Tax Avoidance
| by Paul Gosling 01 Jun 2004 Topic: News |
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Ernst & Young hurt in global tax clampdown Ernst & Young is being challenged by the Inland Revenue over its sale of tax planning advice in an early illustration of the UK Government�s drive to clamp down on tax avoidance schemes. The steps come hard on the heels of a damaging six-month ban imposed on the firm by the US Securities and Exchange Commission on taking on new audit clients. The firm was fined $1.7m (£960,000) as well as suffering the six-month ban. The SEC�s chief administrative law judge, Brenda Murray, said that Ernst & Young had ignored its duty to maintain auditor independence in its enthusiasm to market tax and consultancy services to client PeopleSoft. The firm is not appealing the decision. This is not the first time that Ernst & Young has come into conflict with revenue authorities over its tax avoidance schemes. One E&Y client in the US was Sprint, where a tax shelter devised by the firm avoided tax of around $100m (£56m). The arrangement led to an Internal Revenue Service (IRS) investigation and the dismissal of two senior executives by shareholders worried that they may pick up the bill. A statement from the firm in the UK denied it had been involved in providing improper tax advice. �At the heart of our tax planning is the principle of full disclosure,� said the statement. �All of the tax planning we offer is legally compliant and properly disclosed to the revenue authorities. Businesses are taxed under the law and are entitled to plan within the law. Whether a specific planning idea works is a legal question, which should be dealt with in discussion with the tax authorities and, if necessary, through the courts.� It added: �We do not, and never have, condoned tax evasion or non-disclosure of avoidance arrangements.� It is understood that the E&Y scheme being investigated in the UK involves the use of foreign currency derivatives by large international corporate clients. Corporation tax liability may have been reduced as a result of the currency transactions, without companies incurring actual losses. About 30 corporations are expected to have their tax liabilities in recent years reviewed as a result of the investigation, which could seek to recover £1bn ($1.77bn) for the Treasury. E&Y is one of several firms whose tax advisory practices are currently being actively examined. The Inland Revenue is ending companies making bonus payments through securities, which minimised employees� payments of national insurance contributions and income tax. According to reports, the ending of the scheme will protect tax revenues of £300m ($532m) in the current financial year. The Revenue�s action was reported as being in response to schemes devised and sold by BDO Stoy Hayward. A spokeswoman for the firm said: �We provide advice to clients and will brief them of options available and this concept may be mentioned to them. A very limited number of clients would be relevant to this, although it would be offered to some. The Revenue is not particularly targeting BDO Stoy Hayward and this concept is reasonably well known.� A spokesman for the Inland Revenue said that he was unable to name firms or their clients being investigated. He added: �The Revenue won�t tolerate schemes which are created with the intention to avoid tax and we will do what we can to ensure everybody contributes to the UK�s needs.� These moves follow an announcement by the Chancellor in the Budget of new disclosure requirements on accountancy firms, mirroring those used in the US. Tax advisers who devise and market certain avoidance schemes must now provide the Inland Revenue with details of these schemes. �This will improve transparency and allow the Inland Revenue to make a swifter and more targeted response to deliberate abuses of the tax system,� said the Treasury. The drive against tax avoidance involves not only the Inland Revenue, but also Customs & Excise. Several major corporations, including Vodafone, are being investigated by Customs over allegations that they minimised VAT liabilities through avoidance schemes. A report from FEE, the Federation of European Accountants, suggests that across the EU, some 100bn euros (£67bn, $118bn) in VAT is lost each year through avoidance and evasion schemes. This represents about 10% of VAT due in European countries. There is now unprecedented international co-operation in tackling tax avoidance, with a joint task force being established bringing together tax collecting authorities in the UK, the US, Australia and Canada. The countries� authorities will share expertise, best practice and experience. Under separate measures, the Inland Revenue also now has greater powers to extradite people wanted for tax evasion: in their first use, a man sought for alleged inheritance tax fraud of £160,000 ($284,000) has been returned to the UK from Spain. In the US, it is not only accountancy firms which have been the target of tax avoidance investigations by the Revenue authorities. Several banks, including Deutsche Bank, are reportedly also being investigated: Deutsche asserts it has done nothing wrong in its sale of tax planning advice. KPMG has confirmed that the IRS is investigating its sale of tax shelters, which are also subject to scrutiny by Congress. And the US Securities and Exchange Commission has now begun to tackle the use of complex structured finance deals in order to avoid tax liabilities by large corporations. Meanwhile, in Australia it has emerged that both KPMG and Ernst & Young have made multi-million dollar payments to settle claims from the revenue authorities that they breached anti-avoidance tax laws. The settlements do not involve acceptance by the firms that they have been involved in any wrongdoing. It was probably inevitable. The fall-out from the Shell corporate scandal of overstated mineral reserves is beginning to affect the group�s two auditors, PricewaterhouseCoopers and KPMG. Shell�s announcement that in future the company�s auditors of reserves will now report to group internal audit, outside the business line of command, has led to suggestions from some commentators that PwC and KPMG were not sufficiently vigorous in their evaluation of the previous internal audit and reporting structures. Shell has now announced additional strengthening of its internal reserves assessment procedures, with a significant increase in staff dedicated to reserves management. This will include both dedicated reserves auditors and the systematic use of external experts in the reviewing of reserves levels and processes. External experts will also be called in as part of the external audit function in future, with the largest supply regions audited on an annual basis. But it has emerged that Shell�s internal auditors were not the compliant and silent people that might have been assumed from the initial media coverage of the company�s rows over its reserves statements. Back in 2002 Anton Barendregt, a senior reserves auditor at Shell, told an industry conference that reserves levels should not be used as a performance measure in determining bonuses. Meanwhile, the corporate shock-waves from the scandal are still being felt. As expected, financial director Judith Boynton has become the third senior Shell executive forced out by the crisis, following the departures of chairman Sir Philip Watts and head of exploration and production Walter van de Vijver. An investigation carried out by Wall Street law firm, Davis Polk & Wardwell, concluded that Watts and van de Vijver were first aware of the reserves overstatement three years ago. Their report reproduced memos from van de Vijver to Watts pleading for them to go public on the reserves shortfall. The investigation also criticised Boynton for taking �virtually no action� to assess whether reserves had been correctly booked. The inquiry drew a picture of a climate of fear in the company which prevented a proper challenge to the level of reserves that were declared. Shell accepted that the investigation showed that it �took a more aggressive tack than its peers to demonstrate reserve growth and the potential for rising production in the face of large embedded production declines�. Shell will now have to restate its earnings for 2000 to 2003 and respond to continuing investigations conducted by the US Securities and Exchange Commission, the US Justice Department and the UK�s Financial Services Authority. Credit rating agency Moody�s has reacted to the company�s problems by downgrading Shell�s long term debt ratings from AAA to AA1, with the debts of some subsidiary companies downgraded as low as A1. The ratings are subject to ongoing review, which may lead to further downgrades. The company conceded that its lowered credit ratings �reflect the diminished prospects and positioning� of the group�s oil and gas operations compared with those of its rivals. However, the Royal Dutch/Shell group was able to report higher than expected current year first quarter profits, at $4.25bn (£2.4bn). It has increased investment to generate faster returns on short term projects, while stabilising the position on long term developments in Nigeria and Russia, where costs have gone over budget. The company attempted to improve investor relations by initiating a $2bn (£1.13bn) share buy-back programme. Analysts responded to the results by warning that Shell had fallen significantly behind its competitors. Ironically, an external audit of oil reserves of Russia�s largest oil producer, Yukos, conducted to satisfy stricter controls introduced by the SEC in the wake of the Shell revelations, showed that Yukos had understated proven reserves by 14%. Brunswick UBS suggested that across all exploring companies, Russia�s proven oil reserves could increase three-fold as more external assessments are undertaken. If this is confirmed it would raise Russia to second place in oil reserve rankings ahead of Iraq, but still behind Saudi Arabia. Inland Revenue told to collect more tax The recently appointed permanent secretary at the UK Treasury, Gus O�Donnell, has spoken confidently of the ability of the new Revenue & Customs department to improve tax collecting performance. He told the House of Commons� Public Accounts Committee that much of the annual £26bn ($46bn) �tax gap� could be filled by integrated IT systems matching information now separately held by the Inland Revenue and Customs & Excise. O�Donnell�s comments came as MPs considered a report from the National Audit Office which concluded that while the Inland Revenue has improved its debt collecting ability, it was still failing to take sufficient action to collect older debts. At the end of the 2002/3 financial year, some £14bn ($25bn) remained due to the Revenue, including £4.9bn ($8.7bn) collected by companies through PAYE (Pay As You Earn). But much of the total was owed by insolvent businesses, individuals who could not be traced, or taxpayers who were making repayments by instalments, explained the auditors. The NAO pointed to the practice in some other countries where companies are required to put collected taxes into separate bank accounts in the revenue authority�s name. �Information sharing gives us the ability to put data together,� O�Donnell told the MPs. �This is very bad news for the dishonest taxpayer.� His views were reinforced by the emphasis placed by the Government on the appointment of a heavyweight chief information officer for the merged department. In evidence to the Treasury select committee on the departmental merger, Chas Roy-Chowdhury, head of taxation at ACCA, told MPs that there were potential benefits from bringing together the two tax collecting agencies, including the creation of a one-stop shop for taxpayers. But he warned that tax collectors should be organised so that they specialised in dealing with specific sizes of business, recognising the differences in culture that exist between small firms, SMEs and major corporations. Roy-Chowdhury said that it was essential that Revenue & Customs did not adopt an approach of assuming that all businesspeople are crooks. But the Liberal Democrats� Treasury spokesman in the House of Lords, Lord Oakeshott, said that it was astounding that the Revenue had allowed debt to accumulate in the way it had, with little detailed information on the £14bn of uncollected taxes. Oakeshott accused the Revenue of �gross incompetence�. There are now reports that, as part of the Revenue�s drive for arrears, collectors are going back over three decades to recover unpaid tax. Mike Warburton, tax partner at Grant Thornton, said that people affected were more likely to be self-employed traders who sorted out their own tax affairs, than people represented by a tax adviser. Taxpayers who had outstanding queries dating back prior to the introduction of self-assessment in 1996, and who had inquiries initiated by the Revenue which were never formally closed off, might be at risk of being asked for long-standing arrears. �The old system relied on people getting their act together,� pointed out Warburton. �Where the Revenue has opened an inquiry it could go back, where a taxpayer received a letter. Because the case was opened and not technically closed it can go back.� John Whiting, tax partner at PricewaterhouseCoopers, agreed. �I have seen that the Revenue is going back a long way,� he said. �I would like to think that where a person has appointed a tax adviser, it would bring a case to closure. I find it hard to imagine that 30 years have drifted by, but investigations can meander along for a long time. And if the Revenue has been unsuccessful in the past there is no reason for not having another go. I am certainly aware that the Revenue is putting more emphasis on collection of old debts.�
Last year�s largest international IPO - that of China Life - has hit further problems (see accounting & business news analysis, March 2004). Three investigations have now been launched into the conduct of the IPO, while three class action lawsuits have been initiated in New York on behalf of investors alleging the share issue was fraudulent. Hong Kong�s Securities and Futures Commission has confirmed that it is working jointly with the United States� Securities and Exchange Commission on an �informal inquiry� into the China Life IPO. Meanwhile, the Independent Commission Against Corruption (ICAC) in Hong Kong is reportedly examining allegations that relatives and friends of China Life senior executives were allocated preferential allocations of shares as part of the IPO. China�s Communist Party Central Commission for Discipline Inspection is reported to be conducting its own investigation of the IPO. Alan Tse, a spokesman for ICAC, said it was unable to comment on particular investigations or confirm whether an investigation into a specific company was taking place. But he added that ICAC had a statutory duty to investigate all corruption complaints lodged with it. Where an investigation is conducted, a report will be submitted to Hong Kong�s Department of Justice to decide on a possible criminal prosecution, he said. China Life did not respond to accounting & business� request for a comment. But a company spokesman was quoted in the South China Morning Post as saying that he was unaware of any investigations. Meanwhile, three class action law suits have been launched in the United States, alleging fraudulent conduct during the IPO. A legal action begun by law firm Stull, Stull & Brody alleges that China Life and its directors were aware while conducting the share issue of essential facts which they concealed from investors and potential investors. These included what the lawyers claim was �a massive financial fraud to the tune of $652m (£367m)� carried out by the predecessor company, China Life; that the National Audit Office of China was investigating the claims of fraud and about to publish adverse findings; that �the predecessor company... engaged in criminal acts involving illegal agent services, illegal premium payments, embezzlement and depositing monies in illegal bank accounts�; and that the company�s share price was artificially inflated by these frauds. A second class action law suit was filed by Weiss & Yourman, claiming that China Life and its directors filed materially false and misleading statements, inflating the price of the company�s shares. The third legal action, lodged by Geller Rudman, claimed that the parent company had made �improper use of reinsurance funds to make illegal investments�, not paid its taxes on time and employed unqualified agents, all of which impacted on the value of the newly listed company. China securitisation, a regulatory 'grey' area Bankers in China are understood to be pressing the Government for a modernisation of securities laws, enabling the establishment of special purpose vehicles. Under existing commercial law, a range of financial instruments widely used in the United States, Europe and Australia are not authorised. Restrictions on the use of SPVs are only one factor which bankers say is holding back investments in special projects. Issuers of corporate bonds, for instance, must have a three-year track record of profitability and meet minimum net asset levels, with which an SPV is unlikely to conform. Some recent securitisation deals have been conducted instead through trust agreements with existing companies, but these involve paying higher interest rates than through a bond issue. China�s use of the international securities market for investment may have to wait until new securities legislation is passed, which will also need to confirm that Chinese companies need to use international standards in accounting for securities. Sonia Khao, head of technical services, ACCA Hong Kong, said: �Given the recent history of SPVs in the Enron and Parmalat cases, it is understandable that Chinese regulators are cautious about their use. Regulators will be determined to ensure that the huge inflow of foreign investment continues without the sort of crises of market confidence which have happened elsewhere.� The perception that the telecoms sector share bubble was boosted by accounting irregularities has been reinforced by the news that Nortel joins WorldCom, Global Crossing and Qwest as a case of corporate notoriety. Nortel, whose headquarters is in Toronto, is being investigated by Canadian regulators and the US Securities and Exchange Commission over its financial results since 2000. An SEC formal order will require Nortel to restate results over the last four years. This follows a delay in Nortel�s release of the latest annual report at the request of the company�s audit committee. The audit committee�s own inquiry into the company�s accounts is not yet complete, but the committee has warned that earnings for last year may now be cut by half, with earlier years� losses reduced. The effect of apparent overprovisioning of losses and subsequent overstatement of profits was to both exaggerate the extent of the corporation�s profitability turnaround under new management and trigger higher levels of performance-related bonuses. Repercussions have been severe. Chief executive and former chief finance officer Frank Dunn has been sacked, as was his replacement as CFO, Douglas Beatty and Michael Gollogly, the financial controller. William Owens, who has served on several telecoms boards and is a former US navy admiral, is the new chief executive, and William Kerr the new chief financial officer. Lynton Wilson, Nortel Networks� chairman, said: �The board of directors believes that the actions are about accountability for our financial reporting and are in the best interests of the company and all of its stakeholders, including our investors, customers and employees. These actions are an important step in the process of restoring confidence in the company�s leadership and financial reporting.� But prospects for Nortel are unclear and there is speculation that it may either close or be bought-out. Nortel manufactures telecoms network equipment, including using latest generation VoIP (voice over Internet protocol). It previously hit major problems in the late 1990s, when its workforce of 100,000 was cut by two-thirds. Nortel�s auditors are Deloitte & Touche, which the company says were initially appointed in 1914. The company was founded in 1895 as the Northern Electric and Manufacturing Company Limited. FSAs being herded into consolidation, says life insurer Incoming Scottish Widows chief executive, Archie Kane, has warned that the IFA sector is being driven into major consolidation, with the active encouragement of the Financial Services Authority. �The regulator [the FSA] is pushing IFAs towards consolidation through the regulatory burden on the sector and through things such as PI [professional indemnity] where the premiums have increased quite dramatically,� said Kane. �I think we will see quite significant rationalisation in the IFA sector.� This view was apparently backed-up days later by FSA managing director, David Kenmir, who told a conference that most IFAs are under-capitalised. He suggested principals are often withdrawing too much capital from their businesses, leaving their firms unable to meet liabilities arising from earlier trading. �The economic model of IFAs may not be viable and a number of factors have contributed to this,� said Kenmir. But Jackie Blyth, spokeswoman for the FSA, said it had no desire to consolidate the IFA sector, nor to promote larger firms at the expense of small ones. �We are in the business of regulating, we are not in the business of getting rid of businesses,� she said. �We are here to get a clear, open and competitive market. Our business is providing regulation which provides benefits to consumers and firms.� Tracey Mullins, a director of the Association of Independent IFAs, also questioned Kane�s interpretation of recent events. �We have a lot of discussions at a high level with the FSA,� she said. �I don�t believe it�s a message they have given to us. I know a lot of IFAs feel the FSA would like to get rid of them completely. Historically, the FSA has not been very good at dealing with small firms. Originally, the [FSA] culture was that we understand large firms, we don�t understand small firms. �On professional indemnity insurance, 18 months ago the FSA was being very difficult. They now understand it�s a capacity problem: IFAs have difficulty in finding cover and costs are excessive. Now they are willing to negotiate with IFAs having difficulty in getting cover. The culture is getting better, though it�s not perfect. I don�t believe they have an agenda to get rid of IFAs.� She added that the FSA had acted helpfully in reversing its earlier decision requiring IFAs to move solely to a fee-based structure, which it subsequently recognised was likely to drive many advisers out of business. But the situation for advisers in arranging and paying for adequate PI cover is worsening, with news that the combined effects of the European Union�s Markets in Financial Instruments Directive and its Insurance Mediation Directive appears to require all advisers providing both insurance and investment advice to have cover in place of at least £1m ($1.77m) by April 2006. The combination of the major hike in PI premiums - even without the requirement to increase the level of cover - and compensation demands from clients is severely damaging the viability of the IFA sector. Many IFAs have ceased trading in recent months, faced by crippling claims for compensation arising from alleged mis-selling of financial products, including endowments, precipice bonds and split capital investment trusts. Some of the largest IFA firms - notably RJ Temple, David Aaron Partnership and Berry Birch and Noble - have become insolvent. The first class action writs alleging mis-selling of split capital trusts have now been issued, with many IFAs at risk of being named in future writs. At the end of last year, the FSA fined another of the biggest IFAs, Chase de Vere, £165,000 ($293,000) for �approving and issuing a misleading direct offer promotion which included high income and precipice bonds�. The complaints against Chase de Vere and many other IFAs have been that they understated the risk attached to these structured products. At the beginning of this year, Deloitte & Touche Wealth Management was fined £750,000 ($1.33m) for a variety of compliance offences, including the mis-selling of zero dividend preference shares, a component of split capital investment trusts. The FSA indicated that one in 10 sales by DTWM of �zero dividends� was inappropriate. The FSA�s investigation into split capital investment trusts is its largest ever and has led the regulator to adopt a significantly different approach to that used in the past. It has held a series of meetings with the fund managers responsible for the trusts and urged them to set-up a compensation fund for investors. While the FSA�s objective was to free-up its investigative officials, this was perceived by some observers as indicating that the regulator actually had a dearth of proof of mis-selling. However, the FSA has now again written to the investment managers providing what it regards as clear evidence of mis-selling and urging them to accept the need to contribute to a compensation fund. A leak of the FSA correspondence suggests that the managers were told that this was the �most serious� case of mis-selling the FSA had yet come across. It is estimated that 50,000 investors lost money through the collapse in value of split capital trusts, losing an average of £13,000 ($23,000) each. PricewaterhouseCoopers is currently working for the FSA to provide a clearer calculation of compensation levels required. There are currently 3,910 IFAs regulated by the FSA, of which almost a quarter are also professional firms of accountants, solicitors or actuaries - with accountants probably making up the majority of these. | |