Balance of power shifts in the wake of ship tax change

Governments can see entire industries disappear over the horizon and still fail to react appropriately

THE GOVERNMENT'S new plans to give ship-owners tax breaks to stop them moving offshore will be an interesting test case not just for the shipping industry, but for relations between government and industries more generally.

For the shipping industry has been a pioneer of corporate avoidance of national taxation and regulation. Most industries can to some extent move their activities offshore if they do not like the tax and regulatory regime of any one country. But while it takes a while to move factories abroad and incurs heavy costs, moving ships offshore is normal and natural: moving offshore is, after all, what ships do for a living.

Thus flagging out - registering ships under flags of convenience like Liberia and Panama - was the earliest commercial example of companies moving their operations to a more friendly regulatory environment. The particular appeal of foreign registration was not so much lower tax, but less onerous regulation - however, taxation has played a part, witness the commitment by P&O to bring back half its fleet under the UK flag when the new tax plans go through.

But it has taken a long time. For more than two decades governments have persisted in running tax and regulatory regimes which drove business offshore, and Britain has acted now to try and bring business back only when it became clear that other European Union countries, such as the Netherlands, had been successful with similar plans.

If there is stickiness in industry moving offshore - even in an inherently mobile industry like shipping - there is much greater stickiness in the governmental response. Governments can see entire industries disappear over the horizon and still fail to react appropriately.

Now, the entire world economy is becoming more mobile. It is easier to move an insurance or fund-management business offshore than it is to move a physical manufacturing plant, so as the weight of economic activity shifts from producing physical products to producing intangibles, so the world's output becomes inherently less firmly tied to any one location. Betting - the ultimate intangible business - can use the Internet to locate anywhere it wants.

More than this, new industries are almost totally mobile: if you are starting something new you can put it anywhere. The communications revolution helps. Yet even in e-commerce there are advantages to first-movers. If a business is started in one location it takes quite a bit of shoving to move it. So it is unsurprising that the US, which leads the world in this field, is following a very liberal tax regime. It wants to check any tendency for e-commerce to move offshore. The EU, more concerned with tax harmonisation, is trying to push those countries (like the UK and Ireland) which want to keep the Net a tax-free zone towards some form of Europe-wide tax on e-commerce. The obvious risk is that the EU will lose the e-commerce industry, in much the same way that the US and the UK lost much of its shipping industry.

Might industry become so mobile that it becomes virtually impossible to raise any taxation at all from it? Here, I suggest, the lesson from shipping is more encouraging.

The new proposals are, after all, a tax. The tax is to be set at a low rate, but the fact that companies are evidently prepared to repatriate some of their business suggests that responsible companies accept that a modest level of taxation is acceptable and necessary. The moral seems to be that governments that work to craft a business-friendly tax regime will be rewarded.

Similar implications from the shipping industry can be drawn for personal taxation. Up to now the ability of people to move offshore to tax havens has been more limited than the ability of businesses to do so. Yes, there are plans for cruise liners to sail the world, providing a permanent offshore tax haven, and yes, some places have specialised in providing locations for rich retirees. But neither Panama nor Liberia have proved as attractive havens for the high-net-worth individuals of the world as they have for the shipping industry.

While in theory people who work on screen can base themselves anywhere, in practice their options are much more limited. Social and cultural factors limit mobility too. Even insurance companies in Bermuda have some difficulties in getting people to crew the offshore industry there.

However, once one or two mainstream developed countries start using taxation to attract highly talented people, expect the practice to spread.

It was the Netherlands that bumped the UK into the new shipping measures. While business was quietly drifting off to Liberia, the government ignored the loss. But when the Netherlands found a way of pulling it back, it jumped.

So it may turn out to be with people. The main reason why Ericsson is moving its international HQ to London is because it could not attract internationally-experienced staff to Sweden. Tax is a key part of that. So expect tax competition for people to grow within the EU. As with shipping, no government is going to act if taxation simply drives people to small, specialised tax havens. But once tax competition becomes mainstream, expect action.

The implication of this is that tax competition within the EU, and certainly between EU countries and the US, will gradually reduce personal tax rates. But the process will take a long time to work through.

Perhaps the biggest lesson of the shipping industry is that taxation is becoming a negotiation between two equal partners. The Government may have the legal ability to impose a tax, but with mobile industries it can only collect it if it sets the rate and the framework with the active agreement (not merely the grudging consent) of the taxed. Gradually the power-balance in the game is shifting, and shipping illustrates well the way it will continue to change.