A general criticism of unitary taxation

At the end of last week, I was trying to piece together what concerns me about unitary taxation. I was thinking about specifics and the detailed proposals that I’ve read in passing, mainly from Richard Murphy.

Now, whilst I would say that my criticisms applied to the formula I’ve seen used as an example, they don’t necessarily apply to all forms of unitary taxation. If you change the formula or fix the problems with each variable in the equation, unitary taxation remains viable.

But I knew there was something more fundamental about the approach that I didn’t like. And this is where reading other people’s responses and thoughts, as well as putting down my own, really helps. Having said that, I had written a lot of this post prior to reading Andrew Jackson’s excellent post on unitary taxation and I’ve tried to maintain my original line of thought whilst editing. I’ve approached this from a different angle, I think, but I might be meandering in his footsteps.

This may seem totally obvious to others but I started thinking about what is necessarily true about corporation tax. The main thing is that corporation tax is a tax on profits and this continues to apply under the proposed unitary taxation.

Our current system tries to do the most obviously equitable thing with regards to allocating taxing rights on those profits: it tries to levy the tax on profits where those profits actually arise.

Now, whether our current system does this successfully or not, the principle seems appropriate. A tax on x is charged on the quantum of x occurring in any jurisdiction. Which is the basis of many forms of taxation.

But this isn’t what unitary taxation does. A tax on x is charged according to the proportions of ab and c in a jurisdiction.  So the direct causality is severed between profits and the tax arising on it.

Unitary tax relies on there being indirect causality between the variables of the equation and profit. So, the idea is that x is directly caused by a combination of ab and c.

Of course, unitary taxation doesn’t need to be restricted to three variables. It can be any number of variables you choose. But the more variables you introduce, the less simple unitary taxation becomes. And simplicity appears to have been one of the USPs in unitary tax’s favour.

But the fundamental point is that the relationship between x and will be prescribed for everybody. And is not necessarily a principle cause of x for all businesses. The same logic applies for each variable. It is not necessarily a cause of profit.

If you look at any variable, it is possible to consider an extreme case of a business where profit is not caused at all by it. Including sales. Including employees. Including tangible assets.

Purely as a thought experiment, this suggests that there is no necessary link between profit and any other variable for all businesses. Even if you don’t accept the extreme position, you are likely to accept the lesser position that the relationship between any one variable and profit may be very different from business to business.

Looking at it from another angle, an independent company that has exactly the same variables a, b and c, and even the same amount of profit x, will most likely not pay the same amount of tax as a company that is part of a group because it is the proportions of the variables, rather than their quantum. If we’re not careful, we may be selecting for the business that is part of a group.

Ultimately, that means that if unitary taxation is a “good” system, it is only incidentally so, not necessarily so.

Unitary taxation is no longer trying to establish the right amount of profit in each jurisdiction and basing tax on that. It is giving up on that altogether. Instead the approach it adopts appears primarily aimed at creating a system that will fairly allocate profit amongst jurisdictions for an “average” business.

Given that many of the problems we are trying to address relate to the taxation of exceptional businesses (as suggested by media coverage), businesses that deviate from the “average”, there is a risk unitary taxation will adopt a skewed view of what an “average” business.

Failing that, businesses that deviate from the “average” most will probably be taxed least appropriately by unitary taxation.

Essentially, my previous post’s criticisms relate to symptoms of severing the link between the tax on profits and the profits themselves. The tax is alienated from its subject partially, if not completely.

For me, I would say that alienation is the defining feature of unitary taxation.

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About Ben Saunders

I'm a Chartered Tax Adviser and a freelance writer. This is my personal blog about, well, mainly taxation. I might put other stuff in. Who knows.
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7 Responses to A general criticism of unitary taxation

  1. Doug Bamford says:

    So you’ve got an alienation argument that a principle is violated by switching from a “location of profit” approach to a formulary approach.

    But can’t you just look at it the other way around and say that
    1: multinationals don’t respect the “location of profit” principle
    2: multinationals undermine the “location of profit” principle by artificially shifting profits around for solely tax reasons, an option that is open to them due to the international tax ecosystem.
    Therefore: The “location of profit” approach is irrelevant as it does not apply.
    Therefore: It is necessary to come up with the best available alternative, of which unitary taxation is a candidate.

    So either you should be trying to come up with a way to resurrect the “location of profit” approach in order to rescue the principle or come up with a better replacement for it.

    • “…an option that is open to them due to the international tax ecosystem” seems to be your key phrase here. If the problem is that the “location of profit” approach isn’t being robustly enforced, then
      1: an easy win might be to improve enforcement; and
      2: why do we think any other approach would be any more enforceable?

      That is: if arm’s length is ineffective because multinationals can misrepresent the arm’s length price, why can we assume that there can be no misrepresentation of the inputs to the unitary formula(s)?

      • Doug Bamford says:

        Good points. I’m not saying that unitary taxation is necessarily the answer, but it definitely accepts there is a problem.

        One advantage UT has is that while it is no doubt difficult, expensive and controversial to challenge the prices of all inter-company transfers etc. the details about total profits/dividends/salaries etc. should be relatively easy to determine from the accounts. Staff headcount also seems relatively easy to measure in comparison. Though I do worry about the headcount issue as many firms engage in outsourcing which complicates the picture – and they would outsource even more if this would save them on taxation. Multinationals could end up with very few actual staff working directly for them and many staff engaged in working for them via ‘third party’ companies within each state.

      • Sorry. I really thought I had replied to your original comment. Andrew’s reply was better anyway…

        Briefly, I think that problems with the arms length principle lie with execution rather than the ideal it aims at. The question is whether we can fix the execution or not. I think we might be able to.

        I also think that UT could well be plagued by problems in its application.

        As you discuss, staff headcount could create an incentive to hire staff predominantly in low tax jurisdictions and avoid employment in high tax jurisdictions. Those sort of behavioural shifts are unavoidable.

  2. miketruman says:

    I think it’s a key insight that unitary taxation does indeed give up on taxing the true proportion of profits made in each jurisdiction, and that throws a very interesting light on the now-prevalent attack on multi-nationals: that they are paying no tax despite having £X million of revenue in the UK.
    But there is a counter-argument, that the attempt to calculate profits on the traditional arms’ length principle has proved too susceptible to manipulation. If you say that under the current system the level of profit which would arise in the UK if it were not for tax considerations is the x that you have above (which I think is what we should be aiming to achieve), then the current system actually imposes tax on (x-m) where m is the manipulation of that profit that you can get away with (diverting it into low-tax or no-tax jurisdictions).
    The question is then whether x * (UK abc/World abc) is a better approximation to x than x-m. If it is, then unitary taxation is a better system, by design, but also recognising that it will rarely if ever give an entirely “right” result. It will always be second-best, but it may be nearer to the best than the current system.

    • I agree. The argument that arm’s length is too easy to manipulate relies for its force on the extent to which unitary taxation is not open to manipulation.

      What we don’t have at the moment is any solid evidence of how robust unitary taxation is. The three legs of the formula all seem open to doubt: sales have proved easy to shift around in the past, and moving to PE-based seems just like a bit of a tweak to the current souce-based system; headcount, in these days of outsourcing, seems equally easy to game; and the question of how to measure assets seems to be enormously complicated, what with HP, finance leases, operating leases, long funding leases, historic cost/fair value/NBV/MV, and so on – what would you include on the BS? Not to mention the suggestion that different sectors would use different formulas – how do we apportion/allocate shared costs, never mind defining the sectors?

      All questions which may have perfectly good answers, of course – we just need to start looking at some draft answers so they can be tested.

  3. Pingback: Arms length profit is fiction – an ignoratio elenchi? | Ben's white space entries

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