Eurobonds; what’s all the fuss about

A national newspaper has this week run a series of articles that highlight the perceived abuse of a tax exemption involving many high profile companies. In our view, this appears to be another case of journalistic over simplification to create a problem that doesn’t really exist.

The issue at the centre of the articles is the fact that no withholding tax (“WHT”) is deductible from interest paid on quoted Eurobonds. This means that where a UK company receives a loan from overseas, and this is structured as a Eurobond, interest is paid gross to the lender. In most cases, the UK business will also get a corporation tax deduction for the interest cost. Therefore, the UK Treasury gets no slice of the cake or rather gives away its own slice of cake away, as it picks up the cost of the interest deduction with no corresponding tax receipt on interest income.

It is well publicised that the Treasury consulted on removing the exemption in 2012 and decided not to pursue the position. This conclusion was probably founded on two reasons, and these are best explained by way of examples.

Consider the position of an Australian pension fund, which is exempt from tax on its worldwide pension related income, lending to a UK business. If the pension fund lends directly to the UK company using a simple loan there will be 10% WHT on all interest paid to the pension fund by the UK company.  This tax cost has to be borne by someone, and it is most likely to be the UK business. In other words, this tax cost is rolled into the price of the loan, in the form of additional interest cost. The UK business is still entitled to claim tax relief for all its interest cost and ultimately, the majority of this cost is simply passed on to UK taxpayers.

Instead of a direct loan however, the UK company can issue a Eurobond to the Australian pension fund. The interest cost still arises in the UK in exactly the same way and the interest income still arises in Australia in exactly the same way, but no WHT is payable.  This would seem to be straightforward tax planning. The pension fund has made an investment decision, based on net returns, and the availability of the WHT exemption will have been taken into account in the setting of the interest rate.

Without this exemption, the pension fund would most likely have sought a higher interest rate on the loan. The exemption is therefore to the benefit of UK business, and is firmly in line with the current Government’s “UK is open for business” theme.

If they had decided to remove the exemption, would it really produce significant tax revenues? Estimates of the tax “avoided” have ranged from £200m to £500m. Again, this is considered in the example below.

A possible structure might be for a Canadian parent to subscribe for a Eurobond issued by its UK subsidiary.  The interest cost on the Eurobond arising in the UK is again not subject to WHT and therefore this has been “avoided” due to the Eurobond exemption. If this were removed, is all lost for the Canadian company. Far from it. The debt from the parent could instead be routed through Luxembourg and due to the double tax treaties, no WHT would be due in the UK or Luxembourg, thereby giving exactly the same result as at present.

And this is the second problem the Treasury encountered. They have worked hard to create a strong network of double tax treaties that reduce the WHT payable on interest, often to nil. This even includes the US, a significant provider of loans to the UK.

The result though of this hard work is that it is in fact quite easy not to suffer WHT on loans provided to UK businesses, and if the Eurobond exemption were removed then debt could be restructured to take advantage of other exemptions. Taking action to remove the Eurobond exemption would therefore only produce tax revenues of a fraction of the reported “tax avoided”.

Some will argue that restructuring debt in this way is still “avoiding” tax, and in the context of the current publicity we can see this argument. However, it is easy to choose one tiny element of a vast and complex international tax regime, and claim “tax avoidance”. It is far more difficult to undo the last 25 years of economic cooperation within Europe and the advanced economies, but this is what is needed to ensure the UK Treasury get their WHT.