Government must launch fresh initiatives to radically simplify the corporate tax regime

The G7’s recent deal on corporate tax reform has been widely lauded. Its purported benefits often relate to reining in the tech giants or delivering much-needed revenue for cash-strapped governments. More rarely alighted upon is its potential to simplify the global tax regime, provided accompanying reforms are introduced by governments.

For Demos research on corporate tax reform published last month, I’ve been interviewing tax directors at large businesses. Again and again, interviewees emphasised the complexity of the existing international corporate tax system. Highly qualified people spend seemingly endless hours trying to understand the constant supply of new and complicated tax legislation being produced by governments. 

A related concern was that while the UK’s tax system is complex, it is also extremely unpredictable. Businesses reported that the constant changes to tax regulations led to considerable uncertainty and created unnecessary administrative burdens. Indeed, complexity often appears to be a driver of unpredictability; in a system defined by international tax competition, tax authorities add new layers of complexity to respond to other countries’ changes, further reducing predictability. 

Simplicity and predictability are obviously desirable, but you cannot simply tinker around to make the system simpler or more predictable. These desirable features are actually made possible, or not, as a result of the system’s basic design, of the elements that exist within that regime. Attempts to superimpose simplicity have consistently failed for exactly this reason: when taken individually, every new and more complex measure can be justified. More precisely, simplicity can arise from three possible features of an international regime. 

First, less tax competition, and therefore fewer initiatives and counter-initiatives as well as fewer anti-avoidance mechanisms. The agreement reached at the G7 is a very real first step to achieving less international tax competition. Once the prospect of gains (i.e. higher revenues) from a ‘truce’ become real, the attractions of playing this old game become less obvious. There may not be unanimity at the OECD, but, as with other OECD negotiations, agreement between enough of the largest economies can help to drive an overall settlement. 

It is worth emphasising that this does not require total global agreement on convergence. This is because major developed economies are often only competing with other major developed economies for investment, meaning that even if some developing countries do not converge, this poses relatively little risk to destabilising this convergence. Our interviewees regularly highlighted that when ‘shopping around’ for investment locations, they were often only selecting from a relatively small number of major developed economies. This is because often only these countries had the attributes they were looking for: a highly skilled workforce, a stable and trusted regulatory environment etc. And these, of course, are the higher value added investments that are most useful to the UK.

Second, building simplicity into the international corporate tax regime requires agreement on a formula between countries for allocating taxable profit. This means moving away from arm’s length transfer pricing and the inevitably different interpretations of what this means by different countries (movement in this direction is potentially part of the package being agreed at the OECD).

Again, this is a very real prospect today, given Biden’s initiatives and the push at the G7. The details of Biden’s proposal, especially that taxation of multinationals should take into account sales levels in different countries, may well favour US corporations when compared with other proposals on the table, but the fact is they give impetus to a move towards greater use of formulae. These only create an opportunity - but the Biden administration has advocated taking this opportunity. Its recent presentation to others in the OECD process stated that: “simplification is highly desirable” and emphasised the need to “stabilise the architecture”. The UK can choose to support and even accelerate this direction of travel if it wishes, even if it quite legitimately continues to negotiate the details within this framework in ways that are to its national advantage.

Third, national governments must avoid the temptation to use corporation tax to incentivise particular behaviours or kinds of investment - as opposed to designing a system that reduces the disincentive effects of corporation tax - if simplicity is to be achieved. This will not be easy, but it is possible. 

Sunset clauses can be introduced for existing reliefs, giving business time to adjust, and where cost benefit analysis justifies it, grants can be introduced to replace them. As with other forms of business support (and indeed individual support), the process needs to be properly designed: politicians will need to make improving the interface between business and the government bureaucracy a priority. 

This certainly won’t happen by itself. The UK government must launch fresh initiatives to radically simplify the corporate tax regime, enabled by first steps towards global tax convergence enabled by the G7 deal. And as international negotiations continue on the details of the deal, policy makers must seek a deal on a formula-based system for allocating taxable profits. 

The point is, there is a prize for doing this. Businesses we interviewed were extremely clear: simplification is an important priority for them. As one told us, “You would rather have a slightly higher tax rate with certainty and waste less money on getting advice and paying people to work out what your tax is.” 

It’s clear that businesses are up for paying more in corporation tax to help fund the recovery from Covid-19, and more so if simplification and predictability is a part of this deal. So as well as being pro-business, greater simplicity can aid the transition to a higher rate corporate tax regime; vital if ‘building back better’ is to be paid for. 

Guest blog by Ben Glover, Deputy Research Director, Demos