltd, which in turn is owned by a trust in Jersey of which Mrs Green is the settlor (i.e. set up the trust and its terms). Mrs Green is tax domiciled and resident in Monaco and therefore does not pay any UK tax on any income (including dividends from Arcadia). If dividends were instead paid to Mr Green as a UK tax resident, he would be subject to UK income tax at an effective rate of 36.1% (42.5% additional rate less 10% credit). Quite a saving.
We have tried to show a simplified diagram of the arrangements below although we understand the actual arrangements are more complex than this – we would be happy for Mr or Mrs Green to clarify our understanding.
Of all the tax avoidance schemes raised by UK Uncut, Philip Green’s seem to be most widely viewed as unacceptable. In fact Vince Cable has made comments to this effect but is now part of a Government that has not yet taken any action to counter avoidance schemes of this type. What is so striking is that the solution is so simple.
Should the UK implement a dividend withholding tax?
Currently, the UK only taxes dividends from UK resident companies when received by UK tax residents. In general this means that non-UK residents can be resident in tax havens and not pay any tax at all, whereas residents of the UK would pay tax.
Despite lots of recent rhetoric about how uncompetitive the UK tax regime is, many other states deduct tax on payment of dividends to non-resident companies or individuals (referred to as ‘withholding tax’ or ‘WHT’). In recent times several UK multinational groups have relocated their parent companies to Ireland (Shire, United Business Media, WPP) or Switzerland (Wolseley), but both of these countries in principle deduct their own tax from dividends paid to non-residents (20% for Ireland and 35% for Switzerland). This has not stopped the tax regimes in these countries as being viewed as more attractive overall.
Of course, the tax regimes in Ireland and Switzerland would not be attractive if in practice this dividend WHT was paid on most dividends. Both countries provide exemptions from the tax where individuals are resident in the EU or in another country with a tax treaty. However, tax havens such as Monaco, Jersey, Cayman Islands etc generally do not enter into tax treaties so dividends paid to individuals resident in such places would have WHT deducted at source.
Is there any reason why the UK could not adopt a similar system? It could be compatible with EU law as long as we do not discriminate between individuals resident in the UK versus other EU member states. We also have one of the largest networks of tax treaties covering all of our major trading partners. The only individuals that would be disadvantaged would be those resident in tax havens. We could even copy the law from Ireland (as they have copied much of our tax law in the past and ‘improved’ on it).
Of course, one of the complexities that would have to be dealt with is interposing other holding companies between the UK company and the relevant individual. However, tax treaties already have the concept of ‘beneficial ownership’ meaning that arrangements involving pure ‘conduit’ companies can be ignored. Ireland, Switzerland and other similar regimes seem to cope with these issues.
All of this begs the question:
What is stopping the Government from changing the law to tax dividends paid to tax havens?
Written by admin
February 16th, 2011 at 11:11 pm
I read with a little disbelief that Apple, Cisco and other US corporations are to start lobbying for a repatriation tax holiday.
The US has similar (but not identical) rules to the UK called Controlled Foreign Companies (or CFC) rules designed to prevent offshore tax avoidance. Under these rules, US multinationals are in principle subject to tax on the group’s worldwide earnings. However, US multinationals (like their UK cousins) typically implement tax planning structures to ‘defer’ taxation of their offshore earnings by taking advantage of a range of exemptions (which some might call ‘loopholes’).
Some US multinational companies have taken this tax planning to such an extreme that the effective tax rate they pay on their global earnings is in single digits. One example (which we will dissect in a later post) is Google, which Bloomberg reports pays an average of 2.4% corporate tax on its overseas profits, through legally allocating most of its profits to Bermuda.
However, currently this low tax rate is only a ‘deferral’ rather than a ‘permanent’ tax benefit. Once the earnings of these offshore companies are paid back to the US as dividends, they will be subject to tax at 35%, with credit for the (minimal) foreign taxes paid. Typically, this ‘deferred’ tax liability is not recognised in the group’s published accounts on the basis that the group controls when dividends from low-tax offshore subsidiaries are to be paid, and in theory could decide never to pay dividends to the US (and therefore not pay the tax). However, from a shareholder’s perspective, they cannot get access to these earnings unless dividends are paid up to the US triggering the tax – in effect the true ‘earnings per share’ and other similar measures are significantly understated.
Apple and other multinational groups are to start lobbying to make this ‘deferral’ benefit permanent, which would effectively mean that offshore profits will escape US tax all together.
Unpicking the likely arguments to justify the tax holiday
The Fortune article hints at some of the arguments that these corporations will use to justify this multi-billion dollar one-off tax benefit for their shareholders:
- The tax holiday will bring back cash to the US which can be invested in new jobs
- Even if some cash is paid as dividends to shareholders, they will spend this money boosting the US economy
The first of these is clearly fallacious. There is no reason why if cash is sitting in a group’s overseas subsidiaries, this could not be lent to other group companies (including in the US) to fund investment. The loans could even be interest free to stop further earnings rolling up offshore. What the multinationals are really interested in is therefore repatriating reserves stuck offshore in low-tax structures without paying the resulting US tax on dividends described above.
The second point may have a grain of truth as given more cash most individuals will choose to spend some of this today, although typically will save a proportion or pay down debt. However, the key point is that any repatriation tax holiday would benefit only shareholders of these groups in particular at the expense of all other US taxpayers, including the poor who own no or proportionately fewer share investments. Absent the tax holiday, the US government could collect the tax and use this to either reduce taxes for everybody or fund additional spending.
What can the US learn from the UK?
The situation in the UK is slightly different as, from 2009, we already exempt dividends received by offshore subsidiaries from UK tax. This means that UK groups can repatriate reserves from any low-tax offshore subsidiaries (for which tax planning has been implemented) without paying additional tax.
What is interesting is that there is no evidence that the introduction of the dividend exemption in 2009 has boosted investment or jobs in the UK through repatriation of offshore reserves to the UK.
Progressives in the US such as US Uncut, take note.
EDIT 18 Feb 2011 – one of the comments below clarifies a US tax technical point that a loan from a CFC to a US parent may be treated as a taxable dividend in the US in certain circumstances. This means it may be more complex than the article above describes to repatriate cash tax free back to the US (although further planning may be possible). Note that this difficulty only arises because of low-tax offshore structures having been entered into.
The fundamental point of the article remains that the tax holiday would be a subsidy to shareholders in large US multinationals at the expense of all other US taxpayers, as well as an implicit acceptance of the tax avoidance schemes undertaken.
Written by admin
February 18th, 2011 at 1:24 pm
The Guardian reports that in 2009, Barclays paid only £113m of UK corporation tax, compared to worldwide profits of £11.6bn. It claims that this represents only 1% of its global profits.
While this may be factually true, it is a little misleading, as not all of Barclays’ profits are generated in the UK. However, a significant proportion are likely to be, given that Barclays Capital (much of which is based in the UK) and UK retail banking together make up approximately 65% of its profits (2009 figures).
The key reason why Barclays (and other banks) are not paying significant amounts of UK corporation tax is that significant tax losses were generated in the financial crisis of 2008. As at the end of 2009, Barclays alone had total tax losses (recognised and unrecognised) of £14.2bn. Again, not all of these losses will be UK losses but we can make an assumption that many are given Barclays’ business profile.
Under UK tax rules, these losses can be carried forward indefinitely and offset future profits entirely, until exhausted. In this respect, the UK has generous rules. In Germany, for example, companies can only offset 60 percent of their profits in any one year using losses from earlier years, with the rest carried forward. This ensures that in any specific year, profitable companies make a contribution to tax revenues while allowing relief for genuine commercial losses over time. Other countries (including the US) apply an alternative minimum tax calculation with partial or full restrictions on losses.
You can debate whether 60 percent is a too generous or too restrictive amount of loss relief to allow in a given year. However at a time when banks are making record profits again while the Coalition government is making record cuts, it does not seem unreasonable to ask that banks (and other multinationals) pay a minimum level of corporate tax.
Changing the rules on loss relief would be relatively simple, and would make a significant contribution to the Exchequer. What is stopping the Coalition government?
Written by admin
February 18th, 2011 at 9:03 pm
Many people will be unaware that a key consultation relating to taxation of the overseas profits of large UK multinational groups is due to close on 22 Feburary. While the 100 page consultation document is undoubtedly a dry read, it contains major proposals to significantly change the way that multinational companies are to be taxed in the UK from 2012. In this post we seek to explain what these reforms are and why in practice they are likely to mean multinational companies pay no or little corporate tax in the UK.
Background to current rules
As we described in our article on Vodafone’s tax planning arrangements, under current tax legislation called the Controlled Foreign Companies (CFC) rules, UK groups with overseas subsidiaries are in principle subject to tax on their profits unless they meet one of a number of exemptions. In general, genuine trading companies or companies paying tax close to UK levels will not be subject to additional tax in the UK. Companies who undertake ‘passive’ activities (such as intra-group financing) and pay little overseas tax are likely to be subject to tax in the UK. The rules are designed to prevent UK companies from moving activities out of the UK to low-tax jurisdictions to escape UK tax.
However, these rules are subject to an additional qualification under EU law as a result of a challenge by Cadbury-Schweppes (as then known) that the rules are contrary to the right of freedom of establishment provided in the EC Treaty. The European Court of Justice found in favour of Cadbury-Schweppes and established the principle that CFC rules (in the UK but also in other EU jurisdictions including Germany, Italy and Sweden) can only apply to ‘wholly artificial arrangements’ where a company in an EU member state does not undertake ‘genuine economic activities’. As the meaning of these terms has never been tested in UK courts (not least because the Government settled its case against Vodafone), there is uncertainty over what sort of tax planning within the EU would fall within this additional requirement.
In practice this means that many groups have actively sought to implement EU-based tax avoidance structures and provide enough ‘substance’ (i.e. local employees) to create uncertainty over whether the arrangements would be subject to UK tax under CFC rules. As the ‘wholly artificial arrangements’ test would always be a question of fact applying to a specific taxpayer, even if HMRC successfully won a case against one multinational group, other multinationals could continue to implement EU-based structures, and simply add additional functions to their overseas subsidiary to further build ‘substance’ and uncertainty.
In our view, the Government therefore has little realistic alternative to accepting that while the UK is a member of the EU, it cannot wholly prevent UK multinationals moving activities from the UK to other EU member states. Some reform of the current rules is therefore necessary. However, the detail of the proposed reforms when taken together with existing tax rules will simply encourage further tax avoidance and lead to multinationals paying little or no UK corporation tax.
Key elements of proposed CFC reforms
The general principle underlying the proposals is so-called ‘territoriality’. This means that there will be a general presumption that where profits genuinely arise outside of the UK, the UK will not seek to tax these profits. In our view, this is reasonable for trading companies given the EU law position described above, and the complexity of the existing exemptions.
However, a key element of the proposed rules is the introduction of a ‘finance company exemption’. Under current proposals, only one third of a non-UK finance company’s profits will be subject to UK tax, as long as the financing profits do not arise from loans to UK companies (which would create UK interest deductions significantly exceeding the UK profits taxed on the same loans). In theory, this means that a UK company could take all of its loans used to finance its overseas subsidiaries and contribute them to a subsidiary in a tax haven as additional equity. By implementing an all-paper transaction that can be done in a matter of days, groups will be able to eliminate tax on two thirds of their financing profits from overseas companies. In practice, the need for tax treaties to apply will mean that groups will likely locate their financing activities in tax-friendly EU member states with wide treaty networks such as Ireland and Luxembourg rather than tax havens, but you can bet there will be an industry in obtaining favourable tax rulings for UK clients.
In principle, the finance company exemption itself will only provide a statutory basis for the sorts of deals which multinationals have been able to achieve with HMRC by ‘playing the percentages’ due to the uncertainty over EU law. We would rather tax be based on clear statute rather than through unnacountable deals. However, in our view the rules when combined with the UK’s generous rules on interest deductions will mean an almost complete erosion of the corporate tax base of UK PLC. We describe how below.
It’s the interest deductions, stupid
Anybody familiar with UK Uncut’s coverage of Alliance Boots will know that following the takeover by KKR, the group pays no UK corporate tax. This is because Boots in the UK is paying significant amounts of interest which wipes out its UK taxable profits.
While Boots is an extreme example, many UK multinational groups use interest deductions to reduce their UK tax bill. In some cases, groups have lent billions of pounds in cash from low-tax offshore subsidiaries to UK parent companies. This led to the introduction of the Worldwide Debt Cap rules in 2009 which limit a group’s UK interest deductions to the amount of its worldwide interest expense as shown in the group’s accounts. In other words, if a group pays bank interest of £100 million, it can only get relief for interest deductions of £100 million even if it has other loans from its subsidiaries. While this has gone some way to reduce the impact of some tax avoidance structures, when combined with CFC reform which encourages UK groups to move further profits offshore, it does not go far enough.
Take the following example:
In the above scenario, UK PLC has £4 billion of debt from banks on which it pays interest of £200 million per year. The group has worldwide earnings before interest and tax (EBIT) of £500 million but only £100 million of this arises in the UK. The group has moved all of its loans to non-UK subsidiaries (worth e.g. £3 billion) to an offshore financing company. These loans generate deemed UK taxable income of £50 million under the proposed ‘finance company exemption’ on the basis that the interest on the loans is £150 million (i.e. one-third is taxable in the UK).
What is the corporate tax position in the UK of this arrangement? The answer is likely to be that UK PLC will pay no corporate tax in the UK despite earning £100 million of earnings before interest. In fact, if there are no adjustments for tax purposes from the accounting result, UK PLC will even make a UK tax loss of £50 million. This is because UK tax rules allow UK PLC to take full relief for the £200 million of bank interest against UK profits despite the fact that only a small proportion of the group’s overall profits are made in the UK. In effect, the UK is allowing deductions for interest on debt which is used to finance exempt overseas investments. Note that the Worldwide Debt Cap has no impact in this case because the UK interest deductions equal the group’s interest payable on bank debt.
These numbers are illustrative but are not that different to the reality for many multinational groups. Take a look at any FTSE 100 group accounts and see for yourself.
Allowing interest deductions for investments in wholly or partially exempt subsidiaries will likely lead to most large multinationals paying significantly reduced or no UK corporate tax.
The solution has to be that the UK limits interest deductions to take account of the size of a multinational’s UK business compared to its overseas businesses. Interestingly, this was one of the options considered by the Labour government in 2009 but was shelved due to lobbying by multinationals and their advisors.
How to limit interest deductions
Imposing a limitation on interest deductions is not a new concept. Several of our international competitors have such rules.
Germany’s rules provide that where interest expense exceeds €3 million, interest can only be deducted for tax purposes up to 30% of taxable EBITDA.
Similarly, in the US, interest can only be deducted up to 50% of the US adjusted taxable income.
The interesting point about both these regimes is that their CFC rules will be more restrictive than UK rules once the proposed reforms are in place (meaning they are more likely to tax overseas profits) and yet they still have interest limitation rules. In our view relaxing CFC rules without imposing some form of interest limitation similar to the US or Germany presents an unacceptably loose relaxation of the UK corporate tax base.
Some will say that imposing restrictions on interest deductions will make businesses less likely to invest in the UK. However, the interest limitation would not have a significant impact in the case of inbound investments because in these situations the deductible interest is already limited to the ‘arm’s length amount’ under thin capitalisation rules, i.e. that which a bank would be willing to lend if it imposed interest cover covenants or similar.
In addition, an interest limitation should not be impacted by where a group’s headquarter location is or indeed provide an additional reason for groups to relocate their headquarters outside of the UK. If in our example a new Irish parent company was inserted (as has been done by Shire, United Business Media, WPP and others), the overseas subsidiaries could be moved ‘out from under’ the UK PLC and no longer be subject to CFC rules. However, in this case the UK PLC would not be able to support the debt as an ‘arm’s length’ amount of debt under general thin-capitalisation rules.
It should also be noted that the planning that we describe above is only possible for multinational groups and not small or medium sized groups operating solely in the UK market. The latter do not have any interest expense attributable to overseas investments which they can use to reduce their UK tax bill. Is there any wonder that our small and medium sized businesses are struggling to compete with multinationals whereas in Germany small and medium sized businesses are leading the recovery?
At a time of budget cuts and tax increases for individuals and small businesses, is it really right that our corporate tax reform will reduce the UK tax payable by large multinationals?
February 21st, 2011 at 8:54 am
Why Ireland is an EU corporate tax haven
The Guardian Ireland Business Blog has published an interesting article on Ireland’s ‘real corporate tax take’. It references a report called The Economic and Fiscal Contribution of US Investment in Ireland, written by an economist at the Irish Revenue, and presented to the Statistical and Social Inquiry Society of Ireland in 2010.
The Guardian article highlights the newspaper’s own take on the report from an Irish perspective. However, I think one of the most interesting points is that in 2009, investment in the Irish International Financial Services Centre (IFSC) rose to approximately €1,800 billion. The report says:
“much of the inward IFSC investment involves the movement of capital by multinational companies to subsidiaries in the IFSC that is re-invested overseas”
The amount of IFSC investment and the frank observation of the Irish Revenue that much of this is intra-group on-lending activity appears to strongly support the view that Ireland has become a major hub for intra-group financing by multinationals. This is partially due to its 12.5 tax rate for financing businesses in the IFSC, however many other businesses can operate in Ireland and record no or only a small amount of taxable income. In this case, it is irrelevant what the headline tax rate is as the ‘tax base’ is so small. We explain how below.
Transfer pricing and why it matters
It is pretty well known that Ireland has one of the lowest corporate tax rates in the EU of just 12.5% for trading activities (including financing in the IFSC). A separate 25% rate applies for non-trading activities including financing not in the IFSC. This makes it an attractive place to invest even before you consider its specific tax rules in more detail.
However, what is so unique about Ireland compared to other countries is that it does not have comprehensive ‘transfer pricing’ rules. In general, most states treat contracts between related parties as taking place on ‘arm’s length’ terms. This means that if a company sells goods or services (including financing) to a related party, it is taxed on the market rate, even if a lower (or no) charge is actually made.
Ireland has historically had no transfer pricing rules whatsoever. This means that profitable activities have been located in Ireland and the Irish Revenue will not challenge the profit actually recorded and taxed in Ireland. With effect from 2011, Ireland has introduced transfer pricing rules but only for trading activities (and only transactions with terms agreed after July 2010). For non-trading activities, including intra-group financing activities not treated as trading transactions in the IFSC, transfer pricing rules do not apply. Funnily enough, most international tax planning has traditionally revolved around structuring tax efficient intra-group financing.
All this means that multinational groups can continue to locate their financing in Ireland and pay no corporate tax as long as they do not actually record any profit in Ireland. This in itself does not lower the group’s overall worldwide tax bill. The magic of the Irish regime is that certain other jurisdictions (including Luxembourg) apply their own transfer pricing rules symmetrically to deem transactions to take place at market rates even if the actual rate charged is more beneficial (i.e. allow an additional expense for tax purposes). Take the following example:
In this case, the parent company provides Ireland with £1 billion new equity funding, which is on-lent interest free to Luxembourg. This cash is then on-lent to other subsidiaries around the world (e.g. UK and other EU states) at market interest rates (say £50 million per year).
Ireland does not view any taxable income as arising as it does not apply transfer pricing rules to non-trading transactions (even after changes applying from 2011). Luxembourg helpfully applies its own transfer pricing rules symmetrically to deem interest as being paid at market rates to Ireland for tax purposes, meaning that only a small amount of taxable profit is recorded in Luxembourg. Meanwhile the loan to subsidiaries in other countries is at market rates meaning that interest deductions will generally be available for local tax purposes. The overall result is that the group will pay significantly less tax worldwide.
You might ask why Ireland is used in planning structures like this in place of classic tax havens such as Bermuda, Cayman Islands and Jersey. The answer is that in these cases many countries would apply withholding tax on interest paid to traditional tax havens. Ireland’s lack of transfer pricing rules combined with the symmetrical transfer pricing rules in countries such as Luxembourg allows tax treaties with these countries to be relied on to avoid withholding tax.
This example is simple but highlights a key piece of tax avoidance ‘technology’ that is being used by many multinationals, and is also relevant to other transactions including licensing of intellectual property (as long as this is ‘non-trading’ activity). Stay tuned for further discussion of an example of this in a separate post.
How does this affect the UK?
As we discussed in our post on the implications of proposed reforms to the corporate tax regime, the UK is moving towards a territorial taxation system where the general presumption is that it will not tax trading activities arising outside the UK, and will tax only one third of financing profits, as long as there is no significant tax deduction arising in the UK from the various transactions.
Once we move towards this system, there really is a carte blanche for UK multinational groups to move all of their worldwide financing (and potentially intellectual property) activities to Ireland and similar ‘respectable’ jurisdictions which have tax treaties in place but in reality facilitate tax avoidance. Territorial taxation relies on profits being recorded in the right places, and therefore requires that transfer pricing principles are respected, however Ireland is singularly failing to live up to its international obligations to tackle tax avoidance in this respect.
Will the UK and other EU member states lobby Ireland to introduce comprehensive transfer pricing rules to prevent artificial tax avoidance?
Written by admin
February 23rd, 2011 at 6:02 pm
Robert Peston’s blog today covers a recent speech given by Lord Turner, Chairman of the Financial Services Authority. This is in the context of several banks having recently announced significantly increased profits and large bonus pools (including HSBC and Barclays).
This article does not cover all of the points already addressed in Robert Peston’s blog. However, it is worth noting in more detail the comments that Lord Turner makes on whether the increasing prominence of the financial services sector has benefited society in general, or only those involved in financial services, and what this could mean for public policy. Lord Turner says:
“while some increase in the relative scale of financial activity may have been both inevitable and desirable, there are both empirical and theoretical reasons for questioning whether it all was. Empirically it is worth noting that the period of post-war ‘financial repression’ from 1945 to 1975, apparent both in measures of financial activity and of financial sector remuneration, was one of rapid and steady economic growth which compares well with the subsequent 30 years. There is no aggregate level empirical evidence to support the belief that financial liberalisation and financial deepening has generated superior economic performance.“
If you have read that too quickly, read it again. The Chairman of the Financial Services Authority, the body tasked with overseeing regulation of our financial services sector, is saying that there is no macro-level empirical evidence that financial liberalisation has resulted in superior economic performance, i.e. real value added to the economy. Lord Turner acknowledges that we need to ask ourselves a serious question over whether the growth of the financial services industry has benefited only its participants with no benefit for (or possibly at the expense of) other market players – i.e. corporates, individuals and government.
Lord Turner goes on to acknowledge that there are significant factors that could point to financial services groups making ‘economic rents’, i.e. profits above those necessary for the services to be provided in a competitive market derived at the expense of customers and society. He points to four factors in particular:
- The first involves rent extraction from society in general via tax management activities, which benefit the financial service sector’s clients, but also, through fees earned, the industry itself…
- The second involves rent extraction via high but non transparent margins charged both to retail and to wholesale customers, exploiting deep asymmetries of information and expertise…
- The third involves super normal returns for activities which are also to a degree value added. Market making, i.e. providing liquidity to enable customers to contract in large volumes at reasonable bid offer spreads is, at least up to a certain level of market liquidity, a value creative activity. But market making is an activity likely to be characterised by naturally arising oligopolies and opportunities for super normal returns… Market makers therefore enjoy a systematic tendency to make position taking profits, while customers systemically loose, but in an opaque fashion which few customers understand.
- The fourth involves the encouragement by agents (fund managers or banks) of valueless increased trading activity which not only generates income directly, but which, by generating volatility, can itself stimulate demand for hedging services…”
Lord Turner acknowledges that further work would be required to determine the actual balance of real economic value-adding activity by financial services groups compared with economic rent extraction through the methods described above, although hints that he thinks the latter is likely to be significant. What is clear is that as a society we need to ask ourselves whether we find it acceptable for banks to be profiting from the above activities, and if not, determine what would be appropriate public policy responses.
If we believe that a significant proportion of bank profits are due to economic rents, these profits are effectively transfers from individuals and non-financial companies to shareholders of banks and a potentially significant drag on economic growth. Effective public policy to reduce supernormal profits derived by financial services groups from economic rents could therefore benefit society.
Lord Turner addresses the question of what public policy responses may be appropriate in his speech. He doubts whether supply-side measures to boost competition could have any significant effect on reducing economic rents, for example due to customers lacking information and understanding, and also specialisms within particular market segments creating de-facto monopolies or oligopolies in economic terms. Instead Lord Turner concludes:
“The potential existence of economic rent or of financial activity on a harmful rather than useful scale could justify financial transaction or other financial activity taxes, such as those discussed by the IMF in June 2010. If there are super normal returns which are unamenble to structural remedies, economics teaches that taxation is the appropriate response.”
In one sense, it is surprising that Lord Turner says that a financial transaction tax (or Tobin tax) may be justified, as the IMF report that Lord Turner refers to rejects this in favour of a levy (e.g. the bank levy that the UK has implemented) or a financial activities tax.
Microeconomic theory also tells us that any tax which affects relative prices will generally lead to less social welfare overall than taxes which redistribute profit (pro-rata or by lump sum). Specifically, if we levy turnover taxes on profitable producers then output will be reduced and deadweight loss introduced. In other words, a Tobin tax could lead to banks reducing the services offered to customers on the margin but increase prices with the effect that customers are directly worse off (although some of this loss is offset by government revenues which can be redistributed to customers to make up their loss). In contrast, microeconomic theory tells us that neither a lump sum bank levy or additional profits tax should affect relative prices and therefore overall social welfare.
Does this mean progressives should argue for additional profits tax or increased bank levy instead of a Tobin tax?
Let’s deal with a financial activities tax first. In theory at least, there is no reason why an additional profits-based tax could not be introduced to reflect the economic rents derived from financial services activities undertaken in the UK. In fact, the UK already levies a ‘supplementary charge’ of 20% on companies operating in the UK oil and gas sector, meaning that such companies pay 50% corporation tax on their profits derived from the UK oil and gas activities. However, in applying this to the financial services sector there are two issues to be considered further.
First, we know that banks already have substantial tax losses due to the financial crisis in 2008 meaning that in the short term many will pay no or minimal UK corporation tax relative to their profits. We have already discussed our view that it is appropriate to defer use of these losses over time rather than allowing groups to pay no UK corporation tax in the short term. However, a supplementary charge could instead be introduced on UK profits at e.g. 20% from 2011 onwards while allowing loss relief at 28% (reducing to 24% by 2014), so that banks can still use losses while at the same time the supplementary charge raises tax revenue.
Second, and perhaps more importantly, we know that banks are highly-skilled tax avoiders adept at moving profitable activities to low-tax jurisdictions. Increasing the corporate tax charge significantly will provide additional incentives for banks to move activities outside of the UK. Oil and gas companies operating in the UK and paying supplementary charge ‘in the ringfence’ can’t do this as the oil and gas is physically in the North Sea. However, banks can because their profits will arise (under transfer pricing principles) where their key employees are located or where financial and economic risks are borne. Simply increasing the tax rate on UK profits will not have the desired effect if this leads to the tax base being reduced (with consequential impact on non-corporate taxes including income tax and national insurance).
Similar disincentives could theoretically apply on the margin in the case of the bank levy that has already been introduced. Under current UK rules, the levy is applied based on the value of financial liabilities, and applies to UK parented multinational banks as well as UK subsidiaries or branches of foreign groups. At least for UK parented groups, it would seem more difficult to artificially avoid the bank levy compared to a supplementary charge on profits. In our view, this means that of these two alternatives, a bank levy is preferable.
However, we doubt that the levy of £2.5bn per year implemented by the Coalition government represents anywhere near the ‘economic rents’ referred to by Lord Turner. This requires further econometric research but to put into context Barclays alone earned profits before tax of £5.4bn in 2010.
Why a Tobin tax is still desirable
A significantly increased bank levy is theoretically optimal in microeconomic terms, however there is good reason for progressives to argue for a Tobin tax as well (or instead) due to practical considerations.
In particular, it is highly likely that a Tobin tax could raise significantly greater tax revenues than a bank levy, which could enable spending cuts or tax increases (e.g. VAT) to be reversed. In pure microeconomic terms this will represent a short-run decrease in overall social welfare, as welfare of bank shareholders would decrease by more than the increase in welfare to wider society (including tax revenues). However, this deadweight loss is conceptually no different to many other taxes including income tax or national insurance used to fund desirable social programmes, i.e. increase the welfare of the poorer or more vulnerable at the expense of the wealthy.
In addition, there is good reason to think that tax revenues could be used by government (or non-financial businesses) to invest in genuine economic value-adding activities and thereby increase economic growth faster in the medium run. We all know that banks continue to show reluctance to lend to small and medium sized businesses unless they can be sure that loans will be profitable for them, i.e. economic rents are arguably not being reinvested by banks in economic value-adding activities.
As the Robin Hood tax campaign rightly says, the UK could introduce a Tobin tax without international agreement, and it is not credible to argue that this will lead to an exodus of financial groups from the UK. We already have a stamp tax of 0.5% on transactions involving UK shares and this clearly does not impede the liquidity and attractiveness of the London Stock Exchange as one of the world’s leading financial exchanges. The Robin Hood tax campaign estimates that a Tobin tax of just 0.05% could raise up to £20 billion, about 20% of the UK budget deficit.
What is clear is that banks are making profits from activities with no social or economic value. However we do it, now is the time to increase tax on these activities for the benefit of society as a whole.
Written by admin
March 1st, 2011 at 12:12 pm
Every now and then a quote from a business on tax issues comes along that leaves you flabbergasted.
The Daily Telegraph has today reported on debates taking place in the House of Lords to repeal Low Value Consignment Relief (LVCR). Richard Murphy has covered this story on numerous occasions. LVCR is essentially the mechanism by which online retailers can ship goods (books, CDs, DVDs etc) from non-EU member states to the UK (and the EU more generally) free of VAT and customs duty.
This has been a great business opportunity for the likes of Play.com but also more traditional retailers such as Tesco who have moved their online retailing operations to Jersey or Guernsey to cut indirect tax costs. However, it is no coincidence that high street retailers traditionally dealing in these products are disappearing – remember Virgin Megastore, Woolworth’s, Tower Records, not to mention independent stores?
The Telegraph has a quote from one online retailer saying repealing LVCR would be:
“an attack on business innovation”
Can somebody explain what business innovation arises exactly from a VAT relief that encourages large retailers to move online sales to the Channel Islands while UK mainland stores grapple with having to price in 20% VAT?
Some will argue that repealing LVCR will simply lead to costs being passed onto consumers. Even if this were true this is not necessarily a bad thing as the increased tax revenues on products that are hardly neccessities could be used to offset tax increases in other areas or even marginally reduce the overall VAT rate.
The LVCR is outdated in this era of online retailing and only serves to further reduce the diversity of the UK retail sector.
Written by admin
March 3rd, 2011 at 10:28 am
Anybody who has attempted to read the 191 report by the Office of Tax Simplification on simplifying tax reliefs should be congratulated; it’s not exactly the most interesting document, and mainly deals with obscure tax reliefs that most people will not have heard of.
There is more interesting discussion over whether the income tax and national insurance regimes should be combined into a single tax (although no real conclusion), and the report recommends abolishing the £8,500 threshold for more generous treatment of employee benefits for low paid workers. However, to give you a taste for some of the other content, of the 191 pages, two deal with the duty treatment of angostura bitters and a specific black beer drunk only in Yorkshire. This is hardly the sort of complexity in the tax system that people complain of.
Nevertheless, there is one relief mentioned deep on page 179 related to relief from withholding tax for interest paid on so-called ‘Eurobonds’ over which there is remarkably little discussion in arriving at the report’s conclusion:
P.79 This relief exempts interest paid on Eurobonds from deduction of tax so that the holder of the Eurobond receives interest gross rather than net of tax.
P.80 A quoted Eurobond is a security, including shares (in particular any permanent interest bearing share), listed on a recognised stock exchange, and carries a right to interest. Some of the major issuers are supranational organisations (such as the World Bank or the European Bank for Reconstruction and Development).
Is the policy rationale still valid, does the relief achieve it and what might be the impact of repeal?
P.81 The original policy rationale is to encourage the growth of the UK Eurobond market, as London is one of the centres of the worldwide Eurobond market.
P.82 If it were repealed, it could reduce investment in this area, and also reduce investment in the UK.
Taxpayer take up and awareness
P.83 This relief is targeted at any holder of Eurobonds.
P.84 In the year to November 2010, funds raised through Eurobonds issued on the main UK market totalled £393billion in over 3,300 issues.
Complexity, compliance costs and administrative burden
P.85 The relief is a simplification to the taxpayer as it removes the need to account for withholding tax.
P.86 The policy rationale remains valid and it is a simplification for the holders.
P.87 We recommend that this relief be retained.
The description of the relief from the OTS is brief and it is useful to put it in broader context.
In general, if a UK resident company borrows money from a non-resident company, it will obtain a tax deduction for the interest payable but under UK tax law is required to withhold UK income tax at 20% on interest paid to the non-UK company. The UK has entered into a number of tax treaties and is also obliged to follow the EU Interest and Royalties Directive which means that in many cases interest payable to an EU member state or another country which has a tax treaty with the UK (e.g. US) will in practice not be subject to UK withholding tax. However, interest paid to companies or individuals resident in tax havens will generally be subject to 20% withholding tax as no treaty will apply.
The relief referred to by the OTS is a specific exemption from withholding tax on interest if the debt on which the interest arises is a ‘quoted Eurobond’. This may sound like a complex financial instrument but in practice this can include any loan agreement which is listed on a ‘recognised stock exchange’, even if the lender is a related party. The term ‘recognised stock exchange’ can appear to give the exemption legitimacy but in fact this includes the Channel Islands and Cayman Islands, among other exchanges.
Take the following example:
In this case, the UK subsidiary of a multinational group borrows significant debt from a group company resident in the Cayman Islands. The UK company decides to list the debt on the Cayman Islands stock exchange despite the fact that the lender is a group company and always will be (there is no prospect of a third party buying the debt). As a result of the listing, the UK company is still able to obtain a tax deduction for interest (reducing its UK taxable profits) but is not required to withhold any tax on interest paid. Meanwhile the Cayman Islands lender pays no tax whatsoever. The result is a significant UK tax saving all for the relatively insignificant listing fees and related legal costs associated with listing on the Cayman Islands stock exchange.
The OTS claims that the policy rationale is to promote investment in the UK, and that the relief is a “simplification to the taxpayer as it removes the need to account for withholding tax”. This is either naive or disingenuous. The relief is not a “simplification” but a complete exemption from UK tax for interest paid on these instruments, including to tax havens. The OTS only refers to the Eurobonds issued on the main UK market but neglects to mention that the exemption also applies for listings in tax havens and secrecy jurisdictions.
However, even in these secrecy jurisdictions the listing is public (just ‘public’ enough); anybody can visit the websites of the Channel Islands or Cayman Islands stock exchanges and view the listings for themselves. While we cannot definitively say that all of the listings of debt issued by UK companies on these exchanges are purely for UK tax avoidance purposes, it is difficult to avoid this presumption in many cases.
We thought it would be interesting to highlight some of the companies that have debt listed on these exchanges. Unfortunately the sham of these sorts of instruments being publicly traded securities means that information on holders is not made public – although some borrowers do disclose in their own statutory accounts.
|Issuer||Exchange||Holder||Debt amount||Interest rate||UK WHT saved p.a. (estimate)|
|British Telecommunications plc*||Channel Islands||Group company – unknown||£3,611m||LIBOR plus 10 bps (e.g. 2%)||£14m|
|Everything Everywhere Ltd
(formerly T Mobile (UK) Ltd)
|Channel Islands||Unknown||£1,250m||Floating (assume 5%)||£12m|
|Ineos Holdings Ltd*||Channel Islands||Ineos US Finance LLC (group company)
(Note: LLCs are typically non-taxable entities under US tax law)
|$1,785m||Floating (assume 5%)||$18m|
|Taveta Investments (No. 2) Ltd*
(parent of Arcadia / BHS)
|Channel Islands||Group company – unknown||£180m||8%||£3m|
|BlackRock Finco UK Ltd||Cayman Islands||Group company – unknown||$3,450m||7.43% to 8.90%||$55m|
|Hewlett-Packard Holdings Ltd||Cayman Islands||Hewlett-Packard Marigalante Ltd
|£3,721m||6.5% to 8.3%||£50m|
|Transocean Drilling U.K. Limited||Cayman Islands||GlobalSanteFe Services (BVI) Inc
(British Virgin Islands)
|Transocean Drilling U.K. Limited||Cayman Islands||Transocean Inc
|$750m||LIBOR plus 500 bps (e.g. 6%)||$9m|
These are just a few examples from only two offshore exchanges but is enough to illustrate the point. We would be interested to hear from the above companies to understand what the commercial reason for listing on these exchanges is if it is not to avoid UK withholding tax.
Unfortunately the fact that the OTS has glossed over the Eurobond exemption in its report means it is unlikely to be subject to any further scrutiny (at least until this blog post). One has to question whether the fact that the committee is comprised at least partially by ‘Big 4′ accounting professionals, and led by a former PwC tax partner (John Whiting) has anything to do with this. For good measure we have highlighted the PwC audit clients with a “*” in the table above.
Why has the Office of Tax Simplification given its approval to a tax relief which encourages multinationals to locate finance companies in tax havens and pay no UK withholding tax?
Written by admin
March 4th, 2011 at 10:21 pm
Next Wednesday the European Commission will formally unveil its proposals for the introduction of a Common Consolidated Corporate Tax Base (CCCTB).
The basic idea is that rather than multinational groups completing tax returns in each European state in which they operate under different tax rules, one consolidated tax return is completed and then taxable profits allocated to member states based on specific measures (e.g. turnover by country, local staff, etc). The member state would then be free to tax the profits allocated to them at any corporate tax rate.
The important point is that as a taxation issue, any reform would require the unanimous support of the Council of Europe (made up of ministers from member states). The Department of Finance and business groups in Ireland have already made clear their opposition, and the UK Government argues that the policy would restrict countries’ flexibility to respond to economic developments and pursue growth and investment goals. Some might argue that what these countries are really concerned with is the reduced ability under a CCCTB to artificially relocate profits in low-tax EU member states (including Ireland).
In our view, it is highly unlikely that a compulsory CCCTB will ever be agreed by EU member states. There are too many vested interests concerned with retaining existing systems of taxation. However, we do think that some modest reforms would be possible and could attract the support of all member states. One of these is the treatment of what tax experts refer to as ‘hybrid instruments’ and hybrid entities’.
Tax avoidance through hybrid instruments and hybrid entities
As we have discussed in previous posts, one of the ways in which large multinationals avoid tax is to relocate financing profits to low tax jurisdictions or alternatively make the profits disappear altogether via cross-border transactions. Financing transactions are easy for multinationals to restructure as they do not involve movement of people or real tangible assets, and are therefore ‘paper’ transactions which can be implemented without any or limited public disclosure. We discussed how Ireland’s lack of transfer pricing rules (at least for financing transactions) allows groups to route financing through Luxembourg and effectively make financing income disappear. If groups can make profits disappear for tax purposes, then it is really academic what the corporate tax rate actually is.
Another way for groups to make profits disappear is to use so-called ‘hybrid instruments’ or ‘hybrid entities’. A hybrid instrument is simply a equity/debt investment or other transaction that is treated differently in one state to another. Similarly, a hybrid entity is a legal entity that may be taxable in one state only.
Take the following example:
In this case, a multinational group has deliberately structured its Dutch tax grouping (fiscal unity) so that the parent holding company is legally a Dutch Cooperative. In the Netherlands, this legal form is taxed as if it were a Dutch company (similar to a ‘BV’) whereas its partnership-like characteristics mean that many other countries view the Co-op as a partnership (or ‘transparent’ entity) for their own domestic tax purposes, with profits attributed directly to the members for tax purposes. In the diagram above we have shown a single member of the Co-op being a UK company within the multinational group. You might ask how it is possible to have a Co-op with only one member but Dutch law does make this possible (as long as the Co-op is initially established with two or more members).
The result of the structure illustrated above is that if the UK company lends to the Dutch Co-op and therefore receives interest from the Dutch Co-op, this will not be subject to tax in the UK, as the transaction is viewed for UK tax purposes as being a loan made from the member of the Co-op to itself. Meanwhile as the Dutch Co-op is a taxable entity in the Netherlands, it will receive an interest deduction for Dutch tax purposes which can be offset against trading or financing profits of Dutch companies in the same tax grouping. The result is that the group will have lowered its Dutch taxable profits without any taxation in the UK.
Similarly, it is possible to achieve the same effect by using a ‘hybrid instrument’ that is treated differently for tax purposes across jurisdictions. For example, suppose that a Spanish subsidiary of a multinational group issues preference shares instead of debt to a Dutch parent company for cash to fund its operations (or onward lending). The preference shares may specify that the parent is entitled to dividends of a fixed percentage each year (not dissimilar to interest). The Spanish subsidiary may treat the dividend payments as deductible for Spanish tax purposes due to being similar to interest payments on debt, whereas the Dutch parent company may respect that the dividends have been received on shares and apply the ‘participation exemption’ (meaning the dividends are not taxed). Again, the result is that a financing transaction leads to a tax deduction in the borrower state without taxation in the lender state.
These are just two examples to illustrate a general concept – that the use of hybrid entities and hybrid instruments allows multinational groups to make profits disappear entirely for tax purposes. While there are significant complexities and vested interests to tackle in harmonising an entire tax base across Europe, there does not seem to be any significant reason why common tax status of legal entities and tax treatment of financing instruments could not be adopted.
In fact, the UK among other states has already published a list detailing how it would ordinarily treat foreign legal entities for tax purposes. This does not disturb the local corporate legal aspects relating to these entities but just clarifies the UK tax position. A far better solution would be for each member state to publish a list of the legal entities that may be established under local law and state the resulting local tax treatment. The European Union could agree that all other member states should follow the tax status specified by the state of registration.
March 12th, 2011 at 9:33 am
As we referred to in our post last week on (lack of) effective EU rules to tackle cross-border tax avoidance transactions, the European Commission today released its proposals for a Common Consolidated Corporate Tax Base (CCCTB) within the European Union.
Essentially, a CCCTB would provide a common set of rules for calculating taxable profits within the EU as a whole, and then apportion taxable profits to member states based on a specific method of apportionment. The member states would then tax the apportioned profits following their own corporate tax rates (i.e. Ireland would not be required as a result of the CCCTB alone to increase its 12.5% rate).
The specific formula proposed by the Commission for apportioning taxable profits gives equal weighting to three factors, namely sales, staff and assets used in each member state:
Obviously the details of what makes up ‘sales’, ‘payroll’ and ‘assets’ is critical to how the apportionment would work in practice (and these weightings and specific details can be debated). The definition of assets proposed by the Commission only includes ‘tangible fixed assets’, i.e. machinery and other physical assets rather than ‘intangible assets’ including brands, patents, licences etc. We can already anticipate that some groups will argue that this is unreasonable as their profits are driven by intangible assets (e.g. pharmaceutical groups), however the flipside is that it is relatively easy to transfer intangible assets to a lower tax EU member state (Ireland, Luxembourg, Cyprus, etc) particularly if a transfer within the EU would be tax neutral. More critically, the proposal does not take into account any financial investments including in shares or debt, meaning that minimal taxable profits would be attributed to finance or holding companies which have few employees, but instead profits attributed to states where there is genuine commercial ‘substance’.
Separately, the proposals include measures to avoid the artificial transfer of profits from within the EU to low-tax jurisdictions outside the EU, in particular:
- General anti-abuse rule – this states that “artificial transactions carried out for the sole purpose of avoiding taxation shall be ignored for the purposes of calculating the tax base”
- Disallowance of deductions for interest paid to non-cooperative secrecy jurisdictions – although the benchmark for determining co-operation is Directive 2011/16/EU, which only requires exchange of information when requested for a specific taxpayer (obviously irrelevant if the requesting state does not know which taxpayers have offshore dealings)
- Controlled foreign companies rule – requiring that ‘passive’ (e.g. financing) income of low-tax subsidiaries as opposed to ‘active’ (e.g. trading) income is included in taxable profits
In our view, it is clear that the CCCTB as proposed would significantly reduce the ability of multinational groups to avoid tax through artificial intra-group transactions either within the EU, as these transactions would be ignored and profits attributed to where real commercial ‘substance’ is, or from outside the EU, as the proposed anti-abuse rules would apply. This is particularly desirable due to the fact that under current EU law, the principle of freedom of establishment within the EU is one of the key facilitators of cross-border tax avoidance by multinationals (as we explained in our post on Vodafone).
Some will argue that implementing a CCCTB will involve a loss of national sovereignty over tax policy. To a certain extent this is true, but given that multinationals can organise their intra-group transactions on a global basis, the only way to effectively tackle cross-border tax avoidance is through cross-border tax administration. It has to be the case that the flip side of the freedom to establish anywhere within the EU is that there is at least some common basis for taxation.
In our view, progressives should support the CCCTB as the most comprehensive way to tackle tax avoidance by EU multinationals.
However, even if desirable it seems pretty clear that the CCCTB will not be implemented (at least in the near future), as a unanimous vote of EU member state government ministers in the Council of the European Union would be required for the Directive to be adopted. While the Commission is proposing for it to be optional (at least initially) for groups to elect into the CCCTB, it is not unreasonable to assume that after a few years of the CCCTB being in place there would be proposals to make it mandatory. We would therefore expect multinationals to lobby the UK and other governments furiously to oppose the measure (even though their tax compliance requirements would be significantly reduced), providing an excuse for the Conservative-led UK government, Irish government and others to ‘defend’ business from ‘EU bureaucrats’ (or as David Cameron might put it, ‘enemies of enterprise‘).
With rejection of the CCCTB a fait accompli, what will be most interesting is the basis on which some EU governments and multinationals oppose the proposals while ignoring current systematic tax avoidance at the expense of ordinary individuals and smaller businesses.
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March 16th, 2011 at 9:59 pm
The debate on tax avoidance is due to take a twist after Caroline Lucas, the Green MP for Brighton Pavilion tabled a private member’s bill titled the Tax and Financial Transparency Bill.
The key measures included in the bill are:
- Obligation of banks to notify HMRC and Companies House of corporate bank accounts – to avoid companies evading tax and regulatory requirements by disappearing
- Country by country reporting – meaning multinationals have to disclose where they actually book their profits (i.e. in tax havens or otherwise).
Richard Murphy’s blog has more on this, as he has quite rightly been a long standing advocate of greater transparency in this area. It will be interesting to see how the Conservative-led government and the multinational lobby respond if the bill is given a second reading.
To any multinationals who argue against greater transparency, the question has to be, what have you got to hide from your own shareholders and the general public?
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March 17th, 2011 at 7:00 pm
First of all, it’s worth saying that we are not going to provide an overview of all of the key measures in today’s Budget. There is simply too much to cover in the time we have available (as part-time bloggers) this evening and others are better qualified to comment in their particular areas of expertise (and get paid to do so). The IFS will no doubt give us some indication of how ‘progressive’ overall they think the Budget is, and we will comment on specific areas as we have more time.
In summary, there are some tax measures to be supported (e.g. further anti-avoidance measures, review of low value consignment relief from VAT, previously announced clampdown on PAYE avoidance) and others that progressives should question (tax break of up to £900,000 for ‘serial entrepreneurs’, relief for non-domiciles remitting offshore cash to UK to make UK investments). We are also highly sceptical of whether the private sector will be able to grow significantly in the context of massive cuts to the public sector.
However, we did think it is worth specifically discussing how the Budget affects the corporation tax paid by multinationals (a theme discussed on numerous occasions on this blog), particularly in the context of a further reduction in the corporation tax rate by 2% this year meaning that the rate by 2014 will be only 23%.
In a previous post we have already explained how existing proposals to reform the way that multinationals are taxed on overseas profits would actually result in the end of many multinationals paying any UK corporation tax. The Budget announcement today goes even further than previous proposals to encourage multinationals to avoid UK corporation tax through moving financing profits to low-tax subsidiaries. Multinationals typically use intra-group financing transactions to manipulate taxable profits as financial capital is highly mobile and ‘hybrid’ transactions can be used to eliminate profits altogether.
Under previous proposals, one third of financing profits moved to low-tax subsidiaries would be taxable in the UK. Remarkably, the Budget today announced a further reduction in this ‘apportionment’ to just one quarter. The Government claims that multinationals will therefore pay an effective 5.75% tax on overseas financing profits. However, this assumes that the group does not have any other UK tax losses to offset the apportionment. As we noted in our previous post, there is currently no intention to restrict use of existing losses (or deductions for interest) meaning that many UK multinationals will pay no UK corporation tax whatsoever under the new regime, and George Osborne has made this even more likely in his announcement today.
Aside from the headline 5.75% rate on overseas financing profits, the Government is even proposing to provide a specific exemption for three years from the Controlled Foreign Companies rules for groups which return their headquarter company to the UK.
There have already been rumours earlier this week that WPP is shortly to announce a return of its parent company to UK tax residency, having previously migrated to Ireland. Today, the FT is reporting that United Business Media is considering a similar move. This is consistent with credible rumours that we have been hearing today that an announcement by at least one multinational is going to be made in the next few days.
We all know that George Osborne wants to make the UK business tax regime the most competitive in the G20. However, he should be honest enough to state that he has given up any attempt to tax profits of multinationals which have been moved overseas into low-tax structures. Then we can seriously discuss other measures (such as further restrictions on interest deductions) which would not impact on the attractiveness of the UK as a headquarter location but would mean businesses actually trading in the UK do pay their fair share of UK corporation tax.
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March 23rd, 2011 at 9:51 pm
As we predicted on our blog yesterday, Martin Sorrell has this morning announced that subject to board and shareholder approval, the parent company of the WPP group is going to migrate its tax residency to the UK.
George Osborne is already hailing this is a vindication of his policies, and talks of the ‘tax base’ of WPP returning to the UK.
It is easy to be fooled by some of the PR surrounding this (an area in which WPP themselves excel). However, it is important to look more closely at what will actually change from a commercial and tax perspective.
How WPP migrated to Ireland
Prior to 2008, the parent company of WPP was UK tax resident meaning that it was subject to the Controlled Foreign Companies (CFC) rules. These rules are broadly designed to tax in the UK profits of low-tax overseas subsidiaries which are not involved in genuine trading activities or have no good commercial reason for existing overseas. We have discussed these rules elsewhere on this blog in more detail (in the context of Vodafone, and in response to the Government’s consultation).
In order to avoid application of the CFC rules (meaning there would be no attempt to tax in the UK profits of low-tax subsidiaries), WPP simply inserted a new Jersey incorporated but Irish tax resident company as the new holding company for the group. This will have allowed it to transfer its low tax subsidiaries ‘out from under’ the UK meaning their profits would no longer be subject to CFC rules.
Ireland was chosen for tax residency of the parent company instead of Jersey (or other locations) presumably as Ireland is within the EU and also has access to key tax treaties, which Jersey does not. This will have been important for WPP given its businesses in the US as US tax treaties typically look up to the parent company or ultimate individual shareholders to determine whether, for example, withholding tax rates on dividends and interest may be reduced by a tax treaty.
Meanwhile, using a Jersey incorporated company allows Irish stamp tax to be avoided on any transfers of the company’s shares.
However, aside from the legal restructuring it is not clear that WPP’s business has really changed in substance. It did set up a corporate office in Dublin and will have held board meetings there to maintain tax residency, but it seems none of the key sub-board corporate management was moved to Ireland, and likely remained in the UK and US in particular. It will have been relatively simple for the group to create intercompany contracts under which key staff will provide management, accounting and other services to the Irish parent company. Meanwhile the Irish parent company, whose activities will have been strictly limited to reviewing this advice at board meetings, can argue its ‘effective management’ and therefore tax residency remains in Ireland.
How WPP will migrate back to the UK and what this means
With the above context in mind, it is easy to see how WPP will change the tax residency of its parent company to the UK. This should be as simple as closing its small Dublin corporate office and starting to hold board meetings at its existing corporate office in the UK. There does not need to be any change to existing intercompany contracts or location of staff although no doubt any intercompany contracts will be simplified over time.
The fact that migrating back to the UK is so easy only serves to underline how little impact it will have on tax or employment in the UK. It is difficult to see how any significant additional corporate staff will be employed in the UK, and Martin Sorrell’s belief that European advertising markets are ‘Championship’ or ‘League One’ status rather than ‘Premier League’ is well known and indicates has attitude to further investment in the UK.
The truth is that WPP is only returning to the UK because it has been given a cast iron exception that it will not be subject to CFC rules for 3 years. After this point, the tax payable on low-tax overseas financing profits will be so low (5.75%) that it will likey pay no UK corporation tax when combined with interest deductions in the UK.
The amazing thing is that in order to claim the PR for WPP’s return, George Osborne has relaxed the rules even further than previous proposals (already favourable) meaning that every other UK multinational that had no intention of leaving the UK is ecstatic.
Given that WPP’s return will not increase employment or corporate tax takle in the UK, why has George Osborne waived through the death of UK corporation tax for multinationals?
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March 24th, 2011 at 9:59 am
There has been a lot of coverage over the Government’s consultation on Rebalancing the Northern Ireland economy (or in reality a proposed corporation tax cut), although most of it has been relatively superficial. Among those that are worth reading (even if we don’t entirely agree), Richard Murphy has written several posts on this issue, including an article in the Guardian.
We are not opposed in principle to differential corporation tax or business tax rates within the UK, but there are a number of issues that need to be understood. As the Government’s consultation document itself notes, the ability of national governments to vary direct tax rates on a regional basis is severely limited by EU case law on ‘state aid’, namely the Azores case. In order for regional differences in direct taxation to be permitted under state law, the following conditions must be met:
- The decision to introduce the regional difference in direct taxation must have been taken by the region which has a political and administrative status separate from that of the central government (institutional autonomy)
- The decision must have been adopted without the central government being able directly to intervene as regards its content (procedural autonomy)
- The full fiscal consequences of a reduction of the national tax rate for undertakings in the region must not be offset by aid or subsidies from other regions or central government (fiscal autonomy)
Source: HM Treasury – Rebalancing the Northern Ireland economy
The Government has set out why it thinks a potential devolution of corporation tax rate setting powers to the Northern Ireland Executive would be consistent with these conditions.
One of the key constraints which it notes is that in order for the ‘fiscal autonomy’ condition of the Azores case to be met, there must be no subsidies from other regions or central government to fund the tax cut. In reality, this means that the risk of cutting corporation tax must be met by Northern Ireland alone, meaning that its share of current corporation tax receipts must be calculated, and its block grant from UK central government reduced by this amount. The HM Treasury figures themselves estimate that over a five year period, at most 21% of the corporation tax cut would be recovered through second-round increases in other taxes. This means that a corporation tax cut to 12.5% is forecast (by HM Treasury) to result in a net loss in tax receipts in 2012-13 of up to £250m, rising to £280m by 2015-16.
In order to meet the institutional autonomy condition, it must be the Northern Ireland Executive itself that takes the decision to vary the corporation tax rate. This means that however much Owen Paterson and his Conservative chums are in favour of the corporation tax cut, it must be the elected representatives of the Northern Ireland Executive that decide the extent of any cut (once power is devolved). It remains to be seen what the mood of public debate in Northern Ireland will be once it is explained that they will bear the risk of any corporation tax cut in the short term, and also the long term, if it does not produce the promised growth and increase in employment.
It is also worth noting that at the moment 30% of jobs in Northern Ireland are in the public sector, compared to 21% for the UK as a whole. However, in 1992 this was 37%, meaning there has already been significant progress in the development of the private sector in the past 20 years, no doubt due to relative political stability following the Good Friday Agreement and a ‘peace dividend’. It is not clear how a corporation tax cut funded by a significant cut in public spending (necessary to be consistent with EU law) would promote employment in the public or private sector, in comparison with more targeted investment in the Northern Irish infrastructure.
Whatever the appetite for a devolved corporation tax cut may be, in our view the focus solely on Northern Ireland in any case risks discriminating against other areas of the UK which are themselves struggling compared to the UK average. It is notable that since the Budget, there have been voices from Wales and Scotland questioning why Northern Ireland may be given power to vary the corporation tax rate but not their devolved governments. The same principle applies to Merseyside, the North East and parts of the West Midlands, who may understandably worry about inbound investment being disproportionately directed to Northern Ireland. If Northern Ireland can set its out corporation tax rate, why not Liverpool?
We remain to be convinced that it is possible for any devolution of powers over corporation tax rates to benefit Northern Ireland while remaining compatible with EU law. Nevertheless, there is a case to consider whether more widespread and limited corporation tax reform could aid a rebalancing of the UK economy as a whole.
In some European member states, taxes are levied on a national level in addition to a regional level allowing for a small amount of variation. In Germany, on average 14% (percentage points) of the 29% to 32% effective business tax rate is made up of trade tax collected by municipalities (i.e. cities, towns etc), with the local administrations having the power to vary the trade tax anywhere upwards of 7%. The highest trade tax rate (17%) is in Munich, one of Germany’s wealthiest cities, with other better off cities also high (Frankfurt 16%, Dusseldörf 14%). Eschborn, a municipality near to Frankfurt has even managed to attract corporate headquarters for Deutsche Bank and Vodafone due to lower trade taxes.
It is reasonable to question whether the UK could benefit from a similar system, where a few percentage points difference in effective business tax rates may be just enough to encourage business to consider investing in areas requiring development rather than existing prime locations such as London and the South East.
However, what does seem clear is that the only way to cut corporation tax in Northern Ireland to the Republic’s rate of 12.5% would be to slash spending by the Northern Ireland Executive on public services (and public sector jobs), and hope that this increases growth in the long-term. This is a serious gamble to take with the Northern Ireland economy.
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March 28th, 2011 at 8:22 pm
Accountancy Age today published an article questioning whether the redomiciliation of WPP’s headquarters to the UK from Ireland will actually provide any benefit to the UK. For those not familiar, Accountancy Age is the leading publication in the accountancy sector and will be familiar to anybody working in accountancy or CFOs working for UK multinationals.
The article refers to our post on the day of WPP’s announcement which explains why the move will not increase employment or tax receipts in the UK, and in fact the reforms included in the Budget will provide a massive tax saving to UK multinationals at significant cost.
What is interesting is that Accountancy Age seem to come to a similar conclusion. The article says:
Despite moving its headquarters to Dublin, the FTSE100 company still has a sizeable presence in London. Indeed, a WPP spokesman told Accountancy Age that any relocation of its tax base will result in few, if any, jobs being moved. The same is true of publishing company UBM, who are also likely to move their tax base back to the UK, and pharmaceutical company Shire. As with WPP, their moves to Ireland did not affect their UK workforce numbers to any meaningful extent and a move back will have the same effect…
For firms, the cut in corporation tax will be a boost when trying to convince potential clients to choose the UK. But for UK PLC, the success of the tax cut cannot be judged on the likes of WPP, UBM and Shire returning. The real test comes when industries that stimulate employment and the local economy, such as manufacturing, decide on the UK. Until then, the chancellor is paying a lot of money for very good PR.
It is pleasing to see that despite being a journal for the accountancy industry, Accountancy Age is questioning whether the massive corporation tax cut for multinationals will actually do anything to promote growth in the real economy.
The reference to ‘firms’ convincing clients to ‘choose the UK’ should be read in the context of an earlier comment by the MD of Alvarez & Marsal included in the article that their clients are choosing Ireland, Netherlands and Luxembourg over the UK. Of course, we all know that these jurisdictions are pushing the boundaries of quasi tax-haven behaviour while remaining within the EU, in particular by providing favourable tax regimes for holding and financing companies which only provide employment for armies of accountants and lawyers.
At a time of deficit and public spending cuts, George Osborne should not be spending taxpayers’ money on highly generous corporate tax rules through a ‘race to the bottom’ which does not increase employment or tax receipts.
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March 30th, 2011 at 6:40 pm
George Osborne announced in his budget last month that he regarded that 50p tax rate introduced by the previous Labour government for ‘additional rate’ taxpayers earning over £150,000 as a ‘temporary measure’. The Telegraph is today among those recently suggesting that the Chancellor is pencilling in 2013 as a date for potential repeal, presumably on the assumption that the economy will have recovered from its current slump by then.
We do not have an ideological commitment to a 50p tax rate, however we do think that reducing inequality through the tax system is itself desirable.
Currently, approximately 275,000 taxpayers fall within the additional rate 50p tax band. This represents the top 0.9% of all taxpayers in the UK. When combined with the clawback of personal allowance over £100,000, an individual earning the lower threshold for the additional rate of £150,000 will take home income after tax and national insurance of £90,618 (effective tax rate of 39.6%). In comparison, an individual earning £250,000 will take home £138,618 (effective tax rate of 44.6%). The average FTSE 100 chief executive earning £4.9 million will take home £2.37 million (effective tax rate of 51.6%). We do not think the amount of income tax and national insurance paid at any of these income levels is excessive. In our view, taxation at these levels can be justified on the basis that earning such high levels of income is only possible due to the wider social infrastructure, including a stable political and economic system which provides for property rights, an educated workforce, and a consumer society with wealth and freedom to purchase goods and services.
To put it another way – it is simply implausible to us that the individual efforts of Bart Becht (the Chief Executive of Reckitt Benckiser) are worth £90m. In our view, this level of income can only be justified on the basis that the shares in his company have increased significantly in value. However, Reckitt Benckiser is only able to generate profits from Cillit Bang and other products because on the one hand, the UK provides legal protection for the brand, and on the other hand the wider economy provides a pool of consumers willing and able to pay £3 for a single cleaning product. While this is an extreme example, it illustrates effectively a general point that income of high earners cannot plausibly result solely from their own innate brilliance and hard work, despite the exaggerated notion of self-worth that some seem to hold.
Notwithstanding this philosophical perspective, we do think progressives need to be able to satisfy themselves that the 50p tax rate is the most effective instrument to achieve a fairer taxation system which actually raises revenues to fund public services. The House of Commons Library has published a briefing paper which sets out a summary of the key points of debate. In our view, there are two key practical questions that need to be answered:
- Does the 50p tax rate result in increased tax revenues? If not, is this because of tax avoidance or evasion which can be tackled through targeted measures (for example, further restrictions on tax relief for pension contributions which still provide for up to £25,000 tax saving per year, or increasing the number of HMRC Tax Inspectors)?
- Does the 50p tax rate distort incentives for legitimate wealth-increasing investment activity, meaning tax receipts in the long run may be adversely impacted?
As the Mirrlees reviews notes, “we do not know with confidence what the revenue-maximising top tax rate is”. The report also notes that conclusions on sensitivity of labour supply to income tax (‘taxable income elasticity’) drawn from data on the impact of the abolition of tax bands above the 40% rate in 1988 are unlikely to be directly applicable, not least due to introduction since then of further restrictions on tax reliefs such as pension contributions and an increase in effective anti-avoidance measures.
The Chancellor promised in the Budget that HMRC will review the tax actually collected from the 50p tax rate before determining whether the measure should be retained. Given the points above, we therefore reserve judgment at this point on this specific question.
However, we do think that the tax system needs to be further rebalanced to collect further revenues from the wealthiest in society. In our view, discussion on income disparities is relevant but obscures the more critical issue that private wealth is concentrated in the hands of the few. As the graph below from the Office of National Statistics report, Wealth in Great Britain shows, 44% of private wealth in the UK is owned by the top 10% of households (as of 2008). In other words, the top 2.5 million households in the UK owned wealth on an average (mean basis) of approximately £1.6 million each. We do not have data for the average wealth of the highest 5% or 1% but presumably this will be significantly higher based on the Lorenz curve in the report.
Previous estimates of the effect of the 50p tax rate (excluding restrictions on pensions relief) suggest that it could raise £2.5 billion in tax receipts. Based on the ONS data above, we note that this is equivalent to a tax levied on the combined private wealth of the top 10% of households (£3,950 billion) of just 0.06% (or £960 per household). A wealth tax of 0.25% on the wealthiest 10% of households could raise up to £9.9 billion (each paying £4,000). These are obviously crude figures, and there will be debates over exactly what form a wealth tax could take. However, they do give some indication of the massive scale of wealth inequality and the potential for wealth-based taxation.
In our view, progressives should therefore now be giving serious consideration to wealth-based taxation irrespective of the Coalition Government’s position on the 50p tax rate; however, if the 50p tax rate were to be repealed, it is essential that it is replaced with tax measures which specifically target higher earners or wealthier households.
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April 11th, 2011 at 10:14 pm
We have explained in a previous post how proposals to devolve powers to Northern Ireland to allow it to corporation tax rates locally will inevitably mean that it is required to cut public spending and therefore jobs. This is because under EU law the risk of cutting taxes on a regional basis must be borne by the region alone. On HM Treasury figures alone, Northern Ireland would lose up to £280m per year in net tax receipts (i.e. after any second-order tax revenues arising from low-tax boosted growth).
As local elections on 5 May draw closer it is interesting to note that no major political party in Northern Ireland is opposing the proposals. While the benchmark is the 12.5% rate applicable in the Republic, some parties want to go even further, as the quotes from the manifestos below confirm:
Democratic Unionist Party (DUP) – “Our goal is not to be as competitive as the Irish Republic, but to be more competitive, so we would work towards a 10% rate… We would wish to negotiate with the Government how the benefits from any increase in the revenue raised from corporation tax through the creation of a significantly higher tax base would be shared with the Northern Ireland Executive. We will continue our work to ensure we arrive at the right overall decision, considering options such as targeting and phasing-in a corporation tax reduction.”
Ulster Unionist Party (UUP) – “Ask the private sector what they want and the answers are clear. It begins with devolving the power to vary Corporation Tax… Should we decide to lower Corporation Tax we propose to do it incrementally over a period of up to ten years and in a manner which is flexible and sensitive to an ever-changing economic environment.”
Alliance Party – “Alliance supports the call for a differential rate of Corporation Tax for Northern Ireland, ideally at a level to at least match the rate in the Republic of Ireland.”
Social Democratic and Labour Party (SDLP) – “An all-island rate of 12.5% would greatly boost our ability to attract investment from multi-national powerhouses, as has been the case in the Republic… We acknowledge the risks regarding the impact of a reduction to corporation tax here, not least the potential cost to the Northern Ireland block grant. However, we believe this major step can set the local economy on a new trajectory and issues regarding the block grant can be resolved.”
Sinn Féin – “Sinn Féin believes that we need to… Harmonise all-Ireland taxation and regulation policies”
We admire that each of the Northern Irish parties have a clear desire to take control of their own economic destiny, but in our view the people of Northern Ireland are being sold a story by the major political parties that simply does not stack up.
Interestingly, the Green Party in Northern Ireland takes a different, and in our opinion a more realistic view:
“The Green Party is supportive of plans to give Stormont the power to vary corporation tax. However we think it would be unfair and wholly irresponsible to give a huge subsidy to banks and multinational supermarkets while ordinary families struggle to pay the bills. The Green Party believes there should be no reduction in the top rate of corporation tax which applies to big business but instead we would seek to reduce the Small Profits Rate to help local small businesses and help grow a strong, resilient Northern Ireland economy from the ground up.”
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April 21st, 2011 at 6:31 pm
Why the new SNP Government’s plans for Financial Responsibility will lead to a fight over oil and gas
The dust has now settled on the devolved and local elections (as well as AV referendum) held last Thursday. The biggest surprise is that even under a proportional voting system, the SNP has managed to achieve a majority in the Scottish Parliament (69 seats out of 129).
The SNP has confirmed it is planning to bring forward a referendum on Scottish independence in either 2014 or 2015. We remain sceptical of whether the Scottish people will be persuaded to back the SNP’s case for full independence, however what is clear is that in the meantime the SNP will be pushing for further devolution of powers to the Scottish Parliament in the current Scotland Bill, in particular over tax.
The SNP manifesto makes clear its general strategy to seek full devolution for financial matters and view membership of the UK on a transactional basis:
“Our plan would see all tax raised in Scotland kept in Scotland. Instead of the Tory government in London deciding how much of our income we get to keep, the Scottish Parliament would make a payment for Scotland’s share of ongoing UK services such as pensions, foreign affairs and defence.”
Readers outside of Scotland may be unaware that the previous (minority) SNP government has already presented a paper to the Scottish Parliament on how ‘Full Financial Responsibility’ may work. It is fair to say that the paper (and the previous Draft Budget from November 2010) does not include any significant detail of exactly how tax revenues would be allocated to Scotland in practice.
However, the Scottish Government paper does cite that for 2008-09, the hypothetical tax receipts attributable to Scotland are approximately £55 billion. This figure includes £12 billion (21% of the total) which it is assumed would be derived from North Sea oil and gas. Crucially, this figure assumes that the UK Government would be willing to accept that the Scottish Government would be entitled to all corporation tax receipts relating to its measure of oil and gas fields located in notional Scottish waters (estimated at 91% of total UK receipts). If the UK Government rejected this and the Scottish Government had to accept it was entitled to only two-thirds of corporation tax receipts instead of 91%, its budget would fall by £3 billion (i.e. 5.5%).
The Scottish Government briefing paper makes much of the fact that on its assumptions, it would have run a deficit of only 2.6% of GDP (£3.8 billion) in 2008-9 compared to the UK deficit of 6.7%. However, we can now see how sensitive this figure is to North Sea corporation tax receipts. If Scotland was only entitled to two-thirds of the UK’s corporation tax receipts from oil and gas, its deficit in 2008-9 would have been £6.9 billion (i.e. approximately 4.7% of GDP).
In our view, the above serves to demonstrate how critical a deal on allocation of tax receipts from North Sea oil and gas would be even under a devolution of financial responsibility, rather than full independence. In the context of a Tory-led government which is likely to take a hard line in any such negotiations, readers in Scotland will want to ensure that the SNP Government does not sell the nation short in seeking to achieve its political goals.
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May 7th, 2011 at 11:11 am