The relationship between corporation tax and big business has been subject to close scrutiny over recent weeks with many wondering if the two are no longer compatible. Is corporation tax no longer capable of delivering what it says on the label?
The answer will be driven – at least in part – by what you believe the purpose of corporation tax to be. Many economists think it illogical to tax companies at all, as a company is no more than a conduit between a trade and the shareholders for whom it creates spending power. It may follow, therefore, that the tax charge should fall directly on the shareholders. There are clearly some practical obstacles to this; for example, companies rarely distribute all of their profits. So it may be easier to define the purpose of corporation tax as ensuring that a reasonable amount of tax is collected on UK corporate profits, irrespective of the extent to which such profits are distributed to shareholders and irrespective of the residence of the shareholders.
But before considering how well corporation tax achieves this, there is a further dimension that needs to be considered: how to define UK profits in an increasingly global world where a sale in country A to a customer in country B could well be the product of economic activity in ten different countries. Unfortunately, there’s no straightforward answer to this rather subjective question. For example, Google, HMRC and the OECD all believe that if Google Ireland sells advertising on Google’s worldwide platforms to a UK company, the profit on that transaction should be taxed in Ireland, whereas public opinion in the UK seems to consider that it should be taxed in the UK. There is also the question of tax competitiveness. If a multinational corporation wishes to establish a manufacturing plant in Europe and believes that commercially it can do this either in France where corporation tax is 33.3%, the UK, where it is 19%, or Bulgaria where it is 10%, it is likely to choose Bulgaria. So, the question exists – is it legitimate for a country to adopt a corporate tax policy to deliberately undercut that of other countries so as to seek to attract foreign businesses to establish themselves there?
Incentive to complicate
And what about tax incentives? Should the tax system be used to seek to change behaviour or to encourage specific activities? The UK corporation tax system appears to support both. For example, annual investment allowances may be far more generous than commercial depreciation while the UK also gives special reliefs for films, TV production, computer games and orchestras, which reduce the burden of tax on those businesses. Such reliefs favour or penalise specific types of business and one wonders if they really should be a function of the corporation tax system. George Osborne obviously thinks so while others believe they actually distort it. Why should a film production company, for example, pay less tax than a book publisher if they both make the same profit? Why should a carwash which has high expenditure on plant pay less tax than a car showroom which has high expenditure on buildings, if they both make the same profit? The way we choose to answer such questions colours our view of whether or not corporation tax is fit for purpose. Then, of course, there’s the thorny question of tax avoidance. The urge to counter tax avoidance means that the corporation tax system becomes more complicated and more difficult to understand year on year.
There is a trade-off between simplicity, certainty and anti-avoidance. Anti-avoidance legislation aimed at a specific target is, by its nature, complex. The target needs to be precisely defined but with enough scope to make it difficult to avoid its impact. If the legislation is too simple, it will miss the target. Too complex and it will be very difficult for the innocent to understand the basic legislation that affects their transactions. A good example is the current legislation relating to loan relationships: the legislation on this topic stretches into hundreds of pages, which small companies must struggle through in order to work out if their loan interest costs are deductible. The alternative is to take a broad-brush approach – a TAAR – that potentially catches a great many innocent transactions, which then require a ‘get-out’ clause. This creates huge uncertainty, which is undesirable because people tend to be reluctant to enter into commercial transactions if they cannot tell in advance the likely tax consequences of doing so.
Not up to scratch
Back in October 1999, the ICAEW Tax Faculty set out Ten Tenets for a Better Tax System. But the UK corporate tax system does not consistently meet any of them. Which brings us back to the original question. Is corporation tax fit for purpose? It’s clear that there’s no straightforward answer, but the complex nature and potential grey areas of current legislation seem to indicate not. Yes, it appears to target the right profits and leaves other countries to tax what many consider to be rightfully theirs. And yes, it is competitive. But perhaps it would be more efficient if it were to ‘stick to its knitting’ and simply collect tax rather than attempting to fulfil several other roles simultaneously. Will it last the course? We’ll have to wait and see.