Diageo's Tax Threat

Published in Company Comment on 12 February 2010

High taxes could drive UK PLC not to drink but rather the nearest airport.

Drink maker Diageo (LSE: DGE) revealed solid half-year results on Thursday, albeit it mildly disappointing the market. But what's really set tongues wagging is a comment from the company's CEO that Diageo could relocate overseas due to the UK's increasingly punitive tax regime.

Shares fell 3% yesterday on lower profits to 31 December, but they hardly warranted even a stiff drink. Diageo is already back up to 1,040p, with skittish investors reappraising the defensive qualities of this global giant in the face of a wobbly market.

Net sales after excise duties nudged up to £5.2 billion, but profit fell from £1.2 billion to just under £1.1 billion. Basic earnings per share fell sharply too, from 45.5p to 40.9p, although the adjusted EPS rose to 44.2p.

Yet free cash flow more than doubled to £904 million, which Diageo puts down to improved working capital management. Using comparatively modest borrowings of £8 billion compared to its £25 billion capitalisation, the company is throwing off cash, and the interim dividend was raised by 5% to a well-covered 14.6p per share. The forward yield is 3.8%.

CEO Paul Walsh shrugged off investors' fears, saying: "We are in the early stages of recovery with more encouraging signs in the emerging and developing markets" and claiming that Diageo remains on track to meet expectations over the full year.

A taxing matter

One reason for the profit drop is a £100 million higher tax bill, despite an exceptional tax credit of £101 million arising as a result of settlements agreed with tax authorities. Tax and its associated issues have long been a notable feature of Diageo's business, and when you consider how international this company is and the different ways alcohol is taxed internationally -- let alone companies and individuals -­ that's no surprise.

This tax issue is now coming to the fore, with Paul Walsh telling the BBC World Service this week that:

"We are a global company. We enjoy being headquartered in London, but if the tax regime here in the UK became so egregious, either for corporates or individuals, we would have no option but to look at other alternatives."

Walsh's comments follow similar words from Unilever's (LSE: ULVR) CEO Paul Polman, and actions from the likes of Shire (LSE: SHP) and United Business Media (LSE: UBM), which have already moved to Ireland. Other giants such as WPP (LSE: WPP) and ICAP (LSE: ICAP) look set to follow.

UK going the wrong way

What the Treasury and the Government doesn't seem to appreciate is that a company like Diageo has no reason to remain headquartered in the UK if the business regime doesn't suit.

Diageo's profits, for instance, are derived roughly equally from Europe, the US and the rest of the world, with the US the biggest market. Diageo's results detail the performance of its top-flight brands in every corner of the globe -- they could almost comprise a geography lesson, albeit a rather a gin-addled one -- and Diageo could legitimately claim many other regions as a legitimate base, for more reasons than tax.

I'm not saying the UK doesn't have plenty of attractive qualities -- a peerless legal and financial framework in London, droves of motivated graduates, good schools, executive class recreations, and a working sense of irony -- but so do plenty of other countries. Some, such as Switzerland, don't have our disadvantages, either, like a clogged infrastructure or the perception of rising crime, as well as boasting more favourable tax treatment. A few even throw sunny beaches into the equation.

The point is it's a balancing act, and we seem to be in danger of toppling the wrong way.

50% fudge

It's not only multinational behemoths that are responding to the higher tax rates in the UK.

Bristol-based Hargreaves Lansdown (LSE: HL) declared on Wednesday that it's to triple its interim dividend to get money out of the company ahead of the new 50% tax rate, which comes into force in April. The first company I own that went down this route was Goodwin (LSE: GDWN), which declared a special dividend for this year for the same reason.

Both Hargreaves Lansdown and Goodwin are heavily owned by their directors, and cynics could rightly scoff that they're feathering their own nests; Peter Hargreaves and Stephen Lansdown will save themselves an estimated £2.5 million by bringing their tax bill forward. Yet I don't think the family founders of Goodwin -- long a conservatively run Northern engineering specialist -- are the kind to engage in financial chicanery for a quick buck.

What we're seeing here is the distorting impact of higher rate taxes, which are changing the ways companies allocate capital -- just as the textbooks say they will.

More from Owain Bennallack:

Owain holds shares in Diageo and Goodwin.

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Comments

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BarrenFluffit 12 Feb 2010 , 3:21pm

Are the people who run these businesses really that mobile. With families and schools to consider moving is a significant expense.

theRealGrinch 12 Feb 2010 , 5:54pm

About a year ago, I contacted Goodwin for their annual report and they duly sent me one which was similar to a print off for an essay. It was kind of touching. I wish them well.

jaizan 12 Feb 2010 , 11:19pm

Moving families is easily done if they avoid 50% tax and then when they spend that money, another 17.5% VAT on top.

Labour have created a disincentive for wealth creation that will drive successful people out of the country.

ayshf 14 Feb 2010 , 9:34am

It's almost trivial to move your "headquarters" really. Just buy a office somewhere nice, employ some admin staff direct all correspondence pertaining to the company tax/leagal requirements there and register it as you HQ.

Job done, company former headquarters operates as before. Overtime if Government doesn't get the message move departments there. I would despair if I thought Labour actually believed that taxing the rich and our companies was anything other than counter productive. Bluntly tax 'em hard watch 'em duck. They don't, it's just the worse short of electioneering. As always the "the rich" they actually mean are anyone with a job, a house and a car. Not very mobile, limited opportunities to duck but as always been the case an easy mark, only downside is that they also vote, so can't do it before an election. Labour strategy is to creates a vast pool of wasters on benefits who vote them in so the rest of us ordinaries who work can subsidise them. VAT will be going up mark my words. Tories are no better, possibly not worth voting unfortunately.

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