President Obama wants America to clamp down on businesses avoiding their taxes.Can he succeed? And how big a problem is it anyway? Matthew Partridge reports.
What's going on?
Last week, President Obama outlined a proposed major reform to the US tax system. At the moment, America only taxes its companies on their domestic earnings. The result is that companies have tried to take advantage of this by using schemes such as transfer pricing to shift all their profits overseas (see belowfor how this works). Not only does this depress tax revenue, it also gives companies a perverse incentive to keep their money abroad instead of bringing it back to America to invest, since they get taxed at 35% the moment they bring the money back into the US.
Obama's plans would institute a 14% one-off tax on money held abroad, followed by a long-term 19% tax on future foreign profits. The domestic rate would be cut from 35% to 28% to make tax avoidance less attractive. To avoid firms having to pay tax twice on the same set of profits, they would be allowed to deduct 85% of the tax paid to foreign countries. The new tax would therefore create an international minimum corporate tax.
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Will the changes happen?
Most experts agree that Obama's proposals stand little chance of becoming law, at least in their current form. This is because Republicans control both parts of Congress and have already signalled that they oppose his plans. The most that is likely to be achieved is an amnesty that allows firms to bring back foreign cash to America at a lower rate of tax. But even this could backfire if it encourages firms to hoard more cash in the future in expectation of future amnesties.
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However, there is growing agreement that something has to be done to deal with the growing problem of corporate tax avoidance. As late as the mid-1980s US firms paid nearly 40% of their earnings in tax. Since then the effective rate has plunged to just above 20%. Some people have estimated that, if you consider only profitable firms, the figure is barely 10%.
Is this a global problem?
Some critics of American tax policy argue that America has a particular problem because it has one of the highest corporate tax rates in the world, encouraging avoidance. However, other countries with much lower rates have similar problems, suggesting tax rates are not the major cause. Despite the fact that the UK's tax rate is only 21% (for firms with profits above £300,000), a large number of successful firms pay little or no tax.
How much tax are firms ducking?
One of the most high-profile cases was Starbucks, which paid only £8.6m in tax over 13 years, despite receiving revenue of £3.1bn during that period. Google has also come under fire for paying only £3.4m on UK sales of £2.5bn in 2011. Overall, the Inland Revenue thinks that the corporate tax gap the difference between tax it thinks should be paid and actual receipts is £3.9bn. However, there is a great deal of dispute about this figure.
Richard Murphy of the Tax Justice Network claims that as much as £12bn could be lost through corporate tax avoidance. The Institute for Fiscal Studies agrees that the taxman's figures are probably an underestimate, but says that estimates such as Murphy's take no account of legitimate tax reliefs and consequently "are likely overstated (possibly by a wide margin)".
What can governments do?
Governments across the world are forcing firms to disclose more information about where they make their money and clamping down on some of the most aggressive avoidance schemes. The US Securities and Exchange Commission is forcing all US-listed companies to declare where they generated their revenue. The idea is to make it easier for tax authorities to spot discrepancies between the location of sales and profits.
The UK government has bought in the Diverted Profits Tax (known as the 'Google Tax'). This aims to tax profits generated in the UK, but booked overseas, at a rate of 25%, giving firms an incentive to behave honestly. However, there are concerns that unilateral measures may lead to a patchwork of laws and encourage retaliation.
Should we scrap corporate tax altogether?
Some people argue that trying to stop corporate tax avoidance is impossible because business will always find ways to avoid it. They claim that it would be better to replace it with other forms of taxation, such as a sales tax, or a tax on land.
Accountancy firm PricewaterhouseCoopers says this may already be happening in the UK, calculating that corporation tax has fallen from half of all tax paid by the 100 largest companies to just a quarter in the last decade. But that could mean that some of the foregone tax would end up being indirectly paid by consumers and workers through taxes such as VAT and employers' National Insurance thereby worsening inequality.
How international companies avoid tax
"Transfer pricing" is one of the most common ways for aglobal company to avoid tax. The term refers to the way acompany accounts for transactions between subsidiaries indifferent countries, which can be adapted to shift revenuefrom a high-tax country to a low-tax one.
For example,Starbucks buys all the coffee used in its stores through aSwiss subsidiary. Critics say that this is done at an inflatedrate, which cuts the stores' profits and generates a huge gainfor its Swiss trading arm. Switzerland's low corporation taxrate ensures that the overall tax paid by Starbucks is muchlower than it would be otherwise. While tricks involving tradedgoods, such as coffee, are often obvious, those based onintangible assets, like intellectual property, are harder to spot.
