Income and corporation tax structures must be reformed to combat avoidance

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Ian Read, the irascible Scottish-born chief executive of Pfizer, must often have left his public relations advisers wringing their hands. But last week he surpassed himself when he expressed incomprehension that “the political class” — you can almost hear the derision — was not “applauding” his company’s plan for a reverse takeover by Allergan, through which Pfizer would move its headquarters to Ireland.

Allergan (formerly known as Actavis and before that as Watson) describes itself as pioneering a new model in the drug sector. This model appears to be that of an investment company trading pharmaceuticals businesses.

Dublin-based Allergan is as authentically Irish as an empty bar on a Saturday night; its operational headquarters are in New Jersey.

The planned merger is a tax inversion, a device that enables a US company with accumulated profits overseas to use them more freely without incurring US tax liability. What Mr Read found hard to understand was that the “political class” did not share his joy that the money the US Treasury would not be receiving as a result of the inversion would be available for Pfizer’s other purposes, including, but not confined to, the merged company’s research and development.

It is conventional to distinguish legal tax avoidance from illegal tax evasion. But the reality is that there is a spectrum. The person who avoids the heavy taxation on cigarettes by giving them up wins our approval; the gangmaster who employs illegal workers off the radar screen of government authorities goes to prison when detected. But most cases lie in between. The UK’s HM Revenue & Customs has issued big payments claims to people who invested in highly artificial film finance schemes that did not qualify for the allowances they claimed. Were they avoiders or evaders? The line between avoidance and evasion would be clear only if the law were clear, and it is not. Tax law is complex and the legality of particular actions can be firmly established only if there is a decision by a court on the facts of a particular case.

The Revenue identifies a “tax gap” by reference to the tax unpaid when it loses cases in the courts, a strange definition that makes “tax avoidance” the difference between what the law is and what the department thinks it ought to be. Yet that definition is not so different from the plausible one proposed by the Tax Justice Network, a UK-based campaign group: tax avoidance occurs when, if that is the law, most reasonable people would think the law should be changed if it does not impose tax liability.

Most tax avoidance is based on an assertion that profits are earned in jurisdictions where, in fact, little or no productive activity takes place; or from the anomaly that interest payable on purely financial transactions is generally deductible as if it were a trading expense. These problems have grown, not just as a result of ever more ingenious tax advisers, such as those revealed this week at Deutsche Bank, but also as a result of the globalisation and the capital light nature of modern corporate activity. When profits are earned, and financial transactions completed, in cyberspace, where is the territorial jurisdiction to which they are to be attributed?

Avoidance opportunities are thus inherent in the structural weaknesses of income tax and corporation tax themselves, and any comprehensive attack on avoidance could only be part of a wide-ranging reform of these taxes.

This is something we should not expect any time soon — and certainly not on the global basis that would be required to deal with companies, like Pfizer, that manufacture and sell globally; or the internationally mobile individuals with wealth sufficient to make the employment of costly tax advisers worthwhile.

 

This article was first published in the Financial Times on December 2nd, 2015.

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