February 6, 2011 8:28 pm

Tax: Trouble to avoid

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Multinationals are increasingly in the sights of irate citizens and cash-strapped governments
 
Boots protest

Prescription for a problem: a protest outside Boots chemist in London’s Oxford Street last month, dispersed by police using pepper spray. The chain’s parent is domiciled in the low-tax Swiss canton of Zug (PA)

On an icy Sunday afternoon in January, high streets across Britain reverberated to chants of “Pay your tax”. Protesters wielding loudspeakers and leaflets railed against alleged tax-dodging by big companies at a time when the nation was facing as much as £80bn ($129bn) in public spending cuts.

“The government has to stop the cuts,” said a young activist demonstrating outside a central London branch of Boots, the pharmacy chain. “They have to do something about tax avoidance.”

The emergence of UK Uncut, a grassroots movement that has grown rapidly since its launch in a London pub last September, is being watched with dismay by government and business. The idea that spending cuts would be unnecessary if only everyone paid their taxes is “incredibly naive”, according to David Gauke, a Treasury minister.

“UK Uncut worries people like me,” says a multinational executive. “It shows how much raw anger there is out there. It would be understandable if the facts were right.” He complains about ignorance over how much tax business actually pays in Britain – at least £150bn from all levies, more than one-quarter of all tax revenues. He acknowledges, however, a failure by companies to explain their strategies: “It is very hard to explain a tax structure without looking guilty.”

Such large-scale public protests against corporate tax avoidance – which many businesses prefer to call effective tax planning – are, for the moment, unique to Britain. Agonising over the future of corporate tax is not. For governments dealing with the aftermath of the recession – not least yawning deficits and rising unemployment – it has become evident that globalisation has wrested control of multinationals’ tax affairs from the state’s hands, allowing companies unprecedented scope.

As a result, a topic once seen as the Cinderella of economic policy is fast emerging as a global battleground. “The whole issue of international taxation can only get more important,” says Jeffrey Owens of the Paris-based Organisation for Economic Co-operation and Development, the rich nations’ club.

The issue is rising up the global political agenda. On Friday, Angela Merkel, German chancellor, gave new impetus to proposals to narrow Europe-wide differences in corporate tax, demonstrating the extent to which the debate is now entwined with questions over the future of the eurozone. President Barack Obama last month called for the first US corporate rate cut in 25 years, to be funded by reforms of a code under which those who can work the system “can end up paying no taxes at all”. In December, Japanese officials talked of a “strong sense of crisis” as they unveiled rate cuts and special tax breaks to improve competitiveness.

In Britain, the protesters’ latest target is Alliance Boots, parent of the 160-year-old pharmacy chain. Its tax bills fell drastically after a highly leveraged £11bn takeover in 2007, which marked the peak of the private equity boom. What caught the eye of UK Uncut was the subsequent registration of its holding company in Zug, capital of the low-tax Swiss canton of the same name. The move is likely to keep tax bills low even when the company has paid off the debt and no longer has a big tax-deductible interest bill.

Alliance Boots – which operates in more than 20 countries, including Russia and China – brushes off criticism, saying the Swiss holding company “will better reflect the increasingly international nature of our wider group”. It adds: “If we had registered in Switzerland purely for tax reasons there are many other countries that we could have considered.”

Perhaps so – but Zug is of particular interest to many other businesses. Once best known for kirsch – brandy distilled from fermented cherries – the town is now famous for its rock-bottom tax rates. Located between mountains and an alpine lake, this picturesque backwater (population 25,000) today boasts nearly as many companies as people.

The complaints of Switzerland’s neighbours led to a European Commission accusation four years ago that low-tax cantons offered “unfair tax advantages” to foreign companies in breach of a 35-year-old free trade accord.

Bern rejected the charge but some global companies think it will eventually make concessions, even if that means extending low tax rates to domestic businesses. Peter Baumgartner, director of SwissHoldings, a grouping that represents Swiss-based multinationals, says: “In the longer run it will be difficult to defend the fact that foreign companies are paying less tax than Swiss companies.”

Tax-based tension between governments is mirrored in attitudes towards Ireland. Hostility to its policy of low corporate tax – seen as a cornerstone of “brand Ireland” – was laid bare during negotiations over a European Union bail-out last November. The dispute lingers. “I deeply respect the independence of our Irish friends and we have done everything to help them,” President Nicolas Sarkozy of France said in January. “But they cannot continue to ask us to come and help us while keeping a tax on company profits that is half [what other countries have].”

New business models are ratcheting up such disputes. In the past decade, large multinationals have increasingly moved their “intangible” assets – such as patents, brands, treasury operations, all of which account for a big share of taxable profits – to low-tax countries. Switzerland, Ireland and Singapore are the favoured destinations, accounting together for at least 20 per cent of US intangibles, according to the OECD.

This trend has presented a more serious threat to the tax bases of industrialised countries than conventional avoidance schemes, which revenue authorities can tackle with disclosure notices and legislation. In response, governments are ever more aggressive in their application of rules designed to stop revenues shifting to low-tax countries. But the search for more effective remedies continues.

So far, the results are not encouraging. A UK proposal to impose taxes worldwide on passive income – royalties, interest and dividends – was dropped in 2008 after it precipitated the departure of a clutch of big multinationals such as WPP, the advertising group. London is now relaxing existing rules and is taking a lead from competitors such as Belgium, the Netherlands and Luxembourg, which offer special concessions for patents, a particularly mobile source of income.

An OECD attempt to orchestrate a new approach to international rules on intangibles has so far failed. Multinationals successfully argued that the centralisation and relocation of operations such as brand management were business decisions that could not be attacked as tax-motivated.

Another approach, which is being pushed by charities and campaign groups, is to require greater disclosure by multinationals on what they pay where, in an effort to shame them into paying more. Mike Devereux, a professor at Oxford university, says companies are well aware of the potential costs – in terms of reputational damage, more intrusive audits and uncertainty – to companies that produce a much lower tax bill than their rivals. “If you are a large business, you don’t want to get too far out of line.”

But there are clear limits to the power of reputational threats. As multinationals increase their global reach, loyalty to their home country declines. Directors feel obliged to consider measures to drive down tax, which is often their second largest cost after labour. Moreover, the law is ultimately the only arbiter of what is owed. “Simply demonising tax avoiders and exhorting them to behave better is ... a feeble stratagem,” according to a recent publication by the Institute for Fiscal Studies, a London-based think-tank.

Instead, governments are considering radical reforms. In March, the European Commission will unveil a blueprint for a bloc-wide tax base for companies. European tax revenues would be divided up according to sales, assets and employees in each member state. As well as cutting businesses’ compliance burden – its stated aim – the proposal would reduce the scope for tax planning. However, it is unlikely to be taken up by all members.

An even more radical option is to abandon corporate tax altogether in its current form. “It is very hard to tax capital in the way we try to tax it now by identifying where it is located,” says Prof Devereux. “The more I think about it the more crazy it is.” A better approach to taxing profits would, he says, be a form of value added tax.

Corporate tax would be mourned by few economists; most argue that it depresses wages and damages economic growth. But few politicians would countenance its abolition, particularly as the levy remains an important contributor to national treasuries – albeit dwarfed by the other charges that businesses pay.

Corporate tax’s share of total tax revenues in OECD countries actually increased from 8 per cent in 1990 to 10 per cent in 2008. This apparent resilience may be misleading, however: economists believe the figures are flattered by individuals using corporate structures to avoid personal tax.

The preservation of corporate tax revenues is likely to require a concerted effort to eliminate loopholes and broaden its base. “Over the years, a parade of lobbyists has rigged the tax code to benefit particular companies and industries,” Mr Obama told the US public in last month’s state of the union address. But resisting pressure from businesses is easier said than done. Few ministers feel able to ignore warnings from chief executives that, if pressed too hard, they will take their investment and jobs elsewhere.

Apparently relentless competition for jobs and revenues will result in sustained downward pressure on tax rates, according to the OECD’s Mr Owens. Along with the trend towards increased consumption taxes paid by rich and poor alike, a structural change is under way that is “probably leading to a less progressive system”. Governments should look at other approaches – involving wealth and inheritance taxes, for example – to share the burdens and rewards of globalisation. He adds: “There has to be a role in the tax system to reduce inequality.”

The message is a challenging one for governments. Their struggle to improve competitiveness is likely to exacerbate grievances among voters about the unfairness of the system. Tax protests are a symptom of a concern that is unlikely to go away.

In Britain, UK Uncut, which styles itself as an “army of citizen volunteers determined to make wealthy tax avoiders pay”, is preparing again to hit the streets. “We have hit a nerve,” says one. “We are not going to stop.”

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