Reforms for corporation tax: Key issues for the 2015 Parliament
The previous Government's reforms to corporation tax were among the most significant of the tax changes that it made in the last Parliament. However, public concerns over avoidance and the threat of tax competition from other countries pose serious questions about the future of corporation tax.
The UK's fourth biggest tax…
Taken together, income tax, National Insurance Contributions and VAT account for around 60% of all tax revenues. Corporation tax remains the fourth biggest tax, although the financial crisis saw its receipts fall significantly, from £46.3 billion in 2007/08 to £39.3bn in 2013/14.
…most of which is paid by the largest companies…
Corporation tax payments are highly concentrated in a small number of large firms. 1 percent of all companies account for 81% of all receipts, Oxford University's Centre for Business Taxation has estimated, drawing on data from HM Revenue & Customs (HMRC).
…that shows strong volatility in receipts…
There is a strong correlation between receipts from this tax and the business cycle, so that over the last thirty years corporation tax revenues have accounted for anywhere between 4% and 10% of total tax receipts.
… although revenues have been robust over the last 20 years.
Over the 1980s & 1990s globalisation had been accompanied by successive cuts in corporation tax rates across OECD countries, according to analysis published by the IMF in 2012. Contrary to what might have been expected, there had been no long-term decline in revenues.
The authors found that for the US and all regions, excepting Sub-Saharan Africa, revenues had risen over the previous thirty years.
Chart 1: Corporation tax rates and receipts
Corporation tax rates and receipts, 1978/79 to 2013/14 bars: receipts from corporation tax (real terms, £ billion) line: main corporation tax rate (percent)
The previous Government's changes to corporation tax, while domestically important…
In the 2010 Coalition Agreement, the previous Government set out its aim to “create the most competitive corporate tax system in the G20,” by simplifying reliefs, tackling avoidance and cutting rates. It made four main policy changes:
- Cutting the main rate of corporation tax from 28% to 20% (from April 2015)
- Introducing a preferential tax regime for patent income
- Making capital allowances (whereby the cost of purchasing certain assets can be deducted from taxable profits) less generous
- Modifying the taxation of the foreign income of overseas subsidiaries and branches of UK-resident companies
The Institute for Fiscal Studies estimates that, taken altogether, the annual cost of these changes will be around £7.9bn by 2015/16.
This is almost as much as the current annual cost of the previous Government's cumulative increases in the personal tax allowance, which stood at £8bn per year in 2014/15.
…have not solved the difficulties in taxing international business…
Though there are important differences between them, all industrial countries operate source-based corporation taxes, which aim to tax profits created in that particular country.
The challenge for national tax authorities in a globalised economy is to ascertain where profits are created. This poses practical difficulties, as multinationals often seek to minimise their total tax bill by exploiting the interplay between national tax systems.
It also raises conceptual problems, since it requires the authorities to assign profits that relate to activities that a single company carries out across several countries.
Many transactions within companies – for instance royalty payments, loans and the purchase of intermediate goods – need to be priced, to allow a calculation of the profit made by each national subsidiary.
To do this, international practice relies on the ‘arm's length principle' that companies need to account for these transactions as if they were taking place between two unrelated parties.
However, for transactions that take place within companies, there is no observable market price. For companies where intellectual property is key to profit creation, such as Google, this problem is particularly acute: it is often very difficult to identify geographically where a company has created new ideas. Moreover, it can be difficult to price new technologies that are not traded on the market.
From an international point of view, tax may resemble a zero sum game: the greater the share of profits claimed by one country, the smaller the share that can be claimed by another.
Every location, be it Amsterdam, Barbados, or the City of London, is always offshore to somewhere else. The incentives one government offers to encourage inward investment can, whatever the motives behind them, simply be regarded as the bribes of an unrepentant tax haven to its neighbours.
…accentuated in recent years by the actions of multinationals to avoid tax.
Nevertheless, there has been growing international concern over the scale of ‘base erosion and profit shifting‘ (BEPS): that is, the artificial reduction of taxable profits and/or detachment of tax location from the location of business activity.
In 2013 the OECD started work on a project, underwritten by the G8 and G20 and due for completion at the end of 2015, to consider multilateral initiatives that could effectively reduce the scale of this activity.
Many commentators are doubtful how easy it will be to achieve international consensus on translating these recommendations into law.
Chart 2: Annual change in corporation tax receipts
There is a strong relationship between corporation tax receipts and the state of the economy. Annual change in corporation tax receipts (vertical axis) vs annual change in economic output (horizontal axis), 1979/80-2013/14
These trends pose serious questions about the future of corporation tax.
- Will UK receipts from corporation tax recover in the near future?
- Will the Government's strategy of making the UK ‘competitive' be successful in attracting long-term investments in the UK economy?
- Whatever its present attractions, will the UK's system remain competitive?
- Is international agreement on BEPS likely, particularly if other countries seek to make their own national tax systems more competitive?
- And even if it is, will agreement on BEPS be enough to deliver a stable international system that wins public support?