Unitary taxation has been used by the US for nearly a century
The Google tax controversy has highlighted the huge imbalance between the power of transnational corporations and normal people. Normal people’s tax disputes don’t drag on for decades and they can’t get access to policymakers to secure favourable deals. Neither can they easily create complex structures to shift income and profits from the UK to elsewhere.
If corporate propaganda is to be believed, battalions of lobbyists, accountants and lawyers are heaving their luggage about in ministerial offices and tax havens because of a burning desire to comply with the law.
They go to enormous lengths to manufacture losses, shift profits and engage in dubious transactions to merely comply with the law. The truth is that companies make profits by using social infrastructure (education, healthcare, transport, security and legal system), but too many don’t want to make a fair contribution towards its cost.
For years, the corporate lobby claimed that when corporation tax rates are reduced, companies will stop dodging taxes. The compliant governments have reduced corporation tax from 52 per cent in 1982 to 20 per cent in 2016, but there is no end to tax games in sight.
The same lobby wants to abolish corporation tax altogether. If successful, that would deprive the UK public purse of around £42 billion (page 5 of the HM Treasury forecast). The higher profits will simply line the pockets of executives and shareholders.
As a consequence normal people will have to forego hard-won social rights, or face higher taxes. Income tax yield will need to rise by 26 per cent (see page 8). Of course, companies will still want subsidies and taxpayer bail-outs to rescue them from their own follies, as in the case of banks.
Corporation tax is levied on profits, but former Conservative chancellor Lord Nigel Lawson argues that this should be replaced by a tax on sales. His reasoning is that multinational companies can move profits around, but somehow the sales figure can’t be shifted.
Actually, his proposals complicate the issues even more. The debate about Google is precisely that the company is able to undertake economic activity in the UK, but books its sales in Ireland.
Sales tax is a favourite target for the tax avoidance industry. One such scheme was marketed by Ernst & Young for Debenhams and 70 major high street retailers, and described by a Treasury spokesperson as ‘one of the most blatantly abusive avoidance scams of recent years’.
Another scheme developed by KPMG used offshore structures to enable amusements arcades to avoid VAT. There is little to suggest that tax on sales is immune from attacks.
Lord Lawson’s proposal for tax on sales has no relationship with profit margins. Many fledgling and small businesses either make losses in earlier years or have small profit margins. They would be penalised by a tax on sales. Steelmaking companies currently have sales but are making losses.
They would be forced to pay the tax on sales, which would worsen their cash flow, hasten their demise, and kill-off any chance of recovery. In a long supply chain, the final link in the chain may have a small profit, but will face a large tax on sales. Of course, companies don’t earn their revenues from just selling their products and services.
They also make gains by selling assets and profits from gambling in stock markets. The Lawson scheme does not touch such revenues.
The third option on the table is Unitary Taxation, and a version known as the Common Consolidated Corporate Tax Base (CCCTB) is advocated by the EU. It levies tax based on profits but in a radically different way. Under the current system, a company with 500 different subsidiaries is assumed to have 500 independent taxpaying entities.
This invites companies to indulge in creative games to shift profits through spurious royalty payments, management fees and intragroup interest payments.
The reality is that companies like Google are integrated entities with common products, boards of directors, shareholders, strategy, finance, marketing and everything else.
Their subsidiaries are not independent entities. In essence, unitary taxation calculates the worldwide profit of an integrated entity. It ignores intragroup transactions. The profit is allocated to each country by an apportionment formula that takes account of how value-added is generated. This could be on the basis of sales, assets, number of employees and other key variables.
Each country can then tax its share of profit at any rate that it wishes to.
A system of unitary taxation has been operated within the US for nearly a century to prevent companies from avoiding tax by playing-off one state against another. The apportionment formula is based on sales revenues in each US state. Canada’s system of unitary taxation apportions profits to each state based on two-factor formula of sales and payroll costs.
A similar system can be developed for the EU or the entire world. It can also be applied unilaterally by any state. For example, the UK can choose to ignore/restrict tax relief on intragroup transactions, or redefine the meaning of economic transactions. Unitary taxation is not a panacea, but offers a way of checking some of the corporate abuses.
Prem Sikka is Professor of accounting at the University of Essex
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