The purpose of this article is to analyse the relationship between companies and tax avoidance, focusing on the ongoing discussion of whether companies’ sole duty is to maximise shareholder profits, usually framed as a debate between shareholders and stakeholders. This will be done through the analysis of relevant literature on the issue by jurists, economists, and philosophers, with an emphasis of an interpretation from the optics of morality.
I. INTRODUCTION
In this article, I aim to shed light on the relevance of the relationship between companies and tax avoidance, focusing on the ongoing discussion of whether companies’ sole duty is to maximise shareholder profits. I intend to answer the following question: is it unreasonable to criticise companies for engaging in tax avoidance? Building on available selected literature, I focus on the current legal issues and moral dilemmas posed by corporate tax avoidance.
First, I will concentrate on the conceptual conundrum between tax avoidance, tax evasion and tax flight and how the literature has not arrived at a uniform definition. Second, I will frame the debate as it is traditionally done, as a dispute between shareholders and stakeholders, considering the central notion of Corporate Social Responsibility (CSR), presenting arguments supporting each position. Third, I will argue my point of view based on Michael C. Jensen’s seminal article1 on shareholders versus stakeholders. Finally, I will conclude that it is not unreasonable to criticise companies for engaging in tax avoidance and that maximising shareholder profits should not be their sole duty.
II. TAX AVOIDANCE, TAX EVASION AND TAX FLIGHT
The American judge Learned Hand2 delved into tax issues throughout his judicial life.3 He was not alone in performing this task: Lord Sumner did the same on the other side of the pond, explaining through an analogy that there are lines drawn by the Legislature and that taxpayers can decide to walk outside of them.4 Lord Clyde5 and Lord Nolan followed suit.6 Even South American judges have commented on tax avoidance.7 However, recent rulings have started to observe a different path, such as Lady Arden when describing tax avoidance as an ‘anti-social behaviour’.8
None of the references define tax avoidance. Judith Freedman put it this way: tax avoidance is a ‘definitional quagmire’.9 Kirchler et al. tried to put the differences between each term in simple words.10 On the other hand, Zoë and John Prebble11 posited that tax avoidance was not easy to define, as opposed to tax evasion and that legislations’ definitions were too broad to be of any help12 with boundaries between each legal figure that were hard to pinpoint.13 They added that both tax avoidance and tax evasion ‘involve similar taxpayer behaviour and are each undertaken in pursuit of the same broad aim: to minimize or to eliminate tax liability. They are factually similar, but legally distinct’.14
Defining tax avoidance is no simple endeavour, as much as it is differentiating it from tax evasion and tax flight. From a legal standpoint, authors, judges and legislators have attempted to do so and continue doing so. From an economic standpoint, according to Prebble and Prebble,15 tax avoidance and evasion appear to have the same factual effects. What is remarkable is that the sentiments surrounding tax avoidance have been changing. In that sense, Steven A. Bank16 analysed that in the 1930s, those who tried to avoid paying their taxes ‘were attacked as morally suspect’17 and commented that a shift took place after World War II where tax avoidance progressively became respectable.18
Following that line of thought, the study by Kanagaretnam et al.19 can be linked to Bank’s analysis. A clash occurs because they ‘document that societal trust is negatively associated with tax avoidance’.20 M.H. Hoeflich plays with the idea of gamesmanship and entertains us with the different perception that Americans and English have of the sport cricket: the former see it as just a game, while the latter ‘regard it as far more’.21 Morality as a way to frame the tax avoidance question rears its head. This is where Tony Honoré22 becomes of special importance with his profound explanation of the relationship between law and morals, and how morality alone cannot do much without the aid of law and legislation: without the State’s power of determination,23 individuals would not be able to voluntarily comply and enforcement would find unsurmountable obstacles.
Tax avoidance is hard to define, although its effects are relevant to the economy and the State’s finances. It is different from tax evasion and tax flight, even if their boundaries are ambiguous. Is it legal? It seems to be, as long as it does not cross the lines that law provides. Is it moral? That depends on the eye of the beholder, and it is a question best understood in the corporate context through the discussion of shareholders versus stakeholders, as we will see below.
III. PRELIMINARY IDEAS ON SHAREHOLDERS VERSUS STAKEHOLDERS
The debate of tax avoidance and the maximisation of profits by companies has usually been framed as shareholders versus stakeholders. Michael C. Jensen24 explains that the question resides in how firms measure their own performance.25 He posits there is one theory that vouches for the maximisation of long-term market value of the firm, which is the shareholder theory. The other side is represented by the stakeholder theory, where ‘managers should make decisions that take account of the interests of all the stakeholders of the firm’.26
Freedman adds that we should not discount CSR as the essential element of this contention.27 She adds that it has been defined by the European Commission as ‘enterprises deciding to go beyond minimum legal requirements and obligations stemming from collective agreements in order to address societal needs’.28 The problem at hand is ‘the relationship between the corporate taxpayer and the revenue authorities and government’29 because proponents of the shareholder theory will want to shirk their tax-paying duties, leaving the revenue authorities with less than what they should have gotten had corporate taxpayers paid their fair share of taxes.
Duska goes as far as saying that this is an ethical conundrum, not just a legal one.30 He ties the shareholders versus stakeholders view to the example of donating to charity,31 arguing that there is something called an ‘outside social view’ and something called an ‘inside personal view’,32 the former being what people deem of donating to charities, and the latter being the exact individual reason of why a person donated to charity. Why do we pay our taxes? Why do we avoid them? Is it the same to talk about motives and purposes? Those burning questions all relate back to the morality issue surrounding tax avoidance that Duska presents convincingly.
In recent articles, Samuel Gregg33 compares the ideas of Civil Law and Common Law, stating that the ‘rule of law’ is not the same as the ‘rule through law’, and that the former is more supportive of the shareholder view, while the latter of the stakeholder one. He34 adds that stakeholder theory has gained footing since 1984, and that it stems from ‘stakeholder capitalism’ – a concept coined in 1971 by Klaus Schwab who described it as ‘a form of capitalism in which companies do not only optimize short-term profits for shareholders, but seek long term value creation, by taking into account the needs of all their stakeholders, and society at large’.35 But what about unintended consequences of said view? What about corporatism, accountability and cronyism? Can managers be trusted in their new duty to stakeholders, which is a broader group than mere shareholders? And what about their original fiduciary duties owed to their shareholders?
IV. SHAREHOLDERS VERSUS STAKEHOLDERS IN DEPTH
In the following paragraphs, I will separately present the shareholder position and the stakeholder position.
The Shareholder Position
Milton Friedman, in an oft-cited article in The New York Times, expressed that ‘there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud’.36
This quotation made him one of the leading thinkers of the shareholders’ movement and has generated an unrelenting myriad of authors citing him.37 Friedman goes as far as saying that ‘in practice the doctrine of social responsibility is frequently a cloak for actions that are justified on other grounds rather than a reason for those actions’,38 prefiguring the agency problem that we will describe further in this article.
Though Adam Smith’s39 famed ‘invisible hand’ was only mentioned twice in his whole ouvre, it became one of his staples and perchance his best-known feature: the invisible hand of the market that aligned the self-interested actions of each individual to a solution favorable to everyone involved in society, even if it was not what each person was looking for when pursuing their very own interests.
In line with these authors, although slightly anachronistic, the idea of CSR could be interpreted as a Trojan horse promoting discord and confrontation inside the company. First, between managers and owners, employees and clients, but furthermore between stakeholders that showcase political interests and are after the ownership of the company. The discussion about CSR and its consequences, according to Friedman40 and Smith,41 would appear to divert the company from its function—private initiative and the pursuit of profit—and diminish its efficacy, sabotaging the engine of capitalism. Extending the objectives of a company towards the pursuit of public goods would harm its efficiency by internally increasing its agency problems. From this point of view, executives would become more discretional and perhaps less accountable. They would stop being fiduciaries to the shareholders and would start answering in part to society demands, which, according to Friedman, is the responsibility of public officers.42 CSR would reduce and weaken property rights by attempting to move the company towards the public interest sphere.
Robert Nozick believed in the minimal state, one that would only focus on public safety and the enforcement of contracts.43 Perhaps Nozick’s most famous passage is the following: ‘Taxation of earnings from labor is on a par with forced labor’.44 However, it is not only a philosophical debate, but also a legal one. Chaffee and Davis-Nozemack45 disagree with the mainstream interpretation of Dodge v. Ford Motor Co.46 However, this seminal case expressly showed that directors have a fiduciary duty to their shareholders. While it is related to American Law, it has entered English Law through perpetual discussions.47 It was decided that ‘[a] business corporation is organised and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end’.48 The fiduciary duty gives credence to the agency problem as understood through the lens of Ronald Coase’s49 firm theory.50 We cannot be sure that directors and managers will do what they are supposed to do in the benefit of stakeholders when supporting stakeholder theory. It might as well be an excuse, as mentioned before, to push forward their own personal agendas to the detriment of both shareholders and stakeholders. CSR therewith becomes an issue of good or bad corporate governance.
Watson51 walks uncharted territory because he conducted research on the links between tax avoidance and CSR and how earnings performance can be related to it. Contrary to popular belief, high-performing companies dedicate more of their resources to CSR, while low-performing companies do not.52 He argues that it is a problem of allocation of resources, because ‘corporate social responsibility creates competition for resources between shareholders and other stakeholders’.53 Companies with no money cannot practice CSR. Datt explains why companies should not be shamed for tax avoidance when they have not yet been punished for any wrongdoing.54 If they are punished by, for example, the mass media, they will lose revenue and thus have less resources to conduct CSR. A true vicious circle.
The Stakeholder Position
Avi-Yonah,55 in many articles, goes through the importance of CSR and its relation to corporate taxation. Dowling56 posits that these companies engaging in tax avoidance should be considered socially irresponsible. He argues that just abiding to the letter of the law is not enough to consider companies responsible.57 Dowling says that ‘most of the money “lost” from tax avoidance is a direct financial transfer from society to the company’s shareholders’,58 differentiating himself from the authors worried about the agency problem in the previous section. PwC’s report59 makes it very clear that being transparent about the taxes that companies pay is an essential part of building public trust.
Returning to the philosophical point, Mark Michael60 argues against Nozick that the libertarians’ ideas are wrong because they start from a wrong position, i.e. thinking that there are pre-tax and pre-state rights that belong to individuals before the existence of the state. This idea posited by Michael61 is put against John Locke’s idea of a state of nature which is in fact very similar to civil society, except for one big fact: private property rights are not protected. Michael62 argues that Nozick believes that we have rights that existed before the state, but in reality, it is the state that has created the system which allows us to benefit from its functioning. It is in this very system that we acquire goods and services. Without the state, Michael63 argues, we would not be able to exercise our rights, which is what Nozick fails to consider.64
All in all, the mainstream position today seems to be the stakeholder position because it finds more authors that deal with it from a moral standpoint. At the same time, the shareholder position used to be the traditional one. Nevertheless, we should continue our journey and see what Jensen has to offer on this debate.
V. AN ECLECTIC POSITION ON THE DEBATE
While it could be an easy solution to the problem to simply state that there is no possible solution, alas a sad one at that, Jensen65 developed an eclectic position that might be able to add an extra layer to the debate and, perhaps, even solve it. Could it be possible that each position is right in some respects and wrong in others? This would neither be the first nor the last time this has happened. Jurists often present proposed solutions that are eclectic in nature, solutions that try to mesh the best of each of the viewpoints that came before and come out with a new vantage point that is better than the ones that preceded it. Jensen explains that there is an Enlightened Value Maximization theory and an Enlightened Stakeholder Theory.66 To arrive at that idea, he says that authors used to wonder ‘whether shareholders should be held in higher regard than other constituencies, such as employees, customers, creditors, and so on’.67 This is unproductive and incorrect because it misses the possibility of finding ‘what corporate behavior will get the most out of society’s limited resources’.68
As stated before, companies have a fiduciary duty to shareholders. Yet, at the same time, it is for the long-term benefit of shareholders to do things for their stakeholders. In other words, if shareholders want to get the most out of what they are doing, they will have to consider the context in which companies operate. Failing to do so will result in less profit, not more. The melding of both positions will deliver improved corporate governance and bridge a path that both maximises value and does not choose ‘[s]hort-term profit maximization at the expense of long-term value creation [which] is a sure way to destroy value’.69
VI. CONCLUSIONS
It is not unreasonable to criticise companies for engaging in tax avoidance. Asserting that criticising tax avoidance is unreasonable would make this whole intellectual exercise void. Criticising and critiquing companies for engaging in tax avoidance is exactly what we have been doing and what we will continue doing in the legal, economic and philosophical world. A debate so thoughtful and interesting can never be considered unreasonable. It is indeed reasonable to go forward with this discussion to see whether it is possible to find a middle ground that does not leave out useful elements of every position that we have seen throughout this article. The traditional way of framing this debate used to be shareholders versus stakeholders, a vantage point that proved its usefulness in the early stages of the corresponding literature and jurisprudence, but that has been outgrown in the last few decades. The real world is far more complex than the ideal categories we develop to try to understand it.
Shareholder theorists argued that company’s sole duty was to maximise shareholder profits due to several reasons, as I explained before. On the other hand, stakeholder theory defenders supported that there are far more pressing issues than simply generating profits for shareholders, such as protecting the environment and other CSR related agendas. The debate turns sterile as soon as we realise each position holds value and presents sound arguments on their side of the fence. Therefore, I conclude that Jensen’s eclectic proposition is the right way going forward, by retaining the best characteristics of each school of thought and presenting solutions to their pitfalls. Maximising shareholder profits is not companies’ sole duty, although it would not be a bad idea to push a CSR agenda if they want to maximise their profits. In the long run, creating value has to do with survival, and the survival of the fittest depends on actually offering what stakeholders of all kinds want.
[1] Michael C Jensen, ‘Value Maximization, Stakeholder Theory, and the Corporate Objective Function’ (2010) 22 Journal of Applied Corporate Finance 13, 32.
[2] Helvering v Gregory [1934] 2d Cir 69 F2d 809, 810 . “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
[3] Marvin A Chirelstein, ‘Learned Hand’s Contribution to the Law of Tax Avoidance’ (1968) 77 The Yale Law Journal 440.
[4] Levene v CIR [1928] 13 TC 486 (HL) 501-502. “It is trite law that His Majesty’s subjects are free, if they can, to make their own arrangements so that their cases may fall outside the scope of the taxing acts.”
[5] Ayrshire Pullman Motor Services and D M Ritchie v CIR [1929] 14 TC 754 (CS) 341. “No man in this country is under the smallest obligation, moral or other, so to arrange his legal relations to his business or to his property as to enable the Inland Revenue to put the largest possible shovel into his stores.”
[6] IRC v Willoughby [1997] STC 995 (HL) 116. “[I]t would be absurd in the context of s 741 to describe as tax avoidance the acceptance of an offer of freedom from tax which Parliament has deliberately made.”
[7] Martín A Litwak, Cómo protegen sus activos los más ricos y por qué deberíamos imitarlos: Planificación patrimonial internacional en la era de la transparencia (Galileiland 2018) citing ICA- Industrias Comerciales Argentinas SRL, Fallos 241:210. “[T]he legitimate taxpayer’s effort to keep their taxes as low as legally possible deserves no reprobation.”
[8] R (on the application of Rowe and others) v Revenue and Customs Commissioners [2017] EWCA Civ 2105, [2018] STC 462, [53].
[9] J Freedman, ‘The Tax Avoidance Culture: Who Is Responsible? Governmental Influences and Corporate Social Responsibility’ (2006) 59 Current Legal Problems 361.
[10] Erich Kirchler, Boris Maciejovsky and Friedrich Schneider, ‘Everyday Representations of Tax Avoidance, Tax Evasion, and Tax Flight: Do Legal Differences Matter?’ (2003) 24 Journal of Economic Psychology 536. “Tax avoidance refers to an attempt to reduce tax payments by legal means, for instance by exploiting tax-loopholes, whereas tax evasion refers to an illegal reduction of tax payments, for instance by underreporting income or by stating higher deduction-rates. Tax flight refers to the relocation of businesses, only in order to save taxes, for instance by making use of offshore tax havens.”
[11] Zoe Prebble and John Prebble, ‘The Morality of Tax Avoidance’ (2010) 43 Creighton Law Review 693, 745.
[12] ibid 705.
[13] ibid 708.
[14] ibid 702.
[15] ibid.
[16] Steven A Bank, ‘When Did Tax Avoidance Become Respectable?’ (2017) 71 Tax Law Review 123.
[17] ibid 127.
[18] ibid 128.
[19] Kiridaran Kanagaretnam and others, ‘Societal Trust and Corporate Tax Avoidance’ (2018) 23 Review of Accounting Studies 1588.
[20] ibid.
[21] Michael H Hoeflich, ‘Of Reason, Gamesmanship, and Taxes: A Jurisprudential and Games Theoretical Approach to the Problem of Voluntary Compliance’ (1983) 2 The American Journal of Tax Policy 9, 33.
[22] Tony Honoré, ‘The Dependence of Morality On Law’ (1993) Oxford Journal of Legal Studies 1.
[23] ibid 17.
[24] Jensen (n 1).
[25] ibid 39.
[26] ibid 32.
[27] Judith Freedman, ‘The Tax Avoidance Culture: Who Is Responsible? Governmental Influences and Corporate Social Responsibility’ (2006) 59 Current Legal Problems 359.
[28] ibid citing European Commission Communication COM (2006) 01136.
[29] ibid 379.
[30] Ronald F Duska, Contemporary Reflections on Business Ethics (Springer 2007) 236.
[31] ibid 10.
[32] ibid.
[33] Samuel Gregg, ‘How Stakeholder Theory Undermines the Rule of Law’ (Law & Liberty, 2021) <https://lawliberty.org/book-review/how-stakeholder-theory-undermines-the-rule-of-law/> accessed 12 May 2021. Samuel Gregg, ‘The Soft Corporatism of Stakeholder Capitalism’ (Law & Liberty, 2021) <https://lawliberty.org/the-soft-corporatism-of-stakeholder-theory/> accessed 15 May 2021.
[34] Gregg ‘How Stakeholder Theory Undermines the Rule of Law’ and Gregg ‘The Soft Corporatism of Stakeholder Capitalism’ (n 33). “[T]he claim that any company has a responsibility to all those who conceivably have a stake in the business —employees, customers, local communities, suppliers, the environment, past and future generations, etc.— besides those who actually own or have invested capital in the company.”
[35] ibid citing Klaus Schwab ‘What is stakeholder capitalism?’ (World Economic Forum, 2021) <https://www.weforum.org/agenda/2021/01/klaus-schwab-on-what-is-stakeholder-capitalism-history-relevance/> accessed 12 May 2021.
[36] Milton Friedman, ‘A Friedman Doctrine — The Social Responsibility Of Business Is to Increase Its Profits’ The New York Times (New York, 13 September 1970) 1.
[37] Garret Edwards and Yamila Feccia, ‘Argentina: ¿Qué dirían Adam Smith y Milton Friedman sobre la “Ley de talles”? (Cato Institute, 18 November 2015) <https://www.elcato.org/argentina-que-dirian-adam-smith-y-milton-friedman-sobre-la-ley-de-talles> accessed 15 May 2021.
[38] Friedman (n 36).
[39] Adam Smith, The Theory of Moral Sentiments (Liberty Fund 1982) and Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, vols 1 & 2 (11. print, Liberty Fund 2009). “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages.”
[40] Friedman (n 36).
[41] Smith (n 39).
[42] Friedman (n 36).
[43] Robert Nozick, Anarchy, State, and Utopia (3rd edn, Nachdr, Blackwell 2012).
[44] ibid 169.
[45] Eric C Chaffee and Karie Davis-Nozemack, ‘Corporate Tax Avoidance and Honoring the Fiduciary Duties Owed to the Corporation and Its Stockholders’ (2017) 58 Boston College Law Review 1425.
[46] Dodge v. Ford Motor Co. [1919] 204 Mich. 459, 170 N.W. 668.
[47] Chaffee and Davis-Nozemack (n 45).
[48] Dodge v. Ford Motor Co. (n 46) 1426.
[49] R H Coase, ‘The Nature of the Firm’ (1937) 4 Economica 386.
[50] Mihir A Desai and Dhammika Dharmapala, ‘Corporate Tax Avoidance and Firm Value’ (2009) 91 The Review of Economics and Statistics 537.
[51] Luke Watson, ‘Corporate Social Responsibility, Tax Avoidance, and Earnings Performance’ (2015) 37 Journal of the American Taxation Association 1.
[52] ibid.
[53] ibid 2.
[54] Kalmen Datt, ‘To Shame or Not to Shame: That Is the Question’ (2016) 14(2) eJournal of Tax Research 486.
[55] Reuven S Avi-Yonah, ‘Corporate Taxation and Corporate Social Responsibility’ (2014) 11 NYU Journal of Law & Business 1. Reuven S Avi-Yonah, ‘The Cyclical Transformations of the Corporate Form: A Historical Perspective on Corporate Social Responsibility’ (2005) 30 Delaware Journal of Corporate Law 767.
[56] Grahame R Dowling, ‘The Curious Case of Corporate Tax Avoidance: Is It Socially Irresponsible?’ (2014) 124 Journal of Business Ethics 173.
[57] ibid.
[58] ibid 174.
[59] PwC, ‘Tax Transparency Building Public Trust How Companies Are Telling Their Tax Story’ https://www.pwc.co.uk/assets/pdf/2013-tax-transparency-framework-report.pdf> accessed 12 May 2021.
[60] Mark A Michael, ‘Redistributive Taxation, Self‐Ownership and the Fruit of Labour’ (1997) 14 Journal of Applied Philosophy 141.
[61] ibid.
[62] ibid.
[63] ibid.
[64] ibid.
[65] Jensen (n 1).
[66] ibid 38-9.
[67] ibid 39.
[68] ibid.
[69] ibid 38.
Ernesto Edwards
Abg (Universidad Nacional de Rosario), LLM (LSE) 21′ and Private Law Notes Editor of the LSE Law Review Summer Board 2021