Corporate tax cut in UK has little impact, but low VAT raises reputation

Rate cut has little impact on global ranking
Article published by Vanessa Houlder in Financial Times (www.ft.com) on September 8 2008.

This year’s cut in the corporate tax rate has failed to push the UK decisively up the international rankings, according to a new survey that shows Britain’s efforts to improve its tax competitiveness have been blunted by similar efforts elsewhere.

The UK now has the 20th lowest corporate tax rate of the 27 European Union member states, a slight improvement for businesses on last year’s 21st position, according to the survey by KPMG, professional services firm.

The UK’s struggle to close the gap with smaller European competitors is likely to fuel criticism from businesses and opposition politicians.

KPMG said: “This continued downward pressure on worldwide and European corporate tax rates will add to the pressure on the UK authorities to address the UK’s perceived lack of competitiveness on tax.”

The impact of April’s 2 percentage point cut to 28 per cent was tempered by cuts elsewhere, which pushed average global and European corporate tax rates down by 1 percentage point. The UK’s corporate tax rate remains higher than the global average of 25.9 per cent and the EU average rate of 23.2 per cent.

But the UK is facing tough competition for holding companies from smaller low-tax European rivals, particularly Ireland, Luxembourg, Switzerland and the Netherlands, as demonstrated by recent moves out of the UK announced by Shire, UBM, Henderson, Charter and Regus.

These moves recently sparked an angry exchange between Alistair Darling and George Osborne, shadow chancellor, who called for a cut in the rate to 25 per cent which “would go some way towards undoing the damage the government has done by failing to keep pace with European tax rates”.

Mr Darling rejected Mr Osborne’s criticisms of the competitiveness of the business tax system as “wrong”.

Chris Morgan, head of international corporate tax at KPMG, said the relocation of headquarters was not driven by concern about the tax rate although bringing down tax rates was an important long-term objective. The argument was instead focused on the question of whether foreign profits should be taxed in the UK, he said.

The intensity of international tax competition was underlined by the finding that – for the first time since 1994 – no country in the 106-strong sample had raised rates. Competition has been particularly intense in the EU over the past 10 years, moving average corporate tax rates from the highest to the lowest of any group of countries in the OECD.

The relationship between tax rates and overall competitiveness is complex, with many other factors including political stability, infrastructure, access to new markets and a skilled labour force playing an important role. Sue Bonney, KPMG’s head of tax said: “Undoubtedly, the corporate tax rate is an important factor for businesses but it is far from the only factor.”

Big industrialised countries such as the UK typically have much higher rates than small countries. Countries such as Malta, Luxembourg and Switzerland have far lower effective rates than their headline rates as a result of exemptions and special rulings.

In May, Mr Darling acknowledged the challenge facing the tax regime, saying “Business does have a choice. Business is increasingly mobile. Tax rates have to be globally competitive.”

The UK’s corporate rate cut ensured that it continued to have a lower rate than Germany at 29.5 per cent, preserving the Treasury’s goal of having the lowest rate in the G7.

Low VAT raises reputation

Britain has the fourth lowest rate of value added tax in the EU, according to KPMG which said this relatively low rate underpinned the business-friendly reputation of the indirect tax system .

Britain’s 17.5 per cent VAT rate is well below the average in the EU of 19.49 per cent, in contrast to its position on corporate taxes. KPMG said this was in line with the “generally accepted idea” that indirect taxes compensate for reduced corporate tax yields.

This notion was partly supported by the contrast between the EU’s low corporate tax rates and its high VAT rates. Against a global average indirect tax rate of 15.7 per cent, the EU’s average rate was 19.49 per cent.

The UK’s relatively low rate, together with its stability over recent years, helped secure the UK top position in a KPMG survey of the best countries in the world to deal with from an indirect tax perspective.

The survey found that indirect tax rates have remained relatively stable, in contrast to the declines in corporate tax rates. KPMG said if indirect tax yields were compensating for declining corporate tax yields, this was being achieved by widening the indirect tax base and applying rules more strictly.