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Taxing multinationals

• Robert Peston
• 5 May 08, 10:15 AM

I know it's deeply unfashionable but I feel slightly sorry for the Treasury and how it's been pilloried for proposals to reform the taxation of multinationals.

The ideas underlying its proposals are not intrinsically Neanderthal. It's the possible application of these ideas that is giving British business the heeby-jeebies.

There are two elements to the Treasury's plan. The first is to simplify the taxation of foreign dividends received by large and medium-sized British companies by exempting these dividends from UK taxation.

In itself that would deliver a modest saving for companies, because right now these dividends are taxed on the difference between the British tax rate and how much these dividends were taxed overseas at source.

Note that this, if implemented, would represent a reduction in tax on overseas earnings: quite the opposite of what you would believe on the basis of recent media coverage or the lobbying of big companies.

It's the second element that is terrifying the multinationals - and is why they gave the prime minister an ear-bashing when they trooped into Number 10 last month.

The Treasury wants to levy tax on income earned by multinationals on so-called passive assets that have been sited abroad purely for tax reasons. The government is concerned, for example, that intellectual property such as drug or technology patents is developed in the UK and then registered in low-tax countries to minimise the tax payable on the income generated from the intellectual property.

Understandably any multinational whose profits stem primarily from intellectual property - drug, media and technology companies are the prime examples - worries that they would face a massive tax increase.

So should we feel their pain and hope that the chancellor has a change of heart?

As usual in tax, there is a trade-off between fairness and enforceability.

What the Treasury is suggesting doesn't seem particularly unfair, if the aim is to tax revenues from assets that could only have been developed in the UK but were transferred overseas purely to save tax.

If for example a new drug, turbine or weapons system took advantage of research in a leading UK university - and therefore received a substantial taxpayer subsidy - surely earnings from it should be taxed here.

But in practice, it's rarely as simple as that. Some element of a new product or service may have been developed in the UK, but much of the research and development may have been shared with offshore operations.

There is however a more brutal argument against what the Treasury wants to do: companies that don't like it can simply relocate offshore to more benign tax-centres such as Dublin.

A number of substantial British businesses have already done this or announced they are emigrating. Shire and UBM are only the latest manifestation of this exodus.

In a globalised world of tax competition between countries fairness is a less important consideration for the Treasury than what it can get away with.

Which is why the chancellor, at the slightest whiff of yet another corporate gang-assault on his capitalist credentials, has set up a review of the competitiveness of our tax system.

That review will probably dodge the big political and economic question: should the UK be turned into an Irish-style low-corporate-tax economy or should the government lobby for harmonised global taxation that undermines tax-competition between countries (and, as many would say, also undermines a pillar of national sovereignty)?

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