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By Ben Stupples
Britain’s largest public companies face a bill of more than $500 million from the EU’s investigation into a U.K. tax scheme, highlighting the growing potential cost of the probe.
Diageo Plc, Associated British Foods Plc, Smiths Group Plc, and Pearson Plc together have potential liabilities of 379 million pounds ($538 million) from the government-aid investigation, according to data compiled by Bloomberg Tax. The London-based companies are all listed on the U.K.’s benchmark FTSE 100 index.
The European Commission’s state aid investigation into the U.K., launched in October, comes as part of the EU’s efforts to target member nations giving global companies what it sees as illegal tax breaks.
Previously, the commission has cited Luxembourg’s treatment of U.S. multinationals McDonald’s Corp. and Amazon.com Inc., along with Italian car-maker Fiat Chrysler Automobiles NV. In October 2015, it also identified the Netherlands’s tax affairs with Starbucks Corp. as illegal state aid.
Laws “targeting tax avoidance cannot go against their purpose and treat some companies better than others,” the EU’s competition commissioner, Margrethe Vestager, said in an October statement. “This is why we will carefully look at an exemption to the U.K.'s anti–tax avoidance rules for certain transactions by multinationals, to make sure it does not breach EU State aid rules.”
Like Ireland’s battle over whether Apple Inc. owes it 13 billion euros ($16.1 billion) in unpaid tax, the EU may force the U.K. to recover the relief companies have gained through the exemption.
Diageo, the maker of Johnnie Walker whiskey, on Jan. 25 became the first company to disclose the probe’s potential impact, citing a maximum exposure of 250 million pounds in its half-year results. AB Foods, education publisher Pearson, and engineering businesses Smiths Group have, respectively, disclosed since then possible costs of 25 million pounds, 90 million pounds, and 14 million pounds.
In their filings, all the companies said they haven’t set aside any cash yet in their accounts to cover the potential liability that would arise if the European Commission rules against the U.K.
In an April 18 email, a Pearson spokesman said the company and the U.K. government believe the tax arrangements under EU scrutiny were, and still are, in compliance with state aid rules.
If the European Commission rules against the U.K. government, it “will be required to collect payments within four months of the decision, even if it decides to dispute the decision,” he told Bloomberg Tax. “The timing of any decision is unclear and we are monitoring developments.”
Spokespeople for Smiths Group and Diageo declined to comment. AB Foods’s media office didn’t respond to Bloomberg Tax’s request for comment.
The commission’s state aid investigation into the U.K.’s tax system focuses on whether the country has given multinational businesses unfair relief through its controlled foreign company rules.
Dating to the 1980s, the U.K.’s controlled foreign company (CFC) rules aim to stop businesses from using overseas subsidiaries to cut their tax bills by shifting profits to low-tax jurisdictions.
When the U.K. last changed its CFC rules in January 2013, however, it included a U.K. tax exemption for certain intra-group financing between two subsidiaries based outside the country.
As a result of this change, a global business active in the U.K. can finance a foreign group company through an overseas subsidiary, the European Commission said in October. The exemption allows the parent company to avoid U.K. tax if the subsidiary receiving interest payments via the financing is in a tax haven, or if the financing income isn’t reallocated to the U.K., it added.
“The incentives are thin for the U.K. to recover the illegal aid from companies due to the country leaving the EU and the legal uncertainty to enforce the EU decision,” said Aitor Ortiz, a Bloomberg Intelligence EU antitrust litigation analyst.
“Due to Brexit, the U.K. could delay any legislative change, extending the effects of the current provision” until the country has left the EU, he told Bloomberg Tax. “Having said that, the U.K. is likely to be bound by the EU decision during the transition period.”
In an April 19 email, a U.K. Treasury spokeswoman declined to comment on the investigation.
Since October, a total of 12 FTSE 100 businesses—including WPP Plc, the world’s largest advertising group—have cited the EU probe on the U.K.’s controlled foreign company rules in corporate filings.
In its latest full-year results, filed Feb. 20, InterContinental Hotels Group Plc said it expected the European Commission to publish its findings on the U.K.’s CFC rules later this year or in 2019.
“Should the EC conclude that the State Aid rules are breached, the UK can appeal before the General Court (and possibly the Court of Justice thereafter),” Europe’s second-largest hotel company added. “The Group and its advisors consider that it is unlikely that a finding of State Aid will ultimately be upheld.”
At an April 13 forum hosted by the American Bar Association’s Section of Antitrust Law in Washington, D.C., Vestager couldn’t give any insight on when to expect a final ruling.
“It’s difficult for me to give a precise timing, and that has to do with the way that we work,” she told Bloomberg Tax. “Sometimes, we think we’re approaching a decision, but then we get new information. I cannot give you a timing” of when the commission will publish its decision.
Under former Chancellor George Osborne, the U.K. Treasury officially announced its intentions to change CFC rules eight years ago in the government’s Corporate Tax Roadmap.
The changes included “a finance company partial exemption that in broad terms will result in an effective U.K. tax rate of one quarter of the main rate on profits derived from overseas group financing arrangements,” the 2012 budget said.
The U.K. changed its CFC rules to make it more attractive to multinationals, relying “heavily” on OECD principles for the updated laws, said Isaac Zailer, a London-based partner and global head of the tax at international law firm Herbert Smith Freehills.
The new rules, including the exemption, were part of a “carefully thought out fiscal strategy,” he told Bloomberg Tax. “For any company that took steps to adapt to the regime, it’s probably frustrating and disappointing that this is where it’s ended up.”
(With assistance from Kaustuv Basu)
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