ANGLO-AMERICAN CORPORATE TAXATION The UK and the USA have historically represented opposite ends of the spectrum in their approaches to taxing corporate income. Under the British approach, corporate and shareholder income taxes have been integrated under an imputation system, with tax paid at the corporate level imputed to shareholders through a full or partial credit against dividends received. Under the American approach, by contrast, corpo- rate and shareholder income taxes have remained separate under what is called a ‘classical’ system in which shareholders receive little or no relief from a second layer of taxes on dividends. Steven A. Bank explores the evolution of the corporate income tax systems in each country during the nineteenth and twentieth centuries to understand the common legal, economic, political, and cultural forces that produced such divergent approaches and explains why convergence may be likely in the future as each country grapples with corporate taxation in an era of globalization. steven a. bank is a professor of law at the University of California, Los Angeles School of Law, where he uses history and finance to explore the taxation of business entities in the United States and other countries. cambridge tax law series Tax law is a growing area of interest, as it is included as a subdivision in many areas of study and is a key consideration in business needs throughout the world. Books in the Cambridge Tax Law series expose and shed light on the theories underpinning taxation systems, so that the questions to be asked when addressing an issue become clear. Written by leading scholars and illustrated by case law and legislation, they form an important resource for information on tax law while avoiding the minu- tiae of day-to-day detail addressed by practitioner books. The books will be of interest for those studying law, business, eco- nomics, accounting and finance courses in the UK, but also in mainland Europe, the USA, and ex-Commonwealth countries with a similar tax- ation system to the UK. Series Editor Professor John Tiley, Queens’ College, Director of the Centre for Tax Law. Well known internationally in both academic and practitioner circles, Professor Tiley brings to the series his wealth of experience in tax law study, practice and writing. He was made a CBE in 2003 for services to tax law. ANGLO-AMERICAN CORPORATE TAXATION Tracing the Common Roots of Divergent Approaches STEVEN A. BANK cambridge university press Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo, Delhi, Tokyo, Mexico City Cambridge University Press The Edinburgh Building, Cambridge CB2 8RU, UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Information on this title: www.cambridge.org/9780521887762 © Steven A. Bank 2011 This publication is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published 2011 Printed in the United Kingdom at the University Press, Cambridge A catalog record for this publication is available from the British Library Library of Congress Cataloging in Publication data Bank, Steven A., 1969– Anglo-American corporate taxation : tracing the common roots of divergent approaches / Steven A. Bank. p. cm. – (Cambridge tax law series) Includes index. ISBN 978-0-521-88776-2 1. Corporations – Taxation – Law and legislation – Great Britain – History. 2. Income tax – Law and legislation – Great Britain – History. 3. Corporations – Taxation – Law and legislation – United States – History. 4. Income tax – Law and legislation – United States – History. I. Title. II. Series. KD5504.B36 2011 343.41050267–dc23 2011019853 ISBN 978-0-521-88776-2 Hardback Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. CONTENTS Introduction page 1 1 A brief history of early Anglo-American corporate income taxation 19 part i Twentieth century and the divergence in systems 47 2TheUnitedKingdom 49 3 The United States 70 part ii Explaining the divergence 105 4Profits 107 5Power 142 6Politics 188 part iii Conclusion 221 7 1970s to Present – A Time of Convergence? 223 Index 250 v u Introduction Over the last century, countries have typically followed either the United States model or the United Kingdom model in taxing corporate income. In the USA, corporations are subject to tax as separate entities under what is called the classical system. Income is taxed first to the corporation when earned and a second time to the shareholders when distributed as a dividend. This double taxation was mitigated to some extent in the USA by a 2003 reduction in the rate applied to the shareholder-level tax on certain dividend payments, but it left the basic double tax system intact. The UK system of corporate taxation has traditionally stood in sharp contrast to the US approach by integrating the corporate income tax with the taxation of shareholders. Although this integration could be effected through a variety of means, including a corporate deduction for dividends paid or a shareholder exemption for dividends received, the UK has historically integrated the corporate and individual income taxes through an imputa- tion approach in which shareholders are provided a credit designed to offset at least a portion of the tax paid on that income at the company level. The amount of that credit has declined in recent years, but the UK has retained at least a hybrid approach to corporate income taxation. This sharp divide between the US and UK approaches has not always existed. When income taxation was employed during the nineteenth century, both countries taxed corporate income in a system that was integrated with the individual income tax. It was only around World War I that the nations began to diverge as the USA moved to a classical system while the UK retained a largely integrated approach. Moreover, there have been several instances during the last century when the countries moved closer together, including most notably during the last decade or so. This book seeks to explore the history of British and American corporate income taxation in search of the factors that may help explain why they diverged and converged over the years and what this portends for the future of corporate income taxation in the two countries and around the globe. 1 2introduction The United States and the United Kingdom have always provided a strong basis for comparative study in the legal context. This is primarily because the two countries share a background in the common law method of jurisprudence. Moreover, as a former British colony, the USA inherited or adopted many of the laws and legal practices of the United Kingdom. For example, in Maryland the English common law retained precedential value after America became independent.1 Because of these similarities, comparing the development of the law in the two jurisdictions is often considered instructive for understanding the cir- cumstances under which they have diverged in their approaches. In the tax arena, the basis for comparison between the USA and the UK is not as obvious. On the one hand, since tax is primarily a legislative and administrative, rather than judicial, undertaking, the shared com- mon law background is less relevant.2 Moreover, because the UK first adopted an income tax in 1799, there was little colonial experience to draw upon in the construction of an income tax system.3 On the other hand, each country at least experimented with an income tax during the nineteenth century and this became the centerpiece of each country’s revenue systems during the twentieth century. Under Victor Thuronyi’s modern classification of nations, the two countries would be considered members of distinct families of income tax laws and therefore appro- priate objects of comparative study.4 The USA and the UK also have industrialized economies and well-developed capital markets, with fre- quent market interaction between businesses in both jurisdictions that trace to the founding of America, suggesting that a comparison of busi- ness taxation employed by each nation is particularly appropriate. Finally, the fact that the countries began with similar systems of business 1 See, e.g., A Declaration of Rights, and Constitution and Form of Government agreed to by the Delegates of Maryland, November 3, 1776 at III: ‘That the inhabitants of Maryland are entitled to the common law of England, and the trial by jury, according to that law, and to the benefitof such of the English statutes as existed at the time of the first emigration, and which, by experience, have been found applicable to their local and other circumstances, and of such others as have been since made in England, or Great Britain, and have been introduced, used and practiced by the courts of law or equity ...’ 2 William B. Barker, “A Comparative Approach to Income Tax Law in the United Kingdom and the United States,” Catholic University Law Review 46 (1997): 7, 8. 3 Ibid. 4 Victor Thuronyi, “Introduction,” in Tax Law Design and Drafting (Victor Thuronyi, ed.) (Washington, DC: International Monetary Fund, 2000): xxiv. introduction 3 taxation and then those systems diverged (and converged) over the years, suggests both an inter-jurisdictional and a historical comparison may yield distinctive insights. Thus, while the typical colonial grounds for a comparative US–UK study are less relevant, tax is still well suited to comparative analysis. Indeed, the early drafters of US tax legislation frequently looked to the United Kingdom as a model or source of inspiration or contrast.5 Similarly, post-World War II reformers in the UK have on several occasions looked to the operation of the US tax for guidance in modern- izing the British version, most notably in 1965 when the UK adopted an American-style classical corporate income tax.