Corporate tax has rarely received as much attention, either from policy makers or the public, as in recent years. The coalition government has enacted a series of policy changes including reductions in the main and small profits rates, changes to capital allowances, the introduction of a preferential rate for patent income (Patent Box), changes to rules concerning the taxation of foreign income, and a raft of anti-avoidance measures. The explicit, and fulfilled, aim was to increase the competitiveness of the UK corporate tax system.
The net cost of the package of onshore measures is almost £8 billion in 2015–16, equivalent to a substantial 16.5% of real pre-crisis (2007–08) onshore corporation tax receipts. This net giveaway contrasts with an overall net takeaway from tax measures of £16.4 billion. In terms of individual tax measures, only increases in the personal allowance (at £8.0 billion) represent a bigger giveaway than the £7.6 billion cost of cutting the main corporation tax rate by 8 percentage points. We examine corporation tax policy changes and their effects in a new Election Briefing Note,which is published today as part of the IFS election 2015 analysis, funded by the Nuffield Foundation.
It has long been recognised that corporate income taxes can distort incentives in a number of harmful ways, and they are thought to have a particularly damaging effect on economic growth. The income and activities of multinationals are particularly mobile and responsive to the tax rate. A lower rate works to reduce the impact of distortions and increase the attractiveness of the UK as a location for investment. The 20% headline rate that will come into effect in April is more internationally competitive than the 28% rate inherited in 2010; it will be the joint lowest in the G20 and the joint 6th lowest in the OECD (compared to the 9th lowest and 23rd lowest respectively in 2010 ). The introduction of the Patent Box also makes the UK system more appealing for certain kinds of mobile income, while changes to controlled foreign companies rules (as well as the previous move to an exemption system for foreign source income) have made the UK more attractive as a location for multinationals to headquarter in.
However, the UK’s corporate tax base continues to embed a number of distortions – including a bias in favour of debt financing – and offers a set of capital allowances that are ungenerous by international standards, and that have been made less generous by the current government. Taken together, the changes since 2010 work to reduce the tax burden significantly for profitable companies and those that are internationally mobile, while expansions of the tax base disproportionately harm firms that invest heavily in plant and machinery.
One concern may be over the distributional consequences of the cuts to corporation tax – that is, which groups are likely to benefit most. Corporate tax cuts may be seen as a ‘tax break for big business’. However, it should be noted that the burden of taxes is ultimately on people rather than companies and the burden of corporation tax is not necessarily borne by shareholders (through lower dividends). It can also be borne by workers (in the form of lower wages or employment) or by consumers (in the form of higher prices). Indeed, the relative immobility of labour means that we might expect a substantial share of the burden of corporate tax to be on workers. As such, lower corporate taxes may feed through into higher wages in the medium term.
Corporate tax avoidance has been the subject of considerable public and media criticism in recent years. This has included a number of high-profile media case studies that ‘name and shame’ specific multinational companies. While reforming the corporate tax system to help entice multinationals (and their income) into the UK, the government has at the same time sought to crack down on avoidance activities. In 2015–16 the government expects all corporate tax anti-avoidance measures announced since 2010 to raise a little over £1 billion. This includes expected revenues of £270 million (and £350 million a year thereafter) – less than 1% of corporation tax receipts – from the new diverted profits tax (popularly dubbed the “Google tax”). The total revenue lost through corporate tax avoidance, though presumed large, is uncertain. These measures, which raise relatively little revenue going forward, reflect the government’s attempts to unilaterally reduce avoidance activity.
Multinational tax avoidance is a problem best tackled through international cooperation. The coalition government has supported the OECD’s Base Erosion and Profit Shifting (BEPS) project, which is considering what actions can be taken multilaterally to reduce avoidance opportunities and will conclude at the end of 2015. BEPS is an impressive project that is tackling a broad range of issues on a timescale designed to take advantage of political momentum. The BEPS process is effectively seeking to ‘patch up’ the current system rather than provide any fundamental reform. However, as such reform appears unlikely, especially in the near future, the BEPS process is a sensible development.
Despite a flurry of activity in the area of corporate tax policy over this parliament, challenges remain. In our briefing note we discuss: the need to maintain a competitive tax system in an international environment (where the concept of a “competitive tax system” is a moving target); the continued challenge of tackling avoidance (including any recommendations that arise from the BEPS process); the desirability of reforming the tax base to reduce economic distortions. We also discuss issues raised by the decision to devolve the setting of corporation tax to Northern Ireland from April 2017.
Corporate tax is a complex policy area in an evolving international context; any future changes to corporate tax will likely require balancing the desire to be competitive with the aim of cooperating with international efforts to make the system work better for all countries. The policies that one country views as creating a competitive system may be viewed by another as creating an opportunity for avoidance.