Vodafone in new UK tax ‘scandal’
27 June 2012
Posted by: SAIT Technical
By Reuters/Business Report
The world’s largest mobile phone company, Vodafone
Group, has shaved 1 billion pounds, and possibly more, off the taxes its UK
operating unit might have paid in the past decade, thanks to accounting factors
not seen at other European units.
A Reuters examination of statutory filings made by
Vodafone across Europe over the past 16 years shows the UK taxman has often
gone empty handed, while tax authorities in Germany, Spain and elsewhere have
raked in billions of euros.
Indeed, rather than incurring UK tax in recent
years, Vodafone has racked up tax credits such that it may not have to pay any
tax on its UK operations for the foreseeable future.
Vodafone’s low UK tax bill is in spite of soaring
revenues here and the fact that Chief Executive Vittorio Colao has repeatedly
told investors that Britain was one of the group’s stronger performing markets.
"This is yet another tax scandal,” said Member of
Parliament Margaret Hodge, chair of the parliamentary Public Accounts
Committee, which scrutinises public expenditure and revenue-raising.
"It may be legal, but it’s completely immoral. They
make money out of Britain, and they should put money back into Britain.”
Vodafone declined to answer most questions about
its accounts, citing commercial sensitivity. It said it was committed to acting
with integrity and transparency in all tax matters, while also having a
responsibility to shareholders to control tax costs.
There is no suggestion the company has behaved
unlawfully, and arranging its affairs in a tax-efficient manner within the law
is standard business practice.
"Paying more than was required would be a
dereliction of duty to shareholders,” said Robin Bienenstock, research analyst
at Sanford C Bernstein in London.
The British tax authorities, which lawmakers last
year accused of being "too cosy” with big business, the Treasury and Vodafone
Limited’s auditor Deloitte said they could not comment on individual companies’
Tax avoidance is already at the top of the
political agenda in the UK; last week Prime Minister David Cameron said popular
comedian Jimmy Carr was "morally wrong” to shelter 3.3 million pounds of income
from tax by using an apparently legal tax avoidance scheme.
Tax campaigners say the tough approach to
individuals avoiding tax contrasts with a lax approach toward corporations
doing the same.
HOW DO THEY DO IT?
Between 1998 and 2003, Vodafone’s UK unit, Vodafone
Ltd, made annual profits of around 530 million pounds and paid taxes of around
170 million each year, its accounts show.
While revenues have soared since 2003, reported
profits have plunged. In the past three years, the UK unit has racked up losses
in excess of 100 million pounds each year.
The profit collapse is tied to two factors, the
In 2001, Vodafone limited began making large
interest payments on money it borrowed from companies within the Vodafone
In the 10 most recent years for which accounts have
been published, Vodafone Ltd paid associated companies 3.3 billion pounds in
This reduced the UK unit’s taxable profits by a
commensurate amount because interest payments are tax deductible.
Using the prevailing corporation tax rates at the
time, this translated to savings worth 961 million pounds to Vodafone Ltd,
either in reduced taxes, or by generating tax credits that could be used to
offset future profits.
Tax experts say there have been cases where UK
companies have established units in Luxembourg, which then lend the money back
to UK units, as a tax avoidance mechanism.
This reduces profit in the UK, where corporate
profits are taxed at 24 percent - down from 30 percent a few years ago - while
generating profits in Luxembourg, where financial profits can be taxed at rates
under 1 percent.
Vodafone has a Luxembourg-based unit, Vodafone
Investments Luxembourg S.a.r.l., which it says on its website was "established
as the main financing company for our many operations around the world”.
A spokesman said Vodafone Limited’s interest
payments were to other UK-based units of Vodafone but declined to say whether
these units had in turn borrowed the money from Vodafone Investments
The dramatic rise in inter-company interest
payments seen at the UK unit is not reflected at other Vodafone units in
Vodafone D2 GmbH, the phone giant’s
Duesseldorf-based German unit, paid less than 2 million euros in interest to
affiliated companies in the year to March 2011, the most recent year for which
accounts are available. Vodafone Espana paid 43 million euros in interest to
group companies in that year.
Accounts for the holding company for the Italian
operations do not break down interest payments between affiliated and
non-affiliated companies but do not show any significant rise in overall
interest payments since 2007.
SOARING COSTS OF GOODS
The other main reason behind Vodafone Limited’s
swing to reported losses was an increase in the price its UK unit pays for the
mobile phones and connection services it sells on to consumers. In 2002-2004,
the ‘costs of goods sold’ represented around 55 percent of turnover.
In the past three years, reported costs of goods
sold have averaged 76 percent of turnover, squeezing Vodafone’s income.
Vodafone said in an emailed statement that the
"extremely competitive commercial environment in the UK” had affected margins.
A narrowing gap between revenues and cost of goods
sold can reflect increased competition, whereby companies struggle to pass on
cost increases to consumers via higher prices.
However, transcripts of conference calls with
analysts, that CEO Colao or Chief Financial Officer Andy Halford host each
quarter on the release of earnings results shows the company has warned for
several years that its margins across all European markets were under constant
The UK was not singled out as a market that
suffered an exceptional increase in margin pressure.
In Germany, where Vodafone says call costs are at
the European average or below, the cost of goods sold has not risen
dramatically as a percentage of turnover, and averaged 57 percent in the two
most recent years for which accounts are available.
"This suggests there is some very odd pricing going
on into Vodafone UK,” tax campaigner Richard Murphy said.
At Spanish group Telefonica’s UK division, O2, cost
of goods sold has remained constant at around 58 percent in financial
statements for 2007 to 2010, the last four years for which accounts are
This allowed O2 to generate profits of 788 million
pounds in 2010, on which it paid tax of 189 million pounds.
Had Vodafone’s cost of goods sold in the UK since
2003 averaged the same level as the German unit experienced in recent years,
the unit’s profits could have been 4.7 billion pounds higher, and it could have
incurred an additional 1.4 billion pounds in tax, according to Reuters
calculations based on the company accounts.
By massaging the prices group companies charge each
other for goods and services, multinationals can shift profits from high-tax to
This technique, known as "transfer pricing”,
typically involves a group company in a low-tax regime selling goods above
market price to an affiliate in a higher tax regime.
Tax authorities around the world keep a sharp eye
out for transfer pricing abuses, but it can be hard to spot.
Vodafone declined to say why costs of goods sold as
a percentage of UK turnover rose so sharply.
It said the absence of a UK inco INSIGHT-Vodafone
in new 1 bln stg UK tax ‘scandal’=2
me tax charge for Vodafone Group in the year to
March 2012, was due to high capital allowances and high external interest
charges rather than transfer pricing adjustments.
It also cited the high cost of purchasing a UK 3G
phone licence in 2000. UK profits were indeed hit by a depreciation charge on
licences of 333 million pounds last year. However, in the profitable German
unit, the charge was 519 million pounds.
At Vodafone Germany and Spain, the lower cost of
goods sold and absence of big inter-company interest payments explain their
high profitability - and the high taxes paid in those countries.
Vodafone’s German unit incurred corporate taxes of
3.14 billion euros from 2007 to 2011. Between 2008 and 2010, the Spanish unit
paid almost 900 million euros. In 2011 alone, corporate income taxes payable by
the holding company for the Italian unit were 721 million euros.
A VIBRANT LOSS-MAKER
Vodafone Limited has racked up so many losses in
recent years and its reported profitability has declined so much that it has
even written off previously accrued tax losses, as it no longer expects to have
enough future profits to absorb them.
Yet the ostensibly parlous state of the UK unit’s
finances is in sharp contrast to comments from the company to investors and
analysts over the past few years.
The company’s most recent annual report said the UK
"performed well” last year.
"(Group) Service revenue declined by 0.4%,
reflecting reductions in most markets offset by growth in Germany, the UK, the
Netherlands and Turkey,” the report said.
In every quarterly analyst call bar one since May
2010, Colao and Halford have praised the UK as one of the group’s stronger
Another factor of which they regularly boast in
these calls is Vodafone’s proactive approach to managing its tax affairs.
In 2002 and 2003 the company paid an effective tax
rate of 36 percent. It said it brought this down to 25 percent last year, a
level it has told analysts it expects to maintain in the coming years.
This drop came about even before the UK began
cutting corporate taxes, and rather reflects diligent planning.
"Without further tax planning ... over the next few
years, the underlying adjusted effective tax rate will be in the mid-30s,”
then-Finance Director Ken Hydon told analysts in 2005.
Vodafone boosted its tax team in 2007 by hiring the
head of the HMRC unit that dealt with large corporations, John Connors. Connors
is now Vodafone’s head of tax, according to its website.
Connors, Colao and Halford declined requests for
Around 2008, Vodafone even changed its top
management bonus scheme to ensure that bosses would have a strong incentive for
aggressive tax planning.
Payouts under the group’s Global Long Term
Incentive Plan (GLTI) are tied to the company’s cash flow. However, large
one-off payments to settle tax disputes are excluded from the cashflow measure
used to compute the bonus.
This means that if the company doesn’t pay taxes
for years, cashflow is higher than it should be, facilitating a higher payout
under the bonus scheme. But if the tax authority comes back and forces the
company to pay back taxes, the payment doesn’t diminish cashflow for bonus
HMRC has challenged Vodafone’s tax planning in the
courts. In 2010, the company agreed to pay the authority 1.25 billion pounds to
settle a claim related to its 2000 takeover of Germany’s Mannesmann, which
later became Vodafone Deutschland.
The taxman viewed Vodafone’s decision to structure
the acquisition via Vodafone Investments Luxembourg S.a.r.l. (VIL) as a tax
avoidance tactic, and sought to tax interest payments to VIL that were payable
out of the profits of the German unit.
The settlement - which was criticised by the Public
Accounts Committee last year for potentially costing the taxpayer millions of
pounds - allowed Vodafone to continue to channel interest payments into
Though this fact received little press attention at
the time, Vodafone considered it a major coup.
"This agreement preserves the very significant
benefits of our efficient Group tax structure, which we have benefited from for
many years,” CFO Halford said on a conference call to analysts at the time.
UK A SOFT TOUCH ON TAX?
Multinational corporations pay most of their taxes
in the individual countries where they have a bricks and mortar presence, tax
Hence, Vodafone’s base in Berkshire, to the west of
London, means Britain should enjoy a double dip into the company’s earnings -
on income from its UK phone business and from some overseas income not taxed at
the local level.
But tax lawyers said the UK can suffer financially
because of a willingness to allow structures that might be challenged as tax
avoidance by overseas tax collectors.
"The German system is very rigid and constrained.
There seems less appetite for tax planning and tax-efficient structuring in
Germany than in the UK,” said Ben Jones, tax lawyer at Eversheds. "In France
there is currently a greater capacity for the authorities to clamp down on
structures they don’t like,” he added.
The system may be about to become even more
conducive to tax avoidance.
Chancellor of the Exchequer George Osborne, who has
said aggressive tax avoidance schemes are "morally repugnant”, has published
planned changes to the tax treatment of overseas subsidiaries that campaigners
say will make it easier for big companies to shield profits from the tax man.
As part of a drive to attract more international
businesses to set up headquarters in the UK, Osborne has broadened the
definition of what could be construed as legitimate use of controlled foreign
Campaigners including Murphy say this will make it
harder for HMRC to challenge movements of cash to low tax jurisdictions.
The Treasury has estimated the measures could cost
the Exchequer 805 million pounds a year by 2016, according to documents on the
Osborne hopes any direct revenue hit will be
outweighed by increased job creation.
But Vodafone’s experience challenges the link
between tax rates and jobs.
Despite the UK’s low headline corporate tax rate
and the absence of actual tax charges on Vodafone’s activities here, the mobile
phone giant has cut jobs here by 23 percent since 2007, while increasing
employment by 21 percent in Germany, where corporate taxes are over 30 percent.
Also Vodafone’s investment in Germany has risen 34
percent since 2007, against 11 percent in the UK.
The UK’s relaxing of tax rules is at odds with
moves overseas, and Vodafone is feeling the heat. It faces a major tax
challenge from the Indian government and believes rising fiscal deficits
internationally could spell trouble.
"The temptation of taxation that some governments,
if not all governments, are feeling these days - this is really what I would
put under the number one cloud (Vodafone faces),” CEO Colao said last month.