Book Chapters

Corporate tax avoidance: tackling Base Erosion and Profit Shifting

Date: 29 January 2016
Publisher: Institute for Fiscal Studies

It can rarely be said that corporate tax excites the imagination of the public. Over the past several years, however, one aspect has at least piqued their interest: tax avoidance. Against the backdrop of austerity, revelations that companies such as Amazon, Google and Starbucks paid little or no tax in the UK incited widespread upset, though not necessarily accompanied by a great understanding of the often complex issues underlying these outcomes.

The UK currently (2014–15) raises £43.0 billion from corporate tax. This represents 2.4% of national income, which is slightly below the OECD average. UK revenues have fallen substantially in recent years, largely as a result of the financial crisis and associated recession and subsequent deliberate policy changes rather than any increase in avoidance activity. Taking a longer-term view, most countries have not seen substantial falls in corporate tax revenues over the last three decades. In many cases, falling tax rates have been offset by a higher share of corporate profits in national income. Trends in tax avoidance may also have affected these trends in corporate tax revenue, though we lack robust quantitative evidence on the extent to which it has done so. Concerns about growing avoidance are certainly prevalent.

This chapter of the IFS Green Budget 2016 covers the following points:

  • The OECD Base Erosion and Profit Shifting (BEPS) project aims to foster consensus on how to modify corporate tax rules to prevent multinational tax avoidance. How the proposals are implemented, in the UK and elsewhere, will depend in part on how tensions between maintaining a competitive tax regime and minimising avoidance are traded off against one another.
  • The UK has already introduced a new ‘hybrid’ rule to prevent multinationals from taking advantage of cases where an income stream is taxed differently in different jurisdictions. This is a good move. Other countries may follow, but some may continue to allow some hybrid structures because they can advantage domestic multinationals.
  • Preferential intellectual property regimes, including the UK patent box (a reduced rate of tax on income from patents), need to be modified in 2016 to install a link between the tax break and the underlying research and development (R&D). This will limit some tax competition and will likely raise UK revenues. However, the UK’s patent box will remain poorly targeted at incentivising additional R&D.
  • All countries have committed to aligning taxation rights with real economic substance better by changing the rules on how transfers within companies across borders are priced and the definition of what constitutes a taxable presence. While preventing some avoidance, aligning tax with real activities will sometimes conflict with the principle that the returns to intangible assets are taxed based on the owner’s location.
  • The UK (like most countries) does not meet a BEPS best-practice recommendation for the rules that limit interest deductions of multinationals. The UK government has consulted on possible moves to restrict interest deductibility. The decision involves a trade-off: a more stringent rule would prevent some forms of avoidance but also distort genuine commercial decisions of high-debt firms and make the UK less attractive to multinationals.
  • All countries have agreed to require multinational companies to produce ‘country-by-country’ reports that provide tax authorities with more information on the location of firms’ activities. This, and other information-sharing moves, will assist authorities in indentifying BEPS risks.
  • The BEPS process will result in some important improvements, but is not a silver bullet. Allocating profits across countries and preventing avoidance will always be difficult. A more fundamental change to the system deserves consideration.