We all know by now that the likes of Google, Amazon and Starbucks pay very little corporate tax in the UK.
- We know that our corporate taxes tend to be low though they are not as low as Ireland’s and Sweden’s.
- We might also have an intuition that corporate taxes are a significant part of GDP. We would miss them if we didn’t have them but . . . they are only about 3% of GDP. Surprised?
What is even more surprising is that though our corporate taxes are low, they are a larger part of our GDP than in Germany, say. My first thought was, ah good, we set individual corporate taxes low but gain on the aggregated. But of course earning more from corporate taxes than Germany is just a reminder that we earn less from more productive sources. So perhaps not hurrah for us.
So what are the issues surrounding corporate taxation? The issue that energises us at the moment is the crafty use of tax law and corporate structures to lower tax liabilities. Academic accountants are proposing various different ways of taxing companies and here are my notes below.
Cash-flow taxes
Instigator: Meade Report
Core idea: Tax net cash flow rather than profits.
Changes:
- Abolish deductions for depreciation and interest payments.
- Deduct investment expenditure when it occurs.
Spelled out:
- Investment becomes a current cost.
- Sales of capital costs are treated as any other cash inflow.
- Both loans and interest payments are not subject to tax (similarly to equity injections and dividend payments)
- Trading transactions are taxed; not financing operations
Difficulties:
- Does not apply well to banking trading operations
- Other countries would still be making distinctions between debt and equity
Variant: “R+F”
- Tax borrowings as cash inflows and treat payments of principal and interest as deductibles
- Would apply to trading operations of banks
Follow-up question:
- VAT on financial services
- Allowance for Corporate Equity (ACE)
Instigator: IFS Capital Taxes Group (1991)
Core idea: Provide explicit tax relief for the (imputed) opportunity cost of using shareholder funds to finance the operations of a company
Comparison with other methods:
- Allows for 100% allowance for equity-financed investment not provided for in cash-flow methods
- Equates to allowing the interest cost of debt-finance in ‘standard’ corporate taxation
Essence:
- The normal return on equity-finance investment is removed from the corporate tax base
Mechanics:
- Calculate the closing stock of shareholder funds at the end of the previous period
- Opening stock + Equity issued – Equity repurchased + Retained profits
- PV of a stream of tax payments will not depend on details of deprecation schedule
- Opportunity cost is the risk-free (nominal) interest rate
Comparisons with personal taxation:
- ACE compares with RRA (rate of return allowance)
- Cash-flow proposals compare with EET treatment of savings
- Reduce rebates and carry-forward provisions by aligning timing of tax payments with actual returns
Notes:
- Retains much of existing tax structure
- Taxes the excess over nominal rates of return
- Debt and equity financing equivalent in PV terms and in relation to tax timing provided depreciation schedules are realistic
- Taxes only become liable when returns exceed a normal rate of return
- But if taxing rents taxes effort and risk?
- To implement, only need to specify how the equity based evolves over time and the nominal interest rate
Comprehensive Business Income Tax (CBIT)
Essential idea: Tax the interest on debt financing in the hands of the debtor, i.e., tax corporate profits after depreciation but before interest.
Issues:
- Raises required RoR for both debt and equity financing
- Hugely increase tax in banking and financial services that currently deduct their interest payments
- CBIT effectively taxing returns to debt and equity at the corporate level.
Developments:
- Increasingly, limited interest deductibility across borders to stop subsidiaries in high tax regimes borrowing from parent companies in low tax regimes
- Increasingly, limit deductions for financing foreign operations are exempt from local tax
Comparisons with other systems:
- ACE and cash-flow taxes change the tax base and exclude normal returns on savings (which are taxed at a personal level)
- Cash-flow taxes are close to the expenditure treatment of personal savings
- ACE is similar to RoR Allowance on personal savings.