WHEN THE House of Lords ruled in 1936 that everyone is entitled “to order his affairs” so as to pay less tax than he otherwise would, the lords could not possibly have imagined the complexity we have today in the tax system, nor could they have anticipated the development of intellectual property, intangible assets and financial services. Rather, the facts before their lordships were to do with how the Duke of Westminster was using a tax- deductible deed of covenant arrangement to pay his servants.
For today’s corporate, perfectly legitimate tax management is a world away from that simpler Downton Abbey-esque era – and yet the legal principle in the Duke of Westminster case still holds sway. More recently, however, the so-called Ramsey principle, which was established in the 1980s, holds that highly artificial arrangements are not allowable.
But the sums of money at stake today are large, the legislation is complex, and the reputational issues are critical. Worse, the public debate about tax is often muddied with misconceptions. How, then, is any corporate supposed to order its affairs so as to pay no more tax than it needs to – yet without falling foul of the tax authorities or the anger of the public? Where is the dividing line?
“There’s a smell test that people have about these things,” explains Richard Woolhouse, head of tax and fiscal policy at the CBI which recently published a document called Tax and British Business: Making the case. “Anything that involves a lot of complexity and money flowing around in circles artificially to generate losses is much more likely to be closer to the edge.”
Woolhouse makes it clear that good corporate governance is important. “This is essentially a process of risk assessment,” he says. “Directors need to have proper knowledge; there needs to be a proper governance structure with proper line management; and clear responsibilities so that people have a clear understanding about what the objectives are.” As for the board, he adds: “Good non-execs don’t get bounced into things.”
John Bartlett is head of group tax at oil giant BP. He sits on the CBI’s tax committee and also worked with Graham Aaronson’s working party to draft a general anti-avoidance rule (GAAR), which has now morphed into an anti-abuse rule. “There’s a big difference between responsible management of taxes and the abusive avoidance arrangements that we hear talked of and written about often,” he says. “Certainly BP and most of my peers spend most of their time trying to reassure themselves that they are not getting themselves into those abusive arrangements and are managing taxes in a responsible way.”
In fact, he says it is necessary to spend a lot of time avoiding the “elephant traps” – the unforeseen consequences of anti- avoidance provisions that could force companies to pay tax where the legislation had no intention to collect any.
He believes that the sort of tax-saving schemes which, a decade ago, might have been lapped up by even the most highlyrespected, reputation-aware companies would now be scrutinised much more sceptically by boards.
John Whiting, tax policy director with the Chartered Institute of Taxation, says that, for companies planning a transaction or establishing a new business, “if, at the end of the day, you suffer some real consequences – and you really do – then it’s pretty hard to argue that you shouldn’t get the tax consequences, as well.”
In his view, if a company sets up a financing centre in Ireland, for example – and really does do the financing in Ireland – “it’s pretty difficult to say that they should not be allowed to do that,” he says. “If, on the other hand, what they do is set up something completely artificial in the Caymans which is all about simply diverting [profit] and, frankly, is closer to obfuscation and hiding, then sorry – I don’t go along with that.”
Bartlett discusses another hypothetical example, involving a procurement hub based in Bermuda. “Does that company have a physical presence in Bermuda? Does it have a large distribution warehouse? Does it have hundreds of employees? And if it does not, you would be wondering – where is the business substance there?” he argues. “Surely, it is only a question of time before a tax authority challenges it.”
He adds that ten years ago a bank or an accountancy firm would have shown him and his peers a new tax-saving scheme every week. “And most of them would have no commercial purpose,” he says. “Today, I don’t recall the last time I saw one. Part of that is because they know I probably wouldn’t be interested in it, but none of my peers receive them, either.”
Playing by the rules
The corporate tax scheme industry, most experts say, has dwindled to virtually nothing. “If that business still exists, it exists for the high net worth individuals,” explains Bartlett. And it is a surprise when he also gives credit for this change in attitude to HMRC and, in particular, its soon-to-depart chief executive David Hartnett who, he says, “did a good job of getting a more ethical approach into company boardrooms. Most companies today would be very reluctant to enter schemes like that.”
The DOTAS arrangements – Disclosure of Tax Avoidance Schemes – have also had a big effect since they were introduced in 2004. When, back in February of this year, Barclays’ plans to save tax money on its debt repurchase programme resulted in an immediate clamp-down and the introduction of retrospective legislation [see box], these events showed that “the tax system worked”, says Whiting. “What Barclays did was absolutely by the rules: they found something that they thought was certainly not prohibited, realised it fell into the disclosure regime, did a disclosure to the tax authorities, and the tax authorities took action against it.”
No one wants to talk openly about other companies’ tax affairs, but it is clear that the ability of major web-based retailers to perfectly legally locate their business more or less anywhere that suits their tax strategy is one sign there is something wrong with the international tax system. Woolhouse says that the OECD guidelines on transfer pricing – which make it possible to get cohesion in tax laws across multiple jurisdictions – have simply failed to keep pace with business developments, not least the internet, intellectual property and financial services. “[They need to] take those rules onto the next level,” he says. The House of Lords may now be the Supreme Court, but it cannot move far from the Westminster principle unless the rest of the world does too.
John Bartlett, head of group tax at BP, suggests that boards should be asking the following questions when assessing a company’s prospective tax-saving schemes:
• Is that responsible tax management?
• Is that what the spirit of the law intended?
• Is it how the law actually works?
• Would it succeed if it were challenged?
• What is HMRC’s likely reaction to it?
• How much do we value our relationship and reputation with HMRC?
• Is it worth disturbing that relationship and that reputation for the sake of this arguably avoidable tax?