The 'Tax Simplifier' series aims to make the case for a much simpler tax code with practical recommendations for policy change on a regular basis. Blogs are published twice per week, on Monday and Thursday. Read David's previous blog on tax reform. You can follow David on Twitter @TaxSimplifier.
There has been much outrage in the Press and elsewhere about nefarious activities of multinationals, some of which has been misdirected.
So what are the problems, and how should they be tackled?
A multinational group will need to decide how it conducts its business efficiently in perhaps dozens of different jurisdictions. In that context it will often make sense to have a group treasury operation, lending money to subsidiaries where needed, a base for holding intellectual property, and a base for buying in stock etc. In choosing an appropriate location for these activities the multinational will take into account what human and physical resources are needed there, and also how much tax will be payable there. A tax haven may be chosen, or it may not be suitable because more resources are needed than the tax haven can provide, or indeed because of anti-avoidance tax legislation in the jurisdiction of the parent company of the group.
It is wrong to castigate multinationals for this sort of planning - it is not necessarily highly artificial and aggressive to the extent portrayed in the press. But of course, when tax planning does become more artificial, it needs to be tackled.
The next issue is the amount of interest, royalties and payments for goods then paid by operating companies in high tax countries to these group finance companies, intellectual property companies and group purchasing companies and the like. These charges will reduce the tax bill payable by the operating companies if accepted for tax purposes. But all advanced economies have a tax transfer pricing regime, so that amounts paid by operating companies to related companies overseas will not be deductible to the extent they exceed amounts that would be paid at arm’s length to unconnected persons.
It needs a tough, uncompromising and confident approach from the tax authority to take on a multinational group on transfer pricing issues. The group will have access in the UK, for example, to a team of highly paid advisers, tax QCs and the like, who probably have more time to devote to the problem than the staff of HMRC.
There is cause for concern that this approach has fallen short of what is required because of too cosy a relationship between senior UK tax officials and the companies concerned. The public are left with the impression that the big players are favoured, whilst ordinary taxpayers can be bullied. HMRC needs to act on this.
There is a further major issue in deciding where profits are really earned and so where they should be taxed. If, for example, staff are negotiating sales with customers in a given country, a high proportion of profits attributable to the sales should be taxed there.
Again a robust investigation by the tax authority may be appropriate to make sure that they get the full facts, and that the multinational is not pulling the wool over their eyes. HMRC need to be adequately resourced for this work.
Finally, it is at last becoming recognised that tax law needs to change to reflect the electronic era - where offshore companies supply services over the internet to UK customers it is appropriate to charge them to UK tax, even though they may have a limited physical presence in the UK. Fortunately the G8/OECD are giving every sign that they will address this issue, together with facilitating the exchange of information necessary to tackle all the above issues.