Does Shell pay enough, too much, or too little corporate tax?
It is disputed that corporations use subsidiaries to reduce their tax rate. But isn’t that the purpose of companies: creating value? Do governments facilitate them? What about ethical considerations? Is disclosure of tax transparent? Let’s look at Shell.
Usually a listed corporation has many shareholders. How can such corporations satisfy all shareholders? Fortunately there is a financial objective on which all shareholders agree: maximization of shareholder value. In financial theory this is called the unanimity principle. According to the Dutch corporate governance code: “The Company endeavours to create long-term shareholder value.” A listed corporation can be disciplined easily and indirectly: shareholders sell and buy shares and can approve or not corporate policy and/or performance. What about other stakeholders and ethical considerations? Of course if the reputation of a company deteriorates because of unethical behaviour, it is detrimental to the market value of a company. Corporations “are forced” to take into account ethics. Ethics in this line of thinking is not intentional, but consequential.
How can a corporation create value? A company searches for value-creating opportunities by combining, transforming and moving resources all over the world. Shell (‘Royal Dutch Shell Plc’) creates value because it extracts oil, converts it into petrol and sells it to customers all over the world. Governments expropriate part of this created value (via corporate tax); this leakage lowers shareholder value. Why should Shell not make use of tax-minimizing opportunities created by governments? Governments facilitate companies to attract them; corporations are obliged to make use of those opportunities! “Income taxes are a significant cost to a corporation. Tax professionals must control and manage this cost in the quest to create shareholder value but also be aware of the increasing scrutiny and public debate over income taxes.” (Working together, Energy Sector Income Tax Benchmarking Study, PriceWaterhouse, 2007).
Let’s take a closer look at the “tax performance” of Shell. The average corporate tax rate for 2011 and 2012 is 54.5% (annual report 2012, taxation charge expressed in a percentage of income before taxation, also called the effective tax rate). This seems extremely high, taking into account that average tax rates are usually within a range of 25-40%! The comparable tax rate of Exxon Mobil is 51.2%, of BP 43.8%, and Chevron 51% (annual reports, but with different formats of disclosing). So it seems that Shells’ profit suffers most from a high tax rate. Shell pays the highest tax of all, so it pays too much tax!
Companies have to disclose the causes that the effective tax rate deviates from the (expected) nominal rate. Under note 17 in the annual report one can read: “The taxation charge includes not only those of general application but also taxes at special rates levied on income from certain upstream activities and various other taxes to which these activities are subjected.” Corporate tax for oil companies is usually rather high because their upstream activities are subject to high, specific income tax rates in the host countries where the oil is located (SoMo, Royal Dutch Shell, Overview of controversial business practices, 2009). Besides the upstream segment, Shell distinguishes other (less important) segments: downstream and corporate. I have calculated the average tax rate of these two segments together: 11.1% (I used the annual report and the Shell Investors’ Handbook). It is likely that Shell uses subsidiaries to lower the tax rate. I counted 179 subsidiaries under exhibit 8 in the annual report. Of course 11.1% is low, but not too low. If Shell is rational it should minimize the effective tax rate, taking into consideration the negative impact of societal pressures. If this is Shells’ optimum it pays enough tax. Besides, is 11.1 % exceptional? My colleagues and I have researched the effective tax rate of Dutch listed companies between 2008-2010. Effective tax rates differ a lot, but there are corporations that are able to lower the effective tax rate to percentages close to zero.
Finally, the effective tax rate is not the amount companies have paid in a year. It is the expected amount a company has to pay (in the past, now or in the future). Our research also shows that the subjective element in the calculation of the tax rate is rather high. So the question is whether it is possible to draw conclusions from disclosed effective tax rates. Disclosure about tax is not transparent. (See: Witjes et al., Weekblad Fiscaal Recht, “De effectieve belastingdruk wordt niet alleen bepaald door wet- en regelgeving”).
It can be concluded that Shell pays enough, even too much, tax and certainly not too little! Disclosure about corporate tax should be more transparent in general – not only concerning Shell.