To What Extent do Companies Move Abroad in Order to Avoid Corporate Tax in the UK?
Definition of taxation
“And it came to pass in those days ,that there went out a decree from Caesar Augustus, that all the world should be taxed and it was. ( Luke 2 verse 1)”(James &Nobes 2008/09)
According to Lymer &Oats (2007/08),Taxation is an obligatory tariff paid by the general public, for which no reward is gained directly in return(Lymer &Oats. 2007/08). Taxation has existed since the birth of early civilisation. In the UK taxation has become embedded in our society, that without taxation the country will cease to operate. Taxation is used as a tool by most government to raise revenue to support and pay for its basic functions, in Britain the government depends on taxation as a source of revenue generation, however this is embedded with frequent problems as the tax rules influence the tax payers behaviour.
The purpose of this dissertation therefore is to conduct an in-depth examination of corporation tax avoidance in the UK. The section sets out the background literature organised around corporate tax avoidance and its implication to the UK economy, the objectives are developed followed by details of data collections and analysis. The issue of corporate tax avoidance is motivated by the recurring concerns expressed by government ,academics, stakeholders and tax regulators. The findings are presented in sections followed by discussion and conclusion.
What is corporation tax
For corporation tax purposes pertaining to the UK,the word company is defined to mean any corporate entity or unincorporated association, excluding partnerships, local authorities, and association. The main types of organisation which are liable to corporation tax include clubs and societies, political associations, building societies and nationalised corporations. In the UK, the organisations that are exempt from corporation tax includes trade unions, registered pension schemes etc.
A company is classified as resident if it is incorporated in a country where its management and control takes place, a company’s liability to UK, corporation tax depends upon whether or not it is resident in the UK.(Melville 2010).
A UK resident company is liable for corporation tax on its chargeable profits no matter where in the world those profits arise.(Cooney,2001) in other words it is the measure of profits or earnings on which corporations are taxed, it is also important to understand that differences, across countries in the tax base could lead to significant differences in tax payments on the same fundamental activity. For example fairly generous allowances for depreciation could make one country a more attractive place for investment, whilst a relatively generous, treatment of profits earned abroad could make another country a preferred location.(Bond et al,2000)
A non resident company is liable for corporation tax on profit and capital gains made by its branch or agency in that country, other sources of gains outside the country are not liable for corporation tax.(Cooney, 2001).A company’s chargeable profits include its income and its chargeable gains. The profits of a non-UK resident subsidiary of a UK resident parent company may be subject to overseas tax, but not generally subject to UK, tax unless the subsidiary is treated as controlled foreign company.(Melville 2010). A non -UK resident company is chargeable to UK corporation tax only if it has a permanent establishment situated in the UK .if so the company is taxed on the trading profits of the UK establishment.
The rationale for taxing company profits was considered in the Meade Committee Report, (Meade,1978), which considered the following reasons,
- Privileges of incorporation: Incorporated business benefit from limited liability and it is argued that the company must pay for such privileges.
- Equity: As a corporation ,businesses have to pay tax even on retained earnings ,then on equity grounds if a company’s retained earnings cannot be allocated to shareholders, there should be some means of taxing undistributed company profits
- Revenue raising: A corporation tax levied at higher rates than the basic rate of income tax may be a suitable way of raising revenue.(Meade,1978)cited in Nightingale(2002 p30).
Chapter 2 Literature Review -(1200)
The initial stage of this study was to carry out a literature review on corporate tax avoidance. According to Public Agency of Canada (2009), “a literature review is a basis of understanding theory and concepts; simply by research of existing articles and other publications”. This was a particularly significant procedure, for the reason that it adds to information being generated, in terms of brainstorming the question and, eventually, constructing the main objectives of the dissertation.
The most appropriate literature would be that containing a discussion of the criteria that outline tax avoidance. nevertheless to identify what constitutes as good taxation, one must first assume what the actual purpose of taxation is. From, this one can begin to think about how best a tax system should function to satisfy its main objectives, and what conditions need to be met to make it successful. So that artificial loopholes would not be created to avoid it. With these points in mind ,guiding principles evolved, thus providing a framework against which different tax policies and changes to these policies could be measured.
Therefore one can interpret whether tax avoidance which would cover all forms of reducing one’s tax liability could be used and a difference made between acceptable and unacceptable avoidance. To address this issue of tax avoidance, the solution will not be straightforward, as unacceptable tax avoidance conflict with tax evasion, and as a result there is much debate on the meaning that have to be placed on every rule.
In bid to gain the essential background information, in a bid to understand taxation and critically judge the way it has evolved since its beginning ,a lot of information sources were used. these included books ,articles ,websites, journals, press releases, magazines and government publications. Using these secondary research sources it was possible to determine what the key guiding principles entailed.
2.1 The purpose of taxation
Most government takes on a caring, role by providing “merit “goods e.g. health and education. This goods unlike public goods can be provided privately but left completely to market forces, merit goods would be under consumed and so there is some merit in the state providing such goods as everyone benefits from living in a healthy and educated society.(Nightingale) Taxation is very important in this present world (Lymer & Oats,2007/08) the main purpose of taxation is to generate revenue for government expenditure..
“Taxation is a means of ensuring the redistribution of income and wealth in order to reduce poverty and promote social welfare” (Nightingale).It has been said that what the government gives it must first take away, the financial wealth available to society are inadequate, and so an increase in government expenditure normally means a reduction in private spending. It is a means of transferring revenue from private sector to the public sector.(James &Nobes2008/09).
Taxation is therefore used by government to raise resources and revenue to finance it functions. These functions being to regulate and effectively and resourcefully manage the country in order to provide public goods and develop the economy(James)
A significant way tax is used by government is to manage the country and develop society, through the use of tax reductions. For example the government may offer reduced rates of tax to businesses if they locate in an undeveloped part of the country. (James &Nobes,2008/09). This encourages the growth of the economy by acting as an incentive for beneficial activities that might not otherwise have occurred (Lymer&Oats2007/08). Consequently the taxation system is a powerful method of influencing the level of activity, should the government wish to use it,(James &Nobes2008/09) Finally, taxation can be used by government to raise money to fund the” provision of products and services for common consumption”(Lymer & Oats2007/08).
Therefore whilst the government has other means of generating revenue and resources, taxation is generally the main source of government revenue(James &Nobes,2008/09) “without taxation the country would cease to operate effectively, so, whilst few people would say they like to pay taxes, its presence provides the foundation for an orderly, well managed country”(Lymer and Oates2007/08)
2.2 Components of Good Tax System
“Nobody likes paying taxes, yet they are unavoidable for the provision of social welfare. Despite the need for taxes in modern society the tax system adopted must be acceptable to the general public if dissention is to be avoided,”(Nightingale,2001/02,p8). an example is the unrest caused by the introduction of community charge in the UK, in 1990.in his book the wealth of nations (1776).Adam Smith proposed that every good tax should display the following characteristics.(Nightingale,2001/02)
- Appropriate Government Revenues – The principle of appropriate government revenues states that “a tax system should enable the government to determine how much tax revenue will likely be collected and when. A tax system should have some level of predictability and dependability”. Predictability and dependability are significant matters to the government as they need reliable figures upon which to base their budgets so they can meet their obligations accordingly.
- Certainty – The theory of certainty states that taxes should not be arbitrary the taxpayer should know his or her tax liability and when and where to pay it” (Lymer & Oats, 2007/8). The taxpayer should not have trouble measuring the tax base or determining the transaction’s applicable tax rate or tax consequences” (Nellen, 2002, p3). The trouble with this is, in practice, the tax system can be complicated so taxpayers often have difficulty making sense of the rules, particularly if they undergo regular changes (Lymer & Oats, 2007/08).Most often changing taxes increase uncertainty and reduce stability (Holtzman, 2007). Also, if the computation of a tax is complicated then the taxpayer will lose trust in the consistency of the calculation,(Nightingale 2001/ 02). Consequently, where certainty exists, taxpayers are more likely to comply and administrative costs are likely to be lower (Lymer & Oats, 2006/07)
- Simplicity – The theory of simplicity states that ,the tax law should be simple, so that taxpayers can understand the rules and comply with them correctly and cost efficiently. Simplicity in a tax system minimizes mistakes and increases respect for the structure, thus getting a better conformity (Nellen, 2002, p3). It has been said that “simple tax systems impose less of a compliance burden on the taxpayer than more complex systems” (Holtzman, 2007, p6) so taxpayers would definitely be in favour of simplicity. In addition, taxpayers would be able to better “understand the tax consequences of their actual and planned transactions”, thus enabling them to make more informed decisions (Nellen). Unfortunately, what with all the chances going on the tax system, taxpayers hardly have a chance to get used to the tax system before it changes again (Meade, 1978).
- Equity and Fairness – There are two types of equity – horizontal equity and vertical equity. Horizontal equity is concerned with “treating equal people in equal circumstances in an equal way”. (James & Nobes, 2008/09 p78). Vertical equity states that taxpayers with a greater ability to pay should pay more tax (Nellen, 2002, p2). However, it is difficult to decide which taxpayers are equal to each other, and how much more tax higher earner should actually pay (James & Nobes, 2008/09).
Also, a moderate tax system should be designed in such a way as to be a mechanism for vertical redistribution between high and lower earners so as to achieve more equity and fairness in the distribution of wealth amongst society (Meade, 1978).
Convenience – The theory of convenience states that “a tax should be due at a time or in manner most likely to be convenient for the taxpayer as this will help to ensure compliance” (Nellen, 2002, p2). It also states “the appropriate payment mechanism depends on the amount of the liability and ease or difficulty of collection” ( Nellen, 2002, p2). All issues associated with the convenience of payment will differ according to type of tax in question.
Economy in collection – The principle of economy in collection states “that the costs to collect a tax should be kept to a minimum for both the government and taxpayers” (Nightingale2001/02 ). From the perspective of the government it is important that the administrative costs be kept to a minimum so that the revenue generated from a tax can actually be put towards funding their basic functions.
From the perspective of the taxpayer it is essential that the compliance costs be kept to the minimum. In some cases the compliance costs can be very high, In the UK, “the current tax system has grown increasingly complex over time, and many believe that taxpayer compliance burden had grown accordingly” (Holtzman, 2007). The taxpayer would prefer actions be taken to go some way towards remedying this problem.
Neutrality – The principle of neutrality states that “the tax law’s effect on a taxpayer’s decision as to whether or how to carry out a particular transaction be kept to a minimum...Taxpayers should not be unduly encouraged or discouraged from engaging in certain activities due to the tax law” (Nellen, 2002, p3).
“Neutrality does not imply that the tax system has no effect on behaviour. No tax system which collects revenue can have that property” (Kay & King, 1990, p19). In fact, even the UK government isn’t fully committed to fiscal neutrality – sometimes the government uses “non-fiscally neutral taxes in a targeted way where they consider the knock-on impacts to be desirable (and manageable)” (Lymer &Oats, 2007/08, p29). Therefore it is fairer to say that neutrality is more focussed on “avoiding high marginal rates of tax and imposing very different rates of tax on essentially similar activities” (Kay & King, 1999, p19).Consequently, the reason neutrality within tax system is necessary is “to minimise the economic inefficiency which results from taxation” (Kay & King, 1990, p19)
Efficiency and Economic growth – The principle of efficiency and economic growth states that “ a tax system should not impede or reduce the economy’s productive capacity, but be aligned with the taxing jurisdiction’s economic goals” (Nellen, 2002, p3). Therefore, for a tax to be economically efficiency, it should not “distort the economic decisions which are made by individuals” (Lymer & Oats, 2007/08, p50). For this, low marginal rates are required so as not to deter people from working to their full potential simply to avoid moving into a higher tax bracket (Meade 1978). If an economy is efficient it should have a positive impact on their economic growth.
In addition, “the system should not favour one industry or type of investment at the expense of others” (Nellen, 2002, p3). Transparency and visibility – The principle of transparency and visibility states that “taxpayers should know that taxes exists and how and when it is imposed on them and others” (Nellen, 2002, p3). As a result, taxpayers should have more trust in the system and “more confidence that they can accurately predict their future tax liabilities” (Holtzman, 2007, p1). Taxpayers should also find it easier to reliably recognize “the true cost of transactions” they make (Nellen, 2002, p3).
Minimum tax gap - The principle of the minimum tax gap states that “a tax should be structured to minimise non – compliance. The tax gap is that amount of tax owed less the amount collected” (Nellen, 2002, p3). The purpose of such a principle is that it is important that the amount of revenue a government expects to generate is, in reality, actually generated. The reason being it is highly likely that the revenue will have already been diligently allocated elsewhere – primarily to satisfy the government’s basic functions. Therefore, to help “minimise the tax gap, procedural rules are needed to attain compliance” (Nellen, 2002, p3). Although, it is imperative “a balance exists between the desired level of compliance and the tax system’s costs of enforcement and level of intrusiveness” (Nellen, 2002, p3).
Flexibility – The principle of flexibility states that “tax system should be established in such a way as to be able to cope with changing economic circumstance over time without requiring substantive changes” (Lymer & Oats, 2006/07, p43). This involves a tax being capable of such things as generating higher levels of revenue when wages increase, yet collecting lower levels when wages diminish. This responsive ability aids the government in their pursuit to “reduce the fluctuations in economic activities caused by the economic cycle which often seen as good for an economy in the longer term” (Lymer & Oats 2006/07, p51). Therefore, “a flexible tax, designed properly, can have a stabilising effect on the economy to assist with this goal” (Lymer & Oats, 2006/07, p51).
2.3 Using the tax principles
The canons of taxations, forwarded by Adam Smith in 1776, had been topic of much discussion. Whilst many academics agree with them, some believed that further guiding principles needed to be added. Therefore, from the initial four canons of taxations, the AICPA devised a structure of ten guiding principles. Then a final principle – flexibility – acknowledged by many other writers was added to this list, thus providing a through and detailed illustration of what a good tax system should entail. Therefore, the principles can be used a s a guideline to design new tax elements or “to analyze proposals and to modify them, so that any changes will strengthen the tax system, rather than weaken it” (Nellen, 2002, p10).
However, whilst these eleven principles are very useful, with so many guidelines to adhere to, it is inevitable some conflict amongst them will arise “realistically not all principles can be achieved to the same degree” (Nellen, 2002, p10). Therefore, trade-offs have to be made to achieve an adequate balance between them. After all, “there is no widely agreed upon optimal tax system. Tax system design is matter of judgement” (Holtzman, 2007, p4)
In addition, the principles are not hierarchical and people tend to “disagree about the relative importance of the criteria” (Holtzman, 2007, p4). Consequently, since there is no way of ranking the principles, conflicts exist between them, much debate exists about the optimum tax system. Overall, this poses “various challenges to incorporating the principles of good tax policy into current tax system” but with the help of careful consideration and diligent planning, some of the adverse effects can be minimised, if not eliminated (Nellen, 2002, p10).
2.4 Tax Avoidance and Tax Evasion
Tax avoidance is the legal planning of a corporations tax dealings in order to minimise the corporations tax liability,(Nightingale2001/02).Tax evasion is the illegal planning of a corporations affairs so as to reduce its tax liability, in other words, tax avoidance is the manipulation of a company’s tax affairs within the law in order to decrease their tax liability.(James &Nobes2008/09).alternatively tax evasion, which is the engagement of a company in a legal activity, from which tax is properly due but from which, it is not paid, because the income in question is not declared,(Kay&King,1990), this kind of evasion activity is referred to mostly as black economy.
According to Kay &King,(1990), company’s which use the black economy are illegally evading tax, those, company’s which minimises their tax liability, legally are avoiding it. Like tax evasion, tax avoidance has come under serious scrutiny in the UK.It must be emphasised here that successful tax minimization is neither a sufficient nor a necessary case for tax avoidance.(Int. Tax avoidance and evasion,1987),in between evasion and avoidance, to describe a company which uses tax planning within the law to minimise its tax liability or moving some of its operations abroad to a low tax region, in order to avoid tax, is however to strain the meaning of the language. which by the definition, is unacceptable.
Chapter 3 Research Methodology (1000)
3.1 Research design
According Saunders et al., (2007) research philosophy is divided into three which are “epistemology, ontology and axiology”. Each of the philosophy contains the main differences which will give the way of thinking about research process. It is very important to decide the research approach before designing a research project which could be deductive, inductive or combine deduction and induction within the same piece of research.
The research methodology for this study is based on inductive approach, therefore, in order to gauge the degree to which tax avoidance, meets the criteria associated with good tax policies, an inductive research approach was decided upon. An inductive research approach “involves the exploration of data in the pursuit of developing theories from it to subsequently relate to the littérature” (Saunders et al, 2007, p57).
The reason for using an inductive approach is that, through the study of what has been written regarding tax avoidance, one can discuss corporation tax avoidance in a broader perspective, as the relationship between the inherently global activities of corporate firms and the corporate tax policies of government. As a result, taking the data and discussing tax avoidance, one can relate this to existing literature on the tax system in the UK, should anybody and from that, develop an informed theoretical viewpoint.’ (Saunders et al, 2007,).
3.2 Data collection Method
This research study was mainly carried out by using secondary data because it contains useful source of information, to answer the research questions. The secondary data will involve “re-analysing data that has already been collected” and that could be quantitative and qualitative data used in the research for descriptive and explanatory (Saunders et al., 2000) cited in Vincent (2003). Secondary data includes documentary, multiple source and survey data (Saunders et al., 2007).
To support the research, textbooks and the computing and library facilities at oxford brooks were used widely. The electronic library catalogue provided by the university was used to access particular resources. The databases used to obtain the documentary secondary data were EBSCO (Business Source Complete),and Emerald EBSCO is an Electronic Journal Service, which is contains millions of articles from different publishers among thousands of e-journals. In the EBSCO, Business Source Complete, provides full text journal for business studies which include accounting journal such as The Accounting Review, Journal of Accounting Research, and Journal of international Accounting, and Taxation. The Emerald database is one of the leading publishers of business and management research was used to access data in this study which contain over 190 journals (Thisaveerasingam, 2008). It is very important to evaluate the suitable secondary data in order to answer the research questions. The Emerald, BSC includes ranking of journals and contains more active peer-reviewed business related journals which enhances the reliability and validity of the journals.
|Fewer resource requirements: save the time and money, analyse far large data from collection of government survey.||Access may be difficult or costly: data collection for commercial reason may be difficult and costly|
|Unobtrusive: more likely to higher-quality data||Aggregations and definitions may be unsuitable: purpose may result in other|
|Longitudinal studies may be feasible: creative own work by using existing multiple-source data||May be collected for purpose that does not match the need: data differs from research question and objective|
|Can provide comparative and contextual data: useful to compare data||No real control over data quality: Must evaluate data properly|
|Can result in unforeseen discoveries: example Serendipitous discovery||Initial purpose may affect how data are presented: aware of the purpose of data|
Source: (Saunders et al, 2007).
3.5 Limitations of the research
The secondary data were used widely in this research study. There were huge amount of articles related to these studies that had been published, but, the articles show conflicting results on corporation tax avoidance. As a result it was difficult making the right decisions on drawing a conclusion.
In addition, primary data could not be used in this research. Perhaps primary data from interviewing a few Governmental Institution,(HRMC) Corporate Firms and Professional Accounting Institutions such as tax inspectors, managers and accountants, could give more information relating to corporation tax avoidance. According to Fielding and Fielding as cited by Canning and Gwilliam (1999 p.407) “such a combination of methodologies increases researcher self-confidence in the findings and allow them to be better imparted to the audience with lessened source to the affirmation of advantaged in sight”. In addition, according to Saunders et al., (2007), the combine “deduction and induction” within the same piece of research will be more valuable and often advantageous to do.
Moreover, the time frame available for this research would not permit, for further research in using primary data. In fact, it could have been more valuable to get information from tax inspectors, managers and accountants. But the problems could arise in uncertainty to getting reply from them on time and also due to the sensitive nature of the topic, most of the people involved might not be willing to provide any information.
This chapter has provided details about how the study has been carried out, the basis for the study upon which instruments were used for the data collection method. Secondary data was the most appropriate research method for this work. Explanation for the use of documentary secondary data was given in section 3.3 along 3.4 which explained the advantages and disadvantages of secondary data. The findings regarding the debate of corporation tax avoidance and the current views from the comparative study will be summarised and presented to enable conclusions and recommendations be made.
Chapter 4 (5000) Discussion
How have ‘UK’ companies been successful in avoiding corporation tax?
“Section 8 of the ICTA 1988 provides that UK resident companies are chargeable to corporation tax, on their worldwide income and gains, section 66 of the FA 1988 widened the definition as follows:
A UK or foreign companies that are incorporated in the UK are UK resident for tax purposes; and b.foreign incorporated companies are treated as resident in the country where the central management and control exists”(Nightingale,2001/02)
A UK resident company is liable for corporation tax on its chargeable profits no matter where in the world those profits arise.(Cooney,2001). The decisions of governments regarding corporation tax, affect the decisions of corporate firms regarding where to locate their economic activity and where to book profit.(Clausing,2009).
Corporation tax is designed under rules set by parliament each year, in the Finance Act, the Finance Act may amend the existing rules, it also sets the rate of tax payable.becuase of the annual review of the rules ,circumstances may change year by year, which makes comparability difficult and forecasting uncertain.(Elliot&Elliot,2008).A few years ago not much attention was paid to how big corporations arranged their tax affairs. There appears to be a common rule now, that taxpayers do not like paying tax, although the fact that they may well understand the premise behind the collection of taxes.(Clausing,2009).
The evidence of systematic tax avoidance by UK-based companies strikes a particular ugly note in these strained times(The Guardian,03 Feb 2009). Each additional pound paid in taxation by a corporation reduces the income available for retention for funding future growth.
Tax avoidance is the legal planning of a company’s tax dealings in order to minimise the company’s tax liability,(Nightingale,2001/02).Tax evasion is the illegal planning of the company’s affairs so as to reduce the company’s tax liability, avoidance is the manipulation of the company’s affairs within the law in order to decrease its tax liability.(James &Nobes).In other words tax evasion is the engagement of the company in a legal activity, from which tax is properly due but from which it is not paid, because the income in question is not declared.(Kay&King,1990) this kind of evasion activity is referred to mostly as black economy. According to Kay &King,(1990), corporations which, engage in the black economy are illegally evading tax, corporations minimises their tax liability by legally avoiding it.(appendices1, the black economy includes the moonlighting plumber ,who expects to be paid in cash, the waiter who fails to declare his tip the barmaid who is paid from the till at the end of the evening).
Tax avoidance which covers all forms of reducing a company’s tax liability, could be used and a characteristic made between acceptable and unacceptable avoidance.(int tax avoidance & evasion) the scope of what a company considers as tax avoidance may be different from country to country. in principle, the UK tax law permits a tax payer to use the letter of the law to their best advantage, even though there are some legal activities which are so artificial that they might be seen as evasion. .(James &Nobes2008/09).
Tax planning is arranging a firms, financial transactions to their best advantage to be able to gain from the often anticipated effects of tax rules, in order to make best use of the company’s after tax returns.(James &Nobes2008/09). The use of such requirements as proposed by the legislators, is not criticised by anyone and might be termed ‘tax planning’ the problem area lies between the appropriate use of such tax planning ,and illegal activities. this grey area could best be called tax avoidance.(Elliot&Elliot,2008).the problem lies in distinguishing clearly between legal avoidance and illegal evasion. it can be difficult for accountants to walk the careful line between helping clients in tax avoidance and colluding with them against the HMRC.(Elliot&Elliot,2008).
Tax experts claimed that, a decade ago, a lot UK firms exploited loopholes in the tax system to minimise their tax liability. A concentrated effort by the Labour government straitened corporation tax policies. (GuideMeHongKong.com Oct 01, 2010 ). Although tax consequences are a motivating factor in many company decisions, the company’s actions are planned exclusively to lower corporate tax.
Most corporate firms have financial responses, the taxation of corporate income, and responses to international tax incentives include locating more of its economic activity to low tax countries, financial responses to corporation tax include efforts to shift income to more lightly taxed locations, alter the transfer prices assigned to international trade with affiliates and alter the arrangement of the affiliate finance, or change the location of royalties or intangible asset,( Clausing,2009). It is therefore possible to minimise or do away with a company’s tax liability by entirely satisfactory tax planning, by choosing among tax reliefs and incentives the most beneficial route consistent with usual business transactions.(Int. tax avoidance & evasion).Like the black economy tax avoidance has come under serious scrutiny in the UK.
4.1 Company response (arguments in support of companies adopting this type of tax avoidance)
A high corporate tax burden acts as a disincentive for firms to move to low tax locations, since high tax rate exerts a negative outcome on the profitability of their investments.
Most UK based firms, are concerned not only about UK tax rates but also about the difficulty of the UK tax system. Companies with the ability to move jurisdiction simply, allude to the uncertainty and difficulty of the UK taxes, as being a big concern as the level of tax itself. ( GuideMeHongKong.com, Oct 01, 2010 )
A critical separation of the relationship between the global performance of companies and their tax policies affect most governments, this connection is complex. Most company policies impact governments, decision in affecting the amount of revenue that government receive as tax from these firms and ultimately the type of tax policies that the companies choose.
In the UK the profits of overseas subsidiaries are taxed under the controlled foreign business rules. Firms with huge overseas operations are required to forward their profits back to the UK. There was a row over the taxation of profits in foreign subsidiaries this encouraged the first exodus of major firms in 2008 from the UK ,to low tax countries(Guardian 2010 27th sept). According to research commissioned by HM Revenue & Customs (HMRC), about one in five corporations, have considered the option of relocating their company’s offshore in order to enjoy tax benefits. 64% of the large firms consider bureaucracy levels to have increased over the past year, in the UK( GuideMeHongKong.com, Oct 01, 2010).
The existence of different tax rates in different countries is likely to create opportunities for tax minimisation, for corporations.(Bond et al ,2000).such incentive will attract company’s in country’s with high corporation tax rate, to relocate to country’s with low tax rates. If the firms do relocate to low tax countries ,it could bring catastrophe for the UK economy.
The UK plumbing and heating group Wolseley, announced that it was relocating its tax residence from the UK to Switzerland. ( GuideMeHongKong.com Oct 01, 2010) Wolseley, claims, uncertainty concerning the tax system in the UK had made it to go offshore. The management of Wolseley plans to register the company in Jersey whilst adopting Switzerland as its residence for tax purposes. The finance director of Wolseley claims its crucial for the government to stop the issue surrounding the taxation of profits in foreign subsidiaries, to be able to maintain Wolseley in the UK. (guardian 2010 27th sept). Switzerland gives the chance to repatriate foreign income to a centre by way of very low tax rates.
Wolseley’s other problem centred on the firms return to profitability, after two years of losses, while the company was making a £90m tax gain, as a result of £130m rebate in the US after the sale of non profit making businesses, it was faced with tax increases in other operational location.( http://www.u.tv/News 2010)
Another tax haven is Ireland which is also attracting most of UK firms, eager to lessen their tax liability,. Wolseley joins United Business Media and Shire, the pharmaceutical firm, which has also been attracted by Ireland, 12.5% corporation tax rate. The world's third-biggest chemicals firm and the UK's major private business Ineos, moved to Switzerland. The company is expected to save €450m (£390m) in tax. Additionally, a lot of UK's top bankers have announced plans of relocating to other places. ( GuideMeHongKong.com Oct 01, 2010 ).
According to the statement,Wolseleys, reallocation to Switzerland will save the company about £23m, in taxes this was expected to create uncertainties for the government, that more companies are leaving, despite a promise to lower corporation tax to one of the lowest rates in the G20,countries (guardian 2010 27th September).
The disadvantages of being a UK resident business has never been so clear. UK's position in various global rankings has been dropping, mainly due to its complicated tax structure that is characterized by increasing tax rates. The simple point is that UK companies are paying 28% of their UK profits in tax ,even though Ireland and Switzerland currently appear as the top choice destinations, Hong Kong also stands stronger of gaining favour among most UK businesses in particular those in the financial sector. (GuideMeHongKong.com Oct 01, 2010)
The average tax rate of Wolseley's has increased recently from 28% to 34% at a point in time after the caption corporate tax rate had fallen from 30% to 28%.(.(guardian 2010 27th sept) It is very difficult to state why the company’s tax liability has risen so quickly the main cause was the businesses combination and profit levels. Other issues was the lack of tax arrangement opportunities open to the business following a number of years of crackdowns.(guardian 2010 27th sept)
4.2 government response
The UK Government is losing £25bn a year through tax avoidance, a new report claims. That is £ 13bn not paid by the wealthy, and a further,£12bn dodged by corporations.( accountancyniagazine.com March 2008)
There is substantial budget deficit caused by loss of tax revenue ,through large scale avoidance, there will consequently be severe constraints on future public spending and burdens on UK taxpayers. The avoidance by company’s is however much bigger and more complex to identify. The simple point is that companies should be paying 28% of their UK profits in tax, while the evidence suggests that many high profile British firms pay much less.(The Guardian,2009)
Governments are concerned with treats to their corporate tax revenue ,largely because reductions in the amount of revenue raised from that source might require increases in other forms of taxation or the borrowing or reduction in public spending.(Bond et al,2000)
There are two main channels through which government revenue can be threatened, the actions of governments that compete with one another to offer the lowest tax rate and to attract and retain investment and the actions of companies using methods of tax planning to exploit opportunities to minimise their tax payments. The Independent newspaper,(12th Feb,2010) states that the UK is one of the most attractive places to do business and continues to have the smallest corporation tax rate of the major G7 economies along internationally competitive small corporation tax rate of 21 per cent.
Chapter 5 Conclusion (1900)
6.1 What are the specific problems
Large corporate firms generally want to ensure that their tax planning is legal, efficient and appropriate, that it does not create reputational risks and that reporting and compliance requirements are satisfied.( Thomson Reuters Legal Limited and Contributors, 2009) The complexity of the UK, tax system creates loopholes which allows firms to legally exploit. the tax scheme. The supposed development in company tax avoidance activity in the UK,has given rise to other perspectives on the motivations and effects of the avoidance activity. Several studies has examined corporate tax avoidance as an extension of other tax-favoured activity, (The Review of Economics and Statistics, August 2009,)
Tax avoidance and aggressive tax planning allows firms to become economic free-riders, enjoying the benefits of corporate citizenship without accepting the costs, whilst also causing risky market distortions and moving a bigger share of the tax burden onto individual taxpayers and consumers(www.taxjustice.net, January 2005) Whistleblowers, find the subject of avoidance impenetrable and very ,difficult, to report about firms engaging in avoidance and with its added restraint. Writing about the subject involves prohibitively expensive legal and accountancy advice. There is no accepted definition of what constitutes avoidance the experts and legal minds concerned have done a masterful job, in muddying the waters of the debate, where they have silenced the issue altogether.
There is a lot of evidence from economic studies ,however that companies behave in ways that are consistent with tax-minimising activity, for example, some studies have found that foreign subsidiaries of corporate firms are more likely to use debt finance when based in high-tax countries than when based in low-tax countries(Hubbard,1990) cited in (Bond,2000). There is also some indirect evidence that tax motivated transfer pricing occurs through studies, that have found that companies pre- tax profits tend to be inversely related to the tax rate (i.e. the higher the tax rate ,the lower the pre-tax profits reported,(Grubert &Mutti 1991) cited in (Bond 1990)
6.2 Based on the evidence presented above ,to what extent can a policy meet the current taxation problem
The government should initiate tax policies that are simple to understand and put into practice for companies, in addition it will be more difficult to avoid. The double effect could benefit the UK more than a lot of new rules.
Tax simplification would help, there could be lower headline rates of corporation tax in return for eliminating the complex arrangement of tax allowances which firms at present enjoy. It has been estimated that simplification alone will slash the headline rate by 5%..(The Guardian,03 Feb.2009) Beyond that there is a strong case for a more hard-line move towards tax avoidance, the regular and general avoidance of stamp duty land tax by company vehicles can be stopped immediately, more generally the proposal of a General Anti Avoidance Rule is that tax is applied wherever there is an intent to avoid it, even if the loophole hasn’t particularly been recognized in advance by HMRC.
There is a lot the government can do, to help, for instance Tax arbitrage, which involves playing one state against another. Government can limit that game by co-operating, the British government’s strict resistance to any EU tax harmonisation can subdue sensible, realistic initiatives like agreement on common EU tax base (not harmonisation of rates but agreement to treat depreciation and other accounting conventions in a similar way. Britain has formed a peculiar treaty with Ireland and the Baltic states to block co-operation.(The Guardian,03 Feb.2009)
The chancellor George Osborne, in the June 2010 budget announced the view of ending the UKs interest in foreign subsidiaries, altogether. He proposed changes in the existing rules and the prospect of applying corporation tax to only UK earnings. "The government is committed to reform of the Controlled Foreign Company(CFC) rules and will introduce new rules in 2012. Any changes will deliver a more territorial approach refocusing on artificially diverted UK profits and exempting genuine commercial activities," he said, emphasising the government planned to reduce corporation tax from 28% to 24% with the aim of creating "the most competitive corporate tax system in G20". (The Guardian, sept 27th 2010)
Most, corporations are legal entities, any corporate tax liability is eventually passed on somewhere else in reduced dividend, wages or in higher prices. Corporate profits may not be an ideal tax base, for the government, but there are some fundamental justice in the implication that companies should pay the government of their host country for the infrastructure and other tax –financed services they receive;education,health transport system and policing.(The Guardian 2009)
If the proposal is ratified tax experts says it would mean the UK would be offering one of the most business-friendly, tax regimes in the world. any plans to move offshore would for most firms become superfluous. firms may possibly do their business in the UK and keep their foreign-earned profits away from the HMRC.The Interim tax changes might take place by 2011 and wider reforms by 2012.(The Guardian, sept 27th 2010).
Furthermore, the Corporate Social Responsibility debate needs fully to address the issue of how company directors should act on tax avoidance in the context of their CSR agendas. The current situation has not kept pace with the debate on CSR and should make way for a General Anti-Avoidance Rule that would guide directors in understanding their moral and ethical duties on tax payment. The good behaviour of socially responsible companies are punished by being at competitively disadvantage position, against companies that are more ruthless, which take advantage of the tax avoidance loopholes.
But it is necessary to draw attention to what is going on, tax avoidance symbolize the achievement of practical expertise over social, responsibility.(guardian 2009 feb,02)
The Corporate Social Responsibility outline, is driven by the demand for an ethical move towards doing business. It is not possible to be ethical in one area of business behaviour and to act otherwise in another area, and firms, that operate in this way reveal a major disconnect in their core organisational principles. The statements on Corporate Social Responsibility (CSR) of most companies , has become evident that most firms do not consider tax payment as a part of the CSR plan.
The same holds true for the World Economic Forum. On their website there are 86 pages which refer to Corporate Social Responsibility, but only three pages refer to tax avoidance. Tax avoidance is not referred to in the World Economic Forum’s Partnering Against Corruption Initiative, despite the clear proof that much tax avoidance is linked to dishonest dealings, banking secrecy, offshore trusts, fraud and unlawful capital flight.( www.taxjustice.net January 2005 )
Corporation must implement clear CSR principles in the area of taxation, including requirements to make known all essential accounting information and to abstain from the use of profits-laundering vehicles developed without significant economic reason. CSR reports ought to list the countries in which the business trades, how much profit is made from activities in each one of these countries, and where these profits are taken for tax purposes, indicating any special purpose vehicles that are used, and the magnitude of tax avoidance arising from the use of ‘novel tax planning ideas.’ Only in this way can the important stakeholders, including governments, shareholders, employees and the general public gain the information that they need to decide whether the organisations which control the globalised economy are behaving as good corporate firms.
Tax issues are also missing from the mainstream debate about corporate governance. A report by PricewaterhouseCoopers has identified corporate governance as a key area of concern for investors, with issues such as drop in corruption, conspiracy, nepotism; insufficient disclosure and inadequate transparency of financial statements; poor enforcement of existing rules, and a lack of clear separation of company ownership and management. however, the related areas of compliance with taxation obligations, not using aggressive tax avoidance techniques and transparency of reporting of tax planning method are not mentioned in the PWC report on good governance. .( www.taxjustice.net January 2005 ) The recent economic crisis has considerably increased the financial strain on the UK economy, the country now needs a candid, strong and open debate concerning how corporations are taxed, and it is very hard to carry out this debate if a lot of information are unknown the time for turning a blind eye to avoidance has long gone, we now need a better tax transparency. (the guardian Feb. 05 2009)