Is it possible for taxation of corporate profits to be 'fair'?
Taxation of corporate profits is usually economic double taxation because profit derived from companies is usually taxed (ISAs aside) in the hands of its eventual recipient, as dividend income or as capital gains following the sale of the shares. Nevertheless, as I set out in a previous post, Governments do have to impose tax charges on companies and similar artificial legal persons on, at least, an annual basis to prevent hoarding.
The question is, what does fair taxation of companies look like, and does it have to be based on the same concept (taxation of profit) as for sole traders? In considering this question I am not considering taxes collected by companies from their employees (like employees' national insurance contributions) or customers (like VAT). I am considering where the balance should lie as between employer's national insurance contributions, corporation tax, business rates, irrecoverable VAT, bank levies, petroleum revenue tax, and the like.
The concerns of 'fair tax' campaigners, when looking at multinational corporate profits, can be analysed any number of ways but the two main issues aired in this country are firstly whether the developing world is getting a raw deal from the developed world; and secondly whether the UK is getting a raw deal from US-based multinationals. There appear to be particular difficulties with the taxation of multinational companies operating largely or wholly in the digital sphere.
Current tax systems are still often set up to tax economic transactions largely by reference to a physical presence. This is a problem now because corporate profits are no longer necessarily made by the exploitation of labour and the production of tangible things (both of which require physical presences and so are relatively easy to tax). These days the megabucks are made by machines, and a small cadre of expert and highly remunerated staff, who create and exploit intellectual property and allocate capital.
A part of the current public debate about whether companies, particularly multinational companies, pay a 'fair' amount of tax could be seen not as a dispute about economics (as I pointed out in a previous post, we all know who eventually carries the burden of tax imposts) but an ideological dispute about where the balance of taxation should fall as between capital or labour. But this ideological dispute doesn't don't fit very well with a digital economy, particularly one where many of the inputs are provided voluntarily.
Take Google. How are its revenues created? It appears that most of the revenue is gained by virtue of an algorithm which matches search queries and email text to advertisements. The advertisers pay Google in the hope that the person who inputs the search term will buy their products once the advert is displayed to them. Tax systems tax the payments the advertisers make to Google. Labour theory of value suggests that the value of a commodity is only related to the labour needed to produce or obtain that commodity. What is the commodity here? For the consumer, it is search results. For the advertiser, it is sales. For Google, it is money derived from the advertiser. The algorithm that matches the search results to the advertisements was written in the US. So should all of Google's revenues therefore be taxed there? I suspect that is not the result 'fair tax' campaigners want.
An alternative analysis was put to me a few weeks ago by a 'fair tax' campaigner who suggested that much of the value of Google is created by individuals inputting search queries into their computer, thereby enabling Google's algorithms to match them with advertisers, and that the tax authorities of countries where Google offers the search capability should be allowed to tax Google on the value that is created by those unpaid inputters of data.
The challenge is that there is no economic transaction between the inputter and Google on which a tax charge can be levied- because both company and individual are providing the service voluntarily and for nothing. It is only at the point of an economic transaction that you get an exchange that involves an assessment of value. It is at that point that taxation is levied. (It is possible to levy VAT on me, and levy profit tax on the seller, when I hand over money to buy a computer. But it is not possible to levy VAT on me, or levy profit tax on the seller, if I decide not to buy a computer, or if someone gives me a computer.) Nor can we 'transfer price' the gratuitous exchange between the individual who inputs the data and Google, since transfer pricing rules can only be applied between connected parties where there is an exchange for value, and not between wholly independent economic actors where there is not an exchange for value. (Think about what would happen if it was otherwise. Taxation could be levied on a notional transfer of value as between me and Mr. Jones (my elderly neighbour) because Mr. Smith (my somewhat younger neighbour on the other side) makes me a cake to reward me for cutting Mr. Jones's front hedge.)
To get round that, governments would have to require that users of Google should be paid (by Google) to search. This is not unknown as a concept- Bing offers payment for search from time to time as a promotion. But the practical effect of forcibly monetising what is currently a gratuitous and, most people would accept, fair exchange of consumer data for a service creates a whole host of further problems. Google makes about $12bn a year in profit. That's an average of barely more than half a cent for each of the two trillion searches a year that are carried out on its search engine. Google has about a billion unique users. If it had to make payments to users, even on an annual basis, and even with a minimum cut off, the compliance costs would be mind-boggling. In the UK, it is possible that a Google user would have to file a tax return, even if they had no other non-PAYE taxable income, because their repeated use of Google (thereby deriving a revenue) might fail the 'badges of trade' tests. (I do about forty Google searches a day. I would not want to try to convince HMRC that more than 14,000 small transactions a year did not constitute a trade.)
I am forced to conclude that coming up with a 'fair' system for multinational companies that make money from third parties rather than directly from consumers is fraught with difficulty.
My conclusion, then, is that if we are to continue to tax companies on 'profits' then a globally agreed formulary apportionment (so much value assigned to sales, so much value assigned to staff, so much value assigned to premises) is the only 'fair' solution. Within the EU there have been efforts in this direction for decades but the Common Consolidated Corporate Tax Base project has been moving at glacial speed over the past decade. Countries do not wish to surrender tax sovereignty and that is required for formulary apportionment to work. It would be foolish to hope we could achieve a globally acceptable formula in my lifetime.
So, perhaps the time has come to abandon corporate profits taxation. This is NOT a suggestion that less tax should be paid on corporate activity than is currently paid. But it is a suggestion that we should be thinking about taxing companies on what they consume (labour, resources, energy) wherever they have a physical presence and what they sell (a sales tax on products tangible or intangible) wherever the buyer is located. Rather than by attempting to capture a proportion of some fleeting (and malleable) concept of 'profit'.
Such an approach would have a number of advantages. Firstly it would tend to make tax revenues more stable over time (it is in the nature of capitalism that most companies swing from profit to loss and usually do the latter- and so pay no profits tax- at a time that is inconvenient for cash-strapped governments). Secondly it could be adopted by countries on a unilateral basis without having to wait for an international consensus to emerge (which might take many decades). 'Fair tax' campaigners have expressed the concern to me that such a system makes it more difficult for small enterprises to get off the ground because of the cash flow difficulties caused by a sales tax. But it would be straightforward to exempt SMEs with a turnover of less than, say, £20,000 a quarter from the sales tax. That's what we already do with the VAT regime.
Meanwhile the UK government has been extracting more and more tax from companies through taxes on labour and indirect taxes- the levying of which other taxes obviously has the effect of depressing taxable profits. The recent PwC Report 'Total tax contribution and the wider economic impact' noted that for the 100 Group of companies (a useful proxy for multinationals) £2.86 was paid in other business taxes for every £1 they paid in corporation tax. The ratio was 1:1 as recently as 2005. Indeed, corporation tax is not even the biggest single tax on such companies any more- the crown goes to employer's national insurance contributions. And there is evidence that this is being replicated around the world- OECD statistics show a declining trend in the percentage of total tax revenues accounted for by taxes on income, profits and capital gains. So what I am floating as an idea- which is that we abandon corporate profits taxation- may sound radical or unusual but it is neither. In reality it is already happening.
The concerns of 'fair tax' campaigners, when looking at multinational corporate profits, can be analysed any number of ways but the two main issues aired in this country are firstly whether the developing world is getting a raw deal from the developed world; and secondly whether the UK is getting a raw deal from US-based multinationals. There appear to be particular difficulties with the taxation of multinational companies operating largely or wholly in the digital sphere.
Current tax systems are still often set up to tax economic transactions largely by reference to a physical presence. This is a problem now because corporate profits are no longer necessarily made by the exploitation of labour and the production of tangible things (both of which require physical presences and so are relatively easy to tax). These days the megabucks are made by machines, and a small cadre of expert and highly remunerated staff, who create and exploit intellectual property and allocate capital.
A part of the current public debate about whether companies, particularly multinational companies, pay a 'fair' amount of tax could be seen not as a dispute about economics (as I pointed out in a previous post, we all know who eventually carries the burden of tax imposts) but an ideological dispute about where the balance of taxation should fall as between capital or labour. But this ideological dispute doesn't don't fit very well with a digital economy, particularly one where many of the inputs are provided voluntarily.
Take Google. How are its revenues created? It appears that most of the revenue is gained by virtue of an algorithm which matches search queries and email text to advertisements. The advertisers pay Google in the hope that the person who inputs the search term will buy their products once the advert is displayed to them. Tax systems tax the payments the advertisers make to Google. Labour theory of value suggests that the value of a commodity is only related to the labour needed to produce or obtain that commodity. What is the commodity here? For the consumer, it is search results. For the advertiser, it is sales. For Google, it is money derived from the advertiser. The algorithm that matches the search results to the advertisements was written in the US. So should all of Google's revenues therefore be taxed there? I suspect that is not the result 'fair tax' campaigners want.
An alternative analysis was put to me a few weeks ago by a 'fair tax' campaigner who suggested that much of the value of Google is created by individuals inputting search queries into their computer, thereby enabling Google's algorithms to match them with advertisers, and that the tax authorities of countries where Google offers the search capability should be allowed to tax Google on the value that is created by those unpaid inputters of data.
The challenge is that there is no economic transaction between the inputter and Google on which a tax charge can be levied- because both company and individual are providing the service voluntarily and for nothing. It is only at the point of an economic transaction that you get an exchange that involves an assessment of value. It is at that point that taxation is levied. (It is possible to levy VAT on me, and levy profit tax on the seller, when I hand over money to buy a computer. But it is not possible to levy VAT on me, or levy profit tax on the seller, if I decide not to buy a computer, or if someone gives me a computer.) Nor can we 'transfer price' the gratuitous exchange between the individual who inputs the data and Google, since transfer pricing rules can only be applied between connected parties where there is an exchange for value, and not between wholly independent economic actors where there is not an exchange for value. (Think about what would happen if it was otherwise. Taxation could be levied on a notional transfer of value as between me and Mr. Jones (my elderly neighbour) because Mr. Smith (my somewhat younger neighbour on the other side) makes me a cake to reward me for cutting Mr. Jones's front hedge.)
To get round that, governments would have to require that users of Google should be paid (by Google) to search. This is not unknown as a concept- Bing offers payment for search from time to time as a promotion. But the practical effect of forcibly monetising what is currently a gratuitous and, most people would accept, fair exchange of consumer data for a service creates a whole host of further problems. Google makes about $12bn a year in profit. That's an average of barely more than half a cent for each of the two trillion searches a year that are carried out on its search engine. Google has about a billion unique users. If it had to make payments to users, even on an annual basis, and even with a minimum cut off, the compliance costs would be mind-boggling. In the UK, it is possible that a Google user would have to file a tax return, even if they had no other non-PAYE taxable income, because their repeated use of Google (thereby deriving a revenue) might fail the 'badges of trade' tests. (I do about forty Google searches a day. I would not want to try to convince HMRC that more than 14,000 small transactions a year did not constitute a trade.)
I am forced to conclude that coming up with a 'fair' system for multinational companies that make money from third parties rather than directly from consumers is fraught with difficulty.
My conclusion, then, is that if we are to continue to tax companies on 'profits' then a globally agreed formulary apportionment (so much value assigned to sales, so much value assigned to staff, so much value assigned to premises) is the only 'fair' solution. Within the EU there have been efforts in this direction for decades but the Common Consolidated Corporate Tax Base project has been moving at glacial speed over the past decade. Countries do not wish to surrender tax sovereignty and that is required for formulary apportionment to work. It would be foolish to hope we could achieve a globally acceptable formula in my lifetime.
So, perhaps the time has come to abandon corporate profits taxation. This is NOT a suggestion that less tax should be paid on corporate activity than is currently paid. But it is a suggestion that we should be thinking about taxing companies on what they consume (labour, resources, energy) wherever they have a physical presence and what they sell (a sales tax on products tangible or intangible) wherever the buyer is located. Rather than by attempting to capture a proportion of some fleeting (and malleable) concept of 'profit'.
Such an approach would have a number of advantages. Firstly it would tend to make tax revenues more stable over time (it is in the nature of capitalism that most companies swing from profit to loss and usually do the latter- and so pay no profits tax- at a time that is inconvenient for cash-strapped governments). Secondly it could be adopted by countries on a unilateral basis without having to wait for an international consensus to emerge (which might take many decades). 'Fair tax' campaigners have expressed the concern to me that such a system makes it more difficult for small enterprises to get off the ground because of the cash flow difficulties caused by a sales tax. But it would be straightforward to exempt SMEs with a turnover of less than, say, £20,000 a quarter from the sales tax. That's what we already do with the VAT regime.
Meanwhile the UK government has been extracting more and more tax from companies through taxes on labour and indirect taxes- the levying of which other taxes obviously has the effect of depressing taxable profits. The recent PwC Report 'Total tax contribution and the wider economic impact' noted that for the 100 Group of companies (a useful proxy for multinationals) £2.86 was paid in other business taxes for every £1 they paid in corporation tax. The ratio was 1:1 as recently as 2005. Indeed, corporation tax is not even the biggest single tax on such companies any more- the crown goes to employer's national insurance contributions. And there is evidence that this is being replicated around the world- OECD statistics show a declining trend in the percentage of total tax revenues accounted for by taxes on income, profits and capital gains. So what I am floating as an idea- which is that we abandon corporate profits taxation- may sound radical or unusual but it is neither. In reality it is already happening.