15 April 2021
Changing the Tax Rules
By John Watson
Increased tax rates in the US? An end to the use of low corporation tax rates to attract business? These ideas have been around for so long that they seemed to be gathering rust. Sure, the OECD has been “working on it”, but slowly. Sure, the UK and others have brought in their own digital service taxes but the fact that they would have resulted in tax being paid by American groups meant that the Republican administration were getting ready to respond with tariffs. Now, though, there are signs that a wind may be beginning to blow and, striding the blast like a naked new-born babe, we find Biden’s newly fledged Treasury Secretary, Janet Yellen.
It isn’t the proposal to raise the US corporate tax rate to 28% which will shift global behaviour. After all, the US must always decide how much it charges on activity on its own soil and that isn’t really our business. It is the proposed worldwide minimum rate of 21% which has the potential to change things internationally.
“Aha,” you may think. “Good luck to the US if they really expect all the low-tax jurisdictions in the world to raise their rate to 21%. That is hardly practical politics.” No, but nor is it what is being suggested. The idea is that where businesses within a group pay less than 21% locally, Uncle Sam (or presumably another jurisdiction in which the group has its base) should pick up the difference. If that can be made to work it would have a number of important effects.
First it would cut down on the shifting of profit, or base cost erosion as it is described on the high street. There would be no point in shifting profit out of a jurisdiction with a 21% tax rate because there would be no lower rate available. That would mean that the technology companies would in effect suffer a minimum rate of 21% on all their profits whether they diverted them to tax havens or not.
Second, those jurisdictions which attract business by charging a low corporation tax rate would lose that business. The UK is already moving out of that market with Rishi Sunak’s proposal to increase the corporation tax rate to 25%. Expect squeaks of indignation, though, from any number of other tax havens on land or offshore.
There is no doubt that this sort of change would be beneficial to the world economic system. It would greatly reduce the movement of profits away from the marketplace in which they are earned, so that a country in which a social media platform had a large number of members would not find itself unable to raise any tax from its activities because the profits were channelled elsewhere. Instead it should be able to rely on getting 21%, the rate at which diversion would be pointless. Placing profit-generating activities in the most convenient place rather than in a place dictated by tax considerations could only add to business efficiency.
A splendid idea in principle, then, but there are difficulties. Perhaps the biggest is that the corporation tax rate is only one aspect of the formula by reference to which tax is raised. If all subsidiaries of a group are to suffer tax at 21%, it is important that the aggregate profit of those subsidiaries and the group profit should be identical. This cannot be left to local tax rules. Otherwise you will find that a payment which is deductible, as say interest, in one subsidiary arrives in a taxable form, a capital receipt or dividend perhaps, in another. At one time this was commonplace through what were known as “hybrid instruments” and it has to be understood that these were encouraged by jurisdictions such as Luxembourg which used them to generate business. The question of how profits are calculated for the application of the minimum rate would have to be determined by international rules policed by an international Inspectorate.
Then there are political issues too. Many tax havens, be they offshore or be they EU members, talk loud and long about how they have built a centre of financial expertise which would survive without tax advantages. Mostly that is nonsense and many companies which hold their board meetings in those jurisdictions rely heavily on advice from London or other financial centres in their decision-making. Take away the tax advantage and why would anybody bother with them unless it be to access light-touch regulatory regimes – not always a very good thing either.
Make no mistake then the Democrat proposals will meet resistance from existing low-tax jurisdictions as well, of course, as from corporate America, and particularly digital corporate America, which will see effective tax holidays on the profits of its overseas subsidiaries coming to an end.
It sounds difficult, certainly. But, for all that, a reform of international taxation has to come sometime soon. The world is changing and the baton is being passed on to a new generation which is likely to be far less tolerant than its predecessor of offshore profits being rolled up tax-free while the jurisdictions in which the money is really made are unable to fund basic services. There is much that is unattractive about the Woke revolution but a puritanical intolerance of what is popularly regarded as wrong behaviour has its good side as well as its bad. We shall see, of course, but it is just possible that the Democrat proposals will catch a rising tide.
Cover page image – photo of Janet Yellen by Mark Warner (Creative Commons)