Whatever happens on September 18 I am quite sure that Scotland is going to flex its tax muscles sometime in the near future. In our out of the union the Scottish parliament is going to want to use its power to use tax to intervene in its own economy for the sake of the people it governs. That is one of the basic functions of tax and it is one of the basic functions of democracy, with the two being pretty intimately linked in our combined national histories.
There are problems with this idea though. If Scotland sets its own tax rates there is a first problem. How is it decided which part of the profit that is earned across the UK as a whole is to be taxed in which country? And if Scotland then sets its own tax rules that are distinctly different from the Rest of the UK (rUK), as seems likely given that it has already established its own GAAR, how is the interface between the two tax systems to be managed?
I happen to agree with Martin Wolf this morning that Scotland really does need to take a risk on monetary union if it wins independence. I also happen to think that it would, whatever it does with the currency, be wise to take less risk when it comes to tax.
I am not saying it should not set its own tax rate. That's not my job, although I happen to think it should not start a race to the bottom. What I instead think is that it does need to be wary of putting companies off trading in both the rUK and Scotland and that it has to make it as easy as possible for that to happen, especially when it is so commonplace at present.
By this I mean that I believe that when there are companies in the future who trade in both Scotland and rUK, whether Scotland is independent or not, then the simplest possible system of allocating profits between the two places must be adopted to minimise the tax cost of trading in both territories (you can't use the word countries anymore: it's not yet clear if it applies to rUK). If that is not done there will be the nightmare of, for example, transfer pricing rules applying across this border and issues relating to the allocation of finance, intellectual property, and so many other areas long exploited for tax abuse purposes that will have to be tightly regulated at some costs unless alternative thinking is applied.
That alternative thinking is available. I believe that there will be an urgent need for Scotland and rUK to enter into a corporation tax agreement that will embrace unitary principles. I can see no other way to make the arrangements for separate taxation of profits viable.
Unitary tax apportions profits between places. In the case of the UK we do, of course, already have arrangements in place to determine profits for the existing country as a whole. For individual companies these are clear: they are taxed on a worldwide basis excepting the fact that tax is not due on overseas dividends received. Controlled foreign company rules do not change this: they define which companies are within the scope of the tax charge. The point of mentioning these facts is that these rules do not undermine the logic of sharing a current UK tax base between Scotland and rUK.
How does the sharing take place? It would simply be the case that if a company had a taxable presence in both countries then profits before allowances for things like R & D and capital spending (which may differ between the territories) would be apportioned between the two on the basis of a formula. The formula would, I suggest, be based in the first instance on where customers are, or if they are not in either territory (because they are export sales) from where they are serviced and secondly on the number of employees in each territory. This second part of the formula relating to employees could be weighted by either the number of employees, or their gross pay, or both elements given equal weighting. I do not suggest including assets in any formula: they're just too nebulous to value under current accounting rules and too hard to identify in too many cases.
So, if a company makes, say, £1 billion in the UK as a whole and has 80% of its sales in rUK and 20% in Scotland then half its profits would be allocated on this basis: £400 million would go to rUK and £100 million to Scotland. If staff were in a different ratio, say 60% rUK and 40% Scotland then the split of the remaining half of profit would be £300 million rUK and £200 million to Scotland. Overall rUK would have £700 million of profit and Scotland have £300 million.
There is no more cost effective and regulation light method of achieving a break in the tax union than this. The alternative is massive accounting reform, the parting of the ways for accounting purposes for many groups and very real barriers to trade as a result, which worries me for both parts of the arrangement and whether or not there is to be independence or not.
Of course these formulas are not perfect. I accept that, but then accounting is at least as imperfect in the first instance, and maybe more so. But crucially the arrangement does respect fiscal sovereignty. Note that it is profit that is apportioned. That could be accounting profit. It may, more likely, be profit after disallowances and before tax relief, but this is all subject to negotiation, and if one party wished to allow something the other does not the relevant proportion could be adjusted after the apportionment had taken place. The granting of capital allowances would, I suggest, always be a post apportionment issue, which is why I suggest assets are kept out of the formula or the risk of trade off and double counting becomes significant. The importance point to make is that profit apportionment does not require a consistent tax base: that is simply not true.
Why do this? Several reasons. First, it's simple and would provide certainty when there will be enough other issues to deal with.
Second, it is cost effective for business and tax authorities when the alternatives look very costly.
Third, the data will exist. It will have to for OECD international taxation rules in the future.
Fourth, and I stress it, this creates sovereignty in ways that totally separate taxation that might be more easily gamed cannot.
I suspect that this is not high on anyone's agenda right now. But it needs to be, and soon.
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I expect Salmond & Co would not be happy with this, as the tax receipts they’re looking forward to from oil would shrink dramatically (i.e. as the oil companies have significant staff and sales in the rest of the UK).
That’s not to say other alternatives are any better. This may be best possible solution to what is frankly a stupid problem, given the interconnectedness of the two economies.
This is corporation tax
Oil taxation is different
Most of the tax paid by oil and gas companies is corporation tax. Petroleum Revenue Tax is only about 25% of their overall corporate tax burden. 50% is normal corporation tax. The other 25% is the supplementary corporation tax charge applicable to ring fenced oil/gas profits. (Figures are approximate and off the top of my head, but in the right ballpark.)
Ring fenced, note
So not normal CT
Well it’s pretty complicated, and not my field, but broadly speaking ring fenced corporation tax is part of normal corporation tax, and calculated in the same way – but treated as a separate trade with special rules on deductibility.
But the point remains that, even aside from the ring-fenced trade, 50% of the oil/gas industry’s tax is just normal corporation tax. Your proposal would therefore greatly reduce Scotland’s expected tax take from the oil industry. Saying “oil taxation is different” is not accurate.
A similar problem arises with the Scottish financial services industry, 90% of whose customers would be in the rUK. Therefore, again, your proposal would dramatically reduce expected tax take.
Of course you would see the opposite effect on UK businesses, albeit with a small effect across a large number of players rather than a large effect on two sectors. Someone would need to do a great deal of work to assess the overall net effect – neither of us can have any idea who would gain and who would lose. However the headline impact on the oil/gas and financial sectors are clear, and unlikely to be appreciated by the SNP, given the importance of oil/gas taxation to their economic policy.
You entirely miss the point
These Scottish businesses will be selling in the rUK anyway so those profits would under normal rules be taxed in rUK
But oils rules do, I think, already allow allocation
You refer to the “rUK”. As with Macedonia, “FYROM”, I prefer “Former UK”, whose acronym seems highly appropriate in the circumstances.
All very pretty, but it will be the banksters plus the Russkies and the usual suspects who will be calling the shots. Putin’s people are already heavily involved in the North Atlantic via their recent grip on Norway’s drilling. Others will not stay on the sidelines waiting for the witless politicians to come to some sort of decision.
Also – the EU law considerations would need to be thought through quite carefully.
There will be cases where a Scotland/rUK unitary tax system produces a discriminatory result (i.e. a company would be better off having a Scottish subsidiary than a French subsidiary, or vice versa) and that would likely amount to an infringement on the freedom of establishment.
There is a general point here that any arrangements between Scotland and rUK which give the other a favoured treatment (in any respect) are likely to be challenged.
True if devo-max
Not true if independent
And maybe not if the logic was as I explain which is then not a subsidy but a proper allocation based on economic factors
that’s a different point. Devo-max raises questions of unlawful regional subsidy. Independence creates potential discrimination/fundamental freedom issues if the rUK and Scotland favour or disfavour each others’ nationals. A “proper allocation based on economic factors” would inevitably favour some, and disfavour others – there’s no getting away from it.
Similar issues have arisen re. the compatibility of BEPS with EU law.
What I propose would undoubtedly be BERPS compliant
And OECD tax treaty compliant too
but not EU law compliant – which is the point. You cannot have a rule which means a UK company is treated differently if it has a Scottish subsidiary vs a French subsidiary.
Yes you can
A limited CCCTB is allowed in EU and this is what this is
I agree on a unitary tax system, but I definitely think the Scots should have their own currency. There can be no real independence for the Scots if they keep the British pound; otherwise they risk similar situations to Italy, France, Greece, etc. I can’t understand why Scottish leaders/nationalists are so opposed to this idea. They either have no understanding how a fiat currency operates or the whole independence thing is a ruse.
It is bizarre that a new currency is not their aim
William Keenan was good on this yesterday in the Observer