Last updated: October 2015
A fair tax for a fair profit
With tax justice increasingly coming to the fore in debates on corporate responsibility, Ethical Consumer asked our correspondent Richard Murphy“How do you spot a company that’s got an ethical tax policy?” Here he braves an answer.
Three people have asked me this question in the last month. Once may be chance, twice a coincidence but three times demands a response. You, trusty readers of Ethical Consumer, are the guinea pigs for formulating that reply.
The candid answer to this question is that it’s hard to do so.
First, some facts. There are about 2.8 million companies in the UK at present. Of those about 500,000 record themselves as ‘dormant’ i.e. not trading at any time. Of the rest – and this statistic is shocking – HM Revenue & Customs get a tax return from just over half each year.
When I last researched the issue in 2010 just under 1.2 million companies actually submitted a tax return out of about 1.8 million that were asked to do so.
Of those companies that did submit a return less than a million paid tax. The evidence therefore suggests that HM Revenue & Customs find it hard to work out who should file accounts, let alone who owes tax. Given that’s the case the problem for the rest of us is doubly hard.
That’s not helped by the fact that while there are about 2.8 million companies currently, in the last two years only around 2 million of them filed accounts with the Registrar of Companies. It seems the rest did not bother.
The problem of missing data about companies is, as a result, of staggering scale, and is seemingly being ignored by the government.
Regulation is also a problem: it is now possible for many companies to avoid filing a profit and loss account on public record – and that’s the report we need to assess tax paid. Over 60,000 companies took advantage of this exemption last year. However that still leaves (having allowed for dormant company accounts, where by definition no tax will be paid) 1.6 million sets of accounts that could show a tax charge arising in the UK each year.
How do we tell if they’re paying a fair rate of tax?
It’s still not easy when we have the accounts! Admittedly it’s much easier to tell for a UK-based, small company than it is for a multi-national group. In the case of a UK company what we’re looking for is tax being paid at something close to the the company’s declared tax rate on its profit and loss account – 20% right now for most companies.
It will almost never be precisely that. That’s because some expenses, properly incurred by the company, may not have tax relief allowed on them while some expenses incurred might be given more tax relief than is subject to the equivalent charge in the accounts (e.g. buying new equipment).
That can sometimes be adjusted for through something called “deferred tax” – which is a black art of accounting little understood by most accountants and almost impossible to explain to the lay person. It’s best ignored.
As a result, the relevant ratio we’re looking for is the current tax charge (usually disclosed in a note to the accounts) as aratio of pre-tax profit. It is not the ratio of the tax charge on the face of the accounts to pre-tax profit, which includes deferred tax.
So, if the ratio we find is about 20% then all may be OK. If it’s wildly different – up or down – then questions need to be asked.
There can be valid explanations!
For example, there could have been lots of investment in equipment, or the company may have been loss making in the past and thus allowed to offset those losses against current profits. Both are totally fair. Explanation has to be allowed in any fair appraisal system, but the important point is nothing can be taken at face value.
And that’s the easy case.
Larger, and especially multinational companies, are much harder to appraise for two reasons.
- First of all they have no legal duty to tell us how much tax they pay in the UK. They did until 2005, but not now. The figure for tax they need to disclose is a worldwide one – and given the multiplicity of tax rates around the world and the fact that they do not need to tell us where they make their profits (they simply need to tell us how much they make in total) that worldwide data can be pretty meaningless as a basis for assessment.
- Second, we know that multinational corporations can shift their profits around, if not at will then with relative ease, to exploit places like tax havens. That means high profits need not result in high taxes.
So what do we do about that? Well, three things, I suggest.
- Firstly, we should look at the overall rate of current tax that they pay, as for a small company. The UK headline rate now is 26% but is falling steadily and will be 23% by 2014. We’d obviously look for a company to be paying current taxes of something like that – although my research suggest that to pay at least 5% to 7% less than the headline rate is now normal. These companies have to explain, in theory, why they don’t pay the current rate of tax in their accounts. Unfortunately, since the reconciliation includes deferred tax – and as noted,that’s incomprehensible in most cases – that makes the reconciliation virtually useless all too often. That means that for many multinational corporations the headline rate of current tax paid to pre-tax profit is all we have to go on.
- Secondly, we could ask multinational companies for further analysis, to address these complexities. That could include a request for individual country data, for the UK, for example. But there’s no need for them to supply it, so that may just be wishful thinking.
- Thirdly i suggest that we use whatever other data we can get. And the best ‘other’ data there is is the list showing each and every company they own and where it is located – this list should be filed with its accounts or annual return and sent to the Registrar of Companies each year. We know that not all companies comply with this legal requirement. But if they do, this data can, when matched with data on their profits, let us prepare an index of what their likely tax compliance is.
Given that tax avoidance, by its nature, sets out to be opaque, how would such an index rate the likelihood of tax avoidance?
Multinational corporations do, of course, need a trading company in every country in which they operate. So we should allow them a company anywhere, no questions asked. But after that they’re creating complexity. So all additional companies should count in this index, but the count should be weighted.
They should logically have most companies where most of their customers are. At least, that’s what we’d expect if the subsidiary companies were created for sound commercial reasons. So we should weight each company in each country (after excluding the first one in each case) by dividing the country’s population by the number of companies the multinational corporation has there. One company in Germany (pop. 81.8m) would give a very high score. One in the British Virgin Islands (pop. 27,800) would give a very low score.
Then we should use an inverse of these ratios – we’re looking to score places where companies should not be after all – so now we get very high score for tax haven locations, and low ones for genuine operations. The stats may need to be played with a little – but we end up with a weighting. And that weighting can then be added to the one on tax paid to give a measure in two parts.
The first part is how close the current tax rate is to the expected headline rate. And the second is a measure of how likely it is that the use of artificial structures, that can’t be explained by legitimate commercial need, have influenced that tax rate. That will let us assess how likely it is that the multinational corporation is tax avoiding.
My suggestion is not straightforward. No one has ever done anything like this. And it will take a little work to prepare – and some serious thinking to make it work. But do this and we have a real chance f getting some really good indication of who is, and is not, making an effort to be tax compliant.
I wonder, are you still with me? And if so, do you think this would be useful?
Richard Murphy is founder of The Tax Justice Network and blogs at www.taxresearch.org.uk. His new book ‘The Courageous State: Rethinking Economics, Society and the Role of Government’ is available from www.searchingfinance.com