The future of business tax sits on shifting sands

The past decade or so has seen fundamental shifts in how businesses are taxed. Tax authorities have moved from paper-based submissions to digital filings, corporate tax rates have come down as countries have competed to attract inward investment – although in the UK they are about to go up again – and new digital taxes have been introduced.

At the same time, a perception that corporates are not paying their fair share has driven efforts to tackle tax avoidance, leading to unprecedented levels of international co-operation as countries try to shore up public finances under pressure from long-term demographic trends.

The pandemic appears to be accelerating change, exposing the tensions between the world’s biggest companies – which are sometimes likened to nation states given the influence and capital at their disposal – and tax authorities. Similarly, governments are struggling to encourage and support the growth of small and medium-sized enterprises while at the same time using them as an important source of tax revenue to fund public services. 

For larger corporates in particular, change goes far beyond taxation, with the ways in which they must sustain their ‘licence to operate’ expanding greatly in the past few decades. Boards are now expected to demonstrate not only that they are providing a return for shareholders and comply fully with any and all relevant legislation, but also that they are fostering a culture where sustainability and ethical conduct underpin corporate strategy.

Many business leaders have already woken up to this, although Andrew Harrop, General Secretary of the Fabian Society, comments that their motivations may differ. “A good example is Uber, which fought the Supreme Court case on workers’ status for years and when they eventually lost it, then turned around and said, ‘Oh, that’s OK then. We want to be good corporate citizens.’

“So, while in one sense they’re very hard-edged and lawyerly about it, actually they need to attract workers as well. It’s a tight labour market,” Harrop explains. “If you’ve got a reputation for treating your employees or your non-employees badly, ultimately it kicks back, so while investors matter, your workforce matters, too.”

The question for many businesses is whether they can continue with tax minimisation strategies they’ve employed in the past that seek to reduce tax liabilities to the lowest level allowable by law. For large corporations operating in multiple jurisdictions, taking advantage of differences in tax rules and rates to reduce the amount of tax they pay and so improve returns to shareholders has seemed like old-fashioned good business sense. 

Taking advantage of both domestic and international opportunities to reduce tax is commonplace, with a 2019 study from America’s Institute on Taxation and Economic Policy providing an example by showing how 379 profitable corporations in the US incur an average effective federal income tax rate of 11.3% on their 2018 income, slightly more than half the statutory 21% tax rate. This is less than a third of the headline rates of tax, which in some countries reach 35%.

Until the past decade, this was a widely accepted way of doing business. “There never used to be any negative connotations to this type of planning. In fact, the tax lawyer was usually the cleverest guy in the room,” says Aude Delechat-Patel, Head of International Corporate Tax Disputes at Mazars UK. But the global financial crisis and its aftermath brought the issue of responsible tax planning and governance to the forefront of the debate over government action, business behaviour, stakeholder demands and the role of business in society. 

Indeed, a recent consultation exercise run by the UN’s Principles for Responsible Investment initiative showed institutional investors were unhappy about a wide range of issues around the approach many corporations take to paying tax. 

These included: a lack of evidence from companies of how their publicly disclosed tax policies are consistent with the overall strategic objectives of the organisation, and their broader sustainability commitments; few concrete examples of how companies determine if tax transactions are in line with their risk appetite; and insufficient explanation and granular data to validate corporate commitments to avoid aggressive tax planning.

Vince Cable, formerly Secretary of State of Business, Innovation and Skills in the UK coalition government of 2010 to 2015, believes the perception that large global digital companies are failing to pay their fair share has given some heft to moves towards global minimum tax and greater transparency. However, he is sceptical over whether those efforts will succeed. “I think we have to see whether countries really manage to extract these taxes. And the next few years will show how that’s playing out. 

“I’m not sure how much of a drive there is to raise that floor [of corporate tax rates] because you’ve got countries like Ireland saying: ‘Look, one of our points of competitive advantage and one of our ways of getting companies to come and locate here is that we favour … a very low corporation tax rate.’”

The adoption of a global minimum corporation tax rate is, Cable believes, primarily a device for trying to get the tech companies to pay more tax: “And if that succeeds, it may stop there. And if it fails, in that respect, I think there may be more things targeted at that sector, which is a sector of gigantic companies.”

Digital taxation is also being driven by concerns that ‘bricks and mortar’ businesses are being disadvantaged by existing tax systems, with global online retailers able to take advantage of their international operations and virtual storefronts in competing against local high street stores that – in the UK, for example – have to pay business rates and don’t have the same opportunities to minimise their corporation tax bills.

In the wake of COVID-19, where the contract between business, government and individuals was put to the test, addressing tax matters is becoming more urgent. “Paying your fair share of tax is increasingly part of a company’s reputation, along with how it treats its people, its partners and its suppliers,” says Richard Morgan Evans, co-founder and CEO of Sapience Communications, an investor relations consultancy specialising in helping companies communicate with stakeholders. “The digital companies and their tax arrangements have widened this debate and brought the spotlight on to a broader array of businesses. 

“The standard reply to any media enquiry about tax is to say: ‘We pay all the tax we’re legally obliged to,’” Evans says, but he believes that won’t wash in the future. “Companies need to be more detailed and take the time to fashion a proper strategy that can be argued and justified in public and not just give a boilerplate response. 

“It needs to be a more sophisticated and well thought out policy that has been devised with a view to it being challenged. Companies need to robustly test those policies to make sure it holds water.” 

George Dibb is Head of the Centre for Economic Justice at the Institute for Public Policy Research. He agrees that there has been a change “that has pushed the political conversation quite distinctly in a different direction on tax. The context around it no longer appears to be high tax versus low tax, but the fairness of tax.”

On this evidence, then, it would pay HMRC to combat avoidance by taking a more nuanced view of corporate behaviour. “In an ideal world, HMRC want to make sure they get paid everything that they are owed,” says Alistair Kuechel at IFF Research, who has worked alongside HMRC in the past to gauge sentiment among corporations and individuals.

“There is a belief [that] promoting the moral and altruistic side of corporate tax policy is important and it’s largely done by nudge tactics. You can set draconian penalties – even imprisonment – but from what we’ve seen they recognise that there are other strings to their bow that can be a little cleverer in addressing this. The reputational risk of being named and shamed is real, but being a good citizen and supporting the nation in a tough time is also crucial.”

The attitudes of those running corporations are harder to gauge, but there will inevitably be some who view tax reform as simply another cost to manage. “[The global minimum CT rate] is a good idea, but it’s unlikely to achieve its aims because, in reality, no corporate ever pays the headline rate in the country,” says Ken Bowles, CFO of FTSE 100 packaging giant Smurfit Kappa.

“People might talk about what they do and don’t do, but if you take France or Germany and their headline rates, I can guarantee you there isn’t any corporate on any kind of scale in those countries paying that rate. The gap between the 15% rate and the actual effective rate will be smaller than people might think. Will it bring some of the digital economy into the net? Yes, it will do, but it will also generate an industry around [the] tax function in the Big Four.”

Despite that view, it is likely that international cooperation is likely to continue beyond current initiatives such as a global minimum corporate tax rate. Ultimately, in an increasingly globalised world, purely domestic attempts to reform taxation and tackle tax avoidance are only ever going to have a limited effect. And, as the shape of the post-pandemic landscape becomes clearer and delivering net zero becomes more pressing, the need for governments to respond will only increase. The Organisation for Economic Cooperation and Development is certainly not holding back in its efforts to encourage governments to work together more effectively.

With the rise of the tech giants only adding fuel to the fire, the EU, for example, is pressing ahead with proposals to reform tax systems to “address the challenges of the digital economy and ensure all multinationals pay their fair share”. The days of allowing companies to make huge profits and pay tiny amounts of tax in the countries where economic activities take place may be numbered.

For businesses – large and small – the one certainty is that tax rates, tax rules and tax systems are going to continue to change. After all, governments really do need the money.