What is Islamic Finance?

David Cameron, the FT informs us, aims to boost Islamic Finance (http://on.ft.com/19a8z0t). The first question many will ask is what is Islamic Finance and in what way does it differ from what we habitually refer to as ‘Finance’? Searching the net for some authoritative information revealed a piece written by Abid Shakeel, of the Muslim Council Of Britain in 2009 (http://bit.ly/HpD7RN). It is a concise statement and easy to read. The impression one is left with from this document is that economic differences between ‘Finance’ and ‘Islamic Finance’ are not as dramatic as one might have thought.

The main principles are listed thus:

1. The prohibition or taking or receiving interest at exorbitant rates (Riba), but this does not preclude a rate of return on investment which is agreed up front by both parties contracting. In most cases, the references to interest rates by Islamic financial institutions are to help benchmark the return on investment to offer transparency. This does not imply interest is being used in the transaction.

2. Risk in any transaction must be shared between at least two parties so that the provider of capital and the entrepreneur share the business risk in return for a share in profit.

3. The prohibition of speculative behaviour (Gharar), meaning that gambling (Maysir) and extreme uncertainty or risk is prohibited and thus contractual obligations and disclosure of information are a sacred duty.

4. Investments that violate the rules of Shariah, advised against by Shariah boards, and are generally non-ethical meaning that investment in businesses related to alcohol, pork related products, conventional financial services, entertainment (gambling and casinos, pornography, weapons and defense. An example of index restriction can be seen on Page 5 of the Dow Jones Islamic Market Index Rulebook.

Taking each point in turn the following points are worth noting:

1. No one likes exorbitant interest rates as the public outcry against payday lenders demonstrates. However how is exorbitant defined? There is no economic difference between a rate of interest and a rate of return between two contracting parties if it is agreed up front.

2. Sharing risk and reward is equity.

3. Speculative behaviour, gambling and extreme uncertainty are prohibited but not precisely defined. Are institutions that make markets in specific assets speculators? It would seem that Islamic Finance favours broking over market making and so may not be consistent with fully functioning liquid markets. Western regulators are also moving in this direction. It does raise the question of whether hedge funds are shariah compliant (no would be my guess). Contractual obligations and transparency are a sacred duty as opposed to merely a legal one. Now that is different.

4. Non-ethical investment is prohibited. There are western ethical funds as well though the ethics differ.

Shariah compliant bank savings accounts allocate the banks profits to account holders on some pre-advised basis. Sounds very much like a ‘with-profits’ structure once common in the insurance sector. The banks make money from such activities as Murabaha. The bank purchases a tangible asset and resells to a customer on a cost + basis. The customer repays according to a pre-agreed schedule at the end of which the ownership is transferred to the customer. The + seems economically equivalent to a fixed rate of interest and the whole arrangement bears a strong resemblance to a repurchase agreement.

Another source of bank income might be Ijara. This is quite simply a leasing contract where the customer leases the asset from the bank at an agreed rate and takes ownership on a final payment. Musharaka amounts to equity sharing and Mudaraba corresponds to a partnership. Neither are concepts Finance would have any problem with. Istinaa offers a solution to the prohibition on short selling for producers trying to hedge output (e.g. crude oil). The bank commissions the output at a pre-agreed price and takes the risk of selling it on to the customer (It is unclear whether the bank can pre-agree the price with the customer from the document).

Insurance is based on the principle of Takaful or mutuality. Many contribute to a pot which is available to those that meet pre-agreed terms of need. Not a difficult or alien concept at all and was the basis of mutual societies in the west. The Sukuk or Islamic note is a little more complicated and the following reference may clarify ( http://bit.ly/S7DFx). In essence the note or bond must be structured to correspond to the above principles.

What then is the material difference between Islamic Finance and Finance? Abid Shakeel offers this clarification:

 The difference is in the approach and not necessarily on the financial impact. Some consider this as just a play on words but to Muslims there is an inherent difference in the way the transaction is carried out, and all based upon the previously mentioned prohibition of Riba. The intention is to avoid injustice and unfair enrichment at the expense of another party.

Sharia compliance of investments is judged by a committee of muslim scholars.

Several things emerge from Abid Shakeel’s concise explanation. The economic differences are small and involve concepts well understood and widely used in Finance. The contractual relations have the authority not just of law but also of a higher authority. In Islam the law and higher authority are one and the same. In the west this is not so and the material difference may lie in the ethics and sanctity of the religion of Islam.  It is also evident from wider reading that not all muslim scholars agree on what is and what is not shariah compliant. However, this corresponds to different legal jurisdictions in western societies. The important issue is the religious and ethical significance accorded to financial transactions in Islam.

Energy policy, Nuclear Power and the Parallel Universe

History of the use of nuclear power (top) and the number of active nuclear power plants (bottom). (Photo credit: Wikipedia)

One of the weaknesses of democratic process is that voters are often making judgements about issues on which they have incomplete information and even less competence (about the issues). This is inevitable but it begs the question how do they make judgements? Many seem to follow the lead of those they regard as ‘authoritative’. It is a ‘they probably know best’ approach. However, as I have illustrated in an earlier blog (Measles, global warming and the construction of knowledge), people are far more sophisticated. They recognise the uncertainty that is created by their incomplete knowledge and lack of expertise and act according to the consequences of error. They tend to try to avoid the error that they perceive to be least desirable for them. Hence, in the debate on global warming many side with the scientists because if they are correct humanity will cause its own destruction. Best avoid if we can, they conclude. In the case of the MMR vaccine many sided with (and still side with) a minority view that the vaccine might cause autism. Better to risk measles, mumps and rubella for their child than any chance of autism, they conclude. In both cases they have incomplete information and lack the expertise to make an informed judgement. They pick an ‘authoritative’ voice and heed it according to what they fear most. Probability and cost do not enter the debate.

The global warming debate links directly into energy policy and the Hinkley Point decision. Nick Butler of the FT provides an excellent summary of the issues (http://on.ft.com/Hf0cG4) and is consistently one of the sensible voices in the energy debate. The point I wish to highlight here relates to the perception of nuclear power. For most of my life Nuclear Power was a problem. Safety was a concern and the issue of what to do with the waste was always cropping up. One day I went to sleep and woke up in a parallel universe and it had become part of the solution. Fossil fuels were the new evil because of the fear of global warming and the overwhelming conclusion that burning fossil fuels was a major contributor. Nuclear Power became part of the solution while I slept. Nice clean nuclear power. Huh?

I am assured that Nuclear Power is now safe (by, amongst others, my eldest son, the english major). I will accept ‘safer’. When I press on the matter of the waste however there is silence. So where will it go and how will it be made safe? A deafening silence. One of the justifications for the Hinkley Point development is that it will help the UK achieve its target carbon emissions. Nick Butler lists other ways to achieve this and at lower cost. More important he lists alternatives to Nuclear Power. I too am applying the principle of judgement under uncertainty. I cannot judge the safety of Hinkley Point but I can envisage the consequences of an accident. Moreover, I have no clue as to what the long-term consequences of an accumulation of waste might be.

This is not to say that I approve of fossil fuel. There are reasons to want to reduce reliance on such fuels other than global warming. Solar power seems a good way to go as well as more energy efficiency. The latter is happening steadily though given the ancient housing stock in the UK it can only progress so fast. Solar power, however, may not be being exploited as quickly as is technically possible. I do not see solar panels on many UK roofs. Indeed this is a point of irritation with me. I live in a Grade 2 listed building set in a conservation area. I have a long south-facing roof which would be ideal for solar panels. However, I am not allowed. I favour conservation but there is a trade-off for everything. Moreover, conservation for me does not mean fossilisation but retaining the essence of what is good from the past. Ironically I believe the architect that built my home would have approved of solar panels. Instead I have to accept Hinkley Point.

Syria, Erdogan, Cameron, the nature of democracy and the UN security council

UN Security Council (Photo credit: riacale)

Some weeks ago I wrote a blog about Erdogan and the nature of democracy. The thrust of the argument was that there is more to democratic process than coming to power via a ballot box. Democracy is not dictatorship of the majority. The elected government has a duty to all citizens and not just those that elected it to power. It has a duty to listen to all citizens even whilst in power. Erdogan’s failure to heed this simple tenet caused quite a stir in Turkey. Perhaps he might cast an eye over to the UK to see how the democratic process should work.

From the moment that William Hague declared the Assad regime was guilty of the gas attack on its people the UK population was united in scepticism. Why would Assad cross the thin red line drawn by the West? Surely only the rebels gained by such an action? Where was the hard (or any) evidence? After Iraq and WMD no one was going to accept the word of a UK government in cahoots with an US administration about such a matter. Let the UN have a closer look first was the universal view. The universality of this response is not entirely an exaggeration. Following the matter closely via twitter and online comments to newspaper articles, I came across this view again and again.

There were deeper concerns. No one doubts the gas attack took place. No one doubts that the Assad regime is autocratic and has oppressed its people. No one doubts that some of those rebelling just want more say in the running of their country and less oppression. However, many in the UK suspect that some of those rebelling have a different agenda and one that is not wholly sympathetic to the West. There is barely concealed concern that the UK would be aiding the enemy by acting against Assad. After a long drawn out ‘war on terror’ and the consequent loss of civil liberties in the UK, not to mention many lives, the population have become well-informed of the nature of this war and the protagonists. An instinct to withdraw to defendable borders is apparent.

The most alarming aspect of the Syria situation from the point of view of the UK people is that it is rapidly looking like a proxy war between major powers on behalf of smaller countries, reversing the normal pattern. This is dangerous. The West seems to be acting on behalf of the Sunni Saudi Arabians and Gulf state monarchies, whilst Russia is acting for the Shia Iranians. The West have a nice business going on exchanging oil for arms and other sophisticated goods with the oil-rich Sunnis (money just intermediates). The Russian motive is less obvious, but the Russian commitment is no less clear. The potential proxy war by great powers is very alarming.

The UK population made clear in every way possible its opposition to military action in Syria, in the absence of hard evidence that Assad perpetrated a gas attack. Many are opposed even if such evidence is found. The British capacity for overseas military adventure, finally, has been exhausted. The message was received loud and clear by parliament and communicated by the democratic process to the government. The government was not given parliamentary approval, in principle, to undertake military action. The prime minister David Cameron, could have proceeded using the Royal Prerogative. Remarkably he chose not to do so and gave an undertaking not to do so. This is democracy in action.

David Cameron has been dammed for being weak. How so? Heeding the overwhelming view of the British people in such a matter is not weak but democratic. If the enemy was at the gate and he failed to attack he would be weak. The enemy is nowhere near any British gate. In my view, Cameron was wrong to propose military action in the absence of evidence but quite right to bow to the will of parliament. It showed strength not weakness. It showed respect for democratic process and in the process strengthened British democracy. He should be congratulated not condemned.

The failure to use the Royal Prerogative is a fundamental change in British politics and has wide-ranging implications. The UK sits as a permanent member of the UN security council (along with France, China, USA and Russia). This is now an anachronism and Cameron’s action or lack of it may ring forth some changes in this area. It is not widely grasped that it is in order to defend this status as a permanent security council member that the UK gets involved in many military adventures. Given the changing balance of power in the world and the diminishing military might of the UK, perhaps this status should be reviewed. Cameron may have set off the motion to review without intention.

The British parliament may yet authorise military action in Syria if evidence of use of chemical weapons is found by the UN. However, such action will be within the guidelines laid down by the UN and in keeping with the UK status as a permanent member of the security council. This is as it should be. If the UK population are still against action despite overwhelming evidence then they should realise they are asking for the UK UN status to be reviewed.

The UK and the EU: it is an in or out choice!

Enlargement of the European Union (animation) European Community European Union (Photo credit: Wikipedia)

David Cameron is proceeding with the illusion that the UK can remain within the EU but repatriate some power. Most would be happy with this so politically it is an astute approach. However, in practice the UK faces a straight in or out choice. Moreover, ‘in’ now means joining the eurozone as well. The logic of the single market, and the needs of the eurozone and banking union, all point to exit or ultimately full integration.

The Single Market

The EU is now the compelling issue of UK politics in much the same way that it was in the run-up to the 1975 EEC referendum on whether the UK should remain in the EEC. The UK had joined the EEC in 1973 under the government of the europhile Edward Heath but Labour, under Harold Wilson, had campaigned in the 1974 General Elections (there were two) on a platform of renegotiating the terms of accession. The referendum was to put the issue decisively to the British people. The renegotiation was the political subtext and by implication the europhile Heath had given away too much. My undying memory of the campaign was of Tony Benn and Enoch Powell both supporting the NO platform. The British people voted YES by 67% on a 65% turnout.

The EEC has come a long way since the 70s and is now the EU wrapped around a eurozone. The subtext is the same however; repatriation of powers from Brussels. Of course, the powers do not sit in ‘Brussels’ as such. Brussels normally refers to the EU commission which is the ‘civil service’ of the EU. Power is exercised via the various councils and groups which consist of representatives of each member state. These representatives are elected in their own nation states. The needs of the eurozone are increasingly coming to dominate these policy-making groups.

The voting structure is based on national populations. However, political influence extends well beyond formal voting rights.The most powerful member is Germany. This is also an important change as until 2010 one might have normally referred to France and Germany. The voice of France has become muted.

The issue in the UK is much like it was in 1974. There are those that want an unconditional exit (Farage). There are those that want full integration (Mandelson) and those that want to stay in but repatriate some powers (Cameron). According to Mats Persson of Open Europe ( http://bit.ly/12Nsn3O), the majority is in the Cameron camp. It would seem that David Cameron is more astute than he is credited.

The detail that I am waiting to hear is which powers will be repatriated? At a guess I would say that the power to limit free movement of labour is high up the list. The success of UKip is not simply because of the EU. The subtext is immigration and the difficulty of limiting migration whilst in the EU. A single market in labour, goods and capital is of course the whole point! If the UK is granted power to limit the free movement of labour then the single market concept is delivered a damaging blow. Moreover, this may well be a two-way street. If EU citizens are restricted in coming to the UK why should British citizens not be also so restricted in movement within the EU? Bad news for all those sunning themselves in Spain, Portugal, Italy and Cyprus methinks. I wonder if they will come back and vote?

The other issue high up the agenda, I would guess, is human rights legislation. Membership of the EU does seem to come with a modern, liberal agenda and strict adherence to the European Convention on Human Rights. This issue is inextricably associated with the free movement of labour within the EU. It would be hard to have different fundamental legal rights in principle across a single market for labour. The human rights legislation has upset Britain because it has restricted the state’s ability to remove people deemed undesirable. Something about babies and bath water comes to mind here.

The EU modern liberal establishment does occasionally act in a doctrinaire and impractical  manner. The insurance industry has recently been hit with equal gender directives. Insurance underwriting in my experience has no gender bias. It is all about risks. Women live longer and have a different pattern of car accident claims. It is logical to price these differential actuarial risks into the premium. To declare such differential pricing as discriminatory is patently absurd. This is less about repatriating powers than insisting that economic logic is not wholly ignored when discrimination directives are constructed. This might be better achieved by being fully immersed in the EU as it is hard to see how the UK could operate a different gender policy in relation to insurance within a single market.

It is clear form these three examples that the popular notion of staying within the EU and repatriating powers is so inconsistent with the principle of a single market as to make little sense. What powers can be repatriated that will satisfy the British people and yet not wholly undermine the single market? The eurozone is now complicating matters even further.

The Eurozone

The origins of the eurozone crisis lie within the Maastricht Treaty. It connected a subset of EU states through a common monetary policy (EMU) and made no treaty provision for fiscal coordination. This lack was papered over by the Stability and Growth pact (http://bit.ly/199QLRy), which took its legal authority from the Treaty on the Functioning of the European Union (TFEU).

The markets were at first sceptical of the EMU project but later warmed to it and priced eurozone sovereign debt as if it was guaranteed by some overarching EU body. It took the debt crisis in Greece to explain to the markets that it was not so guaranteed. Worse still, it became apparent that the Maastricht Treaty precluded the possibility of a collective EU institution providing assistance to debt-ridden sovereign states within the eurozone. The crisis management mechanisms have so far been constructed as bilateral commitments from member states. No single eurozone member is liable for all other eurozone member state liabilities.  Individual commitments to crisis management mechanisms such as the EFSF and ESM are limited by design.

The only institution that is genuinely a collective eurozone entity is the ECB. This is why ECB action under the crisis has been so closely scrutinised by the German Constitutional Court. The Court has been at pains to make sure that the ECB did not act in a way that implied a collective bail-out of the debt-ridden states. The ECB has been quite creative in this respect and has provided considerable collective assistance under the guise of monetary policy and of repairing the monetary transmission mechanism. The Outright Monetary Transactions (OMT) programme has been a particularly effective innovation.

The objective of Berlin has been to avoid the crisis becoming an excuse to move from bilateral action to official collective action by EU institutions. Collective actions would make, implicitly or otherwise, each member state jointly and severally liable for other member states. If a collective framework emerged then eurozone sovereign debt would become mutual and the liability of all eurozone states. This is what the markets originally thought was happening which is why they allowed countries such as Greece to borrow excessive amounts at very low-interest rates. Such mutualisation carries with it the risk of moral hazard and the behaviour of many member states in the early years of EMU suggests that moral hazard is a very real issue for the eurozone.

Germany, as the wealthiest member state, took control of the crisis (excluding France) and made avoiding moral hazard its main target. Hence all responses have been structured as bilateral arrangements. This is not to say that Berlin will not ever countenance a collective structure. However, it will not do so until it believes it has put into place safeguards against moral hazard.

The main innovation from Berlin is the  Treaty on Stability, Coordination and Governance in the Economic and Monetary Union or the Fiscal compact for short. This is an international intergovernmental Treaty and outside of the EU legal framework. It nevertheless binds those ratifying to a Berlin-approved fiscal framework and ratification is a pre-condition for access to some bilateral eurozone arrangements (like the ESM). The intention is to incorporate this treaty into the EU legal framework but of course that will require the unanimous agreement of all EU states.

The existence of the fiscal pact reveals a fundamental problem in the EU. There is a subset of member states, the eurozone, with different needs. The EU legal framework is set up for all member states, including non-eurozone. To resolve this requires some significant treaty change and treaty change must be unanimous. This is a politically complex situation and lies behind the clumsy and cumbersome manner in which the crisis has been handled.

Banking Union

The same problem is now evident in the debate on banking union. The union requires a single supervisory mechanism (SSM) for banks. All banks in the union should be bound by the same rules and be supervised by the same entity. Troubled banks must be resolved in exactly the same manner by this authority so there is a need for a single resolution mechanism (SRM). Finally, there needs to be a central fund to finance these actions, namely a single resolution fund (SRF). All three must operate above sovereign states and the single supervisory authority must be able to intervene in member states independently of the views of the government of that state.

Such an arrangement effectively mutualises banking risk across member states. It raises a lot of questions. Will individual member states be willing to give up supervisory control of their own banking systems? Indeed in this framework there are no national banking systems, only EU-wide. The second question is the source of the SRF. The plan is for a levy on banks in the same manner as say the FSCS. Such a levy is sufficient for individual bank problems but what happens if a systemic crisis arises? Will an EU-wide body act to avoid systemic failure in the way the UK government used tax payers money to save the UK system? If so is this not a form of sovereign debt mutualisation? Finally, there is the nature of bank resolution. The Cyprus crisis revealed that the prospective banking union will place senior bond holders and uninsured depositors explicitly at risk in the SRM. They have always been implicitly at risk (that is why the deposits are called uninsured) but it has been rare to bail-in uninsured depositors in the manner we have seen in Cyprus. It will no longer be rare. This may have important implications for financial centres such as the City of London.

The important point however is that this total framework cannot reasonably be expected to operate on an intergovernmental basis. The SSM has been advanced within the Treaty of Lisbon. However, the SRM and SRF may prove more problematic.These steps may require changes to the Treaty of Lisbon. Good luck with that. The likely result will be that banking union may be less smooth in its manifestation than many seem to assume. It essentially mirrors the fiscal union issue and it is unlikely that one can be resolved without the other.

The EU project has reached its day of reckoning. An EU consisting of eurozone and non-eurozone is no longer possible. The direction is now for EU institutions to evolve to serve the eurozone and for non-eurozone states to be marginalised. The eurozone structure will also become ever more integrated and reflect a fiscal framework that is a direct copy of that of Germany. Mutualisation may eventually occur but not before all members have legally enforceable budget constraints built into their constitutions. Talk of repatriation of powers by the UK is so much subterfuge. The UK faces a straight in or out choice. Moreover, ‘in’ now means joining the euro. However popular the Cameron position might be it is a cake-and-eat-it position and thus in practice untenable and somewhat dishonest. On the other hand politics is all about illusion, or should I say delusion.

The EU and the UK: the absurdity of repatriation of powers

The EU is now the compelling issue of UK politics in much the same way that it was in the run-up to the 1975 EEC referendum on whether the UK should remain in the EEC. The UK had joined the EEC in 1973 under the government of the europhile Edward Heath but Labour, under Harold Wilson, had campaigned in the 1974 General Elections (there were two) on a platform of renegotiating the terms of accession. The referendum was to put the issue decisively to the British people. The renegotiation was the political subtext and by implication the europhile Heath had given away too much. My undying memory of the campaign was of Tony Benn and Enoch Powell both supporting the NO platform. The British people voted YES by 67% on a 65% turnout.

The EEC has come a long way since the 70s and is now the EU wrapped around a eurozone. The subtext is the same however; repatriation of powers from Brussels. Of course, the powers do not sit in ‘Brussels’ as such. Brussels normally refers to the EU commission which is the ‘civil service’ of the EU (though it can introduce legislation). Power is exercised via the various councils and groups, which consist of representatives of each member state, and by the European Parliament. These representatives and members of parliament are elected in their own nation states.

The voting structure within the EU is based on national populations. However, political influence extends well beyond formal voting rights.The most powerful member is Germany. This is also an important change as until 2010 one might have normally referred to France and Germany. The voice of France has become muted since 2010.

The issue in the UK is much like it was in 1974. There are those that want an unconditional exit (Farage). There are those that want full integration (Mandelson) and those that want to stay in, but repatriate some powers (Cameron). According to Mats Persson of Open Europe ( http://bit.ly/12Nsn3O), the majority is in the Cameron camp. It would seem that David Cameron is more astute than he is credited.

The detail that I am waiting to hear is which powers will be repatriated? At a guess I would say that the power to limit free movement of labour is high up the list. The success of UKip is not simply because of the EU. The subtext is immigration and the difficulty of limiting migration whilst in the EU. A single market in labour, goods and capital is of course the point of the EU! If the UK is granted power to limit the free movement of labour then the single market concept is delivered a damaging blow. Moreover, this may well be a two-way street. If EU citizens are restricted in coming to the UK why should British citizens not be also so restricted in movement within the EU? Bad news for all those sunning themselves in Spain, Portugal, Italy and Cyprus methinks. I wonder if they will come back and vote?

The other issue high up the agenda, I would guess, is human rights legislation. Membership of the EU does seem to come with a secular, liberal agenda and strict adherence to the European Convention on Human Rights. This issue is inextricably associated with the free movement of labour within the EU. It would be hard to have different fundamental legal rights in principle across a single market. The human rights legislation has upset Britain because it has restricted the state’s ability to remove people deemed undesirable. Something about babies and bath water comes to mind here.

The EU liberal establishment does occasionally act in a doctrinaire and impractical  manner. The insurance industry has recently been hit with equal gender directives. Insurance underwriting in my experience has no gender bias. It is all about risks. Women live longer and have a different pattern of car accident claims. It is logical to price these differential actuarial risks into the premium. To declare such differential pricing as discriminatory is patently absurd. This is less about repatriating powers than insisting that economic logic is not wholly ignored when discrimination directives are constructed. This might be better achieved by being fully immersed in the EU as it is hard to see how the UK could operate a different gender policy in relation to insurance within a single market.

It is clear form these three examples that the popular notion of staying within the EU and repatriating powers is so inconsistent with the principle of a single market as to make little sense. What powers can be repatriated that will satisfy the British people and yet not wholly undermine the single market?

The conclusion I have come to is that the UK now faces the binary Farage/ Mandelson option; full exit or full entry. However popular the Cameron position might be it is a cake-and-eat-it position and thus in practice untenable and somewhat dishonest. This is all the more so when one considers the needs of the eurozone, banking union and non-eurozone member states (a future blog). On the other hand politics is all about illusion, or should I say delusion.

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Aggressive tax avoidance: politician heal thyself

Irishcorporatetaxrate (Photo credit: Wikipedia)

There is a huge debate taking place at the moment about the tax practices of large corporations. The UK is a notable example and Margaret Hodge seems to be at the forefront of the crusade [it is worth googling Margaret Hodge and reading what comes up]. UK politicians are never slow to find a cause, especially if it dims the memory of what might be termed aggressive expense applications and presents them as angels in the pursuit of the common good. The debate may confuse many that have traditionally seen avoidance as within the law and hence acceptable and evasion as beyond the law. As always it is never that simple.

The demonized corporations are all acting within the law. However, the law in many jurisdictions allows the tax authorities to prohibit tax aggressive avoidance. It is this category of corporate tax behaviour that is under scrutiny. The precise definition of tax aggressive avoidance varies from jurisdiction to jurisdiction but in essence it relates to tax behaviour that, whilst technically legal, is against the spirit of the tax code and is clearly contrived to be solely for the purpose of tax avoidance and has no basis in reasonable or normal business practice. It is up to the tax authorities to determine when this is the case and any criticism of corporations by politicians is also a criticism of their own tax authorities.

One must sympathise with the tax authorities because they must interpret ,and challenge in court ,specific cases and can only do so within the legal framework set by lawmakers; the self-same politicians that are kicking up the fuss. It is a bit of a mess and not simply a matter of evil corporations not paying their dues.

The problem stems from the global nature of corporations and differential tax rates and practices across sovereign states, and even within the EU. Tax harmonisation within the so-called single market is some way off. The differential tax rates are deliberate actions by specific jurisdictions in order to attract certain types of inward investment. It is a decision made by politicians! Ireland has had a relatively low corporate tax structure for some time and some may recall Berlin used their need for a bail-out to put pressure on them to make it less generous.

These politically determined differential tax structures allow global corporations to arbitrage tax jurisdictions through transfer pricing and the judicious location of head offices. The transfer pricing is quite straightforward. Subsidiary A ‘charges’ subsidiary B for services through internal accounts and thus the revenue is booked in A. The location of head office, where accounts can be consolidated, is rarely simply a tax matter but it is also a consideration.

In the UK the political focus has been on household names that are largely US originated corporations. However, the same practices are found in UK originated corporations and these may well be depriving other jurisdictions of tax revenue. The UK is not being discriminated against or abused. It is experiencing what all nation states struggle with in a global corporate world.

The solution to the problem is fairly simple. First, harmonise corporate tax rates across sovereign states. Second, clarify the tax aggressive avoidance legislation and strengthen the hand of the tax authorities in implementation. If this does not happen it is a political failure and not because corporations are immoral or tax authorities too lenient. Politician heal thyself.

Postscript 31/01/2016

This subject continues to rumble on. Politician hypocrisy continues unabashed. This link from The Guardian speaks for itself. The same politicians that claim to champion the taxpayer quietly support the offshore tax haven and are not infrequently direct beneficiaries of same.

 

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