First published in DM168

Tobacco’s Big Four transnational companies – British American Tobacco (BAT), Imperial Brands, Japan Tobacco and Philip Morris – collectively earned more than €80-billion in revenue in 2019. However, using aggressive tax-avoidance methods, they have managed to pay negligible tax over the past decade.

In the case of BAT and Imperial Brands, their UK subsidiaries alone lowered their corporation tax burden by £2.5-billion over the past decade.

They do this by offsetting losses made by one subsidiary against profit made by another. This is known as group relief. In this way, Imperial Brands was able to lower its UK corporate tax bill by an estimated £1.8-billion over the past 10 years and BAT by an estimated £760-million.

As a result, BAT, the manufacturer of Peter Stuyvesant and Dunhill cigarettes, paid close to zero company tax.

The annual reports of Imperial Brands, makers of Gauloises, Golden Virginia (the world’s largest-selling hand-rolling tobacco), Drum (the world’s second-largest-selling fine-cut tobacco), and Rizla (the world’s best-selling rolling paper) are so opaque that their actual UK tax burden is virtually impossible to determine.

While there is no clear evidence of tax evasion, which is illegal, there is evidence of aggressive tax planning strategies, in spite of their own codes of conduct suggesting otherwise. This is according to research conducted by the Investigative Desk, a cooperative of specialised investigative journalists, with support from the University of Bath. The teams analysed the annual reports of the big tobacco companies, as well as those of a number of crucial subsidiaries, between 2010 and 2019.

The researchers found that these firms deploy tried-and-tested methods to reduce their tax exposure in more highly taxed regions, and shift it to countries where the tax rate is negligible.

Six European countries play a central role in this: Belgium, Ireland, Luxembourg, the Netherlands, the UK and Switzerland.

For instance, tobacco’s Big Four shift about €7.5-billion of worldwide profit through the Netherlands annually, the researchers say.

BAT and Imperial Brands move these profits on to holding companies in the UK, Philip Morris International to a holding company in Switzerland. Japan Tobacco International seems to send them via the Netherlands straight to the parent company in Japan.

Five avoidance methods

The companies use five main avoidance methods: shifting dividends, group relief – partly based on internal loans – notional (fictitious) interest deductions, profit shifting via intrafirm deductions and royalty payments.

The €7.5-billion tobacco’s Big Four shift through the Netherlands annually consists mainly of dividends from subsidiaries. BAT shifts around €1-billion in dividends via Belgium each year. Tax paid on these profits is less than 1%.

The two British tobacco giants in particular use group relief (loss compensation) as a major method to reduce their corporate taxes. At both Imperial Brands and BAT, the losses involved regularly stem from interest paid on internal loans, resulting in eligibility for group relief.

There are clear indications that at least part of these loans don’t serve any other purpose than lowering their corporate tax bill.

In addition, BAT parked around €3.5-billion in assets in three holding companies in Belgium, which from 2010 to 2017 helped it deduct several millions in notional (fictitious) interest each year. The notional interest deduction diminished over the years and ended in 2018.

The Investigative Desk also found several examples of profit shifting via intrafirm transactions. One is the sale – on paper – of all BAT cigarettes produced by BAT Korea Manufacturing to Rothmans Far East in the Netherlands. They are immediately resold to another South Korean company, BAT Korea, at a much higher price. This way, on average each year €98-million in Korean profits are shifted to the Netherlands.

There are also clear indicators that Philip Morris International and Japan Tobacco International use royalty payments (through the Netherlands) as a tax-planning tool: Philip Morris Holland annually pays between €25-million and €29-million in royalties to a foreign entity. For the Dutch company these are costs, so the taxable profit is lowered considerably. Between 2010 and 2013, Japan Tobacco International Group Holding shifted about €250-million annually through the Netherlands as royalties.

A different perspective

Perhaps understandably, Big Tobacco does not agree with the conclusions that have been reached.

“It is worth noting that this report is not a work in independent journalism, rather it is content co-authored by an institution funded by an American special interest group that is opposed to adult smokers having access to and accurate information about less harmful alternatives to continued smoking,” says Rishaad Hajee, a spokesperson for Philip Morris International. 

“Since embarking upon our transformation to replace cigarettes with scientifically substantiated smoke-free products, which are a better alternative for adults who would otherwise continue smoking, we have seen an increase in reports of this kind.”

He added that globally in 2019, Philip Morris International paid $2.3-billion in corporate income taxes, which equals an effective corporate tax rate of approximately 23%, which is in line with the average Organisation for Economic Co-operation and Development (OECD) rate. “Philip Morris International does not engage in aggressive tax planning,” he says. “And where appropriate, [it] seeks upfront certainty from tax authorities in the countries in which we do business, including the Netherlands.”

Similarly, BAT strongly refutes the report, saying it contains “many inaccuracies”.

According to a company spokesperson, across the periods covered by the report from 2009 to 2019 the group has contributed £330-billion in excise, duty and corporation tax to government across the world.

Specifically in the UK, in 2019 the company paid company tax of £39-million on 2019 UK profits, employee-based taxes of more than £200-million for its staff of 3,000 UK employees, and more than £1-billion in UK excise and VAT.

“BAT complies with all applicable tax legislation and regulations in the countries where we operate,” says the spokesperson. “We are committed to ensuring that the group takes an arm’s length approach to setting the transaction prices for goods and services between two or more group companies. In addition, these prices are in line with what external, independent parties would charge.”  

South Africa not immune

However, research has shown that the annual shifting of profit by multinationals from South African shores, across many economic sectors, amounts to billions annually.

“The illicit trade mainly seeks to unduly capitalise on non- or underpayments of excise, VAT and duties. These schemes are rife and remain a challenge in the sector,” says Johann van Loggerenberg, tax consultant and former group executive at tax and customs enforcement investigations at SARS.

“Having said that, on the flip side, aggressive tax-avoidance and base erosion profit-shifting schemes are less understood, underreported and difficult to explain. They are even more difficult to detect and address. While low in volume, as opposed to smuggling and illicit activities, the values attributable to these schemes run into the billions. To detect and dismantle these require highly specialised skills and expertise and a willingness to tackle large multinationals.”

Looking for the financial statements of BAT SA, a fully owned subsidiary of BAT, which is listed in London, with a secondary listing in Johannesburg, will not help either.

“The BAT listing on the JSE is not of BAT SA, but of the international organisation. BAT SA does not report to the JSE but to London, which means that we have no idea of how much corporate tax they pay,” says Corné van Walbeek, director of research on the economics of excise products at UCT. 

“Of course, BAT SA pays a substantial amount of excise tax, but there is no public record of how much corporate tax they pay to the SA government.”

In the past BAT has published documents on its contribution to the SA economy. These make reference to how many people are employed, how many dependents they have and how much excise tax is paid to the government, but they say very little about the corporate tax that they pay.

“What these companies do is inflate the royalties that they pay for the use of intellectual property belonging to the mother organisation – whether it’s for manufacturing or clinical trials, or on the vaping products, there is no end to the charges,” says someone who previously worked for SARS. “SARS is not good at assessing royalties and calculating what is reasonable and what is not.”

Contacted for comment, SARS says that it is committed to rooting out all illicit behaviour and rebuilding capacity that was eviscerated in the last five years.

Red flag

The fact that tobacco’s Big Four have been involved in tax disputes in at least 11 countries over the last 10 years should be an indication that something is amiss. These disputes have led to claims by tax authorities ranging from €45-million to €1.2-billion.

In the majority of cases, the courts’ decisions have been in favour of the companies.

For instance, Philip Morris has been or is under examination by foreign tax authorities in Germany, Indonesia, Russia, South Korea, Thailand, Switzerland and Turkey. BAT has been or is involved in disputes in the Netherlands (a record claim of €1.2-billion), Brazil, South Korea and Egypt. Imperial Brands is involved in three large tax-related legal procedures in France, Russia and the EU, involving tax claims totalling £672-million.

In the case of Japan Tobacco International, the researchers found three specifications of tax disputes, in Turkey, Russia and the UK. In September 2019, the European Commission announced an investigation into tax avoidance by multinationals. BAT is one of the 39 companies under investigation.

The spirit of the law

In 2016, the OECD and the G20 set up a framework to take action against tax avoidance. Since then it would appear that, far from paying more tax, the financial reporting of tobacco’s Big Four has become less transparent.

It is important, at this point, to understand the difference between companies’ right to pay the minimum tax by way of permissible tax avoidance, and those that deploy the types of structures and practices that are governed by the General Anti-Avoidance Rules (GAAR) and relevant tax laws. 

“While not a crime (in other words, not illegal), these schemes are unlawful and not only can SARS recoup lost corporate taxes, but they also attract penalties and punitive interest,” says Van Loggerenberg.

The problem is the complexity of the structures.

“The complicated corporate structures and the tax avoidance methods employed by these giant tobacco companies is astounding,” says the co-author of the report, Dr Rob Branston, an economist with the University of Bath’s Tobacco Control Research Group and the School of Management.

“They earn massive profits but very little of that ends up being paid in tax. All governments need to update their tax laws so that these companies, profiting from the sale of a deadly product, can no longer use loopholes to avoid paying tax.”

Working together

No impermissible tax-avoidance scheme can be audited or investigated from within a single jurisdiction. The very nature of these schemes is such that they span multiple countries, in both the developed and developing world, and often include complicated cross-border transactions through so-called treaty shopping and other means.

“The use of the so-called DTAs [double taxation agreements] and other international instruments and forums are absolutely necessary to conduct proper investigations and audits of these types of schemes,” adds Van Loggerenberg. 

“Each one has its own intricacies dependent on its nature, the extent and number of role players. It is impossible to properly dismantle these schemes if there is no international collaboration. Our local smaller tobacco companies are by design unable to really practise these types of schemes by sole virtue of their corporate structures being limited to within our borders.

“It is by and large the large multinationals who view themselves as a ‘group’ from within, but for taxation purposes, are viewed as separate entities within each jurisdiction it finds itself.” BM168