August 23, 2012 • 5:09 pm

“Britain will deprive developing countries of up to £4bn in tax revenues”

The Guardian, 23 August 2012; also in The Times

The world is getting smaller and at the heart of the era of globalisation is the multinational company operating in multiple countries; often on multiple continents. But how should governments tax such a company?

This debate has surfaced once again with the Government’s reforms to the rules governing controlled foreign companies (CFCs) which are scheduled to take effect in January 2013.

Today, the Guardian reported that the reforms could cost developing countries up to £4 billion. Could it really?

Some Background

In accordance with international law, multinational companies pay tax in the country in which profits are generated. As such, [other things being equal] companies have a financial incentive to generate their profits in countries with the lowest corporation tax.

This has encouraged ‘tax dodging’ by companies transferring profits to, so called, ‘tax havens’. The mechanics of this are explained in more detail in a presentation by campaign group Action Aid.

Currently, the UK has legislation designed to discourage the transferal of profits to tax havens. For UK-based multi-national companies, when profits are derived in countries with corporation tax below 23 per cent (the UK’s rate), the company must pay a supplement to the UK treasury bringing the payment up to 23 per cent. This reduces the incentive for companies to move to tax havens as they would still end up paying at least 23 per cent.

However, in January, the law is set to change so that only profits directly leaving the UK will be subject to this restriction. In other words, UK-based multinational companies with subsidiaries in developing countries could in future have an incentive to transfer their profits to tax havens which, it has been suggested, may cost developing countries up to £4 billion a year.       

So where is this figure coming from?

The figure can be traced back to a report by Action Aid (cited by the International Development Committee) entitled ‘Collateral Damage: How government plans to water down UK anti-tax haven rules could cost developing countries – and the UK – billions.’

A note at the end of the document explains how this estimate was derived.

Action Aid took a ‘representative sample’ of 10 companies whose collective market capitalisations (values) make up 21 per cent of the London Stock Exchange (LSE). Full Fact asked for further details on the sample and was informed that these particular companies were chosen because they were

‘the only ones that, in 2009, segmented their financial data into something that could be meaningfully interpreted as “developing countries”.’

It was suggested, however, that the sample was ‘quite representative of the composition of the LSE and of a range of different sectors and larger company sizes too’. The relevant companies are listed in the table below:

In 2009, these companies recorded pre-tax profits in developing countries totalling approximately £16 billion.

This allowed the organisation to produce an estimate of the profits of UK listed companies in developing countries which was calculated to be £75 billion (£16 billion is roughly 21 per cent of £75 billion).    

Next, they applied the 2009 average global corporation tax rate (25 per cent) to produce an estimate of the ‘nominal tax incurred by UK companies in 2009’: £19 billion. Ideally, they would have used an average which only included developing countries but there was no figure available. However, Action Aid notes that headline tax rates tend to be higher in developing countries than elsewhere and so 25 per cent may be a bit of an underestimate.

Finally, it was estimated that developing companies would lose one fifth of this revenue through tax avoidance which, with rounding, comes to £4 billion.

It is worth noting that Action Aid estimated that the loss would be one fifth based on a previous investigation by the charity which found that ‘the proportion of SABMiller’s African tax bill that the company was estimated to dodge in 2010’ was one fifth.

So how precise is the figure?

Full Fact has identified a few of issues which might affect the accuracy of the estimate which we asked Action Aid for their thoughts on.

First of all, we questioned whether it was reasonable to assume that just because the market capitalisation of the ten companies represented 21 per cent of the London Stock Exchange their combined profit would necessarily represent 21 per cent of the total profit generated by UK-registered multinational companies in developing countries.

Action Aid conceded that it was true that some listed companies do not have overseas operations but, having inspected their accounts, companies that only operate in the UK tend to make up a very small part of the LSE total market capitalisation and thus their method should provide a reasonable estimate for UK-registered multinational companies in developing countries.

We also asked whether SABMiller was sufficiently representative of all CFC companies which would justify using it as a gauge for tax transferred to havens.

In response, Action Aid informed us that they would, of course, have preferred a bigger sample than one but they did not have comparable data for other companies. However, they did suggest a few reasons that it might be a reasonable benchmark. For example, we were told that they had conducted qualitative research suggesting that the techniques they had found SABMiller to be employing ‘are quite typical’.

In short, the figure of £4 billion is, at best, a very rough estimate; a caveat which is readily admitted by Action Aid who told us that their study was

“not supposed to be a highly precise methodology, it’s an estimate intended to show what the impact might be”.

Moreover, we were told that

“the important point for us is not whether the cost of reforms is or is not £4 billion, which we’ve said from the start is simply a reasonable estimate based on the information available to us, but that the government should do its own, much more detailed, assessment as a matter of the policymaking process.”

This sentiment was echoed by the International Development Committee in their report today.


The most important thing to take away is that the £4 billion figure is a very rough estimate based on a number of unknowns and assumptions which are designed to illustrate a point as opposed to being treated as fact. Action Aid themselves stress it is for the Government to measure such impacts before embarking on policy change.

In any case, the methodology used to derive the figure is, at best, approximate and so the headline figure needs to be taken with a rather large pinch of salt.

Photo: hdptcar

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