OK. Vodafone. What happened is this:
In 2000 Vodafone bought the German Mannesmann group. I forget the sums involved but they were huge. Can we use £50bn for the purposes of this thread without anyone wrongly assuming it to be the correct sum?
Vodafone borrowed the money in the UK. It had to because the banks required it to secure the borrowing over its profitable worldwide businesses. Vodafone then incorporated a Luxembourg subsidiary. The Lux sub had £50bn of equity but no debt. The Lux sub incorporated a German sub, and lent the German sub £50bn. The German sub bought Mannesmann.
So what were the implications? The German sub had interest expense that it had to pay to its Lux parent, that it could relieve against the German profits of Mannesmann. I don't have any issue with that because it's a good example of source taxation - a German expense incurred to buy profitable German businesses.
The Lux sub had interest income paid to it from the German sub, and no expenses. But Luxembourg is the tax haven of Europe. Its tax authorities agreed a ridiculously low tax rate on the interest as an incentive to Vodafone to include Lux in the deal at all (not that it's specific to Vodafone - the Lux authorities offer the same deal to anyone who asks. They rationalise that they'd rather collect 8% on something than 37% on nothing). Now frankly, that's Luxembourg's business, not the UK's.
In the UK, there was interest expense on the borrowing from the bank and no immediate income. Because one of the fundamental differences of holding shares (in the case in Lux sub) rather than lending debt is that the return on shares in the form of dividends is discretionary whereas debt interest has to be paid.
The Revenue wasn't happy about Lux. There are specific anti-avoidance provisions that say that if a UK company has a foreign sub, and that sub pays a materially lower amount of tax than an equivalent UK company would then the profits of the foreign sub are taxed on the UK company as if it had earned the profits itself. So the Revenue said to Vodafone that it should pay UK tax on the Lux interest income.
What the Revenue hadn't reckoned on was that way back when the UK joined the European Union it signed the Treaty of Rome. And among all the other stuff that's in there are clauses that say that all companies within the EU are entitled to establish their businesses anywhere within the EU without being discriminated against due to where they're based). Vodafone argued that it was being discriminated against because it was entitled to have subs anywhere the hell it liked in Europe without the UK tax system penalising it for the European locations it chose. And Vodafone won.
(BTW, when I say Vodafone won the argument, I meant with the Revenue - it did go through some of the lower courts, which found in favour of Vodafone, but didn't make it to the Supreme Court. In my view if it had done then Vodafone would have won. The Revenue did bloody well to get £1.1bn out of them - I think Vodafone probably bottled it a bit!)
That's not a loophole, which might be defined as creating an unexpected outcome from the legislation- it's an unambiguous and inevitable outcome of the UK signing the TreatyIVodafone'st not Vodafone's fault that the UK government wasn't smart enough to realise all the implications of what it had signed up for.
The aspect of this that Vodafone really took advantage of was the fact that there's a fundamental difference in the UK tax treatment of debt and equity invested in a (in this case Lux) subsidiary. If the UK was stupid enough to try to treat equity like debt and compute an interest like return to the parent then at a stroke it would make itself the harshest parent company regime in the world. No-one does it. And that's because economically debt and equity are fundamentally different.
The other thing to bear in mind is to speculate over what Vodafone might have done if it didn't use the Lux structure to buy Mannesmann. The simplest thing would have been to borrow in the UK and have the UK buy Mannesmann direct. The problem then would have been that the interest expense wouldn't have been matched against the German income, so the source taxation principle wouldn't have been met. Plus the UK would still suffer exactly the same stinking great interest expenses, so there was no tax lost to the Exchequer.
Finally, at the time of the deal, Vodafone would have expected to pay UK tax when it started to receive dividend income from Mannesmann. Dividends are now exempt from tax, a deliberate policy decision by the previous government to make the UK an attractive location for US businesses to use to invest into Europe.