Wednesday, February 27, 2013

How to spot a tax thief



Number 1: How to spot a tax thief
 An accountant (who would prefer to remain anonymous for obvious reasons) explains how to get hold of corporate accounts and how to spot the tell-tale signs of corporate tax-dodging.



Introduction

Before I address the purpose of this article I would like to address two of the principal ‘criticisms’ of those who see nothing wrong with tax avoidance. The first and most common complaint is the frankly rather puerile cry that “tax avoidance is legal! It is tax evasion that is illegal”. I am quite often stunned that I need to say this but the fact is that:
a) avoidance has the same effect as evasion – the non-payment of tax
b) It’s done for the same reasons – the non-payment of tax!
It used to be legal to own people as slaves; does that mean it was right or that we should have continued to tolerate it? Of course not.

The second criticism is subtle but even more important. I have often seen it displayed on the blogs and articles of well-read economists and as such it is often repeated as gospel. The criticism is that companies do not pay tax. It is only individuals that pay tax. I actually agree. Clearly all taxes levied eventually end up as part of the charge made for goods and services and since individuals are the end of the purchasing chain it is individuals that pay the tax. However this is only half of the story. Firstly not all individuals purchase the same goods and services but all purchase the basics. That’s why VAT is a regressive tax, duh. Secondly not all individuals bear the same burden of tax.

It is often mentioned by the right wing that the rich do pay more tax than everyone else. Yes, they do as a single group when measured against other single groups. But let’s be clear those who own 80% of the wealth are not paying 80% of the taxes and that is principally achieved by tax avoidance. The mechanisms I will describe below are generally not available to mere mortals like you or I. They require a complex network of friends from privileged backgrounds and often cost tens of thousands to setup. It therefore only makes sense to avoid the tax if you have at least hundreds of thousands to hide. Since the crash in 2008 the richest 1,000 individuals have seen their wealth grow by approximately £155 billion. You can bet they did not pay much in extra tax as a result.


How to spot a tax thief

Much of the current debate around tax has been reliant on others informing us of who is ‘dodging’ tax. Whilst there appears to be solid research confirming who these organisations and people are, it would help if people could decide for themselves whether their own company or clients or suppliers are involved. This guide is designed for the layman. It glosses over many of the subtle details that could invalidate calling a company or someone a tax dodger. However the tax strategies listed out here, if the company is using lots of them do indicate a propensity to dodge some amount of tax.

Ultimately this is a guide; even if a company has a parent in a foreign country this does not necessarily mean it is dodging tax. To really know that you'd need to see the individual transactions. That being difficult to get hold of one can resort to simply calling their bluff and accusing them of it! So few people look at the company accounts apart from the finance nerds that companies assume the staff will not know what they are looking at. As such letting them know you are aware of the parent company in the Caymans can be a bit of wake-up call!

You can download company accounts from Companies House for the cost of £1. From these accounts it is possible to identify likely tax avoiders. Alternatively buy one share in the company you're interested in. This entitles you to see a lot more information but you will then need to wade through the various piles of literature past the guff about their 'green policy' to see what is actually going on. 

The schemes listed below are indicators of tax avoidance. If the company you are studying is doing combinations or all of what sits below it is fair to regard them as probably being engaged in some form of tax avoidance.
1. Parent companies in tax havens
2. Inter-company recharges
3. Interest paid
4. Deferred Taxation & accruals of liabilities
5. Intangible assets
6. Shareholders and the parent – associated companies
7. Tax paid
The most basic technique in tax avoidance is to raise costs. Sales or turnover made by the company is usually inflated to make the company look better and boost profits. This would incur a higher tax liability. So we should begin by looking for instances of companies raising their costs as this will squeeze profits.

Parent companies
The first and most important way to do this is to ‘owe’ money to a parent company. Many organisations now have multiple companies doing lots of little jobs or working in specific markets. They may also buy companies doing work in markets they see a benefit in. As such over time the company may actually not be one single company but a group of companies. The parent is the organisation at the top of the pyramid. The organisation itself will own the companies underneath it.

Where will I find this?
Look in the notes sections which are at the front or back. These will usually have a note related to ownership of the company. If there is a parent, where is that parent based? If it’s based in one of the many tax havens across the world it is more than likely using that parent to dodge tax. Wikipedia provides a good basic introduction to tax havens, which also includes a list of the main tax haven economies.

Inter-company recharges
Each of the smaller companies will be known as ‘associated’ or a ‘subsidiary’. An associate company is controlled by the same shareholders as the parent (more on that later). A subsidiary is controlled by the parent company itself. i.e. Phillip Green owns Arcadia Group (through his wife!) which own BHS. BHS is a subsidiary as it is owned by the parent Arcadia. If Phillip Green controls another company personally this would be an associate as it would be controlled by him personally and not by Arcadia Group. This distinction is important because it introduces a key way to shuffle money around and disguise the real benefactors.

The tax avoidance comes in via Inter-company recharges or overhead recharges. By themselves these do not specifically mean tax is being avoided. Local government often recharges overhead to the local government company running your local swimming pool. They do this because they undertake work on its behalf. It is only fair that the swimming pool company therefore recognises this cost and pays the councils head office for it.

What sets apart tax avoidance is that the intercompany recharges or balances are set to transfer funds in private organisations offshore. It will be easier if we use an invented example. Acme UK sells widgets in the UK. They make £500,000 profit and so would pay tax on this. The directors of Acme UK are not happy about this so they create Acme Group Co and register this in Jersey.

Acme Group ‘charges’ Acme UK for the use of its brand name, patents and for loans that Acme Group has extended to it. These cost £750,000 per year. Now Acme UK books those costs against its £500,000 profit; is making a loss and can claim back tax. The money in the bank from the sales Acme UK has made gets paid to the bank account of the parent Acme Group in Jersey and in effect the £500,000 has moved abroad (and incurs no/less tax). At the same time Acme Co is left with a £250,000 debt on its books so that any future sales are already destined to be moved abroad and have no/less tax paid on them. So now Acme UK is not only not paying less tax it is actually claiming tax back previously paid for the ‘losses’ it is now booking.

Where will I find this?
Look on the companies accounts for specific intercompany balances – note how big they are in relation to the overall size of the company. If the UK company owes a large balance to intercompany charges see if the parent company is stated in the accounts (see Parent Companies section above).

Some companies bury their intercompany recharges in their debtors and creditors or receivables and payables. These are the statements of what the company owes or is owed by other companies. Crucially these amounts are stated when they have not yet been paid. A debtor/receivable is owed to the company – it is a sale made in the year which has not yet been paid. A creditor/payable is owed by the company for goods or services rendered which have not yet been paid.

Even relatively small firms have become quite clever at disguising their profits this way by making the intercompany recharges on both sides. They owe money to the parent as a creditor but also are owed money by the parent or other companies in the group as a debtor. This can make it quite hard to unpick who owes who! In the notes it should state what the intercompany balances are as a % or amount of the total debtor/creditor balance. Deduct these figures from the debtor/creditor balance and you will get a real idea of how much money the company is actually making.

I found one company in the UK which had £36m debtors and £32m creditors. But it had used such confusing systems of jumping money around that when I finally unpicked it all it actually had debtors of only 20% of the figure on the accounts and creditors of a similar size. In other words this company was actually nowhere near as big as they made out. The profitability was lower and yet because it was mainly intercompany balances their tax bill was a fraction of these numbers. They were able to show a larger profit and a larger company off the back of a tiny tax bill and it was all legal.

Interest paid
You can see that booking these ‘loans’ will incur interest costs. Interest is accepted as deductible for calculating corporation tax. In other words if I take out a loan and pay interest on that loan it is legal for me to accept the interest as a cost, lower my profits and pay less tax. But what is a loan? How do you define whether a loan has been made? Is it the passing over of cash? Or that you owe the funds to a 3rd party? What if the investors provide services or an overdraft to fund or facilitate expansion? This 'loan', even though it is not from a bank allows the company to book the interest paid as a cost and reduce their profits.

Using the example given before Acme UK directors realise that all the loans they have on their books from their investors are creating a tax liability. When they repay the investors, because they are based in the UK, those investors have to pay tax on the interest paid to them. Acme must also deduct tax at source and pay it to the government. To avoid this all of the loans are rolled up and paid off by Acme Group – in reality no money switches hands this is a paper transaction. You might hear this referred to as the reassignment of debt. The loans are considered paid off by Acme Group but now Acme UK owes Acme Group for the ‘new’ loan which paid off the old ones.

Acme Group then receives the money offshore from the loan payments and pays it to the investors in their Jersey bank accounts. The money received is offshore and will attract no/less tax.

Where will I find this?
Look on the balance sheet of the company, this is also known as the ‘consolidated statement of financial position’. This shows what the company owes and owns. The other side of this is the profit and loss or ‘income statement’. This is the statement of what the company has done in that financial year.

The balance sheet will show the value of loans outstanding. What percentage of the total assets/liabilities of the company are these loans? Do they give a breakdown in the notes showing how many loans there are or whom they are owed to? See if you can find parent company loans or loans to specific directors or shareholders. These will probably be tax avoidance mechanisms.

The profit and loss account will show the interest paid. What % of the total costs is the interest? Has it grown, did it appear or disappear in one year only to reappear the next? Compare this to other companies. Is it significantly more than its competitors? Different industries require different costs and ways of operating. Some industries will have high levels of debt not because they are doing something sneaky but because that is just how the industry generally funds itself. But if the interest is one of the biggest single costs in the company & if it is significantly more than its competitors you can bet there’s some tax avoidance going on.

Deferred taxation & accruals of liabilities
These are sometimes also referred to as ‘provisions, contingent assets or contingent liabilities’. Accountants have a number of ways of defining these but in essence these represent obligations of uncertain timing or amount.

Let me give you an example. Acme UK has a contract which has worked out badly for it. The contract is not yet finished and it’s not yet certain of the cost it will pay. Acme UK has booked sales from this contract and therefore gained profit from it. However the contract is going badly and therefore it will not make as profit as it first thought. Acme UK is therefore allowed to recognise on its accounts that its profit has been reduced by this cost which has not yet been paid.

HMRC does not allow for these kinds of provisions to offset tax (as they are not real yet!) but they form an important part of obfuscating what is really going on. All sorts of estimates and guesses about potential liabilities can disguise a.) what the company is actually earning and b.) what it actually owes.

Most importantly by recognising these unpaid events the company has then legitimised the cost so that when it finally comes in they can book the cost against their profits and lower the bill. This may not seem a way to avoid tax per se but the key is this: What is a cost? A price is what you pay but a cost can be an opinion. If I have done work for someone or suffered loss through damage how do I tell how much money has been lost? There will be some straightforward costs from 3rd parties which I paid out of my bank account, fair enough. But there will also be my internal costs of handling the issue or problem. My estimate of these will be considered legitimate to book as a cost, but that’s just an opinion. I should create evidence that backs this up but with millions of companies and only thousands of tax inspectors how often will it be checked that what I have done is reasonable or true?

Deferred tax is a particular contingent liability we should pay close attention to. It is the recognition of a tax attributable to temporary differences. This is the difference in value between the value placed on the accounts (it's book value) and its tax base (the value the taxman would consider legitimate). This does not therefore mean that any tax is owed right now. What it’s referring to is the possibility of having to pay that tax at a later date or the fact that the value of the assets or liabilities is different to what the tax man says.

But why would the value be different to what the taxman considers? Well there are several complex and detailed reasons for the differences in the calculations but ultimately what one should consider here is how the company is valuing its future work and assets. If the deferred tax is an asset to the company then it may have written off a lot of 'damaged' stock which it is expecting to get a tax rebate out of. Alternatively if it is a liability then the company maybe over valuing its assets and is recognising that when it sells them it will owe more tax.

Deferred tax is also used to estimate if the losses carried forward will actually be used up. In the UK certain types of loss have a time limit. You can't just use the same loss forever to hold off paying tax. Deferred tax will help to show the amount of tax they intend to pay or not pay next year.

Where will I find this?
It will be in the profit and loss or Income statement under Other comprehensive income, on the balance sheet or statement of financial position it will be listed under non-current assets.

Intangible assets
These are assets (things the company owns) which are not physical. Things like brand or patents or its sales database will be included here. These are the assets the parent company will own and charge the other companies in the group for using. The key is how does one value this? Nike's brand is clearly worth millions but what is it? Is it the copyright for the logo; the name? How does one accurately price this? These brands do not get sold every day. Well there are several ways to arrive at a single number to buy it outright, but what of charging other companies for using it? Companies will often pay to have their brands advertised but that's not likely to be the price for you buying the rights to use it.

Clearly this 'price' is something of a guess. It will depend on what the brand is being used for, what sales you might get from using it. Clearly there is scope here for invention. As such if a company has intangible assets listed, see if you can find out what these are. There may not be a list of the assets of the company which will make it hard to work out the change in value. Tangible (real physical) assets like buildings are often easier to understand than intangible as there are clear methods for working out the value of a building or a piece of machinery. But an intangible asset can be hard to define narrowly enough that one could be certain of its value.

Where will I find this?
Intangible assets are always listed under total/long term assets at the top of the balance sheet/statement of financial position. You should also look for changes in the value of the assets on the income statement/profit and loss account. These would be listed at the bottom under Other comprehensive income or liabilities. These will show up how much the value has changed in any one year. If you know what the intangible asset is they may have written off the cost as a specific cost of goods sold. This would bury it in the accounts with a lot of genuine costs such as parts ordered, staff time etc. You may still be able to find it though if you look at the % of cost that these lines take up. Does one line seem to be 30% of cost one year and 45% the next? If so did sales also go up the same amount?

Shareholders and the parent
Shareholders typically do not own shares in only one company. People who put their eggs all in one basket tend to find they lose out unexpectedly. Major shareholders of major companies almost certainly do not have all their eggs in one basket. As such they will set up companies to gather the income from this into one place. The key is to disturb the chain of money flows. A lot of people get paid very good money in the city to bundle assets into groups and classes which are then shuffled between various entities to such an extent that anyone trying to follow the money trail quickly gets lost. Statements of account typically do not list out individual shareholders or how much is owned by whom.

However for very prominent companies the financial news may talk about a director’s remuneration being paid in company shares. Other famous owners like Phillip Green (Arcadia) or Lord Rothmere (Daily Mail) may well be known and their shareholdings or other activities listed out. See if they are the shareholders of associate companies or clients and suppliers of the main company. If it is an associate company they may be charging the parent for all sorts of services offshore which once paid disappear off the company’s books to somewhere you can't see them. But they will permissible to regard as costs, lowering profit and tax.

Where will I find this?
It is not likely that these relationships will actually be on the financial statements. This is where you just have to dig and see what you connections between individuals and the companies they run you find. Follow the money - who owns the profit and to whom do all these charges for loans and brands get paid to?

Tax paid
I've left the most obvious to last as the preceding part demonstrates how complex hiding these values can be and most importantly that just because the tax paid is low does not necessarily mean the company is dodging. It could be it's just had a bad year. Tax paid should be compared to previous years, turnover (sales) and as a % of operating profit or PBIT/EBIT.

High sales figures do not mean high profit but if the tax paid as a % of sales changes look to see the changes from last year. Did costs go up a lot too, squeezing profit? If costs and tax paid was relatively the same but sales rose then what happened to the profit?

Operating profit is the profit after all costs of goods sold but before operating costs and interest and tax. This is the profit the company makes on the job it was set up to do. If a computer chip maker invested in a bowling alley it would not include the income from the bowling alley in this operating profit as it is nothing to do with its normal everyday job. This profit margin is key because it strips out a lot of the funky accounting in interest for 'loans' or income and costs from overheads or odd sources. How much is the tax as a %? Does it change from year to year?

After you include for overheads as a cost you then get PBIT (profit before interest and taxes) or EBIT (Earnings before interest and taxes). What is the tax as a % of this value? Corporation tax is between 20-24% of a company’s profits but the calculation determining this is so long winded and full of subtle variations that the key is just to see how much tax is actually paid compared to these profit margins.

A lot of the major FTSE companies using these schemes pay tax rates of less than 5%, many as low as fractions of 1%. This really shows up the difference in tax avoidance being achieved. 

For a crude measure deduct the interest from the PBIT and then multiply that figure by 24%. Is what they actually pay in tax significanly less? If it is then the company is definitely bouncing something around!

Be careful though as tax paid may include other taxes which are not taxes on profits such as National Insurance Contributions.

Where will I find this?
Tax paid is listed on the income statement at the end after PBIT or operating costs.


Final remarks

No doubt upon publishing this I will get some screaming banshee of a critic who points out the inaccuracy of what I’ve written in regards to IAS12 or the IFRS rules or UK GAAP. Yes well done, you’re quite right there are subtleties that complicate this picture and invalidate it to some degree. So I’ll repeat myself, this is a guide for the layman written by an accountant. As such I am not going to include the various academic debates surrounding classifications of derivatives under IAS39. If you’re that hot to trot well done, buy yourself a beer, I’m sure you can afford it.

The accountant’s favourite answer is 'it depends'. So much of what is listed above does not guarantee that the company is dodging tax. Just because lines of cost go up one year to the next without corresponding increases in sales may just mean the company is investing money targeting a new market. It will reap the rewards in years to come. That said, if the parent is based in Jersey, you have large inter-company balances, a lot of interest paid to individuals or associated companies etc you can be fairly sure the company is not paying all of the tax that might be due were the taxman to be watching their every move.

Keep your eyes peeled, read financial news concerning the market the company is in, buy a share and download their accounts and look at them. Happy hunting!


Useful links
UK Uncut
Tax Research UK
38 Degrees - Tax Dodging
This is Money - Tax haven usage by the top 20 UK companies, article
This is Money - Tax haven usage by the top 20 UK companies, stats
My Tax-Dodging non-shopping list


About the author


The author is an accountant in an environmental company. On his days off he makes loud offensive rap music and stands outside government buildings with signs. 


About Another Angry Voice 

Another Angry Voice is a not-for-profit website which generates absolutely no revenue from advertising and accepts no money from corporate or political interests. The only source of revenue for Another Angry Voice is the  PayPal  donations box (which can be found in the right hand column, fairly near the top of the page). If you could afford to make a donation to help keep this site going, it would be massively appreciated.



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