I had a conversation at a party on Saturday with a person of my occasional acquaintance, who admits to being a reader of this blog. He repeated to me the often asserted claim that companies have a legal duty to maximise their profits, believing it to be true, and despairing of the prospects of reform for business if that were the case.
I was able to assure him it is not true: companies have no duty to whatsoever to maximise their profits. A company's directors have a legal duty to promote the success of their company, but that term is both widely defined and subject to considerable constraints, as the law shows. This is the law in question, from the Companies Act 2006:
172: Duty to promote the success of the company
(1)A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to–
(a)the likely consequences of any decision in the long term,
(b)the interests of the company's employees,
(c)the need to foster the company's business relationships with suppliers, customers and others,
(d)the impact of the company's operations on the community and the environment,
(e)the desirability of the company maintaining a reputation for high standards of business conduct, and
(f)the need to act fairly as between members of the company.
(2)Where or to the extent that the purposes of the company consist of or include purposes other than the benefit of its members, subsection (1) has effect as if the reference to promoting the success of the company for the benefit of its members were to achieving those purposes.
(3)The duty imposed by this section has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.
So, where does it say that profit maximisation has to be the object of the company? Quite clearly it doesn't.
Sure, ‘success of the company for the benefit of its members' clearly implies a duty to generate profit, or at least a positive cash flow, but maximise it? No way! This is at best a constrained requirement, as is clear from sub-paragraphs a to f.
And in that case judgement has to be exercised. Tax avoidance may not in that case be sound judgement. It is harmful to employees. It may be harmful to the members, who may have to pay more tax as a result in a personal capacity. And it may harm the long term interests of the company whether by reason of risk of tax challenge or because the directors' believe that the resources they need from the state may not be available to them. It could even harm commercial prospects, as Starbucks are finding.
So what is abundantly clear is that in UK law there is:
a) No duty to maximise profit
b) No duty to minimise tax bills
c) A clear duty to exercise judgement.
And there is no way tax cheating can be reconciled with the legal obligation of the directors because it is clearly contrary to the interests of pension fund members, employees, the long term stability of the company and as such to its duty to suppliers, customers and others.
So shall we stop the absurd claim that tax avoidance is a duty once and for all? It's not. Cheating, which is what tax avoidance is, represents an exercise in poor judgement. As such it is contrary to company law.
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Richard, what’s the situation in US company law? It seems to be US companies who are engaged in some of the most blatant attempts to avoid paying the appropriate and fair rates of tax.
There’s a discussion here that implies not http://skeptics.stackexchange.com/questions/8146/are-u-s-companies-legally-obligated-to-maximize-profits-for-shareholders
And candidly there’s good reason for that – no one knows what profit is! It’s very hard to have to maximise an unknown
If I remember correctly, there was a court case in the US where the judge ruled that there is no separate legal duty to minimise tax. However, he did also note that would not preclude under certain circumstances that failure to minimise tax would be a breach of fiduciary duty.
Reference?
Thanks for the reference.
Following the line of thinking through – if executives have a duty to maximise profits for the companies they lead, why don’t these executives have a duty to pay themselves less? If they have a duty to pay less tax, don’t they have a duty to receive less pay? And sometimes we know certain executives would be prepared to work for less than they do, because they did previously (e.g. they got a pay rise, or moved roles).
How subversive of you!
Sure, ‘success of the company for the benefit of its members’ clearly implies a duty to generate profit
I’m not even sure it does that. Social enterprise?
If profit is a surplus to ensure continuity of activity then I think that applies to social enterprise
But I am being broad minded, I admit
[…] I’ve noted this morning that far from there being a legal obligation on companies to avoid tax, this action is probably contrary to the law (as well, as is now clear, good commercial practice, which happen to coincide on this issue). So in that case, who created the myth? […]
Companies should always observe the first rule of the successful predator, your most precious commodity is your prey. Big business seems to have lost sight of that entirely, giving creedence to the theory that much of it is indeed run by the seriously mentally ill with nothing but tunnel vision, this to the detriment of all.
I’m not a legal expert, but presumably, case law plays a role in how company law in interpreted in practice.
Joel Bakan in The Corporation describes the case of Dodge v. Ford (1919) in which the judge stated: “a business corporation is organised and carried on primarily for the profit of the stockholders.”
Bakan goes on to say: “Dodge v. Ford still stands for the legal principle that managers and directors have a legal duty to put shareholders interests above all others and no legal authority to serve any other interests – what has come to be known as “the best interests of the corporation” principle. (Bakan, pp. 36-37)
There is also “the business judgement rule” which wikipedia says is “a United States case law-derived concept [ref is Gimbel v. Signal Cos., 1974] in corporations law whereby the “directors of a corporation . . . are clothed with [the] presumption, which the law accords to them, of being [motivated] in their conduct by a bona fide regard for the interests of the corporation whose affairs the stockholders have committed to their charge”.”
http://en.wikipedia.org/wiki/Business_judgment_rule
These two examples are both from the US of course, but presumably we have parallel examples in the UK?
Co Act 2006 is dominant in UK
As for US – those cases imply no more than s 172 does
No conflict
Ok, splitting hairs here…
How do we measure the success of a company? Is it by its P/L, how much it pays its staff or how much it invests? These are the main barometers of success for most companies. Happy employees, good business relationships and public reputation mean nothing if the company is bankrupt.
All of these require the company to reduce costs.
Costs include taxes.
Quid pro quo it is the director’s duty to reduce the company’s tax bill.
This leads to the debate over the difference between tax avoidance and tax evasion. Legal or illegal.
Tax is not a cost
It is a distribution to society for the right to trade
Shall we get facts right?
This is one reason why it is shown as a distribution after profit is declared in the profit and loss account