Introduction international Organization for Economic Cooperation and Development

Introduction

Many multinational
companies, apparently operating very successfully in the UK, are paying little
or no local corporation tax. Corporation tax is a tax on profits, so if a
company makes no profits, it should not have to pay corporation tax. The
international corporate tax standards have struggled to keep pace with changes
in global business practices, with an increasing share of trade taking place
online. International tax standards have remained largely unchanged for over a
hundred years and now need to be updated to prevent gaps from being exploited. In
February 2013, G20 are initially reported by the international Organization for
Economic Cooperation and Development (OECD) for dealing with profit shifting by
multinational corporations. Although governments enforce by displaying rules
and regulations, still multinational companies try to avoid paying taxes. Tax avoidance involves bending the rules of the
tax system to gain a tax advantage that Parliament never intended. And also
currently, UK government is seeking to lower corporation tax.

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Tax Avoidance in UK

Tax avoidance is
the legal usage of the tax regime in a single territory to one’s own advantage
to reduce the amount of tax that is payable by means that are within the law. Many
multinational companies are avoiding taxes by using different methods such as
Transfer pricing, Country of residence, double taxation, Legal entities, and
Legal vagueness, etc.

According British
tax authorities, multinational companies avoided paying corporate taxes in UK
about £5.8bn by booking profits in overseas entities, a 50 per cent increase
over previous government forecasts in 2016. The following examples avoided
paying taxes in UK:

Netflix: British customers
typically pay £5.99 a month for Netflix, the latest UK filings show.
It registered a 39 per cent fall in its UK tax bill to less than €300,000 in 2016, while its UK
revenues and profits almost split to €22m
and €1m respectively. The company has more than 80 million subscribers but said it employs just 13
staff in the UK. A total of €2.78m (£2.5m) was spent on wages, salaries, social
security and other pension costs, meaning each employee received an average of
€214,000 (£193,000). Netflix UK classifies all its employees as involved in
marketing. Netflix UK says all revenue earned in the UK is for the “provision
of marketing services”.

The oil giant Shell
is among the multinationals with an outpost in the canton from where it
licenses its trademarks around the world. According to A Sunday Time Analysis,
Shell paid no UK corporation tax in 2014 or 2014/15 through it made global
profits of £19.87bn. Shell said it was not paying UK corporation tax because of
tax relief on £1.4bn of investments in the North Sea, and because of declining
production. And also it made a loss in the UK in 2014 and Shell UK paid
royalties to SBI in Switzerland, but that this accounted for less than 2.5% of
SBI’s income. A spokesman said its overall global effective tax rate was about
48% and it was transparent about the management of its tax affairs.

Another company which paid little corporation tax is Thomas Cook, a travel agent. The travel
agent paid a tax bill of £8
million but it is just over 5 % of the £152 million operating profit it makes in the UK, where it has 719 High
Street stores and 8,800 employees. And as a percentage of the firm’s £2.3
billion sales in UK 2016 that corporation tax bill is tiny. The travel agent
says it is down to losses made in previous years. It went back into profit in
2015 after five years of red ink.  

Global corporations have been able to use elaborate
avoidance mechanisms get out of paying their fair share of corporate tax. And it
is not fair. Tax evasion is aimed at avoiding social
obligations. Tax avoidance can lead to the company being prone to accusations
of greed and selfishness, harm society and getting rid of public confidence. A
“fair” tax payment in the countries in which they operate is
considered socially responsible for the companies. Taxes provide funds for
public services, such as infrastructure, health, education and public
investment, which directly and indirectly benefit businesses. In other words, tax avoidance is a scourge on society that undermines public
trust and deprives the public services of the funds they desperately need.

But in the case of multinational
companies that ultimately cannot bear the tax burden or other burdens. The tax
burden paid by the corporation is constituted by the shareholders in the form
of reduced dividends, by the employees in the form of reduced fees, by the
customers in the form of increased prices or if the company has a lot of effect
leverage on the market by suppliers in the form of reduced prices.

The cause of the problem is the current international tax system which is
out-of-date system and created almost one hundred years ago. Over time,
international companies have achieved more to transfer profits to tax areas: in
2012, more than a quarter of these profits were transferred to avoid taxes.
Meanwhile, the government
revenue’s share from corporation tax has fallen in countries such as the US and
the UK.

Global
regulation needed to strict because some of the activities of MNEs are outside
the reach of national law. MNEs
can encourage governments in both home and host economies to reduce their social
and environmental standards and also Trade unions in developed countries resent
this behavior of MNEs. Generally, the global community has not been able to
control MNE behaviors.

Governments
don’t want to control MNEs, even though they may say they do because
multinationals are too big and they might leave if the government rules are too
onerous. It is politically too complex to argue that companies pay more tax,
but government and business should ensure that corporate tax contributions are
a demonstrably fair return to society.

Why UK Government seeking to lower
corporation tax?

The United Kingdom has
announced its intention to reduce corporate taxes to less than 15% and try to
alleviate the impact of the country’s decision to leave the European Union and
increase the prospects for competitive tax cuts. The violation of the EU and
the uncertainty associated with it will hurt the companies and will damage the
economy of the United Kingdom. Due to Brexit, the UK economy will have the most
influence, although there may be doubts that it will also have a significant
impact on the rest of the EU.

The Sunday Time reported that the proposal to reduce taxes for
multinational companies from 20% to 10% can be used if the EU Member States
negotiate the Free Trade Agreement with the UK or deny to access financial services
of the UK on the EU market. If Brexit negotiations do not go as they expectation, UK government
minsters could cut corporation tax by half.

In April 2016,
as the Treasury publication, the long-term economic impact of EU membership and
the options has been estimated to lower foreign
direct investment flows to the United Kingdom from 10% to 26% in the case of UK
departure.

FDI raises
national productivity, also both output and wages. Multinational companies offer better technical and leading knowledge, which
directly increases production on their operations. Multinational
companies bring in better technological and managerial know-how, which directly
raises output in their operations. FDI also stimulates domestic companies to
improve for example through stronger supply chains and tougher competition. And
also, UK is the largest recipient of FDI in the EU, Brexit could reduce the
attractiveness of the UK as a gateway to Europe, it could also lead to a
reduction in investment from the rest of the EU which is the biggest source of
FDI in the UK. It may become harder to attract corporate HQs. The EU was the
source of 4% of the stock of FDI in the UK in 2013. This dependence has fallen
somewhat in recent years, with the EU share down from 53% in 2009.

UK has an FDI
stock over £1 trillion, about half of which is from other members of the EU.
Part of the UK’s attractiveness for foreign investors is that it brings easy
access to the EU’s single market. After Brexit, higher trade costs with the EU
would be likely to depress FDI. Many large European corporates are heavily
invested in the UK and the commercial logic for the investment could be affect
by Brexit.

UK already has one of the lowest
corporation tax rates in the EU but ministers believe a further cut
could help keep companies in the UK and attract new investment. On the other
hand, other EU states could fear losing business to the UK should Britain allow
companies to keep more of the profits they create.

The British Chamber of Commerce
(BCC) has called on the government to maintain its current 19% rate, but
instead cut property taxes and other lump-sum payments demanded of economy. Current, the UK
corporate tax rate is 19% and government plans to cut its corporate tax rate to
17% over the next three years. The UK would lose more
than £20 billion or tax revenue each year which is a large amount and is one
third of the total deficit expected in the UK. And many businesses do not want
a cut. Starbucks Executive Chairman Howard Schultz said about reducing
corporate tax rate to lower than it exits that it is not tax reform, it is a
tax cut and it is fool’s gold. Critics say that this is the only
accelerate a race to the bottom.

Suren Thiru, head of economics and
business finance at the BCC stated that to create a competitive business
environment, the focus should be on reducing the burden of upfront business
costs and taxes and  that would help
startups and companies struggling to make a profit more than a cut in tax on
their income.

According to the head of U.K. tax policy at Deloitte, Bill
Dodwell, UK government can do “broad agreement” in the business
community that providing targeted relief would be more beneficial than a lower
corporate tax rate.

Although UK government is afraid of losing FDI
investments after Brexit, cutting corporate tax to fall to 17 % by 2020 is not
the most effective and efficiency way for UK economic growth. The UK also
maintain inward FDI flows by providing significant laws, especially labour law
as they have highly educated and skilful labours. In addition, they can do effective
and efficiency cross border relationships with other countries. 

 

Introduction

British Prime
Minister, Theresa May signed a letter to European Council President Donald Tusk
invoking Article 50 of the Lisbon Treaty formalising the United Kingdom’s
withdrawal from the European Union on March, 2017. Then, UK would face the
prospect of a “hard Brexit”.

Members of the European Union have the same trading
policy and are represented by the EU in all international trade negotiations.
The UK will become independent players with the freedom to seek its own
commercial transactions with the rest of the world following Brexit. The UK can
use this freedom to seek new trade agreement deals with countries such as
China, India and the United States. But there would not be easy for UK to stand
as a single market after Brexit.

Foreign
direct investment (FDI) comprises investments from outside a country to set up new
establishments, expand existing ones or purchase local companies. According to
government body UK Trade & Investment, the UK has an estimated stock of
over £1 trillion of FDI, and only the United States and China have more. About
half of this stock of FDI is from the European Union (EU).

Foreign direct investment (FDI) means investments from
outside a country to create new establishments, develop existing establishments
or buy local businesses. According to the government agency Trade &
Investment of UK, the United Kingdom has an estimated stock of more than 1
billion pounds of FDI, and only the United States and China have more.
Approximately half of this stock of FDI comes from the European Union (EU).

An important
reason for inward FDI to Britain is unfettered access to the EU Single Market,
so reduced access will make the United Kingdom a less attractive destination.
Randolph Bruno and others (2016) estimate a gravity model of FDI between 34
OECD countries and find that Brexit would likely lead to a fall in FDI to the
United Kingdom by over a fifth. Dhingra and others (2016) calculate that such a
fall would reduce GDP by about 3.4 percent. Quantifying the relationship between FDI and growth is
extremely difficult so the exact number is subject to considerable uncertainty.
But it suggests that falls in FDI would matter for living standards in the UK.

Japanese inward investors have been a
second thought about the future investment in the UK depends on tariff-free and barrier-free trade with the EU that is as
uncomplicated and predictable as possible. A Japanese government memorandum has
expressed concerns over the continued viability of Japanese investment in the
UK in the event of a hard Brexit without access to the Single Market.

Uncertainty
over Brexit could jeopardise
future investment in the UK by Toyota and Nisscan. Nissan announced in October
that it would build its next generation Qashqai sports utility vehicle and a
new X-Trail model at its north of England facility but it has also commented
that Nissan will review its decision after the form of Brexit is clearer. And
also, Toyota announced plans to invest
£240m in its plant in Derbyshire in March before the Brexit. Those that are household names (such as Nissan and Toyota) are
lobbying hard to cut special deals with the government.

From translational
cost theory point of view, there can be increased transaction costs in the
UK economy. British automotive industry is particularly vulnerable to changes in
foreign trade by Brexit. Car manufacturing firms will face 10% tariffs on
British-manufactured cars to enter the EU. They would also be difficult to
import as it would be increased translation costs and other goods sourced from
the EU.

According to Aliber’s Theorem (1970), corporations
invest to the foreign countries which have lower currency rate than the host
country. Therefore, only high currency rated countries can come to invest in
UK. Exchange can impact on FDI inflow as after the Brexit referendum votes were
published, the financial markets showed a radical drop of British pound in
relation to other strong world currencies. During the year 2015, the exchange
rate was above 1.35 GBP/EUR, in the first 6 months of 2016, before the Brexit
referendum, the rate was around 1.30 GBP/EUR. Following the results of the
vote, a major fall of the pound occurred, and the exchange rate since the vote
has been around 1.15 GBP/EUR, resulting into more than 10% of depreciation of
the British pound against the Euro.

Figure1: GBP to EUP Exchange Rate
(source: xe.com)

According to OLI (Ownership, Location, and
Internalisation) Paradigm, Brexit can hinder inward FDI to UK from foreign companies. The UK needed to
concern is about immigration issues. Immigration
helps address skills shortages and the consequences of an aging population.
Free movement allows UK firms access to specialist skill that are increasingly
important to high-value added industries. If the UK adopts the Norwegian or Swiss model, UK must
still sign the freedom of employment. As other government models are chosen to
comply with EU immigration laws with a lack of content in the EU. Restrictions
against immigration can be unfair in London and affect the
competitiveness of businesses located there.

These Brexit-related trade effects are of special
concern to Toyota and Nissan, whose British operations are deeply integrated in
pan-European sourcing and distribution. Nissan has manufactured 500,000 cars per year in the UK,
55% of sales is from export to the EU’s. Also, Toyota’s produces 180,000 cars
annually in UK, 75 percent of which are exported to the EU. In addition to
heightened tariffs on both ends of their European supply chains, these
transnational car manufacturers would face increased logistical costs and border
delays as the UK exits the duty-free EU zone.

Although UK has
championed the single market but being outside of the EU would no longer be an
effective advocate of further liberalisation. UK critics often complain about
EU regulatory excesses, but many regulations are intended to create the level
playing field the single market requires which investors might concern either.

Since
the Brexit vote, foreign investors have continued to open headquarters in the
country. Announcements from Boeing, GlaxoSmithKline, Google, Facebook, Apple,
Jaguar Land Rover, Tata, and McDonald’s have all indicated that these companies
will continue to invest in the UK despite Brexit. Even though some companies
would continue their investments, there is still losing almost £10 billion of
annual inflows after Brexit. Therefore, UK government need to reduce this downward trend in inward FDI.

As the resource based approach, UK has already strong rule of
law, flexible labor markets and a highly educated workforce, all of which make
it an attractive FDI location whether or not it is in the EU.  Supporters of Brexit
claim the UK could attract more FDI outside the EU as it would be able to
strike even better deals over trade and investment.

As a single market, there would be
possibility of greater barriers to trade with the rest of European countries
and the UK economy has benefited from migrant labor as an example: construction
sector has a high percentage of Eastern European workers. Without free movement
of labor, there may be a greater unwillingness to invest in UK. Hence the only
way that the UK may seek to attract investment is through aggressive cutting of
corporation tax.

Large
multinationals, such as Apple, Google and Microsoft have sought to invest in
countries with lower corporation tax rates. For example, Ireland has been
successful in attracting investment from Google and Microsoft. In fact it has
been controversial because Google has tried to funnel all profits through
Ireland, despite having operations in all European countries.

Taxes
are a big issue for multination companies as they are targeted by governments
to pay taxes and are carefully monitored (IFS, 2007). Taxes are part of business and wherever the
business is run, the host country wants to participate. This is where the host
government can intervene sooner through mediation and taxation policies and the
privatization of local businesses. It is logical that governments would raise
taxes for foreigners to limit FDI flows (OECD, 2001). Building
upon privatization of firms is a reasonable method in the quest for growth. Privatization
is the transferring of public services and assets to private firms, from which
brings a change in the way they are managed. This privatization offers many incentives
to foreign companies that can act alone for their interests. UNCTAD (2009)
shows that privatization is the main incentive for foreign direct investment.
It boots FDI inflows and allows companies to use human capital and corporate
brand, while developed countries have the highest human capital and
technological progress. Therefore, UK can attract foreign investment through
reducing tax rate.

However,
reducing corporation tax too much can be negatively impact on the country so
the ministries should be careful about reducing tax percentage rate. And also
government can also consider “broad
agreement” in the business community which providing targeted relief would
be more beneficial than a lower corporate tax rate.