Archive for July, 2016|Monthly archive page

The ongoing saga of the governance of Britain’s Railways

A case in Corporate Governance: Principles, Policies and Practices (Network Rail case 3.2, page 80) raises some interesting philosophical questions about the appropriate relationship between individuals, enterprises, and the state. The people in this case are British train travellers and taxpayers; the enterprises are the state-controlled Network Rail and private train-operating companies; the state is the UK government. Where should power and accountability lie? What is the most appropriate governance structure – a nationalized entity like the previous British Rail, individual private, profit-orientated train operating companies as now, with Railtrack plc responsible for the tracks, stations and signalling selling its services to the operating companies, or a re-classified state-owned corporation, with the national Treasury responsible for its debt?

The case quotes the then leader of the UK’s Labour opposition party, Ed Miliband, saying that when he returned to power at the 2015 election, he would consider re-nationalising the British railways system, re-establishing British Rail and taking over the privatised train operating companies. In the event the Labour party lost that election.

In June 2015, the Government suspended work upgrading two of the country’s most congested rail lines – Mainline Midland and the TransPennine route – because of cost overruns and missed targets. The decision came from the Treasury, which took over responsibility for Network Rail funding and therefore its debt after Network Rail was reorganized into a state-owned company.

Three months later, the rail regulator, the Office of Rail and Road, warned that the company might be in breach of its licence after they found flaws in the way it handled major projects. But the Government refused to release a critical report, which spelt out serious problems with Network Rail and might have undermined Government pledges, because of pending elections.

In July 2015, the Government replaced the Chairman of Network Rail, Richard Parry-Jones with Sir Peter Hendy. The Government also appointed Nicola Shaw, head of HS1[1] (the company known as High Speed 1, which runs the successful Channel Tunnel Rail Link) to draw up plans for Network Rail’s structure and funding. “Network Rail is not working,” she said, “There was a big change last year when its debt (then £38bn) was taken over by the Government. When you have a big change you ought to think about what you want to do from here.” The options she is considering include:

  • government continuing to fund the operation;
  • auctioning various routes (sections of track) as concessions to pension funds and sovereign wealth funds;
  • privatising the entire operation through a public listing.

Shaw said that she would stop short of considering reuniting track and train operations, as was the case under the previously nationalised British Rail. In September 2015, government ministers moved closer to a break up and sell off of Network Rail with plans for a radical overhaul of operations, shifting decisions on track maintenance and new projects to regional line managers. By February 2016, Shaw was suggesting spinning off individual lines to investors and introducing an agency to oversee the industry at arm’s length from government.

While waiting for the Shaw proposals, it seemed that the Chief Executive of Network Rail, Mark Carne, was being overseen by a civil servant, Philip Rutnam, permanent secretary at the Department of Transport, who was previously a merchant banker.

In October 2015, the Regulator issued a damning report naming ‘systemic failings’: a third of railway upgrades – new stations, extra track capacity, electrification of lines – were running late, and key project costs were spiralling out of control. In November 2015, the regulator fined Network Rail £2 million for delays and cancellations that constituted a breach of its licence. By November 2015, Network Rail admitted that train punctuality was not good enough as its debts mounted and six-month pre-tax profits fell by 23% to £246 million while operating costs rose by £88 million.

Meanwhile, Jeremy Corbyn, unexpectedly elected leader of the Labour Party in May 2015, put forward detailed proposals for the re-nationalisation of the fifteen independent train operating companies. Citing the continuing increase in rail fares, he said that bringing the entire network, including Network Rail, back under government control, had widespread support. Legal experts pointed out the potential difficulties, not least European Union law which requires member states to open up their transport networks to cross-border competition, which would rule out UK nationalisation. But in June 2016, the electorate decided in a referendum (Brexit) that the UK should leave the European Union.

Meanwhile the problems of the British railway system continue unabated. Blaming labour disputes, old rolling stock, and track delays, the Southern Railway network cut over 300 trains a day claiming this would make their services more “resilient”. Plans to re-route the new high speed line from London to the North ran through a newly built housing estate. Delays to rail, signalling, and electrification upgrades led to further late running and cancelled trains.

The Times in an editorial wrote that: ‘Thirteen years after its creation, Network Rail remains a byword for botched corporate governance. Without shareholders, ministerial oversight or direct contact with passengers, it is accountable chiefly to itself. It carries an unsustainable £38 billion debt burden but as a public body it has little incentive to pay this down or force on its staff the efficiencies that would cut costs.’

This has to be one of the longest running, unresolved corporate governance cases in the world.

[1] HS1 is owned by the Canadian investment funds Borealis Infrastructure and the Ontario Teachers’ Pension Plan.  It has a 30 year concession to run the Channel Tunnel rail link.

Bob Tricker, July 2016

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Aggressive Tax Avoidance

The use of tax havens and other devices by international corporations, which was waiting in the wings when the third edition of Corporate Governance: Principles, Policies and Practices was written in 2015 (page 404), has now come centre stage.  The corporate governance debate on the topic of, so-called, aggressive tax avoidance seems to have consolidated into two main strands.

On the one hand are those directors and their professional advisers who argue that their role is to maximize their shareholders’ wealth in the long-term, running their organizations while keeping within the regulation and law of each country in which they operate. ‘Tax strategies such as transferring profits from high to low (or no) tax regimes by moving head office domicile, re-routing orders, or charging licence fees, are completely legal or we do not use them’, they say. ‘If governments and regulators do not approve of such strategies, they must change the regulations or the law.’

On the other hand, a growing school of thought argues that the board of a company owes a duty to a wider range of stakeholders than just their shareholders. If a company shifts profits out of a country in which it has earned those profits, the taxpayers of that country are denied the tax benefits that should accrue from the revenues they have generated. Though such a transfer may be legal, it is not fair and could be considered unethical.

In the UK, both the business and popular press have highlighted cases in which large companies and wealthy individuals have failed to pay UK tax. For example, London jeweller Mappin and Webb, holder of the silversmith warrant from Her Majesty the Queen, was shown to have paid no tax for five years on profits of £66 million. It transpired that Mappin and Webb was bought in 2013 by US private equity firm Aurum, which has a base in Luxembourg, a pivotal tax avoidance hub, even though a member of the European Union. Cadbury, the chocolate maker, was also shown to have paid no UK tax in 2015, although it generated over £2 billion in revenues. Cadbury had been sold to US corporation Kraft. The UK tax authorities have also challenged a number of schemes designed by tax accountants and lawyers to reduce or eliminate income tax for rich individuals, including sports stars, media personalities, and business people.

In the United States the Foreign Account Tax Compliance Act (FATCA) is intended to detect tax evasion by US citizens who hide money outside the US. The act requires all financial institutions, wherever they are, to report on the existence of all accounts and financial transactions of US citizens. This call for greater transparency has had unexpected consequences: some UK financial institutions now refuse to accept US clients, because the reporting requirements and the penalties for non-reporting are too great, and some American expats have begun the long process of renouncing their citizenship.

But tax havens are usually far more than vehicles for reducing tax. In fact it would be more appropriate to call them safe havens. Some companies incorporate in safe havens legitimately, even though they have no operations there, to reduce regulation and filing requirements, thus keeping their ownership and financial details unobtrusive. The majority of Hong Kong based companies listed on the Hong Kong Stock Exchange are incorporated in safe havens, many in the BVI. But others, of course, use safe havens as a bolt hole to hide the proceeds of crime or to launder money. Then, of course, there are those who use safe havens to reduce or avoid tax. So, some safe haven users are legitimate and legal; others suspect and, possibly, cloaking illegal activities.

The following table lists most of the significant safe havens. There are a few more minor ones.

Tricker post table

The classic safe haven has been Switzerland, with its banking secrecy laws. Although in recent years, Swiss banks operating in some countries, including the US and the UK, have been pressurized to provide information. Panama has recently come into prominence because of the leaked ‘Panama Papers’ from law firm Mossack Fonseca, which gave explicit details of many firms and individuals involved in offshore financial arrangements. The US state of Delaware provides no protection from US federal taxes, but does have a business friendly court and is less bureaucratic than many other states, which is why so many US corporations are incorporated there.

The British safe havens that are Crown Dependencies or British Overseas Territories have the Queen of England as Head of State and their final court of appeal is the UK Privy Council. Most are also members of the British Commonwealth, as are the Bahamas and the Cook Islands.

Just before being replaced, UK Prime Minister David Cameron held an international conference in May 2016 in London, which brought together many (but not all) of the safe havens with representatives of major economies. The main conclusion was of the need for more transparency, including information about the ultimate owners of companies resident in tax havens.

Bob Tricker, July 2016