UK competitiveness – should you stay or go?

No sooner had the cheers from the government benches died down than the tax
experts, with their pencils sharpened and calculators at the ready, got down to
some serious number crunching.

Chancellor Gordon Brown had delivered what was almost certainly his last
Budget speech. To the dismay of the Tories he had apparently stolen a march on
one of their own tax policies – a cut in the rate of corporation tax.

But, as has always been the way with Brown’s Budgets, the devil was in the
detail. Yes, the headline figure was indeed a cut in the tax rate for larger
companies, from the current 30% to 28% in 2008. But alongside this came an
overhaul of the capital allowances system and an increase in the smaller company
tax rate, purportedly introduced to stamp out managed service company tax
abuses.

One of the principal reasons for the headline cut will have been the UK’s
competitive position among the world’s economies. At a time of increasing global
mobility, large corporations have little difficulty in relocating their main
operations and headquarters as away of minimising their tax liabilities. Ed
Balls, economic secretary and close confidant of the chancellor, will have been
very aware of concerns raised by, among others, the Corporation of London, which
has been worried about losing its position as a premier financial centre, a
place where the world can do business.

Already, Lloyd’s insurers Hiscox and Omega have relocated to Bermuda, where
they hope to halve their effective tax rate. Colt Telecom has shifted to
Luxembourg, while US firms such as Procter & Gamble and Kraft have moved
their European HQs from the UK to the more sedate environs of Switzerland. So
will the cut allow the Brits to take on low-tax Ireland and the growing
economies of central and eastern Europe?

Deloitte’s head of tax policy Bill Dodwell says: ‘Everyone knows that the UK
will never in a million years be able to compete with Ireland in tax rate terms
– it would simply be impossible. The UK couldn’t afford to get near there.’

But Dodwell doesn’t see Ireland, which has a main corporation tax rate of
12.5% as a great comparison. Nor does he rate other parts of Europe as big
attractions.

‘Nobody is going to leave the UK to go to eastern Europe,’ Dodwell argues.
‘It hasn’t got the business environment and all the other things that business
needs. A nice, low tax rate is only a small advantage.’

While Dodwell accepts that the change in the UK tax rate will make a
worthwhile difference, certainly for those companies that are doing well, he
believes that some sectors, such as manufacturing, will suffer. This is largely
because they are heavy investors in plant and machinery and will therefore lose
out as a result of the changes in capital allowances.

But the tax rate is only one part of the UK’s tax competitiveness equation.
Chris Sanger, Ernst & Young’s head of tax policy, says the tax base and the
tax administration are just as important.

Like Dodwell, he believes the changes to the tax rate shows the Treasury has
woken up to the need to reduce the rate to maintain the UK’s competitive
position.

But he is less happy with the tax base – what is actually taxed in the UK.
‘At the moment the UK operates a kind of “top up tax” – that is, if you have
profits that are taxed at less than [the new] 28%, then we will top that up with
an extra UK tax to bring it up to 28%,’ Sanger explains.

‘This is a fairly good incentive not to bring profits back into the UK.’ The
UK government has been consulting on moving to an exemption regime that could
mean profits will not suffer tax when brought back into the UK.

‘This would be a real step forward in making the UK an attractive place to
invest in,’ Sanger says.

The Netherlands has a ‘participation exemption’ that makes it very attractive
to international holding companies. ‘We are hearing positive noises from the
Treasury in terms of consultation on the taxation of foreign profits,’ Sanger
says.

A policy document is expected from the Treasury in late spring that will deal
with areas such as dividends and controlled foreign companies. Mark Schofield,
tax partner at PricewaterhouseCoopers, is optimistic the consultation will prove
fruitful. ‘What would be good to get out of it would be a simplified or
easy-to-follow set of rules so that people have certainty,’ he says.

This concept of certainty is the third strand of the competitiveness
argument. The UK system is notoriously complex. ‘It is not about achieving any
particular benefit,’ Schofield says,‘ it is about having certainty about what
your tax position is, what the rules are and knowing they will stay the same.’

Allied with this is the argument that, rightly or wrongly, Revenue &
Customs has a reputation for being obsessed with anti-avoidance measures rather
than helping taxpayers through the system.

‘Does this focus [on anti-avoidance] give the wrong impression?’ asks
Schofield. In part this attitude is being addressed by the Varney review – Sir
David Varney, the former chairman of the Revenue, has reported on the
relationship between businesses and the tax collector.

The report offers signs of hope. ‘All depends on the quality of
implementation in getting it right,’ Schofield says, while Sanger believes the
challenge will be to maintain the momentum of the review.

So the experts agree that the tax rate is important, but that other factors
influence the UK’s competitive position, and not just in the tax arena –
infrastructure, skills and economic stability are all just as important. But, as
Sanger points out, while tax might once have been sixth or seventh on the list
of factors influencing corporate location, it has now crept into the top three.
As other countries play catch-up, the tax system really does come into play.

So you want to go. But where?

If you like the idea of sun, good scuba diving and the prospect of paying
zero tax, then the Cayman Islands or Bermuda has to be a good bet – Hiscox and
Omega certainly think so.

However, the infrastructure might not be suitable, and it is quite a commute
to the City.

Closer to home, Ireland has to be very attractive with just a 12.5% corporate
tax rate plus the advantage of a vibrant economy and good access to other key
markets in Europe and elsewhere.

The Celtic tiger is proving particularly attractive to financial service
companies looking to relocate their back-office operations, while keeping their
front-offices in the UK. Looking east, Poland’s tax rate is 19%, Hungary’s is
16% while Latvia and Lithuania both charge 15%.

These countries will be of particular interest to manufacturers but at the
moment they are unlikely to appeal to those looking to relocate head offices.

It isn’t all bad: reasons to stay in the UK

AIM, the Alternative Investment Market, has proved highly successful over the
past few years. Although the major attraction is its lighter touch regulation,
it also offers a favourable tax position. AIM-listed companies are, for
instance, termed ‘unquoted’ from a tax perspective, making them eligible for
Enterprise Investment Scheme (EIS) relief and qualifying investments for venture
capital trusts.

Interest paid by a UK company is tax-deductible, so long as there are
sufficient UK profits.

Elsewhere in Europe, companies often find themselves forced to accept a
disallowance simply to obtain closure and certainty on their tax obligations.

The alternative, which can be costly and time-consuming, is to seek a
corresponding deduction elsewhere. Financial services companies (or indeed any
other service-orientated businesses), which have modest requirements for capital
investment, will probably be better off under the UK’s new capital allowances
regime.

Despite everything, the UK economy remains in a healthy state. It has a
highly skilled workforce and the City of London continues to hold a key place in
the financial world.

It could be worse – you could be in Germany and paying 38.3% tax.

European league

So where does the UK stand in the European league table of corporation tax?
The UK’s position in terms of its headline corporation tax rate is not good.
Cyprus scores best, with a tax rate of 10%, followed by Ireland with 12.5% – a
rate that has made Dublin particularly attractive to companies wishing to
relocate part of their operations.

The UK’s new tax rate of 28% will put it on a par with Denmark and Sweden,
and just above the Netherlands, which has proved attractive to the likes of
Royal Dutch Shell. But even with its existing rate of 30%, the UK is still above
France, Belgium and Spain, while Germany languishes at the bottom of the
European table with an eye-watering rate of 38.6%.

COUNTRY/CORPORATE TAX RATE

Cyprus 10.0%

Ireland 12.5%

Latvia 15.0%

Lithuania 15.0%

Hungary 17.5%

Poland 19.0%

Slovakia 19.0%

NMS10 (accession states 2004) 20.3%

Estonia 23.0%

Czech Republic 24.0%

Austria 25.0%

Slovenia 25.0%

EU25 (all EU) 25.8%

Finland 26.0%

Portugal 27.5%

UK (from2008) 28.0%

Denmark 28.0%

Sweden 28.0%

Greece 29.0%

Netherlands 29.0%

EU15 (EU without NMS10) 29.5%

Luxembourg 29.6%

United Kingdom 30.0%

France 33.3%

Belgium 34.0%

Spain 35.0%

Malta 35.0%

Italy 37.3%

Germany 38.6%

Source: Grant Thornton