Why the Independent has got it wrong
The announcement of the new FATCA IGA agreement with the UK today was accompanied by press and media coverage of the Independent Newspaper story on the Eurobond exemption and the reduction of taxable profits through borrowing listed on the Channel Islands stock exchange.23 October 2013
In true tabloid style the Independent have sought to give the impression of bad business practise and this was echoed locally this morning with some rather sour commentary on Radio Jersey which is regrettable.
For the benefit of those unfamiliar with this subject I repeat below the British Private Equity Association's explanation of how Private Equity (the ultimate owner of many of the UK based Co's featured in the news) actually works and the relationship to the Eurobond Exemption.
"Private equity is about investment not tax avoidance
The Independent’s investigation into the tax affairs of private equity-backed UK companies is inaccurate and misleading. It describes the Quoted Eurobond Exemption (QEE) as a tax avoidance loophole, when in fact it is a there to attract international investors to the UK by allowing them to pay tax only once on their investment.
In 2012 around £5.7bn was invested into 820 UK companies by private equity. Over the past five years around £33bn has been invested into 4515 companies based in the UK. Many of our investors, such as international pension funds, are not eligible or required to pay tax in the United Kingdom. The benefit we get from them is in investment, growth and jobs.
How does a typical private equity fund investment work?
We invest capital on behalf of multiple investors, large and small, by investing it into businesses to help them grow – our typical investment period is around five years. We return profits to our investors provided we have expanded and grown the businesses we invest in.
When we invest we do so with a mix of debt and equity. This is determined primarily by whatever gives the lowest cost of capital for the business concerned (but the nature of our investors may also be a factor).
When capital flows back to our investors some are subject to tax and some, such as pension funds, are exempt. The QEE allows international investors to commit capital to our funds and in turn into UK companies, thus only paying tax where it is due.
The alternative, alluded to by the Independent, is for HMRC to apply a 20% withholding tax on these investors and for them to claim it back – imposing a significant administrative burden, delay and thus cost, thereby reducing returns to pension funds and with no gain to the Exchequer
When HMRC rightly consulted on this issue in 2012 feedback from our investors suggested the administrative burden would be disproportionate and punitive and would make the UK a less attractive destination for investment as most European countries do not operate withholding tax on interest – currently only Italy does so it would put the UK at a severe competitive disadvantage.
Accordingly it would be harder for private equity to raise capital and this would mean less investment for UK companies.
A separate issue, confused throughout the coverage, is that all the interest costs shown in the portfolio company's accounts are tax deductible. This is factually incorrect. HMRC only allows a deduction for interest on borrowings which it adjudges to be on an arm's length basis. This is to prevent any abusive practice.
The concern with related companies was that firms not entitled to the relief were getting an unintended advantage and getting a tax concession unfairly. This assumption misses the point that most Private Equity Investor's are institutions and mostly pension funds who are not due to pay tax and whose members retirement pot would be reduced if they had to pay tax with the additional problem of unscrambling the tax witholding arrangement to try get their money back.
The tabloid press are doing Britain a disservice in leading the public to believe there is significant wrongdoing when in fact the subject matter has been looked at very carefully by the authorities, and on balance, it has been confirmed that Britain's interests are better served by attracting international capital and not trying to tax it twice.
Only Italy in the EU applies a withholding tax to this type of business so if the Independent and their chorus of supporters get their way the UK Eurobond market will be damaged and Britain will have less investment and fewer jobs as a result.