A Taxing Dilemma

BBC Radio 4's documentary programme looked this week at tax matters, and in particular, how large corporations manage to re-arrange their corporate structure to avoid paying tax.

While the government axes public spending to try to cut the deficit, Michael Robinson investigates loopholes which let big businesses slash their UK tax bills. This month George Osborne said he plans to make Britain the most attractive corporate tax regime in the G20. But some companies have already moved abroad for tax reasons. And for others able to operate on a global scale, there are many ways for them to reduce their tax liability. So how does the Government square the tax circle?

http://www.bbc.co.uk/iplayer/episode/b00vhgpl/File_on_4_A_Taxing_Dilemma/

Surprisingly, there was little about offshore jurisdictions. The main problems came from variable tax regimes within the European Union, and the fact that European law trumps British tax law.

In the Republic of Ireland, for example, there are offices where the name plates bear reference to subsidiaries of UK companies but where the companies themselves are simply wealth holding companies. All they hold is money - they have no fixed assets, no employees, and while they have to have directors, the directors receive no remuneration. In essence, they are empty shells, a channel for profits, and yet any tax they would pay is levied at Irish corporation tax rates, and not British ones, which are higher.

The UK had sought to stop this loophole, by means of the CFC (Control of Foreign Company Rules) which declared that companies who structured their corporation to avoid paying UK tax would still be caught in the net - it declared that profits would be applicable at UK corporation tax rates where there were "wholly artificial arrangements intended to escape the [UK] tax normally payable".

The UK therefore decided to pursue this in the case of Cadbury Schweppes:

The position of Cadbury Schweppes Cadbury Schweppes had set up two subsidiaries in Ireland to raise finance and provide that finance to other subsidiaries in the Cadbury Schweppes group. The Irish profits were subject to tax at 10 per cent under the rules then applicable to companies established in the International Financial Services Centre in Dublin. It was agreed by the parties that the set up in Ireland was to enable the profit from the intra-group financing transactions to benefit from the low tax regime in Ireland.(1)

The arguments centred around the "motive" of the company, which is a notoriously difficult area for anything to be proven. The UK argued that the company was subject to CFC rules and should pay UK tax, Cadbury Schweppes maintained it was just part of a general corporate strategy with no particular intent to avoid paying UK tax:

In its written statement to the ECJ before the case was heard the UK Government put forward the proposition that the Irish subsidiaries were solely incorporated to avoid UK taxation and the activities were superfluous to the group's commercial business. Cadbury Schweppes maintained that it had incorporated the Irish subsidiaries to conduct a commercial business of raising and lending money. (1)

The EU courts decision was that any tax avoidance structure had to be shown to be one set up with "wholly artificial arrangements" and the CFC rules would not apply if it could be shown "that controlled company is actually established in the host Member State and carries on genuine economic activities there". Otherwise this would be contradictory to EU law, and a restriction on intra-EU free movement. Clearly, despite to all intents and purposes, there being no operations in the Cadbury Schweppes arrangements in Ireland, the Court accepted that it was set up to "conduct a commercial business of raising and lending money", and therefore the ruling was that the CFC rules could not apply.

The same situation arise with Vodaphone and Luxembourg in 1999:

There are always a number of twists and turns to these UK/ECJ cases and Vodafone is no exception. The case centres around the takeover of Mannesmann in Germany by Vodafone in 1999 and, in particular, the establishment of a subsidiary in Luxembourg which owned the European sub-subsidiary companies in Europe and lent money to those sub-subsidiaries and, in return, earned interest on the loans. The UK Revenue argued that the interest income of the Luxembourg subsidiary should be treated as if it had been received by the UK parent company under the then CFC legislation (2)

But once more this was challenged in the Courts, on the basis of the previous ruling, effectively saying that member states could not interfere in the tax regimes of other member states, and that a company had its own freedoms:

The objective of freedom of establishment is to allow a Community national (including a company) to participate on a stable and continuing basis, in the economic life of another Member State. (2)

The Court of Justice in its judgement yet again provided a reminder to national courts that they are obliged to interpret domestic legislation in a manner consistent with Community law. The treaty is directly effective and supreme over domestic law. (2)

The Court reminded us that it is settled case law that the fact that a taxpayer sought to benefit from a tax advantage provided by another Member State does not deprive them of the right to have their freedoms protected.(2)

What this means, essentially, is that while low corporation tax regimes outside the EU may be subject to challenge, tax competition within the EU could not be subject to the same kind of challenge. It is a major headache which is still present within the UK, as more companies seek to minimise UK corporation tax by restructuring their tax systems to take advantage of the ruling, and billions are lost in UK revenue.

As a result - and this will be familiar to Jersey readers - the UK is facing increasing pressure to increase taxes on that part of its tax intake that cannot be restructured abroad - namely domestic taxes - duties on drink, tobacco and petrol - widening the social security payments (essentially starting to function as a payroll tax) - and increasing VAT, as well as cutting back on benefits expenditure.

This targets the home population, who cannot so easily avoid the tax, and it is almost a mirror image of Jersey's solutions to its zero / ten regime.

But the Cadbury Schweppes ruling has other implications for Jersey. Jersey's Comptroller of Taxes has a very similar clause against tax avoidance schemes in Jersey tax law, but if a corporation structured its system to hold profits elsewhere without direct Jersey shareholdings - ostensibly to "conduct a commercial business of raising and lending money", but at an effective tax rate less than the 20% on local shareholders, Jersey could face a real challenge in proving that its rules applied. Whether it is commercially viable yet is debatable, but in principle the opportunity may yet arise. Of course any dividends or funds that eventually ended up back with Jersey residents from the corporate group would be taxed at 20%, but in the meantime, potentially taxable revenue would be outside the Jersey tax system.

Clearly the move to seek tax harmonisation within the EU would go some way to correcting these anomalies, as the situation as it stands is leading to a "race to the bottom", with the money moving to areas within the EU where it is least taxed. But this is unlikely to happen while EU countries such as Ireland are struggling to cope with the world economic downturn:

Dublin's favourable tax regime for big corporations - currently only 12.5 percent - will remain "a cornerstone of Irish industrial policy," a spokesman for the ministry of finance told Dow Jones news wire. His comments came after the American Chamber of Commerce in Ireland urged Prime Minister Brian Cowen to "categorically rule-out" EU pressure on corporate tax. "We have to realise that we are still way out of line in terms of our cost competitiveness, and Ireland's competitive corporation tax rate is one of the few competitive advantages we have" (3)

EU officials have frequently raised the issue of greater tax harmonisation in Europe, with a recent report by ex-commissioner Mario Monti identifying tax divergences as a damaging factor to the internal market. (3)

It is ironic that it is not (for once) offshore "tax havens" that are causing most disruption, but the way in which tax regimes and competition operate with in the EU itself.

Links
(1) www.icaew.com/index.cfm/route/142022/icaew_ga/en/Technical_and_Business_Topics/Faculties/News/Cadbury_Schweppes_and_the_UK_CFC_rules__The_ECJ_Judgment
(2) http://www.accountancyireland.ie/Archive/2006/December-2006/Cadbury-Schweppes--Is-it-really-the-Tonic-Irish-Revenue-Ordered/
(3) http://euobserver.com/19/30950