The Independent View: Budget corporate tax changes could cost developing countries billions

Ahead of the most important austerity budget in a generation, the government plans to open up a huge new tax loophole that will cost ordinary people around the world billions warns ActionAid in a new report ‘Collateral Damage’

The international development charity has revealed that this loophole will allow UK based multinationals to avoid an estimated £4 billion worth of taxes in developing countries and will also cost the UK Treasury £1 billion.

Until now, the UK’s anti-tax haven rules have provided a deterrent to companies seeking to avoid paying taxes in Britain and poor countries alike. The proposed changes will make it easier and more lucrative for UK companies to dodge tax in developing countries.

If the government waters down these rules in the March budget it could inflict huge collateral damage on poor countries like Zambia, Ghana and Tanzania who desperately need that money to fund doctors, nurses and teachers and to ultimately help lift them out of poverty. And with a cost to the UK of £1billlion – everyone loses out.

A recent UK opinion poll commissioned from YouGov by ActionAid also shows strong demand for tougher government action on corporate tax avoidance with 79% saying the government isn’t doing enough to tackle tax avoidance. The results revealed widespread support across the political spectrum and in all regions.

· 74% of Conservative voters, 83% of Labour voters and 87% of Liberal Democrat voters said the government should be doing more tackle tax avoidance.

· 72% said that companies that use legal loopholes to avoid their tax bills in the UK or developing countries were behaving irresponsibly.

The British public wants the government to do much more to prevent endemic corporate tax avoidance. Why should ordinary people around the world continue to pay the price of tax dodging by UK companies? This new loophole could cost the poorest countries as much as £4 billion a year. It’s time for the government to urgently rethink its plans.

ActionAid is calling on the Government to make a full assessment of the changes’ impact on developing countries, and to take steps to mitigate any harm, before they become law. In November last year, the IMF, OECD, UN and World Bank called on G-20 countries to undertake such “spillover analyses” when they make big changes to their tax laws.

Tax justice campaigners from ActionAid will be attending the Liberal Democrats’ spring conference later this week and we look forward to meeting representatives and letting you know more about our campaign.

The Independent View‘ is a slot on Lib Dem Voice which allows those from beyond the party to contribute to debates we believe are of interest to LDV’s readers. Please email [email protected] if you are interested in contributing.

* Martin Hearson is a Campaign Manager with ActionAid.

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9 Comments

  • There hasn’t been much on this, but the ActionAid report “Collateral Damage” does a good job of simply describing what the rule changes mean. I’ve not found any articles that lay out the benefits to the UK (domestic) economy of this change.

    I definitely smell a rat here as the HMRC report (http://www.hm-treasury.gov.uk/d/controlled_foreign_companies.pdf) clearly states that these changes will negatively impact the tax take by ~£1bn per annum in 2015. Given that HMRC are tightening up on the tax system to increase tax take, these proposed changes directly conflict with these initiatives.

  • What a complete pile of rubbish! The CFC rules levy UK tax on profits earned in foreign countries. If anything they act as a disincentive to multinationals to invest in developing countries or leave profits in such countries. Chris Jordan’s point in the comments above is completely wrong: the CFC rules do precisely nothing to protect the developing world from tax avoidance; if anything they do the opposite.

    Once again Action Aid have got completely the wrong end of the stick and their campaign would be counterproductive if the government were foollish enough to pay heed to it. I find it extraordinary how they can come up with such nonsence, seemingly relying on the fact that too few people actually know about these rules in order to rebutt their contention.

  • Chris Jordan 7th Mar '12 - 7:38am

    Dominic – You might want to have a look at HMRC’s definition of CFC’s, which is quite explicitly about preventing companies shifting profits into tax havens http://www.hmrc.gov.uk/international/cfc.htm

    If you want to see exactly how developing countries will lose out if these proposals make it into law, then look at the prezi on our website. http://www.actionaid.org.uk/103143/the_problem_with_a_new_loophole.html

  • Richard Dean 7th Mar '12 - 10:55am

    Is it not possibe for the developing countries in question to develop their own laws along the same lines? Would that not solve the problem, perhaps supported by some international cooperationon policing? Part of “developing” includes developing systems of government, and we are doing them no favours by trying to manage their taxation issues for them.

  • OK, I’ve simmered down after my initial reaction but let me just explain in fairly simple terms why Action Aid have this completely the wrong way round:

    CFC rules are a mechanism that allow (in this case) the UK to tax profits legitmately earned in other countries. They’re not about tackling artificial movement of profit – that is covered by a separate set of rules on “transfer pricing” which are very robust and are continually being strengthened. The CFC rules were originally supposed to tackle the use of so-called “cashbox” companies, where “passive” income (interest, passive royalties etc) was legitimately earned in a company in a low-tax jurisdiction that was a subsidiary of a UK company. So far so good – and indeed the amended, simplified CFC rules will continue to tax such profits.

    But over the years since they were introduced in 1984 the CFC rules have suffered from massive “mission creep” whereby the present set of rules tax all sorts of things they were never intended to capture. They are also hugely burdensome to administer for companies and HMRC alike. That in turn has been the main reason cited by companies like WPP, United Business Media, Shire Pharmaceuticals etc to shift their HQs from the UK to jurisdictions like Ireland – and indeed why Shell decided to have their unified top holding company in the Netherlands rather than the UK. Interestingly, WPP and a number of others have now said they will return to the UK once these rules are reformed.

    But there is even more of a burning platform for reform: successive cases at the European Court of Justice have ruled that the UK’s old rules were in breach of EU law. They cannot carry on as is as they are illegal.

    Now what is the relevance of the CFC regime to developing countries? Well, if anything it is exactly the opposite of what Action Aid are saying. The CFC rules at present don’t just target what you or I might regard as a tax haven, they seek to tax profits legitimately earned in *any* foreign subsidiary of a UK company, including those in developing countries. Indeed they disproportionately affect developing countries as they typically don’t apply to developed countries in North America and Western Europe, where tax rates are relatively high and various exemptions from the CFC rules apply. But let’s take an example: if a multinational wants to set up a regional headquarters for Africa in Jo’burg (a very common expreience) then the current CFC rules can very easily apply to apply UK tax to those activities (and indeed ‘taint’) the local trading activities of the South African company. Whereas if they run the regional operations from London (less efficient in operational terms) it costs them less tax. So there’s a disincentive to build operations and activity in South Africa. What’s more, if they buy a local company with local brands and want to expand that business, throughout Africa, they’ll be penalised for owning those brands in South Africa rather than bringing them to the UK.

    On so many levels the present UK CFC rules are not fit for purpose. They’re not being abolished but they are long overdue for reform. The present reform process has taken a number of years (started under the last govt and continued through various consultation stages by this one). We will hopefully end up with a regime which is simpler, better targeted to real avoidance, acts as less of a disincentive to investing overseas (esp in developing countries) and, importantly, is compliant with EU law. A win-win-win.

  • Martin Hearson 7th Mar '12 - 4:13pm

    Dominic,

    I am confused by your example. The starting point for CFC rules is that they apply to subsidiaries that pay a lower rate of tax, meaning three quarters of the uk rate (http://www.hmrc.gov.uk/manuals/intmanual/INTM202030.htm). So a South African subsidiary of a UK MNC could never be a CFC, since the corporate tax rate the is 28%, higher than the uk rate. Most developing countries have higher corporate tax rates than the uk, so CFC rules can’t possibly deter investment there. Rather, they are designed to apply to subsidiaries located in low tax jurisdictions.

    I am also not sure that your description of the difference between CFC rules and transfer pricing makes sense. CFC rules are designed to stop the diversion of profits into tax havens where transfer pricing rules are not adequate.For example, the government’s policy principles document for the CFC reforms states, “There is a continuing need for protection of the UK tax base from erosion, but the protection required cannot be provided through reliance on transfer pricing rules as tax avoidance is not their primary focus. These rules are concerned with the arm’s length nature of transactions and allocation of profits.” (http://www.hm-treasury.gov.uk/d/cfc_policyprinciplesddocument300709.pdf)

    As you probably know, the CFC rule changes are part of a move from worldwide to a more territorial tax system (this is stated explicitly in the same policy principles document). The IMF, OECD, World Bank and UN all suggested recently that this could have negative impacts on developing countries:

    “The G-20 countries’ lead role in the debate on international tax system creates an obligation on them to ensure its smooth functioning. In that context, it would be appropriate for G-20 countries to undertake “spillover analyses” of any proposed changes to their tax systems that may have a significant impact on the fiscal circumstances of developing countries. Trade agreements are an obvious example — tariffs remain a key source of revenue in many developing countries. But there can be important effects from other G-20 tax policies too, including in their international tax regimes (in moving, for instance, from residence to territorial systems).” (http://www.imf.org/external/np/g20/pdf/110311.pdf)

    Best,
    Martin

  • Martin – the misconception in your post (“surely South Africa has a high tax rate so it wouldn’t be caught by CFC”, if I can paraphrase) highlights exactly why the CFC rules are in dire need of reform. That’s because it’s all too common for companies in countries with notionally high rates of tax to be caught by the current CFC rules: the CFC test isn’t just one of simply comparing the tax rates, in fact it requires a company to calculate what its UK-basis chargeable profits *would have been* if it had in fact been tax resident in the UK. So in practice every year a UK-headquartered group needs to do a hypothetical UK tax computation for every one of its non-UK subsidiaries – and even minor timing differences (eg differences between UK-basis capital allowances and South African-basis tax depreciation) can make the effective rate of local tax in any year (when compared to the notional UK-basis taxable profits) less than 75% of the UK rate. It’s a crazy set of rules (as well as hugely bureaucratic). It also disproportionately affects companies in developing markets, as ones in Europe can often benefit from exemption based on EU principles.

    The distinction between transfer pricing (TP) and CFC is clear. CFC rules are designed to catch businesses that make legitimate decisions to shift people, activities or assets to a low taxed jurisdiction. They don’t do the job at all well, but that is their objective. Of course the actual shift of valuable assets or activities (eg business goodwill) itself will also be subject to tax in the UK at the point of exit, so it’s arguably unnecessary to have CFC rules in the first place. TP rules, on the other hand, are there for a different purpose, namely to ‘correct’ any non-arm’s length pricing that results in an artificial diversion of profits. By and large they do that pretty well – and tax authorities are getting more any more sophisticated in their application as time goes on.

    One of the reasons why TP works well and CFC doesn’t is that the TP rules are a pretty simple, principled-based approach to legislation. CFC, on the other hand, attempts to be very prescriptive, the legislation is many, many times longer and more complex, and the rules are massive overkill in most cases (while still not closing every loophole – and opening others by their sheer complexity). The simplification of the CFC laws – which is what is currently being consulted on – is long overdue.

    Personally, I would abolish them altogether and go the whole hog with a principles-based system, relying on the General Anti Avoidance Rule (GAAR) in the Lib Dem manifesto. But the current proposed changes are a step in the right direction and it is sheer hyperbole for Action Aid to suggest that somehow this is opening loopholes or at the expense of developing countries; the reality is exactly the opposite.

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