Tax Special Investigation: HMRC ‘particularly feeble’ over failure to close loophole

Despite the tax exemption costing the UK economy at least £500m a year, the Government bowed to pressure after intense lobbying from the financial sector to allow companies to use it

The Government chose not to close a tax loophole which costs the UK economy at least £500m a year after intense lobbying from the financial sector, The Independent has learnt.

A consultation in March 2012 proposed limiting the use of the quoted Eurobond exemption, which is being used for tax avoidance by a range of UK companies. But after being bombarded with submissions from financial firms, companies using the legal loophole and major accountancy companies, HMRC decided not to take the proposals forward last October.

HMRC estimated the Exchequer was losing £200m a year due to use of the exemption. However, listings on the Channel Islands Stock Exchange and UK accounts registered at Companies House suggest this was a significant underestimation.

More than 30 companies are paying more than £2bn in total to their overseas owners every year as interest on borrowings. As these can be deducted from the companies’ taxable UK income, this amounts to a corporation tax saving of around £500m when compared to equivalent investment in shares in the company.

Without the exemption, any tax savings from the interest deductions would be greatly reduced by the 20 per cent withholding tax that HMRC would otherwise take from interest payments going overseas. As many more companies list debt in the Channel Islands, and the loophole also works in other exchanges including Luxembourg and the Cayman Islands, the total tax lost may be significantly higher.

Margaret Hodge MP, chair of the Public Accounts Committee, which will raise the findings at a meeting of the committee with HMRC this Monday, said she found HMRC’s behaviour over the consultation “extraordinary”. “It is a persistent finding of my Committee that HMRC is nowhere near tough enough in cracking down on avoidance and closing loopholes. In this case they appear to have been particularly feeble,” she said.

The exemption was introduced in 1984 to encourage outside investment in Britain, but HMRC noted in its March consultation that: “In recent years a number of groups have issued Eurobonds between companies in the same group, and listed them on stock exchanges in territories such as the Channel Islands and Cayman Islands, where they are not actually traded. In effect, the conversion of existing inter-company debt into quoted Eurobonds enables a company to make gross payments of interest out of the UK to a fellow group company, where otherwise deduction of tax would be required.”

The interest also minimises the UK company’s tax bill. HMRC can choose to disallow a proportion of the deductions, deciding what this figure should be on a case-by-case basis. The Government invited submissions to a proposal that the quoted Eurobond exemption “would not apply where the Eurobond is issued to a fellow group company, and listed on a stock exchange on which there is no regular trading in the Eurobond”.

Using documents published under the Freedom of Information Act, the investigation, jointly conducted with Corporate Watch, found that not one of the 44 submissions to HMRC by financial bodies supported the loophole being closed. The majority (34) argued it was necessary to keep it open, while the remainder were keen to find out more about the specifics of the exemptions.

Among those making submissions were companies such as Thames Water, that have previously been revealed as benefiting from the loophole. Representations were also made by the “Big Four” accountancy firms – PWC, KPMG, Deloitte and Ernst & Young – who between them audit the accounts of all of the firms found to be using this loophole. Different companies argued that closing the loophole would be “fraught with practical difficulties”; that the tax raised “is likely to be negligible”; that there are a range of other loopholes companies could use; that such a move would “introduce uncertainty and disrupt markets that are critically important for the UK economy”; that it was impractical to eliminate because the tax relief is “extremely widely used”; and that HMRC could stop it being abused with other tools.

The language used in the anonymised letters was often hectoring, in one case calling the proposals “neither a necessary or sensible approach”.

A spokeswoman for PWC said: “All our responses to Government consultations are done in an open and transparent way. We share our experience on request, particularly on the likely practical impact of proposals, such as how they will affect the Government’s ‘open for business’ agenda. Governments seek input from a wide range of organisations.” A spokeswoman for KPMG said they had never “lobbied” on behalf of any clients about the Eurobond exemption. She said: “We made recommendations on detailed technical aspects but we did not give a recommendation that the exemption should not be changed and we suggested further analysis.”

A spokeswoman from Ernst & Young said: “We do not decide tax policy... We assist HMRC in identifying any unintended consequences of tax legislation. Our responses are the views of EY and not those of our clients..”

A spokesman for HMRC said: “The figure of £200m was a provisional figure. The number of Eurobonds issued intra-group was not known and one of the purposes of the consultation was to identify the likely real impact. It became apparent that the changes suggested in the consultation would not have yielded that amount and would have had adverse effects on companies that are entitled to pay gross under double taxation treaties. The Government decided to explore the issue further in the context of a wider consideration of cross-border payments.”