Tax and company debt

There has been a lot of comment on the way Starbucks and other companies have managed their tax affairs. The debate has focused on particular techniques companies have used and we can hope that those methods will be less prevalent in future. However I haven’t seen any comment on one aspect of company financing and tax which might eventually cause a problem for sustainability campaigners.

In a recent blog I outlined why debt financing for companies is more sustainable than using shares and why changes in central bank policy might harm it. But debt financing also has one significant tax advantage: interest payments are deducted before tax is calculated and so companies with debt pay less tax. To stretch the UK coffee shop versus Starbucks analogy to breaking point, a UK coffee shop with debt will also pay less tax than one without debt. If we want companies to pay the “right” amount of tax this could be criticised. The problem for sustainability is that if debt financing becomes frowned on because of tax, then a useful form of long term financing may be compromised.

That may be an extreme threat, but thinking about it made me wonder what the ideal financial structure for a company is from a sustainability point of view. Given what I’ve said above it would ideally include some kind of debt. The difficulty is that debt is only available if a company is financially sound and the debt will be repaid. If there is a risk of the debt not being repaid only share finance is suitable. This means that in general risky companies cannot use debt. Examples of the types of companies that would struggle to get debt finance would be small companies, companies that have variable or cyclical profits or firms that have a dependency on unproven technology. Since the type of firms we need to see emerge to pilot sustainable business models will almost certainly be small, technology dependent and (in their early days) subject to variable profits there is a problem.

There’s clearly a need to consider this area more; especially if debt becomes less popular either because of tax issues or because of the possible changes in economic policy outlined in my earlier blog. There are two linked questions without easy answers: what is the right financing structure from a sustainability perspective and how can it be future-proofed? 

Further links:

• Click here to read Simon's earlier blog about central bankers, inflation and sustainability