Tax: A time for fresh approach

With mounting pressure on companies to pay a ‘fair share’ of tax, how can global tax rules be reshaped? ACCA’s Chas Roy-Chowdhury investigates

Governments across the globe have become increasingly concerned that many multinational companies are effectively choosing the amount of tax they wish to pay and where. In the UK, for example, Google has been grilled about why, having generated US$18bn in revenue from the UK between 2006 and 2011, the company paid just US$16m in UK corporate taxes for that same period.

The media internationally have been captivated, running stories about minimal tax payments on the back of apparently substantial revenues or profits. However, there is a risk that inflammatory headlines and simplistic reporting can confuse and misrepresent what are in fact complex issues.

It is true that many businesses arrange their tax affairs in a way designed to keep their bills down. Some take a more aggressive approach than others, but nearly all follow the law. Companies have a responsibility to their shareholders to run efficient businesses; this requires the control of costs, and tax is a business cost like any other. If companies pay higher taxes, that cost must be passed on or recovered in some way – perhaps through lower pay for staff, lower returns to shareholders or higher costs to customers.

The general trend among governments worldwide (the US being a notable exception) is in fact to reduce corporation tax rates. The UK, for example, is moving towards a rate of 20% by 2015. Government incentives for specific business behaviours also push down corporation tax payments. Again in the UK, there are numerous incentives for investing in research and development, including the new patent box scheme which results in a corporation tax rate of just 10%.

Another often overlooked fact is that companies pay a wide range of taxes – many of these have carried rising rates. UK VAT is now 20%, double the rate when introduced in 1973, and the top rate of stamp duty has increased by several hundred percent. According to PwC’s latest study on the total tax contribution made by the UK’s largest companies, taxes borne by the Hundred Group increased by 19% between 2005 and 2012 (see below). As PwC’s analysis highlights, the UK’s biggest businesses also make wider contributions to society beyond tax payments; they provide employment, make substantial capital investments and support research and development.

Global challenge:

Nevertheless, the emergence of global businesses presents a major challenge to nationally based tax administrations. Businesses with complex international supply chains become involved in protracted discussions with multiple jurisdictions, seeking to avoid the risk of double taxation. Tax treaties are designed to address such problems but are not foolproof. Tax authorities have become increasingly concerned about the risk of double non-taxation, questioning the ability of companies to manipulate internal structures and transfer-pricing agreements to shift revenues from higher to lower tax jurisdictions.

Another challenge stems from the rise of digital business. When business activity in a location was dependent on having a physical presence there, identifying taxable profits was straightforward. Now a company may be resident in a location far from where revenues are generated. Customers in mainland Europe could pay for a service run by a company headquartered in Ireland, with IT servers in India. Even if a warehouse is located in Germany, this wouldn’t constitute a permanent establishment under standard tax treaties.

The issue of the residence-source tax balance was one of six key pressure areas identified in the February 2013 report from the Organisation for Economic Cooperation and Development (OECD), Addressing Base Erosion and Profit Shifting. Others included international mismatches in the ways that entities are characterised, intra-group financing, transfer pricing issues, the effectiveness of anti-avoidance rules and the existence of preferential regimes.

G20 finance ministers appear keen to develop comprehensive, coordinated strategies to address such issues and prevent the erosion of their tax bases. Redesigning elements of the corporate tax system certainly seems desirable. Change is likely to be impeded, however, by the US, due to its persistently high rate of corporation tax and deferral regime (only taxing foreign profits when repatriated). Furthermore, governments in the developed world might not like the results of ‘improved’ regimes. Achieving a fairer outcome wouldn’t necessarily just shuffle funds between the established Western nations, but would very likely see a shift of tax revenues to nations such as Brazil, India and China.

It may well be time to take a fresh look at how global companies are taxed, but policymakers must take care. Established concepts – such as the arm’s length principle – still have worth. Double-tax treaties do not necessarily require wholesale reworking. There are no quick fixes if global businesses are to be taxed in a way that is not only fair but is also seen to be fair.

Chas Roy-Chowdhury FCCA is head of tax at ACCA. He is the staff expert on ACCA’s Global Forum for Taxation. He worked in public practice before joining ACCA.