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From Private Eye.

WHEN Vodafone bought German engineering company Mannesmann a decade ago for €180bn, it desperately wanted to use the mother of all tax avoidance schemes so taxpayers would subsidise what turned out to be a massively over-priced mistake. The plan was to route the acquisition through an offshore company.

This, however, would potentially fall foul of British anti-tax avoidance laws, and when the company asked the then Inland Revenue to clear the arrangement, it duly refused. Vodafone went ahead anyway and bought Mannesmann using a Luxembourg subsidiary company called Vodafone Investments Luxembourg sarl (VIL), in which it would go on to dump vast profits taxed at less than 1 percent.

An epic legal battle began, with Vodafone resisting the taxman’s efforts to get all the information on the deal and arguing through the courts that the British laws striking out the tax benefits of its deal were neutered by European law which granted, Vodafone claimed, the freedom to establish anywhere in the EU (including its dodgiest tax havens) without facing a tax bill.

VIL’s accounts show that, up to March 2009, €15.5bn income was stuffed into the company, suggesting it is now heading to the €18bn mark and resulting in £5bn in lost tax and interest so far. But, armed with strong advice from eminent legal counsel, tax inspectors were confident they could win the cash back, not least because until 2004 the scam was run through the Luxembourg company’s Swiss branch. This of course was not even in the EU (although that year Luxembourg changed its own rules to allow the trick to work without inconveniencing tax avoiders with the need for an Alpine branch).

A less ‘black and white view of the law’
Officials were further emboldened last year when the court of appeal ruled that British laws striking out the avoidance scheme could conform with European laws. But they reckoned without HM Revenue & Customs’ (HMRC) “permanent secretary for tax”, Dave Hartnett, and his customer-friendly approach to big multinationals.

Despite HMRC’s victories, Hartnett moved the case from his specialists and lawyers – dismissed in recent comments to the FT as “very intelligent people” suffering from “a black and white view of the law” – to a dimmer but more amenable group to negotiate with Vodafone’s head of tax, John Connors, who until 2007 was a senior official at HMRC working closely with Hartnett on handling big business.

The fruits of these talks, conducted without consulting HMRC’s litigators and specialists in the tax law concerned on the chance of success in the courts, was a bill for Vodafone of £800m, with another £450m payable over five years and, remarkably, an agreement that the arrangement can carry on into the future with a promise of no challenge from HMRC. The Eye understands that the settlement also swept up several other Vodafone tax avoidance schemes.

More sweetheart deals to come
The bill for all other taxpayers in lost tax is likely to be at least £6bn. Resentment within the HMRC ranks is high and one former official familiar with the case described it as an “unbelievable cave-in”. But there is no means for the deal to be audited: the National Audit Office refuses to look at specific cases.

Hartnett’s comments to the FT signal more sweetheart deals to come. The “conciliatory” approach can be presented as an urgent cash-gathering exercise, but in practice it encourages tax avoidance and sells other taxpayers well-short. It also masks the fact that staff cuts at HMRC are destroying its abilities to fight tax avoidance. Spending on the activity has already fallen from £3.6bn in 2006/07 to £1.9bn, with more cuts to come, prompting the association of senior Revenue officials to compare the government to “a drowning man who decides to throw off his life jacket, because it weighs too much”. How fortunate then that under HMRC’s reporting practices the Vodafone settlement will count as a £1.25bn success in the fight to close the “tax gap”, rather than a £6bn gift to a large phone company.

PS: The Tories have further cause to thank Mr Hartnett. As Eye 1136 revealed five years ago, government cuts adviser Philip Green had personal discussions with Hartnett over his tax affairs while legal battles raged over schemes for husbands and wives to share their income for tax purposes. Dividends from Green’s businesses continue to be paid to trusts controlled by his Monaco-resident wife Tina, undisturbed by the taxman.