Blog: Strong arguments to retain corporation tax over a sales tax

Is it right that a company with high sales but no profits pays no corporation tax? This was a question raised repeatedly in relation to the taxation of foreign multinationals with sales here in the UK. The question, debated in places such as the Public Accounts Committee, has led to proposed reforms by the OECD, that have been accepted by the G20 and many others, in corporate tax regimes around the world in relation to how profits are calculated and allocated to activity.  But the issue is more fundamental than the international rules – it is more about the role and purpose of corporation tax.

The historic answer …

To answer the question requires the understanding (and acceptance) of the premise under which corporation tax was created. Prior to the creation of corporation tax in the UK in 1965, income tax was charged on the profit of companies and that income tax could be offset against the income tax payable by a shareholder who received dividends from the company. The development of corporation tax itself has broadly maintained this principle, i.e. that the company pays tax on the profits that would have been made by the entrepreneur directly. In practice, the rules are more complicated and the amount of tax paid by the time the profits end up in the hands of the shareholder is different, but nevertheless the premise remains.

So the short answer to the questions is 'yes' – corporation tax is intended to be a tax on profits and therefore should not be paid where those profits do not exist.

Should corporation tax be replaced by with a turnover tax?

This question could be reinterpreted as 'should we change the basis upon which companies pay tax to turnover instead of profits?'  Isn’t a turnover tax on companies the same as with VAT or income tax on an employee’s salaries, for which very limited expenses are tax deductible?

Of course, companies do collect and pay over VAT. But, from a conceptual basis, while applying on a transaction by transaction basis rather than to the company itself, Value Added Tax does (at least in theory) what it says on the tin, namely taxes the 'value added' by a business – this being the difference between the value an item is sold for and what it cost to create. The concept of 'value added' is not that far away from 'profit' (although it does not allow for any relief for employment or funding costs). A business that had no employees, high sales but no profits due to making no margin, would have no 'added value', so any VAT that it would incur on its purchases would be offset by the VAT it collects on its sales, leaving no additional tax for the Exchequer.

Is a Turnover tax fairer?

What taxes are imposed is a matter for governments but will generally be linked to a taxpayer’s ability to pay. A simple turnover tax does not have such a link.  Consider a 20 per cent corporation tax on two businesses: one selling 100 million one penny chews with a five per cent margin and the other selling a £100,000 luxury item at a 50 per cent margin. Both businesses would have the same £50,000 profit and under corporation tax would pay the same amount of tax (being £10,000).

However, under a one per cent sales tax, the first would pay tax of £10,000 while the second would see a 90 per cent tax cut, and pay tax of only £1,000.  If they make the same profit, why should one pay ten times as much tax, merely because it sells goods with a lower margin?

Alternatively, if the turnover tax rate was set at 10 per cent so that the second vendor paid the same amount of tax as before, the first vendor’s tax liability would be double the profit actually made, something clearly unsustainable and out of kilter with ability to pay.  In order to get back to making the same amount of profit after tax, it would have to increase the price of the one penny chew by 10 per cent to 1.1p.

So turnover taxes can result in significant increases in price, as businesses will be focused on profit, while the tax focuses on sales. A simple turnover tax can deter business to business sales, since the tax applies both to the sale on the first business (at, say, 100) and again to the subsequent sale (at, say, 150).  Avoiding this cascading effect (i.e. taxing 250 not 150 in this example) is one of the reasons lying behind the replacement of turnover taxes with VATs, which are now present in over 160 countries.  A similar reason for retaining corporate tax is that those countries that tax dividends paid to them by foreign subsidiaries will recognise that corporate tax has been suffered and only seek to impose more tax if their tax rate is higher. This would not be the case for a turnover tax, and hence could give rise to double taxation of the same profits when paid to foreign shareholders.

But we do have some turnover taxes…

Where we have taxes on transactions (such as stamp duty land tax on houses and stamp duty reserve tax on shares), we hear concerns about the unfairness of the tax and the burden that it places, given that there can be no profit out of which to pay the tax. These taxes are generally kept small in nature to avoid creating distortions and deterring investment.

But could a turnover tax be designed as a simpler version of corporation tax?

This poses the additional question as to whether a turnover tax might be an easier way of taxing the profits of companies than a corporation tax that may be complex to calculate and open to abuse. Leaving aside the argument that that role may already be played by the VAT, there are some difficulties with this, arising from the fact shown above that the profits margins that business make differ between sectors and indeed between businesses of different sizes, as economies of scale can apply.

In order to address this concern, any such tax would need different rates per sector. Indeed, there are 54 categories used in the UK’s Flat Rate Scheme for VAT which charges tax as a percentage of turnover and is explicitly designed to deliver the same tax as would be generated if VAT was applied to the value added. Such a plethora of rates, and a clear disparity between tax and ability to pay if the rates are wrong, shows that this is really not a simplification.


There are strong arguments to retain corporation tax over a sales tax.  Of course, it remains important to ensure that the profits are calculated appropriately and, in an international environment, are taxed in the right locations; but there remains a role for a tax on profits rather than on turnover. 

Blog by Chris Sanger, Global Tax Policy Leader, Ernst & Young LLP and a member of the Management of Taxes Committee of the Chartered Institute of Taxation