So just how good is that Northern Rock transaction?

Here’s what Osborne tweeted out this morning.

It was probably something I ate, because I woke up in a rather sceptical mood: what’s the “gain” he’s referring to, I wondered?

So I looked at the HM Treasury Press Release. It doesn’t tell us much. But it does say that:

The Chancellor has today (13 November 2015) authorised a record-breaking £13 billion sale of mortgages acquired by the government during the financial crisis.

And the word “gain” seems to refer to the fact that the price achieved represented a £280m (or “almost £300m” as the Press Release goes on helpfully to observe. Political rounding, you might call it) surplus over book value.

That’s not especially illuminating because, if I have an asset worth 100, write it down in my books to 10, and then sell it for 30 I can say I’ve made a “gain” on book value of 20 even though actually I’ve lost 70. But because I didn’t know the actual cost to us of the mortgage book – known in the trade as the Granite Portfolio – I left the point alone.

But then I wondered: who purchased it?

Well, it’s something called Cerberus Capital Management LP – “one of the world’s leading private investment firms” – and it’s been on a buying spree of real estate debt from across Europe (as its website helpfully points out) including Germany, France, Britain and Scandinavia. And it seems to be buying this debt through what the Irish Times describes as “a network of Irish companies” Special Purpose Vehicles (SPVs if you’d like to pretend to know what you’re talking about), each of them owning hundreds of millions or billions of pounds of assets but having no Irish employees and paying no Irish corporation tax.

The Irish Times is pretty brassed off about this – well, wouldn’t you be if you were Irish? – but is there a UK angle?

Reader, there is.

The bulk of the loans in the Granite Portfolio pay interest at 4.79% – so says the Financial Times at least. Calculating 4.79% of £13,000,000,000 on an eight digit pocket calculator is a little tricky but I think we get to £623m per annum of interest income. If that income were subject to UK corporation tax (even at our special low low rate of 20%) it would generate UK corporation tax receipts of £125m per annum – less any expenses of course.

But by selling it to Ireland all those prospective tax receipts go to… hang on… the Irish don’t get them either. We don’t and it’s a racing certainty that no-one else will. Typically they disappear off to a Dutch or Luxembourg Company where they’re received as a dividend and are tax exempt.

Cerberus, by the way, is also the name of a “monstrous multi-headed dog who guards the gates of the underworld, preventing the dead from leaving.”

I don’t know that Cerberus have brought the Granite Portfolio through an Irish SPV. But the Irish Times tells us that Cerberus have used this structure to buy other UK property loans – so it’s a reasonable bet. And I’m sure HM Treasury will tell us, if anyone cares to ask them.

We could, of course, have insisted on a UK buyer. That way, we would have kept in the national coffers the contribution made by £623m of annual taxable income. But because a UK buyer would have had a tax liability on that income he wouldn’t have been prepared to pay such a high price. And George Osborne wouldn’t have been able to send out this morning’s tweet trumpeting his “gain”.

I should mention for the sake of completeness that a UK borrower is in principle required to deduct and pay to HMRC 20% tax when he or she pays interest to a foreign lender.  This can be reduced or eliminated if the UK has entered into a so-called ‘double tax treaty’ with the country in which the foreign lender is based.  It will not surprise you to learn that the UK has entered into a treaty with Ireland, and the rate of tax the UK is entitled to deduct under that treaty has been reduced to… zero.

11 November 2015:

Note (1) I now know that the Granite Portfolio was sold to a Dutch Company, Cerberus European Residential Holdings B.V. My understanding – I put it no higher than that – is that this leaves all of the points made above intact.

(2) Friday’s Press Release states the value of the loan book on 30 June 2015 as £12.04bn but information released at the time appears to give a higher value of £12.05bn.

17 thoughts on “So just how good is that Northern Rock transaction?

  1. The objective of these structures is to ensure that the underlying investors in Cerberus’s funds don’t end up paying tax twice. If I’m an investor in the US/Singapore/Bahrain/Australia, and investing in Europe requires me either to pay tax twice or (best case) recover tax through double tax treaties from every individual country in Europe in which a fund has invested, and with which my home country happens to have a treaty, then I find something else to invest in.

  2. It is a good article Jolyon. I read on the bbc that Cerberus immediately sold £3.3bn of the loans it bought from UKAR to TSB. I do hope, as a taxpayer, that Cerberus didn’t find a way to make more from that tranche than UKAR did.

  3. So, what you’re saying is that the government essentially got a lump sum in lieu of future taxes on the interest upfront? Surely that’s not necessarily a bad thing?

  4. If we had bought these assets as an investment then the gain / profit would be important (although, I suspect that an IRR based approach would be more relevant bearing in mind the nature of the assets). We bought it to ‘save the world’ or whatever Gordon’s phrase was and definitely not as an investment. And so the question for me is did we get a good price for the assets when we sold them? One way of that is to compare the sales price to NBV (assuming you have a decent policy of determining NBV). Based on the press release, it would seem that we did get a good price. But I’m sure that someone else will look at it properly.

    I think it is also a bit strange to look at gross withholding tax that might be lost. I’m not arguing that tax is not relevant to the discussion, but it’s not the right number to use. For example, the £13bn of assets sold seemed to be funded by £7.5bn of third-party debt. So presumably it is the net interest cost that is relevant rather than gross. But even that ignores second order effects (like who would receive the interest on the £5.5bn that no longer needs to be borrowed by the government – pension funds or individuals, etc?).

    Your point about the structure may, or may not, be relevant. But that’s nothing specifically to do with this transaction but would apply to pretty much all PE/VC backed transactions. If we had of insisted on a UK only buyer, would it have been a collection of UK pension funds that bought the assets? And if so, how much tax would they have paid? And anyway, how many of Cerberus investors are actually UK investors?

  5. How will the (hypothetical) Irish SPV fare after BEPS is fully implemented? Will it still get treaty relief from withholding if it has essentially no substance and is (in effect) a conduit to somewhere that would not get treaty relief? If the returns would have ended up somewhere that would have got treaty relief, what is the problem?

    The question about IRR on the portfolio sale is a good one, though. Worth a freedom of information request, or perhaps someone could ask the question in parliament?

  6. Good article, and good comments. Here’s my suggestion – a Tax Media Centre

  7. Good idea.

  8. I don’t know but I would expect that a large majority of Cerberus’s investors are not based in the UK.
    For an example of what happens if you limit the universe of buyers to the ‘right’ kind, see the Royal Mail privatisation.

  9. They wouldn’t pay uk corporate tax at 20% though. You would route the receivable through a uk Cfc and get the 5% rate.

  10. One point I think is worth adding is the UK’s general position on overseas persons holding UK debt. Broadly, the UK’s policy (as implemented through a wide network of tax treaties with most western countries) is that most overseas lenders are NOT subject to UK tax on the UK debt they hold (the quid pro quo usually being that UK investors are also not subject to overseas tax on overseas debt).

    Cerberus manage other people’s money, so the “real” owners of the debt will be Cerberus’ ultimate investors. We’ve got no idea who they are, but the following things are almost certainly true:
    (1) All (or the vast majority) of those ultimate investors will be people in real jurisdictions who will pay tax locally on the loan, or pension funds etc;
    (2) All (or the vast majority) of those investors would be eligible for a 0% rate if they held the debt directly;
    (3) The use of an Irish/Dutch holding platform therefore doesn’t reduce UK tax;
    (4) What it does do is introduce a single taxpayer who can make a single tax filing on behalf of all investors. Otherwise, every single investor would have to write to HMRC in respect of every single loan they held. Which would be an administrative nightmare.

    I usually agree with everything Jolyon says regarding the Treasury’s attempts to cook the books to make the deficit look lower that it really is. But on this occasion, I see no issue. To my eyes, the Government sold the portfolio to the highest bidder, which is the right way to get the maximum return for the government, and which is consistent with standard Government policy.

  11. That is a much better argued version of the point I tried to make above.

    I would add that most funds of this type have a mandate to lend or buy loans in multiple jurisdictions, typically the main economies of the EU. This compounds the administrative problem since the investor would have to deal with the tax authorities in every country in which the fund chooses to make a loan. This is not a prospect that is relished by most investors.

    The reality is that to allow this kind of investment in Europe we need structures that allow returns to be channelled to investors without suffering withholding. Generally governments are keen to encourage the ‘monstrous multi-headed dogs’ at the moment because they help to fill the gap left by retreating banks.

  12. You’re looking at it mostly from the perspective of the fundd. But even assuming all of this to be so it still leaves intact the point that, from the perspective of UK taxpayers, a counterfactual where the loanbook is onshore is preferable and you’d want to account for its loss offshore in working out whether there is a ‘gain’ and if so its size.

  13. That is essentially a protectionist argument.

  14. No it isn’t. It’s about getting value for money for the taxpayer.

  15. Your counterfactual sounds like British loans for British taxpayers to me. Free trade and the free movement of capital have similar advantages for those who participate. Remember the UK also has capital that it needs to invest abroad.

    And besides in many cases the benefit of these structures is largely administrative. Many investors who could in theory claim tax back from the UK, France, Germany, Sweden, Spain etc through double tax treaties do not have the resources or willingness to do so. Discouraging these investors is detrimental to the countries that would otherwise receive the investment.

    Of course this is a complex issue, but the main beef I have with your post is that it oversimplifies. ‘Monstrous multi-headed dog’ is a cheap shot.

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