Tax avoidance via Eurobond

One of the most important things about Eurobonds is that they are, unlike many other types of bonds, not taxed at source. In other words, when investors in a bond receive interest payments (which is a form of income) they aren’t taxed on that income. Eurobonds are major vehicles for tax avoidance and evasion.

And this new UK report is brazening in its explanation for why this particular loophole is granted:

The original policy rationale is to encourage the growth of the UK Eurobond market, as London is one of the centres of the worldwide Eurobond market.

In other words, the original policy rationale is to build up the City of London as a tax haven: a place that attracts money by assisting others to avoid tax. That is a quite extraordinary admission.

And this is a huge market: UK £393billion (US$641 billion at current exchange rates.) That is for 11 months: over 12 months that would be worth around US$700 billion. That is a whole lot of tax dodging. The exemption applies to quoted Eurobonds which can in practice, as Prog Tax reports, mean bonds issued in on stock exchanges in the Channel Islands or Caymans, for instance.

So, for example, a company based in London might ask investors for US$ 1 billion and promise to pay that back in five years, plus interest.

So a US company with one subsidiary in the UK and another in the Caymans can get its UK subsidiary to issue Eurobonds on the Caymans stock exchange, and get its Caymans subsidiary to buy those Eurobonds. The Caymans subsidiary receives the interest income but pays no tax on that income, because it’s in the Caymans! Meanwhile, the UK company deducts its Eurobond interest payments from its income there, and cuts its tax bill! And because of this loophole designed to make the City of London more attractive as a tax haven, there’s no witholding tax involved (which would normally be a defence against these shenanigans.)

When a UK company pays interest to an overseas lender it would usually have to send 20 per cent straight to HMRC. The exemption allowed banks and other investors to receive the interest without the deduction if they lent their money through buying bonds via a recognised stock exchange, such as the Channel Islands or the Cayman Islands. In effect, the Government had made HMRC complicit in tax avoidance.

In groups comprising British and foreign registered companies, a common structure, they would cause one of the foreign entities to make loans to the major British company in the group so that its tax liability could be substantially reduced by offsetting the interest it is now paying on a loan that it didn’t need! I know this sounds crazy, but that is how it is done.

This is exactly like a householder deciding to consult with assorted burglars and thieves about plans to enhance the security of his or her residence. The burglars didn’t think it would be a good idea! Let us go through the responses HMRC received in this light.

The first objection to the proposed reforms was that the changes would add to compliance costs, as businesses sought to restructure existing arrangements. That is, it would cost the burglars money.

A second objection is technical in nature, but a translation can be supplied. In the original language it reads: The positive Exchequer effect (in other words the extra tax that would be collected) was questioned by respondents who expressed the view that treaty relief (see below) would often be available in cases where the exemption was currently used. Treaty relief refers to double taxation treaties between pairs of countries that are designed to prevent paying tax twice on a single transaction. Or, in burglars’ language, even if you install new locks, we know of another way to break in.

HMRC described a third objection: that firms would devise securities that had the same tax liability-reducing characteristics as loans without actually being loans. In other words, the burglars would disguise themselves as, say, coming to read the householder’s gas meter in order to gain entrance and make off with some booty.

They take full control of poorly performing companies so that their shares are no longer quoted on the Stock Exchange. As a result, these companies escape the often debilitating need to report their results every quarter, which in turn encourages managements to act tactically rather than strategically. Instead, private equity firms set about making long-term improvements, before eventually selling off their holding back to the investing public at a substantial profit. It is the private equity firms that insist on using the quoted Eurobond exemption to reduce tax bills, rather than the companies they own.