I've just been interviewed by BBC Radio Derby on why Rolls Royce have not paid tax in the UK in the last two years.
They say it's because of R & D credits, but that's only £26 million and the potential UK tax charge was £620 million, s that does not stack.
And they say its because they have to pay tax where they make their sales. Now this second excuse is odd for two reasons. First, because its not true. The world does not have destination taxes. And second it's odd because Amazon make a stack of sales in the UK but say they have to pay no tax here because they're based in Luxembourg. That's the exact opposite of the Rolls Royce line.
So someone, somewhere is spinning an inconsistent story. And I hate to say it, but on this occasion it's Rolls Royce. It makes no sense that Rolls Royce is paying tax around the world but not in the UK. None at all. But it does make the case for radical overhaul of the UK tax system.
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Just had a quick look at the numbers. Of the £620m, roughly 1/3 disappears due the the substantial shareholdings exemption, which is an explicit relief. Half the rest is overseas, and half is deferred tax.
The UK sales are £1.6bn out of £12bn, so if you simply pro-rated the pre-tax profits of £1.5bn you’d expect £200m of UK profits, and so a tax charge of £49m (using 24.5% for the year).
Of that £26m is R&D, leaving only £23m of current tax to account for. Now nearly all the deferred tax seems to be foreign exchange differences: you’d expect a lot of that to arise at the head office, and you’d expect it to reduce the current tax charge. It’s nothing fancy, just reconciling accounting profits to tax profits.
So in fact what we might have is nearly all the deferred tax arising in the UK, which would give a UK tax charge of £200m and thus an effective UK tax rate of nearly 100% (subject to some very sweeping assumptions).
Why are all foreign exchange differences at the Head Office
Aren’t they sales related?
And why such low profit? Why not half – as half the staff are here? They drive the business?
Sorry – your excuses are just tedious
Richard, while I agree with you that it seems strange how low the UK tax is given the large amount of the business based here, saying that someone who merely point out the facts in the Rolls Royce accounts is making tedious excuses is a little harsh, when you clearly haven;t bothered to read the tax note yourself.
and if that FX hedging is being done by a british company with a british bank, where should the profit and loss be recognised?
I have read the notes….
And I’ve suggested that major change to the law is needed to stop this misallocation of taxable profits permitted under current law
As the OECD now agree
So forex should follow the sales, but the profits shouldn’t?
Why should Amazon be taxed in the UK where the customers are, but Rolls Royce be taxed in the UK where the staff are?
Your position is consistent in that you’re saying that all profit should be taxed in the UK, but you’ve not really explained why that should be true for UK and non-UK companies alike.
My position is unitary taxation
And pointing out corporate hypocrisy in seeking to maintain tax injustice
I understand that you have a new way of taxing people, but I do struggle to see your basis of working it out.
You seem to be saying that Amazon should be taxed on a profit share calculated by reference to customer numbers, and Rolls Royce should be taxed based on staff count, while HSBC should be taxed based on a mixture of income, assets and staff count.
As a tax advisor seeking to apply the rules to work out a company’s tax liability, I wouldn’t know where to start.
http://www.taxjustice.net/cms/upload/pdf/Towards_Unitary_Taxation_1-1.pdf
It’s worked in the USA for years
And tax is not run for the benefit of advisers – maybe you did not realise until now?
I can’t fit a boiler, build a bridge, or teach a class. I don’t expect my clients to be able to work out the intricacies of the tax system. If I don’t know where to start with this your unitary tax, how should they be able to do it?
Unitary tax works in the US on the basis of a consistent set of factors. I can’t see the consistency in yours – with Amazon you’re using one factor, Rolls Royce a different one, with HSBC you’re using three.
Can you help me out here?
http://www.taxjustice.net/cms/upload/pdf/Towards_Unitary_Taxation_1-1.pdf
Of, and it’s called the profit split method by the OECD
It is, in fact, already in its rules
I’m sorry!?
Half the profit should be here because half the staff are here?
Please direct me to a set of accounts that proves this strange premise.
http://www.taxjustice.net/cms/upload/pdf/Towards_Unitary_Taxation_1-1.pdf
A bigger question/concept:
Is Rolls Royce acting within the confines of the law?
Yes
Which is not the issue – as is now widely acknowledged
We don’t actually know and won’t know until HMRC conducts an inquiry and publishes the wrong. At the moment we can only assume that since HMRC have not taken action then it must be legal. But given what we know of HMRC’s enforcement record the assumption is far from strong. We assumed the banks were acting within the law because the FSA had not taken any enforcement action until the US regulators blew that assumption under the water. Only last week Ernst & Young paid hundreds of million to settle a tax avoidance scheme the IRS investigated as tax fraud. In the UK it will never happen – the best HMRC has ever done is to ask the Treasury to change the law retrospectively as in the Barclays case last year. My American colleagues were sure they would have been investigated for fraud in the US.
i’m intrigued. Are you suggesting Rolls Royce does not comply with UK tax law?
Not at all
Never said so
I am saying that UK tax law is not properly taxing Rolls Royce
And we have a right to be angry about that
But why are you angry with Rolls Royce and not the government? What they are supposed to do? Not apply the current law to appease your view that we should have unitary taxation? There’s nothing in your analysis that suggests that they’ve tried to bend the current law to their advantage.
If profit shifting is happening the companies are doing
They are moral agents in their own right
As are their directors
If both Rolls Royce and Amazon are acting legally (and there is no credible suggestion to the contrary) then there is no inconsistent story, there must be different technical explinations for what’s happening.
Isn’t it likely to be around what is or isn’t a permanent establishment? I know that Amazon are able to claim their their UK operation doesn’t count as a permanent establishment (which may well seem ludicrous, but it’s an explicit provision of the tax law). Presumably, RR’s overseas operations are different.
It’s a shame people are attacking Rolls Royce for all of this. They employ 12,000 people, many in high skilled roles. They are a successfull export business. They carry out the R&D activity that the tax system wants them to carry out. Further, they do actually pay tax in the territories where they make their money (I think we’d prefer Amazon to copy RR, than vice-versa). And I say this as someone who’s not at all fond of RR due to them making much of their money through the ‘defence’ industry.
Rolls Royce’s story is rubbish. There is no destination based tax
That’s the point I was making
Is it because you had them down as one of the biggest “tax gaps” in your earlier work calculating the total UK tax gap so if you accept they have a plausible explanation of why their tax bill is the way it is it totally undermines the extrapolation in your earlier work? Just a thought.
The thought had never occurred to me
All you note is that the problem has been persistent
So you accept that they’re not likely to be doing anything illegal, but you think they’re lying about what they are doing?
There doesn’t need to be a detination based tax for their activities to be taxed abroad. There just needs to be a foreign operation which gives rise to local taxation. I think that all they’ve done is slightly over-simplify the situation in their response to the criticism that they’re suddenly facing.
I’ve never said they’re doing anything illegal
Nor lying
Spinning is not lying
And I really do not believe all their profits are at the point of sale – and I have seen argument that engines are sold at cost to justify this and candidly under TP rules that is nonsense – UK know how is used on maintenance
Surely all RR was referring to was the fact they make their sales through overseas companies and hence pay tax there not in the UK. That’s not spinning in my view. It seems to me you’re the one doing the spinning by implying/suggesting that they have said they should be taxed on a sales destination basis, which I don’t think is what they said at all.
But if 51% of all employees are in UK it’s very likely all profit is made at point of sale
In fact that’s an absurd claim which has little or no foundation
Sorry a bit confused by that …
Surely it depends what the employees in the UK and overseas are doing. I would hazard a guess not all the UK employees are generating sales or adding value to the business. For example, head offices typically have a lot of backroom admin’ activities and would be basically indirect overhead not profit generating. Local sales offices would have much less of such ‘indirect overhead’ as they would be geared heavily towards the sales side of things.
So my gut feeling is that it makes sense that sales are weighted towards the overseas sales offices rather than to the UK and hence that they would pay more tax on a proportion basis overseas than in the UK.
It’s a difficult one to gauge without being an RR insider because I also suspect and feel that if a lot of R&D activity is based in the UK (which their R&D claim would seem to suggest is the case, otherwise they shouldn’t be entitled to the credit!) then I would expect some weighting should be given to that in attributing profit to the UK. Potentially this leads to a nice little discussion on how to attribute profits to R&D activity especially within a unitary tax concept, but probably not the forum to do that.
And how you define ‘point of sale’? The point RR was making (I think) was the point of sale was overseas, presumably because that is where their salesmen are located, and that is why they pay tax overseas not in the UK. I assume that is not what you mean otherwise you would be arguing on RR’s side.
Which claim is ‘absurd and little or no foundation’?
Sorry – that’s crazy
You mean RR employs some people to lose money and others to make it? Are you serious?
And do you have any comprehension of transfer pricing at all, or the economics of multinational corporations, because it certainly does not look like it?
Your claims are, very politely, absurd
I’m fairly sure RR will have both cost centres and profit centres.
R&D is a cost centre. Head office is a cost centre. Sales is a profit centre. Basic management accounting.
And costs are reallocated to make sure that profits are properly recorded
Absolutely basic to transfer pricing
why would you want to target Rolls Royce like this? It is a large employer in the UK, and its engines are the envy of the world. You accept that they are compliant with UK tax laws; indeed with the tax laws in all the countries they operate in. Would you prefer they upped sticks and took their manufacturing operations abroad?
Oh dear – another of those tedious “they’ll leave if you tax them” comments
They won’t
They can’t
You can’t relocate Derby
Get real
strange reply. All you have said is that our tax laws have failed. You have not identified how you might rewrite them specifically to “tax them”. Besides which it is the invidious, nasty comments that stick. There are many people in Derby that remember the time when Rolls Royce nearly went bust. It was not a happy time. They have since reinvented themselves as a global service delivery company – a business model you do not seem to have fully understood!
I have said time and again on this thread how I would reinvent corporation tax
Here http://www.taxjustice.net/cms/upload/pdf/Towards_Unitary_Taxation_1-1.pdf
And let’s get real: RR makes engine3s. Otherwise it has no trade. And that’s why 51% of its people are in the UK
Facts please
Actually Rolls Royce sells time in the air, and it has a globally organised service delivery operation designed to spot and fix problems before they ground aircraft. There is no money in making engines (notwithstanding that it keeps a lot of people gainfully employed in the UK). As I said – you don’t seem to have understood the business model!
Without making engines it cannot sell anything
Your argument is fatuos
Try selling time in the air without having supplied an engine first
a business model where you sell something at little or no profit to make money selling add-ons is not that uncommon. how about a Kindle, or an Iphone! Nothing fatuous about it.
But for tax the core product has profit attributed….
Maybe it does, but why is any of this relevant to Rolls Royce. You have stated that you accept they are tax compliant, which would imply that if they are doing this then in fact there is no such tax requirement.
I have not said they are tax compliant
Tax compliance is seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes.
That’s what I am saying they and Amazon are not
Actually Rolls Royce is in the process of opening a new factory in Asia where their latest engines will be built. I am fairly sure most of the R&D will continue to be done here but all the growth in manufacturing will move there.
That’s the future
And I can’t see Derby closing right now
No that’s wrong, Are you deliberately misinterpreting what I am saying?
I am saying some employees perform an admin function – they do not of themselves make profit. Take accountants within an MNC for example, they do not of themselves generate profit, they are a cost centre. I don’t think that’s absurd.
Also I am not saying that some measure of profit should not be attributed to these type of people – they obviously perform a function for the company – but to my mind the measure of profit attributed to them should be much less that the measure of profit attributed to a sales function.
What is absurd about that?
It’s absurd because sales people don’t make engines and so they can’t make any profit without those who do
But oddly none of the profit appears to be in the place where the engines are made
Your bizarre logic is that sales take place in a void
They don’t. Companies are integrated holistic units. That’s what unitary taxation recognises and you don’t
Ah! I see where you’re coming from. Of course the location where they manufacture the engines is and indeed should be a profit centre. But do they not have manufacturing facilities outside the UK too and servicing facilities to which clearly profit should be allocated for the same reasons? Their web page mentions they have 20 manufacturing facilities worldwide!
Again not being an insider it’s difficult to understand why the UK base is not making profits and that isn’t explained by RR. It does occur to me that if they are spending a lot on R&D in the UK then clearly that will reduce the UK taxable profits.
So for example, it occurs to me (and obviously pure speculation on my part) that if their business model is to have the manufacturing facilities as the central profit maker and only have some form of routine profit in the overseas sales affiliates, then it is quite possible that at certain points in the business cycle the UK could make losses. RR is obviously investing in R&D at the moment and maybe the answer is simply that R&D spend is exceeding profits at this point in the business cycle. Assuming that R&D leads to new products and increased profitability in the future then potentially they’ll end up paying UK tax then, and more UK tax than if they shared the risk and cost with their overseas affiliates. One would also hope that if this is the model then IP sits in the UK and so the UK will be entitled to the lion’s share of any profits resulting from products developed from that R&D in the future. If the UK continually makes losses then I’d agree that something is wrong, but I am not sure 2 years in a row is enough to suggest that.
Any reasonable tax system should recognise that businesses is risky and it won’t always make profits. Business is inherently risky.
If my speculation is right, then the problem is that the overseas sales affiliates effectively have a guaranteed profit (one would hope it would be a small profit since they have no risk) and it is the UK and other manufacturing sites that take all the risk – though presumably if IP sits in the UK then the UK bears most of the risk . So they’ll always have profits in the overseas sales affiliates and are more likely to have profits in the overseas manufacturing sites than in the UK. So the UK is likely to be the only place there’s any chance of losses as well as profits.
Clearly it would help if companies like RR shared what they are doing more openly because the above is pure speculation and it may be they’re doing something else entirely. It’s impossible to make a judgement without proper knowledge.
At the moment I am getting the sense that RR are not doing what Starbucks/Amazon etc. are doing and sheltering profits in tax havens, they simply have a model that allocates profits and losses in a way that means for the time being at least the UK is making losses and the overseas companies are making profits. I am not sure that is something we should object to it’s just business life. But equally it is not clear if the profit allocation to the UK and overseas is fair. We are left to guess as we don’t have the information.
No let’s be clear – the model has done this for years
And with half of all employees in the UK I think we can safely assume that model is wrong
I do
RR are welcome to say why I’m wrong and I’ll publish any comment they make
Ah, so in fact you don’t think they are tax compliant???
Far from it in my view
Tax compliance is seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken coincides with the place and form in which they are reported for taxation purposes.
That’s exactly what I am suggesting is not happening
Hadn’t looked at employee split. Interesting … I can see your point now.
So did I understand correctly that it’s not just the last 2 years but over a longer period they’ve been paying little or no UK tax?
As you have guessed I am thinking along existing OECD model lines but even then, if we assume a lot of the UK employees are in the UK manufacturing business and a relatively small number of UK employees are my so called ‘backroom’ admin people, then you’d expect a lot of profit from manufacturing to be attributable to the UK.
And re the sales affiliates, if they have limited risk, then I’d expect them to have a small profit. But even giving them say a 3% margin (reasonably generous?) that potentially gives overseas sales affilites a gross profit of under £500m which leaves the best part of £2.3bn of gross profit or £1.3bn of operating profit (pre R&D) to be allocated to the UK and overseas manufacturing sites. And if it’s mostly UK you’d expect a big chunk of that to sit in the UK which ought, one would think, to cover R&D costs of £500m.
This suggests it’s not a limited risk model or the margin attributable to the sales afilites (if they limited risk) is quite high. Quite a bit more than my above 3% suggestion.
Another thought is that my analysis above is down to operating profit. They have £1.1bn of finance income and £400m finance costs. Presumably that net finance income is not sitting in the UK; Either that or a hell of a lot more of the operating profit is being allcoated overseas.
I think you get it
cost plus 5% is more normal, but i dont think it changes your conclusion.
also worth noting that the group is carrying a significant amount of tax losses forward (as mentioned elsewhere RR nearly went bust) – im not sure whether the use of brought forward trading losses to reduce current tax is currently considered “immoral” – its hard to keep up with how the morality needle is swinging……………
Hang on….the collapse was in 1971 if I recall….you’re saying they’re still carrying the losses?
Shall we be a little more credible than that?
well the deferred tax note is showing a large amount of losses carried forward – as you know UK trading losses dont expire, so maybe they are from 1971? who knows !
Page 91, 2nd table, 6th line:
“Rate differences: £58m (2012), £40m (2011)”
Which is to say: Where RR’s profits are being taxed outside of the UK, they are being taxed at a higher rate than they would be if they arose in the UK.
What exactly are we accusing RR of? Profit shifting into high tax jurisdictions? I’m going to go out on a limb here and say that whatever they are doing, it’s not particularly devious.
I am accusing RR of not paying tax here when it seems that based on economic analysis a significant part of their value added arises in the UK
Is it that hard to understand such a simple suggestion?
So you’re accusing RR of shifting profit out of a low-tax jurisdiction into higher-tax ones.
There is no rational reason for them to do this deliberately. There can be no mens rea.
This is only an issue if you regard UK tax as a more worthy cause than any other: if you’d prefer RR to pay £1 here than $2 in the US.
Respectfully – since you have no clue where tax is being paid bar the fact it is not the UK you are simply making this up
No, we don’t know where the tax is being paid, but we know it’s being taxed at higher rates than in the UK. Does it matter where that is, from a tax avoidance perspective?
We have no way of knowing whether it is being paid at higher rates than the UK
Effective tax rate is a combination of tax rate and base
You either continually reveal your ignorance or are astroturfing
Either way, for someone who claims to be a tax professional you’re also a pedant and time waster
Your comments will in future be deleted
Is this a spoof?
Spoof what?