Analysis: Taxing issue for May

Theresa May has vowed to iron out the ‘rougher edges of capitalism’, and she singled out the avoidance of corporation tax as one of them. Nigel Hawkins explores what this might mean for utilities.

The sudden accession of Theresa May to the premiership has caused much researching into her beliefs – and the continuing changes to government policy as it stood prior to the historic Brexit vote.

One stark reminder was her pledge to iron out the rougher edges of capitalism, which has been widely reported of late. These dysfunctionalities cover many issues. They include takeovers in sensitive areas – the controversial £11.5 billion acquisition of Cadbury in 2010 being a particular cause celebre.

Furthermore, May has homed in on the controversial BHS pension fund issue as well as the disinclination – perfectly legal though it may be – of some well-known companies to pay sufficient corporation tax.

More specifically, within the utilities sector, May has also identified inadequate broadband coverage in rural areas and excessive energy prices as market dysfunctionalities.

With the new chancellor, Philip Hammond, due to present the Autumn Statement on 23 November, the corporation tax issue is particularly topical. Famous names such as Goldman Sachs, Starbucks and Amazon inter alia, have regularly attracted unwanted publicity for paying minimal UK corporation tax, both as a percentage of their operating profits and as a proportion of their market worth.

The government, too, has lost out badly from the fiscal implications of the financial crisis in 2008.

Most notoriously, the Royal Bank of Scotland (RBS), the recipient of over £45 billion of emergency taxpayer funding, has reported massive losses in every subsequent year. Many of these are allowed, under current legislation, to be carried forward for offsetting against future profits.

Within the utilities sector, generous capital allowance entitlements have enabled substantial offsetting against pre-tax profits, thereby markedly reducing the overall tax-take. Even so, British Telecom’s corporation tax charge has exceeded £600 million over each of the last two years.

Centrica, despite its woes with low gas prices, still charged a net £252 million in its 2015 accounts for corporation tax. Its tax computations are notoriously complex given the petroleum revenue tax liability arising from its exploration and production operations. SSE’s tax charge for 2015/16 was lower at £193 million, which equated to a charge of 13 per cent on underlying pre-tax profit.

By contrast, the water companies are generally paying low corporation tax, primarily – though not entirely – as a result of the capital allowances regime.

In Severn Trent’s case, it charged £55 million in 2015/16, prior to an adjustment for exceptional tax-related items. While this figure may seem relatively modest, those water companies under private equity ownership have benefited even more as high interest payments depress their net tax liability.

In 2015/16, despite operating profit of £742 million, Thames was able to book a net tax credit of £55 million: the figures for Anglian were £336 million and whopping £139 million respectively.

Whether the water companies are paying a fair level of corporation tax is a moot point, especially since the periodic review makes more than generous allowance for the scale of their ongoing investment. While such payments are totally within existing revenue law, it is certainly possible that the government will amend some of the rules.

The government could set a tax floor, whereby utilities were required to pay a minimum amount of corporation tax every year, irrespective of all the existing capital allowance, interest offsets and historic losses provisos.

More generally, across the corporate sector, there is a case for establishing new criteria for assessing corporation tax, whose annual yield of around £45 billion is broadly the same as it was in 2005/06. This yield now accounts for just 2.5 per cent of annual GDP.

In particular, the government could introduce legislation to specify several tax computations, centring on UK revenues, underlying operating profit and underlying earnings before interest, tax, depreciation and amortisation (Ebitda). If several computations were required, the potential for large companies to undertake aggressive tax reduction stances would be curbed.

With various tax computation menus to choose from, the Inland Revenue could then select the methodology that delivered the highest tax-take – unless it was clearly anomalous. Such a policy would arguably make corporation tax liability fairer, while simultaneously raising the necessary revenue. A similar scenario applies to inheritance tax, which disproportionately impacts smaller estates rather than the richest in society.

In the long term, corporation tax may well be replaced. The largest international companies employ dozens of tax specialists and consultants to circumvent – legally – the highly complex regulations.

Annual rate reductions in UK corporation tax have been a government policy in recent years in the belief that – as per the Laffer Curve – revenues are bolstered by lower rates. Nonetheless, in helping to fund public expenditure of over £700 billion annually, corporation tax receipts remain a notable contributor – of c6 per cent.

More immediately, under the May regime there is clearly political momentum behind redressing the most glaring anomalies thrown up by the corporation tax regime, especially as it affects overseas-owned companies. And it is certainly possible that some utility companies, especially in the water sector, could – in time – be adversely impacted by the determination to rectify some of the existing tax dysfunctionalities within the UK economy.