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Time to flatten tax competition? By Dan Martin

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22nd Sep 2006
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Dan Martin

Cadbury Schweppes' recent victory in the European Court of Justice against the UK's controlled foreign company rules has put tax avoidance firmly at the top of the financial news headlines again, Dan Martin, AccountingWEB business editor, asks members whether it's time to introduce a flat rate corporation tax across Europe.

All companies want to save money. No businesses likes paying taxes and most company owners are likely to jump at any chance which allows them to make profits while legally avoiding contributing to the government coffers at the same time.

It goes without saying that tax avoidance isn't HMRC's cup of tea and its bite has got increasingly sharper over recent years as it seeks to clamp down on the practice, particularly by big businesses. One such method is the controlled foreign company (CFC) rules which aim to recoup UK tax from companies which set up subsidiaries in nations with lower corporation tax rates than the UK. In 1996, Cadbury Schweppes fell victim to the CFC laws as the then Inland Revenue taxed the confectionary giant £8.6 million of the profits made by subsidiaries set up in Ireland, which at 12.5% has one of the lowest corporation tax rates in Europe. Cadbury complained and the UK courts referred the case to the European judges.

Last week, the ECJ finally reached a decision and came out in favour of Cadbury. It ruled that setting up a foreign subsidiary abroad should not be treated as tax avoidance if it is done for genuine economic reasons.

Although the UK courts now have to make the final decision, experts say the ECJ's ruling have significant implications for UK tax avoidance rules. However, critics of big business argue that the government is right to seek receipt of UK taxes on such multinational firms who clearly seeking to avoid payments.

But who is correct? Was the ECJ right in that it is perfectly acceptable for firms to set up foreign operations in lower tax nations if they are doing so for business reasons or is it a reflection of the fact that the UK's level of corporation tax levy is forcing companies to move abroad so it is time to introduce a flat rate across Europe? We put those questions to AccountingWEB members.

Low tax = competition

Several members argued that allowing competitive regimes is part of a healthy global economy. "Competition always produces the best results in the market place," said John Sartoris. "Similarly, the best outcomes in terms of economic efficiency, fairness and democracy result when the ability of governments to raise tax is also subject to competitive forces." He added that this can only happen nation states are allowed to offer competitive tax rates and businesses and individuals can move between them to take advantage. "The failures of controlled economies around the world over the last fifty years surely puts these matters beyond doubt."

Fellow member 'Steven' argued that the consequences of banning low taxes could be catastrophic for the UK. He said: "Ban low tax and tax exemption within the EU and let North America and Asia take our businesses and see our standard of living go down the hill over the next decade."

Also backing competitive international tax rates was 'James S' who said each country has the right to introduce whatever rates it feels appropriate. "Surely if one country wishes to encourage inward investment then it is their right to do so," he said. "A low tax regime is one of the methods of encouraging inward investment." James added that his view of a "harmful tax regime" is the one currently in place in the UK. "Companies are overtaxed and HMRC are overly aggressive for no good reason. This regime is harmful as it drives investment out of the country and over to people with more competitive tax regimes."

Bruce Hogarth-Jones, a solicitor with Essex-based Birkett Long, echoed the words of Lord Clyde who said taxpayers have the right to legally avoiding paying tax. "No man in the country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or property as to enable the Inland Revenue to put the largest possible shovel in his stores," he said. "The Inland Revenue is not slow, and quite rightly, to take every advantage which is open to it under the Taxing Statutes for the purposes of depleting the taxpayer's pocket. And the taxpayer is in like manner entitled to be astute to prevent, so far as he honestly can, the depletion of his means by the Inland Revenue."

No to flat tax

With so much tax avoidance going on, critics argue that a way to resolve the problem is introduce a flat rate corporation tax across Europe so companies remain trading in their country of origin. But for Liz Zitzow, managing director of British American Tax, flat taxes are not the solution. She argued that introducing such a system would damage the operations of smaller solely UK-based businesses. "Flat taxes are regressive taxes. Those with less assets pay a greater percentage of their net worth in tax. This is not fair," she said. "Only graduated tax rates have a possibility of rectifying that situation. The current UK corporate tax is not a graduated rate. The first £10,000 should be tax-free whether your income is £10,000 or £10,000,000."

John Gas believed if a EU-wide flat corporation tax was introduced other countries outside the union would be tempted to offer lower rates to encourage businesses to relocate outside of Europe.

Alternatives

While the majority of members were against a flat rate corporation tax, many believed measures are necessary to prevent blatant tax avoidance.

Accountant Mark Gauden said the big problem are rich and powerful multi-national companies and individuals who are non-resident. These types of taxpayers, he believes, should be given special treatment. Initially however he said each country should be allowed to determine its own domestic tax rates. "On top of these domestic tax rates there should be a cross-border tax supplement agreed by all EU countries - applicable in cases where individuals and companies are visibly active in one country but choosing to be resident tax-payers in a low tax jurisdiction," he said. "Profits legitimately earned (and retained/spent) in a low tax country would not be affected by a cross-border tax surcharge, but those earning in one place and paying tax in a low tax place could be caught."

Gauden said his proposals would have three advantages. "The vast majority of businesses would be unaffected," he said. "Local taxes would continue to be determined locally and immoral taxpayers who think they can be clever and "play the system" to their advantage at a cost to society in general would be targeted."

Liz Zitzow, an opposer of the flat tax, said the answer is to close loopholes. She acknowledged that closing loopholes often results in others being opened but she said it was up to HMRC to stay on top of them. "One method HMRC could use is to send industrial spies with fake UK corporations into hundreds of accountancy firms and see what schemes to get out of tax they are presented with," she added. "If the schemes are illegal, they should be empowered to pull their license to practice right. If the schemes are legal but "unfair", they can recommend changes to the legislation to rid us of that loophole. If we all knew our backs were being watched, some of the crazier accountancy companies out there might think twice before making so-called "clever" recommendations."

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By AnonymousUser
22nd Sep 2006 14:21

hammer blow or damp squib?
Does the Cadbury judgement only have an impact on low tax rates in fellow Member States? Presumably it is not binding on non Member States which have low tax rates (ie the majority of the so called tax havens).

If this is the case, then it would hardly appear to be a hammer blow against the CFC rules - merely a welcome examination of them in order to iron out a few kinks.

I think it is only fair that if you have a bona fide reason for being there, then you shouldnt face the CFC rules, and that the current motive tests are more than a little punitive. It would be nice to think that there might be a re-examination of the motive test and some revised guidance in the form of a statement of practice to look forward to.

Then again I might have totally the wrong end of the stick!!

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By AnonymousUser
25th Sep 2006 09:21

It is suggested above that...
...a flat tax on income is unfair because "those with less assets pay a greater percentage of their net worth in tax".

Of course they do! That is because their Return on Capital Employed (ROCE)is higher. They have risked less assets in their businesses so, if they make the same profit as those who invest heavily in fixed assets, they should expect to pay a greater proportion of their net investment in tax.

There is even an arguable case that,to be fair, taxes on income should vary directly or be graduated with ROCE. That could result in businesses with lower net assets actually paying higher tax than businesses with greater net assets, even if profits were equal(because their ROCE would be higher).

Arguably a reasonably result because the tax take then reflects the risk in investment in the business (greater risk, lower tax; lower risk, higher tax).

But it is the complete opposite of what is suggested in the article above!

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