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A corporation tax system under strain

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Google’s £130m tax settlement with HMRC may have been intended to lance the boil but it has had the opposite effect. Governments are under pressure to raise more tax from the big multinationals and it is not clear whether or not international cooperation through the OECD and other bodies will be enough to deal with the problem. 

There can have been few tax deals that have backfired quite so badly – both for the taxpayer and the tax collector – as Google’s £130m settlement with HMRC. Google, by acceding to the deal being made public, though how willing it was is unclear, presumably thought it would generate some good publicity. So did George Osborne, who publicly patted HMRC on the back and declared the settlement to be a good deal, ‘a great success’.
Lessons have been learned. If nothing had been said about the deal, or if its details had dribbled out later when the company released its accounts, it is hard to think the reaction could have been any greater, or public opinion worked up into such a frenzy. The other tech multinationals may well insist that their tax affairs remain a matter between them and HMRC until a time of their choosing.
Apart from the Google row, however, the episode has again focused attention on corporation tax. Are governments now more or less powerless when faced with cleverly advised and geographically footloose multinationals? Or will initiatives such as those taken by the OECD and the European Union succeed in stopping these firms from playing governments off against one another? What is the role of corporation tax anyway? The chancellor has made much of reducing Britain’s rate to the lowest in the G20, which will mean a rate of just 18% by 2020 (some people will be old enough to remember a 52% rate). It is legitimate, though, to ask about the role of a tax which is hard to collect and, it seems, easy to avoid. Is a low corporation tax rate still a magnet for multinationals, when many of them barely pay it?   
Nor do those multinationals have to work too hard to minimise their corporation tax liabilities. The Lawson reforms of the 1980s were intended to lower the rate of corporation tax, in large part funded by the elimination of reliefs. The end result, a simpler and more streamlined system, was preferable. These days, despite even lower rates, firms still have plenty of reliefs to offset against tax. Even after the Lawson reforms, corporation tax receipts were between 4% and 4.5% of gross domestic product; now they are 2.4%. If the chancellor had in mind a Laffer curve response, in which a lower tax rate brings forward a rise in revenue, he is still waiting. The £43bn corporation tax brought in during 2014/15 is worth having but it could be a lot more; it would have been £80bn or so if it had stayed the same relative to GDP as it used to be.
The result of all this is that the future of corporation tax is up for grabs. Lord Lawson has re-entered the debate, saying: ‘I have long argued that in the modern world corporation tax has had its day as a major source of tax revenue. It needs to be a much lesser tax, bolstered by a tax on corporate sales. While multinationals can artificially shift profits to whatever tax jurisdictions they choose, sales are where they are, and can’t be shifted.’
It may be a little early for such a radical move. Governments are continuing to push a coordinated international response to multinational tax avoidance. The OECD’s base erosion and profit shifting (BEPS) project is the main route to achieving this. The EU is also pushing forward. Some of the more common avoidance schemes, such as the ‘double Irish’, will come to an end by 2020. Ultimately, multinational avoidance requires a multinational response.
However, as the Institute for Fiscal Studies researchers Helen Miller and Thomas Pope put it: ‘Since the opportunities for avoidance arise at the boundaries between tax systems, a multilateral approach makes sense. However, governments can face a trade-off when deciding how to act: changing tax rules can help crack down on avoidance but come at the cost of reducing a country’s competitive position. Many of the actions under BEPS are merely “recommended”. Countries are under no obligation to implement them if they think they will damage their own competitiveness. It remains to be seen how the UK government, among others, will make that trade off.’
Too much cooperation, in other words, may remove a weapon that governments have found useful: using their tax systems to attract global business. Cooperation among OECD countries leaves open the possibility for multinational tax avoidance elsewhere; and there would be nothing remotely new in that. In turn, that leaves open the possibility for more radical reform, if not immediately. Though corporation tax in its present form dates from the mid-1960s, the system has its origins in the 1920s. Since then, international business has changed out of all recognition. It has become, as the IFS puts it ‘more global, digital and intangible’. If BEPS and other initiatives cannot properly address such changes, and the evidence is that it will be a struggle to do so, then there may be no alternative but ‘to scrap the corporate tax system as we currently know it and write a new one’.
That would take us back to something like Lord Lawson’s suggestion, in which companies are taxed according to where their sales occur. Even that might be a long way from perfect. Some companies have large sales but small profits in particular markets. If those profits are in countries with relatively high taxation, sales-based corporate taxation could genuinely drive businesses away. What works for some multinational firms may not work for others. Reform of corporate taxation is in the air. Do not expect it to be easy. But do not expect the pressure for reform to ease up either. 
Issue: 1295
Categories: Analysis , Corporate taxes