Q&A: Taxing corporations in a modern global economy

The House of Lords Economic Affairs Committee launched an inquiry in March this year exploring whether a new approach is needed to taxing corporations in the modern global economy. The inquiry seeks to address some of the key concerns that have fuelled the tax debate, and to assess the extent to which corporation tax has become ‘voluntary’. It considers the case for reform of the allocation of profits between countries, and whether any change should be based on existing treaty arrangements or whether there is a need for a more fundamental reform.

Why is the House of Lords examining this issue?

There has been widespread criticism of multinationals in the press and the Public Accounts Committee (PAC) has interviewed a number of companies and issued a report on tax planning. The perception is that multinationals use transfer pricing or take advantage of international tax rules to reduce their tax liability in the UK in a legal but ‘unacceptable’ way. Against this background, the House of Lords Committee is investigating whether the UK corporation tax rules require amendment.

What are the key issues it is considering?

The overriding question is whether or not the current system is fit for purpose in the modern business world. The committee is specifically focusing on whether there is a good rationale for taxing corporate profits, who really bears the cost of corporation tax, whether the system is vulnerable to an economic downturn or aggressive tax avoidance, and if the system could be changed. The committee also asks how important tax is in considering where to locate a business.

Is there a need to reform the corporation tax system?

Basically no, not in terms of a root and branch reform – in general, the system works well. Simplification would be nice but it is difficult to achieve. Companies value certainty and stability, so it would be better to allow a period for all the recent changes (e.g. on foreign profits) to bed down rather than engaging on wholesale change at present.

Nevertheless, there are some areas where the rules may need modernising. A good example is in applying the permanent establishment concept to new business models and, particularly, to trading over the internet and trading in digital goods and services. Currently, a multinational can have a large turnover in, say, the UK, but not have a taxable presence here. The question is whether or not the rules should be modified so part of the profits would be taxed here. However, any changes should  be done on a global and not a unilateral basis and could result, for example, in UK companies which are exporting having to pay more tax abroad and, presumably, less in the UK.

Concern has also been expressed that the transfer pricing rules do not always work properly. Here, the question is whether existing rules are being correctly applied or whether they need updating. The OECD is continuing to work on the application of transfer pricing rules to intellectual property and there is general acceptance they should be more focused on actual substance.

Is there a meaningful distinction between ‘harmful’ and ‘fair’ tax competition?

Yes. Harmful competition distorts investment because it involves providing incentives only to inward investors, secret ruling and lack of transparency. Fair competition involves reducing tax rates generally, simplifying rules, and allowing special regimes to encourage certain activities, such as research and development, which are available to everyone.

What happens next?

The debate will continue. The deadline for written evidence was 30 April. On 23 April, the House of Lords Economic Affairs Committee held its first oral session, with evidence from Professor Steve Bond and Malcolm Gammie QC. At the time of writing this article, the committee was holding the second session with evidence from the heads of tax for BP, GlaxoSmithKline and Reed Elsevier followed by witnesses from the ICAEW, ICAS, ACCA and the CBI.

The first session largely focused on proposals put forward in the Mirrlees Review of 2010. With the business representatives, the committee planned to ask how easy it is for multinational companies to avoid paying tax on profit generated in the UK, what policies they have to minimise tax and what they see as an acceptable effective rate of corporation tax. They also planned to ask the witnesses whether foreign companies are able to gain a competitive advantage over domestic firms when operating in the UK due to the corporate tax regime.

With the accountancy associations, the committee planned to ask for the witnesses’ views on the chancellor’s proposal that tax avoiders should be named and shamed, whether the distinction in the tax code between debt and equity is justified and the recent Public Accounts Committee criticism of the close relationship between government and professional tax advisers.

The House of Lords committee will, no doubt, weigh up the evidence they have heard in their sessions and received in writing and publish some recommendations, which I am sure will prompt further debate – hopefully, as part of the international discussions scheduled to take place at the G8.
Further details of the House of Lords Economics Affairs Committee are available from the parliament website.