UK: THE GREAT ESCAPE.

UK: THE GREAT ESCAPE. - Billions in corporate tax are being kept out of Treasury hands as companies and their tax advisers exploit the loopholes and grey areas in the tax laws both at home and abroad.

by Robert Outram.
Last Updated: 31 Aug 2010

Billions in corporate tax are being kept out of Treasury hands as companies and their tax advisers exploit the loopholes and grey areas in the tax laws both at home and abroad.

'Only the little people pay taxes.' So pronounced New York hotel queen Leona Helmsley - before she found herself detained in the local five-star prison, that is. A rare bird in that she uttered such fiscal judgments quite so publicly, Helmsley is nonetheless in good company when it comes to the spirit behind her words. Few companies go to the extremes which landed Helmsley in jail, but even fewer view tax as anything but an unattractive option best avoided or at the very least substantially minimised.

Hard figures about the cost of corporate tax avoidance in Britain are hard to come by although it is widely accepted that tax planning, particularly international tax planning, denies the Treasury billions of pounds every year. Growing sophistication in avoiding tax was cited as one of the causes behind the £7 billion shortfall in projected revenues for the Government last fiscal year.

And tax advice is a fast growing business in Britain, where the Big Six accountancy firms alone earned fees in the region of £650 million last year. While one can only guess how much advisers may be saving their customers, the assumption must be that clients are getting decent returns for their money. Not that the fine art of avoidance is all that difficult: tax laws at home and abroad are so riddled with loopholes and grey areas that any well-advised company can easily cut its tax bill substantially.

Hanson plc has long been a classic case of applied tax planning. In the 10 years to 1994, for example, the company's rate of tax averaged around 22% (compared to the current official rate of 33%), thanks partly to a complex corporate structure organised through offshore companies in Panama and elsewhere. The details are quite deliberately obscure, but it is clear that by ensuring capital assets, including subsidiaries, are owned by holding companies in low-tax regimes, Hanson has at least managed to defer massive capital gains liabilities.

Rupert Murdoch's global media empire, News International, has been even more successful in holding down its tax bill to a little over 1% on profits of more than £1 billion over the last decade. The central plank in NI's tax strategy has been to make the best use of massive losses to offset against profits elsewhere in the group. The trick is to net off those profits and losses in a way which minimises the tax liability. A company like NI does not pay tax on net profits for the whole group, and will have a considerable degree of discretion in the way that losses and capital allowances can be used to ensure that profits, especially profits in higher-tax regimes, are offset.

Even where the Inland Revenue is aware that a company is operating in a grey area, it rarely takes punitive action. The last major crackdown which resulted in prosecutions at a major company involved Nissan UK, the car dealership which previously acted as the outlet in Britain for the (separately owned) Japanese car manufacturer Nissan. A massive raid in 1991 eventually led to prosecution of the directors concerned, the flight of chairman Octav Botnar to Switzerland and the collapse of the company. Normally the Revenue is more willing to plea-bargain its way to a deal, saving the cost of a court case.

For many, however, it never comes anywhere near a plea-bargain. So how do companies making money in the UK get away with paying less - or even no - tax? Despite the cliches, simply setting up as a registered company in a tax haven like Grand Cayman or the British Virgin Islands is not enough. Says John Whiting, a senior tax partner with accountants Price Waterhouse, 'There is a myth that an international group can set up a magic structure and all the profits will disappear into it'. While wealthy individuals have considerable trusts and residence rules to shield their income and capital, companies operating in the UK will be assessed on their profits here wherever their ultimate ownership happens to be. Nonetheless companies which operate across a number of different fiscal regimes can still find a variety of ways to keep the taxman at bay.

One favourite ploy has been to shift profits into low-tax countries and losses into high-tax countries. The principle is simple: virtually all tax regimes allow some form of group relief, so that losses in one arm of a group can be offset against profits in another. When different subsidiaries are operating in regimes with very different tax rates, manipulating the result makes a big difference to the final bill.

Another tactic is simply to minimise the profits recorded. If, for example, the parent company exports luxury goods to the US, some of the taxable profit can be shaved off by setting up a company in Bermuda to act as a middleman. The Bermuda company will act as agent and take a cut of the profits - a cut taxed at the (highly favourable) local rate. The US operation will consequently have a lower tax liability, its profits having been artificially reduced.

Alternatively, profits can be manipulated by distorting the terms of transactions between operating companies in the group, that is, by over-or under-charging for goods, materials or services, a process known as transfer pricing. The US Senate has found instances of companies charging their US operations $29 for a safety pin, while purchasing US-made goods for ludicrously low amounts, in order to skew the tax charge. Management or consultancy fees can also be used, while an inter-company loan, fixed at well above or below the market rate of interest, can also achieve the same end. In principle, virtually all tax authorities insist that all such transactions are carried out on an arm's length basis, that is, at the market rate, so that no distortion is permitted. In reality, however, transfer pricing is a very difficult area for the authorities to police.

This is partly because there are inter-company charges for management services and for intellectual property (such as a brand or a patent) for which no market value could be easily identified, and partly because the huge volume of transactions concerned makes it very hard for the Revenue to keep track of every multinational.

Although transfer pricing remains a problem, the UK tax authorities have taken steps to crack down on the offshore tax avoider. Under legislation which was tightened up in the last Finance Act, so-called controlled foreign companies (CFCs) in low-tax areas must pay out 90% of accounting profits to the UK parent. Only subsidiaries which are genuinely trading in the area are exempt; vehicles created expressly to save tax will be caught out.

However the CFC legislation leaves untouched the UK's quirky distinction between income and capital gains, thereby providing another opportunity for avoiding tax through an offshore vehicle. Existing laws mean that a company with assets in a tax haven can defer its capital gains liability indefinitely as long as the ownership of the assets remains outside the UK. Of course, once those assets are realised and repatriated to the UK, there will be a capital gains charge, but until then the untaxed gains are included in the group's assets. That means a stronger balance sheet, which in turn means better credit terms. And funds banked in a low-tax regime can be spent in a high-tax location once the firm's bankers are given a charge over the offshore assets.

When it comes to capital gains and property, yet more grey areas loom large. For under British law a company can classify its property holdings as investments (which fall under the capital gains regime) rather than property dealing (operations, and therefore subject to corporation tax). In that way, gains on property investments can also be sheltered offshore.

If capital gains legislation remains quirky, so too do the rules on stamp duty (currently 1% of transaction value) and tax havens. Stamp duty can still be avoided by drawing up documents in the UK, taking a day trip to Jersey or Guernsey, signing and stamping them outside UK jurisdiction, and leaving them in a local safe deposit or bank vault.

This works because contracts stamped in the Channel Islands can be enforced in the UK courts.

How much these tax avoidance ploys could be reined in, and what that would mean for the Exchequer is a moot point, however.

Figures for the past couple of decades show that the image of an unequal struggle between the poor old government and wily tax specialists is rather misleading. Overall, the take from corporation tax has been rising significantly.

Since 1978/79, revenue has increased fivefold, while GDP only rose fourfold.

And according to the Institute of Fiscal Studies, corporation tax now accounts for 8% of government revenue, compared to 6% in 1978/79. In fact, the UK is bucking a trend, for elsewhere in the western world, tax on corporate income accounts for a smaller and smaller slice of the cake.

Under the shadow secretary to the Treasury, Andrew Smith, the Labour party has embarked on a far-reaching review of corporate taxation. The party's paper, Tackling Tax Abuses (November 1994), makes it clear that also included in the review is a declaration of war on the avoidance industry: '... fairness demands that the Revenue takes a determined attitude to those who engage in systematic tax avoidance'. More recently, shadow chancellor Gordon Brown announced that Labour intended to set up a crack Revenue team to take on the top tax advisers. But Ernst & Young tax partner Richard Law believes that, 'There is a bit of a tendency for Labour to label reliefs of which it disapproves as unjustified fiscal privileges'.

Despite a request in 1992 from the then chairman of the House of Commons Treasury select committee, Tory MP John Watts, there has been no official investigation to quantify the possible revenue a crackdown on avoidance might raise. US estimates of the impact of tax abuse have ranged up to $150 billion (£100 billion) in lost taxes from transfer pricing alone in the last few years. For this country, if the figures of £1 billion each for transfer pricing and the manipulation of advance corporation tax are anywhere near the truth, there are substantial sums to be gained from a tougher regime.

The thing is that although Government tax officials know that companies are running rings around them on a regular basis, they face a dilemma.

All governments are competing to attract inward investment and part of that competition is based on having a favourable tax regime. Tax is, if you like, a pricing issue for government, and if that price is set too high, revenue will fall. The equation was recently stated quite clearly by a senior Greek shipowner following an extensive raid on another owner's offices in the UK. John Hadjipateras was quoted in the Financial Times as saying that shipowners would stay in the country, 'as long as we are wanted. If not, there are other places for us.'

Like most fiscal regimes, tax authorities in the UK have already taken on fairly draconian powers to tackle potential abuse. If the Government really wanted to get tough, the answer might well be to make more use of these existing powers rather than bring in a mass of new legislation. Observers suggest that a Revenue investigation of a major corporation is likely to pay back its costs by three to one; an investigation of transfer pricing by something more like 300 to one. And in one exceptional case last year, an investigation came up with an extra £1.6 million from one un-named company. 'More tax inspectors' may not be a popular election slogan, but it could be a winning strategy for whoever is in power a year from now.

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