As many will know poet Steve Pottinger has a history of taking on coffee shops who don't pay their tax. He began with Starbucks and recently took on Caffe Nero.
Having tackled Caffe Nero Steve spoke to me, curious really as to how it did not pay tax when it appeared to be making about £20 million a year in profits. He got my curiosity, because no one likes an angry poet, and as a result I have written an explanation as to how this comes about (featuring a lot of extracts from various of its accounts). You can see that summary here, but the summary from that report is as follows:
Having taken this tour of the Caffe Nero Group a number of conclusions can be drawn:
- The Caffe Nero operation is successful and profitable, generating an operating profit of about £21 million before tax in 2013.
- This operating profit is entirely cancelled at group level by over £40 million of interest liabilities, at least £13 million of which was due to group companies located in either Luxembourg or the Isle of Man in 2013.
- The debt burdens of the group were imposed upon it at the time that it acquired Caffe Nero: they were not incurred as a result of trading; they were incurred in the course of purchasing that trade, which is a distinct and separate activity.
- The debt burdens arising as a consequence of the purchase of the trade have left the group as a whole in a perilous position: the company acknowledges its marginal solvency and that it can only continue to trade by deferring settlement of its obligations to its parent companies, the top two of which are in the tax havens of Luxembourg and the Isle of Man.
- Accounts for the Luxembourg and Isle of Man companies do not appear to be readily available for inspection.
- As a result of the tax relief available on the interest payment, even though they were not incurred in the course of the trade of the company, any tax owing on the profits arising from sale of coffee in Caffe Nero stores is entirely cancelled and no corporation tax is being paid by the company and none is likely to be paid for many years to come.
It is stressed with regard to the tax aspects of this matter choice is in operation. The structuring is deliberate, and is intended to route interest payments out of the UK via Luxembourg to the Isle of Man tax haven in the process stripping profits that would otherwise be liable to UK tax and leaving nothing due in this country. The structure used is, no doubt, entirely legal and has met with tax authority approval. But that does not mean it is ethical. The intention has been to use an effective tax subsidy secured by cancelling UK tax liabilities with interest charges on sums owing to offshore companies to help finance the cost of acquiring the group. That is the issue subject to ethical challenge here.
Three issues arise as a consequence.
Firstly, the U.K.'s policy of allowing tax relief on interest paid to acquire a trade must be open to question in the future: time after time companies appear to be in trouble because they are laden with debt that their owners have used to acquire them when that liability has nothing to do with the trade that the acquired company actually undertakes. A change in tax law to deny relief on interest incurred to acquire a trade seems long overdue.
Secondly, the use of a Luxembourg company within the structure noted here is not coincidental: under EU agreements tax may not be withheld on interest payments from one member state to another, even if the recipient state then allows the onward transmission of that interest to a tax haven without the tax that might have been deducted in the first state having been charged. This is, therefore, an exercise in tax avoidance. The time for the EU to reconsider the desirability of such arrangements is long overdue.
Lastly, UK company law needs reconsideration with regard to the ability of shareholders to load the debt that they incurred to acquire their interest in a company onto its balance sheet to secure a tax advantage. This debt loading creates financial instability that is potentially harmful to trade in the UK, the stability of employment in UK companies, and the tax revenue stream for the UK Exchequer, all of which are undesirable. Policy in this area is in need of reconsideration.
It's time politicians realise people have had enough of this sort of abuse, whether it's legal or not. Pogress towards reform is long overdue, but seems distant. Until it happens this issue is unlikely to go away.
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I find little, in politics, to convince me that politicians, of any party, care what ¨the people¨ think; or even if the people think.
In reality, the peoples thinking is dependent upon the information they are being presented with. No chance of the not-so-free press or media giving the people much thinking material, given their capture by the ¨forces of evil¨ (or should that be farces of the devil?)
But presumably the purchase was of a company. A company can do many things and carry out many business activities.
How could we apportion interest paid to a specific trade?
I think it entirely reasonable that a formulaic approach be used
Legislation is riddled with them – not least re interest relief
Agreed
Why haven’t hmrc disallowed the interest deduction under thin cap or transfer pricing grounds as they are entirely able to do. The answer will be that banks would have lent the group that money on the same terms as the Luxembourg company and therefore it is deductible. Nero probably has this all agreed with hmrc via an atca agreement
Are you suggesting the group is thinly capitalised and hmrc aren’t doing anything about it?
I am suggesting what I say in the report – that this structuring is abusive, debt loading should not be allowed, EU law to permit this flow to the IoM should be stopped and interest deduction on the cost of acquiring trades should not be permitted
Why not take as read what I say?
I have not said any law has been broken
The issue is not whether debt loading should be allowed – that is entirely a commercial decision for the company, its directors and shareholders as to how they finance the acquisition and operation of the business.
The issue is whether tax relief should be permitted on the interest charges incurred. I suspect that while there is effectively unrestricted tax relief for such interest then debt loading will be seen as an attractive means of finance. If tax relief was restricted in some way then the commerciality of using debt-finance would be reduced and hence its use.
Of course, the devil will always be in the detail and it will be important to ensure that any restrictions do not inadvertently prevent sensible expansion of commercial ventures that require debt finance to do so.
This is not a matter for the directors: law can bar a company using its assets to assist its own acquisition
Your premise is wrong from the outset
thanks for the clarification, i have now read the report. i fear your proposals are too simple to deal with the issue you are trying to address:
1. There are many ways to introduce debt into a company, so solely saying “debt incurred for the acquistiion of shares” or something similar will not stop the issue – some other territories have such a rule and acquisition debt can still be introduced
2. interest paid by a UK company to anywhere in the world (regardless of whether it is EU or a tax haven or anywhere else) can be free of withholding tax regardless of a treaty or anything else.
3. your number 3 isnt a tax issue but more a political one – I personally cant see any of the parties putting restrictions on how UK companies operate but I might be wrong.
You might be wrong
After all, this is in the Base Erosion and Profits Shifting action plan
My point is that except where the law already bars the use of debt, it should be a commercial decision as to whether debt should be used for company finance. Of course, restrictions on tax relief on interest should be considered to make certain uses less commercial, which in turn should reduce some of the abuses you’ve highlighted.
What would not be desirable is for any restrictions (legal or otherwise) inadvertently deterring a business from e.g. investing in new premises, plant or machinery, staff training etc. because the restrictions deny it tax relief on the interest charges it might incur on debt financing of such expenditure. That’s what I meant by “devil in the detail”, but overall I am in agreement with the analysis and that the availability of tax relief for interest needs to be reviewed.
Comemrcially debt finance is cheaper than equity finance but of course that is mainly becasue you get tax relief on debt finance.
It seems strange that the UK Worldwide debt cap rules donlt restrict anything her but I guess it depends on how much the group as a whole has debt finance.
The other thing that intrigued me was the comment
“The debt burdens arising as a consequence of the purchase of the trade have left the group as a whole in a perilous position: the company acknowledges its marginal solvency and that it can only continue to trade by deferring settlement of its obligations to its parent companies, the top two of which are in the tax havens of Luxembourg and the Isle of Man”
That suggests the company is so highly leveraged that it can’t actually pay he interest. Now surely in a 3rd party situation, no lender would let that state of affairs continue which strongly suggest to me that the tax authority could attack the structure under current transfer pricing concepts. And I can assure you tax authorities do take this stance.
One final point regarding the routing of debt through Lxembourg etc. but on paying to tax havens – It really is time more tax treaties had limitation of benfits type clauses and/or anti tax haven / treaty shoppiong provisions.
The intra-group debt looks cheaper than the commercial debt
Maybe unsurprisingly
I did also wonder whether a rule around inetrest only being deductible when paid, or paid within say 9 months of teh year end (like remuneration rules) – and by paid that shouldn’t mean paid and loaned back or rolled up into the principal! I remember the good old days when interest was only deductible when paid 🙂
Another easy win would be to copy the German/Italian (& Norway too now?) rules where only a % of EBIT can be deducted – hence effectively a minimum tax regime.
I used to dislike the Norwegian system – I am beginning to see merit in it
But I do not agree with imputed rates of return on capital that appeal to the IFS
The group as a whole is losing money is it not? So no tax is due at group level. Even if the whole company was UK based no tax would due.
The fact that a UK based subsidiary is profitable makes no difference.
What it does show though is how unworkable your country by country reporting is. You are arguing that a profitable part of a group based in one country should be paying tax when the company as a whole is losing money.
What it shows is how little you bother to read and how far removed from reality your understanding of country-by-country reporting is – which is not a tax assessment system
Please don’t call again
You’re wasting my time
I suppose you could answer a question referring to a simple example regarding CbC then?
Assume 2 countries (A and B) both with 20% corp tax rates.
Company ABC operates only in country A. It has revenue of 200 based on 100 of costs.
Company XYZ operates in both countries. In country A is has revenue of 50, with 100 of costs. In country B, where it exports to, it has no costs but revenue of 150.
How much tax does each company pay?
If it purely exports to B it pays all its tax in A
But that’s a very particular case as you well know
And remember – country-by-country reporting changes no tax law, at all
“If it purely exports to B it pays all its tax in A But that’s a very particular case as you well know”
I asked *how much* tax the companies would pay, not where. Also, as in the example, company XYZ doesn’t purely export to country B (which doubles in this simple example as all offshore sales) – it sells in country A as well.
Given how simple the example is, can’t you just give me an answer in terms of A = and B = ….?
I gave you the answer
You say it’s based solely in A and exports to B
So it pays its tax in A
But if it had a sales operation in B that would be different
But you did not say that
How much clearer could I be?
OK, for sake of absolute clarity, let’s clear this up with a similar example:
Assume 2 countries (A and B) both with 20% corp tax rates.
Company ABC operates only in country A. It has revenue of 200 based on 100 of costs.
Company XYZ operates in both countries. In country A is has revenue of 50, with 75 of costs. In country B, where it exports to, it has costs amounting to 25, but revenue of 150.
How much tax does each company pay, and where?
I presume you can work ABC out for yourself
I repeat: if XYZ only exports to B and has no operation there (precisely, a PE) under existing rules whether or not it does country-by-country reporting you know it will not pay tax there
If, somewhat mistakenly, you are referring to unitary taxation instead of country-by-country reporting then of course the situation is different – but you only supply data for a sales formula
ABC remains the same
XYZ also pays 20 in tax – 5 in A and 15 in B using such a formula
The obvious accounting misallocation of profit is corrected under UT
I’m trying to clear up the difference between unitary taxation and CbC in my mind.
I thought I made it clear that XYZ has a (sales and marketing for example) operation in B (“XYZ operates in both coutries”).
Does this change what XYZ pays under UT and CbC, and what would they pay?
CbC is not a tax system
It is an accounting system. It has never been anything else, ever
If you do not understand that you clearly have not informed yourself about it
UT is a tax system
I have answered the question for UT
With reference to your article about Café Nero, I only ask because under the current tax regime both Café Nero and the group owe no tax, under UT the same would apply thanks to the group as a whole being significantly loss-making.
Debt-financing of acquisitions, for operating costs or simple investment is perfectly legal and is a cost of doing business. It is not a “tax relief” or a “tax subsidy”. Unless you of course are arguing that any business borrowing to invest shouldn’t be allowed to offset the cost of this investment against profits, which would destroy most small business investment, given they can’t access equity markets easily.
You are trying to argue that the local UK entity owes tax as it is profitable as a stand-alone unit. You argue this by saying that the debt used to purchase it should essentially not be included in the calculation because those debts are held offshore – you are using CbC in all but name.
If Café Nero and it’s group was wholly based in the UK and UK owned, no tax would be due, I hope you agree. Yet you argue that because some of the group is based offshore, tax is due from Café Nero. It’s wholly inconsistent, and the only way you could get to such an answer is by applying CbC.
In short, and using my example as reference, under the current regime company CN pays no tax. Under UT is pays no tax. You are arguing that CN owes tax, which you could only get to by treating CN as a stand-alone entity using CbC.
I am arguing the costs hat are offset should be disallowed in the Caffe Nero case
Please pay attention and stop saying CBC is a tax system when it is not
Why should they be disallowed? As I say, debt financing for any reason (be it for an acquisition, investment etc) is treated as a business cost, and is consolidated in the profit/loss statement before tax.
I can see your main thrust is that it is an offshore company holding the debt, offsetting the UK branch profits against it. Are you suggesting that if Café Nero had been acquired in exactly the same way (via debt) by another UK based company there would be no problem with their taxation?
Or do you have a problem with the whole idea of being able to deduct debt financing costs from the profit/loss statement?
I have dealt with this issue already
I think you are trolling
I will now be deleting all your comments
Rather than taking the easy route out and accusing me of trolling or referring me to section 5 of the comments policy, which I notice you do regularly with anyone who questions you too deeply, why don’t you try and answer the question? Or does answering the question expose yourself to the flaw in your reasoning – or simply that you enjoy attacking multinational corporates too much to actually stop and look at the evidence?
You have fundamental inconsistencies in your point of view. Why should the debt on CN’s books be disregarded, when it wouldn’t be if the company and group were wholly UK owned and based? If the debt should be disregarded, why isn’t it for every UK business?
I have answered all your questions
Saying I have not is simple obstruction
The biggest problem you have is that you think there is an ethical dimension to tax. It’s inane. Tax is driven by rules, ethics have no part to play, and certainly not for companies. If rules allow a certain structure to be used, you would have to be a bit dim not to take advantage (or at least consider using that structure taking into account all other considerations), and there is nothing unethical about acting intelligently. I would have sympathy with some of your points of view if they were founded on the basis that the rules – made by democratically elected (i.e. elected by us) governments – should operate in a different manner. But this obsession with introducing ethics and fairness into taxation is simply absurd and futile. Ask a room full of people if they want to pay more tax than they are legally required to and I would venture that not many hands will go up. So if companies or individuals legally reduce their tax liabilities, this simply cannot be regarded as unethical; in your opinion the rules that allow it are wrong and it is of course your right to campaign against such rules; and if you’re successful individuals and companies will have to operate under the new rules and will continue to act legally. There is simply no ethical dimension to this.
PS, why aren’t you lobbying on carried interest anymore. Now there are some rules that really need changing (but again, PE managers are not acting unethically in taking advantage of the tax treatment of carried interest).
So there are rules you think unethical after all – as you admit
In that case your entire argument fails
And that’s because all decisions are ethical – and only a fool denies it
Plainly speaking I think you are spot on with this analysis of Caffe Nero and similar
Groups. I suppose their defence is that you are concentrating just on Corporation tax but they pay Rates, VAT, and Employers NI and provide UK employment. How do you answer that?
Try offering that defence to HMRC for a UK sole trader who does not pay income tax and see how it works
This on MSN – shows what public think – and it’s not what Govt say!!
vote now
Should the government risk driving out multinational companies by forcing them to pay more tax?
7684 responses
Yes, no one is above the law – 62%
No, the jobs and services they provide are too valuable – 14%
I don’t think they would ever leave no matter what tax they had to pay – 24%
http://news.uk.msn.com/uk/farage-condemns-protest-threat-1
Hi
Nero’s head of Customer Service sent me this. Would you be interested to fisk it on your blog?
I’d like to know how to respond.
kind regards,
laurence
Hello Laurence
Thank you for your email.
Over the last few years, we have worked hard to create our business and are proud of generating over 4000 jobs. The figure quoted in the media regarding our profit is before we pay the interest on debt owed to British banks. In 2007 we took on significant debt in order to take the company private (off of the London Stock Exchange) and also to fund the growth and job creation in this country. The level of interest we have to pay off to our banks as a result of that debt is substantial and after paying this we have no profit left on which to pay Corporation Tax.
I hope you will reassess your thinking on this in light of hearing the full picture. It is frustrating to read an incomplete picture of our situation in the press. Irrespective, I respect you taking the time to contact us about your concern.
Kind regards
Justina Virdee
Head of Customer Services
Caffe Nero Group Ltd
Tel: 0207 520 5169
Email: justinav@caffenero.com
Description: Description: cn
From: Laurence Cooper [mailto:laurence.cooper@gmail.com]
Sent: 08 May 2014 21:00
To: Enquiries
Subject: You just spoiled my day
Dear Sirs,
I’m dismayed to read that you are avoiding taxation. I drank your coffee because I thought you did. Now I won’t anymore; and that’s a shame.
Until I hear a clear statement from you that you are going to contribute to the same UK society which helps generate your loot I will count you as a bad lot; effectively parasites on this country.
I shall spend time planning how I can now maximise awareness of your social irresponsibility.
Yours faithfully,
Laurence Cooper
the caffe Nero response is largely true – if you take the consolidated operating profit and deduct interest paid to banks then you practically wipe out the entire profit – this is before you even start thinking about connected party debt to tax havens or similar.
So isnt the crux of the matter “should acquisition finance be tax deductible” rather than some rant about offshore tax havens or similar? ie points 1 and 3 of RM’s original blog, with 2 actually being irrelevant in this particular circumstance. Do we care about this if the banks are UK based and therefore taxed on the income (ignoring the fact that presumably they all have huge tax losses to use which is probably a different argument)
I have made exactly the point you refer to
And yes I do care about whether or not UK banks get the income
It is also the case that a significant part of the loss relates to payment to tax havens
If you lift the veil of obfuscating detail and stand back with the lay person on the Clapham Omninbus and look at the big picture, the motive to avoid tax by what ever means is the same whether you are an individual or a multinational.
This is true for example for Gary Barlow trying to dodge an income tax bill by using a dubious tax scheme, or Cafe Nero reducing their Corporation Tax charge by convoluted arrangements that are a commercial nonsense if they weren’t primarily tax driven.
Ultimately it is a question of morality or more accurately a lack of it.
However, while the criticism of both individuals and large companies is the same, the Government is betrayed by its lack of concerted effort to close loopholes for the latter.
Combine this with TPP and TTIP agreements and the multi nationals appear to be taking a role in the 21st century that is equivalent to that of “Robber Barons” in under the feudal system in the Medieval era.
I am now deeply distrustful of The UK and other first world governments, because their constituent members appear to be dancing to tunes played by oligarchs rather than responding to the overwhelming majority of the electorate.
For the sake of real people, I think the process of globalization should be shoved into reverse gear as soon as possible…..