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CHRONIC INVESTOR BLOG

Our light-hearted take on the world of investing

Taxing times

By Ian Smith , 16 April 2015

The concept of fairness is dominating this year's general election. As the economy recovers from the financial crisis, politicians are falling over each other to proclaim that all areas of society will 'pay their fair share', or that 'those with the broadest shoulders should bear the greatest burden'. Companies that aggressively manage their tax bill are high on the list.

Accompanying any social justice concern is a desire to generate extra revenue to balance the country's economy. That is inevitable in an environment where the two major parties are in agreement that they will not raise money through increases to the basic levels of income tax, national insurance, or VAT, freezing the majority of the government's yearly tax take.

In opposition, the Labour party has said it will take the lead on tax transparency and strengthen tax avoidance regulation. But it was the current, Conservative chancellor who introduced the diverted profits tax this month, which intends to stop multinationals steering taxable profits overseas.

This mimics the larger 'Base Erosion and Profit Shifting' project from the Organisation of Economic Cooperation and Development, which aims to arm governments, by the end of this year, with the ability to make sure profits are taxed where services are performed and value created.

The Financial Times reported this week that the global tax gap as a result of aggressive tax 'minimisation', the latest euphemism for the practice, was a whopping $82bn (£56bn) a year at listed companies.

This was based on analysis from index provider MSCI, which compared the average annual tax rate paid between 2009 and 2013 by 1,093 companies on its MSCI World Index with the weighted average tax rate in the countries where those companies build their revenues. The table below shows the proportion of companies by sector where this gap is more than 10 per cent.

It is not only politicians that are preoccupied with this shortfall. Institutional investors are becoming increasingly agitated. The Local Authority Pension Fund Forum - a group of investors with a cumulative £160bn in assets - wrote to every FTSE 100 company at the end of last month requesting information on their tax management.

Clearly, investors who have bought companies on account of the strength of their post-tax returns that have benefited from aggressive tax planning could come a cropper if regulation tightens practices. Jolyon Maugham QC, barrister at Devereux Chambers, says such global initiatives could have "a depressive effect on earnings and a depressive effect on value" for investors.

Investors have "little idea" of how tax reform could affect their stock picks, says Tom Elliott, international investment strategist at consultancy deVere Group. But the impact of reform would not necessarily be negative.

"Smaller, domestic-based rivals, that never had tax minimisation schemes in place would now find themselves competing on a level playing field," says Elliott.

The good, and perhaps unsurprising, news for UK investors is that domestic businesses are not at the top of MSCI's naughty list when it comes to aggressive tax management. As only the 12th worst country of the 22 represented - with 22.5 per cent of companies having a substantial tax gap - it suggests there could be beneficiaries of a more equal playing field among listed UK equities.

But how can investors really take this issue into account, given the lack of comparable data? Short of identifying the more tax-aggressive sectors, or steering clear of high-profile cases that come to light in the media, it is impossible for the everyday investor to screen on this basis.

Calls for greater transparency are welcome. Any findings from LAPFF's work should be promulgated so that all investors can make their judgments about the vulnerability of their stock picks to toughening corporate tax rules.

 

Sector Proportion of companies with high tax gap (>10%)
Healthcare15.3%
IT14.0%
Energy7.4%
Materials6.2%
Consumer discretionary15.3%
Financials16.5%
Utilities5.0%
Industrials12.8%
Telecommunication services2.1%
Consumer staples5.4%
Source: MSCI

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Ian Smith

Ian Smith is companies editor of Investors Chronicle

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