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Wednesday, 29 August 2007

Now here's a strange thing....

Widespread press reports yesterday mentioned that the National Audit Office had reported that nearly a third of UK companies pay no corporation tax. Now that seems a high number, but curiously there is no mention of this report on the NAO website. In fact all it does say is: “Please Note, the National Audit Office will not be publishing any reports during the Parliamentary Recess between 27 July and 8 October 2007.”

Let’s not speculate on who “released” this report, but instead think about whether it is reasonable. Certainly plenty of firms spend a lot of money on capital investment on which they have claimed capital allowances of 25% of unclaimed expenditure each year (reduced to 20% from next year by this parsimonious government), and that includes a lot of our utilities and airlines who feature in the list. Then there are the barely profitable engineering companies who also make heavy capital investments, and the trading companies with highly taxed foreign operations and head office costs. Then there are the high tech companies who get R&D write-offs courtesy of the government

So what are we left with? Banks and insurance companies who seem to be paying a lot of tax, energy companies who the chancellor is into in a big way with PRT and a higher corporation tax rate on North Sea profits. It all adds up to £52 billion of corporation tax receipts. Perhaps that doesn’t sound a lot in a GDP of £1,300 billion, but figure this: Of that £1,300 billion, 45% is in the public sector, so let’s call that £6 billion spending in the public sector. Let us assume that half of that £6 billion is spent on private sector goods and services, so assume that total spending subject to corporation tax is about £1,000 billion. Corporation tax is only payable on company profits at 28%, so to raise £52 billion in corporation tax receipts, the government needs companies to declare taxable profits of $52 billion/28% or around £185 billion. Yes, £185 billion of taxable profits on £1,000 billion of turnover. OK those numbers don’t take account of taxes on overseas profits that might be outside the scope of VAT, but it includes a lot of other things like corporation tax on chargeable gains, so it seems a fair approximation.

But to put it in perspective how many companies can make a profit of £185 on a turnover of £1,000? The answer is not very many - most mature companies would hope to make a profit of around 10% of turnover. The subtext is that a company’s taxable profits are not the same as company’s accounting profits, and it would appear that in many cases the taxable profits are higher. How does that happen? Mostly because of government legislation. On the one hand, companies are restricted in their ability to deduct various classes of losses against current profits and these losses are eventually written off. For example, a group with losses in several companies in one year will carry forward the losses in each company if it cannot use the losses for group relief. But losses carried forward cannot be group relieved in later years, so if any company in the group goes into terminal decline its carried forward losses will be trapped even if the rest of the group is eventually profitable. Similarly, many companies have substantial capital losses that never get set against capital gains. On the other hand, the depreciation rates for “long life assets” are so low that they effectively never get written off, so that the assets are depreciated faster for accounting purposes than tax purposes, making the taxable profits higher than accounting profits. On the third hand, the legislation can disallow some expenditure, although that expenditure is a real cost in accounting terms.

So the real question the NAO should have been asking is not why so many companies pay little tax in the UK, but why the UK raises £50 billion of corporation tax when our neighbours raise a far lower proportion of their tax revenues in this way?