Tax transparency and the left’s financial illiteracy

When stories regarding tax hit the news, it frequently frustrates me at the lack of clarity with which they are reported. The recent example of Google paying £130m has illustrated this quite well. What I find frustrating is the reaction and commentary from the political left when it comes to matters of tax; in particular corporation tax.

My frustration stems from the fact that by profession, I’m a chartered accountant. I’ve taken exams in taxation and though it’s not the area of finance I work in everyday, I do have a good knowledge and understanding of it. In particular, I can tell when others don’t know what they’re talking about.

The ideology of the right wing parties such as the Conservatives and UKIP is for a low tax society. That’s their stated aim. The caricature that is then made of the more left wing parties is that they are in favour of high taxes. This is generally a false caricature, as the aim of the political left is rather for fair taxation that properly funds public services. Though to put it that way risks putting the cart before the horse. So let me put it this way:

The left aims to have properly funded public services that are fit for purpose, that support the vulnerable and those who have fallen on hard times. In order to fund this, there is then required an appropriate level of taxation and it is the job of a left wing government to determine the fairest way of spreading the cost.

But what is fair? It’s an intuitive notion that pretty much everyone gets, so long as they’ve got a reasonable moral compass. Yet taxation is inherently a quantifiable thing. So we have to try to quantify fairness. And this is where, in my view, the left fails to make a suitable case.

All too often, the discussion veers onto a company’s revenue and we get comments like “Industry analysts estimate true UK sales of the six at £14.2billion. Yet they paid £41.3million in UK corporation tax – just 0.3 per cent.” [source: The Mirror]

Trying to make such a link simply isn’t how corporation tax works. Corporation tax is based on profits, not revenue. I sometimes wonder if journalists reporting on finance matters understand the difference. It is especially unhelpful when phrases like “how much money they made” are used. What does “made” mean? It’s unclear, and where there is a lack of clarity, there is room for misunderstanding.

Corporation tax is quite unlike income tax that the average employee is subject to, as in that latter case, the tax is based on the gross income. It is understandable, then, that mistakes can be made if the two are perceived to be equivalent. Indeed, perhaps it might be fairer if an element of corporation tax were based on revenue, but that’s not the way the law stands at the moment.

The thing is, there are hints in the public domain that some companies are paying less tax than one might reasonable suspect they should. But such suspicions do not constitute evidence. There are a number of reasons why a company that has a large amount of revenue may pay very little tax. The obvious reason being that it’s not particularly very well run and that their costs are almost as much as their revenues, meaning they have very little profits on which they may be taxed. But we don’t know that for sure.

Why not? Well, this gets to the nub of the issue. Transparency. The amount of information disclosed in a company’s annual accounts is not the same as the amount of information as needed by HMRC in their corporate tax return. Worse still is the fact that the disclosures in a company’s accounts include other accounting adjustments that have nothing to do with the corporate tax for the year and which only serve to obfuscate the matter. What are these adjustments?

They’re referred to as “deferred tax” and are an accounting adjustment, not directly related to the tax incurred by the company that year. Deferred tax arises because of the disparity between the accounting rules and the tax rules. In tax, one may have transactions which do not result in a change in this year’s tax but which may either allow you to pay less tax in the future or oblige you to pay more tax in the future. Under the accounting rules, the fact that this is in the future is irrelevant, and the adjustments goes through this this year’s income statement.

So if you read a set of financial statements and see the line entitled “Tax (charge)/credit” on the face of their income statement then the number next to it is likely to be meaningless.

If you want to see the amount that was actually paid, then you have to look at the cash flow statement. But then again, the amount of tax paid in a given year will not necessarily be related to that year, as they’re likely to be paying off the liabilities from the previous year.

I’ll stop shortly. The point is that to read a tax figure off the face of the income statement is naive, and to link it to the revenue number is just plain stupid.

My advice to anyone who wishes to campaign for fairer tax (and there are some beginnings to this, though I’m far from convinced by it yet) is first of all to learn how to read a set of financial statements. Know the difference between P&L and cash flow, strip out any deferred tax and recognise that you are unlikely to be provided with all the information you need to be able to make an accurate judgement as to whether a company is paying a fair amount of tax. If they are an international group of companies, it gets more complicated, given different tax systems in different countries and again, there isn’t enough information in a set of financial statements to clearly see how much profits arise in which countries and what reliefs may be available in those countries.

So by all means, campaign for greater transparency and keep asking awkward questions. But if you assert that a company has avoided X amount of tax then don’t expect to be seen as a reasonable, financially literate person. Any legitimacy to your argument will be washed away as your credibility goes down the drain.

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2 responses to “Tax transparency and the left’s financial illiteracy

  1. Do you think that Amazon, google, Vodafone and other large corporations pay ‘fair’ taxes?
    I think your splitting hairs a wee bit. Yes, revenue and profits are separate things. But do corporations pay fair taxes? Based just on profit.

    • It’s always interesting that when “large corporations” are named, it’s usually only the household B2C companies that get mentioned. Nobody ever seems to mention Amec Foster Wheeler, Kier Group, Mott MacDonald or Compass. Of the 3 you mentioned, only Vodafone is listed on the FTSE, the others are American and listed on the Fortune 500. Do they pay fair tax? It’s impossible to tell for sure. There are hints that they might not in some jurisdictions, but that was my point: suspicion alone is not sufficient and the current amount of detail available in an annual report doesn’t add enough light to come to a firm conclusion.

      One of the problems is IFRS 10 which states a company doesn’t need to present consolidated financial statements if it is a wholly owned subsidiary of a listed entity. Since Google and Amazon are listed in the US, there is no need for consolidated accounts to be filed in the UK, Greece or any other country where they operate. Because their corporate tax returns are not publicly available in the same way their accounts are (and I think they should be) it’s hard to make any firm assertions about their tax affairs. I’ve seen some of the evidence Google presented to a Commons Select Committee, and it’s certainly enough to give cause for concern, but without hard evidence, one cannot say for sure whether they’ve underpaid their UK tax by £13, £13m, £130m or £330m.

      It’s certainly not splitting hairs to point out that revenues are not the same as profits. They would only be the same if a company had no expenses whatsoever (wages, rent, rates, interest, IT costs, marketing, costs of sale).

      To reform the tax system, one must first understand it. And I’m not convinced that those who most desire reform do understand it properly. Richard Murphy is an exception to this, but the first step in reform has to be increased transparency. Personally, I favour having corporation tax being levied on profit, but the rate should be dependent on a number of other factors including revenue, pay disparity (the more unequal, the higher rate you pay) and environmental damage.