UK faces up to relocations and CFC reform

David Cameron says Britain is open for business. But some believe he is not doing enough to tackle tax loopholes. Photograph © World Economic Forum, swiss-image.ch/Photo by Remy Steinegger.

"Britain is open for business," Prime Minister David Cameron confidently declared in July. The trouble with an open door, however, is that it can let as many out as it lets in. Wolseley, the world's largest distributor of plumbing and heating products, is the latest UK company to announce that it is shifting its tax domicile offshore. Wolseley was concerned about controlled-foreign company (CFC) rules, under which overseas companies operating in low tax jurisdictions which are controlled by UK residents face a charge. It follows INEOS, which also cited CFC rules, the reason why it relocated to Switzerland earlier this year, and William Hill, a betting company, which moved its telephone betting service to Gibraltar to avoid the horseracing levy.

The relocations have been condemned by trade unions and tax justice campaigners, who charge the companies of irresponsibly taking advantage of tax havens while the UK economy remains in recovery. They also fear this marks a worrying trend for the government as it struggles to tackle record debt and prove that Britain is open for business. The new government has gone to great lengths to stem the tide of relocations, announcing corporate tax cuts and reforms to CFC rules, which will exempt commercially justified activities, but for the companies that have been leaving the UK, these measures have clearly been too little too late.

INEOS, which moved its headquarters to Switzerland in April, provides perhaps the best example of why businesses are moving offshore.

"The benefits of the move to Lausanne were compelling," a spokesman for the world's third largest chemicals company says. "INEOS estimated that the improvement in financial performance, coupled with current and expected changes in UK tax legislation, will result in significant levels of additional tax being payable by its businesses, money that would otherwise help secure competitiveness and re-investment across its production facilities."

It is a move that has attracted considerable anger from tax justice campaigners. John Christensen, director of the Tax Justice Network, believes the company is relocating its headquarters to a tax haven.

"We are unambiguous about Switzerland's status – it is a tax haven with very deeply rooted legalised secrecy and lax regulation," he says. "In most cases the relocation of headquarters is largely bogus. In very few cases do the key decision makers and the whole paraphernalia of a headquarter operation physically move location."

While much of INEOS's operation remains in the UK, and the company insists it continues to employ around 5,000 people in the country, by shifting its headquarters to Switzerland it estimates potential tax savings of around €450 million ($590 million) between now and 2014, increasing to an annual €300 million after that.

"Tax competitiveness is a difficult issue for all governments," the company's spokesman says. "We will simply make a decision on what is right for INEOS, our businesses and our sites."

While the UK has a statutory corporate tax rate for large companies of 28%, Switzerland, which can provide the company with rates of less than 10%, holds a clear attraction.

"INEOS has said that many chemicals companies have headquarters offshore," says Kevin Hindley, an international tax partner at Alvarez & Marsal – Taxand in the UK. "If they are looking at market perception and asking themselves the question why aren't we doing this too, then that's a worrying trend."

In response to the concerns of companies such as INEOS, the new coalition government, elected shortly after INEOS announced the move, signalled its intention to cut corporate taxes by one percentage point every year to 24% in 2014. But some campaigners believe that a new approach to corporate taxation is needed.

"This is yet another example of companies holding countries and democracy to ransom, which underlines the need for an entirely new approach to corporate taxation that takes account of where profits are actually created and allocates them accordingly on a formulary apportionment basis," Christensen says.

The promise of lower corporate tax rates has not been enough to convince other companies from following INEOS abroad, however, as the case of Wolseley shows.

The UK-listed company has been balloting shareholders on a plan to set up a controversial new corporate structure which, based on last year's published profits, it expects will save £23 million in tax. While Wolseley will continue to be listed in the UK, a new group holding company will be incorporated in Jersey, with its tax residence in Switzerland.

The reason for the re-domicile, as with INEOS, is more than just the lower headline corporate tax rate it can expect in Switzerland. Both companies are concerned about UK CFC rules.

"Wolseley has had long and professional discussions with the tax authorities," says a spokesman for the company. "Despite the review, we felt there was no absolute certainty as to when CFC rules would change or if they would benefit the company. If the UK rules change and there is no longer a tax advantage to Switzerland, then Wolseley would not rule out re-domiciling in the UK."

Under present CFC rules, overseas companies controlled by UK residents which pay less than 75% of the tax they would have paid on their income had they been resident in the UK would receive a charge based on the difference in rates. The UK's CFC rules were designed to prevent companies shifting their profits to tax havens.

In response to these concerns, the tax authorities, under the previous Labour government and under the new coalition government, have been debating CFC reform for more than three years.

"There was a discussion document released in January, but it was put on hold by the change in government," says Chris Morgan, an international tax partner at KPMG in the UK.

The emergency budget in June announced interim improvements to the CFC rules in spring 2011 and full reform is planned for the following year. The aim is to create a more territorial system of taxation, exempting commercially justified activities that do not erode the UK tax base. But the wait has proved too long for some.

"Companies will be fed up with waiting for CFC reform," says Morgan. "The proposed interim measures will make things a lot better, but they're still a way off. The question is, how long can you expect people to wait?"

Wolseley says that it had been considering its move for over a year.

"If they started down the path of relocation before the plans to reform the CFC rules were clear, then it would not be logical to say Wolseley's departure is the direct result of the government not doing enough on CFC reform," says Hindley.

Hindley believes the reforms will stem the tide of companies following INEOS and Wolseley.

"I think CFC reform will put companies' relocation plans on hold," Hindley says. "The reforms won't automatically mean that the future is rosy, but companies will certainly be watching developments with interest. If you're thinking about leaving, you are likely to wait to see what form the new rules take and what will happen as a direct result."

Some companies, such as William Hill, which moved its telephone betting service to Gibraltar to avoid the horseracing levy, and Aviva, which considered Ireland's low corporate tax rate when relocating, are unlikely to be placated by CFC reform. Nor is Diageo, the drinks company, which says it constantly monitors taxation and regulation "to ensure that this remains a competitive place for Diageo to base itself". Companies considering relocating to avoid UK CFC rules may well think twice as a result of the government's planned reforms and the consultation process over the summer, but they will want certainty.

"The government is trying its level best to encourage companies to stay in the UK," says Morgan. "They could possibly use the motive test more generously. They could also issue a press release expediting interim measures to give companies more certainty over what's coming."

"There is a sense that things are moving in the right direction, but the question is whether they are moving fast enough," Hindley says.

Fair taxation on foreign profits, greater certainty, and falling corporate tax rates are likely to encourage more companies to remain in the UK, but the problem of the open door remains. Where loopholes to create artificial structures in tax havens exist, corporations will continue to exploit them.

One of the reasons Wolseley's planned re-domicile is so controversial is that, by the company's own admission, it lacks substance.

"All board meetings will have to be conducted in Switzerland, but none of the executives intend to re-domicile," says Wolseley's spokesman, confirming that "only a handful" of people will actually be based in Switzerland and pointing out that it is a course which a number of companies have taken in the last few years.

"It's ludicrous that a company can be said to be controlled from Switzerland just because they hold their board meetings there," says Richard Murphy, director of Tax Research. "This rule was established in 1929. Those were the days of the steamship. You have to look at economic substance instead. The government needs to be more aggressive on the question of corporate residence. It's so easily manipulated, it's ridiculous."

Hindley agrees that central management and control issues are outdated.

"We haven't yet seen a tax case concerning central management and control issues that reflects the fact that people now have smart phones and laptops and can work anywhere," Hindley says. "Location isn't as clear cut as it used to be."

Hindley advises companies to carefully consider the substance of any relocation, cautioning that HMRC will be taking the issue much more seriously. Murphy, meanwhile, argues that with effective transfer pricing mechanisms, the taxation of dividends and strong CFC rules, it will be useless for companies to try to keep their profits offshore.

The need for government action to prevent companies exploiting tax loopholes is clear to Christensen.

"The fact that companies continue to relocate like this at a time of acute fiscal crisis in Britain and elsewhere in Europe reveals an extraordinary lack of corporate responsibility towards the societies where their profits are generated," he says. "The failure of politicians to protect citizens from this predatory behaviour also reveals the extent to which corporations rather than politicians now rule the world."

This is a view shared by trade unions who argue that if the government does not crack down on tax avoidance, it will face the same problems as Ireland and see Treasury coffers reduced as multinationals move their tax affairs around without generating jobs in the UK.

"Any business leader who demands the government acts faster to reduce the deficit should support a clampdown on these tax avoidance loopholes," says Trades Union Congress General Secretary, Brendan Barber. "It would end the unfair tax advantage that multinationals have over small businesses and would go a long way to reducing public debt without endangering growth."

By announcing its intention to reform CFC rules and cut corporate taxes, the government has attempted to show that Britain is open for business. But if it wants to keep that business, and ensure that it stimulates investment and jobs, then many argue it must do more to crack down on tax evasion. As long as it remains legal for companies to establish artificial tax domiciles based on the location of their boardroom meetings, irrespective of where that company is actually based or how much of its operation actually moves, then it can be argued that the government is not doing enough. Companies have the right to expect fair tax rules, but they should expect authorities to demand fair play in return.