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Nedanstående är Niclas Virins anförande vid ett seminarium arrangerat av Skatterättsligt Forum vid Handelshögskolan i Stockholm den 24 april 2006. Övriga föredragshållare var professor Göran Normann och Erki Uustalu, rådgivare till den estniska regeringen. Seminariet leddes av Leif Mutén.

“In every respect the burthen is hard on those who attack an almost universal
opinion. They must be very fortunate as well as unusually capable if they
obtain a hearing at all. They have more difficulty in obtaining a trial, than
any other litigants have in getting a verdict. If they do extort a hearing,
they are subjected to a set of logical requirements totally different from
those exacted from other people”.
 (John Stuart Mill)

The headline for this speech is Why. I have chosen it because it not only indicates a real problem: why on earth do we tax business income? but also a question to which there may be a positive, explanatory answer. The question is: Is company taxation necessary or harmful? Those of you who know me are probably in no doubt of my opinion. To formulate it drastically I would say that company taxation is an unnecessary evil. Who am I to say such a thing?

My name is Niclas Virin. Five years ago I retired from my position as senior vice president and responsible for tax matters in Svenska Handelsbanken, a position I had held for almost 20 years. Previously I had during almost twenty years occupied different positions in the Swedish Tax Administration, inter alia Chief Inspector of Taxes at the National Tax Court (in Swedish Mellankommunala Skatterätten) a special tax court for cases regarding the taxation of the largest companies. During my career I have also been a member or secretary of several governmental company tax law committees set up to reform the business tax system. Last year I resigned from my position as a member of The Council for Advance Rulings (in Swedish Skatterättsnämnden), which I then had held for twenty years. During all these years I have concentrated on business and company tax law, and as you can understand from what I just said, I have seen it from its four sides – as a tax collector, as a company tax payer, as a tax lawmaker, and as a tax judge.

I have a confession to make: During these years I successively came to doubt my duties more and more as well as the motives and justifications of this form of tax. Over and over again I had as a tax inspector to make decisions contrary to my conviction and common sense just because the law was what it was. As a tax advisor to the bank I experienced the extreme complexity of the tax system and the difficulties to comply with the rules. To the best of my knowledge and ambition I avoided every possible mistake, but I’m sure there were lots of decisions that could be questioned from legal and practical points of view if only you scrutinized the matter deeply enough. Although I tried every possibility to avoid that the bank had to pay too much tax, I’m sure there was a large number of other – and better – ways to reduce the tax bill. It’s just so complicated that you can never be sure of the most efficient solution. I was also as a consultant to the bank troubled by the ways in which very large investments (trains, ships, airplanes, airports, pipelines for gas, oil, heating and cooling, oil- and gas drilling etc etc) were structured in order to have them partly financed by an absent party – i.e. the state that unknowingly was forced to reduce its tax claims. As a lawmaker I became aware of the inconsistency of the company tax system and the impossibility to implement lots of good ideas and suggestions. When finally a solution was found and decided on by the committee and the law bill was approved by the Parliament, I often realized how hollow and incomplete it was and how easy it was to abuse or circumvent. Finally as a member of the Council for Advance Rulings I have been engaged in deciding how these rules and regulations are to be construed and understood and applied. In a number of cases I have asked myself – and my fellow members of the Council – Why have we decided what we have decided? What do we really know of the reality on which the rules have been applied? What do different legal concepts stand for in real life? We had often been of very different opinions; but yet I don’t think anybody was wrong. The business tax law is – and must be - only so vague, so ambiguous and badly adjusted to reality that many questions could correctly be answered in different and even contradictory ways. And every tax consultant and tax inspector can witness that the outcome of most cases in the tax courts is very often a surprise.

Why do we tax business income?

From a national and international perspective company income taxation is becoming more and more complicated and resource consuming. In Sweden a very large part of the tax administration is occupied with business tax matters. A great majority of the total wording of the tax law and of the case law accounts for company and business income taxation. The text volume of the business income tax code is about ten times that of taxation of salary and pension income, but the revenue is only a tenth. And business income tax accounts for a very tiny proportion of total tax revenue, 5-6 per cent.

One reason behind this development seems to be the continuing growth in complexity of economic life. The aspirations of politicians to monitor and direct business activities seem also to have accounted for much of the complexity. In international taxation the protection of national tax bases has forced countries to introduce transfer pricing and thin capitalisation rules and procedures as well as CFC-legislation.

I think there is a widespread opinion that the existence of business taxation is necessary to prevent a leakage in the macro economic system. Without a company tax there would be a black hole in this system where common resources would disappear. There has always seemed to be a general understanding that business income is to be treated in the same way as household income. I think that these are misunderstandings based on ignorance of the economic difference between business and household income.

Secondly, it is my belief that the reason why business taxation is unquestioned is the fact that it has been there for so long that people don’t realise that business taxation is or has developed into an economic anomaly. Originally taxes were levied regardless of profit or loss. It was not until about 100 years ago that the assessed profit of a business more frequently was introduced as a tax base. The social and economic structures of a modern industrialised country are, however, such that what was previously the only rational technique for collecting taxes has now become unnecessary and even economically harmful.

The question can be addressed from at least three different angles. With a juridical, an economic and a social approach.

The juridical approach

In this section I would like to draw attention to some legal and technical problems emanating from the fact that business income is used as a tax base.

To start with: What is company income? Every student of tax law is aware of the problems of the definition of business income. What income is taxable – what income is tax-free? What costs are deductible – and what costs are not? And why? A burning question today is the deduction for sponsorship payments. What significance for the income concept has the commercial accounting? What provisions for future risks and future cost such as guarantees, pensions etc. are acceptable? Can transactions be performed at non-market prices between close companies? What about taxation periods and loss carry back/carry forward provisions?

There is the question of economic double taxation of company income. To what extent should capital gains be taxable? What about taxation of dividend income? What about group contributions or other group taxation issues, such as mergers, demergers etc. How and to what extent should double taxation of company income be alleviated? Should it be at the shareholder level (tax exemption, tax credit) or at the company level (deduction for dividends)? Or should it be alleviated at all?

Income Attribution, Transfer Pricing and Advance Pricing Agreements are other international tax problems. The OECD has developed detailed guidelines for transfer pricing and it has been a topic for many IFA conferences. There is also a Joint Transfer Pricing Forum in the European Union. The IFA congress in Amsterdam later this year will discuss the attribution of profits to permanent establishments. The discussion will never come to an end because the problem is unsolvable. The mere idea of an artificially decided price must be questioned. Not only can the company present reliable arguments for most prices within a reasonable range, but also some transactions that are performed between close companies will never take place at arm’s length distance. An increasing part of the value of new products consists of know-how and other intangible values, which are almost impossible to price.

A burning topic is international offsetting of profits and losses. A well-known example from the ECJ is the Marks & Spencer-case.

Other methods to shift tax bases from one country to another are over- or under capitalisation. As there will never be a scientifically correct debt/equity ratio depending on the unique - and continuously shifting – conditions in every company and group of companies, any standard relation will be misleading.

Different national tax systems create both problems and opportunities for companies operating in several countries. Because companies have the initiative, new patterns of organisation and transactions aimed at tax saving tend to emerge all the time. The lead-time for fiscal counteraction is typically very long.

The growing ambitions of the states to protect their tax bases and their endeavours to broaden them and to counteract other countries’ efforts create a situation where the companies are temporarily overtaxed until the countries have settled their competing tax claims. In many cases over-taxation may never be totally eliminated. So companies are the victims of what is basically a fight between two states.

The rule of law may be in danger where we establish concepts and definitions of phenomena that are difficult, and in many instances impossible, to observe in real life. A good example, discussed in depth at many IFA congresses, is the concept of permanent establishment. Although it is of paramount importance for a correct taxation it is in practice impossible to draw the perfect borderline.

Another example is the concept in the EU merger directive of “branch of activity” (90/434/EEC Art 2 (c) and (i)): All assets and liabilities of a division of a company which from an organizational point of view constitute an independent business, that is to say an entity capable of functioning by its own means. To my opinion this rule is impossible to apply unless very clear facts prevail or formal criteria are met. Depending only on the skill of argumentation something could be classified as inside or outside this definition and the performed act classified as legal or illegal.

The legal framework tends to be very complex and the different components of the legislation so incompatible that nobody really can have a grasp of the entire system. This makes the business tax system a social and political risk, because neither the tax authorities nor the courts can be consistent. Some taxpayers achieve economic advantages by using tax-planning measures that others find illegal or immoral, which distorts competition conditions. Typically the amounts at stake are very high. Time and again we read in the newspapers about tax claims of tens or even hundreds of million SEK in the tax courts. And that makes business tax consulting very important and profitable. There is a lot of money to be saved by skilful argumentation. But how can we accept such an unstable tax base? And as I just said the outcome of the cases in the tax courts is very often a surprise.

In Sweden the effort to combine taxation of current business income with dividend income and capital gains has time and again turned out to be unsuccessful. And how could it be otherwise? It is obvious that the three income items cannot be combined. They are simply not part of the same totality. Sweden has at last decided to abolish the taxation of companies’ capital gains from substantial holdings of shares. One price for that reform, however, is an extended and immensely complicated CFC-legislation.

The economic approach

The negative consequences described above would nevertheless have to be tolerated if business taxation were necessary as one of the Laws of Nature. But it is not. Neither does it follow from any economic law.

The role of taxes in the economic circuit can be described in the following diagram.

H = Household sector, B = Business sector, S = State, L + C = Labour and Capital, W + D = Wages and Dividends, G + S = Goods and Services, P =Prices, I + G = Inheritance and Gifts, W + RE = Wealth and Real Estate, CG = Capital Gains

There is a flow of labour and capital from the household sector to the business sector. In the opposite direction there is a flow of payments for labour (wages) and capital (dividends). The result of the production flows from the business sector to the household sector in the form of goods and services and the payment for it flows in the opposite direction. The purchasing power emanates from the wage and dividend income. The flows of payments and the flows of capital and labour and goods and services are all interdependent.

There is a flow of semi-manufactures round and round in the business sector and a flow of payments in the opposite direction. Successively in this circulation and definitely when the products leave the business sector, profit is created. This profit is used as a tax base in the business income tax system. Part of the profit is distributed as dividends to the shareholders and taxed again. The profits not distributed to the shareholders accumulate to the real values in the business sector. This increase in real values is mirrored in the household sector by a rise in financial wealth, i.e. a rise in the value of shares.

A flow of about the same size as salaries and dividends can also be used as a tax base if there is a general consumption tax (VAT). The consumption (or a part of it) can also be taxed by way of special goods taxes and excise duties paid by the household sector or the business sector depending on the technique of collection, i.e. tobacco, alcohol, petrol, energy, environment pollution, traffic congestion, etc.

Finally taxes are collected in the household sector as a consequence of actions or events there, such as the possession of wealth and real estate, etc. Inheritance and gifts have recently been abolished from tax in Sweden. Households are also frequently taxed for the realisation of capital gains, i.e. the accumulation of values created – and taxed – in the business sector.

In the diagram it is easy to see that business income tax is only a surtax on household income tax or rather a prepayment of household income tax. The tax reduces what would otherwise have been paid to the employees or shareholders and reduces thereby the tax bases for salary and/or payroll taxes, and dividend tax. It can also be seen that the abolition of business profit tax would not create a leakage of tax bases.

If the business tax were removed, profits would, in the short run, rise and, hence, so would dividend income for capitalists, but in the longer run the employees would recover what the capitalists seized and the long-term ratio between labour and capital income would be restored. There is no reason to believe that this ratio would be dependent on the business tax level. In the short run total tax would probably be reduced but in the longer run the state would recover what it lost by a rise in wage and dividend tax revenues. What the companies paid in taxes was financed by sacrifices made by individuals. After the abolition of company tax the individuals make the sacrifices in the form of tax payments instead of goods prices and reduced salaries.

So nothing serious would really happen. Except that taxes would disappear as a cost item in the profit/loss-statement of companies and consequently there would be no company tax to administer and no company tax consequences for investments to take into consideration.

Suppose history started with a system without business tax and business taxation were introduced. What would happen? There would be a decline in return on existing capital. Would the shareholders accept that? Of course not! The value of existing shares would decline and restore the long-term expectations and demands of yield. Prices would rise to compensate for the new cost and salaries would fall. In the long run we would be back where we started but there is a new cost item – company tax – in the profit/loss-statement.

And then, we would also have been obliged to introduce a special company tax code, people would be engaged in interpreting it and trying to avoid its consequences, or - trying to enforce it; the police and the courts would be occupied. Companies must start to make before and after tax calculations; investment and establishment decisions would be dependent on tax consequences. These consequences would be difficult to preview because they concern the future and in the future everything may be changed. Even the tax code itself may be changed. The business risk will therefore increase. Risk implies cost and a loss of economic efficiency.

We would encounter the double taxation problem. Different ways to solve the problem create new problems and the need of a complicated regulation.

Why then do we tax business profit at all? I think most people believe that it is an indispensable part of a comprehensive economic system. We tax the employee so we must also tax the self-employed person. If we tax the self-employed person we must also tax the company. This is wrong! As long as the assets of a company or a sole trader are not used by the shareholder or the business man for his or her personal consumption, there is no need to tax.

The profit of a business is simply not comparable to the income of an individual. The income of an individual is the counter-value of the result of his or her participation in the production process. The income received by the individual is the prerequisite for his living. The individual works to be able to live. Part of the remuneration must be left to his or her fellow citizens because they have not been able to take part in the production process: children, students, pensioners, sick and disabled people, etc. That is taxation. And in the long run there is nothing except the production to share.

Corporate income on the other hand is something completely different.

Corporate income is to a great extent the difference between two estimates of present values of future payments. Each estimate consists in turn of two estimates: inflow of income payments and outflow of cost payments. If there is a positive difference, i.e. the present net value at the end of the time measured is larger than it was at the beginning, then there is a profit. In other words, capital wealth has been created and accumulated and the capital base for future activities has been strengthened. But there is no such thing as a “wealthy company”. In fact, and paradoxically, if the company cannot give its capital a higher yield than the market interest rate it owns too much capital, i.e. can be said to be rich. On the other hand, a company giving an extremely high profit has too little capital, i.e. it is poor. So, the principle of ability to pay tax is irrelevant to companies. The company income is created only to build up a capital to improve the company’s capacity to earn still more money and to pay still more wages and dividends. Nobody can ‘eat’ that capital. A company does not consume for its own sake.

Business valuation today is becoming increasingly difficult as the asset values to a growing extent consist of intangibles and the intellectual skills of the employees. The asset side of the balance sheet walks out of the enterprise every afternoon. Will it return tomorrow? So, the base for taxing the company is much more uncertain and instable today than it used to be. That also makes business profit an unsuitable tax base.

In fact, as a consequence of good behaviour – the creation and accumulation of new capital – companies are punished by taxation. Loss making companies that destroy existing capital, i.e. economic parasites, pay nothing at all for their protection, their access to governmental service and infrastructure. The propelling force of economic progress – the specialisation and division of labour – stimulates the birth of new enterprises. As some of them are bound to fail and go bankrupt, the average level of tax on the net profit in the business sector will rise because of this specialisation and division of labour. So, the company tax runs completely counter to the fundamental process for creation of prosperity!

The false parallel between company income and household income creates a completely absurd consequence in the obligation to pay tax on the formation of new capital. If we started to use the expression “capital creation tax” instead of “business income tax” people in general would perhaps realise this absurdity and it would break the spell of the word “income”. The mere idea of taxing businesses for their profits is absurd. It’s like shooting yourself in the foot or shortening the pole for the pole-vaulter.

The social approach

If business income taxation is so harmful, why do we have it at all? Why did we ever start taxing business profits? And couldn’t any tax system be accused of being harmful? Taxing salaries can be said to reduce peoples’ willingness to work, so by reducing wage taxes we would stimulate the supply of labour. It is probably true that all taxes have harmful and distorting effects and that is because they are compulsorily levied on the taxpayers. Even if people recognise the need for public consumption and accept being taxed for the financing thereof, they are forced to pay for something they wouldn’t have bought voluntarily. But to be taxed is to accept the sharing, with somebody else, the value of one’s contribution to the total production. And nothing can be produced without the input of labour and capital. To live we need produced goods and services. We are simply forced to work “by the sweat of our brows” to survive. So we have to accept that household incomes such as wages, interest and dividends constitute bases for tax despite possible harmful consequences.

But why tax companies? In some way or other even taxes on companies are borne by individuals. If the companies pay them according to profit, labour cost, turnover or any other factor they pass the tax burden on to the individuals – at least in the long run. Companies can – and inevitably do – avoid the burden of the tax; individuals cannot.

This ability to pass on the tax burden to individuals seems to have completely different consequences today than in earlier days when taxing companies was the only possible way to collect taxes. But even then it was not the profit as such that was taxed.

In those days the power to rule was exercised by emperors, kings, and other masters, by travelling around in their realms enforcing the law, judging, settling disputes, etc. He and his court and his counsellors took as temporary regional and local headquarters the different palaces, castles and estates of local princes, counts and landowners, etc. Of course they chose such estates that could best afford to accommodate and feed them, i.e. estates that had accumulated large supplies of products, i.e. profitable enterprises, although “profitable” and “enterprises” were unknown concepts at that time. The subordinates had not only to accommodate their lord and his suite and escort; they had also to deliver goods and services to their lord’s own residence and furnish him with troops, armament etc in times of war and build roads and bridges, etc. The peasantry had to deliver part of their production to their masters and they had to perform workdays and other services. That was the taxation technique of that time although they did not use that expression for it.

In those days economy was primitive and consisted mainly of agriculture, forestry and mining and other forms of extraction of natural resources, shipping and trade. To a large extent trade was performed through barter. Very little capital was accumulated: the harvest was used for consumption and sowing new crops. Serfdom was in practice, if not formally, a reality. The workers received (hardly) enough to survive and they received it in kind rather than in cash. If capital was accumulated it was made in the hands of the rulers and their closest subordinates (and the Church), i.e., in the hands of the entrepreneurs and large enterprises (if you excuse my anachronism) of those days. It would have been foolish to try to tax the workers and ordinary people. There was nothing to collect from them. So there was no alternative to taxing the entrepreneurs.

Today everything is totally different, at least in the developed countries. Money economy prevails; industrialisation has made possible permanent and constant economic growth and thus an unprecedented general accumulation of capital - also in the hands of ordinary people. Anyone may set up a business enterprise. Legal forms for capital investment in joint-stock companies with limited liability exist. You do not need to work for the company in which you own shares. Top management does not necessarily own shares in the company they work for. Employees are free to change their employment. There is a generally accepted legal framework, efficient administration of national and local authorities, high standard of education, etc. Creation of private wealth is possible and widespread.

Enterprises are no longer symbols and economic strongholds for political power but instruments for the general public to create goods and services and to accumulate real capital. It is ordinary individuals who decide in what enterprises to invest their capital. The real wealth consists today – as always – of business and private assets, but it is the general public that owns it and decides what income to take out of it in the form of salaries and dividends.

In a modern economy it is also possible to charge the individuals with tax. What was earlier impossible is today not only possible but also an efficient means of fair individual taxation. The taxation of companies and entrepreneurs not only fails to burden the formal taxpayer but it hits the ultimate payer in an unpredictable way. And it is detrimental to the productive capital.

Objections against corporate tax abolition

Of course there are objections. But how serious are they? Here I will mention three.

The greatest obstacle is that company taxation is so widespread. That makes abolition a difficult educational task. And companies have no political voting rights so their opinion is politically uninteresting. Rather the contrary, I would suspect: People think there is a lot of money in the hands of people out of political control. It’s no risk to tax them. And what about the following news bill of a tabloid paper: “Taxes on salaries are raised to finance tax reductions for companies!”

Another problem relates to international conditions. How will other countries react? If they sharpen their CFC-legislation they will collect our taxes! But will they, really? What they do is to tax their subjects. That is, the benefit they would have got from an investment in the non-taxing country is taken away. That is of course a bit annoying for the non-taxing country, but the main reason why the company tax was abolished was not to attract foreign capital; it was to remove a harmful and unnecessary obstacle for enterprises in general. And after having abolished company taxation because you realized that company tax is a nuisance, you don’t miss it – not even if other countries collect the tax instead. Hopefully, they too realize that the abolition was not so bad after all and follow suit. And then there will be a race to the bottom. The best solution to the political/educational problem and the international problem is probably to reduce the company tax rate to some 5 - 10 per cent. It is then so low that it does not provoke harmful economic behavior and tax evasion etc. Other countries don’t find it worthwhile to counteract and some revenue is anyway received by the state.

My third example: We would create tax-exempt ‘piggy-banks’. Is that a problem? I would say no! Isn’t it positive that everybody saves for his own old age? I think so, but this is a political opinion and I accept that others may think differently. But in Sweden there is a special objection added: We tax pension saving. So it would be necessary to tax piggy-bank companies in the same way as pension companies. But I think it possible to find a definition for taxation purposes of marked piggy-box companies. Another method is of course to abolish the unique Swedish taxation of pension saving.


Undoubtedly the abolition of company (and business) taxation would – at least in the short term – reduce tax revenue. But, as shown in the diagram above, part of the tax otherwise paid by the companies to the Treasury (as taxes) would be paid as taxes on wages and dividends. Depending on personal tax rates the net loss of revenue would be much less than the loss of revenue from company taxes. Maybe only half of that loss!

Part of the remaining loss would be compensated for by the increase in profitability. The risk would decrease and it would become possible to make investment and establishment decisions without any tax effect considerations. That would give business activities a fantastic stimulus and offer companies the possibility to raise wages and dividends. Look at Estonia!

The need for expensive tax planning, tax administration and control would be dramatically reduced. A number of international tax issues (transfer pricing, permanent establishment, international double taxation, CFC legislation) would disappear. The economic double taxation problem would evaporate. In the end the abolition of company tax would even be profitable.

I think it is time to wake up and realise that business taxation today is unnecessary and harmful but – I must admit - that it also gives ample opportunities for interesting and sophisticated discussion and analysis – and business opportunities for tax consultants! By far the most common reaction I meet from them is: “You take the bread out of my mouth”! If that is so I think that’s my best argument. Another aspect is that it is an activity very similar to what the great Swiss/German author and Nobel Prize winner Hermann Hesse in his famous novel called Ein Glasperlenspiel. In contrast, however, to his Glasperlenspiel, that had positive elements in developing human thinking, company taxation is a sterile science and carries negative elements such as threats to the rule of law, economic destruction, and even criminality. Das Glasperlenspiel in Hesse’s novel takes place around the year 2200. I hope that the present game of glass pearls in business taxation is gone by then! Until then, it will remain an unnecessary evil.

Niclas Virin (niclasvirin@hotmail.com)

April 2006.