A common theme seems to emerge from this summer’s frenetic, repetitious and unending round of conferences – taxation and corporate governance. There is nothing new in this, but, in the past, these were fringe meetings and the issues only incidentally interesting. However, it appears that this time may be different.
The issue of tax avoidance has received sensationalist treatment in many places, in the LuxLeaks disclosures in particular: http://www.icij.org/project/luxembourg-leaks and the double Irish Dutch sandwich has entered common usage. There are more measured examinations of corporate taxes paid, for example, MSCI’s May 2015 “Re-examining the tax gap”. This is an updating of an analysis first conducted two years ago on the constituent members of the MSCI World index. In this short period, the number of companies with unusually large tax gaps rose from 213 to 243.
The analysis concludes that if these companies had paid the same level of taxes as their peers, they would have paid an additional USD 82 billion; approximately 20% of their declared profit after tax. Given the publicity attached to the UK “Google” tax and the Australian “Netflix” taxes, it is surprising that, from this analysis, the pharma sector is more likely that the IT to engage in aggressive tax avoidance.
It is clear from the volumes of official publications that the subject has the attention of the authorities. The European Commission’s latest Communication, on their Action Plan, draws attention to the fact that even though the rates of corporation tax have been falling since the early 1980s, the actual receipts have only been stable at around 6.5% of all taxes (2.6% GDP) in the EU.
This is surprising in that more companies are now being formed, the tax base is broader and falling interest rates should have reduced interest deductions. The 2012 US President’s Framework for Business Tax Reform draws attention to the differences between the taxation of equity and debt in many G30 countries. It shows an average of bias in favour of debt of 51%, with the lowest (19%) in Ireland and the highest (97%) in the United States.
This question of a debt bias is prominent in discussions of systemic stability, as excessive indebtedness is seen as a prime causal factor in the recent crisis. In a speech entitled “How to restore a healthy financial sector that supports long-lasting, inclusive growth”, Catherine Mann, the chief economist of the OECD recently called for reforms “to reduce the tax bias against equity financing and to make value added tax neutral between lending to households and businesses.”
Moving back to the issues of evasion, the OECD BEPS (base erosion and profit shifting) programme is expected to produce its final report and recommendations in October. The recent OECD conference on BEPS in Washington was a sell-out, which is perhaps indicative of the degree of interest. In the blogosphere, only a few representatives of that peculiarly American crackpot right were to be heard objecting.
Removing the bias or distortion does not mean that debt will cease to be used as a form of corporate finance. There will continue to be many situations in which debt is the appropriate form of financing. However, the economics of many activities are likely to be radically different. Borrowing to finance share buy-backs and the use of high leverage in private equity transactions are among these. Even the corporate bond market is likely to present different prospects; the sharing of the debt tax subsidy between investors and the company, which drove the excess returns of lower grade securities, is unlikely to persist.
The range of actions available to counter this distortion is wide. The detail settled upon in any country will doubtless reflect the history of tax concessions for the industries resident in those countries, and the power and influence of strong vested interests and lobby groups, including the accountants and tax consultants.
The missing element in these discussions is that of corporate governance. Shareholders can hardly be expected to prioritise actions that will lower their post tax returns. This is one of the clearest instances where strongly empowered shareholders will not drive board actions in the welfare enhancing direction. Board independence is critical, and with that must come greater accountability.
This accountability may be achieved by the appointment of external auditors by an external government body – the FRC, HMRC and the Department of Business Innovation and Skills are all potential candidates. It is worth recalling that the original reason for the appointment of external auditors was for the board to demonstrate compliance with banking and debt covenants, and protect its members. The role has changed with the passage of time.
Quite apart from the immediate issue of taxation, the state is the trustee of future generations, those as yet unborn and without voice or market impact. In this context, if problems were to persist with the power of appointment of auditors proving insufficient by way of influence, then it may become necessary to consider more by way of sanction such as restrictions and limitations on the rights and powers of the corporate legal person, including limited liability. The external auditor power would be firmly in the spirit of solutions to the tragedy of the commons where that party with the usage rights most remote in time has control rights over current usage.
Con Keating is head of research at BrightonRock Group
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