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The Sunday Times

INSIGHT - How Arab Billionaires avoid tax in Britain. Sunday, June 19, 1988

ONE OF the world's biggest and most active investment groups pays not a penny in tax in Britain, even though its portfolio of shares and bonds in this country is estimated at Pounds 15 billion and its annual British profits from dividends and capital gains are thought to run to between Pounds 1-1½ billion.

Insight estimates that the Kuwait Investment Office (KIO) could be avoiding a tax bill of as much as Pounds 500m a year through something called "sovereign immunity".

This is not enshrined in any law but rests on an international convention from the last century. It allows tax exemption to sovereigns and their governments in much the same way as the soil foreign embassies stand on is regarded as sovereign territory.

Kuwait is not alone in enjoying this privilege. The Sultan of Brunei and the Saudi royal family must also be assumed to be tax exempt, as well as less rich royals such as King Juan Carlos of Spain and the Dutch royal family.

The Insight team has found it impossible to obtain any details on the way sovereign immunity actually works and the names of countries that follow this convention. All questions to the Inland Revenue, to the Treasury and the Bank of England, which administers much of this royal money under a company called Bank of England Nominees, were turned away with the answer: "We do not discuss the tax affairs of individuals or companies."

What makes the Kuwaiti Investment Office different is that, while it remains secretive, it has become such a competitively commercial operation that many of its actions and investments are now visible in the stock markets.

Under British law anyone holding more than 5% of a company's shares may no longer hide behind a nominee name but must declare an interest. The KIO holds more than 5% of 30 British companies.Its most spectacular single investment is its 22% stake in British Petroleum. This alone is worth Pounds 3.2 billion.

KIO's total investments in Britain are now estimated at Pounds 15 billion. It is impossible to discover how much it receives in dividends from these investments, but City experts say that the figure cannot be less than Pounds 750m. This does not include the capital gains made on share dealings; the KIO is reckoned to be one of the sharpest dealers on the London market.

Normally gilts have 25% in income tax deducted before they are paid to an investor, and companies paying dividends are obliged to deduct 25% in what is known as advance corporation tax. Investors receiving equity and gilt income are therefore normally able to claim that the money has been taxed, at least partially, at source and their tax bill is amended to take this into account.

However, as the KIO is exempt from tax on the interest it receives on its holdings in government bonds and its shares, it is able to reclaim the tax pre-paid on the estimated Pounds 750m income it receives from gilts and other British investments.

The amount it is currently able to command from the Inland Revenue in tax credits of this kind is thought to be about Pounds 250m a year.

The best demonstration of how this works is its investment in BP. This has already enabled it to claim Pounds 35m in tax credits from the 8p final dividend paid in February on each of its 1.2 billion shares.

The KIO refuses to reveal the full extent of its British interests. "If you have the goods, you don't declare them. It affects the market," said one official last week.

It is therefore impossible to calculate how much the KIO makes in share trading, how many gilts it holds or just how much it receives in dividends each year. Hence, the true amount it receives in tax refunds is unknown.

However, many experts agree that, with an investment body as expert and as active as the KIO, it would be unlikely not to make a further Pounds 750m in realised capital gains over the year. Tax on this would be the full corporation tax rate of 35%, or Pounds 262m. Once again, this is a tax bill the KIO avoids.

The tax benefits the KIO enjoys have caused disquiet in the Inland Revenue, where some officials are questioning whether "sovereign immunity" was ever intended to apply to an organisation as financially powerful and obviously commercial as the KIO.

Their concern is shared by a number of Conservative MPs. Peter Temple-Morris, vice-chairman of the Conservative foreign and Commonwealth affairs committee, said last night: "While these particular rules are reciprocal and historic I think it is very wrong and weak to allow the Kuwaitis privileges not available to ordinary investors just for the sake of having their money here."

Another senior Tory backbencher said: "There is a desire to see it cleared up, with one rule for all."

Gordon Brown, the shadow chief secretary to the Treasury, plans to force a debate in the House of Commons in a bid to control the financial advantages offered by "sovereign immunity".

He has tabled two amendments to the Finance Bill, which is in the committee stage, proposing that companies which conduct business activities in Britain but which are not ultimately managed or controlled here should be charged corporation tax arising directly or indirectly from their activities. The amendments are due to be debated on Tuesday.

Last night Brown said: "We will use the amendments to probe how much has been lost to the British taxpayer over many years and what the government plans to do about it. I am very concerned. If your figure of Pounds 250m on tax credits alone is correct, that would pay for 150,000 health service operations or employ 20,000 nurses.

Britain is regarded as far more liberal in its approach to foreign investment from concerns such as the KIO than a number of other Western powers, particularly America.

A spokesman for the Internal Revenue Service in Washington said yesterday that any foreign government performing government functions operated on a tax-free basis. Commercial activities by governments, however, were not considered by the IRS to be government functions and were subject to tax.

On Friday Fouad Jaffar, the Leeds University-educated general manager and deputy chairman of the KIO in London, said: "The law is clear in this country. You have sovereign immunity for governments. The exemptions we have are no different from other countries' exemptions. It is not specific to Kuwait.

"We don't pay corporation tax on capital gains because we are not a corporation, we are a government.

"Pension funds are exempt from tax in this country and really we are no different from a pension fund. We are investing money for the benefit of future Kuwaitis. Our fund for future generations is our pension fund for the future.

"If the British government doesn't like the law it can change it. If they do change it then fine, we will abide by it, but we would have to evaluate the situation. We have to decide whether to stay in London.

"We run the KIO investments worldwide from this building. So naturally London is a great beneficiary of our activities. Before you look at what you are missing, you have to look at what you are gaining.