Cadbury: The great tax fudge; The beloved British confectioner ran aggressive tax avoidance schemes at odds with its image

June 20, 2013 6:58 pm

Cadbury: The great tax fudge

By Jonathan Ford, Sally Gainsbury and Vanessa Houlder

The beloved British confectioner ran aggressive tax avoidance schemes at odds with its image

It was a deal that provoked visceral reactions in Britain. Even before Kraftcompleted its contentious £11.5bn purchase of Cadbury three years ago, politicians were warning the US group against trying to make a “fast buck” out of the UK confectioner.Painted as a cost-crunching manufacturer of “plastic cheese”, the US conglomerate was seen as a threat not only to Cadbury’s unique British heritage but also to its tax contributions.

The worst fears of critics appeared to be realised just months after the deal when it emerged that the new owner (renamed Mondelez following a 2011 demerger) would reorganise Cadbury in ways that ensured it paid little or no tax in Britain.

Kraft planned to shift Cadbury’s management and purchasing activities offshore to its European headquarters in low-tax Switzerland, leaving the UK operation as little more than a shell, laden with £8bn of debt.

Newspapers claimed that £60m of annual tax payments would be lost and politicians were incensed. “The public will say that this is just tax avoidance and the public will be right,” said Lindsay Hoyle, the deputy speaker of the House of Commons.

But the truth is that HM Revenue & Customs had little to lose from the deal. As a Financial Times review of Cadbury’s tax affairs has discovered, the chocolate maker paid an average of £6.4m a year in current UK tax on its operations in the decade before the takeover.

This was at a time when Cadbury’s British confectionery operations earned, on average, £100m of profits each year. Paying the standard rate of corporation tax would have forced it to hand £30m annually to HMRC, almost five times what it did pay in tax on operations.

Some of the tactics Cadbury used to cut its tax bill were aggressive, involving tax havens and complex structures with exotic codenames such as “Martini”. These tactics would have shocked the company’s Quaker founders. But more often the group simply exploited opportunities offered by the UK’s easy-going tax regime, loopholes or conflicts between national and international laws.

Britons may still see Cadbury as primarily a British business, churning out much-loved treats such as Dairy Milk chocolate and Curly Wurly bars. But two decades of debt-financed expansion have transformed the group and even before the takeover it was a global company, earning 90 per cent of its profits overseas.

This week, at the Group of Eight summit, David Cameron, UK prime minister, called for international action to counter corporate tax avoidance. Stung by the public backlash after revelations about how companies such as Apple and Starbucks pay little or no tax in Britain, the government has promised to tighten up. But behind the rhetoric, the UK has been laying out the red carpet for such companies, cutting tax rates – especially on foreign-sourced finance income – and creating fiscal incentives to shift certain activities, such as research and development, to Britain. How much tax large UK-based multinationals pay, as Sir Martin Sorrell, chief executive of WPP, the international advertising group, observed, is largely “a question of judgment”.

The FT analysed Cadbury’s tax payments and schemes by reviewing a decade’s worth of annual returns and accounts filed by the group and more than 60 of its subsidiaries at Companies House in Britain and in several overseas jurisdictions, including Ireland, the Netherlands and the Cayman Islands. It also talked to a number of former Cadbury executives who spoke on condition of anonymity.

The filings show that while Cadbury took advantage of conventional strategies to cut tax, borrowing heavily in high-tax countries while financing growth through low-tax jurisdictions such as Ireland, it also employed more aggressive tactics.

Cadbury’s imaginative tax department concocted schemes designed to engineer interest charges that could be deducted from its profits to reduce UK tax. It was a game played for high stakes: just two of the schemes uncovered by the FT were designed to save Cadbury some £33m in tax between 2002 and 2008 – a period when its actual tax charge on continuing operations was only £37m.

Such schemes were commonplace, said a former executive, who observed that the tax department appeared to find the process of inventing them “intellectually quite stimulating”.

One arrangement involved an inter-company loan made by one of its UK subsidiaries (named Chaffinch by a bird-loving executive) to another, whose purpose appears to have been to claim millions of pounds worth of tax-deductible interest charges in the borrowing company while not reporting the taxable interest income earned by the lender.

This was a paper-shuffling exercise that aimed to exploit discrepancies between the different accounting practices employed by the two companies, and hence to reduce the confectionery maker’s tax bill by some £17m between 2006 and 2008.

A former senior tax adviser, who spent his career devising avoidance schemes for big corporations, described Chaffinch as “an artificial attempt to avoid UK taxes” after reviewing the accounts of the subsidiaries involved. “It is aggressive tax avoidance,” he added.

Creating an artificial interest deduction may have been a speciality of the tax department. But Cadbury’s executives did not turn their noses up at other ruses, such as sheltering profits in tax havens. One scheme, which ran from 1998 to 2002, involved the group lending two specially-created Cayman subsidiaries £400m free of interest. Their purpose, disclosed in their articles of association, was to lend this money back into the UK to another group company at an interest rate of more than 7 per cent.

In a matter of months, this shifted £30m of profit out of the UK into the Caymans in the form of interest payments, saving £9m in UK tax. Although such “upstream loans” were regarded with extreme disfavour by the taxman, Cadbury dodged HMRC’s anti-avoidance rules by disposing of the Cayman subsidiaries before the end of the first financial year to Allstate, a US insurance company, al­though not before the bulk of the money had been repaid.

But the group’s biggest challenge as its American business expanded was to engineer interest deductions against its US tax bills. It attempted to achieve this by playing off mismatches between the British and American tax regimes.

To do this the group used a set of US and UK subsidiaries, many bearing the name Bruton Lane, a quiet street near Cadbury’s former headquarters in central London.

The nub was that two UK subsidiaries invested $576m in preference shares issued by a US one. Their return came not from dividends but from selling the preference shares back to the issuer at a pre-arranged $89m premium using a “put and call” arrangement. The aim was to convert what would have been taxable income into a tax-free capital deal.

A former executive admitted the group’s schemes ran counter to its public image. “Historically, Cadbury has been very aggressive on the tax side, which goes against what you would think about the reputation of the company from its philanthropic background,” he said.

While many of Cadbury’s schemes involved games around debt, it also made more conventional use of Britain’s generous tax treatment of debt interest, which gives companies wider scope than do many other countries to borrow to invest overseas and offset their interest bills against domestic taxable profits.

Between 1999 and 2005, Cadbury’s net debt increased from £182m to £4.2bn as it went on an acquisition spree culminating in the £2.6bn purchase of the Adams confectionery business in 2003. British pre-interest profits increased slightly from £119m to £138m. Meanwhile the group’s net interest bill rose fourfold from £46m to £199m – much of this deductible against UK profit.

But this was only part of the story. As Cadbury’s foreign profits grew with each acquisition, it faced a fresh challenge. This was how to cut the group’s tax liability in countries such as the US, which had even higher tax rates than the UK.

Cadbury’s solution was to turn to Ireland, where it had owned a chocolate business since the 1930s. Lured by corporation tax rates of just 10 per cent, the group diversified this operation so that it lent into, and received royalty income from, America. A series of specially-created Irish finance subsidiaries was also pumped with £1bn of equity – money again intended for US loans. The objective was to shift profits from America to Ireland in the form of inter-company interest payments. Even after Irish tax rates rose to 12.5 per cent in 2003, the arrangements meant that US profits would be taxed at a rate a hefty 22.5 percentage points below the 35 per cent payable across the Atlantic.

The precise money trail is hard to follow as Irish companies are not obliged to file accounts so long as their finances are underwritten by a parent – in this case a Dutch holding company.

But 2010 accounts filed by Mondelez, after the US group had started to dismantle the Irish lending activity, give some clue as to its scale. They show that two Irish trading companies – Cadbury Ireland and Greencastle – still had loans outstanding of $510m – just weeks from the winding up of their loan books.

Further loans of at least $235m were made to US operations from one of Cadbury’s Irish financing companies, Cadbury Schweppes Treasury America, according to 2007 filings to the US Securities and Exchange Commission.

HMRC’s attempts to catch Cadbury’s Irish lending dodge ended up in court. The group argued that the taxman’s anti-avoidance measures (known as Controlled Foreign Companies, or CFC, rules), which attempted to tax the Irish finance income as if it had been earned in Britain, breached its rights under European law. These allowed it to set up subsidiaries anywhere in the EU without being discriminated against.

The case was never satisfactorily resolved. The European Court of Justice delivered a Delphic verdict in 2006, concluding that the CFC rules could be applied but only in situations where a subsidiary was a “wholly
artificial” creation. The judges, however, declined to define what constituted artificiality. Back in Britain, Cadbury later dropped the case as part of a broader deal with HMRC, leaving legal ambiguities that have since haunted both sides.

A former executive claimed Cadbury wasn’t alone in using contentious tactics. “We were no worse than many multinationals in those days”.

There were plenty of reasons for companies to take a chance. Schemes were simple to set up. As one tax expert noted, they could be “handled from head office, so you don’t need to change the way business works”. There were no sanctions, other than interest on the late tax payment, if the scheme was ruled ultimately to be abusive. “There is no penalty providing the company has not been dishonest,” said Patrick Stevens of the Chartered Institute of Taxation.

While schemes could provoke rows with HMRC, these were always negotiable and conducted behind closed doors. In 2009 Cadbury resolved a number of tax disputes with the taxman in one of the first so-called fast-track settlements, an event described by a former executive as “five minutes in the headmaster’s study”.

The terms were kept confidential. Insiders suggest that the taxman rewarded Cadbury for dropping the contentious tax litigation and sparing it an unwelcome precedent. Whether true or not, the group ended up cutting a deal that allowed it to write back a £64m credit in its 2009 accounts – effectively meaning it was let off tax it had expected to pay.

In a recent speech, Sir Roger Carr, who sat on Cadbury’s board from 2001 and chaired it from 2008 until the takeover, distinguished between tax efficiency and doing things solely to avoid tax. “We reject schemes which serve no commercial purpose other than the minimisation of tax, even though such schemes may be legal.”

Public antipathy has made companies warier of schemes. “Tax has now got on to the board agenda rather than something that is left to the head of tax, who had an objective to keep tax down as far as possible,” said Mr Stevens. The government is also trying to take a more muscular line. In April it introduced a general anti-abuse rule that is designed to make it easier for HMRC to challenge aggressive schemes.

But Mr Stevens says a bigger reason for the decline in interest is that the UK tax regime is so favourable for big companies that there is no need. Corporation tax has fallen to 23 per cent, and finance income of the sort Cadbury generated through Ireland is now taxed at about 5 per cent.

“When you have countries saying ‘come here and we won’t tax you’ you don’t need loopholes,” he said. “Britain is at the vanguard of this trend.”

Policy: UK uses tax to lure business back home

Dozens of big and medium-sized UK companies are rushing to set up offices in tax havens such as Jersey, Malta, Ireland, the Netherlands, Luxembourg and Switzerland to take advantage of a policy introduced by the British government in April.

The policy, which creates an “ultra competitive” 5.75 per cent tax rate – a quarter of the full rate – for subsidiaries in tax havens that provide finance for other parts of a multinational group, has alarmed fair-tax activists. And it comes despite promises by David Cameron, UK prime minister, to crack down on tax avoidance by multinationals.

The policy was a response in part to a European court ruling secured by Cadbury Schweppes, the confectionery company. The 2006 decision weakened one of the tax authority’s main defences against tax havens.

Britain’s initial proposal of tough new anti-avoidance rules provoked anger from business and prompted the departure of 22 companies, including WPP. The ruling Labour party withdrew the proposals. In 2010, a coalition government of Conservatives and Liberal Democrats was keen to send a signal that Britain was “open for business” and began discussing new rules creating a partial tax exemption for finance income earned offshore.

The Treasury – determined to bring companies such as WPP back to Britain – gradually conceded more ground.

But the concessions were contentious. “There was a lot of internal unhappiness,” says a person close to the discussions. “Pragmatism caught fire. It was competitiveness in its rawest form”.

The enthusiastic uptake of the policy means it could end up costing more than the expected £325m a year, say advisers. The rules may end up being tightened. “The political risks are rising,” says one adviser.

Action Aid, a charity, warns that the rules, which encourage companies to borrow at home and abroad, could cost developing countries up to £4bn of tax revenues. The Treasury rejects the estimate and says it has never acted as “the world’s tax policeman”. But the concern is justified, says a multinational executive. “It is an open invitation to strip everyone else’s tax base”.