The last thing that the Government needs is another huge row over taxation, coming on the heels of a thrashing in the local elections and while the nasty whiff of nondoms and capital gains tax (CGT) still hangs in the air. Yet, as each day passes, the cauldron that is the Treasury’s proposals on taxation of foreign income looks dangerously close to boiling over.

That huge corporates such as WPP, the advertising group, and Smith & Nephew, the implants maker, are speaking out against the proposals – and threatening to leave the UK in protest – underscores the deep and growing frustration among British businesses. To be fair, unlike nondoms and CGT, the Government is at least consulting with business on its proposals this time around. And let us not forget that, so far at least, they are just that: proposals.

Yet, nevertheless, the mere thought of HM Revenue & Customs extracting a bigger slug of tax on income earned abroad is enough to make at least two companies – Shire Pharmaceuticals and United Business Media – up sticks and move headquarters to a friendlier tax environment in the Irish Republic.

So what is all the fuss about? Under the old controlled foreign companies (CFC) regime, businesses paid tax on all the income they remitted to the UK from overseas. Those rules have been part of the tax system since the 1980s. Although they sound quite harsh, in practice the rules were only for income that was remitted – in other words, not all of it was – and there was a string of exemptions and “get-out” clauses, which meant that the scheme was not as expensive as it might seem. Companies received credits for tax they paid abroad, although that was a cumbersome process because it effectively meant paying the tax twice then getting a rebate later.

Under the new regime, the Government is saying that any profits remitted to the UK will be tax exempt. But because that system could be open to abuse (by companies diverting UK profits offshore) the Treasury is also doing away with the CFC rules and introducing a new controlled companies (CC) scheme. In a nutshell, it gives the Treasury carte blanche to rake in taxes on any foreign income, regardless of whether it would ever be remitted to the UK.

John Whiting, a tax partner in PricewaterhouseCoopers, the accountant, said that the exemption of taxation on foreign dividends was welcome, but he cautioned that the devil was in the detail. “The Government seems to be introducing a regime that will look more closely at companies controlled by UK businesses,” he said. “On the one hand, there will be a little exemption for some profits, but on the other hand, twice as much tax will be taken back.”

In its proposal document, which it published last July, the Government said that the changes were needed because the existing rules “have become increasingly unsuited to the needs of business and Government” in light of the globalisation and regulatory changes that made the current regime overcomplex.

Regardless of the minutiae, the big worry is that more British companies will start to leave the UK before the changes take effect. The big question, however, is whether they can afford to. Companies such as WPP, which already pays about £200 million in taxes, have their roots in the UK and moving offshore could hurt them reputationally, not to mention the logistics and expense of moving.

Sir Martin Sorrell, the chief executive of WPP, yesterday said: “The economic costs of moving . . . are dwarfed by the savings that we would achieve if the proposals are put in place.” He argues that if the economics of staying in London start to work in the opposite direction for businesses as multinational as WPP, then it makes sense to consider a new home, be that in Ireland or somewhere else.

Mr Whiting said that he believed that other businesses would feel the same. He said that there would not be a wholesale shift of UK corporates offshore, but rather companies would move some of their operations first, then more divisions over time.

“I don’t think that these are empty threats,” Mr Whiting said. “These are big companies that are genuinely thinking about moving parts of their operations. It’s a big issue and it’s not going to go away.”

Changing the rules

The Government’s proposals on taxation of foreign income:

— To exempt foreign dividends paid to large and medium-size UK-based companies from UK tax

— To scrap the old regime and introduce a system that will tax “all of the profits that it thinks should be viewed as taxable in the UK”

— Detailed plans to be out in early July, for implementation next year

What Government says:

— It will create a straightforward regime for taxing foreign profits

— It will improve competitiveness and attractiveness of the UK as a location for multinational business

— It will help to tax “artifically located” profits

What business says:

— The Government is giving with one hand but taking with the other