The Savoy Hotel has been welcoming its well-heeled and connected clientele for 131 years. But for all the Art Deco design and the sublime personal service, the Savoy loses money. Lots of money.
In fact it has been losing money since the current owners — Prince Alwaleed bin Talal of Saudi Arabia and the Qatar Investment Authority — purchased the hotel in 2005. It recorded losses of £20.4m in 2018 and £83m the year before.
The company’s accounts throw up a variety of explanations: terrorism, Brexit and the one-time strength of sterling. Covid-19 will no doubt feature in the current period. But there is another stark reason: in 2018 the Savoy was carrying £347m of debt on which it has been paying an interest rate of up to 15 per cent.
The New Social Contract
Coronavirus has exposed the frailties of our economic and social model. In a series of articles this week, the FT explores the problems and difficult solutions we will confront after the pandemic.
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The money was lent by The Savoy Hotel Limited’s immediate parent, a company called Dunwilco (1784) Limited, which in turn is owned by a company called Dunwilco (1783); that company is owned by Dunwilco (1847), which is owned by the Savoy’s ultimate UK-registered parent, Breezeroad Limited. The debt, which cascades down through this corporate structure, has been refinanced or restructured every year or two.
For the Savoy’s two shareholders — one of the world’s richest men and one of the largest sovereign wealth funds — this convoluted arrangement has two notable effects: the Savoy’s accounts seem impenetrable to an outsider and the business has paid no corporate tax at all in 15 years.
In the modern world of corporate taxation, the Savoy is far from an outlier. The hotel is just one of many high-profile international businesses that have become masters at minimising tax. The method is simple enough: the Savoy’s owners lent the hotel money and extracted untaxed revenue through interest payments to offshore jurisdictions. (The Savoy declined to comment on its corporate structure and tax affairs.) Tax advisers are not short of other ideas, where needed, to ease a company’s fiscal burden.
“My view is the existing framework is totally broken,” says Michael Devereux, professor of business taxation at the University of Oxford’s Saïd Business School. “You can respond to these problems by blaming multinationals [for taking advantage of the rules] or blaming tax havens but I think we have to blame the tax system.”
Across the world, governments have responded to the coronavirus pandemic with massive public spending. They have given cash payments to citizens and picked up the wage bills of entire companies. Fitch Ratings estimates 20 of the largest economies have so far provided fiscal support of $5tn, or 7 per cent of their combined national income — and there could be big bills still to come.
At some stage, governments will need to start thinking about who will pay for their ballooning deficits. And that means they will have a historic and compelling reason to look again at the creaking international framework for corporate taxation.
Multinational companies make an attractive target. The corporate sector as a whole has been a relatively stable contributor to the overall tax take: over the past half century, corporate taxation accounts for roughly 8-10 per cent of revenues in OECD countries. Yet over that same period, tax rates have more than halved, tax breaks have proliferated, and tax avoidance through offshore havens has blossomed.
‘We need a fair system’
Behind this anomaly lies an important corporate divide. Domestic companies — the broader tax base in most countries — enjoy little flexibility in the taxes they pay. But many cross-border companies have seized the chance in recent decades to manage down their headline tax exposure. IMF economists estimated lost revenues from global tax avoidance to be as high as $650bn every year.
In the UK, more than 50 per cent of the subsidiaries of foreign multinational companies currently report no taxable profits, according to a 2019 study by Oxford university research fellow Katarzyna Bilicka. In the US, 91 companies on the Fortune 500 index, including Amazon, Chevron and IBM, paid an effective federal tax rate of zero in 2018.
Emergency funds injected into economies have, at times, flowed through to companies that pay minimal levels of tax — in the Savoy’s case, by paying for 520 furloughed staff.
Many governments are also drawing up plans to collect more revenues from the digital businesses that have prospered mightily through the pandemic — even if their operations are possibly the hardest for the 21st century taxman to pin down.
For multinationals, it is cheap populism to turn them into the scapegoats for soaring Covid-19 budget deficits. But to some of the finance ministers presiding over record borrowing, a reckoning is nigh.
“It is simply a matter of fairness,” Bruno Le Maire, the French finance minister, told the FT. “We owe it to our citizens and companies, especially SMEs, who pay their fair share of taxes,” Mr Le Maire says. “Digitalisation and international tax optimisation have created, for too long, loopholes allowing some companies to escape taxes. We need to re-establish a system based on fair taxation.”
He says the coronavirus crisis “has made this reform more urgent than ever”. “It is time for tech companies that have been thriving in this crisis to contribute to the public effort.”
Changing the system, however, would truly need a revolution. Aggressive tax practices came into sharp focus in the wake of the 2008 financial crisis, giving life to countless political promises to tighten up. While a few made progress, it was individual taxpayers rather than corporations who carried the extra burden.
By 2018, a decade after the financial crisis, big multinationals were paying less tax as a proportion of profit, according to FT research, even though personal tax had increased.
Today Europe and America look closer to a trade war over digital taxes than setting any bold new global standards. Yet history suggests existential stress on exchequers can be the midwife to fiscal inventiveness: the American civil war made the US federal government first turn to income tax, while consumption taxes were initially tested in Europe to bankroll the first world war. Tax campaigners believe the fiscal hangover of this pandemic might be another such moment.
Alex Cobham, chief executive of the Tax Justice Network, a UK-based independent advocacy group, says the world cannot return to “dirty” business as usual. “For decades we have tolerated the idea that paying less tax was just good business. That mood has gone,” he says. “Pinning down the most aggressive tax avoiders was the big opportunity for the next decade — now it feels like it could happen in the next two years.”
‘Harvard of tax departments’
Dozens of interrelated factors have eroded the system for taxing multinationals over the past half century; falling rates, ever increasing cross-border capital flows, hard-to-resist loopholes, and aggressive incentives from states desperate to attract multinationals.
Since the late 1980s, there has been a complete change in mindset, one pioneered and taken to its extreme by General Electric, America’s biggest manufacturer by market capitalisation for most of the past 40 years.
Under the late Jack Welch, who ran the company from 1981 to 2001, a tiny corporate tax team was transformed into a money-spinning entrepreneurial machine, with 1,200 tax lawyers spanning five continents.
The fruits: between 2008 and 2015 the company not only paid no federal income tax in the US, according to research by the Institute on Taxation and Economic Policy, it booked positive tax benefits worth more than $1.3bn over the seven-year period.
GE called the report “deeply flawed and misleading” and claimed to have paid $32.9bn in cash income taxes globally over the last decade. But its tax department has long been acknowledged as one of the most effective in US business.
One of the first tax experts hired by Welch was John Samuels, a tall, bowtied former Treasury official. By the time he left GE in 2014, Mr Samuels was presiding over what was dubbed the “Harvard of tax departments”. “There was low-hanging fruit everywhere. Everyone thought I was a genius, and I’m not and was not,” Mr Samuels said in an interview with his alma mater NYU.
Over the years, public and political unease over these practices has grown. For GE, this has come to a head in the UK, where the government is suing it for allegedly making fraudulent claims to qualify for a tax break and aims to recoup at least £1bn, plus interest and penalties. GE has denied there were any misrepresentations and is challenging the case in court.
“Working out where that line between avoidance and evasion is, and walking on the correct side of it, has turned out to be an important part of the tax strategy of major multinationals,” says a tax expert with knowledge of the GE case. “The HMRC case raises questions about the entire political set-up of tax policy.”
Although there were political pledges aplenty to crack down on aggressive tax behaviour after the 2008 crisis, it was often accompanied by governments offering sweeteners to attract investment from companies.
Pascal Saint-Amans admits that, to some countries, tax regulation remains ‘a four-letter word’ © Eric Piermont/AFP/Getty
“Corporate tax policy has become a playground for populist impulses,” says Mihir Desai, professor at Harvard Business School. “Grand antagonistic gestures — particularly toward foreign companies — can be offset by lucrative deals and patent boxes [a form of tax break for innovation] that no one notices. It’s a recipe for an even more Byzantine corporate tax policy.”
Dan Neidle, head of tax at law firm Clifford Chance in London, says the problem with turning to supposedly easy tax revenue from the corporate sector is “the numbers don’t easily add up. You can raise rates, or reform corporate tax from the ground up, and you won’t make much of a dent in budget deficits measured in the multiple $100bn.”
Corporate profits are likely to decline steeply this year and possibly in 2021 too, he adds, reducing revenue.
But the pandemic — and the breadth of support for business — might harden political views. Nearly a third of the companies that received coronavirus loans from the Bank of England are either based in, or substantially owned by, a tax haven resident, according to TaxWatch UK, a think-tank. Baker Hughes, a GE subsidiary, was granted a £600m loan despite its parent company being sued by the UK over the unpaid taxes going back 16 years.
‘Lincoln’s Two Difficulties’, 1862. Lincoln comments: ‘What? No money! No men!’ © Print Collector/Getty Images
Oblivious to the digital world
Few reforms are as daunting to international policymakers as corporate tax. It essentially requires overhauling principles first laid down by the League of Nations in 1924, which gave countries the right to tax a company’s income based on whether it was physically present in the country.
These principles still underpin bilateral tax treaties, which are seemingly oblivious to how the intangible digital economy has transformed global capital flows. Working out where profit is earned is hard at the best of times for multinationals with a web of international offshoots. Once the existence of tax havens is factored in, it is easy to see why critics view the system as a 20th century relic.
Political inertia has helped it endure. “Our tax system is an oil tanker not a little speedboat and when it creates waves it creates very big waves,” says Anita Monteith, tax technical lead and senior policy adviser at the Institute of Chartered Accountants of England and Wales. “You have to change the rules internationally which is not easy; it causes recrimination and there is a risk of retaliation.”
Since the 2008 crisis, at the bequest of the G20, the laborious business of global tax reform has fallen to the OECD and Pascal Saint-Amans, a former French Treasury official who now runs the Paris-based organisation’s tax administration. He admits that to some countries tax regulation remains “a four-letter word”.
“We have global players but local sovereignty,” he says. “These global players can play sovereignties one against the other. The absence of regulation by countries for fear of losing their sovereignty has meant countries de facto losing their sovereignty.”
Pillars of reform
After years of behind the scenes haggling between 137 countries, the OECD efforts are now focused on two reforms to better capture tax from multinationals.
The first — so-called “pillar one” — strengthens the right of countries to tax corporate income from sales on their territories, regardless of where the company is legally located (a boon for most big economies and a loss for tax havens).
“There will be winners and losers,” says Ross Robertson, international tax partner at BDO. For Europeans, the attraction is capturing a bigger slice of US tech profits; Washington, meanwhile, would have a bigger claim on profits on European luxury goods or cars sold in America.
The second pillar attempts to set a minimum level of tax applied to all multinationals. The OECD estimates the two reforms would raise corporate tax revenues by 4 per cent worldwide, totalling $100bn annually.
Mr Saint-Amans has conceded the year-end deadline for a deal sounds “insane”. That was even before Steven Mnuchin, US Treasury secretary, called for talks to be suspended last month, complaining that they had become an exercise in others taxing Silicon Valley. He also threatened to hit European countries with tariffs if they went ahead with unilateral digital taxes.
Despite these obstacles, Mr Saint-Amans says that given the bailouts they have handed to companies during the pandemic, governments will want to hold multinationals to a higher standard of behaviour. “Countries which have bought out companies will expect that when they are back in profit, they will not put those profits in tax havens,” he says.
Perhaps the most sobering aspect of the OECD process are its limits in a post-Covid-19 age. Even $100bn of extra corporate taxation will be a modest contribution to the world’s fiscal consolidation. A leaked UK Treasury document estimated a £337bn deficit in the current financial year. By comparison, the country’s digital services tax is forecast to raise £280m this year.
“I don’t know if you can satisfy public opinion, which is starting from a different place to where the international tax system starts,” says John Cullinane, tax policy director at the UK’s Chartered Institute of Taxation.
When the epic fiscal repair job begins in earnest, radical options may be contemplated that both bring in serious revenue and offer the promise of potentially being more equitable.
Some scholars advocate an expansion of carbon taxes; data from the OECD reveals 70 per cent of energy-related CO2 emissions, across rich and developing countries, are entirely untaxed. Others have proposed forms of consumption tax, which would tax business income at the destination goods or services are purchased. Both ideas have the potential to keep OECD negotiators busy for a long time.
Whatever steps are taken, the tax historian Joseph Thorndike sees one thing as being almost certain: “In an emergency, everyone pays more.”
Additional reporting by Alex Barker and Paul Murphy