Directors Responsibilities with Regard to Avoidance of Tax - Assignment Example

? Directors responsibilities with regard to avoidance of tax Table of Contents Table of Contents Should company directors have a duty to their company to avoid paying taxes? 2 Introduction 2 LEGAL OBLIGATIONS ON COMPANY DIRECTORS IMPOSED THROUGH DIRECTORS’ DUTIES 4 EMPHASIZING ON WHAT CONTROVERSIES HAVE BEEN FACED IN UK REGARDING DIRECTORS RESPONSIBILITIES 9 STAKEHOLDER THEORY AND THE CLASSICAL ANGLO/AMERICAN SHAREHOLDER PRIMACY MODEL 13 The case for shareholder primacy 14 S. 172 COMPANIES ACT 2006 AND ENLIGHTENED SHAREHOLDER VALUE 17 Conclusions and Recommendations 18 LIST OF REFERENCES 21 Should company directors have a duty to their company to avoid paying taxes? Introduction Taxes are paid to government of the country which depicts that the company is willing to share its profits with the government as it provides the firm with facilities and easy and flexible policies. The firm accepts that the government has legal powers and can to take a share of the company’s profits away. Different countries have different tax rates and they must they paid as they are part of the rules and regulations of the country. If they are avoided they company would not be held socially responsible. It is agreed that the company can take all lawful measures to reduce the tax rates. But any illegal mean to avoid paying tax would result in avoid of taxes which has a negative multiplier effect on the company and its profitability. The duty of the director of a company is to have a good faith; an element that would promote the company following corporate social responsibility as it would be a benefit for the society on a whole. This would result in a positive multiplier effect in the long run and improve its relations with other stakeholders. A good reputation would be built if they pay the exact amount of tax otherwise they would not maintain a high standard of reputation in the market, thereby losing its credibility and goodwill. Tax evasion is practiced by directors illegally and it gives a smudge to the reputation of the company as a whole. But they live in a fool’s paradise if thy think it would not be known to general population and from that immature act they lose their credibility forever. This leads to customers driving away from the company as well. Recently, some multi-nationals have been found to be avoiding paying taxes in millions despite their enormous sales. The examples are Starbucks, Google, Amazon, Facebook and eBay but due to media coverage these multi-nationals have come under severe scrutiny. In countries like UK, businesses prosper because they have portrayed a good social and responsible image for its customers and there is a trust factor. They do this by not providing transparency in the accounts shared by the public. Via doing such an act they are on the verge of becoming directors of an insolvent firm. This would be a threat to the company’s long term profitability. Thus the directors must understand that taxes are a form of cost just like wages, rent, etc. LEGAL OBLIGATIONS ON COMPANY DIRECTORS IMPOSED THROUGH DIRECTORS’ DUTIES It is a natural phenomena in the modern world that governments run on the taxes paid by it’s citizens.1 The expenditures of a state have to be met by the taxes paid. The companies earning more have a bigger share in taxes than the ones earning less. The issue arises when multi-nationals earning in billions use legal strategies to avoid paying taxes. Having made legal grounds to undertake this, their action cannot be termed illegal and they cannot be held accountable in court.2 Such cases have recently come on the scene, thanks to the media reporting, but what can be done about it is still an issue. A director is a high-level employee of the company and is responsible for the company’s performance and answerable to it’s employer, that is, the company. A director is not dutiful to the members of that company, and this also leaves out the company’s creditors and members. So, a director owes its trust element to the company only and this is determined by fiduciary duties. 3By not owing duties to the shareholders or creditors, it does not imply that a director does not safeguard the interests of the shareholders and creditors. It implied that the derivate suits are used as they directors can not be sued by the shareholders, but only by the company itself, in case of a breach of law and variation in traditional corporate law.4 Mostly, the interests of the shareholders are the same as the interests of the company.5 Hence both are served by the director simultaneously. However, in a case where the company’s interests and the shareholders interests conflict, it is the duty of the director to cater for the company’s interest and not it’s shareholders. There are certain instances where a legal obligation is imposed on a director to regard the interests of all those affected by the company.6 General theory dictates that tough no legal obligation is imposed, on grounds of moral and social responsibilities; the director is responsible for the consumers, shareholders and the general public.7 Directors have the power to make decisions for the company. The directors are expected to work in good faith and for the best interest of the company. These rules are present in the common law principles and are understood. These are a part of the Companies Act 1985, which was later amended to Companies Act 1989. It was felt that in some circumstances, it gets vague for the director to define good-will and best interest of the company.8 A decision made in such a scenario may lead to a breach of duty on part of the director. Hereby, the need to make more objective-oriented, clear, certain and accessible law was required, resulting in the Companies Act 2006. 9 One of the added provisions in this Act states that a director must act within his powers. A director transgresses if he uses power beyond that which is given to him by the company. In that case, the director can be held legally accountable.10 Secondly, it is made a duty of the director to promote the success of the company. Good-will for the company relates to the success of the company in this case. For a commercial company, the success would be an increase in value of the company. Hence, it is the duty of the director to ensure that. Moreover, the directors under this act are to exercise independent judgement. There are two parts to this statement. One is that the directors’ job is to give a judgement on a certain issue. Secondly, the director has to give the judgement independently. This ensures active participation of directors in policy-making for the company.11 If this rule was not implemented, some directors would do their duty of decision-making while others would simply go in favour of that decision without doing their homework. Such a relaxation on directors’ part is unacceptable, hence the provision in the Companies Act 2006. It is to be noted that although fiduciary act of Company Act 2006 in UK, which states the responsibilities of a director in a corporate organization, comes under the private law, but it serves public law functions if viewed critically.12 Apart from serving it’s company to make appropriate decisions in managing the financial and non-financial aspects of the company, it also serves as a moral keeper of commercial aspects towards the society.13 This brings duality into the responsibilities of a director.14 The norms to be kept are also judicially defined, which makes them abiding for the director.15 Another interesting legal phenomena is that fiduciary obligations according to Company Act 2006 in UK are imposed when a director is seen safeguarding the interests of some other party than the company itself.16 This third party may be the shareholders or the broader society. What needs to be seen here is how it affects the standing of the company. Safeguarding moral obligations might benefit the company in certain cases while it might adversely affect the performance of the company.17 Here the direction comes under a test, and the decision he makes might come under scrutiny. In the specific case of finding legal grounds for a company to avoid paying taxes, the director has to show his allegiance to his company as well as his duties to the society. How far can the director stretch the legal obligations to help the company avoid paying taxes is up to his expertise. The director has to do this within the legal framework. If duties relating the moral grounds or keeping the broader society in mind cannot be made a part of the company’s law by judicial development, then is becomes difficult for the director to practice serving the company and serving the moral grounds, both at the same time.18 Regarding this issue, Knox, J. states: 'In my judgment there is too long and tenuous a chain of legal obligation between the duty of a director under the model code to report a proposed dealing in a security to the board at one end and a market maker in that security at the other end to justify the finding of a duty owed to the latter by the former to speak'. EMPHASIZING ON WHAT CONTROVERSIES HAVE BEEN FACED IN UK REGARDING DIRECTORS RESPONSIBILITIES If companies avoid paying taxes, it would be a burden on the rest of us. The companies doing business in billions have a moral obligation towards the society in paying taxes. Being able to hire legal experts as their directors, to help them figure out legal ways to avoid paying taxes does relieve them of their legal duty of tax-paying, but on moral grounds they are left with no convincing answers19. Recently, some multi-nationals have been found to be avoiding paying taxes in millions despite their enormous sales. The examples of such companies are Starbucks, Google, Amazon, Facebook and eBay.20 They have implied tax-avoidance techniques to their benefit, but are proving to be a burden on the society. Thanks to the media coverage of this issue, these multi-nationals have come under severe scrutiny. It is evident that their directors are doing a good job for them as in saving them from paying taxes, but are they performing their fiduciary obligations according to Company Act 2006 in UK, in serving on moral grounds as well?21 Quite rightly have they come under scrutiny, paying taxes in only a few millions while having sales in billions. Starbucks is reported to have paid no corporation tax in last three years, while Amazon, Facebook and Google have together paid less than PS30m of tax despite sales of PS3.1bn over the past four years". 22 Starbucks alone has paid just PS8.6m in taxes on a reported PS3bn in sales since 1998. This equates to a tax rate of less than 0.3%. This is a shame for a company of such magnitude. The companies operating in other sectors seem to be following the same trend and compete in paying less taxes as well. Water companies have shown a similar trend of not paying taxes while incrementing consumer prices. The Observer states that of the biggest water companies of Britain paid no or minimum tax on their stated profit of last year even though they rewarded their investors and executives handsomely.23 It is feared that the companies being put under scrutiny are just the tip of the iceberg. More serious offenders will be brought to the screen if further research is carried out. Multi-national drug company as big as Pfizer is recorded to have not paid any tax at all. This is alarming for the government as it indicates the failure of the government to devise a law to collect due taxes. In America, the tax procedures are relatively much more strict than those in UK. One possible solution of this problem could be to impose the same strict laws in UK to ensure that companies pay their taxes rather than finding their ways out of it.24 Either it is shame that can bring about these companies to pay their taxes or it is aggression on part of the government. The later would seem more effective as it would have a legal framework to it while the former would not. What is more alarming is that it is becoming a general trend for companies to avoid paying taxes, being protected by legislative weaknesses. If this continues on, it will have serious adverse affects on the country’s economy and on the general population. Not only should the legal experts draft a law to stop this from proceeding further, but it is also a duty of social organizations to find ways to ensure that multi-nationals pay their taxes as it affects the society as a whole. The multi-nationals are viewed as icons in the society. These acts of tax-avoidance can harm their image and bring shame to their name. This aspect can be cashed on by social organization in compelling these companies to pay taxes. One possible solution of this issue could be that the government introduces a tax on turnover in the next financial bill.25 This would give the companies a choice of either acting as responsible members of community or paying a tax on their turnover. The countries in which these companies do business should certainly impose a tax on them. These countries can pose the argument that as these companies enjoy their half in the tax paid by the citizens of that country, they should give their half to the country they are earning from. A legal draft is inevitable in ensuring that such rules are implemented. STAKEHOLDER THEORY AND THE CLASSICAL ANGLO/AMERICAN SHAREHOLDER PRIMACY MODEL The stakeholder theory was first proposed in the book Strategic Management: A Stakeholder Approach by R. Edward Freeman and outlines how management can satisfy the interests of stakeholders in a business. A loss of confidence is globally noticed in financial institutions. The choice of governance structure and financial crisis are some of the factors which have led to this.26 In this era of competition for capital globally, it is predicted that the ‘Anglo-American’ model which gives primacy to the shareholders will be adopted. Another thought is that the political and elite class resist change and so will resist this model as well.27 The German model will prevail which ensures primacy of multiple parties involved. The important argument should be on the efficacy of these two models. Whether any of these serves it’s purpose and is feasible is to be seen. The case for shareholder primacy Contractarian argument Considering a firm as a nexus of contracts and all its participants, contractarians argue that the non-shareholders that are employees’ management and creditors, are in a position to protect their interests. But shareholders can only rely on contracts given by the board of directors and are at risk in the firm. Thus shareholders value should be maximized since shareholders interest are related with the long-term value of the firm. For this reason control rights should be given to shareholders by elected board of directors to promote managerial accountability. 28 Agency arguments Agency theorists claim the existence of a principal-agent relationship between shareholder principals and managerial agents. In this view justifications for shareholder primacy are self evident. Reduction in agency costs become a primary mechanism for maximizing shareholder wealth and enhancing overall economic efficiency. 29 Pragmatic arguments The stock price is the single best estimate of a firms’ long term value. Maximizing shareholder wealth is attractive as a fiduciary rule when judged against alternative rules. It makes it easy for directors to monitor corporate performance and enables courts to review managerial conduct with some rationality. 30 Jurisprudential argument Considerable evidence is available for historical dominance of shareholder primacy in Anglo-American corporate law. At common law the traditional approach to analyze fiduciary duty equals the best interest of corporation, which is the best interests of shareholders who are the owners of the firm. It would be relevant and useful to analyze by taking another country’s example and trying to replicate in the context of UK. For this matter the Canadian Law could be studies. Under this law and the Canada business corporation act (CBCA), directors shall act honestly and in good faith with the best interests of the corporation. The fiduciary duty of the directors to the corporation is a board and contextual concept. It is not a short term profit.31 As the corporation is an ongoing project. It looks to the long term interests of the corporation. While taking a judgment in favour of the company, the director must also take into care the considerations for the wider society, environment and human rights. If such is done, it is the legal duty of a judge to provide these judges with protection in case a legal issue arises. 32 Examining the rationale for what is arguably the central characteristic of the ‘Anglo-American’ business model. This central characteristic is the widespread acceptance of the maximization of shareholder value (MSV) as the fundamental objective of business activity.33 This is a subject which was considered in the UK during the process which culminated in the introduction of the Companies Act 2006 (CA 2006).34 That process included the Company Law Review (CLR) which began in March 1998 and whose Final Report was issued in June 2001, and continued through various parliamentary stages before the new act became law in November 2006. The CLR addressed ‘the question of ‘scope’ – i.e. in whose interests should companies be run’35. The outcome of the Review was clear support for shareholder primacy with ‘the basic goal for directors’ being ‘the success of the company in the collective best interests of shareholders’36.The resultant CA 2006 requires a director to act in good faith .He should promote the success of the company for the benefit of its members as a whole. Though directors must also have regard for other interests including employees, the community and the environment. 37 S. 172 COMPANIES ACT 2006 AND ENLIGHTENED SHAREHOLDER VALUE Discussing S. 172 in particular and relating it to tax-avoidance, It can create multiple scenarios for the directors. A director might view avoiding paying taxes in the better interest of the company as it would directly bring financial benefits to the company. Another director might think from another angle and come to the decision that paying taxes would benefit the company in the longer run. Taking the examples of Amazon and Google, the non-tax paying approach of these companies has earned them a bad name in the world. The common man is the client of these companies. The companies depend on him for its earnings and growth.38 When the client finds out about this, he loses trust. Trust is what businesses build on. Loss of trust would lead to loss of clients, which would ultimately lead to loss for the company. Hence, two directors working in good-will for the company might reach at opposite decisions based on their insight and intuition. Conclusions and Recommendations The world is object-oriented. Each individual wants to follow the path which would better serve his objectives. Such is the debate between implementing the Anglo-American model or the German model. Due to the competition arising globally on capital, it can be predicted that Anglo-American model would be the rule soon39. However, the elites well satisfied with the present day business would tend to resist any change and would regard the German model being the ideal one.40 The extensive literature that we have reviewed and the evidence thus gained has led us to believe that the issues outlined above justify that the trust is what businesses build on over time and they need to be maintained. The question that in whose interests should a companies be run was not, due to some reason, seriously examined as part of the CLR. MSV as an established corporate objective have contributed to the recent financial crisis through a single objective at long term prosperity and wider social considerations. In particular, there is evidence to suggest that Anglo-American countries have a ‘case to answer’ to their poor measures of social well being relative to those of other developed economies which typically pursue a stakeholder, rather than a ‘shareholder’ model of capitalism.41 This evidence was not considered as part of the CLR. We recommend that it should be considered in any reappraisal of company objectives. In addition to this, other specific issues were raised as meriting re-examination in any such future review of company law.42 Four issues are considered particular emphasis. First was the need for greater corporate accountability; another was a recommendation of the CLR which had not been adopted by government for a standing body to keep company law under review.43 The other two issues were linked to potentially perverse consequences of maximizing shareholder value; these were the regulations governing the market for corporate control in the UK, and also the level of directors’ remuneration. 44 In legal terms, directors have the duty to their company to make decisions which would benefit them financially and would increase the value of the company. These directors are held accountable directly by the shareholders of the company. Moreover the company sue them in case of a breach of duty. It is up to the expertise of the director to bring financial benefit to the company, keeping in view his moral and ethical obligations to the society. Directors of multi-nationals like Amazon, Starbucks and Google etc. cannot be held accountable on legal grounds for failing to find ways to avoid taxes. However, on moral and social grounds they are accountable. By doing this, not only do they harm the society by over-burdening other citizens with taxes, but also bring shame to the company in the eyes of the general public. Ultimately, the public loses trusts in a company and stops investing in it or being its client. This might result in the downfall of a company, or at least bring a decline in its profit figures. Via looking at all the empirical evidences, it could be concluded that for a director, it is important that he oversees the affect his decision would have for his company in the future. Failing to do so could lead to the wrong decision being made. The Companies Act 2006 has defined the duties of a director more clearly and has eliminated the ambiguity present in the previous acts. It is clear that the directors’ job is to bring success to the company and make decisions in the good will of the company. If such is not practiced by a director, a breach of duty can be filed against the director. Thus it’s clear that company directors have a duty to their company to avoid paying taxes and this could have adverse impacts on the company’s financial, social and corporate image. LIST OF REFERENCES 1. Jenkins Committee Report, Cmnd.. 1749 ( 1962) at para. 89. 2. E. Merrick Dodd, "For Whom Are Corporate Managers Trustees?" ( 1932) 45 Harv. L. Rev. 1145, at 1148 and 1160 respectively. 3. Wedderburn, "Trust", at 221: "Fiduciary obligation is imposed by private law, but its function is public, and its purpose social". 4. FIELD, F.“Shame Amazon, Starbucks and Co into paying tax.(Letters)” 2012 5. Wright, Oliver. “How can the company that makes these pay no UK tax?” 2012, The Independent, London. 6. 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