The Chancellor of the Exchequer is a busy man. Given George Osborne’s broad hegemony over almost all government policy, he could be forgiven if some aspects of government policy were working against others. However, this appears to be happening within the Treasury itself, with respect to corporate taxation policy.
We have seen the Chancellor promise further cuts to the headline rate of Corporation Tax, firmly establishing Britain as having the lowest corporate tax rate of all of the world’s major economies.
‘A new 18 per cent rate of corporation tax – sending out the loud and clear the message around the world: Britain is open for business.’
While it may be folly to pay too much regard to the headline rate (capital allowances, for example, remain comparatively low by international standards) it remains a very clear statement of intent: to bolster Britain’s tax competitiveness by further lowering tax rates. But can we square the Chancellor’s fondness for inter-state tax competition where Britain benefits with his efforts to shut down tax competition for others through the Diverted Profits Tax (DPT)?.
Tax competition: as bad as it seems?
Tax competition is entirely compatible with, if not encouraged by, the free-trading economic model to which the UK has subscribed for the entirety of its modern history. The free market capitalism to which the Chancellor is undoubtedly an adherent sees the market allocating its resources to the locations and functions that are most profitable. Taxation is every bit a factor in this allocation, in the same way as regulatory environment, national infrastructure, labour costs, access to materials, and market-provision. How states compete is a political choice, with differing approaches easily being attributable to the left and right of the political spectrum. While Germany may well have higher corporate tax rates, an enterprise that locates there clearly values the infrastructure and skilled workforce which that higher tax environment provides.
However, George Osborne clearly sees Britain’s competitive edge as coming, increasingly, from its fiscal policy.
The patent box has no purpose other than to encourage enterprises to locate their research and development arms in the UK. The ongoing cuts to Corporation Tax can only be construed as intended to have a similar, but much broader, effect. And it is arguable that the Chancellor is right to do so. Tax competition is intrinsically linked to the conservative free market ideology to which the Chancellor is sworn.
This is not simply a Tory ideology, however. It is the ideology that permeates the entire free market economy in which the UK sits. In the EU, the role of tax competition in the free market economy has been repeatedly recognised by the ECJ as being an essential element of the EU’s internal market. In Commission v. France the Court held that the fact that a company gains a tax advantage by establishing in a Member State cannot of itself justify the imposition of disadvantageous tax treatment by another Member State. In Barbier the court held that measures that deprive residents of a Member State from benefitting from more favourable tax treatment in another Member State constitute an obstacle to the movement of capital within the meaning of Article 63 TFEU.
If the very purpose of free movement is to ensure the allocation of resources to their most efficient location, it logically follows that measures which inhibit shopping around for the most favourable environment for those resources must surely be unlawful. It certainly follows that such prohibitions run contrary to the free market principles at the very core of the EU Internal Market.
Pulling in two directions at once
George Osborne clearly sees value in confounding opponents by working in two, sometimes ideologically opposite, directions simultaneously (a kind of political ‘hedge’). Take for example the Chancellor’s substantial reductions in public expenditure while, at the same time, increasing the tax burden on the highest earners. This allows him to defend himself against complaints about the former by drawing people’s attention to the latter. The Chancellor appears to have sought to establish a hedge for his Corporation Tax policies by seeking to appear to clamp-down on lawful tax avoidance.
The Diverted Profits Tax (dubbed the ‘Google Tax’) seeks to shut down not simply those arrangements that are artificial or abusive, but effectively any lawful arrangement that results in an enterprise paying significantly less tax than it would have done in the UK. It provides that arrangements which lawfully bring take profits outside UK tax are brought back within UK tax where the amount of tax that is payable elsewhere on those profits is less than 80% of that which would otherwise have been taxable in the UK. Read in these terms, the DPT appears to provide that any arrangement that takes advantage of more favourable tax conditions in another jurisdiction is prohibited, regardless of whether it is artificial or abusive or not.
In essence, the DPT seeks to bring to an end lawful tax competition between states.
There is an obvious ideological and political contradiction between, on the one hand, seeking to enhance Britain’s competitiveness by slashing away at the UK’s corporation tax rate; while, on the other, seeking to shut down all lawful tax competition between states.
At first glance this might appear to be a clever strategy on the part of the Chancellor: attract businesses in with a low rate of tax, and then prevent anyone else from undercutting the UK further by locking them in using the DPT. However, if you look beyond the abstract conceptual difficulty in resolving these two positions, there are two potential risks attached to the Chancellor’s approach. First, successful implementation of the DPT could result in swift duplication by other states. Second, the success of one approach highlights the failings of the other.
A risky strategy?
The DPT is a unilateral act, and history has taught us that states do not take kindly to unilateral action with respect to corporate taxation.
While the UK may be a lone actor at present, other states are watching closely how the UK implements the DPT. The OECD has also tacitly endorsed such measures in its recent BEPS recommendations. If the UK succeeds in curtailing base erosion through the DPT, it is highly likely that other states will implement similar measures. And the likelihood of such those counter-measures being implemented in other states is exacerbated by the fact that the UK is perceived to be seeking to erode those other states’ tax bases through its low rate of corporation tax.
This exposes the practical inconsistency in the Chancellor’s approach. If the DPT is a success, leading other states to follow the UK in implementing such a tax, and lawful tax competition between states is severely curtailed, what’s the point in slashing the UK’s corporate tax rate? Conversely, if it fails, and tax competition remains despite the DPT, what was the point of the DPT in the first place?
Stuart MacLennan (@SensibleStu) is an Assistant Professor at the China-EU School of Law.