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Corporation tax and tax avoidance essay

After the financial crises, the public has started to raise their attentions to the tax avoidance of some of the Global firms, such as Starbucks, Google and Amazon. These companies have a huge business turnover in UK, but they just pay a few or even no corporation tax to the government. Since that, the public has labeled this tax avoidance action as “immoral”.
Before discussing the “immoral” behavior, I would like to briefly explain the rules of HMRC on corporation tax. The government levies the corporation tax on the limited companies incorporated in the UK and the foreign-based companies with a permanent place of business in the UK and the amount of corporation tax is based on the amount of profit that the company has made. However some of the global companies just pay a small amount of corporation tax comparing with their profits, and it is due to the loophole of the rules. These companies transfer their profits to the tax heaven countries, therefore they can reduce the tax liabilities to the minimum. Google, a multinational corporation which provides Internet searching service, declared a profit of £3 billion for 2012, but the company paid UK corporation tax of £11.2 million, which is around 0.37% of its profit. This unbalance tax-profit ratio is because of the loophole of the rules. Although Google has set up offices in UK, and the advertisements of the business have made in the same country, the company does not close up the offers in UK, and the transactions are made in Ireland, which is a tax heaven. Since the profit of the business is not made in UK, it is not obligated to pay the corporation tax for their business profit. Due to the tax avoidance of Google, UK has lost a huge amount of taxation revenue. Someone has been suggested that the behavior of Google tax avoidance is “immoral”.
First, it is unfair to the hardworking, honest UK taxpayer and the public. Taxation revenue is one of the main revenue of the government. It is the source of fund of supporting the public benefits, such as child benefit, carers and disability benefits, etc. For the taxpayer in UK, they pay different taxes to the governments, based on the requirement of the UK tax law. Since they have fulfilled their responsibilities of paying the taxes, they should have the right of enjoying the benefits which provided by the government. However, Google paid just around £11 million for the corporation tax, in spite of making a profit of £5.5 billion in the UK business, and it is because of the tax avoidance scheme used by the company. One of the former employees from Google said that his former employer has “cheated” British taxpayers out of hundreds of millions of pounds. (The independent, Sunday 19th May 2013) Due to the behavior of “cheating”, the revenue of UK government has been reduced, and some of the public benefits have been taken away, such as children’s centers, legal aid, etc. It will be unfair to the public as they have fulfilled their responsibilities, but they cannot enjoy their benefits that provided by the government due to the tax avoidance of those companies.
Secondly, Google has an unfair competitive advantage to the UK companies. According to the rules of HMRC, limited companies incorporated in UK is required to pay corporation tax. In 2013, the small profits rate is 20%[1] and the main rate of corporation tax is 23%[2], which means that if the company is making a profit that exceed £1,500,000 after deduct the allowance, it will require to pay 23% of its profit as a corporation tax. However, Google just paid less than 1 % of its profit by using a tax avoidance scheme. It developed a system that able to transfer the profit of UK business through Ireland to the tax heaven. Since the tax rate in tax heaven is lower than UK, therefore Google is able to reduce its tax liabilities to a low level even it has a great turnover in the UK business. This behavior helps Google to gain a huge but unfair advantage over UK companies. Since Google develop the tax avoidance system, it able to lower the company’s tax liabilities, as well as remains more profits in the company. Also, it has a higher opportunity to optimize its business than other UK companies, as other UK companies may not have enough resources focusing on optimizing the business after paying the corporation tax. These unfair advantages makes Google more attractive to be invested than other companies and the investors may not be willing to invest in other UK companies.
Finally, someone suggested that the behavior of Google is immoral as it is bad for the economic growth. Google claimed that they did pay tax on profits generated from the services that they provided, but the profit on sales to UK business were transacted in Ireland. These actions have caused a great tax gap[3] in UK, and it has affected on the development of the economy. Since government will plan to develop and improve its economy, and the budget is supported by the tax revenue of the government. If there is a huge tax gap in the country, there may be insufficient finance to support the plan and therefore the budget may need to postpone or cancelled. Referring to the case of Google, Google has avoided part of the corporation tax by using transferring the profit to Ireland, it has caused a tax gap in UK. Due to the tax gap in UK, the development of the country has been delayed and leads to a decreasing competitive to other countries. Therefore someone said the behavior of Google is immoral as it is taking advantages by damaging the development of the country.
However, someone argued that it is the responsibility of Google to maximize the profit of the company. The main goal of every company is to act on the shareholders’ interest and help them to maximize their wealth. Therefore, Google will try their best to reduce the expenses of the company, as well as keeping the tax cost at a minimum level within the realms of what is legal. Since if Google is being “moral” and does not reduce the tax liabilities to the lowest level, the profit of the company will decrease, which means that the earning of each shareholder will decrease too, and they may not continue to invest in the company. Also, Google may not distribute a high level of dividends to the shareholders as the profit has decreased and Google may decide to reserve more profit in the company instead paying dividends to the shareholders. Investors then may not continue to invest in Google as the company will not maximize their wealth and they may think investing in other companies will be better than investing in Google. It may lead to lack of extra financial from new investors, and therefore the business cannot improve or expand, and its competitive will decrease in the long term, leading to a potential risk of bankrupt. Hence that it is the responsibility of Google to reduce the tax cost to the minimum level in order to reach the company’s goal—maximize the shareholders’ wealth.
Moreover, there are arguments that it is not the fault of Google avoid to pay part of the corporation tax, it is the fault of the lawmakers that making the companies too easy to avoid tax. UK tax system is huge and complicated, and most of the tax laws are introduced in an early time by the lawmakers. Since the commercial society when the laws are introduced is different from the present commercial society, therefore the laws may not suitable for the present commercial society or there are loopholes which the company can take advantage of. Hence Google able to avoid a huge amount of corporation tax legally through these loopholes. Since the loophole of the tax laws has caused a great tax gap in the country, the lawmakers has introduced different strategies to seal the loopholes and therefore company will not able avoid the tax easier and the tax gap can be reduced. Thus it is the responsibility of the lawmakers to seal the loophole of the laws so the corporate company like Google cannot avoid the tax easily.
Finally, even if Google has used some “evil” systems to reduce its tax liabilities, but the company has “compensated” the public with different moral activities. The public complained because of the immoral behavior of Google, it has affected the government to reduce the public benefits, and it did not fulfill its moral obligation to contribute to the public. However, Google has contributed to the society by using different methods. For example, Google has provided free training and tools for the charities in UK, and helped them to increase their fundraising and popularity through the Internet. Also Google has offered grants to the charity in the UK through the Google AdWords Grant Account, so those charities can raise more funds from Google and use the account to reach more donors, volunteers and consumers. Besides that, Google provides different products with a discount rate or for free to the non-profit making organizations, so the organizations can manage with cost effective and high flexibility. Therefore, Google has compensated the public with different methods even if it is immoral for Google to use the system to avoid the corporation tax.
Lastly, even if the loophole of the tax law has been sealed and the companies are paying the expected amount of corporation tax, it may solve the moral problem of those companies, but it may have negative impact on the economy of UK. Once the loopholes are sealed, the tax gap of UK will narrow down since the companies are difficult to avoid the tax. However, the foreign companies may think the tax laws will be too strict and it is difficult to making profits in UK, therefore these companies may set up businesses in the countries that have low tax rates instead of investing in UK. Decreasing investment from foreign investors may affect the economic growth of the country, since less business is set up in the country, the gross domestic product (GDP) may have a negative impact and it may decrease the competitive of the country comparing with the tax heaven.
To conclude, there is always a conflict between the main goal of a company and the morality and since morality is very subjective, there is no exact answer for the discussion. In the case of Google, they have developed a system to divert the business profit to the tax heaven, someone suggested that the behavior of Google is immoral because it is unfair to the UK taxpayers, as they have fulfilled their responsibility to pay the tax, but they can’t enjoy the public benefits provided by the government as the behavior of Google has reduced the revenue of the government. Secondly, Google has taken unfair advantages over the UK local companies, as Google is paying an extremely low corporation tax rate comparing the tax rate of the local UK companies due the tax avoidance system, it allows to remain more profit in the company, therefore it will have higher opportunity to optimize and improve the quality of business by using the profit effectively. Finally, the behavior of Google is bad for economic growth. A tax gap has caused in UK as the tax avoidance of Google, therefore the development plan of the country may need to be postponed or cancelled and it may caused a navigate effect on the economic growth in the long term.
On the other side, someone argued that it is the responsibility for Google to reduce the tax cost of the company, since the main goal of a company is to maximize the business profit and the shareholders’ wealth. Fail to fulfill the goal may affect the future development of the company and the benefits of the shareholders. Moreover, it is not the fault of Google to avoid the tax, but it is the fault of the lawmaker to let the company can avoid the tax easily through the loophole. Last but not least, even if the behavior of Google is immoral, the company has contributed to the society through different activities, for example: providing free tools and training to the charities, offering grants to the charities and providing products with a discount rate or for free to the non-profit making organizations.
Even if sealing the loopholes of the tax laws solves the moral problem, it may affect the economy of the country, as the strict tax law may discourage the investors to set up businesses in the country, leading to low competitive by comparing with other countries.
[1] Small profits rate applies when augmented profit is less than £300,000
[2]
Main rate applies when augmented profit exceeds £1,500,000
[3] The different between the actual amount of corporation tax that have received and the amount that should be received without tax avoidance

Capital budgeting techniques: Sensitivity and Scenario analysis

Graphically show and explain the following terms, how you could link them to capital budgeting techniques in your decision making (1000 words)
Sensitivity analysis
Scenario analysis
Sensitivity Analysis Sensitivity analysis is a ‘what if’ tool that examines the effect of increase or decrease in a company’s net profit. Sensitivity analysis can help in answering question like ‘What would be the forecasted net income if sales are increased or decreased by 30%, 20% or 10%.
Sensitivity analysis is frequently used in capital budgeting for determining how sensitive an NPV analysis is to changes in variable assumptions. While conducting analysis, each variable is fixed except one and by changing this one variable, the effect on NPV or IRR can be viewed.
The first step in performing a sensitivity analysis is building a base case scenario. This is typically the NPV using assumptions which are believed to be accurate. From this point various assumptions can be changed which had initially been based on potential assumptions. NPV is then recalculated and the sensitivity of NPV based on the change in assumptions is determined.
Scenario Analysis Scenario analysis is a process of analysing decisions by considering alternative possible outcomes. Scenario analysis is designed to see the consequences of an action under different set of factors.
Scenario analysis takes sensitivity analysis a step further. Rather than just looking at the sensitivity of the NPV analysis to changes in the variable assumptions, scenario analysis also looks at the probability distribution of the variables.
Like sensitivity analysis, scenario analysis starts with the construction of a base case scenario. From there other scenarios are considered known as the ‘best case’ and ‘worst case’ scenario. Probabilities are assigned to the scenarios and computed to arrive at an expected value.
Capital Budgeting and Use of Sensitivity and Scenario Analysis Capital budgeting is the process of analysing a company’s investment decisions such as investing in new equipment, machineries, plants, projects and products. This process involves the estimation of the expected cash flows, the calculation of the Net Present Value (NPV) and the calculation of the Internal Rate of Return (IRR) of the investment. NPV is defined as the present value of all cash inflows minus the present value of all cash outflows. If NPV is positive, the investment is making money and is thus viable. IRR is defined as the discount rate that makes the NPV zero. If IRR is greater than the opportunity cost of capital then the investment is feasible.
There are two obstacles involved in the capital budgeting process. One involves the correct estimation of expected cash flow. The other is the use of correct discount rate also known as the project cost of capital.
Capital budgeting is by definition, forward looking. When dealing with expected resources and demands, uncertainty is a major factor. Sensitivity analysis is a statistical tool that determines how consequential deviations from the expected value occur.
Capital Budgeting example XYZ Water Filtration Plant needs to construct a new water filtration plant to filter 20 million litre water and deliver to consumers. An assessment should be carried out to evaluate the economics of the project and determine which parameter is sensitive to investment value, also to establish a sales price. Market price of water is $4 – $5 per litre therefore, four different water price scenarios would need to be analysed to reach the best economic parameter, they are: $4, $4.25, $4.5 and $4.75.
The selection criteria would be based on:
NPV
Cost of Capital – 15%
IRR
Analysis and Comparison of Alternatives
Preliminary data and estimation
Table 1: Project Information
Water filtration plant cost
$32,750,000
AUD
Water price (assumption)
$4.5
AUD/Litre
Water production
20
Million Litre
Revenue
$90,000
per day
$32,850,000
per year
Operating cost
$1
per litre
$7,300,000
per year
Plant lifetime
15
year
Cost of capital
15%
Table 2: Baseline Cash flow calculation
Baseline cash flow and NPV are calculated as follows:
Year
Revenue
Capital Investment
Operational Cost
Depreciation
Equity to be split
Government take
Cash Flow
NPV
0
(32,750,000)
(32,750,000)
6,334,796
1-15
34,675,000
(7,300,000)
(2,183,333)
29,558,333
(20,690,833)
6,684,167
Table 3: Sensitivity Analysis Calculation
In sensitivity analysis, each variable is changed one at a time to analyse its impact on the end result. In this case the impact of 10% increase or decrease in revenue, capital investment and operational cost is considered on the NPV.
Increase/ Decrease
Year
Revenue
Capital Investment
Operational Cost
Cash Flow
NPV @15%
Revenue
10%
0

(32,750,000)

(32,750,000)
8,895,944
1-15
36,135,000

(7,300,000)
7,122,167
-10%
0

(32,750,000)

(32,750,000)
(2,629,222)
1-15
29,565,000

(7,300,000)
5,151,167
CAPEX
10%
0

(36,025,000)

(36,025,000)
(1,035,312)
1-15
32,850,000
(7,300,000)
5,983,833
-10%
0

(29,475,000)

(29,475,000)
7,302,034
1-15
32,850,000

(7,300,000)
6,289,500
OPEX
10%
0

(32,750,000)

(32,750,000)
1,852,787
1-15
32,850,000

(8,030,000)
5,917,667
-10%
0

(32,750,000)

(32,750,000)
4,413,935
1-15
32,850,000

(6,570,000)
6,355,667
From table 3, a sensitivity graph can be plotted as follows:

Based on above sensitivity analysis, it is evident that the revenue by terms of price is the main variable that is affecting NPV. Hence the economic optimization and evaluation will be based on parameter water price. Using formula in the spreadsheet, following can be obtained:
Table 4: Water Sales Price Scenario
Water Price
NPV
IRR
Payout Time
$4.00
(3,269,509)
12.90%
6.5
$4.25
(68,074)
14.96%
5.9
$4.50
3,133,361
16.95%
5.3
$4.75
6,334,796
18.89%
4.9
Selection of preferred alternative
From table 4, we can conclude that best scenario is at water price $4.74 per litre, refer to criteria NPV, IRR and Payout Time. Then the project is worth doing, with the water price $4.75 per litre resulting NPV>0, IRR>MARR and payout time less than five years.
Benefits of using Sensitivity Analysis
Sensitivity and scenario analysis in useful in capital budgeting techniques for a number of reasons, including:
It supports decision making or the development of recommendations for decision makers such as testing the robustness of a result.
Financial model makers can effectively communicate with the decision makers for example, by making recommendations more credible, understandable and compelling.
Increases understanding of relationships between input and output variables.
It helps the investor to maintain their risk comfort level. Once projections are made concerning a specific investment, it can be decided whether risk should be taken for the worst case scenario.
SOURCE
http://businessplanhut.com/what-sensitivity-analysis-example-and-components-involved

Source: Boundless. “Scenario Analysis.” Boundless Finance. Boundless, 03 Jul. 2014. Retrieved 27 Apr. 2015 from https://www.boundless.com/finance/textbooks/boundless-finance-textbook/the-role-of-risk-in-capital-budgeting-12/scenario-and-simulation-assessments-99/scenario-analysis-427-7232/

http://www.assakkaf.com/courses/ence 627/lectures/chapter5.pdf

http://www.spreadsheetml.com/finance/capitalbudgeting.shtml

http://www.slideshare.net/ranasingh0820/sensitivity-amp-scenario-analysis

https://kristal2011aace.wordpress.com/2011/09/22/w2_adi_the-gas-plant/#comments

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