Analysis – A good mixer helps everybody get on

Back in March, the Inland Revenue brought out a discussion paper on double taxation relief for companies. The subject may not be everybody’s idea of fun, but there’s big money at stake. And they want responses by 30 September.

The paper does not propose earth-shattering changes. Wisely, the Revenue is inclined to keep the credit system we know and love, under which foreign income is taxed in the UK but foreign tax reduces UK tax. But do not assume that credit relief is safe in all its glory.

The problem with credit relief is that it is limited to the UK tax on the foreign income. If income suffers 40% tax abroad and the UK company pays tax at 30%, only 30% foreign tax will reduce the UK tax and the other 10% will be an extra charge – it cannot reduce the corporation tax on profits made in the UK. The UK company will wish it had made all of its profits in the UK instead, where the effective tax rate would have been 30% and not 40%.

Smart companies know a way round this. Have some income from high-tax countries and some from low-tax countries, and then feed them all into a mixer company outside the UK. That company pays the whole lot through to the UK company as a single profit stream, averaging out the tax rates of its components. Mix profits which have suffered 40% tax with profits that have suffered 20% tax, and you get an average rate of 30%. So you get full credit against your 30% UK corporation tax. Magic!

The Revenue knows all this and is not sure it likes it. Three years ago it put a stop to artificial schemes where companies bought income streams simply for this purpose. This year’s discussion paper has a whole chapter on mixer companies and the alternatives. It mutters darkly about tax-driven distortions.

Mixer companies are only needed because the UK does not allow full credit for overseas tax: if you have suffered 40% tax abroad, you will only get credit for 30% in the UK. The reason why the UK does not allow full credit is that if it did, it would be taken for a ride by foreign countries.

They could happily apply very high tax rates to UK-owned businesses, raising money for public spending, confident the UK government would effectively pay the bill by collecting less corporation tax.

But should the UK have the same worry about mixer companies? They obviously give high-tax countries a bit of a free ride, and we do not want that ride to be at the UK’s expense. But the UK is not paying for the ride.

Rather, it is the low-tax countries who pay.

Suppose that a UK-owned group has two subsidiaries, one in country X and the other in country Y, and each country has the same 30% tax rate as the UK. The subsidiaries’ profits would be taxed in their own countries, and there would be no more tax to pay when the profits were sent back to the UK. Now increase the tax rate in country X to 40% and reduce it in country Y to 20%. The UK holding company very sensibly inserts a mixer company so it still pays no UK tax on the profits flowing back to the UK. The UK is no worse off, and the group as a whole has the same average tax rate as before. It is just that country X’s government is richer and country Y’s government is poorer. X gets the free ride, Y pays for it and the UK has nothing to worry about.

Not only that, but mixer companies actually remove, rather than generate, tax-driven distortions.

Without the option of a mixer company, UK groups would not even consider investment in high-tax countries. Capital would be kept out of those countries for tax reasons – a clear distortion. With mixer companies, a group which has income from low-tax countries can decide how to invest its capital around the world on a commercial basis, knowing it can handle the tax implications. Thus capital can end up where it should on economic grounds – a better result all round.

Finally, mixer companies make the UK a more congenial home for business.

They bring wealth and jobs to this country, and therefore extra tax revenues.

Keep Britain business-friendly, for all our sakes.

Richard Baron is deputy head of the policy unit at the Institute of Directors.

Related reading

HMRC banknotes