November 25, 2013 6:09 pm

Hybrid tax schemes face day of reckoning

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When FirstGroup bought Laidlaw, the US yellow school bus operator, in 2007, the UK transport operator financed the acquisition with a $1.8bn intra-group loan.

But strikingly, it was another British company – FirstGroup US Holdings – that ended up paying interest on the loan.

Taxing tactics

Taxing tactics
Understanding corporate tower structure

This quirky structure – involving a big dollar-denominated loan made by one UK subsidiary to another – is a little-known but common strategy used by multinationals with big US operations. The result is a double tax deduction – in both the UK and the US – which is offset by a single UK tax payment on the interest received.

This technique – known as a tower structure – is an example of a hybrid scheme that complies with individual country’s tax laws while exploiting inconsistencies between them.

Simple to set up and often tolerated by tax authorities, they have become a popular alternative to the more widely-used strategy of routing intercompany loans through tax havens, such as setting up a Luxembourg company to lend money to a subsidiary in a higher tax country.

The FirstGroup structure – along with similar schemes set up by Tate & Lyle, the UK sweetener maker, and Linde, the German gases group – result in net tax deductions in the US but are tax neutral in the UK.

Yet it is often hard to work out which tax authority is losing out in such hybrid schemes, according to the Paris-based Organisation for Economic Co-operation and Development. It is drawing up plans for a crackdown on the structures as part of the international drive against multinational tax avoidance.

These schemes make use of the 1997 US “check the box” rules that allow companies to elect to disregard a subsidiary by simply ticking a box on a tax form. This allows foreign subsidiaries to disappear into their parent companies for US tax purposes.

The rules, originally introduced as a simplification, have opened the door to new planning opportunities for foreign companies operating in the US, as well as providing scope for US multinationals to cut their tax bills abroad.

A check-the-box option for FirstGroup US Holdings would mean that any transactions would be regarded – for US tax purposes – as occurring in its parent, FirstGroup America Inc. As a result, the US tax authorities would view the interest payments as coming from the US parent, resulting in a US tax deduction.

The structure results in an estimated $49m-a-year tax benefit for FirstGroup but the benefit is deferred because of significant losses associated with the Laidlaw acquisition and the rules on the timing of deductions for interest in the US.

The company said: “It is important to note therefore that the structure, which as you would expect is approved by HMRC, is not currently reducing the cash tax actually paid in the US in any material way.” It added that the structure made no difference to the level of UK tax paid.

Lombard: Lucky dippers

Jonathan Guthrie

Those fun-loving folks at the Organisation for Economic Co-operation and Development are planning an assault on double dipping. This is the practice of realising two tax credits on the same transaction by shunting money between countries with unharmonised tax rules. Aircraft leasing groups were active here during the eighties. Now some European multinationals are using similar strategies, writes Jonathan Guthrie.

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In a similar deal, Tate & Lyle told investors in its 2008 annual report that it had implemented “an internal financing plan” that was expected to deliver substantial tax savings. In October 2007, it set up Tate & Lyle Holdings Americas, a new UK-based company owned by its US holding company, which has since paid more than $1bn in interest payments under the terms of a $2.5bn intra-group loan. Its tax savings since 2007 are estimated by the Financial Times to total $385m.

Tate & Lyle declined to comment on the estimate but said: “Full details of our internal financing arrangements have been disclosed to and accepted by the tax authorities both in the UK and the US.”

Last year, Linde agreed to pay $4.6bn to acquire Lincare Holdings, a US provider of respiratory homecare services. The new acquisition became a subsidiary of a UK company, Linde North America Holdings Ltd, which is owned by Linde’s US subsidiary. Linde North America Holdings Ltd has borrowed $2.5bn from a group company.

Linde declined to comment on the details of its internal financing structure, adding: “However, we can confirm that Linde’s US subgroup issued debt in connection with the acquisition of Lincare Holdings Inc and that tax relief is being claimed in the US for the interest which accrues on this debt.”

Similar results can be obtained in other countries by using partnerships or by using hybrid instruments, such as preference shares, which are considered to be debt in one country but equity in another. But the US tax system plays a disproportionately important role in hybrid structures because of its check-the-box rules, its high corporate tax rate, the size of its market and big differences between its tax code and that of other countries.

Hybrid structures are now near the top of the list of the loopholes to be closed in the crackdown launched this year by the Group of 20 leading governments in response to yawning budget deficits and public anger over tax avoidance. The schemes would be hit by plans to deny a deduction for a payment that is also deductible in another country.

But some tax advisers are sceptical about the effectiveness of such measures, saying companies find other ways, such as routing loans through Luxembourg, to achieve the same result.

In recent research, the investment bank Citi said companies faced a risk of significantly rising bills. But it noted the difficulty of making internationally co-ordinated tax changes and politicians’ reluctance to act unilaterally on their anti-avoidance rhetoric. It said: “So far, actions speak louder than words.”

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