Why Should A Company Pay A Profit Tax If It’s Not Making A Profit?
There’s a little rumpus building up in my native UK over the coffee chain, Caffe Nero. The argument is that it seems to be making a nice operating profit but not actually paying any corporation tax. There’s also a bit of offshore thrown in here and therefore, undoubtedly, there’s something wrong going on. That, at least, is the way the story is being told from a certain viewpoint.
What interests me about the story is that we’re getting this from one who, on the left at least, is sometimes regarded as one of the country’s leading tax experts. And the part that Richard Murphy leaves out of his analysis is that the company isn’t actually making a profit at all. Which is, of course, why it’s not paying any profits tax: you tend not to be charged a profits tax on profits that you’re not making. This thus looks rather like whipping up outrage at tax not being paid when in fact no tax is due nor could possibly be due.
As Murphy explains it here the situation, although not entirely easy to uncover is, when uncovered, really very simple. Caffe Nero was an extant series of coffee shops when it was bought out by private investors some years ago. They used a little web of offshore companies to do the purchasing: all of which we all agree is entirely legal. They also financed the purchase by borrowing the money to make that purchase.
The complaint is that the company is making operating profits of £21 million a year but that it isn’t paying any corporation tax on those operating profits. Quite why this is an outrage isn’t certain: corporation tax isn’t charged on operating profit, it’s charged on taxable profit. And one of the major differences between the two, operating and taxable profit, is that interest costs are a deduction from operating profits before you arrive at taxable profits. The interest costs that are being charged to the company are greater than the operating profit. Thus there is no taxable profit to tax and thus no profits tax being paid.
This all seems very simple indeed to me. And the web of offshore companies makes no difference to this at all. Even if all the financing had been borrowed within the UK the interest costs would still be greater than the operating profits and no profits tax would be paid. We even have the information that the interest costs being charged are lower than they would be on a straight commercial arms’ length loan. So it’s not even a method of trying to move profits offshore: there just aren’t any economic or taxable profits.
There’s two other things we can say about this. The first is that sure, interest isn’t taxable at the level of the company paying it. But it is most certainly taxable at the level of the person receiving it. So even if no profits tax is being paid then there’s still tax being paid somewhere on that interest income. This financing method changes who pays the tax, sure, but not whether tax is paid at all or not.
The other is that we would actually expect coffee shops to be an unprofitable business. The reason is well explained in chapter one of Tim Harford’s excellent “Undercover Economist”. It’s all Ricardo on rent. The locations where one can run a thriving coffee shop are limited, mainly corners, near stations and so on. Given that limitation the price of rent on such places will be bid up and all of the economic profits from the business adventure will accrue to the landlords (who of course will be paying tax) and not to the operators of the coffee shops. We even have direct evidence of this: Starbuck’s, one of Caffe Nero’s great competitors has pointed out that the reason they’ve not been making profits for some years now is that they overbid on rents for favourable locations.
We wouldn’t really expect coffee shops in such a competitive environment to be making a profit, they’re not making an economic or taxable profit, so why is everyone complaining about the taxes they’re not paying on the profits they’re not making?