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Sheila Gilmore MP: Osborne’s corporate tax concessions could cost developing countries billions

25 June 2012

by Sheila Gilmore, Labour MP for Edinburgh East

Since April I’ve been sitting on the committee of MPs scrutinising the Finance Bill – the annual legislation that puts into effect announcements in the budget. The bill covers big issues such as the scrapping of the 50p tax and introduction of the granny tax.

One of the less publicised but nonetheless significant measures involves changes to the rules on Controlled Foreign Companies. These rules deal with the problem of multinationals attempting to avoid tax on profits liable to UK tax by artificially diverting them to subsidiary companies in other countries. The changes to these rules, which could have a big impact on developing countries and were discussed and voted on last week. This is what happened.

Context

The UK previously operated a global corporation tax regime whereby if a company was headquartered in the UK it was required to pay corporation tax on the profits of any subsidiaries in foreign countries. In practice this meant that the UK headquarters were billed for the difference between what the subsidiary paid abroad and what it would have had to pay were it to be operating in the UK.

The last Labour Government launched a review of these 30 year old rules with the intention to move towards a more territorial corporation tax regime whereby the only profits that are taxed in the UK are those that arise from economic activity that takes place here. This was an attempt to encourage multinational companies to establish and expand their operations in the UK, although there were also concerns that the previous rules could be illegal under EU law. Despite the switch in Government George Osborne confirmed in Budget 2012 that he would press ahead with these changes.

Impact on developing countries

Following this announcement the development NGO ActionAid argued that the new rules would ‘open a loophole costing developing countries an estimated £4 billion and the UK £1 billion.’ This is best illustrated using the following example adapted from an ActionAid report Collateral Damage:

A UK multinational is made up of three subsidiaries with one in the UK, one in a developing country, and one in a tax haven. In an attempt to reduce its overall tax liability on profits across the company, management could transfer ownership of the company’s brand to the tax haven subsidiary and require the others to pay high royalty fees to use it.

However the current CFC rules mean that the UK subsidiary would be liable for the difference between the tax paid in the tax haven and the amount they would have had to pay had all the company’s profits been made in the UK. This discourages UK multinationals from artificially diverting profits from either the UK or developing countries to tax havens.

 Under the new CFC rules only royalty fees from the UK subsidiary to the tax haven would be subject to an additional charge ‐ similar royalty fees from the developing country subsidiary would no longer be covered. This means that although the management would still have a disincentive to artificially divert profits from the UK, they would no longer have such a disincentive with respect to developing countries.

What went on in Committee

There were two amendments on these clauses considered by the Finance Bill Committee on 19th June. The first  was moved by Stephen Williams (a Lib Dem) and would have prevented the provisions from coming into force until anassessment had been made of the impact on developing countries’ tax revenues. The second was a Labour amendment which asked for reviews of both the impact on developing countries and the UK tax base.

Treasury Minister David Gauke resisted both amendments.  Broadly he argued that the advantages of making these changes outweighed the predicted loss of tax income to the UK. He also argued that the original rules were not introduced with a view to benefiting developing countries, but I pointed out that this shouldn’t mean the impact of changes is of no concern to us. The movers of both amendments drew attention to the potential for the new rules to undermine our international development efforts.

The Minister went on to say that it wouldn’t be feasible to produce the impact assessments because it would be too difficult to gather information from all countries that might be affected. He also argued that ActionAid’s estimate of a£4 billion loss was wrong, partly because it was allegedly based on data from only 10 UK multinationals. He said that many developing countries didn’t charge their ‘full’ tax rates in practice with many giving foreign companies ‘tax holidays’ to encourage investment. The Minister then managed to give a number of examples from countries such as Kenya and Rwanda – a remarkable amount of detail despite saying earlier that it was too difficult to gather the information needed for an impact assessment!

Gauke concluded by insisting that without these changes many more companies would leave the UK and that getting companies to stay or even relocate back to UK (such as advertising firm WPP) would be harder. He made the point that if companies leave altogether then no tax will be paid by them to the UK, and he claimed the benefits of encouraging them to stay would outweigh any tax lost from the changes. That said the Government clearly has its concerns about the potential for greater tax avoidance, with a new schedule to the Bill containing provisions to target no less than 10 anti-avoidance schemes.

At the end of the debate Stephen Williams withdrew his amendment. Labour sought a vote on ours but the arithmetic of the Coalition meant we lost by 13 votes to 18 with no abstentions. Frustratingly it is becoming standard practice for Lib Dems to table sensible amendments to obtain positive media coverage, only to withdraw them and vote against anything similar at the last minute (this was a recurring theme during the Welfare Reform Act’s passage).

Although pressure on time will be intense, my Labour colleagues and I will look to secure some further debate on this issue when the bill returns to the Commons Chamber at Report Stage. I’ll keep LCID updated if we are successful.

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