Corporate Tax 2023

Tax in the News – Again

As before, in the introduction to this excellent guide providing a truly global picture jurisdiction by jurisdiction, we look at the issues around corporate taxation from a UK perspective, the UK sitting (as it does) between the US and mainland Europe and being subject to influences from both directions. We hope, however, what we have to say will resonate in other major trading centres and be of some interest to others as well.

Against the background of UK elections where political parties had firmly denied the existence of a “magic money tree” to fund calls for government spending, the fact that nearly all governments across the world were able to fund additional costs during the pandemic simply through borrowing seemed too good to be true. The consequences of the troubles in Ukraine have now tested that to the limit and raising tax to pay off debts is again in the political headlines.

Against this background, global tax competition is inevitable. A difference of only 5% in corporate tax rates on net profits can make a big difference to the net present value (NPV) of the return from a new plant, etc, when investment decisions are being taken. The corporate tax take from the new plant itself may not be huge but there will be savings and tax from increased employment and other local financial benefits so no wonder the competition is fierce.

In this area, however, the EC is trying to resolve its own conundrum of not being a fiscal unity but being concerned that there is fair play on tax between its members. The bigger EC countries (where rates tend to be higher) are also not going to be particularly enthusiastic to bail smaller countries, many of whom have been particularly aggressive on corporate tax rates, out of trouble in the event of another financial crisis.

For all those reasons, the EC is enthusiastically supporting what Pillar 2 has become in order to temper what might otherwise be competitive over-exuberance within the trading bloc.

It is, of course, idle to speculate whether, if the 1960 Treaty of Rome had had a 60 year sunset clause, the negotiators of a replacement treaty would now be filling it with tax provisions.

Certainly, it would be widely understood that State aid is clearly contrary to the principles of fair trading within the EC – and that tax practices (whether discriminatory laws or discriminatory tax administration) can amount to State aid.

But the basic principle of allowing jurisdictions to compete with each other purely on the basis of tax rate would probably not have troubled the 1960 negotiators or those who think that tax competition should end at the State aid boundary.

Anyone, however, who bet against a current drafter not filling a new treaty with a raft of other tax provisions would be taking a different view on the EC’s current understanding of its role in relation to corporate taxation from that seemingly prevailing in Brussels.

Despite the fact that both Pillars have transformed themselves into something else since the OECD’s project started, and that taxing the world’s biggest IP-owning companies under Pillar 1 seems destined to be left on the backburner (despite the fact that countries with a large consumer market, such as the United States, may well stand to make more than they lose as a result of additional taxes being imposed on the foreign operations of their multinational community), Pillar 2 seems likely to be a modified success. The result of that is that we will have continued confusion as individual countries enact their own digital tax measures. The USA will not join in because of the conflict over global intangible low-taxed income (GILTI) but that probably does not matter.

The EC’s increasingly active tax team seems to have brought Ireland on board as regards the 15% rate and is enthusiastically pressing on with an EC-driven Pillar 2. The UK is likely to move in parallel with that.

But all that will do is put a limit on the financial saving available through tax competition. Subject to State aid rules, jurisdictions will still be able to introduce special measures to promote activity or to reflect their own jurisdictional circumstances.

Is this a bad thing? No. Fiscally independent countries should be able to compete with each other for inward investment in whatever way is appropriate – whether that is with their geographical advantages (being on a trading route, having natural resources etc), human resources and capability (a good education system for example) or developed communication or other infrastructure. Tax should be no different from that.

Just as the energy companies around the world understand and have learned to cope with the fact that they have to pay a high price in the form of taxation to extract resources from the jurisdictions in which they operate and the shipping industry and property investors have become used to the fact that there will be special tax measures to encourage them, so people will look at tax as one of the factors to take into account when considering making an investment in any jurisdiction.

The tax rate itself (and even the calculation of the tax base) are almost never the decisive factors in the final analysis – lots of other things will be much more important (not least whether or not you are going to be able to make the profits on which you will pay tax). But it can result in a jurisdiction being crossed off the list early in the process as a potential investee location. If tax is a major differentiator when other things seem more or less equal, that can narrow down the work to be done quite quickly.

That is why it was surprising that, having followed a downward path since 2010, the UK government decided to push corporate tax rate back up to 25%. There are many in the UK who questioned that decision – the difference between 15% in Ireland and 25% in the UK is a marked one, particularly for many US multinationals, when the gap between Ireland and the UK has narrowed on many other fronts.

Compared with the much bigger yields from income tax, VAT and social security taxes, corporation tax is not so significant in the UK. It is not clear why HM Treasury has decided to row back on its “lowest tax rate in the G7 policy”. It is said that there is not a huge amount of evidence of the low tax policy having worked to bring investment to the UK but there are more and more noises that it is discouraging people from making investments here and it would be a shame if other countries got ahead of the game.

As already mentioned, the UK has, in living memory, had to bring in special measures to deal with shipping companies and property investment companies to address the tax deterrent effect of tax competition elsewhere – investment in bio sciences is currently under the magnifying glass for similar reasons. At the same time, however, it has to be recognised that factors other than tax will drive investment to a jurisdiction despite marginal tax rates.

The presence of natural resources is a matter of history or geography in just the same way as having a good education system or good transport infrastructure. The UK financial sector has not suffered as much as many were predicting as a result of Brexit. Taxable profits have certainly moved out as trading has had to be relocated to market jurisdictions in the EC but the fundamental business operations are still in the UK.

With tax rates now having an effective 15% floor, avoiding double taxation of the same profits is going to be even more important. So, jurisdictions would be wise to focus more effort in the mutual agreement procedure (MAP) area and make sure that they can say that potential double taxation issues with other jurisdictions are now quickly and fairly resolved. The OECD league table will become a mark of pride.

That will, of course, improve domestic administration in its train because any respectable competent authority is not going to want to take an unreasonable or unprincipled opening position in discussions with an overseas counterpart. The result of that is going to be that its own judgement will be called into question because it may be seen to be supporting the indefensible.

So tax competition is still around, is generally a good thing and can bring administrative improvements in its train.

Other issues on the mind of corporate tax advisers around the world at present are likely to include the following.

• Transfer pricing – as the impact of the BEPS reforms work their way through the system and jurisdictions fight for their “fair share”, transfer pricing issues will, inevitably, arise. There is more evidence now that jurisdictions are working bilaterally so that nothing drops between the gaps. Investigation techniques have improved but come with some concerns that an efficient and effective enquiry now that opens up prior years that were perhaps not so rigorously looked at will not be popular in any circumstances.
• The allocation of profits to permanent establishments – in particular in the return on capital and IP/other intangible assets areas. Whether a risk return belongs in jurisdictions which only have legal ownership and less than full substance is obviously a vexed issue.
• The tax consequences of remote working and more flexible employment habits – where temporary relaxations during the pandemic are now going to have to be considered.
• Whether, in a generally higher corporate tax world, dividend withholding taxes should be re-examined. Countries such as the Netherlands have been a particular focus for this.
• Tax administration more generally and how countries get the balance right between efficient and effective tax collection on the one hand and encouraging inward investment on the other.

Life in the corporate tax world is never dull.