Debt tax Profit And Dividends

Why have debt?

Corporation tax is a tax on profit. Interest payments on loans are one of the many deductible costs a company can make for corporation tax purposes. So, the more debt a company takes on, the more interest it pays and the lower its tax bill. (NB: Wightlink for example has borrowings of around £244 million)

Dividends, which are the usual way that profits are distributed to shareholders by a company, are not deductible. They are paid out to shareholders after tax has been paid by a company. The difference in the tax treatment of dividends and interest payments is one of the key mechanisms by which corporations can engage in tax avoidance. A simple way to extract money from a company tax free is for the owners of that company to loan money to it. In this case, instead of paying out a dividend after tax, a company pays out interest to a shareholder (NB: Wightlink pay interest of 9.25% on its loans). The shareholder, who may be offshore, receives the profits tax free, and the company pays a lower amount of corporation tax than if it had not taken any loans.

Financial asset stripping

If a company is bought using borrowed money by a company based offshore, as the acquisition takes place the borrowed money is transferred to the company being bought. This process involves the company taking on huge amounts of external debt.

As the company pays off the debt and returns to its normal level of profits it becomes a more valuable company. The owner sells it on, but rather than selling the company itself, it sells the shares in an offshore holding company it has created to hold the shares of the target company. Any capital gain is therefore booked offshore. If the company is bought using borrowed money…………. go back to the previous paragraph! (NB: Wightlink has changed hands a number of times since it was sold by HM Government in 1984.)