There is no alternative to agreeing how we tax companies

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Corporation tax is an increasing headache for policymakers around the world. They are under pressure from large companies, which demand concessions with threats to move their headquarters elsewhere. Rates of company tax have been lowered, rules amended to make life easier for companies that derive much of their income from overseas.

But as some lobby groups welcome these moves, others oppose them. Angry demonstrators besiege Vodafone and occupy Fortnum & Mason. The protesters claim it is unfair that large multinational companies based in the UK pay little corporation tax. Barclays disclosed to an unhappy Treasury committee that, although it continued to rely on UK government support to meet its financing requirements, UK tax represented a very small proportion of its worldwide profits.

The problems are aggravated by competition to secure economic activity and corporation tax revenue. Brass plates on office blocks in tax havens purport to identify the headquarters of businesses that neither make nor sell any product locally. Ireland set the pace among developed countries in attracting global companies to locate activities and report profits there with a 12.5 per cent corporation tax; but that policy is deeply resented by other European Union members. Northern Ireland would like to follow suit and, if it did, Scotland and Wales would seek to jump on the bandwagon.

Most people think of corporation tax as a levy on capital. But financial innovation and globalisation have made capital fungible. Plant and equipment usually have an identifiable location but in a complex business there is no clear connection between that location and the capital that financed the investment.

When corporations’ main assets are intangible, the location of their profit is still more difficult to pin down. A Swiss corporation discovers a drug at its research lab in England, manufactures it in Belgium and sells it in the US. The difference between production cost and selling price is large but where does the profit arise? Surely not in the Netherland Antilles, where the company that owns the patent is resident.

The internationally agreed answer to the division of the spoils is the “arm’s-length principle”, which asks what international transfer prices would be in a competitive market. But there cannot be a competitive market for a branded good or patented drugs: that is why the transaction is profitable for the owner. In practice, arm’s-length pricing is self-referential.

Perhaps corporation tax is on its way out and we should tax savers and investors rather than companies. The fiscal implications are not so large as you might think. The UK government raises about 7 per cent of its revenue from corporation tax but much of that would be collected as income tax on dividends even if corporation tax did not exist.

Another option would tax companies locally on a fraction of their worldwide income calculated by reference to their domestic activity. California’s attempt to do this provoked the widest rift between Britain and America since Paul Revere’s ride. Furious British multinationals understood that the general application of unitary taxation would ensure that tax competition pushed rates up, not, as at present, forcing them down.

We might instead look at the underlying economics. The answer to the drug example is that most of the profit arises in the US because only that location is indispensable to the profit. Allocating profits by reference to the geographical distribution of sales gives roughly the right answer in this case. But not always. The same reasoning would attribute profits from oil production, or German capabilities in precision engineering, to the location of production, not of consumption.

Advocating global economic agreement is, in general, a recipe for expensive meetings with no consequences. But if corporation tax on multinationals is not to disappear into a morass of complexity and avoidance, there is really no alternative to such agreement – and some fresh thinking.

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