Eurobonds scandal: You can blame the tax avoiders. But the Government’s the real villain

At the same time as HMRC complains about avoidance, it is creating fresh loopholes

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You would expect HM Revenue and Customs (HMRC) to know the A to Z of tax avoidance in great detail. After all, it and its predecessor bodies have been collecting taxes since the 17th century. Its immediate forerunner, the Inland Revenue, was created in 1849. It must have an encyclopaedic knowledge of every tax avoidance device ever used.

Why, then, does it preside over a system full of loopholes, with tax revenues draining away at a thousand points? The tax gap, which measures the difference between what should have been collected and what has actually been received, currently stands at 7 per cent of the tax due, a sum of £35bn.

One of the major reasons is well illustrated by the special investigation that The Independent has been publishing this week into the “Eurobond tax scandal”. The series reminds us that governments knowingly distort their tax systems in order to gain competitive advantage in international trade. Last year, for instance, Treasury ministers were trumpeting Britain’s tax advantages in Washington. The US is the biggest source of companies considering moving to Britain for tax reasons. Ernst & Young, the professional services firm, reported last year that Britain was successfully competing with low-tax countries such as Switzerland and Singapore.

So HMRC finds itself having to be responsive to two conflicting requirements – collect the maximum tax possible yet avoid damaging the international competitiveness of Britain as a place to do business. And a perfectly good example is indeed the so-called “quoted Eurobond exemption” that goes back to 1984. The Government of the day introduced the loophole in order to make UK companies more attractive to foreign lenders looking to reduce their tax bills. It works like this.

When a UK company pays interest to an overseas lender it would usually have to send 20 per cent straight to HMRC. The exemption allowed banks and other investors to receive the interest without the deduction if they lent their money through buying bonds via a “recognised” stock exchange, such as the Channel Islands or the Cayman Islands. In effect, the Government had made HMRC complicit in tax avoidance.

What Government ministers rarely envisage, however, is how clever accountants and lawyers will develop a government-created loophole into something that goes much further than intended. In this case, what the experts did was to turn the quoted Eurobond exemption on its head.

In groups comprising British and foreign registered companies, a common structure, they would cause one of the foreign entities to make loans to the major British company in the group – so that its tax liability could be substantially reduced by offsetting the interest it is now paying on a loan that it didn’t need! I know this sounds crazy, but that is how it is done.

HMRC finally calculated a few years ago that it was losing some £200m a year from these manoeuvres. The Independent believes that the actual sum is nearer £500m. Nevertheless, HMRC recently decided to hold a consultation on reforms that could be made to reduce the tax loss. The respondents were overwhelmingly financial firms, companies using the legal loophole, and major accountancy companies.

This is exactly like a householder deciding to consult with assorted burglars and thieves about plans to enhance the security of his or her residence. The burglars didn’t think it would be a good idea! Let us go through the responses HMRC received in this light. The first objection to the proposed reforms was that the changes would “add to compliance costs, as businesses sought to restructure existing arrangements”. That is, it would cost the burglars money.

A second objection is technical in nature, but a translation can be supplied. In the original language it reads: “The positive Exchequer effect (in other words the extra tax that would be collected) was questioned by respondents who expressed the view that treaty relief (see below) would often be available in cases where the exemption was currently used”. “Treaty relief” refers to double taxation treaties between pairs of countries that are designed to prevent paying tax twice on a single transaction. Or, in burglars’ language, “even if you install new locks, we know of another way to break in”.

HMRC described a third objection: that firms would devise securities that had the same tax liability-reducing characteristics as loans without actually being loans. In other words, the burglars would disguise themselves as, say, coming to read the householder’s gas meter in order to gain entrance and make off with some booty.

I am not, however, inclined to accuse HMRC of naivety in the way it conducted its farcical consultation – from which it concluded, by the way, that it would make no reforms to the exemption. It could see tax receipts draining away, it acknowledged a duty to consider putting a stop to the leak, but it has a Government on its back that is intent on making Britain into a sort of tax haven.

Nor do I criticise the companies named by The Independent that have taken out loans with the sole purpose of reducing their tax bills. For their common characteristic is that they are not really in charge of their own destinies. All are owned by private equity firms, or by the giant Ontario Teachers’ Pension Plan Board that behaves like one. Private equity firms are extremely active investors.

They take full control of poorly performing companies so that their shares are no longer quoted on the Stock Exchange. As a result, these companies escape the often debilitating need to report their results every quarter, which in turn encourages managements to act tactically rather than strategically. Instead, private equity firms set about making long-term improvements, before eventually selling off their holding back to the investing public – at a substantial profit. It is the private equity firms that insist on using the quoted Eurobond exemption to reduce tax bills, rather than the companies they own.

So are the private equity firms really the villains of the piece? Again, I don’t believe so. For they in turn work for large investors who supply the capital they deploy. And to these large investors, private equity firms owe a fiduciary duty, which is legally and prudently to maximize their returns. So if the Government itself supplies a loophole that allows tax to be saved, then the private equity firms are more less obliged to use it, for to do so is both a legal and a prudent method of serving investors’ interests.

No, the guilty party is plain to see. It is not Her Majesty’s Revenue and Customs; it is Her Majesty’s Government itself. In a typically muddled fashion, devoid of principle, it goes about chasing tax avoiders and evaders, making a song and dance as it proceeds, while also quietly manufacturing fresh tax exemptions. So as you walk along the high street and pass Maplin Electronics; Pizza Express, Zizzi; Ask; Pets at Home; Pret à Manger; Nando’s; Café Rouge, Bella Italia; Strada; and BHS; reflect that each one of these is not paying the tax it should – by kind permission of Her Majesty’s Government.

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