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Treasury minister defends tax system as multinationals remain under scrutiny

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David Gauke defended the UK’s corporation tax system yesterday and said the government was strengthening HMRC’s ability to deal with transfer pricing abuse and ‘artificial diversion of profits’ out of the UK. In a studio discussion on the BBC’s Newsnight programme, the exchequer secretary to the Treasury said it was important to remember that corporation tax is a tax on profits from activity conducted in the UK.

‘It’s not a tax on sales or turnover, he said. Gauke was responding to a BBC Newsnight investigation into ‘some of the world’s most successful companies, who appear to make massive profits in Britain and yet pay very little tax’.

Charlie Elphicke, the Conservative MP, told the programme that substantial reform was needed to bring the business tax system ‘up to date’.

Gauke declined to comment on particular companies, but challenged the methodology behind the report, which used estimates of UK profit based on global profit margins.

For many people, Newsnight presenter Gavin Esler said, the tax ‘scandal’ was not about what was illegal but what was permitted under the law. Some of the world’s biggest companies, including Coca-Cola and Intel, ‘apparently make massive profits in Britain but in some cases pay as little as 2% tax, while smaller British companies have been paying corporation tax at 26%’.

The big companies are doing nothing illegal, he said. ‘That’s the point.’

Newsnight’s reporter Joe Lynam had confessed on Twitter, before the programme was broadcast, that tax boffins would ‘hate’ his attempt to explain transfer pricing. Global brands are worth billions of pounds, he said. ‘Research by Newsnight seems to show that many of the largest UK multinationals here are paying only a fraction of the corporation tax that they might have paid, and it’s perfectly legal.’

In the absence of country-by-country reporting of profits, Lynam explained, the UK profit was estimated by applying the global profit margin to the published figure for UK sales. ‘That gives us a chance to estimate how much corporation tax could have been paid … and to compare that with the actual rate that was paid. Needless to say, the companies don’t like our methodology and one company referred to it as completely flawed.’

However, on this basis, examination of the UK accounts of 19 of the best-known US multinationals for 2011 showed a ‘tax gap’ of almost £3bn. Intel had paid an effective corporation tax rate of 2%, Lynam claimed. Kraft Foods paid 4.8% and Coca-Cola 13%.

Intel said Newsnight’s methodology was flawed and that the group paid the appropriate amount of UK tax. Coca-Cola said it paid the required taxes in every country in which it operates. Kraft, now Mondelez International, said it paid corporation tax based on the laws of the jurisdictions in which it operates, and ‘complies with all applicable tax legislation in the UK’.

Earlier this week The Times attributed the research cited by Newsnight to Elphicke, a former tax lawyer. As Tax Journal reported on Tuesday, the paper quoted Elphicke as saying that the chancellor ‘should look at a minimum tax rule for corporations’. Elphicke told Newsnight: ‘After the financial crisis, playing the system is no longer acceptable.’

Transfer pricing was the key, Lynam said. In general, the group company that controls valuable intangibles such as patents or trademarks bases itself in a low tax country. ‘From there it can bill its British sister company for permission to use those trademarks, or certain products,’ he said. The effect was to ‘magnify’ the profits in low tax countries and minimise them in Britain.

The OECD’s rules on transfer pricing were designed to prevent abuse. But even the OECD admitted that ‘things are getting a bit out of control’, Lynam suggested.

Pascal Saint-Amans, director of the OECD’s Centre for Tax Policy and Administration, told the programme: ‘The concern is that there has been a shift towards aggressive tax planning, which may have been encouraged by the governments – let’s be fair – but which now needs to be stopped.

‘It needs to be stopped with fair rules which would be clearer and simpler, but which have to be implemented.’

Gauke accepted that if companies were diverting profits to tax havens, then ‘that is a concern, HMRC would consider that to be a risk factor, and we would want to address it’.

Internationally, he said, corporation tax is a tax on activities conducted in a particular jurisdiction. ‘If you have a business that exports its goods or services from one country to another, it’s taxed in the country it is in rather than the country in which it sells.’

He pointed out that where businesses based in the UK provide services overseas, ‘we get the tax from those UK businesses’. The UK could not unilaterally change the system, he said. ‘We would have to work with other countries.’

Bill Dodwell, head of tax policy at Deloitte, said that multinationals had found that it was more efficient to run their businesses on a centralised model. Costs were driven down, producing benefits for consumers.

Groups considering where to base their activities would look at a range of factors including access to skilled labour and the tax situation. ‘Companies do adhere to the spirit of the law,’ he said, and it was ‘open to and sensible for’ multinationals to ‘deliver a cheaper service to their consumers by basing their activities around the world’.

Asked whether it was unfair that smaller businesses could not compete on the same basis, Dodwell said smaller businesses had different strengths: ‘They are very nimble and they can move rapidly into markets in a way that bigger businesses cannot.’

He added: ‘We have to think – where exactly do the profits come from? The US technology companies that are in the news are spending billions and billions of dollars developing their technology in the US, and that really is the key driver of their profits.’

But Ellie Mae O’Hagan, a columnist and tax campaigner, said Gauke should be telling companies that ‘they should not be avoiding tax’.

‘People’s lives are being damaged and destroyed by [public spending] cuts,’ she said. Citing Seamus Milne’s article for The Guardian’s ‘comment is free’ website earlier this week, she claimed that ‘if all tax avoidance and evasion in this country was tackled it could pay off the entire budget deficit’.

There were alternatives to the current system such as those advocated by the Tax Justice Network. Governments should at least consider refusing to give contracts to companies that avoid tax, she said.

Seamus Milne wrote: ‘When austerity and cuts are sucking demand out of the economy, fuelling poverty and joblessness and actually widening the deficit, the need to step up the pressure for corporations and the wealthy to pay their share as part of a wider recovery strategy couldn't be more obvious.’

HMRC guidance: Royalties

HMRC’s International Manual says:

‘The payment of royalties under a licence agreement can be a powerful tool, helping the tax-efficient movement of profits around the world. Royalties may be paid between two connected persons in circumstances where it is doubtful whether the underlying intangible property is particularly valuable, an arrangement that would not be put in place if the two parties were independent.’


‘Royalties are recurring payments under a licence agreement allowing the licensee to make use of an asset belonging to the licensor. Royalty agreements can relate to many different types of asset, both tangible and intangible. For instance, the licensee might pay a royalty in return for the rights to manufacture or market particular goods or to make use of a patent or trademark belonging to the licensor …

‘At the risk assessment stage an issue to consider is how much profit the licensee company is paying away under the royalty agreement, especially where the royalties are reducing the net profits to a negligible level.’