New century, new approach to business taxes, urge tax experts

8 Jan 2021

The Treasury Committee continued its inquiry into Tax after Coronavirus with a session focused on taxation of businesses, held the week before Christmas.

Witnesses at the session were: Chris Sanger, Global Government Leader, Ernst and Young (EY), and Chair, Tax Professionals Forum; Alex Cobham, CEO, Tax Justice Network (TJN); Tom Clougherty, Head of Tax, Centre for Policy Studies; and Annie Gascoyne, Director of Economic Policy, Confederation of British Industry (CBI).

The discussion covered a wide range of domestic and international issues affecting business taxation. These included how to raise tax from business while still encouraging investment; digital services taxes; whether the international tax regime is fit for the 21st century; corporate tax roadmaps; green taxation and profit shifting and tax avoidance by businesses.

Corporate taxes – rates, yield and growth

Committee chair Mel Stride (Conservative) asked about corporation tax and why there has been a greater yield despite the rate going down from 28 per cent to 19 per cent. EY’s Chris Sanger said it is because tax is a big factor in encouraging investment, and if the UK goes above 20 per cent it is in danger of deterring investment, because of the rate but also because it is a change in direction of overall policy. He said the rate, base, administration and policy making are the four key elements for a competitive tax regime.

Tom Clougherty of the Centre for Policy Studies said in the short term, you probably can squeeze a bit more money out of the corporate sector with a slightly higher corporation tax rate before any sort of significant Laffer disincentive effects set in. CBI’s Annie Gascoyne said if you look at the G20 league tables on the headline rate, the UK is much less competitive on the marginal tax rate on an incremental pound of investment: “It matters what the headline rate is, but it matters more what businesses’ expectations of the rates are going to be.” She also praised the corporate tax roadmap, saying it gave some certainty.

TJN’s Alex Cobham said corporation tax is non-distorting because it takes a share of profit and so you still maximise profit at the same point. Raising the rate does bring in more revenue, he said. If you look at the Government’s own projections and the projections of the OBR when this ‘spiral of downward cuts was put in place’, their estimates and projections were for an investment effect—a benefit in terms of increased investment—of ‘precisely zero’, he said, adding ‘that has broadly been borne out’. Gascoyne came back and said ‘we are very, very obsessed with what businesses pay in corporation tax when, overall, it is not the largest business tax that businesses directly pay’.

Stride asked if corporate taxes are the most harmful for growth? Alex Cobham said there is no peer-reviewed and high-quality evidence that, across the board, corporate taxes are bad for growth. Tom Clougherty gave committee member Steve Baker (Conservative) a different view, saying by and large, in terms of the big categories of taxes, taxes on corporate profits, per pound of revenue raised, seem to have the largest impact on GDP per capita. He added that while we are in ‘a very competitive position’ on the rate, the way we treat business investment is ‘very stingy’ – for example we are 33rd out of 36 on a composite measure of how much you let businesses write off their capital expenditure against taxes. Clougherty suggested that both cutting the corporation tax rate and making investment allowances more generous helps with growth but, per dollar of revenue you lose, you get about double the impact in growth terms from changes to investment allowances compared with changes to the rate.

Gascoyne explained that businesses look at an aggregate figure when looking at the cost of employing someone, not breaking it down by different bits. Sanger pointed out that HMRC did a study in relation to the cost of reducing the corporate tax rate from 28 per cent downwards. It showed that, even on its own numbers, 45 per cent to 65 per cent of that was automatically recovered back through other tax receipts into the economy. There is clear evidence pointing to the benefits of reducing the corporate tax rate, he said.

Clougherty said full expensing, which is letting companies write off their capital expenditure in full and immediately, would be one of the best ways to boost growth through the tax system.

Baker asked the panel for their views on the Single Income Tax report of the 2020 Tax Commission, which proposed abolishing taxes on business and replacing them with taxes on distributed income. Sanger said it is important to think about the corporate tax system more widely among the other tax systems. It also acts as a protection against people incorporating and effectively creating money boxes. You should not look at the corporate tax system on its own, and a single tax that applied on withdrawals might have problems in that space. Gascoyne said businesses are comfortable paying taxes. In terms of future reform, it is about that marginal decision about where you can incentivise investment and growth, she suggested.

Cobham is concerned about the ‘missing middle’, saying it is too easy for people to hide personal income as corporate income at the bottom end and too easy for multinationals to reduce their tax rates at the top end.

Stride said the mood music around the Treasury is to increase corporate tax rates on smaller businesses. He asked Sanger about the possible impact of that on the ‘three people issue’. Sanger replied that you would really have to distinguish between the avoidance you are trying to deal with rather than penalising smaller businesses because of the three-person problem. He replied that one or two percentage points is not going to overcome the lack of paying NICs that comes as a benefit of paying out dividends through a personal service company. It may be better to look at the employment/self-employment divide.

Digital services tax (DST)

Conservative Julie Marson asked about the effectiveness of the DST to ensure digital companies ‘pay their fair share of tax in the UK’. Chris Sanger made the point that the UK’s DST is focused on the search engines, the social networks and the platforms, rather than addressing the ability for businesses to sell their own goods over the internet. At the margin, it will deter investment. If the opportunity is there and the ability to sell online is so advantageous compared to physically, you can see that that will still happen.

Alex Cobham argued that the DST does not address the fundamental problem which is not that there is turnover not being taxed, rather it is that these companies are exceptionally aggressive at shifting their profits out of the UK, even though they make much of their sales here. The fact that it can be passed on to consumers will also make it regressive, rather than progressive, as it would be if it was on profit. Working with OECD is the best way to ‘break this knot of profit shifting’.

Tom Clougherty suggested an international agreement through the OECD is somewhat more likely after the US presidential elections than it was before but the American trade department and Treasury are pretty fierce in protecting their own interests. He said: “If there is a path to compromise and agreement, it is by a somewhat wider focus at the OECD negotiations, so that it is not simply about those big tech companies, but more broadly about how we look at the corporate tax base internationally.” He said the UK’s DST ‘sets a bad precedent for good tax policy in general’. The problem would come if lots of other countries follow in our footsteps and if the US continues to put in place retaliatory tariffs because it sees this as a move against American business interests – and that could have a fairly significant impact on global GDP.

Annie Gascoyne said a DST is not a good way of capturing more of the profits. Energy needs to be put into an international agreement if we are talking about capturing profits and not about revenue, which ultimately gets passed on through the supply chain.

Profit shifting

Conservative Harriett Baldwin enquired about the motivation for companies to shift profits. Alex Cobham explained that once you operate multinationally, under the current tax rules that date back to the 1930s, you are in a position to manipulate the prices on transactions within your multinational group in order to get the profits into the lowest tax (or no-tax) jurisdiction that you operate in. TJN has been working since 2013, with a G20 consensus, on a single goal to reduce the misalignment between where the real activity of multinationals takes place — their employment and their sales — and where their profits are declared for tax purposes: “Unfortunately, so far, those OECD negotiations really have not gone anywhere.” The effective tax rate creates an incentive but the statutory rate does not, particularly for multinationals, because none of them pay the statutory rate. TJN and the OECD estimate the annual revenue losses globally at something like $240 billion to $245 billion, he said. There are some tax havens that have seen growth, but even there you see that that growth is not well shared.

Asked by Baldwin what more the UK could do to help poorer countries, Cobham replied that the UK has tried, in its tax technical assistance, to help some countries be better at dealing with the current international rules. But the main thing the UK Government can do immediately is to begin to require multinationals to publish their country-by-country reporting.

Sanger said the UK has been a key party to the BEPS project. The BEPS project did remove the chances for double non-taxation and made sure that the treaties that apply between the UK and all our treaty partners check that the principal purpose of any relief is because there is tax being paid somewhere else, rather than for an avoidance purpose. A lot of the provisions that were in the OECD BEPS project are only just coming into force now. He said: “The whole system is designed to make sure that it puts the multinational in the same position as any other business would [be] if it was transacting at arm’s length. The alternative version is a form of formulary apportionment that would replace the system that we have today with what is effectively an arbitrary formulaic basis. There is very limited, if any, evidence to show that that would give you a system that would be better than the one we have today.”

Labour’s Angela Eagle is irritated at companies such as Starbucks and Amazon, which have a very large turnover in the UK and pay ‘virtually no corporation tax or company tax’. Cobham said we need a system that ensures that multinational companies, like domestic businesses, have to declare their profits in the same place that they make their money. The way to do that is a formulaic approach. The second stage of the BEPS process, the one we are in now, began from the recognition that the old rules, the arm’s-length principle, are not fit for purpose and that we need to take at least some piece of global profits and say, ‘This should be allocated according to where the activity is’. If we want to maintain the efficiency of corporate tax, we do need to keep it focused on profit, not on turnover that creates a distortion, he said.

Cobham told Eagle that if you make it impossible to divorce profits from where the real activity takes place, most of the issue with tax havens is dealt with already because tax havens work by attracting profits that are not connected to economic activity there. The other piece the OECD is looking at is a global minimum tax that would make it impossible to have an effective tax rate below 15 per cent or perhaps even 25 per cent. That would also eliminate the incentive to shift profits, even if you still could.

Clougherty told Eagle that an ‘ideal tax’ would be a relatively flat, simple, straightforward, non-distortionary tax on consumption. He said: “In the way that VAT taxes consumption, an income tax that allowed you to fully deduct savings and investments that you made, and a corporation tax that allowed you to fully expense your capital investments, would effectively be taxes on income when it is consumed. That is the best and least distortionary way—the most pro-growth way, if you like—to run a tax system.” You can tax consumption in a progressive way, he insisted.

Why does the diverted profits tax not address the issue of profit shifting? asked Stride. Cobham said it is a very crude workaround to target turnover. It opens up the immediate ability just to pass that on, effectively as another sales tax—another regressive element—rather than targeting the actual profits of the company.

Windfall tax

Labour MP Siobhain McDonagh asked, given that some companies have done well as a result of the pandemic, is there a case for a windfall or excess profits tax? Cobham agreed, adding that we can identify the excess profit at the global level, then apportion the appropriate share to the UK on the basis of economic activity here and take something between 75 per cent and 95 per cent of that. It is the unearned profits we need to go after, he said. He would not target it by sector, but certainly by size.

McDonagh highlighted that a number of businesses voluntarily repaid business rate relief and others did not claim support that they would have been entitled to. Clougherty countered that part of the reason they returned that money or did not take it in the first place is perhaps that they did not want to be subject to a windfall tax. He went on to say: “[a windfall tax] would be wholly unjust to punish basically those businesses that have helped make the last year barely tolerable for all of us, by providing essential goods and services when we could not get them in the way that we did before.” To describe the money that Amazon is making as unearned when it has invested enormous amounts of money, training and employment in setting up an extraordinary logistics operation that can cater to the British consumer’s almost every need without them leaving their home is ‘extraordinary’ to him.

Sanger, who advised the Labour Government in 1997-98 on the windfall tax on utilities, opined that a windfall tax can undermine the investment proposition for the UK as opposed to somewhere else. That was one of the key things that came out from the windfall tax in 1997, he said.

McDonagh asked Gascoyne if there is a case for introducing an enhanced loss relief carry-back to three years as we saw in the financial crises of 2008 and the early 1990s. Gascoyne agreed, saying it would give those firms that have struggled through the crisis from a cashflow perspective, and which are now potentially saddled with higher levels of debt, a vital cash injection to then grow and invest out of this crisis. Sanger added that a real benefit of a loss carry-back for those three years is that you are supporting businesses that have made profits here in the UK and, indeed, have paid tax here.

Business rates

Gascoyne told Felicity Buchan, Conservative, that business rates are at a point now where it is unsustainable. We are seeing it deter investment and growth, she said, as well as ‘a real competitiveness question about business rates’: “If you are going to spend on investment incentives, business rates are a really good place to do it at this point.”

When asked about the Government’s ongoing consultation on business rates Clougherty said it would be a missed opportunity to simply cut business rates without reforming the way tax works. The ideal reform would be to reduce the burden of business rates, not just by cutting the rate but by stripping out a lot of the business rates tax base, so that it does not apply to improvements that the businesses make to their property, but to the value of the underlying site, he said. He would prefer this to a new land value tax, he said, adding: if you only cut the rates, there is a good chance that the real beneficiaries in about five years’ time will be commercial landlords, who feel able to charge higher rents.

Sanger is concerned that business rates are a ‘colour-blind tax’ because you are paying it whether you are in the red or the black. Cobham commented that moving towards something that reflects the value of land makes a lot of sense but the real question on the business side is about the relative treatment of smaller domestic and larger international businesses.

Tax strategy and certainty

Anthony Browne, Conservative, asked about the benefits of a corporation tax roadmap. Gascoyne suggested it needs to be both specific and realistic for firms to be able to buy into it and plan that into their investment decisions. She added that it might also be useful to have a broader five-year tax roadmap that starts to indicate where the Government are likely to look at future tax reform. For example, the carbon price law is one where Government gives indicative rates two years in advance and then sets them.

Sanger agreed with Gascoyne and added that a roadmap that applies to the end of the Parliament is good but one that also sets the aspirations ready to be included in manifestos post one Parliament is also very helpful. Clougherty hopes a new roadmap would focus again on growth and competitiveness, but this time pay more attention to things like capital allowances and annual investment allowance, moves that ‘could really boost business investment’. He said: “A broader tax roadmap would be great as well. It is a curiosity of the way we do economic policy in Britain that we have these big events of political theatre once or twice a year, where the Chancellor feels compelled to pull a rabbit out of the hat and generate some headlines.”

Browne asked about full expensing of investments. Clougherty replied that on the five to 10-year time horizon, it is not as costly as it looks up front, but there is ‘potentially enormous sticker shock there’.

Greening the business tax system

The SNP’s Alison Thewliss asked if additional carbon taxes would be a way of generating revenue while also incentivising the change to a low-carbon economy. Gascoyne said one thing that probably needs to be done first on carbon taxes is to decide exactly what kind of tax we want and where we are going to tax it because, at the moment, there is a risk of lots of taxes trying to price carbon in different ways. Consumer behaviour is a big one, so that is a question for carbon taxation, but so is industrial energy efficiency and investment. Thewliss asked if behavioural change happens as a result of these tax incentives or otherwise? Gascoyne said ultimately, tax-negative externalities are not hugely sustainable in the long term. Clougherty remarked that there is scope for huge simplification because we have lots of different taxes on environmental ills. Replacing them with a comprehensive carbon tax would be a great move.

On green taxes, Sanger said we must make sure that we are absolutely clear about the incentives we are trying to encourage. Cobham said a lot of these taxes on consumption or emissions end up being passed through in pretty regressive ways. He said it is worth looking at a carbon dividend, where you would say, ‘We will capture the revenue that comes in from taxes on carbon and pass that back out to people’.

Corporate tax avoidance

Labour’s Rushanara Ali asked if panellists agree with HMRC’s definition of tax avoidance as ‘bending the rules of the tax system to gain a tax advantage that Parliament never intended’. Cobham said we have probably moved beyond that in international discussions. Since 2013, we have had a goal to reduce the misalignment between where profits are declared and where the real economic activity takes place.

Separately, we have seen progress in the automatic exchange of information about financial accounts but we need more information in the public domain, explained Cobham. We need lower-income countries included. We have seen country-by-country reporting introduced but the data is held privately. We need that to be public, he said.

Sanger said: “If you were to look back through the Red Book over the last few Budgets, you would see that we are getting lower amounts being ascribed to tackling avoidance. That is because the system is becoming far more robust.” He added that the country-by-country reports that were included as action 13 of BEPS are designed to be given to tax authorities that already have a lot of other information. They are an aggregation of the activities that are undertaken on a country basis and ‘if you were to put those broadly into public [domain], they would be pretty misleading’.

Clougherty said part of letting businesses write off investment costs more quickly and fully is that you would want to get rid of or at least dial down the deductibility of debt interest. He said: “Taxing where production happened made a lot of sense in an industrial economy, going back decades. Whether it makes sense going forward when things are increasingly digital and intangible is open for question.”

Cobham said the FinCEN papers provide a good example of one issue where you have data but you have perhaps deliberately underfunded the regulator so that, in fact, it cannot deal with that data.

Concluding remarks

Committee chair Mel Stride closed by thanking the witnesses and offered two reflections.

“The first is around tax avoidance. The discussion we have had this afternoon has been fairly clear, in and around this issue, as to whether our international tax regime is fit for the 21st century and how we most effectively tax value creation in the United Kingdom. That was a fairly clear part of the discussion. On the avoidance in terms of shifting profits, for example, or the suggestion by Tom about moving money around and shifting interests, I was less clear why the actions the UK Government have taken through time are not addressing those points. For example, why is the diverted profits tax not mopping up profit shifting the way it should do? Secondly, turning to Tom’s point, why is the corporation interest restriction not being as effective as it might be? The Committee would be very interested in that.

“Secondly, lots of our discussions were about how we could provide more money from the Treasury to increase investments and growth, et cetera. Three of the four panellists at least would like to see corporation tax where it is or even lower. The Chancellor is likely to have to take some very tough decisions in which he may well look to the business and corporate sector for more tax rather than less. The Committee would be very interested in hearing from you about which areas would be least damaging in that context. If the Treasury is going to raise some billions per year, not immediately but at some point in the future, what is the least damaging way from businesses’ point of view for it to do that? We would be very interested in that as well.”

Read the full transcript of the 16 December 2020 session is here.

By Hamant Verma