How The Anti Tax Avoidance Directive COSTS UK Taxpayers £Billions in Corporate Tax Avoidance
In a previous article debunking the “Brexit was about tax avoidance” conspiracy theory, Politax made the point that the Single Market was detrimental to our tax avoidance rules – the polar opposite of the conspiracy theory. Following a recent study by Thomas Tørsløv, Ludvig Wier and Gabriel Zucman of University of California, Berkeley and the University of Copenhagen (referred to herein as “Zucman”), we can now put some numbers around the cost of that detriment.
This is how the analysis begins:
“By exploiting new macroeconomic data known as foreign affiliates statistics, we show that affiliates of foreign multinational firms are an order of magnitude more profitable than local firms in low-tax countries. By contrast, affiliates of foreign multinationals are less profitable than local firms in high-tax countries.”
What are we saying here? So they’ve looked at foreign subsidiaries in, say, BVI, and they’ve looked at local based companies in BVI and noticed something stark – the foreign companies are, by a large margin, more profitable than local firms. If there’s a subsidiary of Sainsbury’s in BVI it will be far, far more profitable than a local BVI supermarket.
Then they have looked at the same situation the other way round. If, say, a foreign subsidiary, such as Amazon, is in the UK it will be far less profitable (on average) than a local firm, say Royal Mail.
That shouldn’t be all that surprising – mobile capital will be attracted to the jurisdiction that will tax it the least. Profits will be attracted to low tax jurisdictions, losses will be attracted to high tax jurisdictions. So the most profitable parts of your business are placed in low tax jurisdictions, the low profit part of the business are placed in high tax jurisdictions. Clearly Sainsbury’s in BVI isn’t running supermarkets! Anyway, that’s just the economic reality – what this analysis has done is put values on those tax losses.
The amount of tax avoidance in the UK, as calculated by HMRC, is only £1.7billion. The amount of UK tax avoided in this analysis is over 10x that figure. They are clearly not measuring the same thing. HMRC are looking at the domestic economy and analysing how much is saved by successful tax avoidance practices. It isn’t considering the fact that the mere fact of having an overseas subsidiary is tax avoidance.
The Zucman analysis is basically arriving at their tax avoidance figure by hypothesising that every country in the world equalised tax rates and rules perfectly, such that there would be no attraction of profits/losses and stating how much tax is currently lost (avoided) based on that hypothesis.
Zucman provides a startling illustration “…foreign firms in Ireland (a low-tax country) have a profits-to-wage ratio of 800%: for $1 of wage paid to Irish employees, foreign multinationals report $8 in pre-tax profits in Ireland. In the UK by contrast, foreign firms have a profits-to-wage ratio of 26% only.”
So what’s all this got to do with the EU Anti Tax Avoidance Directive? If you look at the analysis of the top 5 jurisdictions losing the most tax, 4 are in the EU. OK, but that’s not necessarily the fault of the EU, is it?
One of the key tools jurisdictions can use to mitigate profit shifting to overseas subsidiaries is something called “Controlled Foreign Corporation” (CFC) rules. They can be complicated in terms of understanding the legislation, but they are a fairly simple concept.
If Tesco opens a subsidiary in BVI then HMRC will want to tax the profits of the BVI subsidiary. HMRC has no such jurisdiction to tax a BVI entity. CFC rules mean that HMRC will assess the profits of the BVI entity and impose a CFC charge of whatever UK tax would have been payable on the UK parent – solving the jurisdiction problem.
So, say Tesco (BVI) Limited makes £5m and the prevailing UK tax rate is 19%, HMRC will impose a CFC charge of £950K on Tesco plc.
If (for the sake of argument) the BVI charged £250K tax on the profits, HMRC would give a credit for that amount and just tax £700K. Point is, the amount Tesco will be taxed will be the same whether the profits are made in the UK or overseas.
The idea is basically to achieve what Zucman’s hypothesis was to achieve – to remove the incentive to shift profits.
The UK has had CFC rules since 1984, but in around 2004 we ran into a problem. Cadbury Schweppes had a subsidiary in the International Financial Services Center in Dublin called Cadbury Schweppes Treasury International (CSTI). HMRC imposed a CFC charge on Cadbury Schweppes based on profits made by CSTI in 1996 but found itself in court in probably the most famous CFC case in Europe. Every UK international corporate tax professional will be aware of the case.
The complaint was that HMRC’s CFC charge was against the Freedom of Establishment principles in the Treaty of Rome. HMRC, they contended, could not impose a tax which could impede Cadbury’s ability to set up operations in any EU member state. No, said HMRC, if the purpose of the subsidiary was to avoid tax, then Member States are permitted to impose measures to protect their tax base. Setting up a subsidiary in another member state in order to avoid UK tax was an abuse of the Freedom of Establishment and the charge should be allowed to stand. So the case went to the ECJ in 2006.
The EU case if you want to see the full details is “C-196/04”. The ECJ decided that member states could not impose CFC charges based on profits made anywhere in the EEA even if the purpose of the subsidiary was primarily to avoid tax. This is an extract from that Opinion:
“…the establishment by a parent company of a subsidiary in another Member State for the purpose of enjoying the more favourable tax regime in that other State does not constitute, in itself, an abuse of freedom of establishment.”
You can create a subsidiary in the EU “for the purpose” of avoiding UK tax and there is precious little HMRC can do about it. It is only possible to impose a CFC charge if the arrangements are “wholly artificial” – so basically a brass plate.
You may think 2006 was a long time ago, with the Anti Tax Avoidance Directive the EU will surely have used the opportunity to mitigate the problem. Here is the Directive – go to Article 7 (2).
“This point shall not apply where the controlled foreign company carries on a substantive economic activity supported by staff, equipment, assets and premises, as evidenced by relevant facts and circumstances.” The ECJ’s Cadbury Schweppes ruling is now in explicitly contained in a Directive. The Directive goes on to make clear that member states can apply these rules to non-EEA countries.
Let’s return to the Zucman study. Remember 4 out of 5 of the jurisdictions who lose the most tax attributed to foreign affiliates are in the EU. Often when you see people talking about Corporate tax avoidance, you hear about BVI, Panama, Cayman Islands, Bermuda, Guernsey, Jersey, Isle of Man etc. So is this where our tax is lost? Not according to Zucman.
According to the Zucman analysis the UK loses $76bn in profits - $63bn of which is to other EU member states.
France loses $36bn - $29bn to other EU member states.
Germany loses $67bn - $52bn to other EU member states.
The biggest two beneficiaries of this shifted profit in every case is Ireland and Luxembourg.
As things stand, if you are avoiding Corporate Tax in the UK, not only does the EU Anti-Tax Avoidance Directive not prevent you doing it, there is a good chance you are actively using EU rules to do it.
After Brexit we can apply the same CFC rules to the EU as we do elsewhere and save billions in lost tax.
As a footnote, I expect the EU will eventually adopt the CCCTB, or something very similar if they can address concerns that it goes against the principles of BEPS. The UK was always against it, because it is a harmonisation measure and removes the ability of member states to have an independent tax policy. Luxembourg, Malta and Ireland are against it because it basically defeats their business model.
Again, as things stand, the EU Anti Tax Avoidance Directive costs the UK far more in tax avoidance than it prevents.