United Kingdom

ALEX BRUMMER: Time for Chancellor to tax debt interest

Cineworld shares are back in free fall following the decision by Warner Brothers to follow in the footsteps of Disney and take the streaming route. 

That cannot possibly be helpful to Europe's biggest operator of movie houses. The pandemic has been destructive for going out to the pictures and created a surge in demand for home viewing through Sky, Netflix, Amazon Prime et al. 

But the interruption to normal operations is not the main issue for Cineworld. Instead of issuing more shares to expand, it chose the much more risky debt-fuelled model. 

Way forward?: Chancellor Rishi Sunak could discourage excessive risk taking and raise funds for the Exchequer by at best removing the break on debt interest

This can work magnificently (with bumps along the way) as veteran builders of creative enterprises, Martin Sorrell and Rupert Murdoch, have demonstrated. 

However, Cineworld's debt burden of £6billion, when cinemas effectively have been locked down, required cash reserves for survival when the money through the turnstiles stopped. 

Among the big financial lessons to be learned from the pandemic and the cascade of retail failures seen this week is the danger which comes with taking big debts onto the balance sheet. In the case of takeovers, it doesn't matter where the money comes from for the selling directors and shareholders in the acquired firm. 

When the wheels of commerce stop turning, debt finance becomes an enormous problem for successor executives, the workforce and the whole ecosystem surrounding firms. The Debenhams and Arcadia fashion brands fell out of favour and there was insufficient investment to bring them back from the brink. It would have been much easier if successive managements had not layered on the borrowing on the basis that tills would continue to ring. 

Ownership structures make a difference, and it is no secret by now that among the Covid-19 casualties former private-equity owned enterprises including Debs, the AA and Saga had a torrid time under a debt-fuelled model. As much as one distrusts this structure it is not always bad. Pets at Home, which has been a big winner in the Covid era, came out of private equity. So has B&M. Both have felt confident enough about prospects to hand back business rate relief to the Chancellor, Rishi Sunak. 

The common theme which dragged down firms before and during the pandemic, from Carillion in 2019 to Trafford Park-owner Intu, is borrowings. The European shopping centre operator Unibail-Rodamco splashed out £28billion on upmarket Westfield long before lockdown, and is now sinking under a £20billion debt mountain. 

Most of us who have mortgaged ourselves to the hilt to buy a home know how debt works. As long as one stays in work and meets the mortgage repayments, surging house prices take care of the rest. Indeed, so good has this been for generations that Thatcher-era chancellor Nigel Lawson abolished tax relief on mortgage interest. 

The UK tax system favours companies, whether owned by private equity, rich entrepreneurs or publicly quoted, which take the borrowing route. 

Debt interest is an expense charged against tax which is why some companies report earnings net of interest, tax and other chargeable costs. 

Sunak could discourage excessive risk taking and raise funds for the Exchequer by at best removing the break on debt interest. What's holding him back?

Family affairs 

Primark and Topshop (Arcadia's main brand) have more in common than you might think. Both were founded in the mid1960s. Both can claim family ownership and both favoured physical stores over online. So why is Topshop in administration while consumers will queue around the block in freezing conditions to get into Primark? 

George Weston, who is chief executive of Associated British Foods-owner Primark, is unflashy to the core and runs his family-controlled enterprise for the long-term. When sugar was losing money hand over fist, the objective was to reshape the operation so it could better withstand the vicissitudes of the commodity market. When its supply chain was exposed in the Rana Plaza disaster in Bangladesh in 2013, it poured cash into the community and preserved its supply chain. 

As rich as Weston and his family may be, they invest for the future even through a loss of sales of £430m in the most recent lockdown. Most of the dividends paid out on the family's 54 per cent holding are channelled into charitable trusts. Quite a contrast to Philip Green's Arcadia. 

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