Caffe Nero - tax avoidance allegations - valid or not?

There is a well-written letter doing the rounds on Facebook written by someone called Steve Pottinger, in which he returns his Caffe Nero loyalty card to the company, saying that he will not be a customer any more, due to the fact that the company made a profit of £21.1m, yet paid nothing in Corporation Tax (the UK's tax on company profits, currently charged at 21% of profits).

Groups like "Occupy" have been vocal about tax avoidance in recent years, and rightly so in my opinion. It's a disgrace that international companies treat corporate tax as optional.

Of course it's also a disgrace that the tax system is so riddled with loopholes that it is possible to structure corporate affairs in such a way that tax can be avoided.

However, what interests me is whether we can get to a point where consumer pressure & boycotts do so much damage to companies which engage in aggressive tax avoidance, that they are forced through self interest into paying their fair share in tax? This is an interesting way in which people power, through the internet, could change things for the better.

Some people think that tax avoidance is laudable. I think that is perverse. How on earth are we going to pay for schools, hospitals, and everything else, if everyone is trying to wriggle out of paying their fair share? A social conscience is important, and more people need to develop one. Equally, the tax system needs to be reformed so that opportunities to avoid tax are eliminated.

Anyway, I have often found that previous Occupy campaigns have been ill-informed, e.g. they don't understand the basics about companies being allowed to carry forward tax losses from previous years, etc. Therefore I decided to do a little digging on Caffe Nero's accounts, to see if Steve Pottinger's letter to them is justified or not.

I downloaded the accounts for Caffe Nero Group Ltd (co. no. 4129005), which are clearly the main group accounts for the UK operations of Caffe Nero - the registered office is 3 Neal Street, London, and the principal activity is given as the operation of 519 Caffe Nero branded stores in the UK.

As you can see from the group statement of comprehensive income below (the P&L basically), this group paid nil corporation tax in both years ended 31 May 2012 and year ended 31 May 2013, despite making a pre-tax profit of £19.1m and £21.1m respectively.

This looks very odd. A UK company, operating in the UK, which is decently profitable, yet paying nothing in Corporation Tax. How can this be?

Note 6 to Caffe Nero's accounts explains how they have reduced their Corporation Tax charge to nil in both years by claiming group relief.

Whilst I have some basic knowledge of Corporation Tax, I'm not an expert in this complex area. However my understanding is that groups of companies can offset profits in one company against losses from another. So presumably this must mean that there are offsettable losses elsewhere in the group?

Note 22 to the accounts from Caffe Nero Group Ltd shows that its ultimate parent company is Saratoga Limited, an Isle of Man company. There is also an intermediate holding company based in Luxembourg called Rome Holdco Sarl. Another company called Rome Pikco Limited is also somehow involved in the group structure.

Let's not beat about the bush here - there is only one reason why a UK business would have a complicated group structure using Isle of Man, and Luxembourg companies - which is that they are seeking to avoid paying Corporation Tax.

There was a totally unconvincing rebuttal from the company's CEO in Nov 2012, as clearly this issue has been rumbling away for a while now.

Private Equity often avoid tax by making large shareholder loans, at high rates of interest, to companies they buy. Since interest is tax deductible in UK tax law, that reduces their Corp Tax liability to nothing in many cases. There is evidence of something odd having occurred along these lines, but the other way around at Caffe Nero. Looking at its Group Balance Sheet, there is one glaring anomaly - namely the £105m Other receivables. Since retailers sell products for cash, they don't usually have any receivables at all, apart from some modest rent & rates prepayments. So what could this possibly be? (see below):

It appears that the holding companies above Caffe Nero Group Ltd ("CNGL") have stripped out its cash through loans from CNGL to its owners. It is not clear why CNGL is owed this money by its shareholders, and it does not appear to be charging them any interest on these loans, if that's what they are?

Overall then, whilst I haven't investigated the trail any further up the group to the ultimate holding companies, it is blindingly obvious that this group has been structured in this way, with Isle of Man and Luxembourg companies, in order to avoid UK Corporation Tax. There's no uncertainty over that, it's glaringly obvious.

Therefore I fully support the boycott of Caffe Nero shops which is being suggested on Facebook.

Consumer-facing companies like this need to learn that they will destroy their own brand reputation, and hence ultimately their own companies, if they structure their affairs in a way which is clearly designed to avoid paying their fair share of tax on profits made in the UK.

I shall not be visiting any Caffe Nero shops again, but instead will be supporting my local, independent coffee shop, whose coffee is much nicer than any of the bigger chains anyway.

It has been suggested that the consumer boycott of Starbucks a while ago just harmed their franchisees. I have some sympathy with that, but nothing will ever change unless & until big companies are pressured by consumers into doing what is right. As regards Caffe Nero, I cannot find any mention of franchisees, so it appears to be a straightforward operation where the company itself operates the stores. So a boycott of Caffe Nero shops should directly affect the party avoiding tax.

I wonder if any readers who are experts on corporate tax could explain how the group relief works. If you can set up an Isle of Man company to own a UK company, then why doesn't every UK company do that, and then nothing would be collected in Corporation Tax?

Why have the politicians and HMRC not taken action against companies structuring their affairs in such a way as to avoid paying Corporation Tax? It seems scandalous to me.

Finally, perhaps the UK needs to follow other countries where interest payments stop being tax deductible? This might reduce tax avoidance schemes, and make it more difficult for Private Equity to continue their largely destructive interventions into the business activities of UK companies.

Surely it is also time for a "reasonable man" test on tax matters - i.e. if a corporate structure has obviously been set up to avoid tax, then there should be a general rule which over-rides the detailed rules, to mean that such arrangements are set aside and full tax becomes payable. Perhaps the reason that our tax system is so full of loopholes is because it has been developed into more & more complicated, detailed rules. There is a strong argument for tearing up the whole system, and starting again with a blank piece of paper, with simple, general principles. Principles cannot be avoided, whereas detailed rules can.

UPDATE:

I have followed the trail further up the group, by downloading accounts from higher up in the group.

The trail is that Caffe Nero Group Ltd (the main operating group of the coffee shops) is 100% owned by Rome Bidco Ltd, which is a financing company, and has an insolvent Balance Sheet, with net liabilities of £195.2m. It has £337m in financial debt, plus it owes CNGL £85.9m.

Rome Bidco Ltd is itself 100% owned by Rome PIKCo Ltd, which prepares group accounts including CNGL's trading activities. This shows slightly higher turnover, and a lower profit than CNGL, which I think is due to the inclusion of some small overseas JVs. So at this level within the Group, turnover is £205.3m, operating profit is £18.4m, but huge financing costsof around £41.5m create a group loss before tax of £23.3m, which of course incurs no UK Corporation Tax. Note that the loss has been created by the enormous interest charges in connection with the leveraged management buyout of Caffe Nero in late 2006.

Rome PIKCo Ltd is itself then owned by Rome Topco Unlimited, which then seems to be owned by Rome Holdco Sarl (incorporated in Luxembourg), and the ultimate controlling party is apparently the Isle of Man company, Saratoga Ltd. I have downloaded the Annual Return for that company, but it does not file accounts in the Isle of Man, so at this point the trail goes cold.

Now why on earth would anybody create such a convoluted structure? Obviously it is mainly to avoid tax. The nature of the debt, is that the interest charges become more & more onerous as you move up the group. That might make sense, because at each tier the lenders have less security. However, it also seems clear that the main commercial purpose of the structure and the excessively high interest charges, is to suck all the profits and cash from the bottom upwards in the group.

That seems to be to enable the group to pay nothing in UK Corporation Tax, and the profits end up at the top of the group in the zero tax Isle of Man. Funny that! Because it's interest, it's tax deductible. However the commercial reality is that intra-group interest charges have simply been used as a mechanism to dissipate profits, thus negating any Corporation Tax costs, and move them offshore. Simple as that. There's no other rational explanation for why this group is structured the way it is.

So as far as I'm concerned, the boycott is on! No Caffe Nero coffees for me, unless & until they disband the current group structure, and begin properly paying UK Corporation Tax on the profits of the operating group company before the debt. Oh and also time to start lobbying Government to remove the tax deductibility of interest costs, which is the crux of how these people get away with paying no Corporation Tax. Remove that loophole, and the game's up for Private Equity, and not a day too soon.

Comments welcomed below please!

Regards, Paul Scott.

Twitter: @paulypilot