Steve Edge of Slaughter and May explores the complex issues around the taxation of multinationals in the UK.
"The key thing is to make sure that you are taxing the right amount of profit in your own jurisdiction – what other jurisdictions then choose to do should be up to them."
The taxation of multinationals has got a much higher public profile in the UK than anyone would have thought it could have a few years ago.
Inevitably, when a complex topic becomes a matter of public interest, confusion abounds. It is manifestly easier for those on one side of this particular debate to hurl insults (or make critical but unsubstantiated assertions) than it is for those on the other side to defend their position without unveiling yet more complexity and scope for confusion or revealing information that ought to remain commercially confidential.
The public debate has thus been neither attractive nor informative – and the furore has made it less easy for those seeking to encourage investment into the UK to present a picture of ongoing stability.
From the government’s point of view, the classic politician’s answer would be that “something must be done”. The difficulty is then to decide what can be done in the face of public outrage in a way that gets the right reaction in the court of public opinion but does not undo some very good things that have been achieved in making the UK competitive in recent years.
The following pulls a number of the questions and issues together.
Are foreign multinationals all behaving outrageously?
Not at all – most foreign multinationals investing into the UK are keen to have an open and transparent relationship with the tax authority, HMRC, and benefit from the certainty that that gives them. So, they have been inclined to clear their transfer pricing arrangements with HMRC more than others – and also to agree the correct level of debt funding for their UK business. They have not been buyers or users of aggressive tax schemes.
So what is all the fuss about?
While the general approach of using comparative arm’s length pricing to allocate profits between jurisdictions according to the economic activity carried on in each place is a good one (and much better than any of the alternatives that have been proposed – a formulary method would be rigid and produce the wrong answer in almost every case), it is often difficult to find true comparables or work out where the profit generated by “team effort” should go.
If you transfer-price individual contributions on a fragmented basis, too much profit can go to the residual IP. That may be right in some cases but it will not always be right in others (eg, a very specialised distribution warehouse in the UK probably contributes more than an equivalent third-party warehouse would).
The furore about transfer pricing has clearly been overhyped – and some multinationals have not handled the publicity as well as others.
The position has also not been helped by a feeling that non- or low taxation on the receipt of royalty or other intangible income means that the UK system has failed – whereas the correct analysis should be that non-taxation of such payments that have correctly gone out of the UK is the result of a policy decision taken by the home jurisdiction of the group concerned.
What’s the problem with web-based sales?
There are two issues here.
The first is, when an offshore internet or web-based seller has UK staff, how do you value the contribution that they make? That goes back to transfer pricing and the value of that particular contribution to the business as a whole. It can thus be dealt with under existing tax law – the problem is often getting at the facts and also monitoring any changes in the facts. There is no reason, however, why an offshore seller should not have UK-based sale support staff provided that the contribution they make to overall profitability is properly recognised and they do not have actual or implicit authority to conclude transactions on behalf of the offshore seller.
The second, more difficult, issue is whether the UK should tax sales that are made into the UK from abroad (particularly in cases where the web seller has absolutely no presence here). That requires both a political or economic decision and then a change in international conventions.
There is a philosophical debate as to why tax should then be imposed. Is it to level the tax playing field as some have expressed it? That could also be characterised as anti-competitive. Or is it to make sure that everyone pays their fair share? Those taking the latter position have then to deal with whether such businesses are really taking advantage of UK infrastructure and so should contribute to the tax base here – if they do, then the simplest way might be to impose a transaction tax if a way could be found of doing that satisfactorily.
The major question here, however, is whether the UK would lose more from a change in this aspect of the international tax regime than it would stand to gain. Some up-and-coming jurisdictions are already keen to tax offshore profits more than they have done before.
It could be said that this is a natural development in global trade which could overall work in the UK’s favour.
Do we get ourselves into a problem by trying to have a competitive tax system?
Whatever we say and do, jurisdictions will compete with each other on tax. That is supported by the fact that tax is clearly accepted as an area where EU jurisdictions can still compete. Jurisdictions have to build tax into the package that they offer – if they have greater economic or geographic advantages, then they might be able to be more aggressive on tax (for example in the extractive industries area). The UK is an open economy and that openness is reinforced by EU rules.
Thus, it makes no sense to discourage inward investment with an unattractive regime – or to risk British multinationals relocating abroad by taxing their overseas profits more highly than comparative overseas regimes would do. All that is likely to lead to is foreign multinationals taking over British multinationals in order to benefit from the tax synergies that that would produce.
The territoriality changes made by the last two governments have been directed at making sure that businesses have a genuine choice as to where economic activity is carried on – and that tax should be seen as part of the package with the UK not seeking to cancel out (except in cases where there is tax avoidance) a more attractive overseas package by a top-up tax in the UK.
Thus, the government is correct to support low UK tax rates and a global regime that lets profits be taxed where they properly arise, while dealing appropriately with true tax avoidance.
Is HMRC too close to large business?
Absolutely not in terms of the settlement process. The National Audit Office confirmed that when looking at five specific cases. Although, in the early days of the new relationship with business, HMRC relied a bit too much on the competence and drive of top officials, they now have broadly based governance processes in place.
From the taxpayer’s point of view, it is critically important that settlements are principled and correctly founded in the law – otherwise they would not be valid.
In terms of the ongoing relationship, HMRC’s endeavours to understand taxpayers better and to have the sort of relationship with business that businesses have with each other (ie, mutual trust and respect) have paid dividends.
HMRC is much better in working on a real-time basis and much more responsive to the needs of business. The balance is exactly right at present. Things have changed for the better.
How much corporation tax avoidance is going on?
There are historic cases to be sorted out but large businesses in the UK have benefited from the peace dividend of a better real-time relationship with HMRC and a greater understanding by HMRC and the government as to what business needs to be competitive globally.
Aggressive tax avoidance by large corporates is very much a thing of the past. (Remember also that some so-called tax avoidance was a response to the government’s failure to amend the CFC regime to bring it into line with EU rules.) The code of conduct has reinforced this with the banks (though the idea of the government having the right to “name and shame” for breach while the code is said still to be voluntary is causing some discomfort).
A corporate tax lawyer does not, of course, see much of it but the impression seems to be that controlling avoidance at the individual level (particularly since the 50 per cent tax rate came in) has been more difficult – it is to be hoped that HMRC’s General Anti-Abuse Rule, the GAAR, will assist on that.
Is the GAAR useless?
Absolutely not – with all the other measure in place, the GAAR will play an important role in discouraging extreme avoidance. In the corporate sector, there is an argument for saying that it is now not needed but it will be a useful safeguard and may, as mentioned above, play an important role in the individual taxpayer’s area. So it is a safeguard for the future.
How much damage is the parliamentary debate & publicity doing?
Quite a lot in terms of making HMRC unnecessarily rigid and cautious and giving ammunition to those overseas who wish to discourage investments being made in the UK because of uncertainties, public pressure and change of law risk here. The UK is in danger of losing on balance decisions because of this.
Comment in the UK press (where the only stories worth writing about are bad news and information is often unreliable) are not helping. It has been interesting to see tax scandals bubble up and then die down as the true facts emerge.
If the PAC does not trust HMRC, both need to find a way of dealing with that that does not involve fighting a damaging battle in public – something the House of Lords Economic Affairs Committee has just supported as a means of restoring public confidence.
What will BEPS produce as regards the international regime?
The answer is that they will probably retain the arm’s length transfer pricing rule and find it very difficult to muster support for a universal change on cross-border internet selling.
Can the government do more?
It is difficult, when so much press comment is basic and ill-informed, to engage in a debate on these topics through the press. The government has probably, therefore, adopted the right strategy in introducing the GAAR, having the code of conduct for banks, getting the OECD involved, amending the procurement rules to deal with tax avoidance, etc, so as to be able to point at various things that it is doing to deal with perceived abuses.
Should there be more transparency?
Yes between taxpayers and HMRC. Yes also between governments (and especially those in tax havens) – but taxpayers should be told what has been said about them. No to putting confidential details into the public domain (which will mean little to most but could be very valuable to a competitor) simply to satisfy public demand and create something for the aggressive parts of the press to pick over and inflame the current situation unreasonably.
What’s the problem with hybrid transactions? Or double non-taxation?
This is, in some ways, a simple issue – but in others more complex.
Countries such as the US, where organisations take their legal form and existence from the individual states but the tax system is federal, have had to deal for years with the problems that arise when one state looks at an entity in one way but another state looks at it in a different way.
The same issues arise in an international context (something that is a partnership in the US can be treated as a company here and vice versa) – and those problems have been compounded by the check-the-box rules in the US that have allowed many organisations to elect how they should be treated for tax purposes.
On the borders between debt and equity, the US and the UK in particular have adopted radically different approaches – the UK tends to follow black letter law and have specific rules in the grey area between debt and equity, whereas the US tends to prefer substance over form.
All this leads to situations where something that leaves one country as interest, can arrive in another country in a different form or may even be ignored.
Does this mean that jurisdictions should have rules that say that something is not deductible unless it is taxable elsewhere? The answer to that should be no. If you try to adapt your tax system so that it fits in with every other jurisdiction that it butts into, then you will create more complexity than is really justified. The key thing is to make sure that you are taxing the right amount of profit in your own jurisdiction – what other jurisdictions then choose to do should be up to them. That is the approach that underlies the UK anti-arbitrage regime which was brought in to address some of the problems in this area in 2005.