Corporate tax roadmap
There is obviously great uncertainty as a consequence of Russia’s invasion of Ukraine. We are also coming through the turmoil of the UK’s departure from the European Union and the Covid pandemic, however the prospect of disappointing levels of business investment and economic growth remains. The OECD’s work on the reform of the international tax system has culminated in a set of proposals that now need to be implemented.
A frequent request of businesses is that they want to know where they stand and be able to plan for the future. For a business making an investment decision today, it will be more interested in the corporation tax regime at the point that it is making a profit – likely to be some years hence – than in the current system. The more that business knows about that future regime, the more confident it can be to make investment decisions.
At the moment, there is little certainty as to the future of corporate taxes in the UK. In his March 2021 Budget, the Chancellor of the Exchequer, Rishi Sunak, announced increases in the rate of corporate tax from 19% to 25%, the first increase in the corporation tax rate since 1974. He also announced the introduction of a temporarily more generous capital allowance regime – the so-called “super-deduction” in which companies can claim 130% of expenditure on new qualifying plant and machinery between 1 April 2021 and 31 March 2023. The Chancellor has stated that he will assess the evidence as to the behavioural response to this policy before deciding whether to extend its operation.
If the case for providing greater certainty to businesses and investors as to what a future regime will look like is that this can bring greater investment, events of recent years also demonstrate why governments may be reluctant to tie their hands.
When a government requires additional tax revenue, corporate taxes can prove to be the politically least painful means of finding that revenue. Corporation tax may not raise anything like the revenue of the big three taxes – Income Tax, National Insurance contributions and VAT – and, in the view of many economists, is more economically harmful, but it sways far fewer votes. Evidence for this can be found in the muted response to the March 2021 announcement to increase corporation tax (forecast to raise £17bn per annum) versus the difficulties the Government has faced in increasing National Insurance contributions (forecast to raise £12bn per annum).
To a large extent, the attitude a government might take towards setting out a plan on corporate taxes will depend upon whether its sees this as an important matter for increasing growth and investment. In his Mais Lecture of 24 February, Rishi Sunak highlighted the importance of improving business investment for the UK economy and hinted that the tax system may have an important role to play. If he does consider tax policy to be important, he should consider the 2010 corporate tax roadmap as a precedent, even if the policy choices will be different.
The UK’s corporate tax roadmap of 2010
At the time of the announcement of the corporate tax roadmap in November 2010, I was the UK’s tax minister and continued to be so throughout its implementation.
When the coalition Government was formed in May 2010, the principal objective was to reduce the deficit which had grown to a peacetime record level following the global financial crisis. In addition, there was a concern about restoring economic growth at a time when there was considered to be little fiscal leeway. Corporate tax reform was viewed as a relatively inexpensive way of sending a positive signal to businesses and international investors. This was in part because tax reductions could take effect some years after any announcement. This meant that the Budget scorecard – the table setting out the forecast cost to the Exchequer over the following five years – would only contain negative numbers in the final year or two.
More importantly, there was a belief that a competitive corporate tax system would deliver significant benefits for the UK economy. A comparison could be drawn with the Republic of Ireland which had both a very competitive corporation tax rate and favourable treatment (some would argue, too favourable) for multinationals locating their corporate headquarters there. The flow of corporate inversions – as UK headquartered businesses redomiciled to other jurisdictions (often the Republic of Ireland) – was viewed as damaging business confidence with concerns that a growing number of businesses were considering such a move.
Work on the corporate tax roadmap began when the Conservatives were in opposition when there was significant engagement with tax professionals. Two policy objectives quickly emerged. First, a reduction in the main rate for corporation tax which would be paid in large part by broadening the base (very much along the lines of Nigel Lawson’s reforms of 1988). Second, an updating of the UK’s Controlled Foreign Companies (CFC) regime which was viewed as increasingly unattractive and the cause of the growing number of corporate inversions.
The reductions in the corporation tax rate had already been announced in the June 2010 Budget and the roadmap merely reconfirmed the policy. Alongside the roadmap, a consultation paper was published on CFC reform setting out plans to move to a more territorial tax system.
There were two further major policy issues that were considered in the course of preparation of the roadmap. In the light of the desire to lower the corporation tax rate by broadening the base, much thought was given to tightening the rules on interest deductibility. At the time, it was decided not to proceed with this policy and the roadmap set out the reasons for this decision. In Budget 2016 and, therefore, outside the roadmap period, the Government did announce reforms restricting interest deductibility.
The other major policy decision was the announcement of the creation of the Patent Box, in which profits related to patents and other forms of mobile intellectual property would be taxed at a reduced rate of 10%. The policy tension here was between minimising complexity and potential distortions with ensuring that the UK strengthened its competitiveness in areas where it was perceived that economic activity was most likely to be responsive to lower rates. This latter consideration prevailed.
The 2010 Roadmap also addressed the manner in which tax policy was determined and the administration of the tax system. These elements, whilst attracting less comment, proved to be very well-received.
A frequent business concern was instability and unpredictability in tax policy. The roadmap reserved the Government’s right to move quickly when addressing issues of tax avoidance but the broad approach was to provide reassurance that tax policy would generally only change after thorough consultation and with good notice being provided, as had been set out in a Treasury paper on tax policy making that was published at the time of the June Budget.
On tax administration, the Government sought to encourage an enhanced relationship between HMRC and large businesses, based on openness and transparency. This was designed to build on the approach HMRC had adopted in the years running up to 2010 that had seen a less confrontational approach.
When assessing the success or otherwise of the 2010 Roadmap, much of the focus will be on the merits of the policies set out. The Government subsequently over-delivered on corporation tax rate cuts (reducing it to 19% not 24%) but given that in 2021 it was announced that the rate would be increased to 25%, many commentators have argued that cutting the corporation tax rate was the wrong priority. I hold a different view but will not rehearse the arguments here.
The question for the Treasury is not whether it should pursue a low corporation tax rate (it has decided not to do so) but whether there are benefits from setting out its strategy and approach. The response to the 2010 roadmap from tax professionals and large businesses was that the certainty and stability provided by such a roadmap was welcomed and enabled businesses to plan. The UK’s rating in various surveys on tax systems improved, corporate inversions from the UK largely stopped and we started to see more multinational businesses locate their international or regional headquarters in the UK.
There are, of course, disadvantages in setting out a roadmap. A roadmap sets out what the Government is going to do but for many interested parties its significance is what is not included. Unless an exception applies, a credible tax strategy means that interested parties should be able to rely on the roadmap as an indication of future policy developments. This reduces the Government’s flexibility if, for example, it is looking at potential measures to raise revenue. It is better not to have a roadmap than have a roadmap which is ignored by the Treasury in future announcements.
Before deciding whether a roadmap should be produced, Ministers should ask themselves if they have a plan for policy in this area. It may be an unexciting plan – such as leaving well alone – but this would still constitute a plan and an explicit statement of this intention would still provide greater certainty to businesses. If, however, the desire is to keep all options on the table as the Government responds to events, the publication of a roadmap would be best avoided. Businesses and investors are entitled to ask, though, precisely what this may mean for future policy.
Author: Rt Hon David Gauke, Head of Public Policy
In the recent Mais lecture, Rishi Sunak set out his ambitions to accelerate economic growth by fostering a new culture of enterprise focused on capital, people and ideas. Although a roadmap was not explicitly mentioned, the idea of a tax strategy to spur greater business investment was hinted at. So, while the prospect of a roadmap is not a given, there is a sense that the Chancellor is aware of the role that a clear tax strategy can have in order to harness economic growth.
In the rest of this paper, we explore the key components that might be contained in a corporate tax strategy.
The rate of corporation tax is an important signal about the competitiveness of a jurisdiction. Arguably the headline rate is the shop window, a useful device to entice investment in, even though the effective tax rate that a business is subjected to will ultimately be more important.
It seems the days of the UK having one of the lowest corporate tax rates in the OECD are now over. The Chancellor set out his stall on the rate of corporation tax at the March 2021 Budget when he announced that the main rate would increase from 19% to 25% from 1 April 2023. This major reform overturned George Osborne’s legacy of a series of reductions to the headline rate and represents the first increase to the rate of corporation tax for nearly half a century. It is crucial to not forget that the headline rate of 25% now sits on a much-broadened tax base which was the price paid for the earlier reductions in the rate. It will be much harder to shrink the tax base over the short-term and so businesses will feel the pinch from the double hit of a higher rate and broader base.
The Government’s objective behind the increase – explained in the policy document accompanying the Budget announcement - was “to raise revenue whilst keeping the UK’s rate of Corporation Tax competitive relative to other major comparable economies”1. It is projected that the rate increase will bring in some £17bn in the 2025-26 fiscal year2 and according to the IFS, the UK’s rate of corporation tax will be “slightly above [the OECD] average”3. Assuming these objectives are met, on the face of it there is little more that a roadmap could say on the rate. However, this neglects the uncertainty around what the rate increase means for the overall direction of travel, for example, does this represent a one-off increase? And how does this play into the government’s overarching objectives to increase business investment? Explaining the rate increase as part of an overarching strategy would mitigate the uncertainty it has created.
The increase in the rate of corporation tax suggests the Chancellor will pivot towards changes to the base which might include targeted changes to reliefs and incentives. This is implied in his comments at the Mais lecture where he said, “a priority will be to cut taxes on business investment”. This new approach completely reverses the policy choices made over the previous decade where a low corporate tax rate accompanied by a wider tax base was favoured.
One of the most eye-catching changes that the Chancellor has already made to the tax base is the introduction of the temporary super-deduction capital allowance. This provides a vastly boosted deduction of 130% rather than 18% for expenditure on new plant and machinery incurred between 1 April 2021 and 31 March 2023. Although lauded as one of the biggest tax cuts for business investment, the measure is a neat fix to the problem posed by the hike in the rate of corporation tax. Without the super-deduction, there would have been a perverse incentive to postpone investment.
When the super-deduction comes to an end there is a question mark about how the tax system can be used to promote capital investment. Retaining the super deduction would come at a significant cost and it is not clear whether it is having its desired effect. The CBI believes the super deduction is having an impact, with research indicating 1/5 of capital expenditure has only taken place because of the opportunity presented by the super deduction4. Initial OBR estimates were similarly positive suggesting investment would be “10% higher than would otherwise have been the case”5, however this forecast was heavily caveated that it was due to investment being brought-forward (rather than stimulating new expenditure) and furthermore, since those initial forecasts, the OBR has revised its costing down due to evidence of slow take-up.
The biggest challenge with proving the effectiveness of a temporary incentive for capital expenditure is that businesses are unable to change the dial on large-scale investments in such a short space of time. While it is not yet clear what effect the super-deduction has had on investment levels, a longer-term strategy is needed. Without action, capital allowances for plant and machinery will reverse back to a writing down allowance of just 18%. Reverting to this level would place the UK low down the rankings of other OECD jurisdictions (number 30)6 and when combined with the higher corporation tax rate it will ultimately make the UK less attractive for capital investment.
Unlike the super-deduction, the cost of boosting capital allowances should only be seen as a timing difference for government finances given it represents an acceleration of relief towards the year of acquisition rather than spread over the useful life of the asset. In an era of low interest rates this might arguably represent a good investment by the government, however with interest rates rising this option may not be as affordable for the government as it once was.
The Chancellor has also hinted at further reforms to the UK’s R&D tax credit regime. Again, in the Mais lecture it was clear that there was an ambition to ensure that the regime “properly incentivises higher business investment in R&D”. And while there are signs that some reform might already be underway following an earlier consultation, the direction of travel is unclear.
A number of small changes were made in the Autumn 2021 Budget when the Chancellor announced that there would be an expansion of the qualifying expenditure to include data and cloud computing costs. In addition, the regime would become more targeted to ensure only R&D activity carried out in the UK would qualify. What is not clear is whether these changes represent minor tinkering with the existing regime or if there is ambition for wider reform.
Setting the strategy for a tax regime that promotes innovation would also need to factor in the Patent Box. The advent of the global minimum effective tax will significantly reduce the value of the regime. Therefore, any strategy needs to consider how the tax system will attract and retain innovative companies within the confines of complying with the standards set by the OECD’s global minimum effective tax.
The main planks of the government’s international tax agenda for this Parliament are already clear: the finalisation and implementation of the BEPS 2.0 reforms – Pillars One and Two – agreed in outline by OECD countries in October 2021.
The Pillar Two rules have more-or-less been agreed by the OECD and the UK government has already begun the process of implementing them. This is likely to be a multi-year endeavour, encompassing enacting the GloBE minimum tax rules, changing tax treaties to give effect to the Subject To Tax Rule (STTR), introducing a Domestic Minimum Tax (DMT), making consequential changes to domestic tax rules and building the HMRC systems and processes needed to administer the rules. These changes will be complex and challenging but there is considerable impetus behind Pillar Two given the potential revenue that might be raised, and the value of a global minimum tax in protecting the UK’s international competitiveness following the CT rate increase to 25%.
Pillar One is less advanced, and it is unclear whether countries will be able to reach a comprehensive agreement that is palatable to all of the key players (including the US) and even if so, what a realistic timetable for implementing that agreement would be. However, Pillar One remains a key UK priority that the government has invested political capital in, and which is seen as necessary to satisfy voters that want to see digital giants paying material tax in the UK, and to avoid a return to trade wrangling with the US over the Digital Services Tax.
The BEPS 2.0 reforms will make the UK corporate tax system even more complex and burdensome to administer than it is presently. This naturally provokes consideration of how that system might be simplified. Alongside the implementation of the reforms themselves any roadmap could involve:
Rationalisation of the patchwork of existing anti-BEPS rules
Arguably some of the UK’s existing base protection rules may be redundant or of limited impact post-Pillar Two. In particular there is a case for examining the Controlled Foreign Company rules, part of the original function of which is now achieved by the Corporate Interest Restriction (CIR) and where there is likely to be considerable overlap with the Pillar Two Income Inclusion Rule. Other rules that either explicitly or implicitly target arrangements where low-taxed income is realised overseas might also warrant review.
The UK consultation document on Pillar Two implementation indicates that the government does not intend to undertake major reforms to existing BEPS measures alongside Pillar Two implementation. That is perhaps unsurprising – the effectiveness of Pillar Two has not yet been proven in practice, and in any case existing BEPS regimes apply to all groups, including those that will not be in scope of Pillar Two. However, it may be that rationalisation is something that the government returns to in the longer term.
Measures to align aspects of UK corporation tax with the GloBE rules
Pillar Two will mean that the UK effectively runs two corporate tax systems in parallel: the existing corporation tax system and the new GloBE/DMT system. This will be a complication in situations where the two systems treat transactions or arrangements differently, and in some cases could result in double taxation. It might therefore be desirable to align some areas of the UK’s CT rules more closely with GloBE, for example the rules around amortisation of intangible fixed assets, which could potentially result in timing differences that are not fully adjusted for under GloBE.
Measures to simplify or reform administrative processes
Large businesses are increasingly taxed on a group-wide basis: this is how the CIR works, how the GloBE rules and the proposed DMT will work and is a feature of regimes such as the corporate loss restrictions. However, the UK continues to take an entity-by-entity approach to corporate tax returns, with group-wide information provided in supplementary returns where necessary. It may be time for the government to revisit this and develop native systems for group CT returns – although this would require substantial investment by HMRC and might be seen as lower priority than rolling out Making Tax Digital (MTD) to small companies.
A hypothetical roadmap might also address some narrower issues of importance to certain business sectors:
- bank taxes: following the reduction in the Bank Surcharge announced at Autumn Budget 2021 the government is unlikely to make significant further changes in bank taxes in the near future;
- online Sales Tax: the government is consulting on the idea of applying a 1 or 2% tax to revenues from online sales, to level the playing field between traditional retailers that have hefty Business Rates bills and their online competitors with smaller property footprints. It is far from clear whether this will be taken forward, however if it is it will introduce a novel basis on which UK businesses can be taxed; and
- large business tax administration: through the Summer 2021 Review of tax administration for large businesses the government indicated that it believes effective tax administration has a role to play in supporting the UK’s attractiveness as a location for international business investment. This may well be a theme the government returns to in the coming years; however, it remains to be seen how significant any changes in practice will be, especially given the resource pressures facing HMRC.
This paper focuses on corporate tax but other areas of taxation such as personal tax and environmental taxes will also play a part in the attractiveness of the UK and meeting the Chancellor’s priorities around capital, people and ideas to foster greater business investment.
1 HMRC policy paper “Corporation Tax charge and rates from 1 April 2022 and Small Profits Rate and Marginal Relief from 1 April 2023”, published 3 March 2021
Corporation Tax charge and rates from 1 April 2022 and Small Profits Rate and Marginal Relief from 1 April 2023 - GOV.UK (www.gov.uk)
3 Finance Act 2021, Section 6: charge and main rate for financial years 2022 and 2023; Section 8: increase in the rate of diverted profits tax, Stuart Adam (IFS), British Tax Review, Vol. 4, No. 2021, pp. 374-378 Journal Article (ifs.org.uk)
5 Super-deduction supplementary forecast, OBR, February 2022
OBR supplementary forecast information release: Capital allowances super-deduction costing
6 Net Present Value of Capital Allowances in OECD Countries (2020), Tax Foundation, March 2021
Capital Cost Recovery: Capital Cost Recovery across the OECD (taxfoundation.org)