What next in tax?

Richard Murphy speculates on future taxation policy based on an uncertain economic climate.

{mosimage}Introduction

I was at the joint CIOT / HMRC conference on the future of corporation tax a couple of weeks back. An invitation only event, it started on the day the US announced a $700 billion package to bail out their banks, having nationalised AIG and let Lehman Brothers fail in the previous week. So you would have thought those present (many from financial institutions) would be focussed on the future.

I have to say they weren’t. I was disappointed. It was clear HMRC and the Treasury were willing to embrace the consequences of what was happening in the City more readily than those in the commercial tax world. I’ll leave speculation for that aside, not least because the conference was under Chatham House rules and I am not therefore allowed to attribute comment.

What I can do is speculate on what that future might be, even if the City may still be too shell shocked to do so. I’m going to suggest three things. The first is that it is now very obvious that we live in a global and massively interconnected world. That is going to have an effect on tax, sooner than we think. The second is that changes in regulation will impact the way in which tax works. The third is that the downward trend in corporate tax rates is going to end.

They’re contentious ideas, and of course they may be wrong, but right now they seem a lot more relevant as a focus for discussion than continuing debate about residence, domicile, capital gains, transfer pricing minutiae and the detail of residence rules which seemed the focus of attention of those present.

Global taxation

The contagion that spread so rapidly through the financial markets in early September revealed the absolute interdependence of today’s financial markets. It’s not just that they’re related. They are really one and the same thing. Despite that, we have corporate taxation apparently moving inexorably towards a territorial basis.

I can’t see that trend lasting for one simple reason. The US is bearing the brunt of the cost of the bail out of the world’s financial system. That cost is huge. Whatever has been published it will probably cost more than anticipated. These things have a habit of going that way, as we all know. In that case no new President of the USA is going to deliver any programme they have promised if they can’t raise tax.

Tax rises come in two ways. One is the rate. The other is the base. In August 2008 the US Government Accountability Office issued a report on the effective tax rates paid by US multinational corporations.  http://www.gao.gov/new.items/d08950.pdf In it they noted:

The average U.S. effective tax rate on the domestic income of large corporations with positive domestic income in 2004 was an estimated 25.2 per cent. The average U.S. effective tax rate on the foreign-source income of these large corporations was around 4 per cent, reflecting the effects of both the foreign tax credit and tax deferral on this type of income.

It doesn’t take a genius to realise that when the need for revenue increases this disparity is going to be noticed. I cannot see that increasingly tolerant regimes for foreign profits are likely in that circumstance. Nor can I see much room for tax competition in the years to come. Tax cooperation looks much more likely.

Changes in regulation

A recurring theme of comment on the credit crunch is the need for regulatory reform. I’m fairly sure that most who are saying it have little idea what they mean as yet, but a recurring buzz word is transparency. What has been off balance sheet is to go on balance sheet. What has been offshore is to come onshore. What has been hidden in deep dark subsidiaries may be made more prominent.

Of course, all of this may be forgotten depending upon the course of events. If the entire banking system has failed by the time you read this (and nothing seems impossible right now) then worrying about such things may be pretty inconsequential. Assuming that won’t happen, increased transparency may have much the same effect as broadening the tax base. If tax authorities know more, then expect them to either tax more, or to think about how to tax more (which aren’t quite the same thing: the first does not need new legislation, the second does).

I will be astonished if those who will be looking at regulatory reform do not look at the tax consequences.

Tax rates

And then there are tax rates. According to KPMG, http://www.kpmg.co.uk/news/detail.cfm?pr=3166 the average corporation tax rate in the world fell from 26.8% in 2077 to 25.9% at the start of 2008. That continues a long running trend which many, KPMG included, would like to see continue. I suspect their hopes will be dashed.

Countries all over the world are facing the cost of bailing out their banks. Those banks are not going to be the most popular institutions on the planet when the dust settles down. Being realistic, there seems little or no chance that some of the cost that their bail-out will create, will not be recouped from them. In that case three things are likely. First, the falling trend in tax rates will stop, and maybe reverse. Second, they, in particular, will have their tax rate scrutinised. Differential rates for financial services are now commonplace in tax havens. Why not here?  Third, expect measures to attack their offshore activity in particular and to bring it within the UK tax base.

And finally

One final thought: all this may be irrelevant given the raft of tax losses that will be floating around. But in that case expect some limitations on their use as well. It’s highly unlikely that legislators are going to bail out banks and then let them claim the value of their tax losses. That’s a double subsidy I can’t see happening.

We’re heading for interesting times.

Article Added Friday, 03 October 2008

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