I noted some reaction, especially on Twitter yesterday, in response to my comments on the need to support Biden's minimum corporation tax plan. The claim was that we do not need a corporation tax. I completely disagree.
I wrote much of what follows when giving evidence to the Hosue of Lords in 2013. It's worth sharing it again:
There are five fundamental reasons for charging corporation tax on company profits.
First, 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.
Second, 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.
Third, 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.
Fourth, corporation tax is an essential backstop to income tax: if the profits of companies were not taxed there would be a 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 a significant loss of tax revenue to the Exchequer.
Finally, there is a 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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Point 4 seems to me to be a key point: as things stand, there is already a strong incentive to generate, retain and reinvest profits inside a corporate wrapper, taxed more lightly than they would be in the hands of an individual paying income tax and NICs. That advantage is reduced by increasing the rate of corporation tax from 19% to 25%. The debacle of the 10% rate shows what happens if you push the rate of corporation tax too low – if the rate was zero, many small traders would be pushed again to incorporate for tax reasons but would then struggle to treat the company properly as a separate person from themselves, and get into trouble with unlawful distributions, beneficial loans, loans to participators, undeclared salaries, and the rest.
Before a separate corporation tax was introduced in 1965, companies paid income tax and also a tax on net profits. The profits tax was charged at different rates for amounts retained or distributed, and was deductible against the income tax. Capital gains tax was also introduced in 1965. Both in response to the 1955 Royal Commission on taxation of income and profits.
So where is the UK’s Royal Commission to decide what to do next? Have we outsourced that deliberation to the OECD (Pillar 1 and 2), the US Treasury (Biden plan), and the EU (son-of-CCCTB back on the menu now the UK is out of the way)?
The answer is that there appears to be no tax strategy for the UK now
They think hating it is enough
The 2010 coalition had a corporate tax roadmap which set out its long term policy intentions and gave some clarity and certainty about the direction of travel. You might disagree with the policy choices they made, but business and advisers loved it, because they all need to plan for the next three to five years. And today? Nothing. Uncertainty is bad for most businesses.
Agreed
Thank you for this. Your thoughts on tax are always so illuminating to the innocent like me, since they always look at the principles and not just the transactional stuff.
Given the blatant abuse by some multinational companies of their capacity to move their taxable gains for their own convenience, it has been clear for many years now that a solution is needed that would involve full international agreement. With the country that is the base for the biggest of those companies actually proposing an idea, it is disappointing that our own government hasn’t followed the lead of others in signing up to negotiations on this.
And it will need major negotiations, which I look forward to your thoughts on from your accountancy expertise. What should be the universal way of determining profit subject to corporation tax? (It is reported that there are some companies distributing more than their operating profit in dividends and share buy-back). And how should it be divided between the countries where the company operates? (It would not be equitable to tax on the basis of sales if the company has its major manufacturing capacity in developing countries where there is a relatively small sale base). And of course, what rate would be widely agreeable?
(As an aside, I am sceptical about the idea that US shares are only held for 20 seconds on average. The link is dead so I couldn’t check. It would imply that the annual volume of stock market transactions is over one million times bigger than the total capitalisation of US companies, which doesn’t seem plausible).
Jonathan
An answer is now on the blog
Richard
Might it be more collection efficient if a tax equivalent number of shares were allocated to H M G?
(This idea comes from an associate of Dean Baker)
I know the idea
I completely agree that corporation tax is necessary. There were a couple of statements in your post that caught my eye…
“there is a 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.”
“Taxing anything but profit is to tax some factor other than the reward to capital.”
I, as an individual PAYE employee, am taxed on a revenue basis.
1. A company can offset its rental/mortgage costs against its profits and hence tax. I cannot offset my housing costs.
2. If I am travelling to my “normal place of work” I cannot offset transport costs.
3. A company requiring inputs to produce a product can offset those costs. The cost of the food I need to live is not allowed as a tax relief
If I am going to be taxed on a revenue basis I think companies should be also. I would be interested in your thoughts. Not trying to be controversial or antagonistic. It’s a genuine question as to why you appear to think companies should be treated differently from individuals.
Regards
Dave
I have posted some more this morning
You as an individual are taxed on your income and gains. The calculation of both income and gains includes deductions, allowances and reliefs. For example, as an employee, you can claim deductions for expenses in calculating your taxable income, if they are incurred wholly exclusively and necessarily in the performance of your duties. If you were self-employed, you could claim a deduction for expenses incurred wholly and exclusively for business purposes. The “necessarily” adds a high hurdle, so yes in the main employees pay tax on almost all of their gross wages/salary/employment earnings, whereas businesses pay tax on their net income after expenses.
Companies are taxed on their profits (i.e. income and gains). Most of their expenditure will be wholly and exclusively for business purposes, but some many not be, like your mortgage. and that won’t be deductible. Even some business expenditure is disallowed – for example, spending on capital items, or entertainment (including staff entertainment above allowances).
If you are saying that businesses should be taxed on their gross income, with no deduction for business expenses, that is just a sales tax (worse even than VAT – think about the tax cascading up supply chains). You want a business that makes a net loss to pay tax on its income?
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