I gave a talk to an HMRC conference yesterday, talking about tax and corporate transparency. This, broadly speaking is what I said:
We have of late heard a great deal about a place where tax free income has been abused behind a veil of secrecy. There was, of course, a regulator, and a complex rule book that for all external purposes appeared to be rigorous and fair. But because the regulator was far too familiar with those he regulated, and secrecy allowed all involved to believe they would never be held to account for what they did the system broke down, corruption, at least of ethics if not of the criminal sort, occurred, rules were proactively avoided and reputations have been destroyed as the whole sorry debacle has come into the public eye. Sounds just like a tax haven doesn’t it? I can think of several I could have written that of. But it was, of course, the Palace of Westminster to which I was referring.
The MP’s expenses scandal is a salutary lesson for us all. Everyone in this room has power, more power than that of the average person in the UK. Some of you regulate. Some are regulated. Some, like me, try to form opinion. But we are all as a consequence accountable. Profoundly accountable. And we should not forget it.
I think that in that context the reaction to the MP’s expenses scandal this is revealing. It certainly does not show as a Tory MP suggested that we’re a nation made up of jealous people. It does show we’re a nation made up of people who think that taxpayer’s funds should be properly managed, and that we want to see that is done. This is a profoundly important lesson of which, I suggest, we should all take note.
I’ll add another thing. It is only a small step from being angry about an identifiable person claiming legal but inappropriate expenses at cost to the taxpayer to being angry that an identifiable company claims legal but inappropriate tax relief at cost to the same taxpayer. Both after all place a burden on others to settle the bill. And, as is very apparent, that is something most people greatly resent.
Anyone here who thinks that the current anger could not carry over to the corporate sector is, I suggest, seriously mistaken. Big companies in particular are as remote as MPs to most people but those who run them and who can be identified as responsible for any legal but inappropriate claims they make are just as exposed as MPs to taxpayer anger. Fred Goodwin set a precedent, let me assure you. Corporate behaviour is no longer anonymous, and rightly so.
Why then hasn’t that wave of anger broken out as yet? I put it to you that there’s one reason, and one reason only. And that is the veil of secrecy behind which companies can still hide. In the work that I do, and in the academic and other papers that flow from it we say that companies are working in secrecy spaces.
Most people readily recognise one secrecy space. It’s the one I am perhaps most identified with trying to expose: that of the tax haven, or secrecy jurisdiction as I prefer to call them. Secrecy jurisdictions are places that intentionally create regulation for the primary benefit and use of those not resident in their geographical domain. That regulation is designed to undermine the legislation or regulation of another jurisdiction. To facilitate its use secrecy jurisdictions also create a deliberate, legally backed veil of secrecy that ensures that those from outside the jurisdiction making use of its regulation cannot be identified to be doing so.
I’ll be candid: Barclays, Tescos and many, many others have used secrecy jurisdictions to reduce their tax bills. We all know that. They say it’s legal. I’m not going to dispute it. But chucking carbon into the atmosphere is also legal: no one disputes that either. But it’s most certainly seen as an issue relating to corporate responsibility. And child labour is legal in very many countries in the world. But ask any garment manufacturer about the corporate risk of being seen to use it and it’s clear that legality is not the definition of acceptability when it comes to corporate responsibility.
In fact I'll go so far as to suggest that neither Barclays or Tescos would have taken their legal actions against the Guardian if they did not appreciate this difference between legality and corporate responsibility. Remember, the Guardian never alleged wrongdoing by either. They only said that they were successful tax avoiders. That would appear to be enough to provoke legal action. Large corporations are desperate to maintain their rights to use the secrecy space that secrecy jurisdictions provide.
But remember when considering this issue that there is more than one secrecy space. Much less widely known, but at least as pernicious is the secrecy space provided by the rules of the accounting profession. If I were to show you now the audited published accounts of any UK quoted company I can tell you this: they are a work of fiction. Indeed, my friend Prof Prem Sikka and I have often wondered just which of them we should enter for the Booker prize.
That is a big claim: let me explain it. The published accounts of all quoted companies are consolidated accounts. Those consolidated accounts add together the individual accounts of the tens, hundreds and even thousands of separate subsidiary companies and branches that go to make up the entity as a whole. But it is not just addition because when consolidated accounts are prepared something very important is taken away. Every single bit of intra-group trading is hidden from view in a set of consolidated accounts.
It is an extraordinary fact that 60% of world trade is undertaken on an intragroup basis. At least, that's what the OECD say. But not one pounds, euro, dollar, yen or whatever of that trade is reflected in the accounts of the world's largest corporations.
And many of us here know that the biggest single problem in corporate taxation is transfer pricing. And of course you can’t have a transfer pricing problem unless you have intra-group trade. But how can we hold the world's biggest corporations to account for their taxation when the biggest single tax avoidance option that they have available to them is entirely hidden from view in the secrecy space called their consolidated financial accounts?
Let me put this in the context of corporate responsibility. Just what does corporate responsibility mean? I suggest it is acting reasonably within the communities which host the operations of the corporate entity. With regard to tax I have no doubt at all about what this requires. It means that the corporation must seek to be tax compliant in each and every jurisdiction in which it works. Tax compliance is seeking to pay the right amount of tax (but no more) in the right place at the right time. Most accountants I know would agree with that. The trouble arrives when I add that in this context right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes.
Let me spell out one consequence very plainly. If you are tax compliant in the way that I define it you cannot use offshore. By definition, but this is not my definition, it is the usually understood technical definition, offshore means that the place where a transaction is recorded is not the same place as that in which its economic impact arises.
That is, of course, why the tax havens could claim that the current economic crisis did not have its origins offshore. They are right: nothing happens offshore. There are just a bunch of bankers, lawyers and accountants sitting there who record transactions that really take place elsewhere, even though it seems to me that in most cases they choose not to ask where that elsewhere might be. You will immediately see that this activity is utterly incompatible with my definition of tax compliance.
And yet reasonable estimates suggest that at least half of the world's intra group trade is recorded in a tax haven. Of course, it does not go there. We all know that. It's just recorded there, in a form none of us can easily access. And it disappears entirely from view when the parent company accounts are published.
So what, you might ask? Well let me put this simply and directly. Transfer pricing abuse costs lives. Christian Aid estimate that transfer pricing abuse costs developing countries at least $160 billion a year. Global Financial Integrity in Washington DC estimate that annual illicit financial flows out of developing countries are not less than $850 billion a year. Of those at least 65% are mispriced intra-group trade. The data is, of course, consistent. It is the best there is in the world at present. And of course there is a margin of error: we know that. But the tax loss alone is enough to pay for the entire Millennium Development Goals three times over. Christian Aid put it another way: translated into a loss of medical facilities this means that 1000 children die in developing countries every day as a consequence of revenues lost because of transfer mispricing.
You cannot find a stronger measure of corporate irresponsibility than that. No one anywhere has successfully challenged these findings. They have recently been endorsed by the International Development Committee of the House of Commons.
So what have major corporations and the accounting profession done in the face of this evidence? My answer is simple: they've done nothing. All the Big 4 firms of accountants continue to operate in all the major tax havens of the world. Those firms and the major corporations continue to dominate the world of financial reporting. And in a report issued last Thursday by the U.K.'s Financial Reporting Council, which can be fairly said to represent their opinions, they suggested a number of supposed improvements to corporate reporting.
First they suggested that we in the UK should follow in the footsteps of the International Accounting Standards Board and assume that the only significant users corporate accounts are investors. The significance is obvious: they completely deny the relevance of accounting information to those concerned with corporate responsibility.
And as if to reinforce that view they proposed, quite extraordinarily the idea that the audit of all subsidiary companies should be dispensed with.
Think about that for one minute: one of their suggested mechanisms for making corporate accounts more relevant is to remove the audit from all subsidiary companies. I won't ask for a show of hands. But I wonder how many Revenue staff here think that this will improve the quality of information supplied to HM Revenue & Customs? I cannot see any way on earth that it could.
But it will improve the quality of the secrecy space within corporate accounts. It will increase the chance of transfer pricing abuse taking place, without any auditor needing to signing off. It will reduce the quality of corporate governance. It will make it harder for corporations to be held to account where they actually operate, which is locally.
But we should have anticipated this response. MPs did not vote to reform their expenses because it suited them not to do so. Major corporations will not call for reform of accounting while it suits their tax avoidance not to do so.
That is why others are now pursuing this task. Who are those others? You will have heard of many of them. Oxfam. Action Aid. Christian Aid. CAFOD. Save the Children. War on Want. The TUC.
What they want is a new form of corporate accounting. I should declare an interest at this point. I created the concept of country-by-country reporting. All those organisations are calling for it. They want it because it recognises a key component of corporate responsibility. That is that unless you can be identified and be held accountable locally you cannot be responsible to those communities who grant you your license to operate.
And make no mistake about it: corporations do not have a responsibility to be tax compliant for some airy fairy moral reason. They have that duty because they have been granted their rights to limited liability by the same parliaments that create their obligation to pay tax. Their rights to hold property is granted to them by the same states whose property right over the profits they generate is denied by those same corporations when they seek to avoid tax.
I put it as simply as this: the duty to pay tax is not an option, it is implicit in the act of incorporation. That act is local and explicit to a location. The responsibility to account to that location is explicit as well.
Country by country reporting recognises this. In the first instance it simply demands that the company list all those locations where it has a trading operation, whether a subsidiary, branch or permanent establishment. Secondly, it would require that the name of a every subsidiary branch or permanent establishment in every jurisdiction in which the company operates should be identified. And thirdly, and most importantly, it would require that the corporation present a consolidated profit and loss account for each and every jurisdiction in which it trades. But that profit and loss account would incorporate an important twist. It would require that all sales, purchases and finance costs be split between third-party and intra-group transactions. A limited balance sheet for each location would also be required, and most importantly tax provided and paid would have to be analysed in as much detail as is required in current group accounts.
The essential link between corporations and the communities that support them which must underpin corporate responsibility will be created by country-by-country reporting. Tax paid, which is in my opinion the bedrock of corporate responsibility, would be accounted for locally. The harsh light of transparency would be turned on those claims made to relocate transactions to locations where employment and asset data, also required to be disclosed by country-by-country reporting would show that there was no substance to the transactions undertaken. When that happens completely legal but wholly abusive transactions, of the type, I would remind you, MPs made, then come into public view. At which point, like those expense claims, they would be revealed for what they are and be promptly banned henceforth.
Those major aid agencies are not calling this because of their new-found passion for accounting reform. They are calling to this because it is the single most effective way we know of delivering massive new resources to the developing countries of the world. Resources that will take millions if not billions out of poverty.
The Big 4 firms of accountants say we do not understand the issues. We do, I assure you, only too well. We heard what a member of the International Accounting Standards Board said in public session when this issue was forced onto their agenda. He said “it looks like this deals with transfer pricing and we don't want to go there”.
Oh yes we do.
So should you. As investors concerned about the durability of corporate governance within the companies that might underpin your savings. As concerned members of the community who want to know that taxpayer funds are being properly collected and managed. As corporate managers who want to hold your heads up high in a world where substantial trust in you has been lost. And it isn't just me who's saying that: McKinsey's did so very recently. But most of all, for those of you who are Revenue employees you should want this because it is you a vital tool to help you target your resources most effectively on those companies who are undertaking the greatest abuses on our society and other societies around the world.
After the G 20 Gordon Brown said he wanted to explore ways in which the benefits of transparency could be exported to the developing countries of the world.
I tell you: it is possible to do that. Incorporating corporate responsibility into corporate reporting by creating country-by-country accounting has the capacity to deliver more change to developing countries than aid and debt relief; more than Geldof and Bono combined could dream of; more than the Doha trade round could supply.
So do I believe that tax is a key component of corporate responsibility?
Yes, I do.
And do I think promoting that fact is vital?
Oh yes. I do.
And I hope you do too.
In which case please argue now for country by country reporting.