Revenue’s uneven reach has its risks

When the spending watchdog investigated the collection of taxes from large businesses recently, it noted in passing that the distribution was “heavily skewed”. A majority of big companies paid little or no tax, while a small number of very large companies paid bills that ran into billions of pounds.

The sectoral breakdown was even more remarkable. Just three sectors – banking, oil and gas, and insurance – were responsible for two-thirds of all large business corporation tax receipts.

At the other end of the scale, the automotive, real estate, alcohol and tobacco sectors paid just a few hundred millions pounds of tax.

The question of why so many companies paid so little tax in one year does not have a simple explanation.

A low tax bill does not necessarily suggest that a company is deliberately avoiding tax.

One reason companies may have low bills is that the capital allowances they receive on investing in new equipment defer tax payments to some indefinite point in the future. In 2004, £43bn of capital allowances were offset against gross taxable trading profits of £161bn, according to the most recent statistics for industrial and commercial companies available from Revenue & Customs.

Low profitability in a particular year is also an explanation, especially when allowances and deductions are taken into account. Whereas many oil and financial services companies performed strongly in 2005-06, many industrial and commercial companies suffered as a result of rising oil prices. Trading losses from previous years also played a role; in 2004, for example, trading losses from past years of £8.5bn were available to offset profits.

Pension contributions may also be a factor as they reduce the tax bill in the year they are paid. This was the case with J. Sainsbury, the retailer, which paid no corporation tax in 2005-06.

Leaving these reasons aside, the Hundred Group, representing finance directors of FTSE100 companies, argues it is a mistake to focus solely on corporation tax, as it ignores companies’ contribution to other taxes such as employers’ national insurance contributions, business rates and irrecoverable value added tax.

It commissioned a study by PwC which showed that, for every pound of corporation tax, companies pay a pound in other business taxes. Economists also point out that companies do not ultimately bear corporation tax: it is passed on to workers, customers and shareholders.

But the strategies adopted by companies to lower their tax bills can be controversial. Revenue & Customs succeeded in raising £900m-£2.7bn of extra annual revenue between 2003 and 2007 as a result of challenging companies.

One way that companies can reduce their tax bills to low or negligible levels is by having large amounts of debt in the UK, allowing them to offset interest costs against profits. Multinationals often have more flexibility than domestic companies when it comes to loading up their debt in the UK because loans can be made between subsidiaries.

Morgan Stanley has calculated that, in 2006-07, non-financial companies paid about £64bn in interest, reducing taxable profits from nearly £200bn to £133bn.

“There is nothing to stop a standard UK multinational from gearing up in the UK and investing the money as share capital in foreign subsidiaries. It can do it to the point where it eliminates UK tax,” says John Cullinane of Deloitte.

He believes it is significant that the three sectors – oil, banking and insurance – that pay most tax are, for different reasons, hampered in their ability to reduce their tax bills by high gearing.

Bank regulators require their balance sheets to be funded by equity, rather than debt. Insurers are subject to a special, highly complex tax regime, while oil companies’ profits in the North Sea are “ring fenced” to stop them being used to offset losses in other parts of the business.

Given the high taxes paid by these sectors, introducing similar restrictions in other sectors “must be a constant temptation” for the Treasury, Mr Cullinane says.

The Treasury has recently considered whether new interest relief restrictions should be introduced for funding foreign activities, although it appeared to rule this out in its recent consultation on taxing foreign profits. It does, however, intend to clamp down on companies that have higher interest costs in the UK than the rest of the group as a whole.

The high tax contributions of the oil and financial services sectors also has another implication for policymakers. Their dominance implies that the Exchequer would be vulnerable to a downturn in their revenues, or, in certain circumstances, a decision to move the head office to another jurisdiction.

By comparison with many large industrialised countries, the UK receives a relatively high proportion of its tax revenues from companies. “It is probably worrying from a Revenue point of view that we are dependent on a very small number of businesses,” says Mike Devereux of the Oxford University Centre for Business Taxation.

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