Taxation – All’s fair that ends fair …

One day, corporation tax will be an absolute doddle. Each company will simply send in its accounts, together with a cheque for 20% of the profit shown in those accounts.

This is a fantasy. But it is interesting to ask why the Inland Revenue would feel uncomfortable about the idea; and indeed why taxpayers might also feel uncomfortable.

One big effect is that we would switch from capital allowances, given at set rates on a narrow range of assets, to depreciation, given at whatever rates companies choose on all capital assets. This change could be good.

There would be winners and losers, but overall it would seem fairer to give allowances on all business assets at rates reflecting their useful lives. That is, it would be fairer as between the taxpayer and the state: the state would get to tax only the profit after taking proper account of the cost of capital assets. It could, however, easily be unfair as between one taxpayer and another.

The unfairness of comparison

Imagine two identical companies, trading next door to each other and having the same assets and levels of business. If they adopted the same accounting policies, they would report the same profit and pay the same tax. But it is very unlikely they would report the same profit.

An asset might have a useful life of about ten years, but it would still be legitimate to depreciate it over eight or twelve years. If one company chose eight years and another chose twelve years, the former company would pay less tax than the latter. Both the Revenue and taxpayers could have a big problem with this type of unfairness.

The Revenue rightly believes in non-arbitrary government: everyone pays tax according to the same rules. As for the two companies next door to one another, the one paying more tax might well feel aggrieved that the other was paying less. Of course, depreciation only moves profit around between years: eventually, it catches up with you in the form of a profit on sale of the asset. So perhaps we should not worry about unfairness between companies.

If we ever do go over to taxing accounts’ profits, we will have to decide whether to look at the accounts of each company separately or at a group’s consolidated accounts. Changing to group accounts would raise even more challenging questions of fairness than accepting each company’s accounting policies for tax purposes.

The Revenue would probably think taxing groups was perfectly fair: currently it does not have to put up with groups sometimes reporting big profits that do not seem to show up as taxable in any of the group companies.

That is why the rules on finance leases in the Finance Act 1997 allow the Revenue to look at consolidated accounts to see whether they are taxing enough profit (Schedule 12, paragraph 1(2) (a)).

Why give minority privilege?

The unfairness as between taxpayers that taxing group profit would bring would come from two sources. The first is minority interests. A subsidiary may not be wholly owned, and this is reflected in the group accounts by deducting the slice of profit attributable to the minority shareholders.

But should it be deducted? Why should a group with some minority shareholders pay less tax than an identical group with none? Doesn’t that amount to making dividends to the minority a deductible expense?

The second unfairness is foreign accounting standards. A multinational group will be constrained in its reporting by the accounting standards of several countries. The figures in its UK accounts may have to be compiled on a different basis to that of a solely UK group. A company that chooses depreciation over twelve years but is jealous of one using eight years is free to change to eight. But a multinational may not be free to align its accounting policies with those of its UK counterpart.

It will be a long time before taxing group profits can be fair between taxpayers and before we are comfortable about taxing individual companies on their accounting profits – even though that would allow a massive simplification.

The Chartered Institute of Taxation makes the point with its motto – ‘Justice between State and Citizen’.

I would only add, Justice between Citizen and Citizen.

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

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