The Fair Tax Mark is a good idea. A clear benchmark for responsible practice in tax management would go a long way in providing clarity to the debate on tax and corporate responsibility. A consultation draft of the FTM criteria for UK based multinationals was released last week. It is a blink-and-you’ll-miss-it open consultation period so here are my quick thoughts (as a non tax expert, but a representative of the non-specialist, but interested core audience for such a tax mark).

The key principles for the criteria are based on transparency and operating within the spirit of the law. Like the FTM’s earlier criteria for UK domestic businesses, the new standard focuses heavily on process measures; 65% of available points (the initial pass mark) are awarded for policy, governance and transparency . There is much to recommend here; providing full accounts, transparency on beneficial ownership, disclosure of subsidiaries and disclosure of tax policy and who is responsible for it. All good stuff.

My comments concentrate mainly on the  assessment of the fairness of the outcomes of this process. The principle for this is set out as:

 “A company should pay the right amount of tax (but no more) in the right place at the right time according to the spirit of the law of the jurisdiction in question.”

This, I think, is the right target zone for corporate responsibility on tax, and one around which there seems to be a large degree of consensus.  As the standard points out, the principle is pretty close to the CBI’s recommendation that businesses should only engage in reasonable tax planning that is aligned with commercial and economic activity and does not lead to an abusive result.  It also aligns with what companies are increasingly saying publicly about their tax principles:

 ‘We will only enter into commercial transactions where the associated approach to taxation is justifiable under any reasonable interpretation of the underlying facts, as well as compliant in law and regulation’

and

 ‘In every country where we do business,  [we] adhere to both the letter and spirit of the law regarding our business practices, and the UK is no exception’.

However the devil is in the detail.

Those last two statements come from Vodafone and Starbucks; companies that are regularly held up as examples of multinational tax dodging. So a fair tax mark aligned  to the ‘spirit of the law’ principle would need to provide clear and broadly agreed criteria able to assess whether companies like these are living up to this principle.

However, on the substantive questions of  whether companies are paying tax according to the spirit of the laws in all the jurisdictions where they operate, the criteria remain surprisingly vague and broad.

Tax rate

The assessment of tax rate, is  based on the same approach as  in the standard for UK-only companies – looking at the overall tax bill. There is nothing in the methodology for assessing  the split of profits and tax between countries, which has been core to many  tax controversies.

6 points are awarded based on the overall rate of  current tax (averaged over four years) and how this compares to the “expected headline rate”.  It is not stated what this expected rate should be – whether the UK headline tax rate, or a blended rate, based on the different tax rates in the countries where the company operates (which seems like a big gap in the specificity of the criteria).

Up to 3 “bonus” points can be earned back by a company with a low effective tax rate, if they provide a clear explanation of how it is arrived at (for example  through capital allowances, losses carried forward  etc…). As has been pointed out by others in relation to the domestic standard, this marking scheme means that companies that have a low tax rate for completely uncontroversial reasons (like making great big capital investments) are docked 3 points. It has been argued that this doesn’t matter, as losing 3 points out of 29, would not prevent a company being awarded a pass. But ultimately if we are concerned with establishing clear criteria for good corporate practice that does not seem like a satisfactory solution.

Tax havens

The other substantive criteria is about tax haven operations (defined as subsidiaries in countries scoring 65 and up in the financial secrecy index such as Switzerland, Luxembourg, Hong Kong, Singapore, Malaysia, Philippines, Dubai, Ghana plus a host of familiar offshore islands). Companies lose 4 points for having subsidiaries in any of these locations, but can win them back by showing that the finances there reflect ‘true economic substance  located in that place’. No further guidance is given for what that means, or how it will be assessed, which again seems like another big gap right in an area where the greatest controversy is.

When companies defend their international structure which includes hubs for intangible transfers –   loans and interest payments, self-insurance, charges for intellectual property and employment of international contractors etc…,  they say that while tax is one factor in the location of these hubs, the transactions themselves reflect the economic substance of managing a modern, information driven  international company,  and are within the spirit of the law. Campaigners say they are profit shifting mechanisms that exploit loopholes.

Simply stating that the location of subsidiaries should reflect economic substance  does make clear how to apply a test that decides between these two interpretations.

The model tax policy, gives one clue to the FTM view, stating that companies should ideally commit  ‘Not to maintain any type of connection to tax havens when this is not a legitimate trading activity with the purpose of serving the local community’.  Under this policy would be ok to invest in agriculture in Mauritius, but not to structure FDI into other African countries through a joint venture registered there. It would be ok to sell cups of coffee in Geneva, but not to trade coffee beans there. OK to operate a clothing store in Hong Kong, but not to run an international sourcing operation there. OK to run a bus company in Dubai, but not to run a shipping operation. Building a factory in Ghana is out too. Such a restrictive view of what constitutes legitimate investment goes well beyond ‘the letter and spirit of the law’.

These gaps in the assessment methodology around what is the fair ‘expected rate’ of tax for UK registered multinationals with complex international operations and what is a legitimate basis for assessing ‘economic substance’ of a location are two areas that seem undercooked in a standard being considered as almost-ready-to-go after the formality of a 2 week consultation.

Constructively, I think it might be helpful to have two different scores and two separate pass marks (or potentially two different standards) for disclosure and performance, rather than  conflate them (learning for example from the Global Reporting Initiative where A, B & C grades for reporting, were widely misinterpreted as grades for performance and were eventually withdrawn).

This would allow for a faster-track consultation and implementation of the disclosure  principles, and a longer process to clarify the substantive criteria.

Is it a duck or is it a rabbit?

Underlying the substantive issues I think is a deeper question about what the FTM is for. Is it, as it says on the tin, a standard to assess whether companies’ tax affairs are aligned with the letter and spirit of the law? Or is it, as its history and governance would suggest a campaigning tool to encourage companies to respond to campaigners wanting to change the law? Do its criteria define what all companies should do, as intended by legislators, or is it a gold standard for those that want to make specific commitments beyond compliance?  Both roles are legitimate. But they are not the same. And fudging them by patching over the gaps with unclear criteria does not serve us, the audience well.