Benjamin Franklin, one of the founding fathers of the US, is reported to have said:
In this world nothing can be said to be certain, except death and taxes.
This statement couldn’t be more true today. The recent row over Google, Apple and now Facebook’s tax deals in Europe is reinforcing the dogged certainty of taxes and their challenges to big businesses.
Corporate taxation has always been a vexing concern for both businesses and governments. This is because it is often driven by different and frequently divergent interests. While businesses are profit driven, governments pursue social welfare.
As such, most firms tend to distance themselves from the social welfare maximisation agenda, believing that it is the responsibility of governments and NGOs. Google’s European public affairs chief, Peter Barron, strongly captured this view in a recent letter to the Financial Times:
Governments make tax law, the tax authorities independently enforce the law and Google complies with the law.
This belief by firms and the attempt at a neat separation of the roles of business and government is epitomised in the phrase: the business of business is business.
But such an approach would hit African and other developing countries hardest. They have limited financial resources, weak governments, and the greatest development challenges.
So is there a way of managing the tension between the profit-driven interests of firms and social welfare obligations of states when it comes to taxation?
More regulations, more problems
In some cases, interests of businesses and governments can be reconciled through regulation. However, there is no watertight regulation and many regulatory systems are dotted with loopholes.
Some of these systems could be exploited through creative and efficient corporate tax planning and avoidance schemes. Again, this is where African and developing countries with weak regulatory institutions, including tax authorities, will be severely disadvantaged.
Corporate taxation is also a controversial issue often exacerbated through politics and corporate lobbying. Given that corporate responses to taxation are largely influenced by their need to compete and keep costs as low as possible, countries with tough corporate taxation regulations may not be favoured destinations for businesses, especially for multinational corporations.
As such, taxation provides an arena for games and contestation. Set up as a game, it becomes a source of corporate innovation and competitiveness. This is at the heart of most corporate tax planning activities.
A soothing name for this, which is often appealing to the business community, is “strategic regulatory arbitrage”. The actors in this innovative space often include tax consultants, lawyers and financial analysts.
Confronting the moral question
The exploitation of loopholes in a regulatory system, while often legal, raises an important question about the essence of a regulation and the purpose of the law – that is, what should count most: the spirit of the law or the technicalities surrounding its interpretation and implementation?
If the spirit of a law is to be taken seriously, then the arrangement of one’s tax affairs to pay as little tax as possible is inimical to revenues accruable to the government through taxation. Since corporate taxation is always on profits, it is difficult to argue that it constitutes an input cost to businesses. Although on the face of it, it appears to do so.
Instead, tax avoidance could suggest an irresponsible practice of denying broader society its share of profits from a firm’s economic activities. This is despite the fact that the firm would have used some critical resources from society to achieve profits. Some of these may include natural, human and physical resources. Tax avoidance in this case becomes a free ride.
Is self-regulation the middle ground?
The string of incessant corporate tax cases suggests that government regulation, alone, is obviously grossly inadequate in tackling the impact of corporate tax avoidance strategies. This is mainly due to information asymmetry between governments and businesses.
In other words, businesses have better understanding of their operations and the regulatory loopholes they can take advantage of in the course of their operations than governments do. Given the endemic information asymmetry involved, reflexive law (or self-regulation) is being acknowledged as a useful complement to public regulation.
Self-regulation is at the heart of the corporate social responsibility agenda. As an alternative business paradigm, it operates from a viewpoint that fostering a better society and enhancing human development is a collective project between business, government and society. This alternative paradigm suggests that businesses can also constitute a force for good. They control large resources, wield power and have expertise.
Self-regulation can be useful in many ways. First, it saves the government the cost of designing and enforcing regulatory measures. Second, it empowers firms and offers them the opportunity to adopt efficient and effective measures. In other words, business policy should complement public regulation and not undermine it. This is ethical business regulation, which has been endorsed by the UK government.
But to what extent should self-regulation be trusted? Despite the advantages of self-regulation, it also sometimes fails when employed in isolation.
After all is said and done, it is obvious that corporate tax avoidance is not going away any time soon. It is impossible to eliminate it as long as there are creative and innovative people to unravel tax systems and regulations. Maybe it is a necessary evil – a tolerable act of irresponsibility – and a price for the benefits of entrepreneurial capitalism.