Deal was designed to let Terra Firma extract £890m from Four Seasons Health Care, said to be in dire financial straits

This article is more than 2 years old

This article is more than 2 years old

Britain’s second biggest care home operator was made to borrow money through a very expensive loan from its private equity owner in a deal designed to extract £890m in cash from the struggling business.

The disclosures are likely to raise fresh concerns over the future of Four Seasons Health Care, which operates more than 300 care homes across the UK, and has been drowning in debt.

Described in reports as teetering on the brink of ruin, Four Seasons has been hammered by cuts to council care budgets brought on by years of austerity. This month, its private equity owner, Terra Firma, will plead with lenders to approve a financial rescue package.

However, filings in the tax haven of Luxembourg and data from the Paradise Papers reveal how Terra Firma hoped to make a vast profit from the business after acquiring it in 2012.

Four Seasons was made to borrow £220m from Terra Firma subsidiaries. The repayment terms were huge – 15% interest a year, on a compound basis, over 10 years. By 2022, when it was due to be repaid, Four Seasons would have owed its controlling shareholder four times the original sum.

The debt was later written off because of the financial struggles at Four Seasons. However, the bond stated a nominal repayment value of £890m. The intention seems to have been to extract profits from any future sale of the business largely tax-free – a manoeuvre that will raise concerns about whether buyout groups are suitable owners for businesses that form a key part of Britain’s care infrastructure.

Facebook Twitter Pinterest A Four Seasons care home in Bracknell. Photograph: Photofusion/Rex/Shutterstock

Four Seasons provides 17,000 beds to elderly and ill people and most of its revenues come from the public sector.

The man behind Terra Firma is Guy Hands. Despite making millions for his co-investors on a string of successful deals, Hands is best known for the disastrous takeover of the record label EMI, which collapsed under its debts after the credit crunch.

The financial engineering revealed by the leak of 6.8m documents from the files of the offshore law firm Appleby suggests Hands hoped to extract profits from his care homes while legally avoiding taxes that might otherwise have been due.

The scheme was designed with the help of the big four accountancy firm Deloitte. Its advice took the form of a 34-step plan – a list of actions such as setting up subsidiaries to create a complex layered structure, often across several countries, and then transferring cash, shareholdings, borrowings and other assets such as property or intellectual rights between them.

The structure involved tiers of companies in Guernsey, Jersey and the UK, some of which were inherited from the previous owner. Deloitte’s innovation seems to have been the creation of two new Luxembourg companies, Carmel Capital IX and its subsidiary, Carmel Capital VIII. They were used to inject two separate loans. There was £175m raised from banks, and the £220m shareholder loan – Terra Firma’s own cash.

Elli Group (UK) Ltd, a British holding company for Four Seasons, signed up for a “deep discounted bond” to borrow the money from Terra Firma via its Luxembourg subsidiary Carmel IX.

Deloitte’s step plan outlined the tax advantage: normally, Britain levies 20% tax on interest payments to lenders from outside the UK. Terra Firma is based in Guernsey.

“The UK applies a 20% domestic withholding tax on interest,” Deloitte’s plan noted. “However, the return on the deep discounted bonds does not take the form of interest, and therefore, no withholding tax should apply on the deep discounted bonds between Carmel Capital IX and Elli Group (UK) Ltd.”

Private equity firms typically aim to make a return of four times their investment. The sum repayable to Terra Firma would have provided that level of return, tax-free. The repayment could have been triggered by a change of ownership, for example a sale or stock exchange listing of Four Seasons.

After the takeover, Four Seasons struggled. Most of its income is from the public sector, and local authority care spending has been falling, while increases to the minimum wage have pushed up its payroll costs.

In its British accounts, the group eventually conceded: “The current funding structure of the group may not be appropriate for the long-term needs of the business and in October 2015 advisers were appointed to conduct a review of the group’s funding arrangements.”

In 2014, Terra Firma slashed the value of its investment. The value of the £220m deep discounted bond was reduced to £72m. This represented the new principal amount – the money owed by the UK company to Carmel IX. In 2015, the value of the loan was further cut, to £20m. It remains at that level for now.

However, the loan remains on the books. Should the fortunes of Four Seasons improve, Hands could in theory recoup the cash with profit.

Terra Firma said: “No tax advantage or additional shareholder protection has been afforded as a result of FSHC [Four Seasons Health Care] Group’s structure or Terra Firma’s use of debt instruments in capitalising the business.

“When Terra Firma acquired FSHC Group we inherited a structure with a number of offshore companies. The existence of that structure in fact creates additional tax obligations.

“FSHC Group is not profitable and therefore has not been liable to pay any UK corporation tax under UK law. However, owing to the structure we did pay UK tax in 2016.”

A Deloitte spokesperson said: “We are unable to comment on specific client matters on grounds of confidentiality.”