Why corporate tax needs reform

Margrethe Vestager © Getty images
Margrethe Vestager: provoking fury

Apple faces a €13bn tax bill after Brussels ruled its tax arrangement broke European law. Does this spell the end for tax-dodging by multinationals? Simon Wilson reports.

What exactly is Apple accused of?

The European Commission (EC) hasn’t accused Apple itself of breaking any law. And Ireland’s government is content with the amount of corporation tax the firm is paying. The problem is more a case of whether Ireland was right to be satisfied with that.

The EC thinks it wasn’t: Margrethe Vestager, the competition commissioner, stunned Apple, Dublin and the US government – all of whom are furious – by ordering the Irish government to recover a mammoth €13bn in back taxes from the tech giant, on the grounds that Apple’s “sweetheart” tax arrangements in Ireland since 1991 amounted to illegal state subsidies under European Union law.

Is Vestager right on corporate tax?

That will be for the courts to decide, in what most expect to be years of expensive legal wrangling. It is certainly true that Apple, with its superabundance of intellectual property and intangible assets – the kind that are much easier to shift around to game the system – has been a world leader in exploiting the gaps between national tax jurisdictions. The current spat centres on two Irish-registered subsidiaries that hold the right to use Apple intellectual property to make and sell its phones and computers in the world outside the Americas.

The EC says that a stitch-up between Apple and Dublin allowed most of the profits to go to a “head office” that only existed on paper, and meant Apple paid tax in Europe of less than 1%. In Ireland itself, it says Apple’s effective tax rate in 2014 was virtually nil (0.005%).

What does Ireland say?

The government is seething – and worried. Michael Noonan, the finance minister, says the EC demand is “bizarre and outrageous” and that he would rather “defend the integrity of our tax system” than accept a $13bn windfall – a sum that exceeds Ireland’s annual healthcare budget. In effect, Ireland has been accused of being a giant tax haven. That charge has the potential to threaten the country’s entire economic development model, which is unusually dependent of foreign direct investment (it’s second only to Singapore in terms of FDI per capita).

Apple first arrived in Cork in 1980, opening a small factory with 60 workers. Now that factory employs 6,000 people; Microsoft, Intel and Pfizer also have substantial operations in the country, and Google and Facebook have their international headquarters in Dublin. There are 700 US companies in Ireland employing 140,000 people (in a country of less than five million).

So this is about reputation?

Yes. In the case of Ireland, it’s about protecting its reputation as a legitimate low-tax regime in the face of a complex collision between competition law and tax law. In the case of Apple, and similar companies, it’s about trying to keep its profits out of the clutches of the US taxman, where the average combined rate across the various states is 39.1% (compared with Ireland’s 12.5%), while not actually stepping over the legal line. But in a broader context, the Apple/EU case is about the fact that it is getting ever easier for companies to disguise where their profits are being made, and harder for national governments to keep up.

The share of corporation tax (as a proportion of overall tax take) has slumped from 32.1% to 8.9% in the US since 1952. In the UK it has fallen from 10% to 6% since 1989. That suggests that companies are getting better at bending the rules – avoiding tax – even if they are sticking to the letter of the law.

Can’t they be shamed into paying up?

There has been much discussion in recent years about “tax shaming” and tax as a moral issue rather than a legal one. Large numbers of companies that comply with the letter of the law have been accused of not complying with the spirit of it, and found themselves pilloried in the media.

It is naturally very frustrating for UK firms who uncomplainingly pay large tax bills – not to mention individual taxpayers – to see multinationals avoid doing so. But again, the power to bring about change lies with policymakers, not business leaders. Companies are accused of acting unethically for taking advantage of tax loopholes, but they might argue that politicians are to blame for permitting those loopholes.

What’s a better solution?

People and companies should, of course, be ashamed of evading tax, argues Tim Harford in the FT earlier this year, but “a system that is driven by public shaming has gone badly wrong. Shame is an uneven incentive; it may keep celebrities, politicians and consumer brands in line, but less prominent figures and corporations will escape censure.”

Moreover, there is more to good tax design than closing loopholes. The long-term solutions surely lie in overall lower tax rates on a broader base within a simplified system and exceptions eliminated – together with multilateral reform of the global tax system of the kind being pursued by the OECD. In the meantime, companies will increasingly have to factor in the “front-page test” when working out how to keep both the taxman and their shareholders happy.

Britain’s tough new tax rules

It’s not just big business that’s facing a more rigorous approach from policymakers. Britain’s tax professionals – accountants, lawyers and financial advisers – are “firmly in the taxman’s sights”, says Emily Cadman in the Financial Times. Last month HMRC published its long-awaited proposals for a clampdown on professionals who facilitate aggressive tax avoidance. If approved, the new regime will include new punishments for individuals and firms involved in designing, marketing or facilitating avoidance schemes that are later “defeated” by HMRC.

Ominously for the avoiders, tax campaigners warmly welcomed the move, while John Cullinane of the Chartered Institute of Taxation warned of the risk from rules that prevented taxpayers “getting access to honest, impartial advice on the law”.