Multinational Tax Management- The Illegitimate Way to Boost Profits

Amazingly, I briefly covered the issue of corporation tax a few weeks ago.  Although this highlights the fact that I hadn’t read the TLP, I’m quite proud of my brilliant proactive background research.  All jokes aside though, this link does highlight a great worry for the average, honest, hard working British taxpayer.

In the case of Barclays, although they saved the taxpayer money by refusing the government bailout, that does not excuse the corporation tax, or lack of that they were reported to have paid earlier this month .  Does this mean that in the future if I choose not to apply for benefits when I am in trouble, I will only have to pay a 3% tax rate?  If only...

It’s easy to see why people are so angry about this issue.  As individuals, we are all victims of a financial structure that has failed, yet we are the ones that have been lumped with increased VAT rates, rising levels of unemployment, freezing of public sector pay; the list goes on and on...  Barclays of course will argue that they are abiding by the laws set in place, and they are right.  With businesses looking to maximise their profits, why would you not capitalise on the opportunity to look abroad, where tax rates can be far more attractive? 

Whilst on my work placement, I had a discussion with a colleague about my plans to move abroad and work somewhere with a lower income tax rate than in the UK; he raised the issue that it was unfair to want to do that.  After everything this country has given me in having an excellent healthcare system and free education etc, what right do I have to not repay that debt through paying taxes to the country that has given me the opportunity I have? 

It goes to show the huge gulf there is between what is ‘right’, and what is good business. 

For all the talk of legitimacy and corporate social responsibility, the more I look into it; the more I question its relevance.  If a business were to genuinely claim that they were legitimate, would they utilise the tax havens of this world through outsourcing operations?  There has to be a point where you draw the line between making money to improve shareholder wealth, and just being plain greedy.  This isn’t a business being innovative by developing new ways to improve efficiency; it is cheating countries out of money through loopholes.  With academics like Suchman suggesting that businesses needing to conform to the sets of rules and values held by a society to have a right to exist, there is very little evidence of some of these companies adhering to any of the rules and values I hold.

Yet the power that they hold puts governments in the situation where  they can not afford to lose these companies by closing up these loopholes.  It’s not right.  It’s not fair.  It’s also not going to change any time soon, and until the day it does, it’s people like us that are going to feel the effects whilst companies like Barclays get to report £4.6 billion profits that we will never see.

It’s a shame, but it’s something I suppose we have to live with.  In this case, maybe ignorance is bliss..

It’s amazing just how difficult it is for large companies to raise capital for future projects.  An outsider would assume that this would be fairly straightforward, and yet when you look into it, the different methods and factors that need to be considered makes it far more complicated.

A phrase I have always carried with me is ‘Fail to plan, plan to fail’.  It’s incredible how relevant it is to this topic.

Before you even consider raising capital, you have to determine what your rate of return will be.  If the rate of return is too close to that of the cost of capital, you risk the profitability of the project if any unforeseen circumstances arise.  Looking at the example of Sky when they released their broadband package in 2006, they predicted a post tax return of 10.5% by 2011.  It would be expected that to ensure profitability, Sky would have aimed for an extremely low cost of capital.  With the estimated cost of capital being 9%, you have to wonder why they even considered opting into such a venture.

There are of course plenty of examples of ‘loss leader’ products, such as Sony with their PS3.  As seen in this link http://www.engadget.com/2010/02/05/playstation-3-still-a-loss-leader-six-cents-for-every-dollar/ , Sony was still yet to see a profit on their consoles in 2010!  Instead the money was clawed back through games and other add-ons.

Evidently, there are times when you need to look at the bigger picture when planning, as what could seem like a foolish venture that would see no profitability could see high returns that are directly influences from a ‘loss leader’ product.

After considering the rate of return, it is then necessary to find the best method to fund these returns.  Businesses can either choose to exchange equity or debt for finance.  Both options have distinct advantages and disadvantages, and both are far more complicated than I had anticipated.

Provided you can live with giving up an amount of ownership in the business, raising finance through equity seems like the way to go: no contractual agreement on dividend levels, no need to repay the investment and the ability to trade on brilliantly liquid and international market seems fantastic.  After looking at the timeline of raising equity finance being around 2 years, and the cost of listing shares on the stock market, you have to plan a hell of a long way in advance. 

Financing through debt is of course the other option.  The world of bonds is in my opinion overly complicated, and in some cases it seem to blur the lines of legality.  They offer ‘investors’ the comfort of knowing that they have a guaranteed repayment with a fixed percentage of interest.  The business gets a source of income and the benefit of having this debt tax deductable. 

There are other forms of debt finance including a variety of loans, I am however very conflicted with the whole concept of debt.  It seems every aspect of this capitalist world we have created has been built on money we do not have.  Through poor planning, arrogance or just plain stupidity, we have seen countries brought to their knees from this culture we have developed of spending more than they can afford.  When the bubble bursts, we see banks, bailed out with taxpayer money and governments put into situations where they are forced to negatively affect the livelihoods of millions of people.

For me, raising finance is something that should never be taken lightly and the restrictions imposed on the stock exchange are there to ensure a level of safety and security that is lacking in that of debt finance.  For business, debt can have huge advantages, but it seems as though eventually it will come at a cost that society has to deal with. 

Seems as though a collective failure to plan in the marketplace has resulted in the epic failure that is the 'credit crunch'.

The Stock Market- A Long Term Perspective

Whenever I think of the stock market and investment, I am reminded of my days as a GCSE business student.  We had a competition where we each had to choose companies on the FTSE100 to invest in.  Whoever made the best return on their investment was the winner.  With it being winter at the time, I decided to invest in gas companies- my logic being that it was cold so people would spend more money on heating.  Needless to say, I didn’t win.  Instead the winner was a student that (to put it politely) was a bit dense.  When our teacher asked him how he had decided to invest, he replied “I just picked the ones I liked the names of”. 

It’s quite amusing to see that there are plenty of examples similar to this.  To hear that monkeys and playmates have succeeded in embarrassing the ‘experts’ of the investment world does raise the question as to whether there is any way to accurately predict the performance of individual companies, or the market as a whole. 

If you were to consider Kendal’s idea of ‘Random Walks’, it would suggest that even trying to predict share price movements is difficult, if not impossible.  With there being an estimated (2002 figures) $60 trillion traded daily on global financial markets, for investors to accept this and allow their money to be left in the hands of luck would be suicidal. 

Fama has a sensible take on stock market efficiencies- that market efficiency can be defined as weak or semi strong depending on the reaction to new information.  Looking at the recent example of Shell, they saw their share price fall from 2,268 at the start of trading on February 3rd to 2,155 at the close of trading that very same day, purely from the fact that they released details of their annual profits.  This instant and fairly significant reaction to new information is evidence of the London Stock Exchange being a semi-strong form when it comes to market efficiency. 

The most surprising thing about Shell’s share price falling 3% in one day is that they actually reported a rise from $9.8bn to $18.6bn.  This is an anticipatory approach was taken towards Shell that hasn’t quite worked out.  Not quite the perfect market efficiency that is strived for, but in the real world, and considering the nature of our race, perfect efficiency could never happen.

In the Turner Report, one of the key criticisms of stock market pricing is individual behaviour is not entirely rational.  People tend to allow themselves to be ruled by their emotions which will not always be the rational decision to make.  In the case of Shell, this could quite possibly explain the over-anticipated profit levels.  Over the past year however, we are assured by Richard Hunter, head of equities at Hargreaves Lansdown Stockbrokers that shares have in fact risen by 27%.  Looking at the long term, it can be seen that it is usually the case that good performance is rewarded with a good share price.

With the level of uncertainty in returns, can the stock market be seen as anything more than speculative gambling?  From a short term perspective, it certainly seems like a daunting prospect.  When you start to look at the bigger picture however, it becomes evident that the stock market can provide returns that would dwarf any savings account you will ever find.  Looking at the graph in this link, you can see that even after an economic crisis, the performance of the FTSE 100 over the past 23 years is impressive. 

On http://www.coolinvesting.com/, there is a great quote that answers the question, ‘why invest?’.

“It really is nearly a rhetorical question. Investing is the best way to secure your future. In this world there are two ways to earn income; one is to exchange you labor for dollars and the other is to have your money earn money for you. The rich know this and the poor don’t. It’s as simple as that.”

With that in mind, and looking at the long term performance of stock markets, these pension and insurance funds seem to be invested in the most sensible place possible.  Forget roulette wheels, poker, accumulators or anything else- the stock market is the smart way to gamble!

Corporation Tax and its Effects on the UK

Before I go claiming any credit for this, I will hold my hands up and admit to directly taking this
link from Robert Peston's twitter.  With not everyone having twitter and at this moment in time, Peston not including it in his blog, I thought it might be worth sharing.

If this is article is true, it raises one glaringly obvious question for me: Why is there no outcry from Labour, or the media?  Does this not essentially mean that we, the UK public are being forced to deal with an ever increasing VAT with the reassurance from the government that "we're all in this together" when the large companies of this country are able to avoid corporation tax essentially?

The piece is very one sided and the author is clearly no Tory.  With that in mind, I certainly wouldn't take it as gospel truth.  What I will say though, is that if this is the case, and if this is really happening, you really have to question if the Conservatives are doing anywhere near enough to decrease the level of debt in this country.

Shareholder Wealth: As Value Adding as it Seems?

Creating shareholder wealth is seen almost as a holy grail for business to achieve.  If you can maximise the wealth of your shareholders, you are attaining one of, if not THE most important strategies of the business.  It can be difficult to argue against.  Albeit over two centuries ago, Smith’s idea of the ‘invisible hand’ guiding the marketplace in such a way that efficiencies are rewarded with investment can still be seen as relevant in modern times.  This success can then be seen to benefit the society as a whole.

Just look at BP- before the Gulf of Mexico oil spill, it was estimated that for every £8 paid into UK pension funds, £1 can be attributed to BP.  A perfect example of looking after the shareholders and also creating a positive outlook for millions in the UK, surely?

Looking at the picture after the oil spill however and we see a potential problem with focussing too much on shareholders.  BP halved their dividend paid from the figure before the disaster.  This will have a significant impact on both shareholders, and in extension, almost every member of the UK public that holds a pension.   In non-monetary terms, the environmental impact of the coastline has devastated livelihoods and sea life, and killed 11 people.

Is it too harsh to hold BP so culpable for this?  It could be chalked down to misfortune, maybe it was completely unavoidable.  Looking at BP’s track record; namely the Texas City disaster, the history of budget cuts forcing cutbacks on safety and training cannot, and should not be ignored.  These budget cuts will have undoubtedly resulted in improved profit margins and will most likely have had a positive impact on the shareholder, and yet now BP are in a situation where a relentless pursuance of maximising shareholder wealth has come back to bite shareholders where it hurts the most- their wallets.  With an estimated £40bn loss for shareholders in dividends over the next 10 years, every shareholder and almost every UK citizen with a pension will see a huge loss. Maximising shareholder wealth?  Perhaps not...

The use of performance indicators as tools to measure shareholder wealth can also be brought into question.  Domino’s Pizza are considered to be one of the best performers on the stock exchange since the economic downturn.  This can be seen by an ever improving EPS figure.  Are these the be all and end all indicators to highlight good business performance though?

Writer and producer of The Wire, David Simon has an interesting take the use of statistics when reporting, “as soon as you invent that statistical category, 50 people in that institution will be at work trying to figure out a way to make it look as if progress is actually occurring when actually no progress is”.  A perfect example of this in the real world is the use of a share buyback shame- something Domino’s and several other FTSE companies frequently take part in.  By spending surplus cash to buy shares and take them out of circulation, businesses are able to artificially increase the earnings of each individual share without actually improving the share price.

The emphasis of improving shareholder wealth is stressed to managers so much that they are put under immense pressure to meet these figures.  When it comes to self preservation, why wouldn’t management do anything they could to make the figures appear more attractive than they actually are?

Should shareholder wealth be held in such high regard even with the clear and obvious flaws?  Maybe not, but with the power shareholders wield, nothing is going to change any time soon.