Have Osborne’s tax reform plans gone far enough?

Government proposals to change the tax system typically receive a guarded welcome from tax experts and business, who often complain that the reforms don’t go far enough.

Early reaction to plans to simplify tax rules for UK multinationals, announced earlier this week by chancellor George Osborne, fit this pattern.
The proposals include changes to tax rules on multinationals’ foreign profits – the controlled foreign companies (CFC) regime; a timetable for cutting the rate of corporation tax to 24%; and a tax cut to encourage corporate investment in research and development.

The changes have a common goal: to make the UK a more attractive place to do business. This can be achieved by making the tax system simpler and less changeable, the government believes.

CFC changes are likely to be of most interest to business. Over the past few years UK companies, including advertising group WPP, Shire Pharmaceuticals and media company UBM, have relocated to Ireland, where business taxes are lower.

graph-corp-tax-reform-timetableThe government has announced a consultation that intends to introduce an entity-based system that will target a CFC charge on the proportion of overseas profits that have been “artificially diverted” from the UK.

Exemptions will be des­igned to minimise compliance burdens and focus the taxman’s attention on industries at a higher risk of avoiding corporation tax. Specific rules will be designed for the banking, insurance and property industries.

An exemption will be created that allows groups to manage overseas financing operations more efficiently, while protecting the UK tax base. The exemption will work by looking at the finance company’s debt-to-equity ratio and applying a CFC charge to the extent that it has excess equity.

Companies had suggested to the Treasury an effective rate of less than 10%. The government proposes a debt/equity ratio of 1:2, so two-thirds of overseas finance income will be exempt from a CFC tax. At a 26% corporation tax rates this will equate to a 9% tax on overseas finance income.
The government wants to introduce new CFC rules in the Finance Bill 2012. As an interim step, the 2011 Finance Bill will contain an exemption for “foreign-to-foreign” group transactions that do not pose a risk to the UK tax base.

Changes to CFC rules have been eagerly awaited; the previous Labour government was reviewing the issue.

But Deloitte’s head of tax policy, Bill Dodwell, expressed disappointment that the proposals fail to extend Labour’s plans. “There is no more ambition than we had seen under the previous government,” Dodwell told the FT.

Chris Sanger, head of tax policy at Ernst & Young, said proposals to reform CFC rule would make tax rules clearer. Many UK businesses would have breathed a “collective sigh of relief”.

“This is a pragmatic way of protecting the UK tax base while exempting a significant proportion of overseas finance income.”

Business groups and tax experts have broadly welcomed the coalition’s tax reforms; the CBI, for example, endorses moves to a “more competitive” tax system. But many tax experts argue that the changes are too timid, or quibble over the details.

A new 10% tax rate for income from patents has been welcomed, but tax experts expressed disappointment that the rate would not apply to a wider range of intellectual property such as royalties and brands.
Unintended consequences may follow. Ernst & Young warned that companies could move income from royalties offshore in response to the tax change.

“Despite pressure from UK businesses, the coalition government has retained the policy of the previous government in relation to the development of a UK patent box,” Sanger added. “This will be a disappointment to multinationals outside of the pharmaceutical industry, but perhaps not a surprise given the messaging to date and the state of the public finances.”

Kevin Hindley, a managing director at independent tax advisers Alvarez & Marsal Taxand UK, agreed.

He said he expected the “vast majority of companies” will continue to look at places like Luxembourg to find a favourable tax regime for their non-patent IP.

“The chancellor’s plan to endorse the previous Labour government’s policy of introducing a tax rate of 10% on income from patents will significantly benefit only a small number of patent-rich industries, such as clean-tech and pharma,” he said.


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