I’ve blogged recently about the dangers of corporate tax evasion, given the new powers open to prosecutors under the Criminal Finances Act, but what about its seemingly much less dangerous and perfectly legal cousin: tax avoidance? There’s some evidence that the mere threat by Her Majesty’s Revenue and Customs (HMRC) to apply diverted profits tax is causing companies to pay more tax than they’re perhaps legally liable to pay. How does that sit with the board’s responsibility to deliver returns to the company’s shareholders?
Diverted profits tax
Diverted profits tax is a relatively new tax introduced in the U.K. in 2015 to address public concerns that large companies, and especially big American tech companies, were booking profits in low tax jurisdictions as a means of avoiding higher corporate tax rates in the U.K. The rate is set at 25%, which is significantly higher than conventional corporate tax (19%). One of the more striking features of the tax is the requirement on companies to notify HMRC in the event that the arrangements they have in place potentially fall under the legislation. Failure to notify can result in additional penalties. Notifications have risen steadily, from 48 in 2015/2016 to 220 in 2017/2018.
Duties under Section 172
How does the duty to pay all corporate taxes due, while not overpaying, fit together with the more general obligation on directors to balance the needs and wishes of the company’s various stakeholders? Directors are to do so under Section 172 of the Companies Act. By way of reminder: Section 172 of the Companies Act 2006 imposes a duty on directors to promote the success of the company. In doing so, directors are required to consider:
- The likely consequences of any decision in the long term
- The interests of the company’s employees
- The need to foster the company’s business relationships with suppliers, customers and others
- The impact of the company’s operations on the community and the environment
- Desirability of the company maintaining a reputation for high standards of business conduct
- The need to act fairly as between members of the company
Section 172 has generated plenty of controversy itself in recent months as a result of the Financial Reporting Council’s new corporate governance code. One of the reasons for this is the perception that many of the factors listed above have not been given the attention they deserve, on the basis that directors too readily equate “success of the company” only with maximizing shareholder value.
If that’s right, legal tax avoidance would seem to be a quite legitimate means of increasing net profits. The counterargument in particular to the “desirability of the company maintaining a reputation for high standard of business conduct,” might be that it’s more prudent to avoid tax avoidance schemes altogether so as to minimize the risk of reputational damage.
To pay or not to pay?
A major U.K. drinks manufacturer operating in 180 countries was the first to admit that it was being asked by HMRC to pay diverted profits tax. Although the company originally challenged the demand, it has agreed to pay in excess of £140 million in additional corporation tax, despite the fact other unidentified large multinational companies are reportedly agreeing to pay more tax. Whether these agreements are being reached on the basis of technical and legal advice from professional tax experts on the prospects of defending the claim, or on the basis of concerns about reputational damage in the face of a mere threat of a claim from HMRC is unclear.
As with Goldilocks, the challenge for boards is to make the bowl of porridge “just right.” Too hot and HMRC will threaten action with attendant reputational risk. Too cold and shareholders will complain that the company is failing adequately to safeguard corporate profits. At all events, at least so far as the Financial Reporting Council is concerned, it seems that simply following professional advice may not always be the best course.
In delivering their proposed new Code, they wrote: “It is important to recognise, however that the duties and responsibilities of directors to the company are different from those of professional advisers. Directors are subject to the duty under section 172 of the Companies Act, as well as duties to exercise independent judgement and to exercise reasonable care, skill and diligence. Professional advisers, on the other hand are subject to whatever legislation, standards or supervision applies to their particular profession and contractual obligations to their client.