Exchange Rate Risks, Ethics and Tax Avoidance

On Thursday David Cameron talked about an anti-business culture developing in the UK with wealth creation being referred to as 'anti social'. With all of the discussion of senior executive pay, big business is feeling 'un-loved'. The fact of the matter is that the UK economy is reliant on multinationals, they may represent only 2% of British companies but they are responsible for 38% of British industrial employment, 23% of service sector employment and four fifths of all spending on research and development.

The UK is home to half of all multinationals headquartered in Europe who presumably are there to minimise the company's tax burden.

For a business, what does achieving the most efficient tax result mean? There are ethical pressures to pay tax at the appropriate rate, in the appropriate country, at the appropriate time but what about those of your competitors who don't? The result will be that they will have higher cash reserves, lower cost financing and increased dividends. Back to the ultimate business objective, Shareholder Wealth Maximisation. In this context, moving or allocating profits to a low tax jurisdiction, your shareholders may say was an obligation.

Certain things would have to happen in order to create a level playing field with regard to tax avoidance,  international co-operation and transparency being just two of them. The Tax Justice Network (TJN) produce a Financial Secrecy Index which ranks companies according to their secrecy and the scale of their activities. The members have a shared concern that tax avoidance causes poverty.

The World Economic Forum in Davos in January this year shared that view too, Nick Mathiason from the Guardian came up with five steps to end global tax evasion. The discussion at the WEF was about using this funds, (avoided tax) by big businesses, which could be accessed if we all pulled together, and we could use it to beat austerity. What a good idea. I wonder why we aren't doing that now? Seems simple.

Could it be because recently we have seen that individuals too have ways of minimising tax payments.The current UK top rate of income tax is 50%. They pay themselves though private companies and save themselves thousands just like Moira Stewart from Radio 2, (well, I'm old) top NHS civil servants and the student loans chief Ed Lester. But, won't they be spending their (available) money in this country which generates more wealth? If the government (be it Cons/Labour/Lib) got it, what would they do with it? Instigate more public sector reforms which costs millions and ultimately fail or use it to pay benefits to those who don't deserve it?

The Guardian reported on 23rd February that a spokesman for the Her Majesty's Revenue and Customs (HMRC) task force, targeting those individuals who evade tax, say they have found evasion to be as high as 75% in the selected group. They're targeting people who own property abroad, fast food retailers and market stall holders, i.e. small businesses. Something tells me they're missing the point. Back to upsetting big business.

Another real issue for businesses who import or export goods is currency related risks. In an extreme example, the sanctions in Iran have caused the rial to fall drastically against foreign currency which has resulted in businesses not only being exposed but suffering transaction and economic risk. Iranian students studying in other countries are unable to receive currency from families, only the rial which is reducing in value every day. Sanctions have been placed on Iran because of their nuclear activity and in this case it's not just the businesses who are directly effected by the devaluation, it's all of the population.

During the last quarter of 2010, money spent by big business on investment was down but UK exports rose by 2.3%, that's good news but ultimately puts those exporters at risk, however these risks can and are managed. A forward contract may at least provide some guarantee of what future costs may be but benefits may not be derived if rates are favourable. Businesses could insist that all trade, whether that be import or export, be settled in their home currency, thereby avoiding the exchange rate risk. That risk is then passed on to the customer. Not necessarily risk free then - you'd have to be in a pretty good position to expect that of your customers, no competitors and so on.

Netting is another method where inter-organisational currency debts are settled for the net amount, taking into account the 'some you win, some you lose' attitude. Matching inflows and outflows and concentrating on the part of the trade which remains unmatched can work for some. Gambling (in an educated guessing kind of way) on what you expect the currency market to do is also an option adding in a borrowing factor just to make things really interesting.

There are many options to manage risks associated with currency exchange rates, the ultimate aim being that you (the management) aim for best value for the shareholder, but the tax question, that may not be so simple.


References: Hyrck and Andreoli (2005) Foreign Tax Strategies can be a boon to Multinationals. BBC news.  Guardian news. FT. Arnold.