Introduction and summary
HMRC have alleged that General Electric fraudulently obtained a tax advantage in the UK worth US$1bn by failing to disclose documents relating to the group’s financing arrangements.
The allegations revolve around the financing of certain GE companies in Australia, which HMRC allege that the company routed via the UK in order to gain a tax advantage. In using UK companies as part of the transaction, GE required clearance from HMRC to ensure that they met UK tax rules. This was granted on a partial basis in 2005.
In documents before the High Court, HMRC allege that their approval for the transaction was only given on the understanding that the funds would be used to invest in businesses operating in Australia.
However, according to HMRC’s case, the tax authority would later discover that after leaving the UK for Australia the AUS$5bn used in the transaction was not invested in any business. The transaction was in fact part of a complex and contrived tax avoidance scheme that would circulate money between the US, Luxembourg, the UK and Australia before being sent back to the US just four days later. The transactions had no commercial purpose other than to create a “triple dip” tax advantage in the UK, the US and Australia.
HMRC allege that GE deliberately supplied misleading documentation in order to gain clearance for their transaction. This included omitting key passages from the minutes of a board meeting at GE in order to hide the tax avoidance scheme which GE knew would not comply with UK tax rules.1
HMRC are now seeking to annul the 2005 agreement they came to with GE over the scheme. Corporate filings in the United States have disclosed that if HMRC are successful, the tax bill for GE could total US$1bn before any interest or penalties, which are likely to be substantial.2
General Electric told TaxWatch that they believe that the transactions will be ruled permissible on their technical merits.
The company denies that it deliberately misled HMRC about the nature of the transactions.It claims that any information omitted from the documentation given to HMRC was not relevant to the tax issues being considered.
GE is therefore asking the High Court to make an order preventing HMRC from going back on the Clearance Agreement.3
Although it is not uncommon for HMRC to accuse companies failing to provide all relevant facts concerning a particular transaction, this appears to be the first time that HMRC has accused a major company of engaging in fraudulent misrepresentation in order to gain a tax advantage.
Debt, hybrids and arbitrage
The tax avoidance scheme at the heart of this case is a hybrid arbitrage scheme. The principle behind hybrid arbitrage schemes is relatively simple, although in practice the schemes are usually very complex.
Different countries often have different tax rules governing any particular transaction or corporate entity. Companies seeking to engage in tax avoidance can exploit these differences to create transactions that generate a deduction against taxable profits in one jurisdiction, but no corresponding taxable income anywhere else. The result of this could be that a transaction is taxed no-where, or that a company achieves two tax deductions on the same transaction.4
Tax arbitrage schemes typically involve so called “hybrids”. Hybrids are the tax equivalent of the proverbial elephant in the story of the blind man and the elephant. They are financial instruments or corporate entities, that appear to be two different different things under the rules of different tax authorities. So for example, one tax authority may consider a financial instrument to be a loan, and another may consider the same instrument to be similar to holding shares (equity). This can result in a mismatch in the way that the instrument is treated for tax purposes, as the tax treatment of debt is entirely different from equity.
The Australian Arbitrage
In late 2004, GE executed a series of multi-billion dollar transactions that exploited a mismatch between Australian and UK tax law.
The Australian arbitrage centred around an Australian Partnership, GE Commercial and Consumer Finance LP. This partnership borrowed funds and paid interest to a UK company, GE Capital Finance Limited. The partnership was a “hybrid entity” because it was considered to be a taxable entity in Australia, but for UK tax purposes the partnership was a so-called “transparent entity” which did not have its own tax liability. Any profit or losses it made were attributed to its partners, which were two other UK based GE companies, IGE USA Investments Limited and GE Capital Investments Limited.5
The effect of this hybrid arrangement was that two tax deductions were made on the same loan, one in Australia, one in the UK. The Australian Partnership deducted interest payments on the loan it received from the UK against profits made in Australia. For UK tax purposes the loans created a loss for its UK based partners and so was tax deductible in the UK against UK profits also.6
In addition to this, the money loaned by GE Capital Finance in the UK to the Australian Partnership had itself been borrowed from a GE company based in Luxembourg.7
The interest being paid to Luxembourg resulted in a double deduction of interest in the UK on the same loan. This double deduction was partially offset by the fact that interest payments made by the Australian Partnership would be coming back into the UK. However, the overall effect of the transactions was that GE would be able to deduct interest payments from their profits in the UK on a loan taken out by an Australian entity.
UK anti-arbitrage rules
Tax arbitrage has been known about for a long time. In the early 2000s the use of arbitrage schemes by Roger Jenkins, a Barclays employee then thought to be Britain’s richest banker, earned him the title, “King of the Double Dip”. In 2004 an internal report by the then Inland Revenue estimated that the Treasury was losing upwards of £638m a year on Barclays’s tax avoidance schemes, many of which involved cross-border arbitrage.8
In order to combat arbitrage schemes, the UK government introduced new anti-arbitrage laws in 2005. These allowed HMRC to disallow a tax deduction claimed by a company in the UK where there was no corresponding taxable receipt somewhere else, or where the company had claimed another deduction for the same expense.9
The new rules applied only, however, if the main purpose of the arbitrage was to gain a tax benefit in the UK. If the arrangement was designed to gain a tax advantage elsewhere, then the rules would not apply.
In order to be effective, HMRC was required to issue a notice to companies that they were going to apply the rules to any particular transaction. However, companies could seek clearance from HMRC and an agreement that it would it would not seek to apply the rules to the structure at any point in the future.
The 2005 legislation not only applied to new transactions, but to schemes already in place at the time the legislation was passed and any future benefit that might be generated from these schemes.
GE seeks clearance for the Australian Investment
Court documents show that GE became aware of the proposed rules in early 2005, and became concerned that they might apply to a number of structures used by the company, including the Australian scheme which became known as the Australian Investment.10
The company sought a meeting with HMRC to discuss the forthcoming rules, and an initial meeting was held on 01 April 2005 between Dave Hartnett, then a commissioner at HMRC, William Morris at GE, Steven Edge, a senior partner at the law firm Slaughter and May, and other officials from HMRC and GE.11
Following this initial meeting, a series of meetings were held between representatives of GE and HMRC officials over a period of six months as GE sought clearance under the new anti-arbitrage rules.12 According to a recent judgment at the High Court, GE were seeking clearance for 107 loans amounting to £21.2bn. The Australian Investment was just one part of the clearance application by GE.13
Court documents demonstrate that from the outset, officials at HMRC were highly sceptical that the Australian Investment could escape the UK’s new anti-arbitrage rules.14
During negotiations, HMRC repeatedly made clear to GE its position that there was no commercial reason for GE, a US headquartered corporation, to make investments in Australia via its UK subsidiaries using a hybrid structure.15 Therefore the main purpose of the structure in their view was to gain a tax advantage in the UK. As such, HMRC would only allow clearance for the structure if GE agreed to give up any tax advantage resulting from the scheme.
Despite HMRC’s reservations GE did eventually reach a settlement and gain a partial clearance for the Australian Investment without fully giving up the benefit it gained from the tax avoidance scheme. There is a very little detail given in the court documents regarding how this deal came about, a point which GE highlights in their defence.16
To understand why HMRC might have come to a deal, it has to be understood that throughout the time that the discussions were taking place (a period of just over six months), HMRC was labouring under the impression that the purpose of the transaction was to finance the acquisition by GE of financial services companies operating in Australia. Specifically, HMRC believed that the funds would be used to fund real economic activity in Australia.17 In particular the documents mention a company called the Australia Guarantee Corporation a company which GE had purchased from Westpac, an Australian bank. Australia Guarantee Corporation was Australia’s oldest home grown financial services company, and provided a range of financial services including car loans and personal loans.
This is important because as far as HMRC are concerned, the acquisition of a business by a UK company would not usually raise concerns.
Anti-arbitrage rules would only apply to this kind of transaction if a hybrid was involved in the purchase, and if the main purpose of the transaction was to gain a tax advantage in the UK.
Although GE were open about the fact that a tax arbitrage was taking place,they argued that if the Australian Partnership (the hybrid entity) did not exist, it would make little difference to the UK tax position. This is because the alternative would be for the UK companies to buy shares in the Australian operating companies directly, and to fund these acquisitions with debt. Interest payments would continue to be deducted from taxable profit in the UK. The inclusion of a hybrid entity, and the additional tax deduction gained from it was therefore only relevant for Australian tax purposes.18
A compromise position seems to have been reached in which HMRC would accept GE’s argument but disallow some of the interest deductions on the basis that had the UK companies invested directly in the Australian operations they would not have done so using only borrowed money. As a result HMRC did not allow GE to claim 100% of their UK interest costs (on the Luxembourg loan) against their UK tax bill.
The missing minutes
To support their case in the current dispute, HMRC cite a range of documents provided by GE during clearance discussions which they say suggested that the funds raised by the UK subsidiaries would indeed be used to acquire financial service companies based in Australia or to provide working capital for GE companies operating in Australia.
For example, in one document provided to HMRC setting out some of the financing arrangements, the “utilization of funds” was described as:
“business acquisition and funding for Australian business assets”.
In one email sent by Roy Clark of GE to Ken Almand of HMRC, the email stated:
“Just to remind you of what we said at the meeting, references to ‘business assets’ means assets such as photocopiers for lease, mortgage advances, power stations etc. ‘Business acquisition’ means the purchase of shares of operating companies”19
In another email sent by Roy Clark on behalf of GE on 28 October 2005 an extract of the minutes of a board meeting at IGE USA Investments were attached .20 These minutes outlined the tax advantage in Australia of structuring the transaction in the way proposed.
At the time, Ken Almand set out his understanding of the minutes in a file note:
“The Board minutes are undated. They suggest that the Australian partnership structure has Australian tax advantages and that the acquisition was a long term equity investment”21
However, as HMRC would later discover, before sending the documents someone had removed key passages from the minutes which suggested an entirely different purpose to the transactions.
HMRC allege that the full minutes revealed that the UK transactions were part of much larger and more complex set of transactions which were entirely circular. Over just four days, billions of dollars were borrowed from a commercial bank, then moved between General Electric companies in the US, Luxembourg, the UK, Australia and back to the US before being returned to the same bank it had came from. According to HMRC, these transactions had no commercial purpose other than to move companies GE already owned into the hybrid structure and create the tax deductions in Australia, the UK and the United States.
Another point that the deleted passages would have revealed, is that the loan taken out by GE’s UK subsidiaries, which amounted to AUS$6bn, was vastly higher than the value of the underlying assets they were supposed to finance ($529,100,000). The effect of this was to increase interest deductions within the hybrid scheme.
It appears that HMRC obtained the full minutes of the IGE board meeting from the Australian Tax Authority. In addition, HMRC also managed to obtain a document which it says shows that the planned transaction was designed to create a “triple dip” tax deduction. This document was created before the transaction took place but not presented to HMRC at the time. HMRC also learned that GE told the Australian Tax Office that the main purpose of the transaction was “to gain a tax advantage in the UK not Australia”.22
From HMRC’s point of view, all of this confirmed what they had suspected from the beginning, that the purpose of the so called Australian Investment was nothing more than to take advantage of a tax arbitrage opportunity in the UK, and reduce their tax liability.
In fact, HMRC argue that the transaction may well have fallen foul of an anti-avoidance rule on the statute book since 1996, which disallows interest deductions on loans taken out for tax-avoidance purposes. The existence of these rules is another reason that HMRC believe that GE had an interest in not fully disclosing the purpose of the transactions.
General Electric’s Defence
General Electric deny any wrongdoing and do not accept that they gave a false and misleading account of the transaction to HMRC.
They say that HMRC are focusing on a few selective documents given to them as part of the clearance talks, which have been taken out of context. Even in context GE deny that the documents have the meaning being ascribed to them by HMRC. GE also deny that the transactions were not allowable under the UK’s pre-existing unallowable purpose rules.
Much of GE’s case relies on what was said in meetings between HMRC and GE during the clearance negotiations, and in particular the 01 April 2005 meeting between David Hartnett, Will Morris and others.23 GE claim that in these meetings they made clear what the purpose of the transactions were, and that the Australian investments were already in the hands of GE prior to the transactions taking place. HMRC have asked GE to provide details of what was said in these meetings, and by whom. GE say they will present this evidence at the trial.24
The company makes the point that HMRC presented almost no evidence regarding these extensive discussions, and there is little mention in HMRC’s case about how the Clearance Agreement was reached.25 If HMRC was so sceptical about the Australian investment from the outset, why did it come to an agreement? GE is inviting the judge to infer that this was because HMRC was happy with the transactions and accepted that they did not fall foul of the anti-arbitrage rules, having been made aware of the facts in the discussions.
When it comes to the missing minutes and other documents such as those obtained from the Australian Tax Office, GE do not deny that they failed to disclose these documents. However, they claim that they were not relevant, and that it was clear that the minutes of the contested meeting sent to HMRC were an “extract”. They also say that HMRC never requested a full copy of the minutes.26
In addition to this litigation, there is also a case before the tax court where GE are contesting HMRC’s assessment of their tax liability. GE expect that the tax court will find in their favour, and told us: “We comply with all applicable tax laws and judicial doctrines of the United Kingdom and believe that the entire benefit is more likely than not to be sustained on its technical merits.”27
The importance of the case
Although the allegations made by HMRC in this case are serious it is important to emphasise that there is a limit to how far the allegations go. The fraudulent misrepresentation allegations are only raised in the context of a contract law dispute around the Clearance Agreement reached between GE and HMRC. All that HMRC are seeking from the legal action is to void the agreement.
It may seem surprising that HMRC can accuse a company of a tax fraud involving huge sums of money, and limit that accusation to a dispute about a clearance agreement.
As a matter of law, HMRC has complete discretion to deal with tax fraud by criminal prosecution or by civil litigation or contract settlement; and in civil litigation it is up to HMRC to decide whether to plead fraud at all, regardless of the facts of the case.
When HMRC first filed their particulars of claim in January 2019, there was no mention of fraud, with HMRC arguing that the clearance should be set aside on the ground that GE had made an innocent misrepresentation, a material non-disclosure, or a mistake.28
The fraud allegation was only introduced by lawyers acting for HMRC once proceedings had already started. GE challenged whether HMRC should be allowed to do this on a procedural basis.
The High Court recently ruled that HMRC were able to amend their claim to fraudulent misrepresentation on the basis of a failure to fully disclose information relevant to the case. HMRC were not allowed to proceed on the basis that GE had positively made false statements of fact regarding the purpose of the transactions and their tax treatment during the clearance negotiations. This was in part because after 15 years HMRC were not able to produce enough evidence detailing the statements that they alleged GE had made. In his conclusions, Mr Justice Zacaroli said:
“while I have rejected the attempts to infer many years after the event that specific positive representations could be implied from limited references in the contemporaneous documents, the essential allegation which lay at the heart of Mr Jones QC’s submissions – that GE failed to disclose the complete picture, and that it did so deliberately – will be permitted to go to trial on the various alternative legal bases asserted by HMRC. I stress that, beyond the conclusion that there is a sufficient pleading for this purpose, and that the prospects of success cannot be shown to be fanciful on an interlocutory application such as this, I say nothing about the merits of the claims of deliberate non-disclosure or fraud.”
Despite HMRC having an arguable case that GE obtained a tax advantage though a deliberate non-disclosure, as revealed in the case documents, at no point didHMRC conduct a criminal investigation or even a civil fraud investigation under HMRC’s Code of Practice 9.29 In fact, it was revealed in the Zacaroli judgment that at no point during HMRC’s 8 year investigation into the matter did they even mention fraud30 even though the facts of this case as alleged by HMRC appear to fit the examples of the kind of circumstances in which it states it will generally consider starting a criminal investigation.
These include “where, pursuing an avoidance scheme, reliance is placed on a false or altered document or such reliance or material facts are misrepresented to enhance the credibility of a scheme”, “where deliberate concealment, deception, conspiracy or corruption is suspected” and “where materially false statements are made or materially false documents are provided in the course of a civil investigation”.31
This will not come as a surprise to many. There has been for a long time a general reluctance on the part of HMRC to use the tools it has to combat tax fraud when it faces complex tax avoidance schemes operated by large multinational companies.
HMRC rarely brings cases of complex tax avoidance by large corporates to court. It has never brought criminal charges against companies or their advisers for dishonest implementation of complex tax avoidance schemes. Speaking in 2005 to Accountancy Age, Dave Hartnett suggested that the reason why HMRC did take a more aggressive approach to tax fraud was that that sort of thing simply didn’t happen in the UK. He said:
‘The dividing line between evasion and avoidance is the line which is
honesty. Advisers in America became dishonest. I haven’t seen that to anything like the same extent in the UK,’32
But according to HMRC’s case against GE, that kind of dishonesty was happening with a major US corporation operating in the UK.This case also speaks to the problem of defining tax avoidance as being “perfectly legal”. Hybrid arbitrage schemes would usually be considered a form of avoidance. However, given the anti-avoidance rules in place dealing with these and other schemes, many tax avoidance schemes rely upon some form of fraudulent misrepresentation in order to operate.33
Many other countries are far less reticent to tackle tax avoidance as a matter of fraud than the UK.34 In the US, the IRS has brought criminal charges against major accountancy firms for devising and marketing tax avoidance schemes. Under European civil law jurisdictions, cases that the UK would consider as avoidance are regularly prosecuted as tax fraud.35
There are now more and more voices in the UK calling for HMRC to change the way it approaches tax fraud, most recently, the All Party Group on Responsible Tax published a paper which called for HMRC to launch a criminal investigation against the promoters of tax avoidance schemes if any scheme they promoted was found to fail the General Anti-Avoidance Rule.36
If HMRC are successful in their case, it may well open the door to HMRC taking a more robust approach to tackling large and complex tax avoidance schemes.
The case of HMRC vs IGE and others is scheduled to go to a full trial in July 2021.
1HMRC’s particulars of claim paragraph 35d
2GE 2019 FORM 10-K, pg96, https://www.ge.com/sites/default/files/GE_AR19_10-K_0.pdf
3GE’s Defence and Counterclaim paragraph 61
4For more information on tax arbitrage and HMRC’s approach to it see HMRC’s internal manual on international tax arbitrage, INTM594510, available from: https://www.gov.uk/hmrc-internal-manuals/international-manual/intm594510
5The transactions are set out in HMRC’s particulars of claim, paragraph 38
6The tax effects of the Australian / UK hybrid entity are set out in HMRC’s particulars of claim paragraph.27
7This was the so-called “SARL Loan” described in HMRC’s particulars of claim, paragraph 19a
8R. Brooks, The Great Tax Robbery, chapter 3.
9Chapter 4, Avoidance Involving Tax Arbitrage, Finance (No. 2) Act 2005, https://www.legislation.gov.uk/ukpga/2005/22/part/2/chapter/4/2005-07-20
10In a response to further information requested by HMRC, GE state that at their original April 1st meeting with HMRC they expressed concern that “the anti-arbitrage rules could impact upon existing GE structures” (response to question 4)
11GE’s Defence and Counterclaim paragraph.14 and Defendant’s Response to Claimant’s Request for further information, response to questions 3 and 4.
12As demonstrated in Appendix 2 – Timeline – correspondence and meetings occurred throughout 2005.
13Judgment of Mr Justice Zacaroli, HMRC vs IGE USA Investments and Others, handed down on 31st July 2020, paragraph 15, [EWHC 2121 (Ch)]
14On 28 October 2005 a file note was composed by Ken Almand of HMRC, stating “Still no evidence as to why the acquisition is held by the UK and still no convincing evidence as to why acquisition was 100% equity funded”, HMRC’s Particulars of Claim paragraph.32b
15See for example, HMRC’s Particulars of Claim paragraph.33
16GE’s Defence and Counterclaim, paragraph 3.4
17HMRC’s Particulars of Claim paragraphs.19 and 38
18See paragraph 19d, HMRC’s Particulars of Claim
19HMRC’s Particulars of Claim paragraph 32b
20Ibid. paragraph 35
21Ibid. paragraph 36
22Judgment of Mr Justice Zacaroli in HMRC vs IGE USA Investments and others [EWHC 2121 (Ch)], paragraph 110, handed down 31st July 2020
23GE’s Defence and Counterclaim Paragraph.18.2
24Defendant’s response to claimant’s request for further information
25GE’s Defence and Counterclaim paragraph 3
26Defence Counterclaim P.29.2
27Correspondence TaxWatch received from GE on 21 July 2020
28Particulars of Claim p.55
29Court documents do make reference to a mandatory referral in this case to HMRC’s Fraud Investigation Service, however, this will have been done under Code of Practice 8, a procedure designed to deal with instances where a company has “sought to take advantage of a scheme or device to reduce a tax liability”.
30Judgment of Mr Justice Zacaroli in HMRC vs IGE USA Investments and others [EWHC 2121 (Ch)], paragraph 134, handed down 31st July 2020
31HMRC’s criminal investigations policy available from: https://www.gov.uk/government/publications/criminal-investigation/hmrc-criminal-investigation-policy
32Alex Hawkes, “The taxman gets tough”, Accountancy Age, (October 19th 2005), available from: https://www.accountancyage.com/2005/10/19/the-taxman-gets-tough/
33A more detailed analysis of the legality of tax avoidance schemes is available from: https://www.taxwatchuk.org/is_tax_avoidance_legal/
34For example, tax avoidance by Google was pursued as tax fraud by the French and Italian authorities, see: https://www.thetimes.co.uk/article/google-pays-france-1bn-to-settle-tax-fraud-investigation-wrdnzz3p6 and https://www.reuters.com/article/us-google-italy-tax/italian-tax-police-believe-google-evaded-227-million-euros-in-taxes-sources-idUSKCN0V614L
35Another good example of this is the current cum-ex scandal gripping many European countries, that has seen police raids on major law firms as part of an investigation into tax fraud. Cum-ex fraud is referred to as dividend-stripping in the UK and is pursued as an avoidance issue.
36MPs call for crackdown on advisers behind unlawful tax avoidance, Financial Times, 19 July 2020, https://www.ft.com/content/c17bcb9e-dd56-451f-ab2a-c288c2649d94