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					 Is Corporation Taxation Practice a
            CSR Issue?
The Duke of Westminster’s guide to
          tax “avoidance”

             Gregory Morris
              PhD Student
         University of Nottingham
          Tax Research Institute
What will be covered?
 Part A
   •terminology
   •Duke of Westminster’s “principle”
   • the requirements of tax law
   • the “limits” within which tax
   “avoidance” occurs
 Part B: three examples of tax “avoidance”
 Part C: approach of tax authorities
Part A:
 Terminology:
    •“Evasion” is unlawful,
        •not disclosing income, e.g. offshore bank
        accounts
        •falsely describing events
        •backdating documents
    •“avoidance”, “mitigation”, “planning” are not
    unlawful
    •“aggressive”, “unacceptable”, “immoral”,
    “abusive” interesting, but are they “contested
    concepts” and are such terms helpful?
Part A:
 Requirements of tax law
    •1689 Bill of Rights
        “Levying of money for and to the use of the crown,
        [………], for other time, and in other manner, than the
        same was granted by Parliament is illegal.”

    (above referred to in 1992 case to as reason for
    granting restitution)

    •It is presumed that there must be express statutory
    authority before any tax can be due

    •“it is mine and nobody can take it off me unless the
    law clearly states that to be the case”
Part A (cont.):
  Duke of Westminster

  Lord Tomlin’s principle (1935)

     “Every man is entitled, if he can, to order his
     affairs so that the tax attaching under the
     appropriate Acts is less than it otherwise would
     be. If he succeeds in ordering them so as to
     secure this result then, however unappreciative
     the Commissioners of Inland Revenue or his fellow
     taxpayers may be of his ingenuity, he cannot be
     compelled to pay an increased tax.”
Part A (cont.):
  The parameters for tax advisors:
  •Negligence….Hurlingham
     best and most appropriate advice for clients
     (ultimately client decides)
  •Fraud/Cheating ….. Re Charlton
     crudity of criminal law
  •Furniss v Dawson and later cases
     the courts and “substance over form”
Part B:
 Three practical examples

 •sheltering UK company profits through the
 payment of interest by a UK group

 •reorganising operating companies across, say,
 Europe

 •maximising “after tax” value of executive
 incentives
Part B: first example, interest deduction

   •interest payable can be a tax allowable expense
   •UK groups of companies treated as one entity for
   certain tax purposes
   •within certain multinational groups possible to
   reorganise ownership of group companies and
   introduce debt into a UK company
   •interest is paid by the UK company, a corporation tax
   deduction is obtained and yet the interest received is
   not (or was not…wait for Part C) subject to taxation
Part B: first example, original position (simplified)
                     USA Parent


       Dutch CV

       Dutch Co

       UK Holdco                    Other Holdcos

       UK Opcos                     Other Opcos
Part B: first example, important info

   • in USA possible to make an election
   in respect of certain corporate entities
   which will mean that such an entity is
   transparent for USA tax purposes

   •certain types of Dutch entities are
   transparent for Dutch tax purposes but
   opaque for USA purposes
Part B: first example, step one

   The Dutch Co, which is owned by the
   Dutch CV, incorporates a new UK
   subsidiary company (“New Ukco”)
Part B: first example, intermediate position A (simplified)

                         USA Parent


              Dutch CV

                    Dutch Co

            New UKco        UK Holdco        Other Holdcos


                            UK Opcos          Other Opcos
Part B: first example, step two

   The Dutch Co, which is owned by the Dutch
   CV, sells the UK Holdco (which owns the UK
   operating companies) to the New UKco

   The consideration received by the Dutch Co
   on the disposal of the UK Holdco is a loan
   note issued by the New UKco

   The New UKco now has new debt on which
   interest is payable
Part B: first example, intermediate position B (simplified)

                         USA Parent


              Dutch CV

                    Dutch Co

            New UKco        UK Holdco        Other Holdcos


                            UK Opcos          Other Opcos
Part B: first example, intermediate position C (simplified)
                          USA Parent

             Dutch CV

                    Dutch Co

                   New UKco

                    UK Holdco                Other Holdcos

                    UK Opcos                   Other Opcos
Part B: first example, step three

   The Dutch CV creates a new entity, in
   this example referred to as “LLC”

   The Dutch Co assigns the asset which
   is the consideration received on the
   disposal of the UK Holdco to the “LLC”
Part B: first example, final position A (simplified)
                           USA Parent

             Dutch CV

     “LLC”           Dutch Co

                    New UKco

                     UK Holdco                 Other Holdcos

                     UK Opcos                    Other Opcos
Part B: first example, step four

   The New UKco now owes money
   to the “LLC” and has to pay
   interest on the outstanding debt
Part B: first example, final position B (simplified)
                           USA Parent

             Dutch CV

     “LLC”           Dutch Co

                    New UKco

                     UK Holdco                 Other Holdcos

                     UK Opcos                    Other Opcos
Part B: second example, reorganisations

   •many MNCs are structured such that fully functioning
   subsidiaries are present in a number of countries
   •each of these subsidiaries is responsible for many
   activities, e.g. R&D, manufacturing, sales, distribution
   •each subsidiary is an “entrepreneur” in its own right
   and is in receipt of returns appropriate to such activity
   •in the “global” economy, this model of a MNCs
   operations might not be as commercially efficient as it
   could be e.g. stock holding, marketing, distribution,
   global response to customer demand etc
Part B: second example, initial position



             Multinational corporation


       Opco 1       Opco 2      Opco 3

         Each Opco is a fully functioning entity,
            an entrepreneur in its own right
Part B: second example (cont.)
   •establish a new company with substance (“Newco”),
   in a low tax jurisdiction (for example, Switzerland)
   which takes on and centralises many of the functions
   currently performed by the Opcos
   •intangible property is assigned, transferred etc to
   Newco together with the functions of R&D, marketing,
   sales, distribution etc
   •each Opco becomes a contract manufacturing entity
   or a distribution company with limited risk
   •the economic returns to Newco reflect the risks
   associated with responsibility for R&D, marketing,
   sales, etc
Part B: second example, final position


             Multinational corporation


      Manco 1 Manco 2 Disco 3            Newco

      •each Opco has become a contract manufacturing
      company or a limited risk distribution company
      •Newco is the central entrepreneur company with
      major commercial risk and commensurate returns
      taxable in a low tax jurisdiction
Part B: Third example, executive incentives
   •why “executive” incentives rather than corporation
   tax?
   •share options:
       •Growth from date of grant to date of exercise taxed at 40%
       (and even higher)
       •Employers and employees national insurance contributions
       payable
   •capital gains tax rate is 18%
   •executives prefer growth in value of shares to be
   taxed at 18% not 40% plus 1% plus employers NIC
   •there are corporation tax consequences
   •many ways of “turning” income into capital..two
   considered
Part B: Third example, background
   •prior to Finance Act 2003 significant tax planning in
   this area

   •major changes in Finance Act 2003
       •Redefined “security”
       •Defined “by reason of employment”
       •Caught many “growth” arrangements

   •2003 legislation changed many times (part C)
   •prior to 2008 capital gains tax as low as 10%

   •many arrangements developed
Part B: Third example, “joint ownership”
   •executive interested in growth in value of share….not
   really interested in current value of the share
   •more than one person can have ownership of a
   share, each can own part
   •split ownership of share such that in effect one person
   owns growth in value the other person owns current
   value
   •the executive acquires the part of the share which is
   equal to the growth in value
   •the value of the part of the share acquired by the
   executive at the date of acquisition is small in
   comparison to the value of a whole share
Part B: Third example, “joint ownership”
                                  •red represents part of
                                  share equal to 99% of
                                  value of share at date of
                                  acquisition
                                  •blue represents part of
                                  share held by executive




       At date of    At date of
       acquisition   “vesting”
Part B: Third example, “joint ownership”
    The part of each share owned by the executive is
    captured through a formula (simplified) as follows:

    EI =    MV – IV)               100
              IV            X       1
    Where:
    EI is the executives %age interest
    MV is the market value of a share at any time
    IV is the initial market value of a share at date of
    acquisition
Part B: Third example, “joint ownership”
    •possible to make vested ownership of each part of a
    share subject to continued employment and
    performance conditions ….share parts can be “clawed
    back”

    •the part of each share owned by executive is a
    capital asset, the growth in value of which is subject to
    capital gains tax (18%)

    •possible to “postpone” purchase of each part of the
    share until vesting
Part B: Third example, “growth in value”
    •under 2003 legislation, executive subject to income
    tax to the extent he acquires a security for less than
    market value
    •possible to create a class of shares such that the
    relative value of the shares will increase if certain
    conditions are satisfied and those conditions are part
    of the shares rights
    •e.g. 10,000 B Shares which are entitled to minimum
    dividends, voting rights and liquidation rights until
    such time as the value of the company is say, £100
    million or more
Part B: Third example, “growth in value” (cont)

     •the value of such B Shares when created is low

     •once conditions are satisfied the B Shares increase
     in value

     •increase in value subject to capital gains tax (18%)
     not income tax

     •possible to defer payment for B Shares at acquisition

     •requires very careful, but perfectly legal, drafting of
     the articles of association
Part B: Third example, executive incentives

     •executives are offered share based incentives (very
     topical now)
     •commercial conditions…continued employment and
     performance conditions
     •in certain circumstances a choice is possible:
        •share options….taxed at 40% (perhaps more) plus NIC
        •joint ownership ….taxed at 18% no NIC
        •growth shares …. taxed at 18% no NIC
     •each is legal, the latter two “invented”
     •what would you do?
Part C: approach of tax authorities

     •previously referred to (i) negligence, (ii) fraud/evasion
     and (iii) approach of the courts (changes over time)
     • contest and litigate
     •very important: disclosure of tax avoidance schemes
        •principles
        •HMRC very pleased
     •specific anti avoidance legislation
        •clearance sometime available … is this satisfactory?
        •lack of clarity… debt push down and “hybrid” entities
        •“retroactive” legislation … the Finance Act 2003 legislation
Part C: approach of tax authorities: debt push down
      •anti avoidance legislation introduced in 2005:
         •Four conditions to be satisfied including “hybrid” entity and
         tax avoidance motive
         •Two safe harbours
             •no tax in country of residence e.g. in a tax havens; and,
             •non tax paying entities e.g. pension funds

      •first response … “LLC” is a non tax paying entity
      therefore is not subject to new legislation … but
      HMRC disagree
      •second response … “LLC” resident in “tax haven” …
      BUT withholding tax at 20% on interest paid to tax
      havens
      •third response … use quoted Eurobond exemption
      from withholding tax
Part C: approach of tax authorities: executive incentives


      •legislation introduced in 2003
      •legislation further amended in 2004,
      2005 and 2006
         •introduced “tax avoidance” motives
         •extended and amended definitions
         •reduced safe harbours
      •finally gave warning of “retroactive”
      legislation
Part D: the future
             what is to be achieved?
  companies should recognise and accept their
           social responsibilities?
   •companies should pay the proper amount of corporation
                           tax?
  •companies should not engage in abusive, aggressive tax
                        activities?
                           BUT
                           •what is “proper”?
                  •what is “abusive” or “aggressive”?
      •where should it be paid? …. does it matter if a UK company
                           avoids foreign tax?
Part D: the future
 •introduction of a “general anti avoidance rule”
      •Experience of other countries
      •Recent research
      •Moving the “problem” one level up (how important is certainty?)
 •more detailed legislation … following DOTAS
 •consideration of the behaviour of advisors, professional ethics and
 “limited context” decision making e.g. FIN 48 decisions
 •the nature of “property ownership” … “it is mine and nobody can take
 it off me” … is this still appropriate?
 •social contract/pragmatic/moral approaches?
               NB: an international issue but tax is national
Is Corporation Taxation Practice a CSR
                Issue?
The Duke of Westminster’s guide to tax
              “avoidance”

           Gregory Morris
            PhD Student
       University of Nottingham
        Tax Research Institute