Budget 2011: Multinationals cause tax headache

By Simon Duke for MailOnline
Updated: 06:35 EDT, 22 March 2011

Big corporations are fleeing Britain's tax regime and George Osborne has to work out how to encourage firms to stay - and pay. City Focus by Simon Duke.

Dilemma: Osborne faces delicate balancing act

Faced with the largest peacetime deficit on record, George Osborne is preparing measures aimed at stemming the exodus of big companies from these shores.

Tomorrow's Budget is likely to herald a far-reaching overhaul of rules governing how much tax multinationals pay on profits they earn overseas.

At stake is the £47bn that firms are forecast to pay into state coffers in the coming financial year - equivalent to around 8% of total tax receipts.

Even for accountancy wonks, the Controlled Foreign Companies (CFC) rules are an obscure and dusty corner of the tax code.

But impenetrable as they are, the CFC rules are a growing source of rancour between the Government and big business.

The CFC code was originally conceived to stop more companies from bypassing HMRC by channelling all of their profits through subsidiaries in low-tax jurisdictions.

But over recent years, a number of big British firms, including advertising giant WPP and pharmaceutical group Shire, have shifted their tax residence to Dublin, where the corpocity residence to Dublin, where the corporation tax rate is just 12.5%

Building materials group Wolseley and publisher Informa have set up camp in Switzerland, with Luxembourg and the Netherlands among the other popular destinations for footloose multinationals.

It is not so much the rate of tax that is pushing companies towards the exit. Despite regular protestations from big business, Britain is not an especially high tax economy.

According to the Oxford Centre for Business Taxation, the UK corporation tax rate is the lowest in the G7 and has been 'well below' average for the past 25 years.

Instead, it is the way foreign earnings are taxed that has made Dublin, Zug and the Hague such powerful magnets. Under current rules, firms must pay the UK exchequer the difference between Britain's 28% corporate-tax rate and the profit charge levied on its foreign subsidiary (provided it was lower).

But, increasingly, these principles are coming under attack with nations 'racing to the bottom' in a bid to lure big corporations. Ireland, for instance, has abolished tax on foreign earnings for multinationals, which have to do little more than set up a brass-plate operation to exploit the rules.

The advantages for corporate refugees are clear. WPP, which is domiciled in Dublin for tax purposes and incorporated in light-touch Jersey, has reduced its corporation tax rate from 26% to 22% over the past five years. Based on last year's £850m profits, its 'continuing tax planning initiatives' have reduced contributions to the taxman by £34m.

Although so far only a trickle of companies have jumped ship, Osborne could conceivably be dealing with a flood as Diageo, Reckitt-Benckiser, HSBC and Barclays have all threatened to move.

But the Chancellor faces a delicate balancing act. Were he to follow Ireland's lead, he'd effectively be giving the green light to wholesale tax avoidance, making the task of tackling the deficit more Herculean still.

Mike Warburton, at accountancy group Grant Thornton, said: 'The Chancellor has a big hole to fill but he's not going to do that if more multinationals leave.

'But it's important that we have CFC rules. There has to be legislation to avoid a leakage of tax.'

Instead of dismantling the CFC legislation, it is likely that the Government will perhaps cut the rate of tax charged on overseas profits.

Following the 'corporate roadmap' published by the Treasury in the autumn, Osborne could also introduce exemptions on profits from intellectual property and, crucially, exempt a large portion of overseas 'finance income' from corporation tax.

Many UK-based multinationals are already bending the rules by setting up financing subsidiaries in low-tax jurisdictions.

Profits are funnelled through these 'treasury' divisions, and are subject to lower rates of tax when the cash is moved back 'on shore'. Richard Murphy, director of Tax Research UK, fears that tomorrow's Budget will 'legitimise' these 'grey areas'.

The opportunities for major corporations to avoid 'significant amounts of tax' are likely to 'proliferate' over the coming years, he argued.

Not only will this dramatically increase the burden on ordinary workers, but it also creates even more obstacles for smaller companies, which generally don't have the know-how or resources to exploit tax loopholes.