What these companies have in common is that they derive pricing power from intangible assets like intellectual property or branding. It is currently standard multinational practice to hold brands in legal wrappers in low-tax countries such as Ireland, and then lease them to operations in higher-tax countries like France. Called ‘transfer pricing’, this wheeze has the effect of reducing profits in France and increasing them in Ireland. Another trick, popular with technology companies, involves employing marketing teams in London to negotiate sales with UK clients, but to register those sales from a call centre in Dublin.
Companies draw on the economic strength of a given country to make profits, and it is only reasonable that those profits are taxed in that country. It is hardly news that multinationals’ tax strategies fail to pass this common-sense test. What is new is wide-spread public indignation. We happily turned a blind eye when government budgets were expanding. Since 2010, however, Mr Osborne has only been able to justify his swingeing budget cuts – which will continue to 2020 if his party remains in power – in combination with assurances that big business will pay its ‘fair share’. The diverted profits tax is the latest of these assurances.
Transparently political as the move is, it is hard not to support it in principle. The problem is instead with the timing: Mr Osborne has jumped the gun.
The Organisation of Economic Cooperation and Development (OECD) is already looking in depth at the taxation of multinationals. The project on Base Erosion and Profit Shifting, or BEPS, was launched by the G20 group of nations in 2012. An Action Plan was released last year, and some provisional ideas published in September, but the final report isn’t due until December 2015. Bill Dodwell, head of tax policy at Deloitte, expects new rules “in 2016 at the earliest, and more likely in 2017”.
It is not clear how Mr Osborne’s new tax fits with the OECD proposals. Few details were given: only a tax rate of 25 per cent, a start date of 1 April 2015 and estimates of what it might raise: £25m in 2015-16, then £270m, £360m, £345m and £355m in the years to 2020. What kind of model underpins these seemingly random numbers is anybody’s guess.
The risk is that the UK takes one route and the OECD another. This might introduce problems of double taxation, and would almost certainly create complexity just as the G20 is working to reduce it – on the basis that it is complexity that allows multinationals to play systems off against each other. It goes without saying that the taxation of multinationals requires multinational agreement.
Whatever the Chancellor has in mind, taxes on multinationals will rise, reckons Mr Dodwell. The OECD’s preliminary conclusions point towards the principle of taxing profits not based on where sales are legally transacted – which digital business models have made irrelevant – but on the location of marketing operations. Where staff are based, and the kind of role they perform, will become more important than the location of a legal corporate entity. That will favour global ‘talent’ centres like London or New York over tax havens in the Caribbean. Interestingly, however, officials have already moved away from the initial idea of a separate tax regime for technology companies. A ‘Google tax’ is not on the cards.
Everyone agrees the current international system – rooted in a past when companies had more tangible than intangible assets, and more physical than virtual points of sale – needs reform. What is less clear is whether Britain’s multinationals, for all their complex arrangements, actually get away with paying outrageously little tax. Unilever’s effective corporate tax rate has been 26 per cent for the past three years. So was SABMiller’s (SAB) in the first half. Reckitt’s was 22 per cent, down from 26 per cent. Of the big consumer-goods groups, only Diageo’s tax rate seems low, at 17 per cent.
If tax rates rise, investors will be the ultimate losers. Mr Osborne is dishing out tax-breaks to Isa-holders with one hand, but clawing them back with the other. Such are the paradoxes of austerity politics.