Targeted review of corporation tax


We have today (12 July 2016) published a ‘Targeted review of corporation tax’ for the water sector undertaken on our behalf by Alvarez & Marsal.

We asked Alvarez & Marsal to review the reasons for differences between actual corporation tax paid by the companies over 2010-15 and the level of tax allowed for during the 2010-15 price review (PR09). Our objectives for the targeted review were to:

  • improve understanding of water companies’ individual tax positions and the actual impact of recent changes;
  • consider and evaluate alternatives available to funding tax in the 2020-25 price review (PR19); and to,
  • consider further options to improve transparency in reporting of the corporation tax charge for the regulated business.

This followed reports from the National Audit Office (“NAO”) ‘The Economic Regulation of the Water Sector’, and The Committee of Public Accounts (PAC) ‘Economic Regulation of the water sector’ that highlighted these differences, and recommended that we review our approach to setting allowances for the cost of debt and corporation tax at future price reviews.

Findings of the targeted review

The main reasons for differences between actual and allowed corporation tax during 2010-15 as identified by Alvarez and Marsal were:

  • the reduction in corporation tax rates from 28% to 21%;
  • sector specific agreements made with HMRC after PR09 regarding deductions available following the removal of the Industrial Buildings Allowance in 2013 and the Infrastructure charge receipts agreement with HMRC in 2011; and
  • group tax relief acquired from associated companies but not paid for in full.

Policy considerations

Changes in corporation tax rates and other tax law changes

At previous price reviews, the risk of any general changes to the tax regime, including tax rates, sat clearly with companies and they keep any savings or absorb any losses. The Alvarez and Marsal report highlighted that there was no true-up mechanism in place in respect of corporation tax at PR09 and PR14, other than described below, and explored some of the objectives and issues that we might face in considering this type of mechanism.

We did adopt at PR09 and preserved at PR14 a clawback policy which ensures that, at a future price review, the corporation tax benefits arising from any capital restructuring are passed back to customers. For PR19 we may consider the possible use of a true-up mechanism to also correct for both the impact of any future changes in the rate of corporation tax, and future one-off tax changes affecting the sector, whilst seeking to retain incentives for companies to minimise tax bills by negotiating with HMRC to reach an agreement etc. The impact of any increased or reduced deductions at future price controls would pass through to customers.

Interaction of capital allowances and group relief

The report highlights inconsistencies in how companies apply and report on capital allowance disclaimers and group relief claims. This may be due to companies interpreting their obligations on this differently – in particular what it means to be a ‘standalone’ company.

In light of the wide range of approaches to the use and reporting of group relief transactions, we will review the disclosures made in the annual performance report for 2015-16 in respect of group relief transactions. We will then seek to ensure that our methodology and business plan requirements for the PR19 price review are clear in order to ensure companies adopt a consistent approach to tax including group relief. If appropriate, we would consider possible further changes to our regulatory accounting guidelines, for example, to achieve this. We will also consider the function of group relief in incentivising and delivering value.

Base Erosion and Profit Shifting

The UK Government has confirmed that it intends to implement the recommendations of the OECD’s Base Erosion and Profit Shifting (BEPS) project which will, inter alia, lead to restrictions on interest deductibility for UK companies for which the annual interest expense exceeds certain thresholds. This could lead to higher tax charges for some water companies from 2017. Any additional tax due during the current price control period will be absorbed by the company. We will continue to engage with companies and HMRC to ensure we understand the potential impact and are able to take this into account appropriately when setting tax allowances at PR19.

Independent review

At PR09 and other earlier reviews we commissioned independent consultants to review and challenge the company business plan projections. Under our Water 2020 programme for PR19 we will consider commissioning expert tax review of company business plans.


As the lack of transparency around the regulated company corporation tax charge made comparisons with the PR09 Final Determination difficult we, following the PR14 Final Determination, have already introduced changes requiring companies to make additional disclosures on corporation tax within their Annual Performance Report for 2015-16 onwards.

The Alvarez and Marsal report has reviewed our changes and makes further recommendations.

We are already consulting on these further recommendations in our revised Regulatory Accounting Guidelines for the 2016-17 reporting year. We will review the tax disclosure notes due to be published as part of the 2015-16 reporting, looking to identify best practice and any further improvements to our guidance.

As the corporation tax regime continues to evolve we will continue to monitor wider developments relating to corporation tax and tax disclosure, including HMRC’s consultations concerning its Business Tax Road Map including BEPS and requirements for qualifying companies to publish their tax strategies and also the Financial Reporting Council review of companies’ tax reporting to encourage more transparent recording of the relationship between tax charges and accounting profit.