HMRC allowed Vodafone to route a loan through a series of foreign companies in order to avoid paying UK Corporation Tax running into hundreds of millions of pounds. 

In the light of this, the opportunity for the Prime Minister and the Deputy Prime Minister to act on their words last week, about large UK companies who avoid paying tax, may have come quicker than either realised.

Documents filed in Luxembourg regarding a Swiss branch of Vodafone show that it had a wage bill last year of just over seven thousand US dollars (USD), yet made a staggering two and a half billion USD ($7,290 USD in wages set against a profit of $2.448 billion USD). Page seven of the Vodafone Luxembourg company’s most recent annual accounts (enclosed in the document below) highlights these figures.

This profit was generated as interest on $27 billion USD of loans to Vodafone’s US interests, where it will have been given tax relief and thus reduced US taxes.  There is nothing unusual about this; it is normal practice for a global company to fund its foreign businesses through a mixture of debt and equity and, as long as the debt is not excessive, the interest on it is tax-deductible where it’s paid.  This is, however, on the basis that it is taxed in the hands of the lender of the money.  Here’s the clever bit, though:  the loan was transferred through the Swiss branch of Vodafone’s Luxembourg company as it meant UK corporation tax would not apply to the $2.5 billion paid this year.  Nor would UK tax apply to the profit in other years covered by HMRC’s sweetheart deal entered into with Vodafone in 2010.

Luxembourg did not tax this profit as they do not apply corporation tax to profits generated in foreign branches. This is why the Swiss branch was used rather than the Luxembourg business. It also explains why the loan was routed via the Luxembourg company rather than from a Swiss branch of the UK company, where it would have been subject to corporation tax in the UK.

Switzerland also did not apply corporation tax to this profit even though it was here that the branch registered the profit.  This is because no work was actually done in Switzerland – as shown by the tiny wage bill.  The Swiss branch simply transferred the loan and collected the profit.  As such the Swiss only apply what is in effect a transaction tax – shown in the document below as $627,178. 

UK tax laws brought in by Nigel Lawson in 1984 clamped down on this kind of scheme and said that the tax haven company’s profits should be taxed anyway.  Recent European Court decisions have restricted the application of these laws to wholly artificial cases where there is no genuine economic activity. It is difficult to imagine the UK Courts finding such arrangements as anything other than artificial.  It is for this reason that most companies cannot get away with such a set up.  However, in Vodafone’s case they received approval from Dave Hartnett, HMRC’s top tax commissioner as part of their wider sweetheart deal in 2010. 

This is not so much a tax loophole in legislation, but rather an avoidance scheme that should have been challenged by HMRC. HMRC’s own procedures say that where they would expect a legal challenge to be successful, they must only settle for 100% of the outstanding tax due.  Clearly they failed to do so.

This is one of the deals which the Public Accounts Committee has been questioning in recent weeks, with Mr Hartnett now summoned three times.  To date, questions on Vodafone have been stonewalled on the grounds that legal privilege applies.

However, these documents put in the public domain (albeit obscurely in Luxembourg), when combined with other documents put in the public domain by Vodafone (where they tell their investors that they have settled all liabilities with HMRC on deals like this, known as Controlled Foreign Companies or CFCs), suggest HMRC have agreed to allow this scheme without penalty.

As the Vodafone interim management statement (the page of the document enclosed below) shows, Vodafone reported in 2010 to their investors that when they settled with HMRC they had “reached agreement that no further UK CFC tax liabilities will arise in the near future under current legislation. Longer term, no CFC liabilities are expected to arise as a consequence of the likely reforms of the UK CFC regime due to the facts established in this agreement. The settlement comprises £800m in the current financial year with the balance to be paid in instalments over the following five year”.  So arrangements like the one using the Swiss branch appear to have been included in the sweetheart deal with HMRC.

The lost tax to the UK from this one arrangement is considerable.  This year alone the Treasury would receive around £400 million UK pounds, if based on a rough exchange rate of 2.5bn US dollars as 1.5 billion UK pounds taxed at corporation tax of 26%.  However if other years are included under the scheme, the potential tax lost is far higher – potentially £2 billion in total.  This is based on the fact that the Swiss branch arrangements were put in place in early 2006, and the HMRC deal covers the period up to 2012 allowing for next year a similar profit to avoid UK tax (12.5bn USD at roughly 7.5bn UKP would generate 2bn UKP in corporation tax).  Vodafone may wish to clarify these figures more precisely.

So what next? Firstly, Vodafone may wish to issue a statement explaining these arrangements.  Secondly, Mr Hartnett has announced he will retire in the summer but currently continues in post.  Contrary to earlier statements, he is not prevented by law from commenting on this case.  The 2005 legislation does not require him to comment, but does not prevent him from doing so where certain criteria is met. This includes where disclosure is part of the function of HMRC and one such function is assisting Parliament. As such, he could write to the Public Accounts Committee now clarifying HMRC’s interpretation of Vodafone’s public statements.  Whether he chooses to do so is at his discretion of the tax commissioners.

Thirdly, a retired High Court Judge, Sir Andrew Park, is currently investigating HMRC’s deals on behalf of the National Audit Office.  He is due to report in the Spring 2012.  The terms of reference for Sir Andrew’s investigation are set out on their website at http://www.nao.org.uk/publications/work_in_progress/larger_tax_settlements.aspx.

I hope Sir Andrew will now confirm that he will interview Andy Halford, the Chief Financial Officer of Vodafone, as part of his investigation.  Such questioning could consider not only the Swiss branch arrangements, but also the statement from Vodafone that they were given five years to pay their tax liabilities in breach of HMRC’s own guidelines. 

The Public Accounts Committee will wait for Sir Andrew’s report before holding any further hearings.  If these issues are not adequately addressed in this report, and as these documents are already in the public domain, the Public Accounts Committee may wish to call senior executives from Vodafone to Parliament in the Spring.

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