As Britain's tax laws become globally less competitive, companies of all sizes, from all sectors are taking their business elsewhere

Synchronica is just the kind of growing high-tech company that Britain needs to encourage if it's to remain internationally competitive in the future. The Tunbridge Wells firm, which listed on the AIM stock market in 2004 and reported a turnover of £2.1m last year, is about to double the size of its research and development staff, creating more than 20 new well paid jobs. But they won't be in Britain.

Instead, Synchronica has chosen to expand its Berlin operation. Chief finance officer Angus Dent admits the problem of Britain's burdensome tax regime played a part in the decision. "We choose to pay tax in Germany," he says.

He's not the only British director looking enviously at the generous company tax rates in some overseas countries—25 per cent in Netherlands and Portugal, for example, and only 12.5 per cent in Ireland. And it's not only the level of tax but the way it's administered that's causing some of the UK's leading firms serious concern. FTSE-250 media giant United Business Media has already announced it's switching its tax residency to Ireland. And Sir Martin Sorrell, chief executive of FTSE-100 advertising firm WPP, says the company will consider moving its tax domicile if plans to reform the taxation of overseas profits are "introduced, ratified, confirmed and implemented".

The biggest bugbear for Sir Martin and other directors of multinationals is last year's government-floated idea of US-style passive-income tests to stop companies moving profits to tax havens. The passive approach "would mean that a UK company could be taxed on certain types of undistributed income of any company it controlled, whether that company was based abroad or here," explains David Blumenthal, a corporate tax partner at law firm Mishcon de Reya.

The government has promised a further consultation document (due out as we went to press) on the proposal. But Philip Harle, a partner in the tax team at law firm Lovells, says the passive-income tests are "a big turn-off for businesses as they introduce complexity, uncertainty and administrative expense". The problem isn't just that it could drive home-grown companies to shift their tax residency overseas. The proposed move is a disincentive to inward investment. "The change in the tax regime, given the reductions elsewhere, is definitely discouraging inward investment," says Andrew Scott, economics professor at London Business School. "Only knowing that things are going to get worse, but not being able to pin down clearly what the changes are, is just horrendous in terms of making investment decisions."

But Andrew Cahn, chief executive of UK Trade and Investment, reported a record year for inward investment in his most recent (2006/07) annual report. A total of 1,431 companies decided to locate in the UK, creating 36,526 new jobs. One company that has decided this year to set up in Britain is China Mobile, the world's largest mobile phone operator. Henry Ge, the firm's chief representative in the UK, indicates that tax is not the only issue companies consider when deciding where to locate. "London is the best place for us to be, as it's at the heart of technology convergence in Europe, and it offers us the technical capability and expert talent we need in order to grow our business."

But there are an estimated 77,000 multinational companies in the world with 866,000 subsidiaries. They increasingly keep an eye on tax laws when selecting the most competitive countries to locate their businesses. Until recently, many were lauding the UK government for creating a competitive climate in Britain. But now the UK's corporation tax rate has climbed above the 26.8 per cent average for other Organisation for Economic Co-operation and Development countries—even after the recent cut to 28 per cent.

"Over the past decade, this government has worked to create a tax regime to encourage business, and has been rewarded by a flowering of entrepreneurialism," says Chris Sanger, head of tax policy at Ernst & Young. But since 2004, Britain has fallen from fourth to sixth in the firm's European Attractiveness Survey, which measures the most applealing locations for business. India and Russia have sped past the UK. "The UK economy needs an environment that is predictable, stable but flexible. This challenging contradiction seems to elude policymakers," Sanger warns.

In the past couple of years, there has been a raft of tax changes for both large corporates, and small and medium-sized enterprises (SMEs)—some implemented, some still in the pipeline—that have added to companies' burdens. The number of pages of tax law has jumped from around 5,800 to 9,800 since 2001 and this avalanche of changes has contributed to the climate of uncertainty. This has bred a lack of trust in the government's intentions, notes tax specialist Lynne Oats, associate professor of accounting at Warwick Business School.

"The government has said that it's dropping the headline rate of corporate tax to 28 per cent as though it's some wonderful thing," she says. "But there's more to tax than the headline rate—it's about what gets taxed and how you work out the taxable profit." For example, changes to the capital allowance regime on tax allowable depreciation could mean that some companies end up paying more tax.

Graeme Leach, chief economist at the Institute of Directors, is concerned about the complexity of the current corporate tax regime. He notes that the overall burden of all tax is increasing, despite the cut in the rate of corporation tax: "Over the past decade, we have had an increase in taxation as a proportion of GDP and, at the same time, an increase in the complexity of the tax system." The tax issue has now created a "tipping point", Leach says. "There is a hidden cost to all this—the loss of those inward locators that would have come to the UK, but now never will," he says.

Charles Alexander, chairman of the Confederation of British Industry's (CBI) tax task force and president of GE Capital Europe, says: "Key business decisions, such as where to locate a corporate HQ, are now strongly influenced by the competitiveness of the tax system. You don't need to be a tax expert to work out that every penny spent on tax leaves less available for investment in jobs, research and development. An uncompetitive tax system affects everyone."

As other countries develop their own business skills and infrastructure, tax could become more important as a competitive differentiator.
"While the focus is on the multinationals, the government must not overlook the need for a competitive tax regime for all businesses," says Andrew Green, a tax partner at RSM Bentley Jennison, the UK member of RSM International, a network of accounting and consulting firms. He points out that increases in corporation tax rates for small companies from 19 to 22 per cent is hurting small firms that have between them more than 10 million employees.

Around two-thirds of companies pay less than £10,000 in corporation tax, but many of these will find themselves paying more under the changes, says Green. "A cut in the rate of corporation tax would be good for all companies-large, medium and small," he says. "Government finances are tight and observers will say that we can't afford to cut the rate of corporation tax. I say we can't afford not to."

The changes are so complex that there are winners as well as losers. One SME that reckons it may benefit from the new small-companies tax regime is £3.5m-turnover Broadbean Technologies, which provides services that allow recruitment companies to track and manage their online advertising spend. Managing director Dan McGuire expects the company's corporation-tax bill to rise by around £9,000 in the next financial year. But this should be more than offset by generous allowances for research and development expenditure. Yet as the company grows, McGuire admits that it will be taking a close look at how it can become tax efficient. "We've just set up an office in Amsterdam and we're opening one in Los Angeles," he says. "We'll be looking at the most efficient ways to manage our revenues."

Business leaders appreciate the government has to raise revenue to pay for services. But some suggest that lower headline tax rates could increase revenue. The CBI's Alexander argues that the tax take would rise over time if the corporation tax rate were cut to 18 per cent because it would stimulate more economic activity. Although the Exchequer would lose as much as £4.2bn a year in the first seven years with the lower rate, government revenue could be boosted by as much as £15.6bn in the following four years as more business activity worked through the economy.

Back at Synchronica, Dent confirms that the company will keep its base in the UK, even though expansion will take place abroad. "We have employees who are key to the business in the UK and it would be difficult now to move them," he says. But the worry is what new start-ups will do. "If you roll back the years," he adds, "I suppose at that stage we could have gone anywhere."

The great British tax exodus

Going...
Smiths Group. The engineering giant was reported in June to be "considering" moving its UK headquarters overseas, because of the government's proposals on taxing foreign profits.

Going...
Kohlberg Kravis Roberts. Only one of the eight London partners at KKR, the private equity giant that owns Alliance Boots, is a UK taxpayer. Dominic Murphy, the partner who led the Boots buyout, is tax domiciled in Ireland. The remaining UK taxpayer is Labour peer Lord Hollick.

...Gone
Shire Pharmaceutical and United Business Media. Both the FTSE-100 pharmaceutical firm and the FTSE-250 media giant have switched their tax residency to Ireland. Irish corporation tax is 12.5 per cent, compared to 28 per cent in the UK.