Lessons from the corporate tax trends of 2015

The journey currently being undertaken by corporate tax globally has picked up speed in 2015. That journey is gradually transforming the role played by corporate tax (by which I mean tax on corporate profits) in the overall revenue raising programmes of governments worldwide, as well as the ways in which corporate tax is effectively raised. When a lot of change is going on simultaneously, it becomes harder to keep track of where things are heading. However, I do think it is possible to see some trends developing.

 

What are those trends, and what do they mean for corporates and their advisers as they take stock, and then look forward? What follows is a purely personal view. 

 

 

The global trend for some time now has been for rates of corporation tax to reduce, while the base has been broadened. To state the obvious, the latter helps to pay for the former.

 

It might have been expected that by now the so-called race to the bottom had been largely run, but even over the least year or so we have seen further CT rate reductions announced or implemented by countries such as Australia, Japan, Denmark, Portugal, Spain and, of course, the UK. This has not, however, been accompanied by any forecast decrease in the revenue take – usually the opposite.

 

That is because the base has continued to be broadened, and this shows few signs of slowing down. US-based multinationals have long appreciated the difference between the headline rate (punitive) and the effective rate (surprisingly low). All corporates, and their advisers, need to factor into their planning the global base broadening agenda.

 

Take the UK as an example. By 2020, over a ten-year period the CT rate will have fallen by a startling amount – from 28% to 18%. In some respects, the regime has become even more competitive, particularly with the ‘territorial’ approach to dividend exemption and the recast CFC rules. Overall, though, the trend has been and is to broaden the base. This is achieved through a mass of avoidance measures, the withdrawal or restriction of incentives (capital allowances, the patent box, goodwill relief) and, most starkly, by a restriction of base erosion via deductible interest. The UK is still a generous regime in comparative terms for the deductibility of corporate interest. That is changing, though – think of bank loss carry-forward, the hybrid proposals and the current corporate debt consultation.

 

Of course, it has always been the effective rate which matters. However, as headline rates continue to reduce, at the same time as much conventional BEPS planning runs out of track, it is becoming ever more important to look critically at the projected base and the effective rate which follows.

 

 

For those of us who have been working in the tax world for a long time, it can be hard to adjust to the declining relative significance of corporate tax. To take only one example, the debate and action in relation to BEPS has tended to reinforce the impression that corporate tax is hugely important – perhaps the most important tax around. So, avoiding it, minimising it or paying the ‘fair share’ of it is a huge deal, and should sensibly be the primary focus of companies, their advisers and other stakeholders such as tax authorities or the OECD.

 

For a number of reasons, that view is too simplistic.

 

First, in most countries, corporate tax raises a relatively low proportion of total revenue. In the UK, for instance, the forecast published in March 2015 by the Office for Budget Responsibility predicted that for 2014/15 corporation tax would raise around 7% of total tax receipts. This means that it is of relatively limited significance as a source of raising revenue, or as a concern in relation to any ‘gap’. Perhaps governments should focus more (as some clearly have) on indirect and employment taxes than the political football of corporation tax. It also means that when companies emphasise their ‘total tax contribution’ to an economy, and not just the corporation tax they pay, they actually have a point.

 

Secondly, and partly as a corollary of this, companies need increasingly to plan for, or react to, tax changes other than corporate tax. In the UK, the staged reductions in the rate of corporation tax, coupled with the ‘tax lock’ on the rates of income tax, VAT and NIC, leaves the chancellor with three ways of raising more tax. He can broaden a tax base, he can increase a ‘non-locked’ tax or he can invent a new tax. Base broadening of corporation tax is rule 1. As to new taxes which directly affect companies, planning will now need to take account of the diverted profits tax, and the apprenticeship levy announced in the Autumn Statement. Doubtless more will follow.

 

 

For many years, companies and their advisers have spent their time at the stakeholders’ cocktail party cornering the tax authorities and nodding politely over their shoulders at the supranational bodies. They need to adjust, as bodies such as the OECD and the EU should no longer be regarded as wallflowers at the party.

 

When the OECD launched the BEPS initiative, many were sceptical. If stand-alone consultations – such as those on intangibles or business restructuring – had largely failed to produce concrete action, how could such an ambitious and comprehensive programme ever hope to succeed?

 

The outcome serves as a reminder that timing is everything. The BEPS initiative was launched at a time when the negative publicity in relation to multinational tax planning was being harnessed by various governments to gain political backing for revenue raising change. The OECD’s programme of proposals is undoubtedly having some success on a multilateral basis, particularly in relation to reporting and transparency issues, but its greater success has been in acting as a catalyst and engine for change. In some cases, the change has been in tax authority behaviour; there is evidence that some jurisdictions have in effect begun to implement the OECD proposals in areas such as transfer pricing as if they had already become law. In other cases, countries have jumped the gun with unilateral actions in relation to BEPS, contrary to the OECD approach. Step forward the diverted profits tax. Less controversially, the UK’s commitment to introducing hybrid debt and hybrid instrument rules is a good example of the importance of timing. As the UK wants to broaden the CT base, while still having fewer aggregate restrictions on cross-border debt planning than, say, France or Germany, the hybrid proposals are timely. Overall, there is no doubt that the OECD’s importance in corporate tax development has increased, and may continue to do so.

 

The trend of CJEU decisions seems to have shifted away from favouring the taxpayer. The EU, however, has assumed prominence in the corporate tax world recently for different reasons. The state aid investigations are a reminder that great care is needed in obtaining rulings for cross-border planning. Regardless of the eventual outcome of those investigations, no company would take lightly the publicity implications of such an exercise.

 

 

One of the underlying tenets of the OECD BEPS initiative is that behaviour which erodes the global tax base is bad, regardless of any lack of clarity as to which country’s tax is being eroded. The creeping success of the OECD initiative marks a greater willingness by some countries to introduce rules which effectively endorse this approach.

 

The hybrid proposals illustrate the shift. In the UK, the current anti-arbitrage rules largely turn on loss of UK tax. So, if a cross-border debt structure produces the same result purely in UK tax terms as the likely alternative structure, the hybrid structure may well be effective. In endorsing the OECD hybrid proposals, however, the UK has moved away from this approach, towards the ‘global policeman’ role suggested by the OECD. That role may simultaneously protect the UK corporate tax base, where it denies a UK deduction, but it is nevertheless an important shift in approach. Other countries may well follow suit, and Australia is already consulting.

 

In parallel with this shift, however, expect countries to continue to play bad cop, by taking any measures possible (and which are EU compliant) to boost the competitiveness of their own corporate tax system.

 

 

A further identifiable trend which corporates need to take account of is the introduction of rules (both hard and soft) explicitly designed to influence behaviour in relation to corporate tax. Such rules may arrive via a Trojan horse, such as the recent HMRC consultation titled Improving large business tax compliance.

 

In one sense, these rules create a pincer effect when combined with adverse publicity for corporate tax planning – whether through a governmental hearing or simply through the media. The pincer movement means that corporates will need to develop a tougher skin if they wish to continue with planning which is arguably at the artificial or aggressive end of the avoidance spectrum. In the UK, for instance, the Autumn Statement presages a requirement for companies to publish their (UK) tax strategies. We already have sector specific codes of conduct, and ‘special measures’ are likely for what are judged to be high risk businesses.

 

Within the tax legislation proper, it is also worth pointing out that the diverted profits tax is a particularly stark example of a tax intended to influence corporate behaviour. Its intention is less to raise DPT revenues than to discourage the adoption of structures caught by DPT.

 

 

As the late, great Yogi Berra once said: ‘When you come to a fork in the road, take it.’

 

Perhaps the biggest question now for corporates and their advisers is whether collectively these new rules of engagement lead to a fork in the road. As multinationals change track and restructure, as they beef up substance and activities wherever they can, do they continue to strive for structures which rely on conventional planning strategies? Or do they step back and take a quite different approach, perhaps intended to produce greater stability while demonstrating different behaviours? Once the UK rate is 18%, for instance, should intangibles be moved here, with the addition of greater substance?

 

Maybe we’re reaching a fork … and it’s time to take it.