The great escape

The decision by Shire and United Business Media in April to change their tax
domicile from Britain to Ireland proved to be the tipping point for UK
multinationals, tax consultants and trade associations. Rather than just
muttering to each other about their frustration over the government’s constant
tinkering with the corporate tax regime, they were emboldened to launch a public
condemnation of the government’s proposed changes to the tax ­treatment of
foreign income.

“[Their] decision to move to Ireland has brought the problems that have been
bubbling under the surface into sharp focus and pushed this issue back onto the
boardroom agenda,” says John Whiting, tax partner at PricewaterhouseCoopers.

Sir Martin Sorrell, chief executive of advertising giant WPP, said his
company would also consider moving if the proposals are implemented. “The
proposals will lead to the exodus of a number of multinationals,” he says. “I
have been surprised by the number of our clients and non-clients who are
considering this action.”

This public criticism galvanised the UK government into action, of a sort.
The beleaguered Chancellor, Alistair Darling, said the government would form a
new working group to look at the long-term challenges facing the UK tax system.

“I am determined that we do what is necessary to remain one of the world’s
best places to do business and to ensure we maintain our strong and resilient
economy and our position as the world’s leading financial centre,” says Darling.

This decision has been welcomed by tax consultants. Bill Dodwell, head of tax
policy at Deloitte, says: “I hope the Chancellor now realises the size of this
problem and the negative impact that these changes could have on the UK
economy.”

Ironically, the proposed changes to the treatment of foreign income were
supposed to make life simpler for British business. For a long time, UK
businesses have been asking the government not to charge tax on dividends paid
out of profits earned abroad. The Treasury recently agreed in principle to these
exemptions, but said anti-avoidance rules had to be tightened.

Passive aggressive
The government has proposed that worldwide “passive income” should be taxed.
This includes earnings from interest and royalties. This has a particular impact
on pharmaceutical and media companies, which make much of their profits from
intellectual property and royalty streams.
Major UK pharmaceutical companies say they will be watching the situation
closely.

AstraZeneca is in ongoing dialogue with the government to ensure that the
Treasury fully understands the concerns of businesses affected.

At the recent presentation of its first quarter results, finance director
Simon Lowth said: “The corporate structure is reviewed from time to time in
light of changes to the commercial, the tax environment and our wider business
activities, but as yet we don’t have any formal plans to change the existing
structure.” The company has since told the government that it will not leave the
UK.

While businesses are frustrated with the ­government for adding complexity,
rather than ­simplifying the tax regime, these proposed changes have sparked
other concerns. Ian McCafferty, chief economist adviser at the CBI, says: “These
changes will deter companies from remitting these profits to the UK. That will
reduce the funds that companies have available to make investments in the UK,
which will harm the health of the economy.”

The proposed changes to the tax treatment of foreign income is the latest in
a long list of gripes that British business has with the government over changes
made to the corporate tax regime.

Since Labour came into power in 1997, the tax system has become increasingly
complex. The average number of pages contained in the finance bill rose from 153
pages during 1980-4, to 463 pages between 2000 and 2007. In 2007, Tolley’s
Yellow Tax Handbook totalled 9,866 pages, more than double the page count
in 2001. The UK now has the longest tax code in the world, resulting in the
spiralling cost of compliance.

“While the change to the tax treatment of ­foreign income is the most urgent
issue, this is just part of a broader issue among the business community about
the whole UK corporate tax system,” says McCafferty. And he worries that the UK
tax system is eroding British business’s ability to compete in the global
economy. “Ten years ago our tax system was highly competitive, but it just isn’t
anymore,” he says.

Stop messing
The government’s tinkering with the tax system has unnerved the business
community. PwC’s Whiting says: “The constant stream of changes mean that the tax
system is not as stable as it ought to be.” There is also a growing frustration
in the business community with the government’s increasing tendency to act
unilaterally.

These constant changes to the system, many of which are retroactive, mean
companies find it increasingly difficult to make long-term investment
commitments, says McCafferty.

Rather than cutting and pasting together the corporate tax system, companies
are increasingly demanding legislators just start afresh. “Making the UK tax
system more attractive would attract more businesses to the country and generate
higher corporation tax receipts over the longer term,” says McCafferty.

Martin Temple, chairman of the manufacturers organisation EEF, says he
welcomes the government’s announcement that there will be a ­strategic review.
“We want them to demonstrate that they are committed to reducing corporation
tax. Rather than rushing out some minor changes, we would much rather that they
made a strategic statement of intent and made it clear that there will be a
radical re-haul of the ­corporate tax regime,” he says.

In March, the CBI’s tax taskforce outlined its proposals for such an
overhaul, including ­cutting the corporation tax rate to 18% – ­matching the new
capital gains tax rate – within eight years and simplification of the tax system
to stimulate the growth of small and medium-sized businesses.

In its report, the CBI said that the UK is facing stiff competition from
other European Union countries including the Netherlands and Portugal, which
have already cut their corporation tax rate to 25%, while Ireland’s is only
12.5%.

Even though most think the government is finally getting the message that
British ­business is seriously concerned about the changes to the tax system,
some doubt whether the ­government will have the stomach to do anything
ambitious.

Corporate tax receipts raise a significant amount of money for the
government’s public purse, equivalent to £50bn, or about 9% of total income.
Whiting says that it is because corporate tax makes such a significant
contribution to the UK’s public spending that government is reluctant to making
sweeping changes to the system.

As Mark Prisk, shadow minister for business and regulation, says, “The
reality is that the government’s cupboard is bare. It has been spending money
like a drunken sailor.”

Old Shire, new Shire
Pharmaceutical group Shire is moving to Ireland via a scheme of arrangement that
creates a new UK-listed, Jersey-incorporated holding company whose tax domicile
will be Ireland.

The new holding company, Shire Limited, will swap new shares for all existing
shareholders on a one-for-one basis. The group will keep its listing in London
and on NASDAQ. Its headquarters will remain in the UK. The scheme has been
approved by shareholders and is expected to be approved by the High Court at the
end of May.

UBM’s move to Ireland follows almost exactly the same procedure.

Where in the world
Assume that a fictional company, ABC Pharma plc, has subsidiaries in the US and
the Netherlands and receives dividends from both. Let’s also assume that the
Dutch subsidiary holds some patents and receives a royalty stream from the US
subsidiary for those patents. With the current UK tax regime, both the US and
Dutch subsidiaries pay local corporation tax.

When the dividends are received in the UK, the parent has to pay further tax
if the country where the tax is sourced has a lower rate than in the UK. For ABC
Pharma plc, the tax rates in the US and the Netherlands are almost the same rate
as the UK so there is normally little or no additional tax income to be paid.

Under proposed changes, the government has agreed in principal that dividends
from places such as the US and the Netherlands will not be taxed in the UK. But
the government has also tightened anti-avoidance measures to stop companies
squirreling money away in low-tax regions. Under the proposed changes, the
government will demand a much greater analysis of so-called “passive income”
streams which include earnings from interest and royalties.

The implications for ABC Pharma plc is that there would be no tax paid for
earnings made by its US and Dutch subsidiary that are then repatriated to the
UK. But the company will have to provide an analysis of the streams of passive
income passing between its subsidiaries. The royalties received by the Dutch
from the US subsidiary could be seen to be of ultimate benefit to the UK parent
company and, therefore, taxed here.

“Not only will companies have to pay additional money to carry out this
analysis of all the passive income streams, but they may have to start paying
tax on incomes that are not even repatriated to the UK,” says
PricewaterhouseCooper’s Whiting.