Corporation Tax

Structure and scope of corporation tax

There is currently much interest and debate in the UK about the structure and scope of corporation tax. The debate has included a wide set of issues, ranging from the level of the headline rate, and the impact of various European Court of Justice decisions on a variety of issues, to the extent to which the administration of tax creates uncertainty and additional costs for business. The role of the deductibility of interest costs against corporation tax has also played a prominent role in this debate. This report considers two complementary sources of evidence on the impact of existing tax systems on the use of debt. First, using aggregate data and unconsolidated accounting data, it compares the use of debt across countries to that country’s tax rate. As might be expected, a higher tax rate is associated with a greater use of debt. The obvious explanation is that the relative benefit of debt over equity increases with the tax rate, and hence so does the use of debt.
It also seems likely that companies that are part of multinational groups are more sensitive to the host country tax rate than purely domestic companies. However, although there is some evidence of this in the academic literature, the simple evidence presented here is not consistent with this hypothesis.

The second source of evidence presented in the report is a set of structured interviews held with the tax directors of 14 large multinational groups in the UK. These groups include both UK and US parented multinationals, and cover a broad range of sectors. The interviews covered two issues: how tax affects the existing financial structure of the groups, and how potential reforms to the UK corporation tax might affect decisions regarding financial structure.

Broadly, the results of the interviews indicate that UK multinationals typically hold all third party debt in the UK. Having raised debt in the UK, it is then disseminated around the group as needed, using both equity and debt, and taking into account the tax profile of both the funding and receiving countries. Few UK multinational companies now make use of hybrid entities or hybrid-based financial products. Legislation in 2005 significantly limited the scope for such activity, and most respondents considered that highly structured tax-driven products had only a short shelf life. Respondents were asked to comment on a number of hypothetical reforms to the UK tax regime. There was some agreement about the logic of introducing some form of interest apportionment to restrict relief to interest on borrowing to finance activity in the UK. However, a consensus view was that it would be impossible to introduce any form of apportionment in practice without creating considerable administrative and compliance cost, and uncertainty.

As might be expected, the option of simply reducing the rate of tax at which interest could be relieved – say, to 15% - met with little support. The consensus view expressed was that such a reform would impose considerable costs, and reduce the attractiveness of the UK as a location for economic activity. However, a rather more favourable response met the hypothesis that the tax rate on interest received would also be cut. Most respondents considered that a 15% rate on interest received and paid would be sufficiently competitive such that the incentive for offshore financial planning would be removed. Debt would be pushed down to subsidiaries, reducing the overall UK expense, while there would also be an incentive to remit interest to the UK. Perhaps not surprisingly again, reducing the corporation tax rate on all activity also met with a positive response. Profit repatriation generally would be encouraged should this change be coupled with an exemption from tax for overseas dividends.

Source: Michael P. Devereux (Director of Centre for Business Taxation) , Socrates Mokkas (Research fellow), James Pennock (PricewaterhouseCoopers), Peter Wharrad (Vodafone), (Dec 2006), Interest Deductibility for UK Corporation Tax, Oxford University Centre for Business Taxation