There have been extensive reports in the press about revelations contained in the so-called “Paradise Papers”.
One of the most intriguing of these has been the accusation of tax avoidance levelled at the Duchy of Lancaster, part of the Queen’s private estate. I was therefore interested to read the details contained in this article in the Financial Times… and from it, I learnt that I am a tax avoider too! Before moving on to the specific issue, I will just point out that most stock market investors are also tax avoiders – and any investor is foolish not to be, given that the government encourages and facilitates avoidance of tax through ISAs and pension schemes (amongst other mechanisms), all of which confer favourable tax treatment on investors. Clearly this is done (by governments of all stripes) to encourage saving and investment, which is seen by most as a public good (up to a point).
Now coming back to the Duchy of Lancaster, and my own case. The article states that the Duchy invested in the suspicious and mysterious sounding “Dover Street VI Cayman Fund LP” – however that name is familiar to me, because I happen to know that the series of Dover Street funds are managed by none other than HarbourVest Partners LLC who are also the managers of the FTSE250 firm HarbourVest Global Private Equity Ltd – HVPE. Moreover HVPE invests exclusively in the HarbourVest funds (of which there are many), including the Dover Street funds. Therefore as a shareholder in HVPE I am also an indirect investor in that similar Cayman Islands registered fund (having checked with HVPE, I learnt that have only invested in Dover Street VII onwards)!
I have written previously about HVPE, here and in our recent July newsletter. They also presented at ShareSoc seminars in November 2015 and September 2016. Anyone investing after that seminar in 2015 should be rather pleased to see the share price climb from 862p then to 1296p now, as the company’s NAV/share has also grown substantially. Note that as well as its investee funds being offshore registered, HVPE itself is also registered in Guernsey. This is not unusual and many investing companies are registered offshore, other examples coming to mind are Ocean Wilsons (OCN, Bermuda), Fair Oaks Income Fund (FAIR, Guernsey), Real Estate Credit Investments (RECI, Guernsey). There are many others listed on the London Stock Exchange or the LSE’s specialist Funds Market that you may come across. Many ETFs are also registered in offshore jurisdictions and/or in Ireland.
Are they all doing something illicit or dubious? In short, the answer is “no”. They are part of standard tax planning, which is a principle accepted by HMRC. So, why are these companies registered in offshore jurisdictions? As mentioned in the FT article, the reason is often to avoid double taxation. These companies are designed explicitly to provide good returns to investors, without incurring tax additional to that paid by the operating businesses they invest in, simply as a result of the investment process. Private equity investors like HVPE and its offshore funds are investing in operating businesses which, in turn, pay corporate taxes on their profits in the jurisdictions within which they operate. Is it fair and reasonable that the funds should pay further taxes on the already taxed income of those operating business and on capital gains resulting from successful investments? Take into account that the investors in those funds (like the Duchy of Lancaster) will be liable for taxation of any income distributed by the funds and of capital gains resulting from their investment in the funds. It seems to me that an offshore domicile is a reasonable precaution against investors suffering excessive and unreasonable layers of taxation on their investments. The principle which HMRC accepts is that the investors in these vehicles are liable for tax on their investment returns and gains, in accordance with their tax status, but the vehicles themselves are not, if registered in an offshore jurisdiction. In the case of HVPE it is also worth noting that there are even more layers which could result in further layers of taxation were it not for the offshore domicile. That is because Dover Street is itself a fund of funds and one of the “bottom layer” funds it is invested in is operated by Private Equity manager Vision Capital Partners (VCP), (according to the FT article).
Though I think a mountain has been made of a (pretty harmless) molehill in the Duchy of Lancaster story, there are certain aspects that are troubling to me. The first is that one of VCP’s investee companies is BrightHouse. Like H.M. Queen, I was not aware that BrightHouse was one of the over 6,000 privately owned businesses that HVPE is indirectly invested in and I am not best pleased. That’s because BrightHouse has come under regulatory scrutiny over the way it treats its low-income customers, as explained in this article, which also reports that VCP stands to lose its investment in the company as an indirect consequence of that scrutiny. Investment in firms with questionable ethics often leads to losses, ultimately, as well as being morally repugnant. I shall have words with HVPE management and expect them to do likewise with VCP.
The bottom line of this post is that one needs to dig beneath the sensational headlines of these news reports to understand the real story.