Tax in a global economy by The CBI

Tax in a global economy

The way forward

Tax in a global economy The way forward

Contents

Foreword 4 Executive summary

1 The tax imperative: the need for a competitive system

2 International taxation: setting out a roadmap

3 Domestic taxation: stability is the top priority

References 30

Tax in a global economy The way forward

Foreword

Getting the tax system right is more important than ever. The global recession in 2008-2009 was far deeper than previously thought and recoveries across the world have been slower than expected. Now, mid-way through 2013, several indicators suggest that growth is gradually gaining momentum. For this to continue, the UK must retain its place as a good place to invest in and to do business from. In the long term, the need to rebalance the economy towards greater business investment and exports remains, so tax competitiveness is key to both short and long term prosperity. The direction of travel is positive – the KPMG Tax Competitiveness survey shows that the UK’s tax competitiveness has improved significantly – but the international struggle for investment is as fierce as ever. We need a two pronged approach. At home, our domestic tax system must be as competitive as other major economies. For the most part, this means committing to stability and allowing the changes introduced so far to take effect. However, there are parts of the tax system that need more attention. Business taxes are much broader than corporation tax alone, and focus should now turn to other large taxes, in particular business rates, which place a disproportionate burden on certain sectors. We also need to tackle reform at the international level, and for this we need to work closely with our competitors, to get the right outcome for everyone. Any changes made to the international landscape should not undermine the gains we have made domestically.

John Cridland Director-general, CBI

Tax in a global economy The way forward

Five years ago, in the CBI’s UK Business Tax: a compelling case for change, the chair of the CBI tax taskforce wrote that “for many, the subject of corporate taxation is seen as arcane, labyrinthine and difficult – something to be left to trained tax lawyers or accountants” but cautioned that, in fact, it is a subject that matters to everyone. Five years later, as we are still in a slow recovery following a deep recession, the media and public interest in corporate taxation demonstrates this to be more apt than ever before. Last time, the members of the CBI tax taskforce were keen to see a simpler, more competitive and more stable tax system, with a clear and consistent approach to policy making. Starting before the last election, but accelerating since 2010, the UK government has responded by publishing a Corporate Tax Roadmap and improving the tax policy development process, whilst simultaneously making the UK’s headline corporation tax rate significantly more competitive. These actions all contribute to the government’s ambition of having the most competitive tax regime in the G20. Businesses are increasingly mobile and are facing decisions about where to invest in long term projects. In order for the UK to encourage long term investment which would deliver employment and growth, the UK tax regime as a whole needs to be part of a world class package of reasons to invest in the UK. In order to capitalise on the progress made in the last five years, the government needs to allow a period of consolidation for the UK rules whilst leading the way in reforming international tax rules. Stability in the domestic tax system will allow the welcome changes to take effect, and a published ‘roadmap’ of international taxation objectives would help to ensure that the UK remains the best place in the world to invest.

Mark Elborne Chairman, Task and Finish Group CEO, General Electric UK & Ireland

Tax in a global economy The way forward

Executive summary

Five years ago the CBI issued a report 1 and made a number of proposals to reform the UK corporate tax regime and help us become one of the most competitive business environments in the world. Since 2008 the UK government has published its Corporate Tax Roadmap and made welcome progress toward delivering significant improvements to the UK corporate tax system. For instance it has: •R educed the rate of headline corporation tax to 20% by 2015 to give the UK the joint lowest rate in the G20 •R eformed the Controlled Foreign Companies regime, introduced dividend and branch exemptions, and given the UK a more territorial tax system, and • I ntroduced incentives to encourage innovation which have already started to encourage interest in the UK. But more still needs to be done. In this report, the CBI calls for the government to build on the work of the last five years and deepen its focus in key areas to secure the UK as one of the most competitive business tax systems in the world. The CBI recognises that there is a balancing act between securing competitiveness, an ability to accommodate changing business practices and stability in the tax system. There will always be tension between these elements, but now given the tough economic backdrop, even more than in 2008 the UK needs a tax system that supports investment and growth.

Therefore the CBI recommends that the UK government:

1 Sets out an international tax roadmap

There is currently significant focus on the need to reform the way in which multinational businesses are taxed. Much of this activity is taking place at the international rather than the national level. This is entirely appropriate given the desirability of internationally coordinated rules. In order to participate effectively in this process, the government should set out a roadmap with clear principles and priorities for its international tax policies. This will deliver more certainty and predictability to the system. In developing its international tax policies, the government should follow certain principles and processes: • Common, coordinated and consistently applied international tax rules are needed to allocate taxing rights among countries without triggering double taxation. The same types of rules governing taxation of multinational businesses are often applied inconsistently across countries. There is a need for a common set of rules that delivers more certainty for cross-border trade and investment. • Maintaining and improving UK tax competitiveness should be a core objective when the UK seeks to shape international tax rules. Revisions to the way multinational businesses are taxed should be coordinated with other policies and not undermine the progress on making the UK the most competitive tax regime in the G20. • Any changes to long-established principles must bring real benefits and not just increase administrative burdens. Radical proposals, such as replacing the arm’s length principle with formulary apportionment or reforming the taxation of companies by moving to a turnover or a destination-based tax system would raise as many complex issues as the current rules. Any reform to the way cross-border activities of business are taxed should be delivered through revising existing practices and not by introducing any radical solutions.

Tax in a global economy The way forward

• Policies must be forward-looking and able to anticipate changes in business practices. It is challenging to predict how business practices will evolve, so international tax rules should be able to adapt to the new ways and be supported by a regular review of key international tax policies. • Any changes in tax rules must be based on international coordination. The UK cannot develop any changes to the taxation of multinational business in isolation. The rules will only work if the global playing field remains level. • Sufficient time should be allowed for consultation with relevant key stakeholders. The government should seek to agree key parameters and resist any changes that have not been given sufficient time for all stakeholders to understand their impact. Proper time for consultation must be allowed and not be curtailed because of international timetables or other pressures. • HMRC and HM Treasury should recruit more international taxation specialists. To manage an international tax system effectively, HMRC and HM Treasury need to recruit or train more international tax specialists and secure a budget for external expertise. • International agreement on a few key international tax components would be welcome. Key components could include obtaining international consistency on a definition of ‘economic substance’ or common principles of Controlled Foreign Companies rules. • Dispute resolution must be coordinated internationally. A systematic approach to resolution is critical to instil confidence in the regime and avoid issues escalating and becoming an impediment to global development. • The government should expand its support for capacity building for developing countries’ tax authorities and tax policy functions. This will help encourage more consistency in the application of international tax rules. It will also strengthen developing countries and encourage investment and growth.

2 Focus on stability of the domestic tax system

The absence of frequent legislative changes and consistency of approach are regarded as the major factors that businesses take into account when assessing the attractiveness of an investment location. The government should not seek to make major changes in the short term. Instead it should allow the changes made over the last five years to take effect. The key areas that the government should not change in the short term include the headline rate of corporation tax, tax treatment of interest and resisting a unilateral approach to tax transparency. The government’s focus should be on tax changes in a very limited number of areas that remove existing distortions in the tax system or provide a clear stimulus to business investment. The government should: • Level the playing field for expenditure on infrastructure and other capital assets. The UK has one of the least generous capital allowances regimes in the G20 with no allowances available for certain types of capital expenditure. In order to attract international investment to infrastructure projects in a competitive international environment, the UK must take steps to improve this regime. • Limit increases in business rates. Business rates are one of the largest business taxes that are not related to profits and place a significant burden on physical businesses. The government should at the very least cap business rates increases at 2%. The medium to long-term aspiration should be a full reform of this regime to minimise unintended distortionary effects while ensuring that the business rates system works consistently with other policy measures and objectives such as those encouraging environmentally friendly construction. • Reduce employer National Insurance Contributions (NICs). NICs are one of the most distortive forms of taxation and are essentially a tax on labour. In the long term, by increasing the employer’s NICs threshold additional employment opportunities for young people and part time workers could be created as the marginal cost of expanding employment would be lower.

Tax in a global economy The way forward

• Enable small and medium sized businesses to flourish alongside large businesses. Simplification of the tax system and policies to assist small and medium sized businesses in raising finance will unlock the potential growth that they offer the UK economy.

• Further improve tax policy making process. Tax policy making requires further improvements in the consultation process, more effective interaction between tax policy makers, strengthening the independent review of tax laws, improving the economic analysis capabilities within HMRC and HM Treasury, and making significant improvements to the process of drafting tax laws in order to achieve a more predictable tax system.

• Need for common coordinated and consistently applied international tax rules • UK tax competitiveness should be a core objective when shaping international tax rules • Any changes to long established principles must bring real benefits • Policies must be forward-looking • Any changes in international tax rules must be based on international coordination

Set out a roadmap

• Sufficient time should be allowed for consultation Process

International

Principles

Exhibit 1 Summary of our recommendations

• More international tax specialist should be recruited • International agreement on a few key international tax components should be achieved • Dispute resolution must be coordinated internationally • Support for capacity building for developing countries’ tax authorities should be expanded • International tax principles around profit allocation should be reviewed • Transfer pricing rules should be reviewed but not changed fundamentally • International withholding tax regime should be reviewed

Address international tax issues

• The UK government should be involved in further development of core EU tax policies • EU should be cautious when using enhanced cooperation on tax issues Principles

• EU State Aid rules should be reviewed

Focus on stability

• Provide time for changes introduced by the government’s Corporate Tax Roadmap to take effect • Reassurance that the deduction of interest will be retained where it is a genuine business expense • A unilateral approach to tax transparency must be resisted • Tax policy making must be transparent and predictable

Process

domestic

• Consultation process should be improved • More effective interaction between tax policy makers • Strengthen the independent review of tax law • Improve economic analysis capacity and capabilities of HM Treasury and HMRC • Level the playing field for expenditure on infrastructure and other capital assets

Remove distortions and provide stimulus for business investment

• Limit increases in business rates • Reduce burden of employer NICs • Enable small and medium sized businesses to flourish alongside large businesses by simplification

Tax in a global economy The way forward

1 The tax imperative: the need for a competitive system Five years ago the CBI published its major report UKÂ Business Tax: A compelling case for change andÂ made a number of proposals to reform the UK corporate tax regime and help us once again become one of the most competitive business environments in the world. A huge amount has changed since then, both in terms of the economic environment and in the attitudes of government, business and civil society towards the UKâ&#x20AC;&#x2122;s tax system.

The financial crisis, the global and national recessions and the surge in government borrowing has made it even more important to use the tax system to stimulate long term sustainable growth. There have been many positive moves in that direction but this report finds that there is still more to do to ensure business capitalises on the emerging recovery.

1.1 Economic context

Since 2008, the UK has suffered a deep recession followed by a weak recovery. In the first quarter of 2013 the economy was still 3.9% smaller than it was at its peak in the first quarter of 2008. The failure to match its previous trend growth of 2.3% has made the case for implementing reforms to improve the competitiveness of the UK even more compelling.

Exhibit 2 UK year-on-year growth consistently below its long-run trend post financial crisis 5 4 3

UK historic trend rate of growth = 2.3%

2 1

-5 -6 Source: CBI analysis of Office for National Statistics (ONS) data

2009 - Q4

-4

2009 - Q2

-3

2013 - Q1

2012 - Q4

2012 - Q2

2011 - Q4

2011 - Q2

2010 - Q4

2010 - Q2

2008 - Q4

2008 - Q2

2007 - Q4

2007 - Q2

2006 - Q4

2006 - Q2

2005 - Q4

2005 - Q2

2004 - Q4

-2

2004 - Q2

-1

2003 - Q4

Tax in a global economy The way forward

In the run up to the financial crisis, the UK was already running a £36.7bn budget deficit, despite the economy operating above its potential and a financial boom flattering tax revenues. The Office of Budget Responsibility (OBR) estimates the financial crisis and recession increased the structural deficit (ie the amount of the deficit that would not be closed by a cyclical recovery in tax) to £135bn 2 or 8.9% of GDP at its peak in 2009. The government has embarked on an eight year programme of tax rises and public spending cuts to correct the deficit in the public finances. While there is only limited room for across-the-board cuts in marginal tax rates to improve incentives to invest, work and innovate in the short to medium term, some taxes are more growthprohibitive than others. Research by the Organisation for Economic Co-operation and Development (‘OECD’) shows that cutting corporation tax as a share of overall tax revenue by one percentage point can boost the long term level of output by two percentage points thanks to an increase in capital investment. Exhibit 6 shows the importance of higher output for deficit reduction. If UK economic growth continues to disappoint, tax hikes and spending cuts alone will not succeed in cutting the deficit. Policymakers who are determined to return the economy to long term sustainable growth must raise our international tax competitiveness to support the deficit reduction strategy.

Exhibit 3 Negative economic shock 2009 = 100 130

11% permanent loss of output

120

110

100

OBR Budget 2013 forecast

16 2017

Pre-financial crisis trend

Source: March 2013 OBR Economic and Financial Outlook

Exhibit 4 UK structural deficit (£bns) in 2012-13 prices 800 750 700 650

£135 bn structural deficit

600 550 500 450

05/6 06/7 07/8 08/9 09/0 10/11 11/12 12/13 13/14 14/15 15/16 16/17 2017-18 Public spend

Tax revenue

Source: Institute for Fiscal Studies, post Budget 2013 analysis

Tax in a global economy The way forward

“To return the economy to long term sustainable growth…(we) must raise our international tax competitiveness”

Effect on GDP(%) from 1% reduction of a given tax in the share of tax revenue

Exhibit 5 Impact of tax mix on output 2.0

Exhibit 6 The impact of growth on tax revenues Government spending and tax revenues (£bn)

Corporation tax

900

2.01 -0.5

1.5

850

Personal income tax 1.0

1.13 800

0.5

£765.1 750

0.0 -0.5 -1.0 -1.5 -2.0

£734.6

£723.0 £696.9

700

£671.6

-0.74 Consumption tax

650

-1.47 Property tax

600

550

Source: OECD: Tax and Growth 2010 -2.5

500

09/10

10/11

11/12

12/13

Spending OBR Autumn Statement 2010 OBR Budget 2013 Tax forecast

13/14

14/15

15/16

16/17 2017/18

OBR Forecast with 0.5% lower annual growth OBR Forecast with 1% lower annual growth

Source: CBI analysis of OBR Budget 2013 Economic and Fiscal Outlook

Tax in a global economy The way forward

1.2 Real progress on tax reform

Despite the challenging economic times, the government has made good progress in improving the competitiveness of the UK tax system. This includes the cut in the headline rate of corporation tax to 20% with effect from 2015 from 28% in 2010, and innovative measures such as the introduction of ‘above the line’ R&D tax credits and the Patent Box regime. Furthermore, it has created a more territorial tax system – where companies pay taxes only on profits earned in the UK. Significant reforms include:

• A revised Controlled Foreign Company (‘CFC’) regime 3 • Partial and full exemptions for certain non-UK sourced intra-group finance income • Non-taxation of foreign dividends and overseas branches. These changes have brought the UK into line with many other tax regimes and have thereby enhanced the UK’s standing as a competitive tax system.

Exhibit 7 Summary of 2008 report recommendations and government progress to date An explicit policy framework

• Publish a road map for strategic reform of the corporate tax system • Develop tools for dynamic tax policy analysis • Move towards a target corporate tax rate of 18% • Restrict taxation to UK-sourced profits

Simple taxes at low rates

• ‘All business inome less all genuine business expenses’

Achieved Partially achieved Achieved (1) Partially achieved

• Full consolidation regime • Abolish schedular system

Not achieved (2)

• More alignment of taxable profits with company accounts Detailed three-year rolling prorgramme of legislative priorities

Achieved

• Robust impact assessment for new policies • Improve consultation process A ‘no surprises’ legislative and administrative process

• Purposive approach to drafting of legislation • Enhance effectiveness of parliamentary scrutiny

Partially achieved

• Introduce independent review of tax law • Improve tax administration • Improve transfer of expertise between HM Treasury/HMRC and commercial sector • Enact most new corporate tax laws outside of annual finance bill process

Promote growing and enterprising businesses

• Phase out small companies’ rate to achieve simplification • £100,000 pa investment allowance for SMEs available in full • Exempt SMEs from complex rules that are necessary for multinationals

Not achieved (2) Achieved Not achieved (2)

• Alleviate the burden of transfer pricing Meet the challenge of diverse national tax systems

• Reduce instances of double taxation

Partially achieved

• Take leading role in discussions on improving coordination between national tax jurisdictions • Introduce safe-harbour provisions for routine transfer pricing issues

(1) 18% headline corporation tax rate remains a long term ambition but in the current fiscal environment reduction to 20% rate is welcome (2) Continues to be CBI priority but this report does not put forward any further thinking on this issue

Not achieved (2)

Tax in a global economy The way forward

Exhibit 8 Competitiveness of global economies 100 86

86 79

83 75

67 56

40 26

27 20

0 2007

11 4

Ireland 2008

Netherlands 2009

2011

Switzerland

Luxembourg

2012

Source: KPMG UK Tax Competitiveness Survey, December 2012

The UK now has the most competitive tax regime4 with the Netherlands in second place and Ireland in third, according to KPMG’s sixth Annual Survey of Tax Competitiveness.5

Ernst & Young has reported that at least 20 multinationals are planning to move their regional or global headquarters to the UK over the next year, drawn by the competitiveness of the tax regime.6

Exhibit 9 Improved UK tax competitiveness: success stories Corporation tax policy existing sites in Montrose and Irvine in Scotland. In January 2013, WPP, the world’s largest GSK’s announcement referred to the government’s advertising agency moved its tax residence back confirmation that the Patent Box would offer a to the UK. It had transferred it to Ireland in 2008 lower rate of corporation tax on profits generated along with a number of other high profile from UK-developed intellectual property. companies. The original decision was said to have been driven by the existing tax regime’s effect on CFC reform taxing unremitted foreign profits earned overseas. UBM moved its global headquarters back to the Sir Martin Sorrell, Chairman of WPP, has said the UK in late 2012, largely because of the CFC reforms. move back to the UK is a result of the UK This reversed a move that took them to Ireland government providing “more certainty in relation four years earlier. The multinational media to corporation tax policy”. company put the proposal to its shareholders, who voted almost unanimously to return. Patent Box regime GlaxoSmithKline (‘GSK’) has confirmed plans to invest more than £500m in a manufacturing plant at Ulverston in Cumbria and to invest in two

Tax in a global economy The way forward

“There is a constant need to improve the tax system further to attract more internationally mobile investors, entrepreneurs and employees” 1.3 Creating a tax system to boost growth

The CBI welcomes the government’s intention to build the most competitive tax regime in the G20. However, the change in the economic environment and the increasing focus on tax avoidance and evasion means that the government needs to carefully balance its tax policies to improve tax transparency, revenue raising measures and tax incentives. The UK is yet to realise the full economic benefits of its improved tax competitiveness. Business investment fell sharply in the global financial crisis and has failed to recover fully. Businesses base their investment decisions in part on the post-tax returns they expect to make. Thanks to cuts in the headline corporation tax rate, post-tax returns have improved, which should lead to increased business investment in the medium term. However, in the short run, economic volatility in the Eurozone has increased the perceptions of the risk of doing business in the UK while the weak recovery has caused expected returns to be scaled back. This has led business investment to be held back. As the perceived risk from the Eurozone recedes and the UK economic recovery gathers pace, investment is expected to pick up. In a globalised world tax policies cannot merely be built around a single country. The differences in the competitiveness of national tax systems are becoming more important and multinational companies are becoming ever more responsive to them. The UK competes with other locations for mobile business activity. There is a constant need to improve the tax system further to attract more

internationally mobile investors, entrepreneurs and employees and retain existing investment and talent in the UK. To achieve this in the short to medium term, the government should focus on the following priorities: – I nternational taxation – look at the principles and processes that should govern the UK’s international tax policies and issues that must be addressed on an international stage. –D omestic taxation – ensure the UK tax system remains competitive by focusing on stability, and only making changes necessary to remove distortions and provide stimulus for business investment. There are a number of areas where further work is required. These include improving tax policy making and administrative processes, further work on enterprise taxation and bringing more clarity and certainty around international tax policies. The following sections of the report make recommendations for UK business tax reform in the current economic context.

Tax in a global economy The way forward

2 International taxation: setting out a roadmap Taxpayers need certainty over the rules governing the taxation of cross-border business activities. This can only be achieved if consistent, internationally agreed tax rules and principles guide how governments allocate taxing rights between them. The UK government should continue to work with both OECD and non-OECD countries – focusing especially, but not exclusively, on the BRICS – to update international tax rules and deliver a consistent and coordinated set of international standards that reflect modern commercial reality. However the government should do this without undermining the competitiveness of the UK tax system. Any period of change in international taxation should be followed by a period of stability – analogous to what is recommended for the UK domestic tax system. The government should publish an international tax policy roadmap, setting out its strategic view on the relationship between the UK’s and other jurisdictions’ tax systems and the tax principles set by the international and supra-national organisations, such as the OECD and EU. This would provide a framework for the governments dealing with existing and new issues that arise in the international context. Publishing the direction that the government intends to follow would inject more certainty into the tax system. Set out below are: • Principles the government should follow in relation to international taxation. • Processes the government should follow when developing its international tax policies. • International tax issues that the government should be looking to address through multilateral action over a number of different time periods.

International taxation The essence of international taxation is whether, and to what extent, a country has the right to tax an individual or a company that is in some way connected with that country. There is no single “international tax system”. Each country has its own national set of rules, which has often developed over a long period of time and determines how it taxes its residents and citizens and what types of revenues it wishes to bring into the tax net. International tax law consists of international tax principles (eg OECD Model Tax Convention) and bilateral or multilateral agreements (eg double tax treaties) and determines the taxing rights between countries.

2.1 Principles 2.1.1 Common, coordinated and consistently applied international tax rules to allocate taxing rights among countries without triggering double taxation The UK has been closely involved in the OECD and EU work for a long time but in the world post financial crisis, with emerging economies playing a more active role, there is a need for a new and deeper level of international engagement on tax. This is driven by two factors. Firstly, non-OECD countries are increasingly taking action to shape international tax policies. Secondly, the same types of international tax rules are often applied inconsistently across countries. Cooperation would help the move towards a common set of rules, which would deliver more certainty for cross-border trade and investment. This should be applied consistently to ensure an efficient allocation of taxing rights without the risk of double taxation.

Tax in a global economy The way forward

Territorial and worldwide taxation 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. In contrast, worldwide taxation is a method whereby a country taxes profits of its resident companies wherever they are earned in the world. In a worldwide taxation system relief is normally given for taxes already paid overseas but the system is often very complex and burdensome to apply – because the parent company will have to analyse and re-compute everything on a basis which is consistent with the tax law in its home jurisdiction. Tax regimes around the world have increasingly moved towards a territorial basis of taxation, as simpler and a more appropriate basis of taxation; coupled with tax treaties to eliminate or reduce double taxation and CFC regimes to protect the tax base. This has been the case with the UK system. Having a territorial system has been instrumental in ensuring a more effective prevention of double taxation for businesses operating in the UK. Introducing a balanced package of reforms to the UK’s foreign profits regime has also significantly boosted our tax competitiveness. Any significant change to the foreign profits regime, and in particular the CFC rules and the foreign dividend and branch exemptions, could harm the stability and competitiveness of the tax system. The majority of countries have territorial systems. Debate on whether the US should reform its tax system to move towards a territorial basis of taxation has been increasing, fuelled in part by the issues around the taxation of multinational corporations, many of which are US-headquartered companies.

2.1.2 Maintaining and improving UK tax competitiveness should be a core objective when the UK seeks to shape international tax rules The government must ensure that any changes aimed at greater transparency are coordinated with other policies and do not undermine the progress on making the UK one of the most competitive tax regimes in the G20.

2.1.3 Any changes to long established principles must bring real benefits and not just increase administrative burdens Fundamental reforms to the tax system, such as addressing base erosion and profit shifting (BEPS) must bring real benefits. Any reform to the way cross-border activities of multinational corporations are taxed should be delivered through revising existing practices and not by introducing any radical new solutions.7 Several specific examples are set out below: • Arm’s length principle: It has been suggested that the existing transfer pricing framework (see box on page 20) and the arm’s length principle, which underlies the OECD and the UN’s transfer pricing rules, are not fit for purpose in their current form and that significant changes are necessary. It is true that globalisation and changes in business practice since the arm’s length principle was first formulated (eg digital transactions and intangibles) mean that we should continue to evaluate the effectiveness of the principle, and whether any changes need to be made. (And, indeed, the OECD is working to address this as part of their project on transfer pricing of intangibles). However, as a general matter, the arm’s length principle continues to work well and should not be jeopardised. • Formulary apportionment: Suggestions have also been made that as an alternative to transfer pricing based on arm’s length principles, multinational companies should be taxed on the basis of a system of formulary apportionment. Under this approach, global profits made by multinational corporations would have to be declared in each jurisdiction they operate in and then apportioned and taxed between jurisdictions based on given criteria, with the aim of preventing profit shifting and tax

Tax in a global economy The way forward

“To achieve a workable set of international tax rules, the system must be capable of accommodating changes in the way in which modern businesses operate” base erosion. However, taxing multinationals on the basis of formulary apportionment would raise equally difficult issues, including: • Complexity: The requirement for different formulas to reflect different sectors, such as financial services and sectors with valuable IP, would be highly complex. • Fairness: It is far from being ‘fair’. Wealthy countries generate higher sales, pay higher wages and have more expensive property values. Any mix of these factors will inevitably result in income being apportioned away from less-developed countries, even if greater economic activity takes place there. • Double taxation: Such a system would almost certainly lead to double taxation of corporate profits as countries construct different rules, eg US state apportionment system. • Distortion: A system based on a formulary apportionment could lead to arbitrary distinctions between related party and third party arm’s length transactions resulting in tax considerations distorting commercial decisions. • Turnover tax: A tax system based on turnover or sales is unlikely to provide a solution to address the issues of base erosion and profits shifting. Sales, especially of digital goods and services, would be difficult to trace and hence could result in increased tax avoidance. Furthermore, most countries already operate some form of a sales tax. For example, the UK has VAT, which is an EU-wide tax and a matter of EU law. An additional turnover tax is likely to be challenged under EU law. • Destination-based corporation tax: Some commentators have argued that companies should be legally bound to pay corporation tax in the countries where their customers are located. Similarly to the formulary apportionment proposal, destination-based corporation tax system would result in significant losers and winners. For example, large developed countries would have a clear advantage over smaller developing countries. In addition, such a system would be difficult to enforce and could entail risk of double taxation if source and destination countries tax business income differently.

2.1.4 Policies must be forward-looking and able to anticipate changes in business practices To achieve a workable set of international tax rules, the system must be capable of accommodating changes in the way in which modern businesses operate. One of the key issues with the current system is that it was established at a time when there was limited cross-border activity and intangible assets were less important. The UK government has an opportunity to play a leading role in tackling areas where technological advances – or other developments in the way business is conducted – present challenges to achieving an equitable allocation of taxing rights while not imposing multiple taxation. Finding new ways to deal with the international allocation of profits will not be easy as it is challenging to predict how business practices will evolve in the future. It is therefore important that international tax rules should be capable of accommodating changes in business practices and be supported by a regular UK review of key international tax policies. For example, the review could formally convene every five years and involve engagement with key stakeholders and be supported by a robust economic analysis. There should be an agreed process for considering and implementing issues that emerge from consultation and a balance should be sought between making changes and not undermining the stability of the tax system. The government should also ensure that HM Treasury and HMRC are granted sufficient economic resources to engage in this review.

2.2 Process

The government should develop its tax policies and engage in multinational action on international tax issues guided by six principles.

2.2.1 Any changes in tax rules must be based on international coordination Any major changes to rules on taxation of multinational businesses should be coordinated internationally. The UK cannot develop these rules in isolation. It needs to ensure it has a prominent role in shaping international tax policies with the OECD, EU, the United Nations (UN) and International Monetary Fund (IMF) to keep

Tax in a global economy The way forward

“HMRC and HM Treasury should seek to improve their communication on taxation with the general public”

priorities for the UK tax system on the agenda. The UK must develop its relationship with non-OECD countries, which are increasingly taking action to shape international tax policies. It is important that the global playing field remains level and that all countries are involved in any significant changes in international taxation. This means HMRC and HM Treasury must continue to deploy significant resources to these areas. With appropriate involvement from the UN and other non-OECD stakeholders, the OECD is a natural forum to lead on any substantial tax reforms given its capacity for extensive analysis, ability to work with a broad range of countries, and its track record as an international standard-setter on tax. These factors enable the OECD to reach multilateral solutions, and prevent potentially damaging, uncoordinated unilateral action by individual countries. The UK government should continue to actively participate in and support this multilateral process.

2.2.2 Allow sufficient time for meaningful consultation with relevant stakeholders Reform of international tax rules will not be quick or easy. It involves both drafting the appropriate rules and taking into account the impact of any changes on tax treaties, guiding international principles, and recommendations. Any consultation on changing international tax and other rules must allow time for meaningful dialogue with business and other affected stakeholders. A recent example is the speed at which the BEPS proposals are progressing. It is important that businesses continue to participate actively in this process, otherwise there is a risk that significant changes will be made without a full understanding of international business models and a careful consideration of the potential impact they would have on cross-border business activities. The international tax community should heed the lesson from the UK of allowing adequate time for consultation to create welltargeted tax policy. The UK should agree key parameters and resist any changes that have not been fully thought through. Any changes to the international rules on taxation of multinational corporations should not:

• Undermine the competitiveness of the UK tax system • Result in unnecessary additional administrative and compliance burden for businesses, or • Result in additional cost to the Exchequer.

2.2.3 HMRC and HM Treasury should recruit more international taxation specialists The lack of resources at HMRC has been obvious to business. For example, despite the revision of the CFC rules being a major international tax project, HMRC was able to commit very few specialists to the work. The government’s investment of £77m in HMRC avoidance and evasion work announced in the 2012 Autumn Statement, including hiring more transfer pricing specialists, is a welcome development. However, HMRC and HM Treasury should recruit more international tax specialists and buy in external expertise such as economic analysts in order to manage an international tax system effectively. These departments should continue to benefit from secondments of external advisers as they can gain from their technical and commercial expertise – as long as the appropriate safeguards are in place. HMRC and HM Treasury should further seek to improve their communication on taxation with the general public. For example, the HMRC briefing Taxing the profits of multinational businesses published in October 2012 was a useful publication. The government should take this further and consider taking a more strategic approach to its communication with the general public on tax matters. This could include regular and relevant briefings on tax issues (similar to the CBI’s The UK corporation tax system: 12 misunderstood concepts).

Tax in a global economy The way forward

2.2.4 Achieve international agreement on a few key components The difficulty of redefining the international tax system should not be underestimated. International agreement on a few key components of an international tax system would be a welcome achievement and demonstrate commitment to this agenda. Key components could include obtaining international consistency on: • A common definition of ‘economic substance’ • Common principles of CFC rules or an agreement on what type of activity CFC rules should cover • More focused and coordinated transfer pricing documentation requirements 8 • Common Limitation of Benefits (LoB) anti-conduit provisions • A common approach to hybrids • The separation of risks and assets from management, in particular in relation to intangibles, and the most appropriate tools to deal with this. In addition, with regards to tax administrations, agreeing an international set of common standards for risk profiling of corporate entities would be a welcome development. The risk-based approach applied by HMRC could be used as a model.9

2.2.5 Dispute resolution must be coordinated internationally As more countries with different sets of tax rules become involved in international trade, it is essential that the international tax system has an effective dispute resolution process. This needs to be robust and internationally coordinated with modern data handling and sharing capabilities. Although a better functioning international tax system should lead to a fall in the number of tax disputes, it is unlikely this would happen immediately. A systematic approach to resolution is critical to instil confidence in the regime, and avoid issues escalating and becoming an impediment to global development.

Governments should make greater use of Mutual Agreement Procedures (MAPs) and mandatory arbitration procedures. These would help reduce levels of double taxation quickly and effectively. Tax authorities should also aim to increase the number of multilateral audits and agree a standardised process for Advanced Pricing Agreements (APAs) which would lead to an increase in the number of multilateral APAs. Tax authorities also need to update their systems and practices to ensure they can cope with modern data handling and sharing. A good example would be setting up an operational unit to coordinate and manage international cooperation. This would ensure that technology was used to make the system more efficient and to check that the relevant legal gateways were in place to allow the mutual exchange of information. Another goal should be to streamline tax administrations so that multinational businesses would only have to deal with a single tax authority (a ‘one-stop shop’ approach).

2.2.6 Expand support for capacity building for developing countries’ tax authorities and tax policy functions The government should expand its support for capacity building in developing countries to enable their local tax authorities to strengthen their ability to administer tax laws, collect the appropriate amount of tax, operate under the rule of law and achieve more effective dispute resolution. This is in the interest of both governments and businesses and involvement by businesses should be encouraged. Putting these systems in place and providing assistance on current tax cases would inspire market confidence, attract investment, encourage tax transparency and result in better tax collection. Recent capacity building projects with, for example, the Tanzanian and Ethiopian governments to assist them with more effective tax administration and tax collection are welcome and similar projects should be considered with other developing countries.10

Tax in a global economy The way forward

2.3 International tax issues that must be addressed

Given the OECD discussions over international tax principles this report focuses on the short term priorities for the OECD and EU. Outlined below are issues the government should focus on initially. This list is by no means exclusive or static – other priorities are likely to arise as the international tax debate evolves. Any new issues should be capable of being accommodated within the process framework outlined above.

2.3.1 Issues to be addressed globally • International tax principles around profit allocation should be reviewed There is a need to review taxation rights over permanent establishments (PEs) and profit allocation issues created by modern business practices to address the way businesses operate. This analysis needs to be both rigorous and informed, particularly in light of some of the assertions made in the current debate on digital transactions. The analysis should also examine the impact any changes would have on UK taxation for inbound and outbound investment.

Permanent establishment A permanent establishment is a fixed place of business which generally gives rise to tax liability in a particular country. • Transfer pricing rules should be reviewed but not changed fundamentally In a globalised economy, business functions operate across borders. Production, assembly, sales, marketing and management functions may be located in territories spread across the globe. There are growing doubts over the effectiveness and practicality of current transfer pricing rules based on the arm’s length principle.

However, the arm’s length principle should not be abandoned. The current rules do create problems, such as access to market price comparables (especially in relation to IP) and concerns that developing countries find the regime overly complex. However a move towards formulary apportionment, as discussed above, would raise equally complex issues and a crude formula is unlikely to produce an equitable result.

Transfer Pricing Each corporate legal entity that is tax resident in the UK is required to pay UK corporation tax on the taxable profits that are attributable to the UK. The starting point therefore is to work out what profits relate to that business activity in the UK. In the case of a UK company that only does business in the UK this is a fairly simple calculation, based on accounting profits with tax adjustments that are required or permitted by law. But where a UK company is part of an international group of companies, and there are transactions that take place between the UK and other group companies, it can be more difficult to determine what profits relate to the business activity in the UK due to intra-group pricing arrangements. This is dealt with by transfer pricing rules. The fact that a company engages in transfer pricing should not be equated with tax avoidance. Companies that transfer goods or provide services to affiliates across borders are required by law to establish the price at which the goods or service are transferred – the transfer price. Companies have an obligation under statute and accounting rules to ensure that their intra-group – and especially crossborder – transactions are made and recorded on an arm’s length basis.

Tax in a global economy The way forward

“EU Member States should be particularly careful when applying the [enhanced] procedure in the area of tax”

• International withholding tax regime should be reviewed Withholding taxes can be an effective tax mechanism provided they apply to pure income profits such as interest, royalties or dividends. Withholding taxes on active business income can lead to significant overseas tax burdens and discourages cross-border business. For resource rich countries withholding taxes are a simple and effective method but they need to be used carefully to avoid distorting business decisions. This is important from a UK perspective as the benefit of the 20% headline corporation tax rate could be undermined. A withholding tax of just 5% can result in an effective rate of more than 20% of net income.11 The government should resist moves to make greater use of withholding taxes that are not linked to reasonable profit margin expectations (eg as a result of the BEPS review or otherwise).

2.3.2 Issues to be addressed at the EU level • The UK government should be actively involved in further development of core EU tax policies There are a number of EU tax policies with clear benefits to both the taxpayers and the tax authorities. These include: • Greater administrative cooperation between tax authorities • Continued streamlining and extension of the Parent-Subsidiary and Interest and Royalties directives • Greater use of the infringement procedure to promote the single market • Allowing for cross-border loss consolidation and the potential for eliminating cross-border transfer pricing issues. It is important that the government participates fully in further development of the above and other core EU tax policies.

• EU should be cautious when using enhanced cooperation on tax issues The EU enhanced cooperation procedure can be a useful mechanism to overcome paralysis, as it allows a group of at least nine Member States to move ahead with an initiative proposed by the European Commission if it proves impossible to reach unanimous agreement among the 28 Member States within a reasonable period. However, the enhanced cooperation on the Financial Transaction Tax has shown the difficulty of applying this procedure in the area of tax due to the extra-territorial impacts on non-participating member states. EU Member States should be particularly careful when applying the procedure in the area of tax. • EU State Aid rules should be reviewed EU State Aid regulations place restrictions on the amount of public money that can be granted to private companies to uphold competition across the EU. As a result they have a major impact on local economic development and regeneration activities. State Aid regulations, including their application to tax matters, need to be more proportionate, streamlined and clearer across the whole of the EU. Uncertainties regarding the scope and application of regulations can act as a deterrent to investment activity.

Tax in a global economy The way forward

3 Domestic taxation: stability is the top priority Following the recent changes to the domestic tax system that included the government’s Corporate Tax Roadmap, the short to medium term priority must be stability. This chapter looks at: • Principles the government should follow to further improve UK tax competitiveness • Process improvements the government should implement, and • Domestic tax issues for the government to address. These proposals are not special pleas from business to reduce its tax contribution. Instead they are the features of a competitive and stable tax system that does not distort investment decisions but instead promotes economic growth. 3.1 Principles

In June 2010, the government set out its intention to restore the tax system’s reputation for stability and avoid piecemeal changes to the tax code.12 “A stable tax system is vital to business. The government will avoid unnecessary changes to tax legislation. In bringing forward reform, the government will work with business to ensure that any changes improve the sustainability and long-term stability of the corporate tax system.” 13 Many of the developments in the tax regime over the last five years were much needed to increase tax competitiveness. Now those changes have been made, a period of calm is needed to allow the changes to take effect. When assessing the competitiveness of a country’s tax system important factors include the effective tax rate, stability and advance warning of major changes.

Businesses making location decisions need stability, as long term investments need a predictable tax system. Unheralded shocks can have a destabilising effect that spreads beyond their intended remit, such as the windfall tax on the North Sea profits in 2011, the bank levy, U-turns on VAT and, more recently, the first draft of the public procurement rules. Inevitably, some tax changes will always be necessary to address specific issues, and the government should reserve the right to tackle tax avoidance. However, changes should be predictable and involve business consultation. It is important that the government’s focus is on tax changes that remove existing distortions in the tax system and not a patchwork of new measures. Incentives or reliefs should be targeted appropriately to avoid unnecessary deadweight and more importantly other fiscal levers should be identified and considered to ensure that tax policy does not become a blunt tool. The key tax areas that the government should not change in the short term are: • Corporate tax: the Corporate Tax Roadmap must be given time to bed down. The UK corporate tax system has undergone considerable changes over the last few years. Cuts to headline corporation tax, the overhaul of the CFC rules and the introduction of the Patent Box regime have been welcome developments. However, these changes need time to take effect. Although the CBI has a long-term ambition of seeing a headline corporation tax rate of 18%, in the meantime the priority must be stability and certainty, pending a brighter fiscal environment. The changes made under the Corporate Tax Roadmap need to become stable features of the tax system to provide businesses with the assurance to make strategic long term investments. • Treatment of debt and equity: The deduction of interest should be retained where it is a genuine business expense. This is an important element of the UK’s competitiveness and business needs reassurance that it will remain an important part of the tax system. Any significant change would undermine the government’s pursuit of stability in the tax system, given that the

Tax in a global economy The way forward

“When it comes to tax policy, openness should become the default position of HM Treasury”

issue was discussed at length during the review on the taxation of foreign profits. There are already restrictions on the amount of deductions through the thin cap and worldwide debt cap rules and intergroup debt will feature in the OECD’s BEPS process. Any additional changes could result in instability. • Tax transparency: A unilateral approach must be resisted. The number of competing regimes 14 introduced recently has created uncertainty for businesses and increased the compliance burden at a time when resources should be spent investing in the business and not on compliance procedures. Reforms aimed at increasing tax transparency should be well-targeted and not harm commercial business activity, which is underlined by the CBI’s Statement of tax principles.15 The government needs to be committed to a multilateral approach and the agreement reached at the June 2013 G8 summit regarding high level profits reporting to tax authorities is a good example of this.

3.2 Process

We propose five reforms to further improve the tax policy development process.16

3.2.1 Tax policy making must be transparent and predictable In the current economic climate it is important that tax policy supports rather than inhibits economic growth. Sudden and unexpected changes harm both businesses and the Exchequer, and should be avoided unless there are exceptional reasons for immediate intervention. It is important that stakeholders have early warning of policy changes. There needs to be a transparent, methodical process for changing tax laws in a way that engages all stakeholders, minimises surprises and ensures legislation is stresstested before becoming law. In the majority of cases there is no need for budget secrecy. When it comes to tax policy, openness should become the default position of HM Treasury.

3.2.2 Improve consultation process The government should talk to key stakeholders before it publishes consultation documents to establish whether there is a real need for policy change or consultation. The consultation on tax and public procurement published in February 2013 was an example of how policy should not be made. It had a very short consultation period and the implementation schedule did not follow the recommended practice. If stakeholders had not reacted to the consultation immediately, it could have led to largely unworkable measures. While we acknowledge that huge strides have been made by the government with a more transparent process, the volume of consultations has in turn created a burden for business. The government should therefore seek to further improve its consultation exercises. Options could include deploying web-based consultation tools with the appropriate controls and differentiation for key stakeholders, as the European Commission does, or carry out a greater number of informal consultations.

3.2.3 More effective interaction between tax policy makers Interaction between HM Treasury, HMRC and the Parliamentary Counsel continues to cause difficulties. This has led to problems in moving from a policy conception to well-drafted legislation during the drafting stage. This happened with the new CFC regime where the proposed new rules resulted in extremely complex draft legislation despite an effective and productive consultation. It is also a recurring annual problem with the time-restricted Finance Bill process. The quality of legislative drafting needs to be improved to ensure that onerous legislation does not undermine policy development.

3.2.4 Strengthen the independent review of tax law It is important to have an independent process for reviewing the effectiveness of tax laws. The formation of the Office for Tax Simplification (‘OTS’) has been a welcome step. However, more needs to be done. If the OTS is to be effective it needs to be properly funded. Furthermore, the OTS should be given the power to comment on whether proposed legislation meets its policy objectives.

Tax in a global economy The way forward

“The UK has one of the least generous capital allowances regimes.”

3.2.5 Improve economic analysis capacity and capabilities The Corporate Tax Roadmap recognised the benefits of having stable business taxation and the most competitive corporate tax regime in the G20. However, more needs to be done to strengthen HM Treasury and HMRC’s tax economics expertise and increase the use of dynamic effects of tax rates on tax revenues. Full dynamic tax analysis – which forecasts the effects of businesses’ reactions to incentives created by policy – will strengthen the evidence base in supporting a move towards a more economically efficient tax system. When comprehensive dynamic analysis has taken place, for example with HMRC’s 2012 analysis of the top rate of personal income tax, the analysis highlighted the mistaken assumption that higher tax rates automatically raise significantly more revenue. Full dynamic analysis needs to be introduced for all major taxes to make an accurate trade-off between the need to raise tax revenue and the potential cost in economic activity foregone as a result of higher tax rates.

3.3 Domestic tax issues

While the primary objective of the government in the short to medium term should be the stability of the tax system, there are several domestic tax issues that should be addressed to improve the UK’s tax competitiveness without destabilising the system.

3.3.1 Level the playing field for expenditure on infrastructure and other capital assets The tax system can have a significant impact on the viability of business investment projects, and the lack of tax relief for certain infrastructure assets discourages investment, distorts the tax treatment of investment and decreases the competitiveness of the UK as a destination for mobile investment. A new capital allowance for infrastructure assets would help restore the attractiveness of the UK as a place to invest. This would follow the IMF’s recommendations 17 to increase spending on infrastructure, in part by reducing “marginal effective corporate tax rates to bring investment forward”. The lack of capital allowances for certain assets has caused the UK to have the least generous present value of capital allowances in the G20 (see Exhibit 10). This means returns on investments in non-qualifying assets suffer a much higher effective tax rate, and therefore require a higher level of profit to produce a given post-tax return than investments in qualifying assets. The continuing absence of tax relief is also leading to material distortion of effective tax rates between sectors. This is illustrated by effective tax rates of 35% or more for major infrastructure projects such as waste treatment, airport infrastructure, bridges, roads or hospitals. This makes it around 20% more expensive to invest in a non-qualifying structure or building, compared to plant receiving standard capital allowances.

Tax in a global economy The way forward

100

Chile

New Zealand

United Kingdom

Japan

Netherlands

Poland

Norway

Hungary

Germany

United States

Austria

Ireland

Canada

Australia

Mexico

Slovenia

Italy

Turkey

Finland

Denmark

Iceland

Sweden

Israel

Luxembourg

France

Portugal

Spain

Czech Republic

South Korea

Belgium

Switzerland

Slovak Republic

80 Greece

Present value of capital allowances per £ or capital investment

Exhibit 10 The UK has one of the least generous capital allowances regimes

0 Source: Corporate Tax Ranking 2012, Said Business School (2012)

Over the five years from 2012-13 to 2016-17, an estimated £55bn (28%) will be spent on currently non-qualifying infrastructure assets. However the proportion of non-qualifying assets differs by sector as highlighted in Exhibit 11.

Exhibit 11 Estimated proportion of currently non-qualifying expenditure on infrastructure for a 5 year period 2012/13 – 2016/17 Water and floor management Waste

Total investment (£bn)

Non-qualifying expenditure (%)

Non-qualifying expenditure (£bn)

28.6

25%

0.7

8.1

30%

Transport

70.4

40%

Energy

58.2

30%

Communication

34.7

TOTAL

200

28%

Source: KPMG estimate based on total infrastructure spend for five years based on £195bn for 2010/11-2014/15 identified in HM Treasury’s Infrastructure UK (March 2010) paper Strategy for National Infrastructure (Chart 18, page 15) upifted pro rata to £200bn to agree with HM Treasury’s Infrastructure UK (October 2010) paper National Infrastructure Plan 2010

Tax in a global economy The way forward

Under the current regime, it is more profitable for firms to undertake marginal investments in other EU countries such as Italy, France or Germany. Infrastructure investments tend to be undertaken by large multinationals that have options in a variety of countries, so a capital allowance for infrastructure that improves UK competitiveness may generate significant economic returns by encouraging investment here, relative to the amount of tax revenue foregone. This will help to address the UK’s relative infrastructure weakness in the long term. Although tax is not the only factor that companies consider when embarking on infrastructure investment, if this type of incentive improves the competitiveness at the margins, then the UK will reap the benefits. The allowance must be targeted appropriately to secure the desired investment and to not contravene EU State Aid rules. Once again, this allowance should be part of a stable regime that gives businesses the confidence and security to enter into long term capital investment plans.18 In a recent report 19 KPMG found that such reliefs could unlock tens of thousands of jobs and provide a stimulus for double-digit increases in capital expenditure. It said that those organisations that suggested tax reliefs for infrastructure or capital investment reported they would increase headcounts by an average of 6% as a result (7% among FTSE 100 companies), increase capital expenditure by 12% and R&D expenditure by 17%.

3.3.2 Widen focus to other business taxes As well as corporation tax payments, businesses contribute to the Exchequer in the form of employer NICs, business rates, fuel duty, stamp duty, customs duties and a variety of environmental taxes. Businesses also collect a large amount of tax on behalf of the government, such as personal income tax through PAYE and VAT. Virtually all taxes, including personal income tax, employees’ NICs and VAT depend on the successful operation of business.

Exhibit 12 UK business tax contribution in 2012/13

Corporation tax £39.4bn, 24% Total taxes £546bn

Other taxes £26.6bn, 16%

Business rates £25.7bn, 16%

of which business taxes £165.2bn, 30% Employer NICs £60.2bn, 37%

Fuel duty £13.3bn, 8%

The government must therefore take a broad view of the overall business tax system to further improve the UK’s tax competitiveness.

Composition of the UK tax system in the international context • T he UK tax burden is above the developed country average both in terms of the amount of corporation tax collected and the overall tax burden. •C ontinental European countries collect a higher share of GDP in tax which is mainly due to higher payroll taxes. In addition, Italy and France both raise a substantial amount of tax revenues from wealth taxes. • I n an international context, the UK’s tax system is relatively efficient. Although the UK’s total tax burden is significantly higher than the US, Japan or Switzerland, corporate and labour income taxes are in line with those countries that have a low tax share of GDP.

Tax in a global economy The way forward

34%

only a third of business rates was paid for by companies outside the utilities, banking or retail sectors

Exhibit 13 Corporation tax and overall tax burden in 2011 in G7 and other select competitor countries Tax revenues as a proportion of GDP 50

UK a middle tax country, both for business tax and overall tax burden

40 4.1 30 3.0 4.6

14.9

2.7 5.2

2.1 6.4

16.5

16.0

3.5 7.6

0.9 10.8

23.5

1.7 Germany

1.7 Netherlands

3.7

2.2 11.3

11.0

24.9

24.3

2.7

2.5 France

11.6

13.0 16.8

15.9 11.9

10 0

3.1

0.9 10.8

20 2.6

3.2

2.9

3.1

2.9

2.8

United States

Japan (2010)

Switzerland

Canada

Ireland

United Kingdom

Corporate income tax

Income & payroll tax

Consumption tax

Property tax

Italy

Other

Source: OECD (2012)

3.3.3 Limit increases in business rates Business rates are one of the largest business taxes that are unrelated to profit. For this reason, they have a distortionary effect on the UK economy, particularly between sectors and areas of the country. In particular, the digitisation of large parts of the UK economy means the tax burden is not reflecting the way that the economy has developed. The Hundred Group stated in 2012 that 16.9% (£3.9bn) of the total tax contribution of businesses was business rates, but only a third (34%) of business rates was paid for by companies outside the utilities, banking or retail sectors.20 In the long run, the Department of Communities and Local government and HMRC must work together to reduce the aggregate impact on current users of commercial property in order to minimise the distortionary effect. The reform should also align incentives on property use, which push businesses in opposite directions and so are economically inefficient. For instance, there are incentives to retro-fit energy efficient measures for commercial property through the Green Deal, but at the same time, increasing energy efficiency

increases rateable value, which drives up business rates liability. Aligning these incentives could be undertaken within or outside the current business rates framework. Given the complexity of the current business rates system, full-scale reform should be a medium to long term aspiration. In the meantime, interim measures should be taken to prevent the tax creating a potentially persistent bias against sectors that still use physical property. In the past, we have called for business rates increases to be capped at 2% (rather than uprating by RPI) until full reform is possible. This will cost £365m in 2014/15, rising to £1bn in 2016/17,21 and should be pursued at the very least.

3.3.4 Reduce employer NICs The burden of employer NICs should not be underestimated, employer NICs is actually the largest business tax raising £59.2bn in financial year 2012. This is a tax on labour and one of the most distortive forms of taxation so a move towards reducing the contribution employers make in the long term would boost employment.

Tax in a global economy The way forward

“Increasing the employer’s NICs threshold will reduce the marginal cost of employing staff.”

Youth unemployment leads to labour market scarring and a permanent loss of skills, earnings and employability. Increasing the employer’s NICs threshold will reduce the marginal cost of employing staff. Particularly at the current time, such a policy could boost youth employment and also create additional part-time employment preventing workers losing touch with the labour market. Raising the NICs threshold will encourage firms to take on young people who would otherwise remain a cost to society, or increase hours for part-time workers, which could lead to long term economic gains that would partially or fully offset the initial loss in tax revenue. A £1,000 increase in the threshold before which employers pay NICs would cost the Exchequer £3bn. In more general terms a reduction in labour taxes which is offset by greater contribution from consumption and property taxes can improve competitiveness and growth (see Exhibit 5 and related discussion). In Budget 2013, the government announced it would introduce a £2,000 employer NICs allowance from 2014/15; this will be particularly effective in reducing the marginal cost of taking on workers for the smallest firms. Raising the employer NIC thresholds would complement this policy by reducing the marginal cost of expanding employment and hours for all firms. When the public finances permit, employer NIC threshold could be raised in step changes to lift workers on the main minimum wage out of employer NIC contributions. This will help increase the global cost competitiveness of UK low productivity workers – supporting employment and economic growth.

3.3.5 Enable small and medium sized businesses to flourish alongside large businesses The government should prioritise measures to support small and medium sized businesses, which have the potential to inject between £20bn and £50bn into the economy by 2020.22 The backbone of the strategy should be to simplify the existing complicated system rather than introducing new reliefs. Not only is it very hard to target these businesses effectively, but creating more reliefs may harm smaller businesses which find it harder to deal with compliance.23 The convergence of corporation tax rates for small and large companies was a good example of reducing the complexities smaller enterprises faced with the small companies’ rate.

Simplification Paperwork is a huge and costly burden for small enterprises and there is still much to be done to simplify administration for these businesses. Where possible small enterprises should be given an opportunity to opt out of the complex rules by providing them with an alternative simplified regime. This type of administrative relief will have greater benefit than offering countless other incentives. As PwC said in a recent report, cutting red tape and the complexity of the tax system can boost overall economic growth, which means minimising the time firms need to spend complying with the rules is in governments’ interests too.24 The option to allow corporation tax to be calculated by reference to accounting profits, avoiding the need to understand complex tax deductions or reliefs is one option to simplify the regime for small enterprises. Of course some businesses would suffer from the loss of reliefs such as R&D tax credit and so for this reason this proposal would be offered as an option that is binding for five years to combat avoidance.25 This recommendation should be cost neutral. As Judith Freedman has pointed out 26 losses are more of a burden on the smallest companies as relief is deferred until profits are made, removing any incentive for further investment. By providing a rebate (a credit system similar to the R&D tax credit) or allowing a company to adjust the loss to its value at the date at which it is utilised could be considered to relieve the loss burden.27 In most cases, this would cause tax reliefs to be brought forward (by accepting a rebate) rather than necessarily enhancing their value and would therefore entail a minimal cost to the Exchequer.28 The HMRC Customer Relationship Manager (‘CRM’) programme should be extended, which as a dedicated resource would do a lot to change small and medium sized businesses’ perception of HMRC and foster the working relationship that has been successful with large businesses. A closer relationship between taxpayers and tax authorities means issues can be raised and resolved quickly reducing the need for enquiries into low risk matters. The success of the tax system in the UK depends on the ability of HMRC to serve all levels of the tax community.

Tax in a global economy The way forward

Reduction of the obstacles in raising finance Schemes to encourage investment in small and medium sized businesses need to continue. These companies have limited access to traditional finance markets, while larger companies have the opportunity to benefit from diverse sources of finance. Targeted incentives can address this imbalance. Steps taken in Budget 2013 to ensure equity finance is attractive to high-growth firms, by removing stamp duty on AIM-listed shares and allowing AIM-listed shares to form part of ISA investments, are welcome. The introduction of Seed Enterprise Investment Scheme (SEIS) and extension of Enterprise Investment Scheme (EIS) over the last few years has highlighted the government’s commitment to encouraging investment in these businesses.

The potential for significant alternative forms of finance to boost economic growth should not be underestimated. The government, businesses and academics should undertake a review into whether the tax treatment of raising finance reflects modern business practice. This could prevent some of the delays that have been reported when HMRC have been asked to provide clearance on the tax treatment of alternative sources of finance such as peer-to-peer finance, crowd-funding, retail bond markets and self-insured retail bonds. Often legislation has not kept up to date with the alternative processes for raising finance. There is clearly a need for more clarity in this area to avoid what appears to be a potential blockage in developing these forms of finance, which are vital to economic growth in early stage businesses and the creative sector.

Schemes for small and medium sized businesses EIS and SEIS are tax reliefs designed to encourage investment in small enterprises to help them raise finance through the provision of tax relief for the investors. Both regimes offer a reduction in income tax and exemption or deferral of capital gains tax.

“Small and medium sized businesses have the potential to inject between £20bn and £50bn into the economy”

Tax in a global economy The way forward

References

1 UK Business Tax: A compelling case for change. CBI. 2008 2 This estimate is sensitive to the amount of UK output that is judged to have been permanently lost as a result of the financial crisis. The OBR’s estimate of permanent output loss and the associated current output gap is broadly in line with the average of independent forecasts 3 Under which companies are only taxable on profits generated in the UK and not on profits earned overseas (except where they have been artificially diverted from the UK) 4 In terms of being the most commonly cited when respondents were asked to name their top three most attractive countries from a tax perspective. The UK was ranked as the most competitive against the other countries mentioned in the survey, ie the Netherlands, Ireland Luxembourg, Switzerland and the US 5 This survey involved interviewing 57 senior tax decision makers from a significant percentage of the largest publicly listed companies and foreign subsidiaries in the UK 6 Favourable tax draws companies to Britain by Vanessa Houlder. The Financial Times. 7 October 2012 7 For example, one of the debated options – using the customer base of a business to determine the profit allocation – would not be fair on those economies with significant levels of outbound investment 8 Attempts at an international standardisation of transfer pricing documents have not been successful as some tax authorities have not been willing to compromise on their reporting requirements resulting in a drift towards onerous standards. As real-time working strengthens at HMRC, discussions with taxpayers are more timely which results in more effective transfer pricing documentation. An international effort to mirror this approach would help taxpayers reduce the compliance burden 9 HMRC has been applying a risk-based approach to monitor and enforce businesses’ compliance with their tax obligations. Once a business is able to prove that it has its affairs in order and appropriate systems are in place it can become ‘low-risk’. This approach has freed HMRC’s resources to concentrate on pursuing non-compliant businesses 10 HMRC and the Department for International Development should build further on their success in this area. See joint submission by ActionAid, the CBI and Christian Aid (http://www.publications.parliament.uk/pa/ cm201213/cmselect/cmintdev/130/130vw04.htm) for more information 11 For example, if the profit margin as a percentage of revenue is 20%, then a 5% withholding tax based on revenues results in a 25% effective rate based on profits 12 Tax Policy Making: a new approach. HM Treasury. June 2010

13 Corporate Tax Reform: delivering a more competitive system. HM Treasury. November 2010 14 These include Dodd-Frank; Accounting Directive; CRD IV as well as the voluntary Extractive Industries Transparency Initiative 15 http://www.cbi.org.uk/media/2051390/statement_of_principles.pdf. Statement of tax principles. CBI. 2013 16 Also see 2.2 of this report 17 http://www.imf.org/external/pubs/ft/survey/so/2013/CAR052213A.htm. IMF Annual Survey British Economy. May 2013 18 Assuming this allowance would apply only to future spending (to minimise the cost to the Exchequer and ensure that the proposal incentivises new private infrastructure spending) at the outset, this would cost an average of up to £200m per year if assets are depreciated over 25 years (4% depreciation rate); or an average of up to £130m per year if assets are depreciated over 40 years (2.5% rate) 19 Annual Survey of Tax Competitiveness. KPMG. 2012 20 Total Tax Contribution. The Hundred Group. January 2013 21 The final year before a business rates regime based on revaluation of commercial property comes into force 22 Future Champions – unlocking growth in the UK’s medium-sized businesses. CBI. October 2011 23 Small Business Taxation: Policy Issues and the UK. Judith Freedman. 2003 24 Paying Taxes. PwC. 2013 25 This simplification would need to be drafted to ensure the option to choose between two regimes does not in itself create a tax burden by preparing two computations 26 Small Business Taxation: Policy Issues and the UK. Judith Freedman, 2003 27 An interest mark-up to compensate for the delay before they can be utilised identified by Mirrlees Review (Small Business Taxation, 2011) 28 This could apply to SMEs which have been trading for less than five years with a maximum surrender of tax losses of, for example, £200,000

Tax in a global economy The way forward

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