he Autumn Statement next week, we should get some indication of how the government intends to put into practice the biggest change to international taxation for almost a century. For the UK, this presents both a huge challenge and an opportunity.
The stakes could hardly be higher because the proposed changes go to the heart of creating a modern tax system that is fit for purpose, is accepted as being fair, and does so in a way which maintains the UK’s competitive position in the international marketplace. These are all issues raised by the Base Erosion and Profit Shifting (BEPS) proposals, announced by the OECD last month.
There is widespread agreement that the current rules of international taxation – most of which date from the 1920s and 1930s – are not fit for purpose. Designed for a manufacturing age, they no longer appear capable of taxing multinationals appropriately in today’s digital age.
Nimble taxpayers have been able to arrange their affairs so that the bulk of their profits are either not subject to tax at all or arise in low tax centres – even when their operations on the ground are based in high tax locations.
The European Commission’s investigations into whether tax rulings obtained by companies such as Apple amount to illegal state aid, as well as the rulings announced recently in the cases of Starbucks and Fiat, are but a symptom of the dysfunctional nature of the current system.
The BEPS project – which is designed to tax multinationals “where economic activities take place and where value is created” – is the OECD’s answer to the question of how to reform that system.
The challenge for the UK government is how to implement the detailed proposals put forward by the OECD without undermining the UK’s newly-acquired status as a tax friendly environment in which to do business.
One of the explicit goals of the last coalition government was to reform the UK corporate tax system and, by and large, this has been successfully achieved. Significant curtailment of the UK’s controlled foreign company rules has made the UK an attractive holding company jurisdiction, while the successive lowering of corporation tax rates – which will be down to 18 per cent by the end of the decade – has encouraged many groups to move substantive business operations to the UK.
It would be ironic if that competitive advantage were now to be put in jeopardy by an overzealous implementation of the BEPS proposals.
On the other hand, if the government were to take the opportunity of the BEPS initiative to simplify the UK corporate tax system, that could build upon the positive changes from the last Parliament to create an even more sustainable and effective tax code.
Take, for example, the OECD’s proposal that interest deductions on debt be limited to 30 per cent of earnings before interest, taxes, depreciation, and amortisation (EBITDA).
Whatever the merits of that rule – and there will no doubt be significant lobbying about whether exemptions should be created for long-term infrastructure projects and other sectors such as the real estate market – the concept has the considerable benefit of being simple to understand and apply.
It would, however, be nothing less than tragic if the UK government were to introduce this new test on top of the existing plethora of rules – thin capitalisation, worldwide debt cap, and unallowable purpose (to name only three) – which UK companies currently have to navigate to obtain tax relief. If this new test is introduced, those other rules should be abolished.
Clearly, the stakes for the UK are high. The BEPS project is not without its critics and it remains to be seen how other countries will take forward its recommendations in practice. If implemented unthinkingly, the proposals could make the UK (once again) a less than friendly place to do business. But if done correctly, this could provide a rare opportunity to sweep away the piecemeal rules – that are often incoherent from a policy perspective – and have the considerable benefit of making the UK tax system truly competitive for the twenty-first century.