Senior tax officials were criticised by MPs yesterday because their estimate of £35bn lost every year in unpaid tax is just “the tip of the iceberg”, as it does not include the use of legal avoidance schemes such as the one most recently reported in The Independent.
Officials from HM Revenue and Customs were interrogated by The Committee of Public Accounts at a hearing in Westminster over its failure to claw back tax from big businesses. Margaret Hodge MP, chair of the committee, listed all the legal tax avoidance schemes used by household names that would not be included in HMRC’s calculation of the tax gap and said, “at the moment, therefore, your tax gap is clearly the tip of the iceberg”.
A joint investigation between this newspaper and Corporate Watch revealed last week that more than 30 companies, including major high street chains, the Channel Tunnel rail link and Camelot, are using a tax-avoidance scheme by which UK companies load up with debt from their overseas owners and use the interest to slash their taxable UK income.
Payments are sent to the owners tax free because the loans are made through offshore stock exchanges such as the Channel Islands that qualify, under HMRC regulations, for the Quoted Eurobond Exemption. Without the exemption, the owners would have to pay a 20 per cent “withholding” tax which would cancel out most of the savings from the interest deductions.
Last year HMRC considered restricting the exemption to stop it being used for such “intra-group” lending, but decided to keep it open after lobbying by financial and accountancy firms. It estimated the loophole was costing the UK economy £200m a year, but analysis of the Channel Islands Stock Exchange and UK company accounts suggests a figure of over £500m.
Ian Swales, a Liberal Democrat member of the committee, asked HMRC: “The Independent last week was full of examples of intra-company loans being charged at 16 per cent. Do you believe that’s a good arm’s length rate for an intra-company loan?”
Britain’s most senior tax man, Jim Harra, the Director General of Business Tax, replied: “We would look at each case on its own facts to determine what a good arm’s length rate would be.” He pointed out that this newspaper had reported some examples where HMRC had restricted the interest deduction.
Mr Swales later asked: “What do you do where a UK company suddenly buys shares in an offshore country, lends the money back to the UK and, miraculously, the amount of interest they pay is roughly the amount of the UK profits, as quite a number of UK companies have done? Why do you allow that to happen?”
Interjecting to speak about the companies exposed in The Independent as benefitting from the legal loophole, Ms Hodge said: “It’s all of them: BHS, Maplin, Pets At Home, Ask, Zizzi, Pizza Express, half of the health companies who get money from the taxpayer for health. It goes on and on and on.”
On the question of why the Government had not acted to close the Eurobond loophole, Mr Harra said: “The Government has not decided it’s not going to do anything about it, but the Government has decided it would not be right to implement the proposals put forward in that consultation because it is clear it would not have had the desired effect and would not have yielded the £200m that we anticipated that it would.
“We monitor how it is used and we were concerned that intra-group financing of the kind you described was not how it was envisaged that this exemption would work. Though we are clear that unless and until some reform is made that that is the effect that the rules have.”
Among Mr Harra’s justifications as to why he doubted closing the loophole would save the millions HMRC initially anticipated, was that companies would use other tax-avoidance schemes. He said: “There are a wide array of other ways whereby withholding tax is not applied, what the measure would have done is just put some administrative obstacles in the way.”
Edward Troup, Tax Assurance Commissioner, said HMRC could not guess what would be owed by those who use loopholes to avoid tax as it can only collect what the law allows.
HMRC also admitted in the hearing that it has only collected £440m from Swiss accounts for the current tax year, despite George Osborne basing the year’s borrowing on a tax office estimate that they would collect £3.1bn.
Tax trick: how it works
The quoted Eurobond exemption was set up in 1984 to make British companies more attractive to foreign investors. It allowed companies to pay interest to an overseas lender tax free, if the money was lent through a stock exchange such as the Channel Islands or the Cayman Islands.
However, savvy British companies soon realised the exemption could be used by their foreign owners to legally send their profits through tax havens, thus reducing or entirely wiping out their UK tax bills.
Instead of investing their money in the shares of the companies they buy, an offshore owner will lend them money, often at extremely high interest rates, through an offshore stock exchange.
The companies can then take the annual interest off their profits before they have been taxed in the UK, potentially eliminating their tax bill. Without the exemption, 20 per cent of interest payments could be deducted by HMRC, greatly reducing the overall tax saving.