Written evidence submitted by TaxWatch

  1. TaxWatch is a UK charity dedicated to compliance and the sound administration of the law in the field of taxation. We are an investigative think tank which conducts forensic research and analysis on tax avoidance, tax policy and tax law, publishing our research to improve public understanding of tax issues. Through our work we seek to encourage high standards of tax conduct and civic responsibility. We welcome the opportunity to provide this submission to the Treasury Select Committee’s inquiry into Tax After the Coronavirus.
  1. This submission is focused on areas where we have undertaken specific research and developed expertise; tax avoidance and profit shifting (particularly in the technology sector), the taxation of tax exiles, the abuse of tax reliefs, and tax enforcement.

Tax avoidance and profit shifting – the scale of the problem

 

  1. Tax Avoidance by multi-national companies is a clear issue of public concern with opinion polls regularly finding that the vast majority of the public consider the practice to be morally unjustifiable. It therefore must be the case that any tax reforms which result in increases in taxation must be pared with efforts to improve tax compliance in order to ensure continued public support for the tax system.
  2. The main form of tax avoidance practiced by multi-national companies involves moving corporate profits to a low tax jurisdiction in order to avoid corporation tax in the UK.
  3. This can lead to corporate profits disappearing from national accounts altogether. As has been explored by the Bureau of Economic Research in the United States, profit shifting can artificially deflate GDP and productivity statistics.[1] All of this makes measuring tax avoidance an extremely difficult task.
  4. The UK government does not publish any estimate of the impact of tax avoidance on the Treasury, UK GDP or productivity. HMRC’s measuring tax gaps publication explicitly does not estimate tax avoidance via profit shifting.
  5. Academic research has sought to make estimates based on analysis of national accounts, or through an analysis at anonymised tax returns from businesses. These estimates put the impact of profit shifting on the UK Treasury in the region of £20bn-£25bn, making it an extremely significant problem.[2]

Profit Shifting – Tech Companies

  1. Although my no means restricted to technology companies, the practice of profit shifting has been particularly controversial in this sector.
  2. Looking at figures published by 8 of the largest US technology companies, we found that over the last five years technology companies have faced a tax rate of just 9.6% on profits globally. By contrast, the same companies have seen a tax liability of 45% on profits generated in the US.
  3. Often it is argued that low tax rates in the UK and other non-US jurisdictions from US headquartered multi-national companies is a result of the fact that most of the value of these corporations (and therefore profit) is created in the United States.
  4. However, on the basis of stock market filings, we found that the companies in our study declared 63% of their profits outside the US.[3]
  5. For companies to be declaring most of their profits outside of the US, whilst paying single digit tax rates on those profits, is an outcome that cannot be achieved without aggressive tax avoidance and profit shifting.
  6. TaxWatch has sought to demonstrate how much extra profit and tax would be generated in the UK if profits were re-allocated to the UK based on the sales these companies made to UK customers. This methodology arguably understates the amount of profit generated in the UK, because it assumes that costs are spread equally across all markets, when in fact most of the costs of producing digital services are not located in the UK.  
  7. On this basis we found that the top five tech companies operating in the UK managed to generate estimated profits of £8.1bn from UK customers in 2018.[4] These same companies only paid a combined total of £237m in taxes on these profits in the UK, an effective tax rate of just 2.9%. That puts the total amount of tax avoided by the companies in the UK at an estimated £1.3bn in 2018.
  8. It should be noted that the Digital Services Tax will only bring in a fraction of this amount, and demonstrates that much more needs to be done to counteract profit shifting by major multinational companies operating in the UK.

Tax and Transparency

  1. One policy that would reveal the extent of profit shifting would be the publication of country-by-country reports by multi-national companies. Under the OECD country-by-country reporting standard companies must report to HMRC the amount of tax and metrics of economic activity in each country in which they operate.
  2. The breakdown of a company’s activities by country is important because it quickly allows tax authorities to identify mismatches in profit which provides an indication as to whether companies are moving profits to low-tax jurisdictions.
  3. Currently these country-by-country reports are only provided to tax authorities on a confidential basis. The OECD planned to publish aggregate, anonymised data on a national level, however, the UK government has not agreed to this publication.
  4. Parliament has already passed legislation that allows the government to put country-by-country reports into the public domain. However, this power has not been taken up.[5]

Tax exiles

  1. One legal way of paying less tax is simply to leave the UK take up residence in a tax haven. However, the practice of becoming a tax exile, whilst continuing to own and control UK businesses, has become increasingly controversial and was the subject of some debate at the height of the coronavirus crisis, as some argued that businesses owned by tax exiles should not receive government support.
  2. Currently, a UK business owner will see tax paid by their company on profits in the form of corporation tax. When the leftover profits are distributed to them in the form of a dividend, the individual then pays dividend income tax on the cash received if they are a UK tax resident.
  3. Tax exiles do not pay the dividend income tax element, even though the profits are ultimately from the same source – the activities of a UK company.
  4. This position could be equalised by the introduction of a withholding tax, which is a tax paid by companies on behalf of the recipient of the dividend. This would mean that the dividend income tax element would be paid up-front, by the company, on behalf of the shareholder. The tax paid can be claimed back by the recipient if they have to pay income tax on their dividends in another jurisdiction with which the UK has a tax treaty. However, if the recipient was not subject to income tax, they could not claim the withholding tax back.
  5. Dividend withholding taxes are common in a number of countries and have the benefit of making the collection of taxes more efficient.
  6. A more ambitious policy still is to take the approach of the United States which has a world-wide income tax system based on citizenship. Citizens of the United States are liable for US federal income taxes – regardless of whether they live in Boston or Bermuda. In order to get out of paying US federal income tax a US citizen must renounce their citizenship and pay an exit fee.

Tax incentives and tax reliefs

 

  1. As of October 2019 the UK had 1190 tax reliefs according to the National Audit Office,[6] which is about 50 more reliefs than the UK had in 2011, when the Office of Tax Simplification was asked to review tax reliefs.
  2. These reliefs grant substantial benefits to UK tax payers and in some cases give rise to substantial cash payments to claimants in the form of tax credits. In total, so-called “tax expenditures” were estimated to cost £155bn in 2018-19.
  3. Tax reliefs are therefore a key policy tool defining the scope of the tax system, and any discussion about tax reform should consider the issue of tax reliefs.
  4. Currently there is little ongoing scrutiny of the value for money provided by specific tax reliefs, resulting in a real risk that money is being wasted.
  5. TaxWatch has studied Video Games Tax Relief (VGTR), and found major concerns about the administration of the relief and whether or not it is currently targeted appropriately.
  6. Although VGTR is a relatively small relief, we believe that our research uncovered a remarkable lack of oversight on a government programme that costs a significant amount of money. We believe that similar issues would be found in other tax reliefs. In fact, our research has found very similar issues in the operation of High-End Television Tax Relief, and Film Tax Credit. The government has accepted that that R&D tax reliefs are subject to significant levels of fraud, and sought to change legislation in this area to counteract tax fraud (legislation which has since been delayed).

Video Games Tax Relief

  1. Video Games Tax Relief is one of the creative industry tax reliefs, a group of eight corporation tax reliefs. All of the creative industry tax reliefs allow qualifying companies to increase the amount of tax deductible expenditure taken off their profit, reducing the amount of Corporation Tax the company needs to pay. Where the increases in allowable expenditure result in a loss being declared for tax purposes, companies can claim cash back from the government. In 2018-19, a total of £1.1 billion was paid out across all of the Creative Industries Tax Reliefs.[7]
  2. Video Games Tax Relief (VGTR) was introduced in 2014 and was originally estimated to cost £35m a year. At the time it was established the purpose of the relief was to to support the production of culturally British games. Much was made of the fact that 95 per cent of UK video games developers are SMEs.[8]
  3. Since its introduction costs have spiralled, with VGTR costing over £100m a year for the past four years. In 2019-2020 there were 350 claims for a total of £121m.[9] The cost of VGTR continues to rise, though the majority of the money is not going to SMEs, but to large multinational companies, some of which are involved in aggressive profit shifting.
  4. By 2018, close to half of all relief was claimed by just four companies – all of which were subsidiaries of large multinational groups headquartered outside the UK.[10] In 2018-19 there were 350 VGTR claims for a total of £104m, with £37.6m (36%) alone going to the developers of Grand Theft Auto V, Rockstar North. In fact, since VGTR was introduced in 2014 our research has found that one quarter of all relief granted under the scheme has gone to Rockstar North.
  5. In 208-19, of the 350 VGTR claims in this period, 315 of them were for less than £1m, for a total of £30m. This makes Rockstar North’s 2018-19 tax credit claim worth more than the value of all of these 315 sub £1m claims combined. There were 29 claims (excluding Rockstar) of over £1m, totalling £35.4m.
  6. To access funding developers are required to gain certification from the British Film Institute that their game is “culturally British”. In a European Commission ruling on VGTR, it was stated that “the incentive objectives of the fund would be to make cultural products that are likely to be uneconomical, commercially viable, thereby promoting the production of new cultural products that would not have been made in the absence of the tax relief”.[11]
  7. However, despite this intention, our research found that many of the games claiming VGTR were parts of long running franchises, worth hundreds of millions, if not billions of pounds, including Batman, Halo, and Mortal Kombat. These highly profitable games would clearly have been produced without the need for subsidy.
  8. Furthermore, our research found that the “cultural test” required to gain certification from the BFI is meaningless, with games able to gain taxpayer funded subsidies even if they are produced overseas, and regardless of their subject matter.[12] In fact practically all that was required was that the writer of the game’s narrative was British, even if the storyline itself concerned entirely non-British cultural references (e.g. Batman).
  9. Finally, our research in this area has found that companies can combine tax reliefs with tax avoidance in order to gain additional benefits. For example, Grand Theft Auto V is widely known to be the most profitable entertainment product in history, making over $6bn in revenues. Despite this, the UK company responsible for developing the game, Rockstar North, has earned average profits in the region of £1m a year over the last 10 years. Due to the operation of the tax credit system, the low level of profit in the UK, which must be the result of profit shifting, allows the makers of Grand Theft Auto to claim cash back from the government. This outcome is facilitated because the company locates its cost, which attract tax credits, in the UK, whilst putting revenues offshore.
  10. Despite the clear problems that our research into VGTR found, a government evaluation of the relief conducted in 2017 found it was having a positive impact on the industry.[13] However, this review only sought the views of video games developers. The conclusion of the review, that developers found free money to be “positive”, was perhaps unsurprising and suggests that the Treasury needs to take a more rigorous approach to the evaluation of tax reliefs. 

Enforcement

  1. There is increasing evidence that HMRC needs to take a more robust approach to tax fraud.
  2. As a matter of law, HMRC has complete discretion to deal with tax fraud by criminal prosecution or by civil litigation or contract settlement; and in civil litigation it is up to HMRC to decide whether to plead fraud at all, regardless of the facts of the case.
  3. We believe that this means that HMRC does not pursue cases as tax fraud, even when the facts of the case clearly suggest fraud has taken place.
  4. A powerful current example of this is the case currently before the courts concerning General Electric.[14]
  5. In this case HMRC have recently amended their claim in the High Court to allege that GE obtained a substantial tax benefit via fraudulent misrepresentation.
  6. However, during the procedure to amend HMRC’s claim, it was revealed that at no point during HMRC’s 8 year investigation into the matter did HMRC raise the issue of fraud, even though the facts of this case as alleged by HMRC appear to fit the examples of the kind of circumstances in which it states it will generally consider starting a criminal investigation.
  7. HMRC rarely brings cases of complex tax avoidance by large corporates to court. It has never brought criminal charges against companies or their advisers for dishonest implementation of complex tax avoidance schemes.
  8. However, evidence emerging from the loan charge scandal suggests an abundance of dishonest behaviour on the part of tax advisors marketing tax avoidance schemes.
  9. Many other countries are far less reticent to tackle tax avoidance as a matter of fraud than the UK.
  10. In the US, the IRS has brought criminal charges against major accountancy firms for devising and marketing tax avoidance schemes.[15]
  11. We believe that there is scope for HMRC to pursue a much more robust approach to the detection and prosecution of tax fraud, which would reap dividends in terms of promoting levels of compliance.

 

September 2020

 

 


[1]National Bureau of Economic Research, Offshore Profit Shifting and Domestic Productivity Measurement https://www.nber.org/papers/w23324

[2]See for example, Bilicka, K. A., Comparing UK Tax Returns of Foreign Multinationals to Matched Domestic Firms. American Economic Review, available from: https://digitalcommons.usu.edu/cgi/viewcontent.cgi?article=1945&context=econ_facpubs and European Parliamentary Research Service, Bringing transparency, coordination and convergence to corporate tax policies in the European Union: Assessment of the magnitude of aggressive corporate tax planning. Retrieved from http://www.europarl.europa.eu/thinktank/en/document.html?reference=EPRS_STU(2015)558773

[3] TaxWatch, US effective tax rate over four times higher for tech companies, 08 April 2020, https://www.taxwatchuk.org/us_tech_companies_worldwide_profits/

[4] TaxWatch, Top five tech companies in the UK avoided an estimated £1.3bn in tax in 2018, 10 February 2020, https://www.taxwatchuk.org/tech_companies_2018_update/

[5]The 2016 Finance Act compelled large businesses in the UK to publish tax strategies. Schedule 17 (6) of the Act permits the Treasury to compel companies to include their country-by-country reports with their public tax strategies through issuing a new regulation on this issue.

[6] National Audit Office, The Management of Tax Expenditures, February 2020, https://www.nao.org.uk/report/the-management-of-tax-expenditures/

[7]HMRC, Creative industries statistics, 13 August 2020, https://www.gov.uk/government/statistics/creative-industries-statistics-august-2020

[8] HM Treasury, Video games companies to begin claiming tax relief, 19 August 2014, https://www.gov.uk/government/news/video-games-companies-to-begin-claiming-tax-relief

[9]HMRC, Creative industries statistics, 13 August 2020, https://www.gov.uk/government/statistics/creative-industries-statistics-august-2020

[10]The Guardian, Revealed: global video games giants avoiding millions in UK tax, 02 October 2019, https://www.theguardian.com/games/2019/oct/02/revealed-global-video-games-giants-avoiding-millions-in-uk-tax-sony-sega

[11]European Commission, Commission Decision of 27 March 2014, https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32014D0764&from=SV

[12]TaxWatch, Swedish goats, Japanese hedgehogs and Batman: the £324 million tax bung to the ‘culturally British’ gaming industry, 18 November 2019, https://www.taxwatchuk.org/cultural_test_tax_relief/

[13]HMRC Research Report 459, Video Games Tax Relief Evaluation, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/629773/Video_Game_Tax_Relief_Evaluation.pdf

[14]For more information about this case see TaxWatch’s report, Around the world with $5bn – HMRC’s allegations of tax fraud at General Electric revealed, https://www.taxwatchuk.org/ge_hmrc_tax_fraud_allegations/

[15]See for example the US Justice Department’s criminal prosecution of KPMG for marketing tax avoidance schemes,  Department of Justice, KPMG to Pay $456 Million for Criminal Violations in Relation to Largest-Ever Tax Shelter Fraud Case, https://www.justice.gov/archive/opa/pr/2005/August/05_ag_433.html