Water companies pay billions to shareholders but little tax. Why?

http://www.guardian.co.uk/business/2012/nov/10/utilities-water-bills

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It will take seven years to build, cost about £4.1bn – nearly half the cost of the Olympics – and has already provoked resentment among residents, including impressionist Alistair McGowan, who fear it will blight their neighbourhoods.

Britain's first supersewer, due to stretch 24 miles from Acton in the west of London to Abbey Mills in the east, might perform the necessary task of preventing raw sewage polluting the Thames, but it is difficult to love. And the really vexed question regarding the Thames Tideway is, who is going to foot the bill?

Simon Hughes, the Liberal Democrat MP for Bermondsey, where machines are due to start their work gouging out the tunnel, has long been of the opinion that it is wrong that the taxpayer should even underwrite the risky project. Surely Thames Water could afford to bear all of the burden? Had it not put something away?

Hughes's digging into Thames Water revealed a byzantine accounting structure, with multiple companies, subsidiaries and an offshore site. He took advice from a former director of utilities at the European Bank for Reconstruction and Development, Martin Blaiklock, on the workings of the maze that was Thames Water's company accounts and others.

What he discovered was a system that he believes is letting down the customers and the taxman and one that appears to be repeated across the UK, where 75% of water companies are owned by private equity firms. The first part of the jigsaw is an annual bumper dividend paid to investors or to companies which are often their own subsidiaries, sometimes offshore, and which rip out funds that publicly owned waterworks might once have kept aside for infrastructure investment.

In the five years to March 2012 Thames Water declared total dividends of £1.18bn. In the same period, Kemble Water Holdings, the Macquarie Group-led vehicle that owns Thames Water, paid out dividends to its investors of nearly £700m. Over at Yorkshire Water, a dividend of £63.4m was paid last year to its financing company. Similarly, at Anglian Water, a dividend of £193.6m was paid this year to Anglian Water Services Holdings, via a subsidiary in the Cayman Islands.

Blaiklock found that across the country between 2009 and 2011, total dividends had reached £3.3bn.

The reasons given by the companies for the dividends was the need to move funds on to pay down amassed debts sometimes taken on by holding companies through the purchase of the water companies themselves. At other times, they said, the money was needed to fund infrastructure investment and to repay shareholders for their investment. The result, though, was undoubtedly a severely weakened balance sheet, Blaiklock told Hughes.

The water companies' shrunken finances meant they were unable to invest in large-scale projects and became ever more reliant on rises in water bills to pay their way and on the government to support projects such as the new supersewer tunnel. This is the second part of the jigsaw, according to Blaiklock.

Anglian Water's household customers were told this year that they will see bills increase on average by £22, from £401 to £423. Thames Water customers have been warned that their bills are likely to rise by as much as £80 a year to help them pay their part of the bill for the new tunnel. Yorkshire Water has told its customers that the average water and sewerage bill is going to rise by £21 from £340 to £361, in order for it to maintain the quality of its performance.

A utilities sector populated by weakened water companies unable to significantly invest and dependent on big price rises approved by the water regulator Ofwat was surely not what Margaret Thatcher had in mind when her administration privatised the waterworks. That the chief executives of the companies concerned have been showered with performance-related bonuses in recent years could be considered to add insult to injury.

But it is the final piece of the jigsaw that is perhaps the most concerning and which Hughes is now urging the influential Commons public accounts committee to investigate. Despite the billions of pounds swilling about the industry, Hughes discovered that little corporation tax is being paid by our major water companies – in some years none at all.

Thames Water enjoyed a tax rebate of £79.6m in 2011-12 and paid just £26m in tax the previous year, despite a net cash inflow for that year of £943.1m. Yorkshire paid just £2.9m last year and £11.1m in the year before, despite an operational profit of £303m. In 2012, for the regulated part of Anglian Water's business, the company paid no corporation tax at all. In 2011 it paid £500,000 corporation tax on the profits and in 2010 it was £1.4m.

The companies say that a combination of interest repayments (on debt) and capital allowances has been used to offset or defer tax payments. Hughes and Blaiklock fear there is more to it than that, despite the water companies' protestations.

An alternative world is proposed by Hughes: if Thames had paid no dividends to shareholders and placed its profits in the banks or suitable investments, they would today have the £4bn needed to cover the costs of Tideway tunnel.

An unlikely scenario perhaps. But even if Thames had paid shareholders only 50% of what they have received as dividends since 2000, they would have £2.1bn set aside. Thames rejects this reasoning, arguing that such large-scale projects always involve the state, pointing out that a new company has been set up by the government to build the tunnel, and adding that if Thames had to foot the bill it would need to pass on the huge costs to its customer.

The other companies say they have behaved responsibly, that their debt is simple a necessary evil of being a utility company. Hughes, though, is determined to keep on digging. In a letter seen by the <em>Observer </em>to the Commons public accounts committee, which is due to quiz the bosses of Starbucks and Google over tax avoidance, Hughes writes: "The aggressive capital structure implemented by Thames has resulted in the company becoming so indebted that it does not have the financial strength to invest in the large capital projects.

"As you may know there is currently a proposal to build a tunnel through London to collect the sewage overflows from our ageing Victorian sewerage network. The current estimate for the cost of this project is £4.1bn.

"Moody's, the credit rating agency, has said that given the high gearing of the company even limited involvement in the Tunnel project will have a negative effect on Thames Water's credit rating. As Thames is required by its licence conditions to keep an investment-grade credit rating it cannot participate in the tunnel project."

The question Hughes poses in his letter is simple: "Is there a particular problem in the water industry, which is a regulated monopoly with high capital requirements and which allows companies to reduce the capital stock of the utility while lowering their tax liability, and does this requires a policy response from the government?"

In other words, is there something fishy about the way the water industry does its business? At the very least there appears to be a case to answer.