Tax Break

John Fisher, international tax consultant

Archive for the tag “Paul Krugman”

Teaching Mrs Merkel German

How many times in one reign does a monarch have to listen to Tom Jones singing Delilah?

Nostalgia ruled for most of last week. While the British indulged in a House of Windsor love fest, the world delighted in snippets of the Queen over her sixty year reign. It was Prince Charles, the King-in-Waiting, who stated the obvious at the Buckingham Palace Doorstep Concert noting that for many people this was the third jubilee they were enjoying along with the Queen (who, frankly, did not by that stage look like she was enjoying anything very much).

My memory leapfrogged over the Golden Jubilee and sprinted straight for the 1977 Silver Jubilee. That was a very different occasion – the generation which, back then, we called middle-aged had lived through the Second World War and brought an old camaraderie to the festivities, as opposed to today’s middle-aged who brought Stevie Wonder, Tom Jones and Paul McCartney.

Maybe it was just the glasses, Jim. Or maybe not

But, Silver Jubilees aside, I was reminded that 1977 was an annus horribilis (as, indeed, was much of the decade but my Latin does not stretch that far). Britain was governed by a minority Labour Government which, in turn, was governed by the Trade Unions who kept bringing the country to its knees.  James Callaghan, the hapless Prime Minister being fattened  for the slaughter by Mrs Thatcher, had swept into No 10 a year earlier with the slogan “Jim Won’t Fix It”. This was a play on the title of a popular TV show and branded him immediately as totally incompetent.

 Meanwhile, across the pond the Americans put a Georgian peanut farmer into the White House who, apart from claiming to have been attacked by killer rabbits, let his team spread compost over US diplomacy. At one diplomatic function Chief of Staff Hamilton Jordan (another Georgian) was reported to have told the Egyptian Ambassador’s wife that he had always wanted to see the pyramids, while fixing his gaze somewhere well south of her eyes.

Jack and Bobby Kennedy. Or maybe not

From the economic viewpoint  the world was down the tubes. The collapse of the Bretton Woods exchange rate system  early in the decade followed by the Arab Oil Crisis had led to rampant inflation – or to be more specific – stagflation. This state of affairs was the nightmare of every adherent of the  school of economic thought that had ruled since the 1930s – it broke the rules of Keynesianism. Inflation together with slow growth and steadily high unemployment was not to be found in Lord Keynes’s song book.

It was no wonder, therefore, that a radically different breed of economist managed to insinuate itself into the frontal lobes of the world’s politicians and the world was presented with Monetarism in the UK and Reaganomics in the US while the French elected the rabid socialist Francois Mitterand just to prove a point. That should have been the end of history, but it wasn’t. Things started going visibly pear-shaped towards the end of the century and neo-keynesianism ( a potpourri of everything that had come before) has been on the ascendant among economists, if not politicians, ever since.

Sadly, since the financial crisis hit in 2008 all we have heard from European leaders (until the French played their usual “driving the wrong way down a one way street card’  in electing a socialist president) is austerity, austerity, austerity. The Eurozone has to collectively tighten its financial belt, balance its budget (well, almost) and keep within very low inflation targets.  Bung up taxation, slash public spending, pay off your loans. And, meanwhile, let the continent  burn.

Strange. I always thought Paul was born around the same time as Beethoven

Leading this bloody crusade is none other than Europe’s Supreme Leader – Angela Merkel. Locked into a  mindset of classical economics and simple housekeeping Frau Merkel, along with all the other European big chiefs  other than M Hollande who has yet to prove that he is not a left wing nutjob,  is missing something fundamental. And that something was observed by a German – Georg Wilhelm Friedrich Hegel.

Frau Merkel should ask the Queen about Hegel’s “Zeitgeist” . She should ask her about her 60 years of regular meetings with her prime ministers from Winston Churchill to the current young boy. The Queen would doubtless tell her that the spirit of the times  has changed.  Beethoven could not have written the Ode to Joy in 1967 London and Paul McCartney would have had trouble with Yesterday in 1827 Vienna. So why is there an assumption among political leaders that, because something did not work in 1977 it will not work in 2012 OR that something that did work  in 1982 will work in 2012?

Did I say at any cost? Maybe not

Back in the 1970’s inflation had got out of control  and – let’s make no mistake – reasonably stable prices are a sine qua non (Latin again) for a stable economy. Stagflation was a reality. Unions were at their most powerful. People’s expectations were at the bottom of the pit. It was critical to bring order to the money markets and bring the unions in line, at whatever the short-term cost, to facilitate a basis for nations to move on. It was left to  Thatcher to tame the Coalminers and Reagan the air traffic controllers.

The European crisis of the last few years is against a very different historical backdrop. Inflation and the unions are not a major threat. The financial crisis is precisely that and not a crisis of economic fundamentals (with the exception of Greece which will soon be sent on its way to Hades). It is the handling of the crisis that threatens to upset the applecart.

Any fool can see that, by everyone getting their house in order at the same time demand just deflates (Paul Krugman has pointed out that  you cannot use the analogy of a spendthrift household that needs to tighten its belt when referring to an entire country because the spendthrift household can rely on demand being created by responsible households as opposed to the entire country where demand just disappears).

Should I buy ingredients for another cake or pay off the mortgage?

Krugman, like Keynes, has no problem with  balancing budgets when the economy is booming. However, when the economy is in recession it is time for increased government spending. It is clear that, whilst in the long-run governments may be highly inefficient participants in the economy, in the short run they will spend much more freely than private households concerned about the future. This supports the contention that taxes should not  be reduced in a recession if that means less government spending. Alongside all this there should be quantitative easing (basically, central banks injecting cash into the economy) and increased targets for inflation.  Balanced Budgets would  still be sought but over a much longer period. Within the Eurozone they will need more banking unity and some form of joint eurobonds to protect weaker economies that cannot devalue their currency to increase competition.

Angela, go with the flow!

It is not an exaggeration to state that the next few months are going to be  critical for the future of the European Union. If Mrs Merkel prefers not to battle with the stark prose of her fellow German, Mr Hegel, she might prefer that nice Mr Shakespeare’s Julius Caesar (not in Latin):

There is a tide in the affairs of men.
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat,
And we must take the current when it serves,
Or lose our ventures.

It’s peace and democracy, stupid

Bayern Munich 3 Chelsea 4

We accountants do not care much for the front section of the newspaper. If  a story cannot be reduced to prime numbers, it is not for  us. After a cursory glance at the headlines we skip to Section B to be hypnotized by the latest business and finance news followed by yesterday’s football, baseball and cricket results. Reaching the back page we take a quick look at the paper’s weather forecast and then commit its earthly remains to the nearest bin.

I am grateful, therefore,  to Nobel Laureate (Economics) Paul Krugman who shone a different – albeit obvious – light on the Euro Crisis in a recent New York Times article:

 “Failure of the euro would amount to a huge defeat for the broader European project, the attempt to bring peace, prosperity and democracy to a continent with a terrible history”.

I wonder how long they had to queue?

I am British, which explains why I have been in denial on this issue for so long. When Britain negotiated belated entry to the EEC  (the forerunner of the EU) in 1973 and promptly held a referendum two years later to decide whether to have the marriage annulled, the British Government talked lots about the importance of a Common Market. What they always avoided was the unhidden agenda of the six founding fathers – West Germany, France, Italy, Netherlands, Belgium and Luxembourg – of achieving political union: a United States of Europe. The Six had one thing in common – they had all, in recent memory, been overrun by  foreign troops. Britain, too, had been overrun  by foreign troops – Americans  – who were overpaid, oversexed and over here but, while this was hardly less traumatic (especially for the husbands dying for King and Country overseas), it did not compromise Britons’ fierce commitment to independence that has remained uninterrupted for a thousand years.

The  twenty other countries that have joined since 1973 generally fit the “We had better share some independence rather than risk our heads being kicked-in every 50 years” philosophy shared by the Six.

As has been clear from Day 1 (or, to be more precise, D Day) Britain has no place in the EU. It is a  bridge between the Old World and the New and should have  economic status not dissimilar to Switzerland – access to the Single Market is all that it ever really wanted.

With Britain out, political union could proceed and the Euro could thrive (I joke not).

Of course there will still be a few minor roadblocks along the way like: cultural diversity; getting over a history of regularly pulverizing each other; and Greece (World War 1940-45, Civil War 1946-49). But it was pleasing to recently see troubled Spain (Civil War 1936-39) taking  a leaf out of Germany’s fiscal notebook  (World War 1939-45, World Cup 1966).  The slow march towards the Common Consolidated Tax Base – a precursor to fiscal union, itself a precursor to political union – advanced another step.

It will be recalled that Spain is having a little trouble meeting its Teutonically imposed budget targets this year. It needs to raise more taxes.

So, following Germany’s lead a few years ago, the Spanish legislature invited the Interest Expense to step up to the executioner’s block  for a haircut.

While international tax advisers will be aware that Spain has been quite a paradise for the tax planning of interest expenses (double dips et al), it does look like it is time to put the castanets  back in their box and get down to serious business.

The rain in Spain falls mainly in the plain

To replace the old Thin Cap (3:1) rules which apply to shareholder finance, the Spanish have introduced a general net interest deduction limitation  of 30% of , basically, EBIDTA (a la Germany). To the uninitiated, who may find this as understandable as the programming language of their computer – I will explain it in English like wot it is spoken. Ladies and Gentlemen, hold on to your hats.

You start with the financial statements of the Spanish company (or consolidated tax group)  and open them at the Profit and Loss Statement. Using your eyes and a calculator you work out operating profit – earnings before interest, taxes, depreciation and amortization  (EBIDTA)  plus a few secret ingredients. If interest expense minus interest income arrives at more than 30% of the operating profit you start to sweat and move on to Stage 2.  In Stage 2, if it is a single company (as opposed to a consolidated group) the rules will only apply if financing expenses are derived from certain related party transactions. In addition, up to one million euro of net interest expense is always deductible. If you are wondering why Stage 2 is not performed before Stage 1, you are right – the accountant will now have to decide whether he can charge his client for the wasted hours on the EBITDA calculations. Accountants  sometimes do that sort of thing. Amounts not deductible will be carried forward for up to 18 years to be included in the same 30% limitation each year while, if the net finance expenses are less than 30% in a given year, they can be carried forward for up to 5 years.

What, sadly, the Spanish have omitted is a (brilliant) German  exception to the rule. For Germany, where an entity is in a consolidated group  even if  the 30% rule is breached, as long as the equity ratio (equity to debt) of the company is not less than 99% of the equity ratio of the consolidated group the rule will not apply. What is clever here is that they are effectively saying that if the German situation reflects a more conservative position than the international group as a whole – then it is fair to assume that the interest charge is not designed specifically to hurt Germany and should be allowed.

While, to paraphrase Neil Armstrong this may be “One small step for Spain, one smaller step for Europe” it is still a step in the right direction of unified policies.

It couldn’t happen to a nicer airline

Some years ago I flew Iberian to Spain and vowed never again (Iberian, not  Spain). Among the numerous insults I suffered on the flight (and I was flying Business – Heaven knows what happens in Coach), was when the young female flight attendant came round offering immigration cards and, smiling politely, I refused as “I am a British citizen”. “You still need an immigration card. Britain is not part of the EU” she growled. I smiled benignly and informed her that Britain had been part of Europe when her country was still a fascist dictatorship. They didn’t allow me on the Business Bus when the plane landed. I suppose old fascist dictatorships die hard.

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