Tax and British business

Tax and British business Making the case

Update: 2013

Contents

Foreword 3 1

The tax contribution of business

4

2

Why tax management is neither abuse nor evasion

8

3

Understanding how the business tax system works

12

4

Why is corporate tax so complicated?

Twelve misunderstood concepts

14

5

A competitive global tax landscape

29

6 Summary

31

Annex 1 CBI statement of tax principles

32

Annex 2 Tax management im the courts

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References 34

Tax and British business: making the case

Foreword

A year ago we launched a report Tax and British business: making the case. This aimed to bring a more informed voice to the UK debate over business tax and to help support pro-growth tax policies.

It highlighted the significant contribution that business does make across all taxes. It discussed the way in which the corporate tax system works.

It also attempted to explain how the landscape of corporate tax management had changed significantly over the past decade.

In particular it made a clear statement that the CBI does not support abusive tax arrangements which serve no commercial purpose and that the majority of businesses manage their taxes with complete integrity and fully engage with HMRC. We have now emphasised this in our recentreleased recommended statement of tax principles (see annex 1).

Since the launch of that report the debate has clearly moved forward. The PAC hearing last December has brought tax issues onto the front pages of the newspapers.

The government has made great progress towards making the UK corporate tax system more competitive in recent years.

So it is important that this good work is not undermined by a misinformed debate about business and taxation.

The structure of the report has remained as per last year.

• F irst, it places the tax contribution of business operating in the UK into a wider economic context, arguing that business underpins the majority of tax revenue collected by the government.

•S econd, it shows how over the last 10-20 years the scope and appetite for abusive tax avoidance has already been severely circumscribed for large companies such that many previous abuses have been reduced or eliminated.

• T hird, it explains why the responsible management of tax issues is a necessary part of business activity, made more important by the complexities of the UK and international tax systems.

• F ourth, we have expanded on last year’s chapter entitled ‘Nine tax rules which can lead to confusion’. We now cover twelve tax concepts in more depth, ranging from issues around the definition of the corporation tax base to international issues such as transfer pricing and tax havens to complex accounting issues and conventions.

• F inally, it explains why a competitive tax system is vital to the future growth of the UK economy, in the face of growing global competition for mobile business activity.

We hope this document will support and inform the public debate on the corporate tax system and the importance of maintaining a competitive tax regime which promotes growth.

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Tax and British business: making the case

1 The tax contribution of business

Businesses pay their way in tax

The UK business community makes a very large contribution to the Treasury’s coffers every year. In the latest financial year, businesses operating in the UK paid around £164bn in taxes, which is 30% of the total UK tax take of £546bn for 2012-13. To put this into context, it is more than the combined 2012-13 budgets for the Department of Health and the Department of Education.1 At a time of public austerity, with public net borrowing figures of £119bn for 2012-13,2 the significance of business’ tax contribution is even more evident.

But in a globalised world, if this contribution is to be safeguarded, the UK will need to maintain a pro-growth tax environment.

Although the principal tax contribution by businesses comes through corporation tax, it is far from the whole story, as Exhibit 1 shows. Out of business’ total contribution in 2012/13, 26% (£39bn) was from corporation tax, the rest being paid through a number of other taxes such as: Employers National Insurance (£59bn), business rates (£26bn), and fuel duties (around £13bn).

Breaking the business contribution down further shows that as well as paying tax on their profits, they also make a contribution based on their roles as property owners, employers, consumers of goods and services, and for the environmental impact of their business.

While there is a great deal of focus on the share of their profits that businesses pay, Exhibit 2 shows that companies contribute to tax in many other ways.

It is also worth noting that businesses contribute to the efficient running of the tax system and of the economy, on top of their direct tax contribution. While these do not count as direct contributions to tax revenue, they show that business activity underpins the existence of tax flows and economic growth beyond those it pays and collects. There are three main areas: • E conomic prosperity. Virtually all taxes, such as income tax, employees’ national insurance contributions and VAT depend on the successful operation of British business, including creating jobs, paying wages, supplying goods and services and processing transactions. So while businesses in the UK may pay around a quarter of all tax revenues, they underwrite the vast majority of the government’s annual tax take, which is used to fund public services and to invest in the UK’s future.

• T ax collection. Business also makes a significant contribution through its role in collecting taxes for the government, such as income tax through PAYE and VAT on sales. Data collected by The Hundred Group showed that large companies in the UK, as well as paying £16.3bn, collected a further £37.2bn in taxes for the government in 2010.3 This is a significant cost that businesses meet as part of their contribution to the UK government.

Exhibit 1 Business’ share of total taxes, 2012/13 (£bn/%) Corporation tax £39.4bn, 24%

Total taxes £546bn

Other taxes £26.7bn, 17%

Business rates £25.7bn, 16%

Business taxes £164bn, 30%

Fuel duties £13.3bn, 8% Employers’ NICs £59.2bn, 37%

Source: HMRC, CBI Analysis

Tax and British business: making the case

Exhibit 2 Total estimated business tax contribution, 2012/13

ÂŁbn Profits 44.7 Corporation tax 39.4 PRT 1.7 Capital gains tax 2.0 Betting and gaming duty 1.6 Property 29.0 Business rates 25.7 Stamp duty land tax (property) 2.2 Stamp duty & SD reserve tax (shares) 1.1 Employment 62.4 Employer NICs 59.2 PAYE agreements 0.1 Consumption (product) 11.0 Irrecoverable VAT 12.0 Customs duties 1.0 Aggregates levy 0.3 Climate Change Levy (CCL) 0.6 Renewables obligation 0.5 Other 1.0 Total taxes borne by business 164.3 Total taxes 545.5 Taxes borne % total taxes 30%

• F unding retirement. The vast majority of UK pension funds (84%) hold shares or bonds tied to businesses. Pensioners, through their pension funds, rely on these companies continuing to make profits in order to provide them with a reliable and secure retirement income. As the UK faces up to the problems of providing adequate social care and retirement income for a rapidly ageing population, the contribution that business makes to pension incomes will become ever more important.

Global context: UK firms pay more corporation tax than those in similar countries

UK business pays more corporation tax than businesses in many of our competitor countries, even those with a much higher rate, international comparisons show. In 2011, UK corporation tax made up 8% of total UK tax receipts. UK businesses pay more corporation tax as a proportion of GDP than their counterparts in the US, France and Germany (Exhibit 3).4

Exhibit 3 Corporation tax receipts as a proportion of total tax receipts and GDP, 2011 8.0 UK

10.3 2.6

US

63 5.7

France

2.5 46

4.6

1.7 Germany 0

Source: HMRC, ONS, PwC Total Tax Contribution, CBI analysis

2.8

2

CT % of total taxes

Source: OECD

4

6

8

2

10

12

CT % of GDP 5

5

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Tax and British business: making the case

Corporation tax contribution varies by sector

While businesses pay a large share of the overall tax take, the business tax burden does not fall uniformly across all businesses.

Many business taxes are targeted towards a certain sector or type of business. For example, two similarly sized companies may pay very different amounts in business rates because one – such as a retailer – occupies more commercial building space than another – such as a creative agency. Corporation tax bills also differ between businesses and sectors, despite there being a common headline rate of corporation tax (currently 26%). The three reasons for this range in tax contributions are:

Exhibit 4 Corporation tax receipts by sector, 2010/11, £bn 4.4 3.7 4.5 5.4

Manufacturing

5.7 4.9 4.8 5.7

Distribution

63 18.1 16.4 15.3

• The profitability of a sector • The size and type of companies within each sector • The availability of deductions or reliefs.

Sector profitability The corporation tax contribution of companies within different business sectors varies significantly and can change markedly on an annual basis. For example, when oil prices spiked in 2008/09, corporation tax receipts from North Sea oil and gas producers also spiked. Conversely, the recession affected the profits of financial services firms most significantly, seen in the sharp drop in corporation tax receipts from this sector from 2007/08 to 2009/10.

The fact that profitability differs between sectors, and that changes in the business environment affect sector profitability in different ways, means that the corporation tax contribution of sectors is not uniform across the economy or through time.

Size and type of company Corporation tax revenues are dominated by big businesses: the largest 1% of companies pay 81% of all UK corporation tax and 60% of small firms pay no corporation tax at all. The amount of tax paid by business also differs widely by type of company. By far the largest share was paid by companies that are part of multinational groups, whether UK or foreign-owned (42% and 45% respectively).5

16.5

Other industrial and commercial 10.3 7.0 4.6 6.2 Financial excluding life assurance 2.1 0.7 1.1 1.1 Life assurance

46

5.7

2 10.4

5.6 7.3

North Sea 0

2

2007/08

4

6

2008/09

8

10

2009/10

12

14

16

18

2010/11

Source: HMRC

Three key facts about corporation tax • T he top 1% of companies pay 81% of all corporation tax •S ixty percent of small companies pay no corporation tax •O ver half (55%) of all companies claim capital allowances, while 10% claim group relief and only 1.8% claim double tax relief Source: Oxford University Centre for Business Taxation

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Tax and British business: making the case

One reason for the difference in corporation tax paid by different types of firms is that profitability varies by type: we would expect a large multinational group, with large profits in the UK, to pay more corporation tax than a SME. But this is also due to the existence of a lower rate of tax for companies with profits under £300,000 a year (the Small Profits Rate, currently 20%) and marginal relief for firms with profits between £300,000 and £1,500,000.

Deductions and reliefs As noted in the previous section, there are many factors which, taken together, have a significant impact on the corporation tax liability of a company – these include the deductions or reliefs that companies can claim against their corporation tax bill. Their availability and size differ by sector, depending on factors such as the capital intensity of a business. This means that businesses from across the economy end up facing different ‘effective’ rates of corporation tax, even though the headline rate (currently 26%) applies to all firms with profits above £1.5m.

A more detailed examination of how the system of deductions and reliefs operates in the UK can be found in chapter 3, Understanding how the business tax system works.

Conclusion

British business makes a major contribution to the country’s tax revenues. It contributes more than a quarter of the total tax take and plays a key role both in collecting taxes paid by other taxpayers and also in delivering the economic growth and wealth that indirectly leads to higher tax revenues from consumers and larger incomes for pensioners. The business community in this country also pays more corporation tax than businesses in many of our competitor countries. But not every business pays an identical share of its revenues in tax, as the final contribution will depend on the sector of the economy the company operates in, the size of the firm and the deductions and reliefs available to it.

Against that background it is vital that the government and organisations that operate and use the tax system understand that a pro-growth business tax environment underpins economic prosperity. A tax environment which does not encourage British business to grow would translate into fewer jobs, less opportunity, and lower tax receipts. That would not be good for the British economy or British workers.

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Tax and British business: making the case

2W hy tax management is neither abuse nor evasion There is a very loud and vigorous debate underway over whether businesses pay their ‘fair share’ of the total tax burden. In the current era of austerity there is also a great deal of concern that businesses either abuse the system or even evade paying their proper contribution. While it is important to have a debate about business tax it is vital that that discussion is based on facts and on an understanding of the whole purpose of the tax system, rather than on misinformation, misunderstanding or prejudice.

There is insufficient public recognition that, barring a few extreme examples, business is trying to comply with a massive number of tax and other regulatory rules. The tax system is very complicated – in fact, the UK has one of the largest tax rulebooks in the world.

Businesses therefore need to employ experts to ensure that they follow all the rules and take advantage of any tax reliefs available to them. This is known as tax management and is an important function of the business world alongside other areas such as human resources, financial management and overall corporate decision making. For the health of the tax system, and for public confidence in it, it is essential to distinguish straightforward tax management from illegal tax evasion or abusive schemes to avoid tax.

It is a dangerous – if sometimes convenient – myth that all tax management is abusive, and that tax management is the same as evasion. That is simply untrue and not fair to British business .

Settlements, ‘lost’ revenue, and the tax gap

One example of this debate over how the tax system operates has been the recent discussion, most notably in the Commons Public Accounts Committee, about whether Her Majesty’s Revenue & Customs (HMRC) has entered into ‘sweetheart’ deals with very large businesses that have led to tax revenue being foregone. There have also been questions as to whether this is contributing towards what is perceived to be an ever-growing ‘tax gap’ – the difference between the amount of taxes the government should arguably collect and the amount of taxes it actually collects.6

In fact, the tax gap estimated by HMRC has been shrinking over recent years (for example, from £39bn in 2008-09 to £35bn in 2009-10). Furthermore, the total corporation tax gap attributable to the 800 very largest companies/groups handled by HMRC’s Large Business Service constitutes approximately 3.5% (£1.2bn) of the total tax gap of £35bn.7 Despite reports to the contrary, very large business is only a relatively small element in the tax gap.

Beyond the part of the tax gap that measures abusive tax arrangements, there are many honest disagreements over interpretation that relate to tax management. The determination of taxable profits is not a precise science and there will often be a difference in good faith between HMRC’s view of the tax due and a company’s view.

Such differences of interpretation are an expected part of the tax system, and the final result is usually determined by detailed discussions on the application of the relevant law. It should also be noted that HMRC contains some of the most experienced tax specialists in the UK (supplemented, in specific cases, by private sector expertise), so there is not the imbalance in resources sometimes claimed. If agreement cannot be reached, the courts will ultimately decide, but both parties are usually keen to avoid the costs and uncertainty of litigation and so a ‘settlement’ is reached.

There is often a distinct advantage to the government in getting payment today, rather than a notional sum, totally dependent on risks of litigation, at some undetermined point in the future. The yield from inquiries by HMRC’s Large Business Service and the resulting settlements have nearly doubled in five years, from £2.2bn in 2005-06 to £4.06bn in 2010-11, due to the adoption of more sophisticated risk profiling.

Furthermore, HMRC has been keen to point out that, from its perspective, such a settlement is always based on interpretation of the law and not, for example, purely on a ‘split the difference’ basis.

Thus, there is never any liability which HMRC ‘waives’. Some commentators arrive at a higher potential liability by multiplying an ‘income’ number by the statutory tax rate (26%). But that ignores credits, deductions, deferred tax and a host of other items which mean that cash tax will almost always be lower (see chapters 3 and 4 for more detail).

Tax and British business: making the case

Evasion, abusive arrangements and tax management

In order to understand what tax management is and how it is a positive part of the way that the government operates and uses the tax system, it is vital to distinguish it from abusive arrangements and evasion. Quite simply, anyone who evades tax by not declaring taxable income is involved in criminal behaviour. Similarly, where companies and their advisers devise or implement abusive arrangements that are legal, the CBI believes these should be tested by HMRC to the full. But all of this is very different to responsible tax management.

It is therefore wrong to brand all tax management as ‘abusive’. Tax management is necessary and indeed often encouraged by the government. The majority of businesses seek only to reach a clear and certain outcome in the taxes they pay, while satisfying stakeholders that they have been thorough in applying all reliefs and allowances made available by law, so that they do not pay more than they are legally obliged to. This is no different from the attitude of most taxpayers – pay the tax due.

Tax management is a well-established principle of British law There is a core legal principle in the UK that governs tax liability whether it is for a private individual, a small business or a multinational corporation. The principle that dates back to a judgement by the House of Lords almost 80 years ago states that taxpayers individual and corporate should pay tax, but no more than specified by law.8 In that case one of the Law Lords said that everyone is “entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be.” He added: “If he succeeds in ordering them so as to secure that result, then ... he cannot be compelled to pay an increased tax.” A stricter approach to abusive, highly artificial arrangements is now taken, but this general principle remains at the core of business tax management.

Rooting out abusive arrangement and evasion • T ax evasion – not declaring taxable income that is due – is rightly illegal •A busive arrangements are those which are highly artificial, with no commercial purpose • These abusive arrangements are unacceptable Corporations are aware of their responsibilities to the society in which they operate to pay the tax they owe – but their principal role is not to generate revenue for the government. The principal economic contribution that any company makes to the UK is to provide goods and services that people want, thereby enabling that business to employ workers, support a supply chain and generate profits, from which taxes are paid, dividends are paid to shareholders (often pension funds) and investment is made to grow the business.

Declining trend in abusive arrangements

The scope and corporate appetite for abusive arrangements has diminished significantly in recent years. This is partly due to the development of a much more open, effective and less adversarial relationship between taxpayers and HMRC, along with the introduction of new reporting requirements and anti-abuse initiatives. The evolution of tax case law has reduced the scope for abusive arrangements, while adding to the complexity faced by business. But, very importantly, it is also due to changing corporate attitudes towards tax management, with businesses becoming more aware of the reputational risks posed by tax and becoming more engaged in tax governance.

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Tax and British business: making the case

MRC has new tools and techniques to tackle abusive H arrangements The past ten years or so have seen a noticeably less aggressive approach to their tax affairs by the majority of companies and less adversarial, more open relationships between taxpayers and HMRC. Apart from the consequences of developments in the case law approach described above, some of this has stemmed from greater legislative reporting requirements, and various HMRC initiatives. The main changes in practice that have contributed to the decline in abusive arrangements are: •E nhanced relationship. HMRC has changed the way that many businesses are dealt with, encouraging them to discuss both compliance and tax management issues more readily. Areas of potential dispute have been identified more speedily, and avoided in a number of cases or resolved more quickly in others.

This has led to a significant reduction in both the number and value of open issues for large companies between 2007 and 2011. The number of open issues fell from 7,624 to 2,721 and the cumulative value from £35.1bn to £25.5bn over the period.9 • Senior Accounting Officer. Since 2009, a Senior Accounting Officer takes reasonable steps to establish, maintain and monitor the adequacy of the business’s tax accounting systems and processes and certifies to HMRC annually that those systems allow for the submission of materially accurate tax returns.

• Disclosure of Tax Avoidance Schemes. DOTAS requires promoters of tax arrangements that satisfy certain characteristics to report details to HMRC ahead of implementation. In 2009, HMRC said DOTAS had led to the introduction of 49 anti-abuse measures, cutting off more than £12bn in scheme-based abuse opportunities.

• Transactions with affiliates. Significant resources are devoted by companies to compiling documentation about how terms are agreed for transactions with affiliates in order to prevent an adjustment for tax purposes under ‘transfer pricing’ rules.

• R isk profiling. HMRC has used the shrinking resources at its disposal to achieve a greater return on its investigative efforts by risk-profiling industries, businesses, and activity. In many instances, HMRC may well have come out of a settlement with more tax than it would otherwise have done because companies have been prepared to settle in return for speed and certainty.

•G eneral anti-avoidance rule. A study group set up by the government suggests a GAAR should focus on abusive arrangements with no commercial purpose. If this proposal can successfully be targeted at preventing abusive arrangements without creating uncertainty in relation to the tax treatment of normal commercial arrangements, the CBI believes it should be supported.

Corporate attitudes towards tax have changed The scope for abusive arrangements has also diminished due to changing corporate attitudes. Tax has become a more important issue for most companies and is often now on the agenda of the board of directors. There are greater reputational issues at stake than ever before and companies are talking about their tax affairs in a different way and through different media. Additionally, tax is a topic increasingly seen by many stakeholders as an important area of corporate social responsibility (CSR). A number of companies are using CSR reports as well as financial statements to provide information on tax.

Many companies are starting to form a tax strategy and policies that express their views on timely compliance and cooperation and, indeed, their positions on the scale of how they balance tax management and risk. They generally reflect the need to remain competitive on tax as against others in the same industry or market.

Only a minority of companies discuss their tax strategies or policies in financial statements, but the number is growing. More companies, however, are showing interest in how taxes are part of the economic value they create and distribute to stakeholders, whether as taxpayers or tax collectors on behalf of government.

Tax and British business: making the case

“Tax has become a more important issue for most companies and is often now on the agenda of the board of directors.”

Internal governance on tax is much tighter than it was previously.

This is partly because of the greater profile it has within the business, but also a result of external factors involving HMRC (greater reporting requirements and closer cooperation on a real-time basis), the OECD (development of transfer pricing guidelines) and the EU Commission (VAT as a community tax).

Finally, HM Treasury and HMRC have made efforts to make business feel more engaged in the policymaking process, through consultation. This allows businesses to better understand the legislation which reaches the statute book, as well as how HMRC will apply it. This in turn makes abusive arrangements less likely.

The courts have reduced the scope for abusive arrangements Statutory interpretation of tax law has changed over the years, since the Duke of Westminster case (page 9). This has added to the complexity of the tax system, increasing the importance of proactive tax management to ensure compliance. It has also significantly reduced the scope for abusive arrangements, and taxpayers (and their advisers) are aware of this – and often welcome it.

The general liberty of a corporate taxpayer to order its affairs to reduce its tax bill remains true, but the overly literal interpretation of statute which was applied in that case has been much criticised since. In the years that have followed, there has been a shift away from a literal reading of the judgement to interpretations that put greater weight on contextual approaches designed to identify the purpose of a statute and to give effect to it (for further details, see annex 1).

Conclusion

People are concerned that taxpayers – and especially businesses – pay their fair share of tax and do not manage to pay less than they should. However this important debate is coloured by a focus on tax evasion and abusive arrangements. These should not be confused with tax management, which is simply how businesses use the tax system to make use of incentives and ensure they pay what they are required to pay. Action by lawmakers, HMRC and companies themselves has helped to reduce the number of abusive arrangements seen as contributing to a tax gap.

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Tax and British business: making the case

3 Understanding how the business tax system works Taxpayers have to work out how much tax they are legally obliged to pay according to the combination of some long-established principles in the statute and other measures including incentives or penalties which change more regularly. Not only is the management of tax costs permitted by law, it is often directly encouraged by government incentives.

This trend provides three reasons why businesses will need to use tax management. Firstly, it is important to remember that governments often alter the incentives within the tax system to encourage a specific behaviour on the part of businesses and individuals. In the same ways as individuals use the tax incentives aimed at them, such as individual savings accounts (ISAs), businesses also use the incentives provided which are, in the government’s opinion, to the benefit of the UK economy.

Second, the sheer complexity of the tax system means companies have to make decisions even where laws are unclear. This very often makes it difficult to establish the one, scientifically ascertainable ‘right’ amount of tax owed by a company. Third, many British companies have been successful on the world stage, but that often involves dealing with multiple jurisdictions, all with slightly (or very) different rules, and all wanting a slice of the tax pie. Proactive management is required to avoid double taxation (which almost always would mean less taxation for the UK). It is worth examining each of these arguments in turn.

The government uses deductions and relief to encourage business behaviour

One of the features of the last 30 years has been the increasing use of the tax system by governments of every colour as a delivery mechanism for social and economic policy objectives. As intended, taxpayers respond to these incentives. There is a range of factors which, taken together, have a significant impact on the corporation tax liability of a company – these are the deductions or reliefs that companies can claim against their corporation tax bill.

Their availability and size differ by sector, depending on factors such as the capital intensity of a business. This means that businesses from across the economy end up facing different ‘effective’ rates of corporation tax, even though the headline rate (currently 26%) applies to all firms with profits of above £1.5m.

Examples of the main reliefs available to business are: • G roup relief. This allows the transfer of losses between companies and is the most significant relief available to businesses. It is substantially more important, relative to income and trading profit, for financial companies than it is for industrial and commercial companies.

• C apital allowances. These allow a reduction in the amount of corporation tax payable, offered as an incentive for investment in certain fixed assets. Industrial and commercial companies benefit proportionately more from these, reflecting the more capital-intensive nature of this part of the economy.

• L osses carried forward. These can be used to offset against trading profits and are of greater benefit to financial companies for whom profits and losses can be volatile.

• R &D tax credit. This incentivises research and development activity by providing relief against a company’s corporation tax bill relative to its R&D expenditure. Pharmaceutical and advanced manufacturing firms benefit most. Additional tax credits are available to encourage innovation in the UK. Exhibit 5 shows the effect of deductions and reliefs on the corporation tax bill of two aggregated business sectors, to illustrate the extent of the impact they have on a company’s taxable profit.

Other allowances or reliefs target more specific matters. The important point is that tax management is needed to ensure expenditure qualifies. For example, a number of Enterprise Zones are being identified where tax ‘breaks’, including reduced business rates and, in some cases, more attractive capital allowances, will be available by reference to investment in particular geographical areas. Again, management is needed to ensure investment is in the right place, and the tax reduction can be secured.

Tax and British business: making the case

n increasingly complex tax system makes tax A management a necessity

The complexity of the tax system adds to the importance of carrying out responsible tax management. Businesses are faced with a constant stream of decisions about their financial affairs each day, many of which have tax implications. As mentioned in the previous section, this complexity arises in part from the decision of governments over the years to use the tax system to incentivise businesses to act in a particular way.

The Office of Tax Simplification identified more than 1,000 tax reliefs in the tax system and took action in the 2011 budget to begin removing them.10 But complexity breeds complexity, and the increased volume of tax legislation has been accompanied by a rapidly increasing number of complex anti-abuse provisions. A large amount of tax legislation, estimated to be as high as 40-50%, is taken up with what are often termed anti-avoidance measures, trying to clarify the precise nature of what a government intended to offer by way of an incentive or where a subsequent government wishes to narrow its scope.

Many UK-headquartered companies earn the majority (and in some cases almost all) of their profits from overseas operations, which also adds to tax complexity for business. These companies which operate in multiple jurisdictions can also themselves face different foreign tax regimes which will thereby affect their UK tax liability. For example, despite the move to a dividend exemption regime 11 the receipt of certain payments such as royalties will still bear UK tax subject to a credit for foreign taxes paid. In such circumstances the UK tax liability can differ significantly by sector, such as for pharmaceuticals and other intellectual property-dominated companies. Proactive management is required to avoid double taxation (which almost always would mean less taxation for the UK). This tax management is not abusive but is absolutely necessary if the business is to remain viable.

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Exhibit 5 Main determinants of taxable profit (Percentage of profit and other income) -26.9 -38.2

69

Group relief -15.2

-4.5 Capital allowances -6.9 -8.6 Previous losses offset against trading profits -3.5 -12.7 Double tax relief 63

-45

-40 -35 -30 -25 -20 -15 2 -10 Industrial and commercial companies excluding overseas and North Sea Financial companies excluding life assurance

-5

0

Source: HMRC; CBI Analysis

There is no such thing as the ‘right’ amount of tax The myriad of incentives shows it is not possible to identify a single, scientifically ascertainable ‘right’ amount of tax. Corporate tax law is too complex, too uncertain and with too many interactions for that to be the case. This means one cannot simply say that if the proportion of a company’s profits paid in tax is lower than the statutory tax rate (currently 26% for most companies) this must result from abusive arrangements. The availability of capital allowances, deductions provided by statute, the mix of UK and overseas profits and tax losses can all legitimately lower the effective tax rate.

Conclusion

There is a great deal of misunderstanding over the use of tax management by businesses, which leads it to be confused with tax evasion or abusive arrangements. It is important to highlight that tax management is not only legal, but is an essential feature of a wider legal principle that taxpayers, both individual and corporate, should pay tax but no more than is specified by law. For businesses the need for tax management is driven by two factors: the use by governments of the tax system to encourage behaviour and the growing complexity of the system, domestically and internationally.

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Tax and British business: making the case

4 Why is corporate tax so complicated?

Twelve misunderstood concepts The collection of tax revenue is fundamental to the sound functioning of a stable and prosperous society, and is one of a government’s oldest and most well-established roles. That is as true for the UK as any other government. So, once the UK government has decided which services to provide it then seeks to raise the money to pay for those services by a number of means, one of which is through the collection of tax.

Within that tax portion the government needs to decide how much to raise from certain sectors of the economy – individuals and businesses, for example – and within those groups from what types of activity. Further decisions need to be made as to the type of tax to be used to raise money from certain activities or sectors – income, property, consumption, etc – and the government must also decide whether certain activities within certain sectors should be treated differently.

Recently, governments have begun to use the tax system to deliver other governmental goals. This might be something in the individual sector like the child credit, in the corporate sector it may be the desire to encourage research and development through use of a tax credit, or the wish to discourage certain types of environmental activity by use of ‘green’ taxes. This has resulted in a daunting amount of legislation built up over many years.

It is important to note that while some tax legislation reflects a coherent policy rationale, much reflects ad hoc responses to historical problems that have long since passed away. Tax law will always be playing catch-up with business practice, simply because business is constantly evolving in response to changing market conditions, consumer preferences etc, while making and changing law is a lengthy process. This process of falling behind and catching up makes the law sometimes appear ineffective, and responses make it still more complex – and more easily misunderstood.

So the UK tax system is very complicated. There are currently more than 20 major taxes in the UK and a number of them are borne wholly or partly by business. In determining the effect of tax on business we need to look at the collective burden of all of those taxes. However, much public focus falls on the corporation tax paid by companies on their profits, and this paper will reflect that public focus.

Corporation tax is one of the ways in which British businesses are taxed. It is calculated based on the profits they earn – not on the income they receive. That broadly means they are taxed on their income after deducting the costs (eg manufacture, labour, transport, premises, finance) of earning that income. These costs could include the costs of raw materials and services received from others such as advertising and marketing. The costs may also include funding costs such as interest paid on money borrowed for use in the business. The costs may be payable to a supplier based either in the UK or abroad. This is how most countries across the developed world typically tax businesses on their profits.

In relation to business, in all developed economies there will be a system of accounting rules which help to give investors, regulators and the company itself an accurate picture of the economic state of a company at a single point in time (the ‘year end’).

Tax and British business: making the case

While this accounting picture may be important for tax, tax rules are trying to do something different – raise tax, but without endangering the viability of the company by challenging cashflow, in particular, or the company’s ability to grow, more generally, by requiring tax revenue before a profit has actually been realised.

Therefore, there are always going to be significant differences between the economic snapshot of the accounting rules and the more pragmatic approach of the tax rules.

This chapter also has a particular focus on international tax issues where interaction with foreign laws can add another level of complexity. This is true for UK headquartered companies expanding overseas, and is equally true for overseas based companies looking to do business in the UK. For UK-based businesses going overseas, it is crucial that they can compete with companies from other countries, and the UK government explicitly recognises that in certain areas, and makes provision for it. Equally, the UK tax system is one of the factors that an overseas business looking to set up operations in the UK will take into account. Some businesses may be able to establish their operations in another EU member state or elsewhere in the world, and the government offers certain incentives to encourage them to invest in the UK.

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BUILDING BLOCKS OF THE TAX BASE Concept 1 Losses Particularly during the financial crisis, the losses companies have incurred and can carry forward have attracted significant attention.

Where a company makes a loss for corporation tax purposes, calculated according to the statutory rules, there is no immediate ‘negative payment’ or refund from HM Revenue & Customs (HMRC).

There are rules which allow a company to obtain some relief for the loss by way of set-off.

If a company makes a loss in a particular trade or business, it can offset that loss against total profits from all trades and businesses it carried on in that period. If you have only one trade or business or insufficient total profits, you may be able to choose to offset the loss or remaining loss against total profits in a specified period or periods during a given length of time (‘carry it back’). Otherwise it will be ‘carried forward’ to be set off against the profit from that trade or business for future periods. If you are a member of a group of related companies, you may also be able to surrender that loss to another of those group companies so that it can offset the loss against its current year profits, enabling the group as a whole to benefit more immediately (see Concept 2).

The rules for carrying back losses may require some detailed calculations. If you’ve previously paid corporation tax, you can claim for the loss to be offset against profits for the12-month period before the accounting period in which the loss arose. But you can only do this if your company was carrying on the same trade at some point in the accounting period or periods that fall in the preceding 12-month period.

For example, if your company has a trading loss of £100,000 in the 2012 calendar year accounting period and profits of £220,000 in the preceding 2011 calendar year, you can carry back the £100,000 loss to be offset against the profits for the previous accounting year, reducing them from £220,000 to £120,000.

If an accounting period doesn’t match that 12-month period exactly, the profit for that period is time apportioned and the loss can only be offset against that portion of the profit falling within the 12-month period.

In the same example above, assume that the company changed its accounting date, so that it had taxable profits of £25,000 for the accounting period 1 July 2011 to 31 December 2011 and £110,000 in the accounting period 1 July 2010 to 31 July 2011. You can claim to offset both £25,000 of the loss against the profit of the later period and £55,000 (6/12 x £110,000) against the profits of the earlier period.

Apart from the potential for surrendering the loss to another group company by way of group relief, any amount not set off against current or prior year profits can be carried forward indefinitely for offset against profits from the same trade. In the example above, £20,000 (£100,000 – £25,000 – £55,000) can be carried forward in this way.

There are also complex rules that can apply where a trade or business changes significantly in nature to restrict or eliminate relief in future periods.

Tax and British business: making the case

Concept 2 Groups The taxation of groups, particularly multinational groups, is often misunderstood.

Large or complex businesses often involve one ‘parent’ company owning shares in a number of other companies which it controls as part of a wider group.

There are UK rules which apply to companies in such group relationships. Some of these rules provide relief where the group is disadvantaged by being set up as a group of separate companies, rather than as divisions of one company.

In the UK, businesses can organise themselves in different ways – as individuals running a small business alone, as partnerships (operated by a number of people) or as companies.

For large or complex businesses typically one ‘parent’ company will own shares in a number of other companies which it controls as part of a wider group. Together, these companies operate the overall business or businesses of the group. It would not be unusual for a very large business to have hundreds of these ‘subsidiary’ companies in its group structure.

There are many non-tax reasons why groups contain multiple companies rather than just one single company as part of their structure – these include: operational or management organisation, legal/regulatory requirements or simply historical reasons (eg groups formed through mergers or acquisitions).

Companies are generally taxed on the profits which they make as a whole, aggregating the taxable profits of however many trades or businesses they carry on (see Concept 1). This means that if one business division makes a profit, but another makes a loss, the company only pays tax on the net result of both businesses taken together – ie on its overall profit as a single company.

To ensure that the same overall corporation tax is paid regardless of whether a business chooses to operate through a single or multiple companies formed into a group, tax rules allow one company in a group to surrender its loss to be set against the profit of one or more other members of the same group. The loss can be shared among more than one company in a ratio which the group decides.

Effectively this ‘group relief’ puts the group in the same tax position as if it had chosen to put all of the business divisions into one single company – ie tax is paid only on the overall profit made by the group.

Group relief enables the current year sharing of tax profits and losses within different companies in a group to give a fair overall taxable result, for example: Company X operates two business divisions – cake sales and biscuit sales.

• C ake sales make a profit of £300 • Biscuit sales make a loss of £100 •O verall profit of Company X is £200, and tax is paid on this overall profit amount.

However, if instead Company X needed, for non-tax reasons, to operate cake sales itself, but to set up Company Y (a separate company owned by Company X) to operate biscuit sales, the results could look different: • C ompany X makes a profit of £300 on cake sales – and pays tax on all £300 of this profit •C ompany Y makes a loss of £100 on biscuit sales and pays no tax • I f group relief did not exist, overall as a group, tax would be paid on profits of £300 even though the net overall profit was only £200 •G roup relief enables Company Y to surrender its £100 loss to Company X to reduce its taxable profit to £200, so that the group suffers tax on the same amount of profit as if it had operated its business in divisions rather than separate companies.

The group tax rules mean that looking in isolation at the statutory accounts of just one company which is part of a larger group will not give an accurate indication of the tax that should be paid by the group as a whole – the profits of the individual companies need to be consolidated in order to appreciate the overall profit made by the group, and the level of tax that the group might be expected to pay.

Transfers of capital assets between companies in the same group are generally deemed to take place so that no loss or gain is recognised for corporation tax purposes. The principle behind this is similar in nature to that for group relief: economic gains or losses that arise during the ownership of an asset by a group should only be taxed or relieved when the asset leaves the group.

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Concept 3 Where income is earned The question of where income is earned is critical for the application of the UK tax rules.

Under the UK tax system each corporate legal entity that is tax resident in the UK is required to pay UK corporation tax on the taxable profits it makes from doing business in the UK. Legal entities which are not tax resident in the UK pay corporation tax on the taxable profits they make from doing business in the UK provided they have a sufficient ‘branch’ or other presence in the UK which constitutes a ‘permanent establishment’ earning income in the UK. The UK is home to a larger number of multinationals than might otherwise be expected based on the size of the UK economy alone.

This is through a fortuitous mix of history, the pre-eminence of the London financial markets, investments in infrastructure and a stable regulatory environment. These UK headquartered multinationals may generate huge revenues from their worldwide operations but have only small or sometimes no UK based operating activities.

It is important to understand that the headline sales number (sometimes also referred to as turnover or gross revenues) is not equivalent to net profits or net income, as this figure does not take into account all the business expenses incurred to generate those sales revenues. Taxable profits are gross sales or revenues, less business expenses, plus or minus any adjustments required or permitted by the tax law (see Concept 9). In the case of a UK permanent establishment of an overseas company, the profits are based on amounts attributable to that business activity in the UK. Where a UK company has established a business presence in another country (either as a subsidiary or as a branch/permanent establishment) then, subject to certain exceptions, the taxable profits of those companies earned in other countries will not generally be subject to UK taxation (see Concept 6).

Businesses may differ significantly from each other as to which part of their business activity generates the most value. For example, a business participant in a market that has few barriers to entry and is highly competitive is likely to succeed due to excellence in

operational delivery and the management of the supply chain and cost base. On the other hand, success in the luxury goods market requires excellence in maintaining and protecting the brand, supported by strong marketing, design and high quality standards.

In the case of a multinational company with a UK business, understanding the value chain of the business and where that value is generated or owned is fundamental to properly allocating income to the value that is generated from the business activity undertaken in the UK. Factors to be considered include: • T he location where value adding functions – eg sales and marketing are performed • T he location where risks that determine the level of value generation are assumed • T he location of key value adding risk management and function leadership (substance required to manage value adding functions and risks) • T he location of value generating assets, both intangible and tangible.

In the case of a multinational group, the transfer pricing rules in particular will help to ensure that taxable income is recognised in the country in which it is earned (see Concept 4 for more detail on transfer pricing).

If a key value driver of the business is moved from the UK to another part of the multinational group outside of the UK, the transferring UK business will be taxed on a fair market price for what has been moved.

After a UK company has paid its taxes, paid interest on or repaid its debts and paid dividends to its shareholders, any earned taxed income left over is available for reinvestment in the UK business or elsewhere, or returned to shareholders where the reinvestment opportunities are insufficiently attractive. Interest income and royalties received by UK companies are subject to corporation tax while, with some exceptions, returns from investments in the form of dividends and capital returns are generally not taxed in the hands of UK companies (see Concept 9).

Tax and British business: making the case

INTERNATIONAL CROSS-BORDER CONCEPTS Concept 4 Transfer pricing Transfer pricing – prices charged between related companies – has been much in the news owing to concerns over erosion of the tax base.

Long-standing OECD rules require where sales take place between connected businesses that sale must take place at the same price that unconnected parties would arrive at (the ‘arm’s length price’).

The transfer pricing rules apply to transactions between UK parties as well as transactions between UK and overseas parties. Transfer pricing adjustments must be made in the self-assessment tax returns.

Now consider a situation that is identical in all respects, except that the Portuguese supplier is now a member of the same international group as the UK company. You would expect in both cases that the UK company would make the same amount of business profits, that the price paid by the UK company for the clothes supplied by the Portuguese company – ‘the transfer price’ – should be the same in both cases, and that’s exactly what the transfer pricing rules are designed to do. The UK tax authorities have an interest in ensuring that the price paid by the UK company to the Portuguese supplier is not too high, and the Portuguese tax authorities have an interest in ensuring that the price received by the Portuguese supplier from the UK company is not too low. In each case the tax authority interest is backed up by legal and audit rights.

While a company’s taxable profits for UK corporation tax purposes are based on accounting profits with detailed tax adjustments that are required or permitted by law (see Concept 1), there is an overriding requirement that for transactions between connected persons, the UK tax liability will be calculated by reference to the arm’s length price for the goods or services.

This seems fairly straightforward, so why can getting the transfer price right become difficult in practice? Using our earlier example, what if the international group decided it made economic sense to have all the clothes designed by a group company in Spain, the clothes manufactured by a group company in Portugal, and all the manufactured clothing stock purchased by another group company in Switzerland that is responsible for the marketing strategy across Europe and that sells the clothes to a group company in the UK on the basis that any unsold stock is bought back on request.

Where a UK company is part of an international group of companies, and there are transactions that take place between the UK and the international member companies of that group, it can be more difficult to determine the arm’s length price for the transactions to ascertain what profits relate to the business activity in the UK. Take the example of a UK company that is not part of an international group, and which buys clothes for retail sale from a company based in Portugal. Let’s assume that the commercial deal the UK company has agreed with its Portuguese supplier means that it is not able to return any unsold clothes and therefore ordering the right amount of stock and the right clothing lines will have a large effect on the amount of profits it makes. Also, because no returns of unsold stock are permitted, the UK company may have been able to buy large volumes of clothes at a discount. The business profits that the UK company makes will be a direct reflection of how successful the UK company is at operating its business, including managing business risks such as stocking the right amount and type of clothes.

The UK company is now protected from making any business losses from not managing the business risks that relate to the amount and type of clothes to stock. The UK company also benefits from the marketing campaigns run by the Swiss company. The UK company is still responsible for operating its business well and should expect to earn the level of profits that is commensurate with this UK located business activity and risks. However, this will be only a share of the total business profits created from the entire group’s operations, as clearly Spain will want to tax the business profits from the clothes design, Portugal will want to tax the business profits from the clothes manufacture, and Switzerland will want to tax the business profits from the marketing and distribution activities, including a reward for taking the stocking risks and owning marketing intangibles. The transfer price or arm’s length price will need to be established for each of these intercompany transactions, so that the profits are fairly allocated between all the countries where business activity takes place.

This will also ensure that the UK company’s income is not taxed more than once, as this would put the UK company that is part of an international group at a competitive disadvantage to a UK company that is not part of an international group.

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Concept 5 Tax residence As noted earlier in relation to ‘where income is earned’, where a company is resident is crucial for determining its tax liability. However, not all the rules on residence are immediately understood.

The tax residence of a company is established by applying relevant tax rules to certain facts about the company, such as where the company is established and where certain key activities are carried out.

Whether a company is tax resident in the UK or not will determine how much UK tax it has to pay on its profits, especially where the profits are earned outside the UK (see also Concept 4 and Concept 6).

A company is tax resident in the UK if it is incorporated in the UK or its central management and control is in the UK. What constitutes central management and control has been the subject of numerous cases determined in the courts over a lengthy period. Whether a company is tax resident in another country depends on the domestic tax legislation in that country, although not all countries scope their taxes based on residence.

Tax residence is usually quite easy to determine, but where the answer is not clear or obvious countries will often agree between themselves some specific ‘tie-breaker’ tests which they will apply.

These are set out in agreements between the countries called ‘double tax’ treaties. Even if a territory does not charge tax according to residence, that concept will be important in relation to double tax treaties, which aim to prevent double taxation of the same income, usually by reference to the residence territory having primary taxing rights.

It stands to reason that if some key facts about a company change, the tax residence can change as a result. Likewise, if a company wants to be subject to tax in the UK or in another country, it needs to change the way it operates in order to meet the requirements of the tax rules to be UK or overseas resident.

There are a number of tax consequences to changing the tax residence of a company: these can be positive or negative, or a combination of both positive and negative impacts, depending on the company and the countries involved.

A change of tax residence is not something a company undertakes lightly since it means the company has to change the way it operates, and this involves tax effects. That said, several years ago, some companies who were unhappy about the way the UK tax rules applied to their profits, chose to move their tax residence to a country that they felt had a better tax regime. In many cases, this was because the old UK tax rules used to tax profits that were earned outside of the UK, even if those profits were already taxed in the country where they were earned. We see this less now and, in fact, many companies that previously moved away from the UK have now chosen to return because of recent improvements to the way the UK taxes profits from overseas.

It is important to remember that a company’s profits earned in the UK are generally subject to tax in the UK, no matter where the company itself is tax resident.

Tax and British business: making the case

Concept 6 Worldwide and territorial taxation Recently the UK has changed its rules to move from a ‘worldwide’ system to a more ‘territorial’ system.

‘Territorial’ taxation is based on the principle that a country taxes profits made in that country and leaves other countries to tax profits earned in their country.

‘Worldwide’ taxation (which is now quite unusual in developed countries) is a method whereby a country taxes profits of its residents wherever they are earned in the world.

UK companies conduct business overseas either through foreign branches of their UK companies or through foreign subsidiaries of those UK companies. Foreign governments will impose their own taxes on the profits earned in their countries.

The UK tax system has rules which govern how profits earned outside the UK by UK companies, or by UK parented multinationals, should be dealt with for UK tax purposes. These rules are carefully designed so that they do not put UK companies at a disadvantage when competing for business overseas, and do not create a tax incentive for foreign takeovers of UK parented multinationals. This situation can arise when the UK tax system imposes incremental UK taxes on profits earned overseas in circumstances where a comparable foreign parent company would not suffer such an incremental layer of tax.

International tax systems generally have laws which follow either ‘territorial taxation’ principles or ‘worldwide taxation’ principles when dealing with foreign profits. The distinctions between these two approaches are explained below.

Territorial taxation broadly imposes tax on profits earned within the territory in question. If a UK company has established companies in other countries then, subject to certain exceptions, the taxable profits of those companies earned in other countries will not generally be subject to UK taxation.

One exception to this is in relation to ‘controlled foreign companies’ (CFCs – see Concept 8), although an updated regime which comes into effect in 2013 makes this more territorial. Another exception is when those profits are remitted to the UK as interest or royalties.

In that case, because these payments are generally deductible in the country of payment they will be subject to tax when received in the UK. Similarly, the profits or losses attributable to a permanent establishment of the UK company in another country will usually be taxed or relieved in that other country without also being part of the company’s taxable UK profits, either under the terms of a double tax treaty (see Concept 5) or by virtue of an election for profits and losses to be disregarded.

In a worldwide taxation system relief is normally given for taxes already paid overseas but the system is generally very complex and burdensome to apply – because the parent has, in some fashion, to analyse and re-compute everything, wherever done, on a basis which is consistent with the parent company’s tax law. A worldwide taxation basis is expected to have the effect that the total tax suffered on profits earned in a given jurisdiction is at the higher of the tax rate in the local jurisdiction and the rate in the home jurisdiction (ie the UK).

On an international basis tax regimes have increasingly moved towards a territorial basis of taxation as being a simpler and more appropriate basis of taxation. The UK tax system was originally founded on a basis which followed worldwide taxation principles but has been changed over recent years so that territorial principles now predominate. This change followed a non-partisan review initiated under the prior government, has continued and been completed under the current government. This responded to significant concerns that the existing worldwide taxation basis was putting UK companies at a competitive disadvantage and providing a tax incentive for foreign, rather than UK, ownership of multinational groups. The review lead to legislative update which, among other changes, included an updated approach to the taxation of foreign dividends and foreign branches together with an updated ‘controlled foreign companies’ (CFCs) regime.

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Concept 7 Tax havens ‘Tax havens’ have been at the centre of public scrutiny over the past months. In fact there is an important distinction to be drawn between low tax jurisdictions and secrecy jurisdictions.

Tax havens have traditionally been considered to be low or no tax countries which attracted corporations and wealthy individuals to deposit large quantities of money offshore in order to avoid paying significant amounts of tax on the interest. However, those same countries do provide other non-tax benefits for companies which are often forgotten or ignored.

So why do corporates still use tax havens to locate group companies, particularly given the increased focus by non-governmental organisations and the associated negative press which assumes that the primary use of subsidiaries in tax haven jurisdictions is to avoid tax? In fact there are a number of non-tax reasons to use companies located in tax haven territories, such as the stability of the government and a clear legal framework (circumstances often overlooked). Many of the reasons that corporate groups use tax havens are predicated on the ability to: • T ake advantage of the clear legal framework and to protect from unpredictable local laws where the activity is carried out • Take advantage of beneficial regulatory requirements

There has been increased public and press interest in the use of ‘tax havens’ by multinationals in recent years. Although there is no common international definition of the term ‘tax haven’ the US government Accountability Office describes the features of a tax haven as: “A country with nil or nominal taxes; a lack of effective exchange of tax information with foreign tax authorities; a lack of transparency in the operation of legislative, legal or administrative provisions; no requirement for a substantive local presence; and self-promotion as an offshore financial center.”

The use of the term ‘tax haven’ has sometimes been stretched beyond this concept in recent years by tax activist organisations, to include jurisdictions such as The Netherlands and the US state of Delaware. Many groups have companies registered in The Netherlands, traditionally as holding companies of overseas subsidiaries due to the extensive tax treaty network, or in Delaware to take advantage of the favourable corporate law regime, but not to avoid tax. Nor could it be said that countries such as The Netherlands or the state of Delaware fit the usual concept of a tax haven. With the UK significantly reducing its main corporation tax rate and offering special rates for exploiting patents (the patent box), it has even been described by some as a ‘tax haven’.

The traditional benefit of investing cash though a tax haven has largely been negated as high tax countries have evolved rules to tax interest arising in a tax haven. Therefore, the tax benefit of holding cash offshore no longer exists for most companies when undertaking legitimate tax planning. In addition, punitive withholding tax rates on interest paid to a company located in a tax haven have negated much of the benefit of routing intra group funding through a tax haven entity.

• Provide a neutral tax territory for joint ventures • Sell or provide services within the tax haven country itself.

Increasingly the focus of the OECD and other international bodies is on tax secrecy jurisdictions, where it is possible for wealthy individuals and corporations to hide away income and therefore evade tax in the country in which they reside. The tax secrecy jurisdiction will not exchange information with other countries and so it is not possible for another country to enforce their local tax laws which seek to tax the overseas income of their residents.

Additionally, there is often no requirement to disclose beneficial ownership of shares and the use of nominee shareholders and directors is common in order to avoid transparency.

Tax evasion has no place in society and the vast majority of multinationals do not engage in such activity. Furthermore there is significant pressure on tax secrecy jurisdictions to open up to other nations and exchange information about the funds that flow through their country in order to ensure that these amounts are fully taxed where necessary. Legislation has been introduced by the US (‘FATCA’) to ensure that foreign banks provide data to the US revenue authorities or alternatively suffer a 30% withholding tax on their US source income. HMRC has recently announced that agreements have been reached for the automatic exchange of information about accounts held by UK residents in the Crown dependencies of Jersey, Guernsey and the Isle of Man and overseas territories such as the Cayman Islands and the British Virgin Islands (BVI). Therefore assets hidden away in tax secrecy jurisdictions have become increasingly vulnerable to detection by, and therefore taxation by the UK and others tax authorities.

Tax and British business: making the case

Concept 8 Controlled foreign companies (CFC) rules Controlled foreign company (CFC) rules, which deal with the taxation of income arising in overseas subsidiaries of UK groups, are a necessary part of protecting the UK tax system.

CFC rules are designed to prevent profits which should properly be taxed in the parent jurisdiction from being inappropriately re-characterised or relocated and dealt with as foreign profits, and thereby suffering tax only in a no tax or lower tax jurisdiction.

Whether the UK has a worldwide basis of taxation or a territorial basis (see Concept 9) some protective CFC anti-avoidance rules are required first to prevent groups from locating profits in low tax jurisdictions and therefore avoiding UK tax and second to prevent stripping of the UK tax base into foreign subsidiaries.

For example, for a UK parented group, inappropriate treatment as foreign profits would achieve deferral of UK tax (perhaps indefinite deferral) under a worldwide taxation regime, or exclusion from UK tax under a territorial taxation regime. Thus both the UK’s old worldwide taxation based system for taxing foreign profits, and its modernised territorial-based system, have CFC rules in place which protect the UK’s right to charge tax in respect of profits which should be allocated and treated as UK profits.

Well-designed CFC rules need to draw a fine (and very difficult to achieve) balance which gives appropriate rights to the UK to tax what reasonably belongs to it but doesn’t claim the right to tax more than that. If additional UK tax is charged on profits which are really foreign profits rather than UK ones, solely because there is a UK parent company, this provides an advantage for foreign owned multinational groups and increases the likelihood of UK parented groups being taken over by foreign parented groups (because the UK is essentially providing a tax incentive for such acquisitions).

The rules also need to be as easy as possible to apply and able to accommodate technological or other changes in background which can fundamentally change the way normal commercial business is carried on. If they are not, then the rules will become obsolete and

difficult to apply, and will be unlikely to achieve their intended balance of taxing what belongs to the UK but no more. This will have the same effect of providing an incentive for foreign ownership because it will not be possible for business to predict with any confidence what UK tax will be due on foreign profits if they are held under UK ownership.

It has been suggested that the changes made to the UK CFC rules were a simple weakening of the UK’s defences against UK tax avoidance made so as a favour to business. This is not true.

The changes made to the UK’s CFC rules were made to modernise them so that they could cope with the way in which normal modern business is conducted and were well targeted so that they protected UK rights to tax UK profits (without going further than necessary to achieve this).

In 1984, when the prior CFC rules were introduced, there was no general access to email or internet. This meant, for example, that all supporting functions for individual businesses had to be located with those businesses rather than, as will now often be the case, there being specialist centres supporting particular functions of multiple businesses within and across different countries.

The world has changed and the tax rules needed to change to reflect that.

The principles which underlie the modernised UK CFC rules are international principles for the allocation of profits which were developed by the OECD. The CFC rules apply these principles in a way which asks simply whether the profits should be attributed to the UK or whether the profits should be attributed as foreign profits.

They do not attempt to test whether the allocation of those foreign profits between different foreign jurisdictions gives a fair balance of taxing rights between each of those jurisdictions. They thus do not seek to counter foreign tax avoidance – a matter for foreign jurisdictions to address for themselves by developing their own tax laws which adequately protect their rights to tax profits which belong to them. There are international agreements in place to help reach common principles or counter unacceptable regimes and practices.

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ACCOUNTING AND ADMINISTRATION Concept 9 Cash tax and book tax Differences between cash and book taxes lead to great misunderstandings but can be attributed to tax and accounting rules.

‘Cash tax’ is what companies ultimately have to pay in relation to their corporation tax liabilities.

‘Book tax’ is the amount of corporation tax charged against profit as shown in the company’s financial statements.

Figures in the accounts referring to tax are determined by accounts rules rather than tax rules.

The amount of tax paid by a company for any period (‘cash tax’) is almost invariably different to the tax charge for that period shown in the company’s accounts (‘book tax’).

While the starting point for working out the profit on which UK corporation tax is charged is one of generally accepted accounting procedures, a company’s taxable profit in its tax return is hardly ever the same as its accounting profit on which the book tax charge is based. There are many adjustments which tax law requires to be made to the accounts profit in order to arrive at the taxable profit.

The UK’s corporation tax rules essentially result conceptually in four types of adjustment to accounts profits to arrive at a taxable profit: 1 A dd back to accounts profit those items of expenditure that are not tax deductible - such as most penalties, entertaining expenses, dividends and provisions for future liabilities. The write-down in the value of assets by way of accounts depreciation is also not deductible for tax, although the impact is reduced in some cases by specific allowances – capital allowances – that are deductible as set out below.

2 Deduct from accounts profit allowances and reliefs which are provided for in the tax rules. Capital allowances are available at different rates and over different periods for some specific types of capital expenditure. Occasionally, a tax deduction can be claimed in respect of expenditure over and above the amount actually spent – a super-deduction – as with the current research and development (R&D) regime.

3 R educe accounts profit by amounts which are not taxable for that period. An example of this results from fair value accounting, particularly in relation to assets/liabilities other than debt, where the accounts reflect unrealised profits but the tax return does not include them (this stems from the corresponding rule that does not allow unrealised falls in value for tax purposes on the basis of an accepted accounting procedure). Most dividends are not subject to corporation tax in the recipient company.

4 Increase accounts profit to include amounts which are taxable for that period but not shown as such in the financial statements. For instance, related to the provision of capital allowances in relation to certain expenditure on an asset, if you sell the asset for more than the amount still to be claimed in future periods – its tax written down value, the tax rules can sometimes clawback some of the allowance given by imposing a balancing charge which needs to be added in to taxable profits.

One of the largest causes of difference between cash and book over the last recent years has been pension contributions because of the ever increasing deficits in the pension funds. These contributions are generally eligible for tax relief on a paid (not accounts) basis.

While there is no limit on the amount of contribution which an employer can make in each period, when a contribution is paid in an accounting period which is large compared with the prior year contribution, the company may not receive tax relief for the entire payment in that period. Instead, part of the tax relief is ‘spread’ forwards into future periods according to a formula. Group and multi-employer pension schemes require additional complex rules to determine any tax relief. Companies are also increasingly seeking alternative ways to fund their pension schemes which do not solely rely on cash contributions but utilise other assets owned by the company or group: tax reliefs are often available for these kinds of contributions provided certain rules are followed.

Losses may also give rise to a difference between cash and book tax. Tax losses do not normally result in current period cash tax relief but can only be set against taxable profits in other ways.

Because of the necessary adjustments it is even possible to have on the one hand an accounts profit and a tax loss or on the other hand an accounts loss and a tax profit for a particular period. We looked further at losses in Concept 1.

Tax and British business: making the case

A company might carry on more than one trade or business, in which case the tax rules also need to be applied to each separately. This can complicate things further.

In a cross-border scenario these issues are even bigger and could lead to more divergence between the two concepts. ‘Cash tax’ and ‘book tax’ are even more unlikely to be the same in the overall consolidated accounts of an international group operating in several different countries, as both amounts will be the result of adding together figures from the various countries. We consider groups in Concept 2.

In addition, unrealised intercompany profits/losses in individual company accounts are adjusted out for consolidated accounts purposes, whereas they are likely to remain taxable particularly if they relate to cross-border transactions. International issues are considered in Concepts 4 to 8.

There are some accounting concepts which also impact the differences between ‘cash tax’ and ‘book tax’. Concept 10 looks at how accounts seek to smooth out some of the difference via deferred tax accounting and Concept 11 covers the need to reflect liabilities conservatively by way of provisions for uncertain transactions.

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Concept 10 D eferred tax accounting The difference between current and deferred tax accounting is complex and causes endless confusion.

Deferred tax accounting is a set of rules that impact the amounts of corporation tax shown in the accounts of a business in addition to the current tax charge. It deals primarily with the timing differences that can occur when items of income or expense are included in the financial accounts in different periods to those in which they are included in a tax return.

The UK tax rules specify the amounts of income and expenses that are tax deductible. For example, the way capital allowances work may mean that only part of the money that a business spends on equipment in any one year is allowed as a deduction against the tax due on profits made in that first year.

Similarly, there are accounting rules that determine when items of income and expense must be included in the accounts of a business. For example, an item of new equipment depreciates in value over its useful life. In the same way that only part of the cost is allowed for tax when it is spent, only part of the accounting depreciation is charged as an accounting expense in the year that the cash is spent.

There are many differences between the accounting rules and the tax rules, as explained in Concept 9. This creates a mismatch between the amounts that have been included in the tax return and those included in the accounts for a period. Deferred tax accounting seeks to address this mismatch so that the tax in the accounts relates more closely to the profit in the accounts on a like-for-like basis, and reflects all of the tax that will ultimately be due on that profit. It affects the ‘book tax’ for a particular year insofar as it reflects adjustments in the amounts which are allowed by accounting rules to be held as deferred tax assets or deferred tax liabilities in the balance sheet.

Deferred tax assets and liabilities in the balance sheet represent the tax effects of timing differences between accounting and tax rules that will reverse in future periods. For example some expenditure qualifies for a 100% capital allowance in year one, in this case a deferred tax liability can be booked because the amount of the tax allowance exceeds the amount of depreciation. This liability will gradually decrease over a numbers of years as the cumulative accounting depreciation starts to catch up with the amount of the tax allowances (which are generally more generous or less conservative). The liability will be extinguished when there is no longer a timing difference, because the cost of the asset may have been fully depreciated and all available tax allowances used.

Deferred tax assets can arise in the alternative situation where tax relief is given in future periods for an amount of expenditure that has already been charged in the accounts. This can occur, for example, where a business makes an accounting provision for future expenditure that is not immediately deductible for tax.

Tax losses may also give rise to a deferred tax asset to the extent that it is probable that the asset will be realised: this is usually determined by reference to future profit forecasts because future tax deductions will only be of future benefit if there are likely to be future taxable profits to offset them (see Concept 1 for more on losses).

Tax and British business: making the case

Concept 11 Provision for uncertain transactions In some of the commentary on HMRC settlements there has been clear misunderstanding on the requirements for companies to provide for certain tax liabilities in their accounts.

Companies may need to make a provision in the accounts for the uncertainty surrounding certain transactions when they expect to discuss the interpretation of difficult tax rules with HMRC. In the UK, a company must file its tax return within 12 months of its year end, so will prepare detailed computations of the tax due at that point. This is part of the ‘self-assessment’ process – ie the company’s view of the correct tax treatment of all the transactions which have taken place in the year. At this stage, even though HMRC may not have reviewed the computation, the company will be aware of a number of items where it is likely that there will need to be a discussion with HMRC before the tax treatment can be finalised. For example, there may be questions such as: •W hether a payment to terminate an onerous contract is a trading payment (allowable for tax) or a capital payment (not allowable) •W hether the prices used to buy or sell goods from related parties are reasonable ‘arm’s length’ prices under international transfer pricing principles •W hether a particular piece of equipment qualifies for capital allowances.

The accounting rules apply to tax provisions in the same way as they apply to any other uncertain liability. There must have been a transaction which has given rise to a potential obligation to make a payment, and it is more likely than not that a payment will have to be made. The company must also be able to estimate the amount of the payment with reasonable accuracy, and the amount of the provision will have to be approved by the company’s auditors.

For example, a company may believe that a particular payment should qualify as an allowable trading payment, but may also be aware that HMRC have won a tax case on a similar payment, but with some factual differences, so the outcome for the company is uncertain.

It may take several years before complex transactions are agreed with HMRC. At each year end, the company will review its provisions, and either increase them (if it thinks HMRC’s case is stronger than previously) or reduce them (if it is more confident of there being a lower final amount of tax payable). An increase in a provision results in an additional tax charge in the profit and loss account; a reduction results in a credit (lower tax cost).

When an issue is finally settled (see Concept 12), the remaining provision will be released to the profit and loss account. The final amount of tax due will be compared to payments already made, and any over or underpayment will result in a further release or charge to profit.

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Concept 12 Agreement and settlement There has been much talk of ‘sweet-heart’ deals between HMRC and taxpayers. There is however a very robust – and recently strengthened – set of settlement rules in place by HMRC. If HMRC and the taxpayer cannot agree on a particular tax issue, then ultimately it will proceed to litigation and the Tax Tribunal or higher courts will reach a final decision. But litigation is expensive and uncertain, so it is often in the best interests of both sides to reach a settlement. HMRC will only settle an issue on a basis which is a feasible outcome of litigation, so if there is an ‘all or nothing’ issue, HMRC cannot simply agree to ‘split the difference’. However, if there is a range of possible outcomes, HMRC can settle for any reasonable figure within that range (but could not settle for a figure outside the range).

There can be a genuine difference of view between HMRC and a company on how tax law applies to a particular transaction. This does not necessarily mean that the company has used a ‘scheme’.

Questions such as…

• Whether expenditure is capital or revenue in nature •W hether an amount is an ‘arm’s length price’ for goods or services received or supplied •W hether the accounting treatment of a financial instrument ‘fairly represents’ the taxable profit or loss •W hether all the conditions for a particular relief have been satisfied. …need to be taken into consideration.

Some issues will be ‘all or nothing’ (or ‘binary’) issues: for example, either a relief can be claimed or it cannot. Other issues can have a range of outcomes – for example, an arm’s length royalty is not a precise figure, but an acceptable range such as (say) between 3% and 5% of sales income.

HMRC’s Litigation and Settlement Strategy (LSS) sets out the key principles on which it will resolve disputes. This provides that in strong cases it will settle for the full amount HMRC believes the tribunal or courts would determine, or otherwise litigate. In ‘all or nothing’ cases it will not split the difference; and in weak or non-worthwhile cases it will concede rather than pursue.

HMRC will not do ‘package deals’ – if there are several issues to be agreed, each one must be considered on its own merits.

If agreement cannot be reached, then an issue will proceed to litigation. It is usually binary issues which are resolved in this way.

The case will initially be decided at the tax tribunal but either side may be able to appeal to a higher UK court and, in some instances involving EU law, to the Court of Justice of the European Union (although higher UK courts may also refer issues directly to the CJEU for pronouncements on the interpretation of EU law). After a finding in any court about the interpretation of legislation, the matter may revert to the court system or for settlement to be reached between the taxpayer and HMRC on the interpretation of that finding to the facts.

When HMRC settles for a figure the LSS means it should be one which could have been reached in litigation, and there is no question of any tax being ‘waived’. The total settlement may be less than HMRC originally hoped, but in any dispute (whether in tax or the commercial world) the final figure is rarely all that either party had hoped to achieve (see Concept 11 for an explanation of how companies need to make provision for uncertain transactions).

Tax and British business: making the case

5 A competitive global tax landscape

Businesses now place a much larger value on operating within simple and predictable tax environments. A key characteristic of any competitive tax regime is that it is simple to understand and efficient to comply with. It must also work together with other tax systems to avoid the double taxation of profits, for example through double tax treaties. The concern is that the growing complexity of the UK tax system means that the UK has become a less attractive place for business to invest. Against that background, it is vital that policymakers, businesses and outside commentators have an intelligent debate about the business tax system.

The UK must compete for increasingly mobile business activity – or risk losing out

If the UK is to retain and attract the business and talent it needs to stimulate economic growth, a competitive and stable tax environment is a necessity. Thus, the government’s stated ambition on headline corporation tax rates and its reforms on the taxation of foreign profits and intellectual property have been steps in the right direction, as they would make the UK a more attractive destination for investment by multinational companies, both those based in the UK and inward investors. The proposals for reform of the Controlled Foreign Companies regime are intended to protect the UK tax base from artificial diversion of profits, including those attributable to intra-group financing arrangements, without undermining the UK’s attractiveness as a location for multinationals through excessive compliance burdens.

Increased mobility of goods, services, labour, capital and ideas have combined to require companies to structure their operations in an increasingly global manner, with diminishing regard for national boundaries and jurisdictions. These factors, added to the growing strength of developing economies and the reduction in trade barriers, have led many businesses to globalise activities. In conjunction with this, the internationalisation of shareholder bases and the geographical diversification of company ownerships have loosened the historical ties between companies and specific jurisdictions.

Not only does an uncompetitive tax system risk driving business offshore and erode the competitiveness of UK businesses, it also threatens government tax revenues. High capital mobility, leading to increased business responsiveness to tax differentials, threatens the stability of corporate tax revenues. This is particularly important given the strategic significance of the UK’s highly mobile financial services and knowledge-intensive businesses. Those who argue that the business tax burden should be raised to meet the UK’s fiscal needs must recognise the risk that this would jeopardise current levels of tax paid by business to government. Business wants to contribute to Britain, but it simply cannot do that if Britain is not competitive with its foreign peers. Lost business costs the UK not just the corporation tax paid each year by these businesses, but the other business taxes which together account for more than three times the value of corporation tax.

In an era of globalisation and competition, an attractive tax environment is vital to the UK. The cost of an uncompetitive regime is lost business activity, lost revenue and a tax environment which does not encourage British business to grow. And this translates into fewer jobs, less opportunity, and lower tax receipts. That is not good for the British economy or British workers.

The globalisation of business means that not only are differences in the competitiveness of national tax systems becoming more important, but multinational companies are also becoming ever more responsive to these differentials. In this global context the UK competes with other locations for mobile business activity. The UK economy is significantly boosted by the presence of many of the largest multinational companies in the world. As the government noted in its Corporate Tax Roadmap, “the UK is an open economy and many of the best known businesses in the world are located in the UK, generating growth, creating jobs and making a significant contribution to the public finances.” 12

Reductions in the UK corporation tax rate are needed to maintain competitiveness

Recent reductions in the corporation tax rate and the government’s aim to reduce the rate to 23% have attracted criticism from some commentators. Critics have claimed that in a time of public austerity, business should be paying more taxes and that this tax cut is ‘unfair’. But that misses an important point: business understands that it must shoulder its share of the burden, but unlike an individual for whom there is a welfare safety net, there is no safety net for business. If businesses become uncompetitive, and can no longer compete, they cease to exist, and the jobs, tax revenue and agglomeration benefits they provide will all disappear.

So, such cuts are an important factor for the competitiveness of the British economy.

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52

Additionally, corporate tax rates are falling throughout the world – according to KPMG, the average global corporation tax rate fell by 3% between 2005 and 2010. This means that rate reductions in the UK are necessary just to keep pace with this global trend.13 Exhibit 6 shows how the headline statutory rate of corporation tax has been falling in major economies over the last 15 years – and how the UK’s rate has had to fall in recent years to remain competitive.

Two further measures of a country’s corporation tax rate – the effective average and effective marginal tax rates – also show that the UK regime is far from being the most competitive in the G20.

These measures show the size of the disincentive presented by the corporate tax system to locate activity in a particular country and 5 the size of the disincentive to undertake a greater quantity of investment once the location decision has been made. The effective average tax rate (EATR) is the most comprehensive comparator between countries and the effective marginal tax rate (EMTR) in effect measures the proportionate increase in the cost of capital for a specific investment project as a result of corporate taxation. The UK has the 9th and 15th lowest rates of EATR and EMTR of the G20 countries, respectively.14

Exhibit 6 Statutory headline corporation tax rates 1996-2011 (%) 40 35 30 25 20 15 10

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The competitiveness of companies operating in the UK with respect to their foreign equivalents is also an important tax issue. If many other countries allow their companies to use a certain method for accounting for the tax implications of intellectual property, for example, but the UK does not, UK companies will be at a disadvantage.

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12 new EU members

Source: OECD

Exhibit 7 Effective average and marginal tax rates G20 countries, 2011 Effective average tax rate (EATR) (%) Russia Turkey Saudi Arabia South Korea China Indonesia Canada Mexico UK Australia Italy Germany France India South Africa Brazil Argentina Japan US

Conclusion

The UK government has announced its intention to construct the most competitive regime in the G20 to encourage companies to invest and stay in the UK. This does not just mean a competitive headline rate of corporation tax, but includes the use of other incentives to ensure the UK tax environment is attractive to business. However, tax competitiveness is important to governments, and to the national economy. If certain tax incentives give the UK a competitive edge, then the UK benefits.

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United Kingdom

OECD average

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Effective marginal tax rate (EMTR) (%) Russia South Korea Turkey Saudi Arabia Italy China Canada Mexico France Germany Indonesia Australia South Africa India UK United States Brazil Japan Argentina 0

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Source: Oxford University Centre Business Taxation

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Tax and British business: making the case

6 Summary

There is a very vigorous debate underway over the amount of money that businesses pay in tax. Unfortunately much of that discussion is shrouded in misunderstanding. It is vital that there is an intelligent debate over the UK’s tax regime, since a competitive system that is seen as fair is an essential ingredient for the competitiveness of the UK economy.

The reality is that businesses pay their way in terms of total tax revenue, contributing more than a quarter of total receipts. On top of that, businesses play a key role both in collecting taxes paid by other taxpayers and also in delivering the economic growth and wealth that indirectly leads to higher tax revenues from consumers and larger incomes for pensioners.

The business community in this country also pays more corporation tax than businesses in many of our competitor countries. But not every business pays an identical share of its revenues in tax, as the final contribution will depend on the sector of the economy the company operates in, the size of the sector and the firm and the deductions and reliefs available to it.

People are concerned that taxpayers – and especially businesses – pay their fair share of tax and do not evade their liability or use abusive arrangements to pay less tax. Action by lawmakers, HMRC and companies themselves has helped to substantially reduce the number of abusive arrangements that have been seen as contributing to a tax gap. It is important that the debate is not

distorted by a focus on tax evasion and abusive arrangements.

These should not be confused with tax management, which is simply how businesses use the tax system to make use of incentives and ensure they pay what they are required to pay.

Tax management must be understood as simply describing what is open to all taxpayers, whether individuals or businesses: they should pay tax, but no more than specified by law. One reason for misunderstanding is that the range of tax incentives used by government, the increasing complexity of the system and the need for multinationals to navigate different tax jurisdictions makes tax management even more important to ensure business pay the tax for which they are liable. The tax system is by its nature very complicated and there are some rules that, while in place for a specific purpose, can add to misunderstandings.

Tax competitiveness is important to governments, and to the national economy. If certain tax incentives give the UK a competitive edge, then the UK benefits. This competitiveness will, of course, benefit entrepreneurs and other owners of capital. The UK must continue to look to lower the business tax burden, even in these times of austerity, as long-term competitiveness of the UK economy will lead to long-term tax revenues. But it will also benefit workers, their families, the supply chain and the exchequer. A competitive tax system that encourages growth benefits everyone – that would be good for Britain.

“A competitive tax system that is seen as fair is an essential ingredient for the competitiveness of the UK economy.”

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Annex 1 CBI statement of tax principles

To advance the debate on the responsible management of tax by UK business, the CBI offers this statement of tax principles for its members.

Intention of statement of principles

This statement of principles is intended to promote and affirm responsible business tax management by UK businesses.

These principles are based on five key observations: •P ublic trust in the tax system is a vital part of any flourishing democracy • T ransparency and cooperation between HMRC and business contributes to greater compliance and a better functioning tax system •M ost businesses comply fully with all applicable tax laws and regulations, recognising the obligation of the UK government to protect a sustainable tax base • T ax is a business expense which needs to be managed, like any other, and therefore businesses may respond to legitimate tax incentives, and statutory alternatives, offered by governments • UK businesses contribute significantly to the UK economy and pay a substantial amount of tax comprising not only corporation tax, but also National Insurance, business rates and other taxes.

The objectives

Tax planning principles

•U K businesses should only engage in reasonable tax planning that is aligned with commercial and economic activity and does not lead to an abusive result •U K businesses may respond to tax incentives and exemptions •U K businesses should interpret the relevant tax laws in a reasonable way consistent with a relationship of ‘co-operative compliance’ with HMRC • I n international matters, UK businesses should follow the terms of the UK’s Double Taxation Treaties and relevant OECD guidelines in dealing with such matters as transfer pricing and establishing taxable presence, and should engage constructively in international dialogue on the review of global tax rules and the need for any changes.

Transparency and reporting principles

Relationships between UK businesses and HMRC should be transparent, constructive, and based on mutual trust with the result that HMRC should treat business fairly and with respect, and with an appropriate focus on areas of risk. UK businesses should therefore: •B e open and transparent with HMRC about their tax affairs and provide all relevant information that is necessary for HMRC to review possible tax risks

• T o enhance cooperation, trust and confidence between HMRC, UK business taxpayers and the public in regard to the operation of the UK tax system

•W ork collaboratively with HMRC to achieve early agreement on disputed issues and certainty on a real-time basis, wherever possible

• T o promote the efficient working of the tax system to fund public services and promote sustainable growth.

•S eek to increase public understanding in the tax system in order to build public trust in that system, and to that end:

− T hey should consider how best to explain more fully to the public their economic contribution and taxes paid in the UK

− T his could include an explanation of their policy for tax management, and the governance process which applies to tax decisions, together with some details of the amount and type of taxes paid.

Tax and British business: making the case

Annex 2 Tax management in the courts

Judicial interpretation of tax law has changed over the years since the Duke of Westminster case, to the complexity of the tax system and significantly reducing the scope for abusive arrangements In 1981 in the Ramsay case, the House of Lords held that if a group created a matching capital gain and loss (on loan notes) at no economic risk to itself (the gain not being taxable due to a statutory tax exemption), the loss was not allowable as a tax loss. In Lord Wilberforce’s judgement he said “There may, indeed should, be considered the context and scheme of the relevant Act as a whole, and its purpose may, indeed should, be regarded.”

This ended arrangements where the same transaction, effectively, went in a circle, within a group of individuals or companies. But taxpayers were still uncertain how far the principle extended. In Furniss v Dawson, a third party had agreed to buy a family’s shares.

The family, however, first sold them to another company for shares, which itself sold on to the third party. The House of Lords said that the inevitability of the onward sale meant that the family’s sale should in effect be regarded as made directly to the third party.

Difficulties remained, however, in determining what constituted a connected series of transactions with pre-ordained steps with no commercial purpose, and a string of cases followed. But the 1997 McGuckian case was marked the high-water mark of looking at Ramsay and Furniss as a free-standing principle in this way. In this case, the sale proceeds of the rights to certain dividends expected to be declared shortly by a company controlled by the taxpayer were treated as income (although the basis of the judgment was not entirely clear).

Mawson v BMBF in 2004 was the last major case to reach the House of Lords in this specific area and it effectively set the standard for current interpretation by the courts. The test is that the court has to go back to basics and try to find out which transactions a given tax provision was intended to cover. ‘What was the objective intention of Parliament in enacting this provision?’ Yet in answering this question, one must look at the words actually used not the words which arguably ought to have been used. More recent cases in the lower courts have made clear the need, in applying this case law, that the facts must be viewed realistically, leaving taxpayers facing a rather strict assessment of the tax status of their transactions.

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References

1 The combined budgets for the Department for Health and Education for 2012-13 are £156.1bn. Comprehensive Spending Review, HM Treasury, 2010

9 Report by the Comptroller and Auditor General on HM Revenue and Customs 2010-11 Accounts

2 Commentary on the public sector finance, OBR, June 2013

10 UK’s tax system has over 1000 reliefs. HM Treasury press release, 8 November 2010

3 Total Tax Contribution: Understanding the economic contribution that large companies make to UK public finances, PwC 2010 survey for The Hundred Group 4 Revenue Statistics 2013, OECD 5 Corporation Tax in the UK, Devereux M, Loretz S, Oxford University Centre for Business Taxation, 2011 6 The tax gap represents the amount of tax that the government believes may be owing. This number needs refining in two important ways. Firstly reasonable people might disagree on some of the assumptions behind some of the numbers. Second, government statistics tell us that the tax gap is actually made up of a ‘hard’ tax gap and a ‘soft’ one 7 This includes both ‘avoidance’ (£1bn down from £2.1bn in 2004-05) and ‘technical issues’ (£0.2bn) 8 Inland Revenue Commissioners v Duke of Westminster [1936] A.C. 1

11 Prior to 1 July 2009, all foreign dividends were subject to UK corporation tax, and credit was then given for foreign tax suffered to prevent double taxation.

From 1 July 2009, most such dividends are exempt from corporation tax as part of the move to a more territorial tax system 12 The Corporate Tax Roadmap, HM Treasury, 2011 13 Corporate and Indirect Tax Survey 2010, KPMG 14 Corporation Tax in the UK, Devereux M, Loretz S, Oxford University Centre for Business Taxation, 2011

For enquiries about this report or a copy in large text format, please contact: Richard Woolhouse Head of tax and fiscal policy CBI T: +44 (0)20 7395 8098 E: richard.woolhouse@cbi.org.uk

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