One of the questions posed by the House of Lords yesterday was:
Is there a good rationale for the existing system of taxing corporate profits?
I provided the following written answer:
There are five fundamental reasons for charging corporation tax on company profits:
- Companies are not tax neutral. They can significantly change where and when tax is due, who pays it and at what rate. For this reason alone it is vital that there is a corporation tax to tackle the worst of the distortions that the mere existence of companies can create in a tax system.
- Corporation tax is efficient when compared to taxing shareholders on the profits companies make. We simply do not know who the shareholders in many companies are, with this being especially true in the case of multinational corporations. Moreover shares are traded frequently: it has been suggested that the average period for holding a share in the USA is now around 20 seconds.[i] Many shareholdings are themselves hidden in other companies and trusts, many of which in turn are in tax havens to hide their true ownership in an attempt to avoid the taxes due if the true ownership was revealed. In combination these facts mean that replacing corporation tax with a tax on shareholders on the income streams they derive from companies would be a recipe for ensuring some of those owners would pay no tax at all. That would be profoundly unjust.
- Corporation tax charges companies for a benefit provided by society. That benefit is limited liability. This is an extraordinary privilege created, for all practical purposes, in the Victorian era, which if put forward as a new idea now would fail all tests of reasonableness. The idea that a single person may, by signing a few pieces of paper, escape responsibility for paying their debts would be absurd but for our familiarity with it. That privilege may have benefits but also imposes costs on society, partly from tax lost when tax debts are not paid, and partly from society bearing the cost of failed companies. Nothing better illustrates this than the cost of bailing out the banks in 2008. It could be argued that some of this cost could be recovered by increasing the annual fees charged by most states to the companies that are registered within their domains for the privilege of keeping a company on its official register of companies, but that would be unreasonable: it would be equivalent to a poll tax. The answer comes instead in the form of a tax on profits that compensates society for the costs companies impose on it; costs broadly equivalent to scale and that must, if any system is equitable, be settled based on a company's capacity to pay which profit implies.
- Corporation tax is an essential back stop to income tax: if the profits of companies were not taxed there would be considerable incentive for anyone undertaking a trade to incorporate and so either avoid or defer tax on the profits they make. This would, inevitably lead to significant loss of taxation revenue to the Exchequer.
- There is good reason for taxing profit and not, for example, turnover or cash flow. If appropriately measured profit is the best measure of the economic gain resulting from trade and as such is the best guide to the return to capital resulting from its use in a business. There is, admittedly, good argument for saying that at present International Financial Reporting Standards do not appropriately measure profit and that UK GAAP was of considerably more use for this purpose, but that is a secondary consideration that can be resolved. Taxing anything but profit is to tax some factor other than the reward to capital. Cash flow is, for example, arbitrary and exceptionally difficult to identify as a measure for taxation in complex business enterprises (as indicated by the failure of the accountancy profession to ever come up with meaningful or comprehensible funds flow statements for inclusion in financial statements) and also gives rise to enormous difficulty in separating capital and income flows whilst any form of tax on turnover, however disguised, behaves in exactly the same way as VAT for economic purposes: the incidence will almost invariably fall on customers in most cases, the impact will be inflationary and so considerably economically distortive and the one thing that can be guaranteed is that capital will go untaxed.
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Richard, I am not surprised the Committee asked this question given that Mike Devereux (that known opponent of corporation tax) is their Special/Expert Adviser!
I also made clear I completely rejected Devereux’s work – to the committee
It was the sticky moment they did not like
Why can’t 2 be solved by a withholding tax imposed by the company on distributions and profits on share buy backs? 4 can be solved some form of close company tax on shareholders. It can’t beyond the wit of man and must be easier than the current system or unitary taxation.
In respect of Point 2, could you not tax return to shareholders by way of a withholding tax on distributions to shareholders? In order to get credit for the withholding tax, taxpayers would need to engage with the system, so as long as the withholding tax was set at >50% highest marginal rate for individuals there would be an incentive to engage. It’s more efficient that taxing profits, because there’s no arguments about quantum of taxable funds or scope for fancy avoidance round the definition of ‘profit’.
Apple has almost never paid a dividend
But there were £80bn of dividends that were paid last year in the UK so Apple is an exception – just like there are many exceptions to the current rules and hence the purpose of this blog – so I am not sure that invalidates the idea. As you regularly point out Apple’s position is not sustainable anyway and it is not difficult to see how exceptions like this would be tackled. The PFIC legislation in the US already does something similar.
But £80bn is vastly less than a £200bn plus share of gdp
very intersting interview with Michael Hudson on the Real news from your first footnote – this was even backed up by a Newsnight discussion last night whre there was surprising concensus from even the neo-lib Adam heath (City AM) that the stck market ‘boom’ was probably a bubble and that all this had nothing to do with a real economy.
If the tax credit associated with a dividend represented the tax rate actually paid by the company it would greatly reduce the desire to avoid tax at the corporate level because dividends from those companies would be subject to higher taxation in the hands of the individual. The great fiction when it comes to corporate taxation in the UK is that all dividends have the same tax credit attached to them.
I cannot imagine any tax that could do that which would not be almost instantly avoidable
I confess that I really don’t understand your response. My argument is that if you receive a dividend from a company that paid no corporation tax on the reserves that have been distributed then you should pay a tax on that dividend as though no tax had ever been paid. If on the other hand you received a dividend from a company that had paid tax at 21% you should get a 21% tax credit against personal income tax due. The problem is that the tax credit attached to a dividend covers the first 20% of tax payable by the individual even if the company isn’t paying taxes, why should it do so if the company hasn’t paid any tax?
From an accounting point of view it would really just involve the companies knowing the year in which reserves had arisen and the actual amount of tax paid during that year.
UK dividend taxation hasn’t worked like that for over 15 years.
The current system is that a dividend received is grossed up by a notional tax credit of 1/9 (so the “tax” is 10% of the gross), the tax is calculated on the gross amount, and then the credit is deducted from the tax due.
For example, if you receive a dividend of £100 and are in the higher tax bracket, it goes:
Actual dividend 100
Notional tax credit 11.1
Gross dividend 111.1
Tax at 32.5% 36.1
Less: credit (11.1)
Actual tax payable 25
In most cases all this does is reduce the effective tax rate (to 25% for the higher-rate band), although there are some cases where it has deeper effects. It certainly makes the tax bands a bit complicated – you can’t just apply the effective rate unless you’re very sure all the income is in one tax bracket, for example.
The system you suggest used to be applied to dividends from overseas companies: it’s credit for the underlying tax in the company. It was always quite a complicated system to administer, as you had to find some way of attributing tax paid in earlier years to the pool of reserves accumulated in the company, and there’s no clear and simple way to do that. It has some similarities to the way trusts are taxed, too.
If you were to apply it to UK dividends now, you’d end up with some taxpayers paying more tax on their dividends than they now do and some paying less – which is of course not necessarily an argument for or against it, just an observation.
Corporate taxes dilutes citizens’ representation
That’s a statement that can only imply support for regressive taxation
You say in point 3 that tax is the price for limited liability.
But when we say ‘limited liability company’, we’re referring to the liability of the shareholders, not the liability of the company itself which is unlimited to its last penny.
If tax is the price to society for that limited liability, then surely that’s an argument for taxing those who benefit — the shareholders.
I think it quite reasonable to tax the company as their agent, especially when we have no idea who many shareholders are
Yes, that was your point 2.
So what are you trying to say in point 3 that differs from point 2? You say in point 3 that limited liability is a benefit to the company. It isn’t, it is a benefit to the shareholders.
“In any event, the City of London is far too busy getting very rich indeed from moving the dirty money generated by so many organised criminal entities around the world. The real world economy is now a largely criminal economy, and it operates offshore and in cyberspace for the most part, and the British national interest demands that the UK continue to provide the lion’s share of professional services to the new money!”
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