Scottish Independence, Tax and Base Erosion

There has been a great deal of comment about Scottish Independence, whether Scotland will be better or worse off and its tax revenues as a result of the two reports published by HM Treasury and the Scottish executive which show widely differing results. I am not going to comment on the politics of government statistics (although it is important to recognise that statistics produced by governments need to be read in their political context, particularly when it comes to tax) but instead focus on the assumptions which the Scottish executive make about tax receipts for an independent Scotland.

My contention is that they may well have underestimated the impact of base erosion and profit shifting on their corporate tax base. This would not be surprising as they have no involvement with this at present as HMRC in the UK collects corporate tax. This lack of exposure to corporate tax seems to  be resulting in confusing tax receipts with Gross National Income rather than with actual  taxable receipts. I thought I would illustrate this by reference to three sectors of some importance to the Scottish economy, Oil, Banking and Whiskey.

There are some positive aspects to Oil to start with. As someone who worked in the Oil Taxation Office I have some familiarity with Corporation Tax on North Sea Oil. One of the key policy issues in the design of the regime was how to avoid profit shifting, the mechanism chosen was the “Ring Fence” around production activities up until the point where product was first landed on the mainland or shipped. Within the ring fence broadly only exploration and production expenses are allowable in calculating taxable profits. This is the regime that an independent Scotland would inherit which appears to be fairly robust against profit shifting. So far so good, from an Independence perspective. However, with the benefit of future tax revenues comes the cost of future tax liabilities. In Oil and Gas the primary liability is tax relief on the cost of abandonment and remediation when facilities are closed down. These are considerable and will reduce tax revenue as they arise. So for Oil the picture is mixed, a tax revenue stream which is less affected by profit shifting, but with a liability in terms of abandonment which will erode this revenue stream.

Banking provides another picture. Financial Services allow a business to write its income books in a number of locations. How would banking respond to an independent Scotland? Let’s assume the tax rate in the UK is 20% and the rate in Scotland closer to 17% as an example (this is based on statements so far on what the Scottish CT rate will be), in this case it  makes sense (at the margin)for a financial institution to write profitable business in Edinburgh rather than London as the after tax return is  higher based on the tax rate differential. Is this 17% tax rate sustainable? Does this mean that Scotland would have to mirror the UK Corporate tax rate to maintain competitiveness? If it does so what is the knock on effect on other tax rates, particularly income tax? HMRC has considerable experience of dealing with Banking, how sophisticated would a new Scottish government be when setting  up the Scottish Revenue from scratch? Finally, where would an Independent Scotland stand on the Financial Transaction Tax (FTT)? In seeking admittance to the EU, would it agree to implement the proposed FTT? If it did so, what would be the impact on the Scottish Financial Sector?

Finally Whiskey, a quintessentially Scottish Industry you might think. Well yes and no from a tax perspective. While Scottish Whiskey is produced in Scotland, that doesn’t mean to say that the taxable profits arise there. Let’s take Diageo’s whiskey portfolio of 15 malt whiskeys and 7 whiskeys, where are these brands owned? Well a significant number are owned in the Netherlands not Scotland. So the taxable profits from the Intellectual property of these brands doesn’t result in tax in Scotland, but in the Netherlands. So which proportion of the profits of the Scottish Whiskey businesses are subject to tax in Scotland?

While the tax on North Sea Oil profits will arise in Scotland (subject to the abandonment and remediation issue), the position for other sectors is more difficult. Banking and Whiskey illustrate that GNI in a sector isn’t a guide to taxable profits. Given the Scottish Executive’s lack of involvement in corporation tax, I would suggest that their forecasts of tax receipts from corporation tax in an independent Scotland should be treated with some caution.

No comments yet.

Leave a Reply