How much is not enough?

Comedian Bob Hope used to tell jokes about how much money Bing Crosby had.
“Bing doesn’t pay income tax,” Hope would wisecrack. “He just phones up the
government and says, ‘How much do you need?’”

Few people can afford such largesse (fewer still have such a generous
inclination). But to paraphrase the old saying, companies are different from us:
they have more money. There is an evergrowing debate about how much companies
pay – and ought to pay – in taxes. News about corporate tax avoidance schemes
feature in the papers with almost as much regularity as ‘fat cat’ headlines
about executive pay.

The issue is a key part of the debate about the proper role of companies in
society and their contribution to it. It is increasingly on the corporate
governance radar and the corporate social responsibility (CSR) agenda. Companies
have to decide, for example, whether they prefer to be able to boast about the
number of hospitals their tax bill could fund or, at the other extreme, to be
aggressive tax optimisers in hot pursuit of every avoidance opportunity which
can enhance shareholder value. That makes tax strategy a boardroom issue, not
simply an operational matter to be dealt with by the finance department.

A case in point: last February, fund management group Henderson Global
Investors published the results of a survey in a report entitled Tax, Risk
and Corporate Governance. The institutional shareholder had written to the
chairmen of every company in the FTSE-350, asking them to complete a
questionnaire about their company’s strategic approach to tax.

But far from rabidly urging companies to pay as little tax as possible, the
covering letter sent to the chairmen made clear that, in Henderson’s view,
“Arrangements that minimise the amount of tax paid in the short term may be
detrimental in the longer term if there is a significant likelihood that they
will be challenged by tax authorities.”

It added that boards ought to be able to offer shareholders “a high degree of
assurance that risks relating to overall tax strategy… are fully evaluated and
judged to be appropriate”.

Twenty-three companies explicitly declined to respond to this survey. Some
argued that to do so would amount to selective disclosure to one shareholder of
price-sensitive information (which might therefore suggest that this information
ought to be disclosed to investors). For its part, Henderson said in its report
that it did not expect pricesensitive information to be revealed, but that “tax
management, as an important aspect of overall risk management and internal
control, is an appropriate topic of governance-focused inquiry by investors”.

Be that as it may, what the survey actually found was that, of the companies
that responded, only 38% had formally reviewed their tax strategy at board level
within the last year. Half admitted that they had not adopted a documented tax
policy for the company.

Returning to the issue of how aggressive a stance companies choose to take
with their tax affairs, 45% of the FTSE-350 respondents said that they adopted a
“conservative approach” to tax and tax risk, though such caution was much more
prevalent in the smaller companies index, the FTSE-250, than in the FTSE- 100,
where companies demonstrated much less willingness to even answer the question.

About a third of all companies professed to adopt a “medium” risk approach,
and just a single respondent said they were “aggressive”. In their written
comments, respondents wrote variously of their compliance with the letter of the
law or with the spirit.

It’s in the middle ground where much of the difficult debate is to be had.
“Where there are grey areas in tax legislation and its application we are
prepared to be challenging and we judge this to be in the interest of our
shareholders,” replied one chairman.

Another responded in quite a different vein: “We deliberately avoid ‘leading
edge’ schemes or aggressive tax planning as these inevitably entail more risk in
terms of HM Revenue & Customs attitude to them.”

A survey by Ernst & Young revealed that almost two-thirds of tax
directors in global companies considered that “the opinions of media,
institutional investors or analysts” were important challenges to the tax
function. Almost half said that their tax strategy had become more conservative,
and the key reasons for this are listed in the chart on page 2.

“Finance directors must look at how tax can affect their company’s
reputation,” says Chris Sanger, the partner for tax policy development at Ernst
& Young. “The world has changed where tax can be left solely to the tax
directors and there’s a reputational risk.”

John Whiting, tax partner at PricewaterhouseCoopers, says, “Had you asked
this sort of question 10 or even five years ago, the vast majority of companies
would have said that they simply try to minimise tax. It is certainly apparent
now companies need to think about their attitude to tax risk – to tax, generally
– and apply some corporate governance to it.”

Readers will be familiar with the judgment of Lord Clyde in the 1929
Ayrshire Pullman Motor Services case: “No man in this country is under
the smallest obligation, moral or other, so to arrange his legal relations to
his business or to his property as to enable the Revenue to put the largest
possible shovel into his stores.”

Are those days gone? No, Whiting insists. “It’s a foolish businessman who
organised his affairs so as to enable the Revenue to put the largest possible
shovel into his store. People are still entitled to plan, and HMRC would
acknowledge that tax payers are allowed to plan.”

One problem is that as the Treasury looks at the amount of tax that is being
avoided – legitimately, as far as the letter of the law is concerned but perhaps
beyond what the Revenue would regard as acceptable tax mitigation – the pile of
laws needed to plug the gaps grows almost exponentially.

The ICAEW recently published data on the sheer volume of tax legislation. In
1980-84, for example, the average Finance Act was 153 pages long. Over the last
five years the average has been 481 pages, while the 2004 Act that brought in
the new disclosure regime was a Harry Potter-beating 634 pages.

Whiting says that the blame can’t be entirely placed at the feet of tax
advisers who find the loopholes that the Treasury subsequently feels it has to
close. “In some cases, if the legislation had been written better or there had
been better consultation in the first place, we wouldn’t have to [close
loopholes] now,” he says. “So the fault’s not all on one side. But nobody wants
terribly complex legislation landing on them every day, and yes, everybody has
to acknowledge their responsibility.”

At the same time, however, tax schemes can be a red rag to the HMRC bull.
Take the case of the card services VAT scheme, for example, by which retailers
typically convert 2.5% of the value of each high street transaction into a card
handling fee which is not subject to VAT, saving themselves some 37 pence per
£100 in sales.

Having pursued Debenhams through the courts – and recently won in the Court
of Appeal – HMRC is also setting its sights on the details of the transactions
that were put in place to effect the card handling structures. Chris Tailby,
HMRC’s director of the Anti- Avoidance Group, wrote a letter in Tax
Journal earlier this year in which he made plain that, as a result of the
investigations that will be undertaken, “the VAT in issue could amount to more
than they have avoided”. He added that some retailers have asked HMRC to give
undertakings that it will not collect more than was avoided in the first place.
“Those letters have had a short answer, as I’m sure you can imagine,” he wrote.

Whiting counters allegations that the VAT scheme is based on an artificial
structure. “Isn’t it a bit artificial that we’ve got this exempt and
standard-rated split? You’d expect me to say this but I’ve got a deal of
sympathy with the companies because what the Debenhams merchant charge was
trying to do was to reflect reality. The fact is when I go to Debenhams, not all
the hundred cents in the dollar is going to the retailer. Some of it is going
off to the card handling company.”

The details of this particular case aside, the implication is clear that HMRC
is taking an increasingly no-nonsense stance. This heightens the risk issues,
though doesn’t necessarily mean that what the retailers are doing is ‘wrong’.

There is another aspect to this debate, however, and that is that companies
tend to reveal remarkably little information about their tax payments – not just
corporation tax or VAT, but business rates, employers’ national insurance
contributions, and duty on everything from property deals to air travel. Whiting
argues that the debate on companies’ tax strategy and contribution to society
would be better informed with what PwC calls a ‘Total tax contribution
framework’. “It fits in with the general corporate responsibility push that we
need to show how responsible we are,” he explains. “But it also says, if we’re
paying all that lot are we managing it all properly? It’s not a campaign for
lower taxes but it’s a campaign that just says, let everybody on all sides take
any decisions based on full information.”

FTSE-100 brewer SABMiller is said to be interested in expanding its CSR
reporting in this way to show how it contributes to society, particularly in its
home territory, South Africa. Others want to show how they make contributions to
Treasury coffers even though loss-making and hence paying no UK corporation tax.

If there are two key messages they are these: that tax strategy must be a
boardroom agenda item, and that companies must engage in the public debate about
corporate taxation.

Otherwise, the risk is that ill-informed policy-makers may pander to a
headline-influenced voting populace by edging ever closer to something
resembling the spoof Canadian income tax return that appeared on the internet a
few years ago. It contained just two lines: “(1) How much money did you make
last year? (2) Send it to us.”

Additional reporting by Michelle Perry

CHEMICAL REACTION

The ability of tax strategy to damage corporate reputation isn’t a new risk.

In 1991, Hanson, the Thatcher-era takeover darling of the City, made
unwelcome overtures towards ICI, at that time regarded as the stock market
bellwether.

ICI fought a highly aggressive PR campaign, determined to prevent one of
Britain’s leading manufacturing groups falling into the hands of a perceived
asset stripper.

ICI’s efforts included a thorough investigation of Hanson’s tax affairs.

Hanson had long had an effective tax charge that was up to 10 percentage
points less than the standard rate, but was never really explained to analysts
or investors (though there were hints about clever use of capital allowances).

“If we told our auditors, Ernst & Young, all the things we do, they would
probably market the techniques to their clients,” said Hanson finance director
Derek Bonham at the time.

But ICI made a good stab at unpicking a complex web of offshore brass plate
subsidiaries, some with share capital of £2 but hundreds of millions of pounds
of transactions.

Though there was never any suggestion that Hanson had done anything illegal,
the press coverage of its use of tax havens – coupled with revelations about
corporate ownership of racehorses – left an indelible impression on many that
Hanson was not a fit and proper business to acquire such a mainstay of British
industry. Hanson soon dropped its bid attempt.