What You Need to Know About Corporate Taxation

Image courtesy GotCredit on Flickr

Becoming a company carries a new range of legal commitments and responsibilities.  One of those responsibilities is corporate taxes.  Whether they like it or not companies are affected by them.  The concept might be alarming at first but understanding its generalities and who it affects helps its management. Corporate taxes have been a frequent topic in the news and the headlines of articles and major publications because it is a major concern for big and small businesses.  Let’s talk about a little more about corporate taxation.

Definition

Corporate taxes are levied on the profits a corporation, large or small, generates by all levels of government.  Corporations are legal entities, not individuals or the owners of a company.  As such, corporate taxes can be considered the equivalent of the personal income tax an individual pays. The rates and laws of corporate taxes vary notably across multiple countries, since different governments and nations perceive corporate taxation differently. This is why companies have chosen to have their headquarters in specific places where corporate taxes are way lower.  One example is seen in companies that have moved to the Republic of Ireland (Irish tax rate is only 12.5%) compared with the rate they would have to pay in the U.K. 

Mobile capital: the example of the U.S.

Another example could be seen in the United States.  This country has one of the highest corporate tax rates in the world. It is 35% and almost 40% when state taxes are added.  For this reason, some American companies have “relocated” outside the country, through mergers with or purchases of a foreign company.  This way they become a foreign entity and can be still managed from the U.S. but because of their headquarters address (at least on paper) they are no longer subject to U.S. corporate taxes. They are taxed according to that foreign country’s rules. Therefore, this business behavior is increasingly seen due to high corporate rates that companies are trying to avoid.

Another reason for this tax behavior in the case of the United States is because its corporate tax system could be considered different compared to most other developed countries systems.   This country taxes corporations based on the profits they make worldwide as opposed to profits they make at home.  On the other hand, other countries tax corporations for the business that takes place in their own territory. So there are American companies earning money overseas, and since they do not have to pay U.S corporate tax until they repatriate these moneys, their profits are sitting overseas as a mechanism to avoid  bringing the money home and paying American taxes.

Corporate taxes are a matter of debate in many countries due to their economic impact.  Thus, there is some concern that being tougher on taxes may do more harm than good. Those who favor higher corporate taxes argue they give governments the assets to fund programs (education, hospitals, security), to raise revenue, to encourage specific investments in specific industries, to stimulate economic growth (basically taxes provide many nations with a large source of income) for the welfare of the nation.  Others argue that lower rates help companies hire employees and producing goods, thus boosting an economy.  Although, the desire for some companies to pay lower taxes and reduce their tax bill is understandable, there are some that simply do not want to pay it at all.  And of course, they are considered by many unpatriotic corporate citizens.

What can be done about the taxation system?

Image courtesy 401(K) 2012 on Flickr

When companies leave, particularly in the case of the U.S., the country loses significant tax revenue, money that would probably be reinvested into the nation through more jobs, more improvements, more infrastructure, and prosperity in general terms.  This situation undoubtedly preoccupies the government and for this reason it is experiencing an increasing pressure to stop it, and the approach do not seem to be yielding the results expected regarding foreign inversion.  It is believed that when companies prefer business overseas to protect their income they are betraying their nation.  This situation has forced the government to implement strategies to close these tax “loopholes”, obligating companies to stay loyal to the U.S. and keep their capital into their jurisdictions. 

The bottom line is that taxes have been affecting decisions in companies concerning location and investment to manage and control their tax obligations. Because corporate taxation plays a special role in economies, nations should consider the complexity of the topic and design reforms that improve the welfare of all the parties affected and reduce the risk associated. As it was said by Kate Elliot from Rahtbone Brothers PLC:  “A total lack of tax planning is bad for investors and evasion is illegal, but we know companies operate in grey areas.  The key thing for investors is to understand where a company sits on this spectrum: how light or dark grey its tax practices are.”