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Why Vodafone did not have to pay UK tax on the Verizon deal

How does a UK company manage to earn £84 billion in one deal without paying any tax? It is the question many people are asking after Vodafone sold off its stake in US telecoms company Verizon Wireless without apparently troubling the UK taxman. The deal has once again sparked off discussions over corporate avoidance schemes, and the notion of paying a “fair share” of tax.

Vodafone’s headquarters are in Berkshire, and the company is one of the biggest listed on the London Stock Market, so one might think it should pay UK tax on its profits. And if it is not paying UK tax, this could only be as the result of some dodgy tax avoidance scheme. This sounds like a reasonable assumption, but unfortunately it is wrong.

The assets being sold are owned by a Netherlands-based holding company, so according to international rules no tax is due in the UK. Moreover, even if the assets had been owned by a UK company, and UK tax was in principle due on the profits, the sale would likely qualify for the capital gains tax relief applied to the sale of “substantial shareholdings”, introduced by the 2002 Financial Act.

So, whether subject to international tax rules, or to national tax rules, Vodafone is not liable to UK tax on this deal.

Taxation as a donation

It is commonly accepted that corporations should pay their “fair share of tax”. Given Vodafone benefits from being headquartered in the UK, perhaps it should pay UK tax on its profits anyway, as a matter of corporate social responsibility. Again, this idea sounds reasonable, but is it?

Essentially, this would be asking Vodafone to pay tax which is not due by law. Or, in other words: we would be asking Vodafone to give a donation to the UK exchequer. Not many individuals – if any – would do that.

Also, the legal obligations of corporations are distinct from those of individuals. Company law requires directors to act in the interest of their firm - this does not necessarily mean paying the least amount of tax possible, but it often does.

So, Vodafone cannot be blamed for not paying tax which is not due under the law. Indeed doing so could – depending on the circumstances of the donation – be deemed to be contrary to (company) law.

Change the laws

For Vodafone to have been liable for UK capital gains tax fundamental changes would need to occur to both national and international tax rules.

On the international front, it is rather coincidental that the deal was announced just a few days before the G-20 Leaders’ Summit in St. Petersburg where new measures to combat tax avoidance and evasion will be on the agenda.

In particular the OECD’s new action plan on base erosion and profit shifting, known as BEPS, is set to be discussed. The plan’s objective is to ensure that corporations pay their “fair share of tax”, by identifying actions needed for countries to prevent base erosion and profit shifting as a means to curbing corporate tax avoidance worldwide.

The OECD initiative, which follows a request from the G20 in June 2012, has many merits, not least in maintaining the momentum on the need for urgent international tax reform. But there is still concern over whether it can efficiently resolve existing problems.

The BEPS action plan is premised on the maintenance of basic rules which underpin the current international tax system. These basic rules stipulate that tax is due either in the “country of residence” (ie where the company is based), or the country where the economic activity takes place. Such notions of entitlement on the basis of residence and source date back to the 1920s, and are unsuitable to deal with a global economy. Constantly patching-up these rules, and making small amendments, in order to deal with the challenges of such an economy is not a long-term solution. A deep reform of the international tax system is necessary.

In particular, it is worth considering a complete change in paradigm from residence and source-based taxation to destination-based taxation. Under a corporate destination-based tax, tax would be due on the country where the customer is located. Such a tax would deal with tax avoidance by removing its incentives: there would be no tax reasons for a company to relocate its headquarters or economic activity, since tax would be due wherever the customer is based. Customers are difficult to move; the company’s market is where it is, and it is not easily susceptible to manipulation.

So, eliminating, or at least significantly minimising, corporate tax planning and avoidance requires a deep reform of international tax law as it stands.

Business friendly?

Had Vodafone been deemed to be liable to UK tax rules, tax would still only be due if the current law granting a capital gains exemption for “substantial shareholdings” was abolished. This sounds like another reasonable proposal. In the context of the current budget difficulties, when ordinary taxpayers are suffering from difficult tax and benefits measures, is it really fair to grant such relief to big corporations?

But it is important to understand the rationale for such tax measures. This exemption was adopted as part of the UK drive to attract investment – which in turn creates employment and growth – by creating a business-friendly fiscal environment. It is the same rationale that led to the recent decrease in corporate tax rates.

The downside of this policy is of course the loss of (potential) revenue which must be weighed up against the gains in employment and growth. This is a difficult calculation to make, a matter of policy choice, and different countries have adopted different positions. What is fundamental, however, is that the public – and the politicians – understand the calculation, and its consequences.

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