British water companies are avoiding millions of pounds in tax by loading themselves up with debt listed on an offshore stock exchange, an investigation has revealed.

The disclosure is likely to reignite the public outcry about legal tax avoidance by big firms at a time when Britain is drowning in debt and suffering painful public spending cuts. It comes only a week after industry regulator Ofwat announced that water bills would rise by an average of 3.5 per cent to £388 a year. Corporate Watch found six UK water companies took high-interest loans from their owners through the Channel Islands stock exchange. Interest payments on the loans reduce taxable profits in the UK and, thanks to a regulatory loophole, go to the owners tax free.

According to the report, Northumbrian, Yorkshire, Anglian, Thames, South Staffs and Sutton and East Surrey water companies all borrowed from subsidiaries of their owners based overseas. Those owners can receive the interest payments tax free by issuing the loans through the Channel Islands stock exchange as "quoted Eurobonds".

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When a UK company pays interest to a non-UK company, it usually has to withhold 20 per cent of the payments and give it to the UK tax authorities. But if the loans are issued as quoted Eurobonds on a "recognised" stock exchange – such as those on the Channel Islands or Cayman Islands –they benefit from an exemption, so no tax is taken off.

Corporate Watch found that some £3.4bn had been borrowed by the six companies using this method. It highlights Northumbrian Water as "the most brazen case", as it paid 11 per cent interest on just over £1bn of loans it has taken from its owner, the Cheung Kong group, a Hong Kong-based conglomerate run by Li Ka-shing, the world's ninth-richest person.

The Treasury considered closing the loophole last year, questioning the way companies were using it, but decided against it. The report also found that Britain's 19 water company bosses were paid almost £10m in combined salaries and other bonuses in 2012.

The huge levels of debt used by the industry overall to finance its operations are also costing UK consumers £2bn a year more than if it was publicly financed – equating to nearly £80 per household.

The figure comes from the difference the Government pays to borrow money and the rates that the water companies secure on the international money markets. In total, the report found, the companies have amassed debt of £49bn and paid more than £3bn in interest payments on it in 2012, as well as £884m in dividends. Total revenue in 2012 came in at £10bn.

This suggests that almost a third of the money spent by people on water bills in England and Wales went to paying either interest charges on water company debt or dividends to their owners, most of which are now based overseas. The water industry defended its financing and insisted consumers receive a "good deal".

Paul McMahon, director of economic regulation for trade body Water UK said: "The tax framework has been put in place by the Government and companies work within that regime. Clearly government debt is cheaper than private debt. But it's not free and the public sector is inheriting the risk that comes with that."

Anglian Water did not dispute the report's figures but said it contributed "£150m in other taxes" to the UK economy in the past year.

A Southern Water spokesman said it was "undertaking a major capital improvement programme from 2010 to 2015. A spokesman added: "At £1.8bn, it is the equivalent of spending nearly £1,000 for every property in the Southern Water region over the five-year period."

Northumbrian Water said it could not comment on the report until it had spoken to its shareholders. But it argued that the figure for its tax payment was "unrepresentative" and that Northumbrian Water Ltd, one of the group's operating subsidiaries, paid £30m in tax in the 12 months to 31 March 2012.

Thames Water accepted that interest rates had effectively wiped out operating profits, but said a tax credit received for 2012 came from "previous years" and that investment was at its "highest-ever" level.

Sutton and East Surrey Water told Corporate Watch it could not comment because it was "up for sale".

South Staffordshire Water confirmed it had Eurobonds in emails sent to Corporate Watch and also said it was investing heavily.

Ofwat said the rate of investment in infrastructure had doubled to £108bn since water privatisation and claimed that without regulation bills would be £120 a year higher than they are now.

The lowdown: Water suppliers

Northumbrian

Owner Cheung Kong Infrastructure Holdings (Hong Kong)

Operating Profit £154m

Tax Paid £0

Debt £4bn

Chief exec Heidi Mottram – salary, bonus and benefits: £595,000

Yorkshire

Owners Citi (US); GIC (Singapore) Infracapital Partners and HSBC (UK)

Operating Profit £335m

Tax Paid £0.1m

Debt £4.7bn

Chief exec Richard Flint – salary, bonus and benefits: £800,000

Anglian Water

Owners Canadian Pension Plan; Colonial First State Global Asset Management and Industry Funds Managment (Australia); 3i (UK)

Operating Profit £363m

Tax Paid £1m

Debt £6.9bn

Chief exec Peter Simpson – salary, bonus and benefits: £1,024,000

Thames

Owners Macquaire Group (Australia), China Investment Corporation, Abu Dhabi Investment Authority

Operating Profit £577m

Tax Paid -£70m (tax credit)

Debt £9bn

Chief exec Martin Baggs – salary, bonus and benefits: £845,000

South Staffs Water

Owners Alinda Capital Partners (US)

Operating Profit £16m

Tax Paid £0.2m

Debt £488m

Chief exec Elizabeth Swarbrick – salary, bonus and benefits: £202,000

Sutton and East Surrey Water

Owners Sumitomo Corporation (Japan)

Operating Profit £17m

Tax Paid £1m

Debt £219m

Chief exec Anthony Ferrar – salary, bonus and benefits: £290,000