Finance Bill

Public Bill Committee, 11 May 2004.

Standing Committee A

(except clauses 4, 5, 20, 28, 57 to 77, 86, 111 and - Schedule 2 - Disclosure of value added tax avoidance schemes

Howard Flight (Conservative, Arundel and South Downs)

I beg to move amendment No. 7, in

schedule 2, page 257, line 22, at end insert

'and the Treasury shall with any such designation provide details of the circumstances in which they believe such a tax advantage may be obtained.'.

John McWilliam (Labour, Blaydon)

With this it will be convenient to discuss amendment No. 8, in

schedule 2, page 257, line 37, leave out from 'the' to end of line 38 and insert

'main benefit of the scheme is the obtaining of a tax advantage by any person in the circumstances specified in the designation of the provision by the Treasury in accordance with paragraph 4(1).'.

Howard Flight (Conservative, Arundel and South Downs)

I welcome you to the Chair, Mr. McWilliam. In addressing the two amendments, I hope that the Economic Secretary will deal with some of the problematic issues that we did not cover entirely during the debate on clause 19, which was the introduction to the contents of schedule 2, and in particular with some of the practical problems raised by the Institute of Chartered Accountants.

John McWilliam (Labour, Blaydon)

Order. Just in case I have misunderstood the hon. Gentleman, my colleague suggested at the closing of the previous sitting that he was not minded to allow a debate on schedule stand part, so it would seem to me that rather more than an introduction to the schedule took place.

Howard Flight (Conservative, Arundel and South Downs)

I thank you for your comments, Mr. McWilliam. There was discussion as to whether there should have been a broad debate on clause 19—the introductory clause—or schedule 2. There was a stand part debate on clause 19 covering the whole territory. I was merely making the point that the Economic Secretary has not yet responded to some of the issues raised in that debate that are relevant to the two amendments.

The amendments are designed to bring better proportionality to the proposed measures in the schedule. As pointed out, the provisions are likely to result in excessive and unnecessary compliance burdens and costs for business. Equally, as has occurred in the USA, they are likely to lead to Customs and Excise being snowed under with reports, especially where the requirements are too loosely drawn for businesses with a turnover of more than £10 million. How many extra Customs and Excise staff are the Government proposing to take on to deal with the processing of reports?

As with many other measures that have been introduced, such as the lowering of tax rates on small businesses that are incorporated, the Government fail to heed our warning on this matter at their own risk. Hon. Members will appreciate that schedule 2 provides two different, wide-ranging sets of powers for Customs and Excise to be defined and determined in regulations. However, even if the regulations confine reporting objectives to specific schemes, they are unlikely to reduce the potential burdens on Customs or business.

Amendment No. 7 would require the Treasury to include in any scheme designation details of the way in which the designated provision may be used to avoid VAT. The objective is to assist business in complying with VAT scheme reporting obligations in respect of such arrangements, and, with regard to paragraph 5, to make it impossible for Customs and Excise to overdesignate or designate provisions without supporting explanations of the nature of the abusive scheme that it seeks to deal with.

Amendment No. 8 has two purposes. First, it would substitute a main benefit approach for the existing main purpose approach test in paragraph 5. The Inland Revenue clauses later in the Bill apply a benefit test rather than a purpose one. We suggest that taking the benefit rather than the purpose route would make the objective of providing more objectivity in defining the application of the clause more achievable. It should be easier to define the benefits that flow from an arrangement than to determine their purpose, which will inevitably be subjective and will reflect what the individuals in any business that has put such arrangements in place think that the purpose might be. In our view, the VAT clauses should follow the same approach as the later Revenue clauses.

Secondly, the amendment would tie the reporting requirement to the sort of arrangements that the Treasury had in mind in designating the provisions. The combined objectives and intended effects of our two amendments would be to reduce the number of cases to which the provisions could apply, without reducing their effectiveness, and to lessen the potential for snowing under of the Customs and Excise officials involved in operating the measures in schedule 2.

John Burnett (Liberal Democrat, Torridge and West Devon)

I welcome you to the Chair, Mr. McWilliam. I have served under your wise chairmanship on many occasions in the past.

I will make a general point, because this is my first time in this Committee Upstairs, although I have spoken in debates on the Floor of the House. That point is that the Finance Bill is scattered with anti-avoidance provisions. Hon. Members of all parties will welcome such provisions, but we should not forget a principle in British tax law that has been enshrined for at least a century. There was a leading case at the end of the 19th century or the beginning of the 20th, the effect of which is that individuals, companies and trustees can so organise their affairs as to mitigate the tax that is due and payable—whether it be value added tax, income tax, capital gains tax, inheritance tax or whatever.

Another problem is that there have been many aggressively marketed, artificial schemes. Ten or 15 years ago, leading cases taken up by the Inland Revenue, such as the Ramsay and the Furniss and Dawson cases, narrowed the ability of taxpayers to use artificial schemes to avoid taxation. It is a very difficult line to tread, but I hope that the Government agree with the general principle that all persons—in tax, persons means individuals, trustees and corporations—can organise their affairs in such a way as to mitigate the tax that they have to pay.

I support amendment No. 7, because in dealings with the taxman—Customs and Excise or the Inland Revenue—there must be some balance. We cannot be taxed by fiat of the Customs and Excise—what it believes to be the law. We can be taxed only by what actually is the law. I believe that amendment No. 7 goes a small way towards redressing that balance in favour of the taxpayer.

I am grateful to the Law Society for providing a few examples of fairly simple and straightforward steps that are ordinarily taken by VAT payers. For instance, a company can obtain a tax advantage by joining a group of companies for VAT purposes, which in itself may be subject to anti-avoidance provisions. We have to know what Ministers and the Inland Revenue, Treasury and Customs are driving at when they make such provisions in anti-avoidance laws.

I also support amendment No. 8, which is a logical amendment to ensure that the test is benefit rather than purpose. I look forward to hearing from the Economic Secretary on those general and specific points.

John McWilliam (Labour, Blaydon)

Before I call the Economic Secretary, may I remind hon. Members of my colleague's ruling in the last sitting? If anyone wants to make any points on schedule 2, they had better use the vehicle of these two amendments to do it.

John Healey (Labour, Wentworth)

The amendments relate to the hallmarks scheme, which is the second element of the new disclosure rules. It requires large businesses to disclose use of schemes that have certain provisions, or hallmarks, that are characteristic of avoidance. The objective behind the designation of certain hallmarks that are or are likely to be associated with avoidance schemes is to provide Customs officials with information about new VAT schemes that they do not already know about, which may be avoidance schemes. Early action can then be taken to examine the scheme, and if necessary act against it, either by litigation or by making changes to legislation.

The hon. Member for Torridge and West Devon (Mr. Burnett) vividly described the challenge that the Revenue faces in this modern age, given modern tax planning and advice. He referred to aggressively marketed and highly artificial schemes. He was not present at the last sitting when we debated at length the points that he raised. With your indulgence, Mr. McWilliam, I shall briefly repeat that the general principle that companies have a right to organise their

affairs in such a way as to mitigate tax is correct, but when such activity becomes abusive—in other words, when their action is contrary to the purpose or spirit of the legislation—we move into a different realm. It is right that Customs and the Inland Revenue act to protect the taxpayer and those businesses that pay the full amount of tax that is due; indeed, they have a duty to do so.

Howard Flight (Conservative, Arundel and South Downs)

What the Economic Secretary just said is extremely important, in that he set the juxtaposition in which it is accepted that a citizen has the right not to pay more tax than he is legally obliged to pay, although he used the somewhat questionable word ''abusive'' in his definition. A major objection to the hallmarks scheme is that the requirements are worded such that anything other than paying the maximum VAT constitutes a scheme to be reported. I cannot think that that is the Government's intention, as Customs and Excise will be snowed under. That was one of the main criticisms made by the Institute of Chartered Accountants about the drafting.

John Healey (Labour, Wentworth)

I am aware of that, but it is a serious misrepresentation of the way in which the measure will be brought into effect. Far from being a scheme that will catch anything that is not the fullest possible payment of tax, the hon. Gentleman will be aware—he has had a chance to study the draft statutory instrument—that, as with the listed schemes that we discussed last week, the hallmarks will be designated specifically by Treasury order, subject to affirmative resolution, and therefore debate in the House. Drafts of the order will be exposed for comments one month before it is laid, so it will be subject to consultation and parliamentary scrutiny. The first hallmark will be designated at the same time as the first listed schemes under the same order.

It is highly unlikely that Customs will be ''snowed under'' by notifications under these provisions. There will be a central unit, as I explained during our proceedings last week, but we anticipate being able to cope well within existing resources to deal with this. The central unit will be staffed by existing staff in Customs who will be redeployed to work in the unit.

With the hallmarks scheme, we have designed arrangements to minimise the burdens on business. Any burden need fall only on those who think up such schemes, and we have provided a facility for promoters to remove the disclosure requirement on their customers by making prior disclosure themselves. Promoters who make use of that facility can relieve businesses and clients of any burden. If a business with a turnover of more than £10 million chooses to use a scheme not disclosed by the promoter, it will have to consider whether it needs to be disclosed.

Howard Flight (Conservative, Arundel and South Downs)

What the Minister has just said seems to be the nub of the matter, in that we all understand that the intent is that advisers will disclose to the Revenue schemes that will be become hallmark schemes, but he is also saying that if businesses use hallmark schemes, they will have a number, so they should disclose it. Anything that is not hallmarked will be left with the law, which goes back to what is disclosed, what is

reasonable tax planning and what is potentially a scheme. If you look at the schedule, you find that virtually everything is to be regarded as a scheme unless it maximises tax. How practical are hallmarks for businesses with a turnover of more than £10 million, and what aspects of their normal tax planning must they disclose? That is still not clear.

John McWilliam (Labour, Blaydon)

Order. Mr. Speaker has asked us to be vigilant about ensuring that all hon. Members stick to the rules. The hon. Gentleman would have been correct in referring to me as ''you'' 30 years ago when I was a tax commissioner, but that is no longer the case.

John Healey (Labour, Wentworth)

The situation is contrary to the hon. Gentleman's interpretation, and I shall detail the conditions that must be met for a hallmark to be listed. That is likely to be specifically drawn according to particular conditions and is contrary to his wide suggestion that anything that is not the fullest possible payment of tax will become a disclosable activity.

To finish the point about the burdens on business, the high de minimis will keep the additional burdens to a minimum, and businesses that are required to disclose have only to send an outline of their scheme and disclose the hallmarks involved to Customs.

Amendment No. 7 would require the Government to specify the tax advantage that would be obtained through use of a scheme bearing a particular hallmark at a time when they are adding new hallmarks to the law. In other words, it would require the Government to give details of the tax avoidance scheme in which the hallmark features. However, at the time of listing those hallmarks, the Government will not necessarily know the details of the arrangements by which the taxpayer seeks to obtain tax advantage. The very purpose of the hallmarks scheme and the measure is to discover those details, and that purpose would be removed and neutered by the amendment.

John Burnett (Liberal Democrat, Torridge and West Devon)

Is the Minister saying that the disclosure provisions are so weak and insipid that an educated person in Customs and Excise would be unable to quantify the tax advantage?

John Healey (Labour, Wentworth)

No. I am going to explain that the purpose of the arrangements is one of the conditions for notification under the scheme. If the hon. Gentleman bears with me, I shall come to that point later.

Amendment No. 8 would change the definition of a ''notifiable scheme'' so that a hallmark scheme is notifiable only when its main purpose is obtaining the tax advantage under the scheme that would be specified under the first amendment. As I have said, the Government will not necessarily know at that stage what the avoidance scheme is or exactly how it obtains a tax advantage.

A scheme is notifiable under the hallmarks provision only if all three of the following conditions are met. First, the main purpose of the scheme, or one of its main purposes, must be the obtaining of a tax advantage for any purpose. Secondly, a person must obtain a tax advantage that includes or is associated with a hallmark provision. Thirdly, the designated hallmarks associated with the scheme must comprise,

for instance: confidentiality conditions limiting disclosure of a scheme; sharing the tax advantage with another party to the scheme or with the promoter; and fees payable to a promoter contingent on tax savings. Designated hallmarks included in a scheme must comprise: pre-payments between connected parties; funding by share subscriptions or loans between connected persons; construction work associated with property transactions between connected persons and certain offshore suppliers. It is highly unlikely that ordinary commercial transactions will come within all three requirements.

However, some arrangements may have to be reported under the hallmarks provision if the main purpose is to gain a tax advantage but there is, on examination, no tax avoidance. The process allows for that possibility, although we expect that such instances will be few, and that the vast majority of schemes reported are likely to be avoidance. In such instances, a decision will have to be made on whether the scheme is avoidance. That may involve further inquiries or the provision of further information by the business.

John Burnett (Liberal Democrat, Torridge and West Devon)

Presumably—and I would like the Minister to confirm this—the decision as to whether a scheme falls within the rules is initially made by an official at Customs and Excise. What level of seniority and experience will that person have? Will the decision be appealable, and if so, to whom, or to which court or tribunal?

John Healey (Labour, Wentworth)

At the risk of going over ground that we have already covered in a previous sitting, I shall explain to the hon. Gentleman that the notification scheme in clause 19 and schedule 2 simply draws to Customs' attention schemes that it would otherwise have to uncover in the normal course of assurance visits. The scheme triggers business as usual for the Customs officer. There will be the same inquiries, examinations, rights of appeal and decisions as there are at present. No change is made to that by the provisions in clause 19 and schedule 2.

The system proposed in the clause and schedule, which amendments Nos. 7 and 8 would severely curtail, is no different than if an avoidance scheme had come to Customs' attention via a VAT visit or through normal correspondence. The hallmarks disclosure provision simply brings to the attention of Customs matters that would otherwise remain hidden or be identified only much later. In all other respects, it is business as usual.

Far from helping the scheme work—or, as the hon. Member for Arundel and South Downs (Mr. Flight) argues, bringing proportionality to the proposal—the amendments would seriously undermine the operation of the measure as the Government intend. It would undermine this element of the Government's anti-avoidance strategy, which plays a vital part in securing revenues and creating a more level playing field for those businesses that fulfil their tax obligations. For that reason, I ask the Committee to reject the amendments.

Howard Flight (Conservative, Arundel and South Downs)

There would not be much point in having a vote on the two amendments, but I will make one or two comments.

First, in preparing the amendments, I consulted a leading anti-avoidance individual who had been working for the Treasury in that capacity for a long time, and was concerned about the issues that I have raised. The Minister's explanation is not entirely convincing, and there is not anywhere near an understanding out there about how the arrangements will operate. The schedule 2 provisions will operate broadly as I have described with regard to larger businesses. There is the danger of being snowed under, with people protecting themselves from being attacked while not reporting something that they should—that will be the gut reaction of every business. The Government and Customs and Excise are unwise if they do not realise that that is how people will naturally and rightly behave.

Benefit, rather than purpose, is the correct way to measure this. The Minister has said on many occasions that for any scheme its purpose is self-evidently to reduce the tax burden. However, greater specificity is needed about what is being provided for the Revenue under subsequent clauses.

I am left entirely unclear about the duty of a large business in respect of reporting hallmark schemes. If I am left unclear, I am arrogant enough to believe that businesses, too, will not be clear about the arrangements. I beg to ask leave to withdraw the amendment, but I hope that the Minister will think further about the arrangements. No doubt he will discuss them further with outside professionals, but as the schedule stands, the concerns that we have raised are valid.

Amendment, by leave, withdrawn.

John McWilliam (Labour, Blaydon)

May I point out that under Standing Orders, the moment a Member asks permission to withdraw an amendment, I should put that to the Committee? I allowed a little leeway just then.

Schedule 2 agreed to.

Clause 21 - Reverse charge on gas and electricity

Mark Prisk (Conservative, Hertford and Stortford)

The clause follows on from EU directive 2003/92, which will be implemented in January 2005. The purpose of that is to change the place of supply for the respective utilities and, therefore, the point of taxation. I have met representatives of the various utility organisations, including the gas and electricity industries, and their view is that the clause is a welcome step. As the Committee will realise, it mitigates an evident anomaly and is a direct response to the previous liberalisation of the markets for utilities. Accordingly, we have no particular problems with it and we welcome what is probably an overdue step.

Question put and agreed to.

Clause 21 ordered to stand part of the Bill.

Clause 22 - Use of stock in trade cars for consideration

Mark Prisk (Conservative, Hertford and Stortford)

We skate gently from gas and electricity to motor vehicles.

As I understand it, clause 22 changes the basis for valuing the taxable benefit of the private use of motor dealers' demonstrator cars and other cars that are in the ownership of a particular enterprise. I have three areas of concern and they reflect discussions with those who are affected. I have talked with representatives of the Society of Motor Manufacturers and Traders and I have listened to their concerns. It has become clear that the alleged avoidance method—the nominal valuation—is not something that they reported as being used by the society's member companies. Clearly, somebody must be using it, or the Government would not be alleging that there is avoidance.

I also understand that an estimated £5 million of additional revenue is anticipated from the closing of the alleged loophole. What studies have been made of who is engaging in the avoidance and what proportion of the market it represents? If the leading trade bodies are unaware of that particular approach, one wonders what is the evidence for the basis of the clause.

The experts in the field have asked whether the nominal value would have the effect of avoiding a significant VAT charge, as it is alleged. On subsection (2), the Chartered Institute of Taxation, which is a leader in this field, said:

''We are not altogether convinced that a nominal value (the sum of £1 for two years' use is cited . . . ) would in normal circumstances have the desired consequence of avoiding a significant VAT charge.''

It then went on to cite the case of the European Commission and France. It is not often that one hears those two litigants involved in the same thing, but it is a mild pleasure. I would like the Minister to respond to that particular case, because it was applied in UK law terms in the case of Customs and Excise commissioners and the Yarburgh Children's Trust.

The essence of the matter is whether the nominal value approach will secure the significant reduction in the VAT that is argued. I am sure that the Minister will be able to respond to that, but I am not sure whether he will be willing to. I hope that he will. I confess that it is not a case with which I am intimately familiar, but it is important. If the leading experts in the tax field question whether the effect of the clause is as stated, it is important that we understand what the Government's response is.

Lastly, there is the question of the definition of open market value. The proposal is to base it on price charge by comparing it to private rental businesses. Even someone who is not an expert in that particular field, such as myself, will understand that it is difficult to make a direct comparison between the typical contractual arrangements in the open market of car

rental businesses and an employee who is making the occasional use of a demonstrator vehicle of their employers' ownership. If you were an employee who used a demonstrator car there would be restrictions that are not applicable in the former case. The car would be required to be available on the forecourt first thing every morning, and perhaps throughout the day. More importantly, there would be a constraint on the mileage useable by that individual; that is not a condition that most car rental businesses impose. There would also be a difference between the vehicle condition required by the employee of the car dealership and that required by the person renting a vehicle.

All those aspects affect value. They are different from the conditions of a private rental business and they change the open market value. The essence of my point is the concept of free use. Will the Minister explain the basis of open market value that the Government are applying here? Do the Government accept that making this direct comparison in value terms might not be appropriate? There are other forms; I draw the Committee's attention to that of the full cost of providing service, where the concept of free use is appropriate.

John McWilliam (Labour, Blaydon)

Order. The word ''you'' should not be used; I have never sold a car except at an extreme loss to myself.

John Healey (Labour, Wentworth)

I will deal with the questions of the hon. Member for Hertford and Stortford (Mr. Prisk) on the nature of the avoidance and who is involved during the course of my explanation of clause 22. I will also do my best to explain the relevance and the operation of nominal value and the case for moving to a market valuation.

The hon. Gentleman asked about losses. They are currently estimated at £5 million a year. That is not a theoretical loss: the estimate is based on abuses that are currently taking place and are known to Customs officials. If this scheme were to be expanded to its full capacity, it is estimated that the annual loss would be between £20 million and £25 million.

Mark Prisk (Conservative, Hertford and Stortford)

Will the Minister answer my specific question by giving the Committee some idea of the proportion of the market that is engaging in such avoidance?

John Healey (Labour, Wentworth)

As I have said, I will do my best to answer that in the course of my remarks.

Clause 22 counters a serious VAT avoidance scheme as part of our wider determination to clamp down on artificial and abusive tax avoidance activity. The changes that we are making will tackle underpayments of VAT on the private use of demonstrator cars—cars that are used in the motor trade for demonstration purposes but that are also made available to sales staff for their private purposes on weekends and evenings and at other times when they are not being shown to customers. Using a tax avoidance scheme promoted by many tax advisers, some motor dealers and manufacturers are paying a only tiny fraction of the VAT that they ought to pay when they make demonstrator cars available to employees.

Where a demonstrator car is not used wholly for business, dealers and manufacturers are required to account for tax on the provision of the car to the employee for private use. That is based on the full cost of providing the car. Using rates agreed with the major motor trade bodies, the VAT due is normally about £120 to £140 per employee per year. However, by charging the employee a nominal sum for the use of the car—typically £1 for a couple of years' use—some businesses have at a stroke been able to limit their tax exposure to the VAT on only this nominal amount. To answer the hon. Gentleman's question, this avoidance scheme works because in VAT even the smallest amount of consideration—even £1 a year—counts as payment for a supply. The result of this is the loss of virtually all the tax that should be due.

I have explained the scale of the current revenue loss and the scale of the full revenue loss if the scheme were to be expanded to full capacity. For some of the larger businesses in the motor trade, the loss runs to hundreds of thousands of pounds a year. The changes that we are making will give Customs the power to direct an open market valuation when a car is supplied for a consideration by a motor dealer or manufacturer to an employee and its value is artificially low.

Mark Prisk (Conservative, Hertford and Stortford)

My understanding is that the Chartered Institute of Taxation questions whether making this nominal value would achieve the aim on the basis that the £1 charge for, notionally, two years would not be considered to be in the course or furtherance of business. It would not enable a business to seek exemption from the VAT charge. Is the institute correct in making that assessment?

John Healey (Labour, Wentworth)

I had understood the hon. Gentleman's explanation of why this avoidance scheme would not work to be related to a concern about the interpretation of the law. The clause is a direct response to the avoidance that we know takes place. I have tried to explain why and how the use of a nominal payment that constitutes a consideration allows an avoidance in this field that is not available to employees in other fields. That is why we are looking to close the scheme.

Mark Prisk (Conservative, Hertford and Stortford)

I am trying to say that the very fact that it is questionable whether the nominal charge enables a business to make itself exempt in these circumstances means that Customs and Excise already has the powers, because such a payment would not be made in the course or furtherance of business. Therefore, even if the Treasury's view is that this is an attempt to avoid tax, the clause is unnecessary because Customs already has the powers to challenge such nominal payments.

John Healey (Labour, Wentworth)

I have tried to avoid giving a blunt answer to the hon. Gentleman. He has asked me the same question a third time, so I will say that, in our view, the Chartered Institute of Taxation is wrong. Any small amounts of consideration—even a pound a year or a pound over two years—is regarded in tax law as being received in the course of business. That is why the scheme works and why it allows the payment of VAT on only that nominal value.

What we propose in the clause requires a European Community derogation, which we applied for in February. The changes will take effect following receipt of the derogation on a day to be appointed by the Treasury. The measure is proportionate, necessary and a targeted response directed at the avoidance of VAT on company cars used as demonstrator cars. Car salesmen at present are getting away with avoiding the VAT on their company cars that other businesses have to pay. This measure will put an end to that.

Mark Prisk (Conservative, Hertford and Stortford)

I am interested in the Minister's comments on whether the notional payment is a consideration. Unless I have missed the point, I did not hear any explanation from him—I am sure that it is an omission on his part—on open market value and rental businesses. Does he have any comments in response to those points?

John Healey (Labour, Wentworth)

I will write to the hon. Gentleman about open market valuation and about the issue of free use, which he also raised.

Question put and agreed to.

Clause 22 ordered to stand part of the Bill.

Clause 23 - Charge and rates for 2004–05

Howard Flight (Conservative, Arundel and South Downs)

We are pleased to note that the RPIX is effectively being applied to indexing personal allowances. We also note the continuing wide gap between that and the new consumer price index pick-up measure. Notwithstanding that, there will be substantial fiscal drag as earnings, especially overall earnings in the public sector, rise faster than inflation. We are interested to know how many people are now paying tax in the top 40 per cent. bracket, and how many more the Government anticipate will be paying tax in that bracket after this year's Finance Bill.

Dawn Primarolo (Labour, Bristol South)

I do not have to hand the precise figures on the number of people moving into the higher rate, but they are published regularly and I will ensure that the hon. Gentleman receives them. He needs to be reminded of the signs of prosperity in the economy. Between 1997–98 and 2002–03, average earnings for men and women of all talents increased by 25 per cent., whereas prices only went up by 12 per cent. The sign of a prosperous economy in which people are earning more is that some of them move into the higher rate band.

The hon. Gentleman will also be aware that the interaction of the tax credits and the 10p starting rate is ensuring that those on the lowest incomes are retaining as much as possible, and in particular are avoiding the regressive nature of many changing allowances, which, as he knows, is more of a benefit for those at the top of the income range.

I have already provided a written parliamentary answer to the hon. Gentleman. Perhaps the information has escaped his notice. I am happy to ensure that that information, which is contained on the Inland Revenue website, is made available to him and the Committee.

Question put and agreed to.

Clause 23 ordered to stand part of the Bill.

Clause 24 - Personal allowances for those aged 65 or more

Howard Flight (Conservative, Arundel and South Downs)

The clause serves to increase age-related personal allowances by 3.3 per cent., together with related income limits. Why has there been special treatment for this category of people, when the basic personal allowances—the age-related allowance for married couples and the blind persons allowance—have all been based on RPIX at 2.8 per cent.? What is the logic for having 3.3 per cent. for one group, while others, which are apparently equally worthy, have only 2.8 per cent.?

Dawn Primarolo (Labour, Bristol South)

This is to be consistent with the Government's promises elsewhere on average earnings. The Government increased the guaranteed element of the pension credit by using the July average earnings seasonally adjusted headline rate, and promised to continue to do that for the remainder of the Parliament. Accordingly, we have used the July average earnings measure this year, as in previous years, because of clear commitments that the Government made in this area.

Question put and agreed to.

Clause 24 ordered to stand part of the Bill.

Clause 25 - Charge and main rate for financial year 2005

Howard Flight (Conservative, Arundel and South Downs)

A year ago, the main corporation rate for this year was set at 30 per cent. As I understand it, corporation tax bands are not changed, which in a sense means that the value is eroded with inflation. Does the Minister know whether the Government intend not to make any changes to corporation tax bands in future?

Dawn Primarolo (Labour, Bristol South)

Much as I am tempted to make announcements for the Chancellor for future years, I shall not do so. However, the answer to the hon. Gentleman's question about whether we keep the competitive rate of corporation tax under review is yes. The Chancellor always seeks—in setting the headline rate on corporation tax, or the various allowances and interactions in the tax system—to ensure that our corporate tax system is highly competitive as it is and still one of the lowest in Europe. Our competitive advantage remains.

John McWilliam (Labour, Blaydon)

Order. I have to point out that the clause is about the year 2005 only and not about any other year.

Question put and agreed to.

Clause 25 ordered to stand part of the Bill.

Clause 26 - Small companies' rate and fraction

John McWilliam (Labour, Blaydon)

This clause is about 2004.

Howard Flight (Conservative, Arundel and South Downs)

The clause sets the starting rate of tax for small companies for this year. The key point is that, under the new corporate distribution rate, the starting rate for the overwhelming majority of small companies will be 19 per cent. and not zero per cent.

Question put and agreed to.

Clause 26 ordered to stand part of the Bill.

Clause 27 ordered to stand part of the Bill.

Clause 29 - Special rates of tax applicable to trusts

Howard Flight (Conservative, Arundel and South Downs)

I beg to move amendment No. 57, in

clause 29, page 23, line 35, leave out subsection (4).

John McWilliam (Labour, Blaydon)

With this it will be convenient to discuss the following:

Schedule 4—Amendments relating to the rate applicable to trusts

New clause 1—Repeal of section 677 of Taxes Act 1988

'Section 677 of the Taxes Act 1988 (sums paid to settlor otherwise than as income) is hereby repealed.'.

I suggest to hon. Members that it is probably useful if they include anything that they would like to say on clause 29 stand part now.

Howard Flight (Conservative, Arundel and South Downs)

I thank you, Mr. McWilliam, for the comments that you have just made, because the territory is very much interrelated. In the course of my remarks, I want to make a point about amendment No. 31, which, for technical reasons, has not been selected, but is a central part of the point here.

Both clause 29 and schedule 4 increase the income tax rates for non-interest in possession trusts—discretionary and accumulation trusts—from 25 per cent. to 32.5 per cent. and for UK company dividend income from 34 per cent. to 40 per cent. That opens up what we perceive as an unfair imbalance in the treatment of UK company dividends. Whereas higher-rate taxpayers are taxed at 25 per cent., the income received by the beneficiary in a non-interest in possession trust will be taxed at 40 per cent. I think that that will also apply to pension-saving arrangements that fall under the funded unapproved retirement benefit scheme, or FURBS.

Next year, the Government are proposing sensible measures for streaming that I describe as automatic look-through. At the least, I ask why the tax is being put up a year ahead of that, which will result in a year of unfairness, and why it would not be more sensible to combine the two in the same tax year and to delay the tax increase for another year.

I had an extraordinary constituency case, where a little girl's father died at 35, leaving her £10,000. Her grandfather put that into a discretionary trust. He was going up the wall because he was already having tax estopped on it and could not get it back from the Revenue. He said, ''I hear that the rate is now going up to 40 per cent. What sort of justice is that? The amount involved is tiny.'' I said to him, ''As I understand it, in another year you would be alright because it would be a straightforward look-through situation, but I am afraid that this year, for some half-baked reason, you will have to pay even more tax, unless we can persuade the Government to coincide the two measures.''

New clause 1 would abolish section 677. We see no need for schedule 4, which introduces consequential amendments arising from the increases to the schedule F trusts rate and the rate applicable to trusts. Moreover, it complicates an already over-complex situation. The essence of the point is that, if we deal with the whole lot together, once we move to stream the higher tax rates, we do not need section 677 or schedule 4.

Certain capital sums paid to a settlor are taxed as income by section 677 when there is undistributed income in the trust. Schedule 4 introduces yet more complex first-in and first-out matching rules to relate the tax credit received by the settlor to the tax paid by the trustees. We would welcome an explanation of the provision, which appears to be a little capricious. Already the problems with sections 677 and 678 are made worse by schedule 4. The explanatory notes have turned up in the past day or two but, when I and others focused on this area, we did not have the explanatory notes to sort out some of the problems.

Section 677 could be repealed given that UK trust income is increasing to the new 40 per cent. rate. The key point is that, once the tax rate has been increased, you do not need all the clutter that section 677 and schedule 4 bring. There will be virtually no accompanying tax revenues once the rate has been upped to 40 per cent. The amount of tax at stake will diminish over the years as the amount of undistributed income that has suffered tax at rates of less than 40 per cent. reduces over that time. The related rules of section 678—capital sums paid by a body connected with the settlement—will become similarly redundant over time.

To sum up, it seems extraordinary that the Government are not dealing with the new tax rate and streaming at the same time. If both were dealt with at the same time, you could simplify an area of taxation that is ludicrously complex, and made more complex by the provisions of schedule 4, for little or no loss of revenue.

John McWilliam (Labour, Blaydon)

Just to remind members of the Committee, it is 30 years since I have been the trustee of anything. The word ''you'' is being used too often.

John Burnett (Liberal Democrat, Torridge and West Devon)

I want to address my comments to amendment No. 31. It is a popular misconception that all beneficiaries of non-interest in possession trusts are—

John McWilliam (Labour, Blaydon)

Order. That amendment has not been selected. However, the argument can be made.

John Burnett (Liberal Democrat, Torridge and West Devon)

All I can say is that I am anxious to speak to that amendment. I am not moving it.

John McWilliam (Labour, Blaydon)

Order. For the sake of clarity, it is not possible to move the amendment, because the amendment is out of order. I accept that it is out of order on a technicality, but I suggested to hon. Members that they should take the group of amendments and clause stand part together. The argument is in order.

John Burnett (Liberal Democrat, Torridge and West Devon)

I shall therefore proceed to make the argument—[Interruption.] I am willing to give way to the hon. Member for Ealing, North (Mr. Pound), who, if we are very fortunate, might regale us with details of his naval career.

It is a popular misconception that only the very rich are beneficiaries of non-interest in possession trusts. That idea is wrong for various reasons. Often, for example, simple mitigation of tax, with property prices being so high, will involve, on the death of a first spouse, the creation for at least two years of a non-interest in possession trust—a nil rate inheritance tax trust. There could be 10 beneficiaries of that trust, including the surviving spouse, and many of those beneficiaries could be extremely badly off. I do not understand why the Government have a fair system in place for the next tax year and a patently unfair system for this tax year.

Howard Flight (Conservative, Arundel and South Downs)

It is not just patently unfair, but made more unfair by the increase in the rate to 40 per cent.

John Burnett (Liberal Democrat, Torridge and West Devon)

That is absolutely right. For that reason I hope that the amendment will be pressed to a Division, unless the Government accept it, because we support it. It is patently unfair to discriminate doubly for one year against many individuals who are low-rate taxpayers, thus ensuring that they pay considerably more tax.

Howard Flight (Conservative, Arundel and South Downs)

Tragically, we cannot specifically vote on the measure as the amendment has not been selected. Therefore, unless the Government can satisfy us that they will deal with the issue, the only possibility is to vote against the clause.

John Burnett (Liberal Democrat, Torridge and West Devon)

I understand that, but we have to be very careful in the Committee because we might want to keep our powder dry until Report. Nevertheless, I hope that we shall receive from the Paymaster General, who is invariably generous and courteous, some words of compromise and sense.

Dawn Primarolo (Labour, Bristol South)

I hope that in explaining clause 29 and schedule 4 to the Committee, and responding to the amendments, I will also be able to address the specific point about the future changes to trusts, about which the Government are currently consulting, and how they will interact with the clause. I hope that hon. Members will then be satisfied that the calamitous situation that they believe possible will not come to pass.

Clause 29 changes the applicable rate for trusts from 34 per cent. to 40 per cent., and the corresponding schedule F trust rate from 25 per cent. to 32.5 per cent. The rate applicable to trusts has traditionally been set above the basic rate, which

reflects the fact that many—but, as the hon. Member for Arundel and South Downs said, not necessarily all—of the ultimate beneficiaries are liable to the higher rate tax. Higher rate taxpayers still can, and do, achieve an unfair tax saving by channelling their income through trusts. Increasing the rate applicable to trusts ensures that the right amount of tax is paid by the higher rate taxpayer.

The ultimate tax liability of the beneficiaries who receive income from a trust will not be affected by the increase in the rate applicable to trusts. Beneficiaries will continue to get a credit for the tax paid by the trustees so that higher rate taxpayers will not have to pay any more tax when trust income is paid to them. Beneficiaries who are not liable for income tax, or are liable at the starting or basic rate, will be able to claim the repayment, as is the case at the moment.

Clause 29 and schedule 4 are part of a wider package of changes that will modernise the way that we tax trusts.

Howard Flight (Conservative, Arundel and South Downs)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

If the hon. Gentleman will let me finish this point, I shall give way to him. The changes will reduce the compliance burdens faced by smaller trusts. From the tax year 2005–06, there will be a £500 basic rate band for trusts that pay tax at the rate applicable to trusts. Trusts established for the most vulnerable will benefit from the new rules; the trustees will be taxed only at the vulnerable beneficiaries tax rate.

This is a complex area. The Inland Revenue has consulted widely on it, which has been welcome. That consultation continues, and it is designed to ensure that all the details are correct. The provisions will ensure that trusts for the vulnerable do not pay more tax. In many cases, they will pay less, and it will be backdated.

Mr. Flight rose—

Dawn Primarolo (Labour, Bristol South)

I knew that that would be the crucial point. The measures will be backdated to come into effect in 2004, even though we will require legislation in 2005. The reason for that is that although these changes are widely welcomed, there are still more details that we want to ensure are correct. That is the right way to proceed.

Howard Flight (Conservative, Arundel and South Downs)

The Minister has uttered the magic words.

When I was making inquiries in relation to the constituency case that I mentioned, I was surprised to find that, historically, there seemed to be ludicrous complexity about whether there could be a straight look through. The case is straightforward. There is an orphaned daughter. Money was the father's only savings. The mother is still alive. A trust has been set up in favour of the daughter, and it has been organised by the grandfather to protect her against the possibility of the mother walking off with the money. However, the child has to pay tax on the income on £10,000. It is extraordinary that the rules result in that. I hope that I am right in understanding that once the new streaming arrangements have been sorted out they will give a complete look through.

Dawn Primarolo (Labour, Bristol South)

With your leave, Mr. McWilliam, I will briefly touch on the proposed modernisation. The hon. Members for Arundel and South Downs and for Torridge and West Devon know full well that this is a very complicated area of taxation. All manner of arrangements—to put this delicately—can be found in it, ranging from vulnerable trusts, for which all Committee members want the Government to make the necessary arrangements to simplify the provisions, to extremely creative high taxpayers who seek to reduce their tax unreasonably.

That is unfortunate, and it provides a challenge for the Government. I will explain it by addressing the points that were made about the changes in section 677 of the Income and Corporation Taxes Act 1988. The changes in the arrangements that we are seeking to make are designed to ensure that we meet that challenge. With regard to the operation of section 677 and anti-avoidance, we are still dealing with higher rate taxpayers, and we are also reviewing, updating and modernising trust arrangements and the tax system for trusts so that we pick up the points that the hon. Gentlemen are rightly making.

The new system will involve an irrevocable election made jointly by trustees and the vulnerable beneficiary for the tax paid by the trustees to be based on the circumstances of the vulnerable beneficiary. It is difficult to comment on the constituency case of the hon. Member for Arundel and South Downs, but then I always marvel at the complexity of his casework. No one has visited me in Bristol, South inquiring about an offshore trust and the unreasonableness of the 40 per cent. tax rate.

John Burnett (Liberal Democrat, Torridge and West Devon)

On the point to which the Paymaster General has alluded, I think that she said that, on the inception of a trust for a vulnerable person, the election would have to be made by the settler trustees and the vulnerable person. I hope that in due course she will reconsider that, if it is so, because sometimes the vulnerable person is not capable of making an election and might refrain from doing so because they would not want the property put in trust.

Mr. Flight rose—

Dawn Primarolo (Labour, Bristol South)

I will just answer that question before I give way to the hon. Gentleman.

I beg your indulgence, Mr. McWilliam, as we are going quite wide of the subject. The points that the hon. Member for Torridge and West Devon raised are precisely those on which we need further consultation, to ensure that we get that balance right. He is right: it is not straightforward. It is simple for a Minister to say that we wish a measure to apply as a principle, but we have to ensure that it is delivered in the circumstances that we seek to achieve.

The hon. Gentlemen will have to be disappointed this year that the provisions are not available in the Bill. I hope that they will look forward with expectation and encouragement to the legislation next year making an appropriate response to these matters.

Mr. Flight rose—

Dawn Primarolo (Labour, Bristol South)

I want to get this matter out of the way so that I do not stray too far from the amendments, so before I give way I point out that the other issues that we are considering are the basic rate band, the £500, and harmonising definitions and tests. There is broad consensus that we should have a common definition of trust income tax and capital gains tax. As the hon. Member for Arundel and South Downs said, there is also the question of streaming income and ensuring that it is right to deliver the things that he correctly identified in circumstances where it would be appropriate.

I do not plan to say anything about next year's Finance Bill. I was trying to be helpful with regard to current consultation in the context of clause 29. I will give way to the hon. Gentleman and then return to the amendments.

John McWilliam (Labour, Blaydon)

Order. We are so wide that sometimes I feel as though I have been transported to the steppes.

Howard Flight (Conservative, Arundel and South Downs)

Just to put the record straight, the case in question concerned a trust that was entirely domestic, and these measures are essentially about domestic trusts. It was also modest, with only £10,000, and illustrated the correct use of trusts. A grandfather was simply trying to protect what little his deceased son had received for the benefit of an orphaned child.

Dawn Primarolo (Labour, Bristol South)

I think that I answered the hon. Gentleman's point when I said that all the arrangements for all those who benefit from such trusts will be backdated. I hope that that settles the point. We should not stray any further.

Amendment No. 57 would omit schedule 4 from the Bill. That moves to the other half of the challenge that the Inland Revenue faces in dealing with trusts, where avoidance by extremely wealthy individuals may inadvertently occur, to put it delicately. We are seeking, as an ever-helpful Inland Revenue and assisted Minister, to ensure that the clauses continue to work as intended.

New clause 1 and amendment No. 57 would repeal section 677 of the Income and Corporation Taxes Act 1988, which charges tax on capital payments made by trusts to the individuals who put funds into the trust. The amendment and the new clause would create new opportunities for tax avoidance. Section 677 contains anti-avoidance legislation to stop individuals who put funds into a trust avoiding tax when they withdraw funds from it. New clause 1 would sweep section 677 aside, but section 677 is a necessary defence against avoidance. If it did not exist, people could place funds in an offshore trust that paid little or no tax on its income and arrangements could later be made for funds to be returned to them in a non-taxable form, thereby avoiding tax altogether. That is just not acceptable. Such schemes are not caught by any other anti-avoidance measure, and I hope that the Committee will understand why section 677 is a necessary part of the tax system and new clause 1 should be rejected.

Schedule 4 simply ensures that the proposed change in the rate applicable to trusts is taken into account when section 677 operates. In the simplest case, it ensures that a person receiving a capital payment from a resident trust does not get credit for tax paid at 40 per cent. if the trust had paid only 34 per cent. In the worst case, someone could receive a credit at 40 per cent. when no UK tax had been paid. The amendment, by omitting schedule 4, would make nonsense of the tax credit calculation and create a new tax avoidance opportunity for higher rate taxpayers.

I hope that the hon. Member for Arundel and South Downs, who said that sections 677 and 678 are highly complex and capricious provisions, sees that the Government's amendment in the schedule is a necessary consequence of the increase in the rate applicable to trusts. Schedule 4 aims to ensure that the tax credit given to a settlor when calculating their income tax liability on a capital payment from the trust more closely matches the tax paid by the trustees.

The change to section 677 is necessary to ensure that wealthy settlors pay the right amount of tax. I cannot see why that is unreasonable because everyone else pays the right amount—well, I hope that they do. I certainly do. Without the change, the notional tax credit that they receive would be calculated on the wrong basis. These are anti-avoidance provisions and are necessary to ensure that the right amount of tax is collected in all cases. In any case, the tax revenue at stake would depend enormously on behavioural effects when tax planners are ready and willing to exploit any loophole—this would be a large one—for the benefit of their clients. There is an ongoing risk, because trusts that are based offshore pay no UK tax and that could be used to achieve the avoidance.

I hope that the hon. Gentleman accepts my undertakings on trusts for the vulnerable and that he will also, perhaps reluctantly, accept that section 677 is absolutely necessary. If he does not withdraw his amendment, I shall ask my hon. Friends to vote against it.

John Burnett (Liberal Democrat, Torridge and West Devon)

The Paymaster General has lived up to the billing that I gave her. Softly, gently and subtly, she has won over this Member.

Steve Pound (Labour, Ealing North)

The hon. Gentleman has been seduced.

John Burnett (Liberal Democrat, Torridge and West Devon)

The right hon. Lady frequently seduces me with her words.

I was delighted to hear what she said. She handles the Committee with great expertise, and did so especially in connection with amendment No. 31. I am delighted to hear that there will be no discrimination against some disadvantaged individuals in this tax year, 2004–05.

Howard Flight (Conservative, Arundel and South Downs)

The Paymaster General has indeed responded to our main concern about the commitment to backdate. On the more technical aspects of schedule 4 and section 677, in a domestic context, I trust that the Minister understands the point that I was making.

I was under the impression that taxation of income from non-UK offshore trusts was done on a look-through basis under other legislation, and that the issue was therefore thoroughly dealt with elsewhere. She is effectively saying that that is not the case, and that there is a reliance on something in section 677. If that is so, I accept her argument. My point was based on the understanding that the section was really about domestic trusts, and did not touch on offshore trusts. On the basis that the Minister knows her stuff—I am sure that she does—I accept the argument that we cannot get rid of section 677 if it is relevant to the offshore territory. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 29 ordered to stand part of the Bill.

Schedule 4 agreed to.

Clause 30 - Provision not at arm's length: transactions between UK taxpayers

Mark Prisk (Conservative, Hertford and Stortford)

We come now to the important, if not easily comprehensible, issue of transfer pricing and thin capitalisation. Clause 30 and schedule 5 change the way in which prices are set between associated businesses for transactions within the United Kingdom. The clause will require arm's-length pricing, and the whole process, of course, will have to be supported by extensive documentation. Committee members will immediately recognise—as I am sure do you, Mr. McWilliam—that that represents, potentially, a huge compliance burden. Given the complexity of UK-UK transfer pricing, I shall give some examples to illustrate my point.

Let us consider head office costs. Most groups of companies do not make arrangements for each and every transaction or transfer between companies to be priced in the manner required by the legislation, so there will be significant change there, in terms of recharging. UK groups often find that it is easier not to charge interest on intra-group loans; or, at least, if they do charge interest, there is no need to charge at market rates. That will have to change because of the clause. Committee members will realise that it could have a significant adverse effect if loans have to be charged on an arm's-length basis within groups, as is required in this and subsequent clauses.

Another example—and a problem that is particularly difficult to resolve—is that of intellectual property. Companies may have to value their intellectual property and start charging royalties to UK-group companies for that use. We can all think of a number of market sectors in which that will be particularly relevant. Examples include oil and gas, and the pharmaceutical industry.

The Chairman's attention having been called to the fact that eleven Members were not present, he suspended the proceedings.

Other Members having come into the Room and eleven Members being present, the proceedings were resumed.

Mark Prisk (Conservative, Hertford and Stortford)

One could get a complex. The moment one starts to talk about UK-UK transfer pricing and thin capitalisation, Committee members' attention wanders.

Steve Pound (Labour, Ealing North)

So does the Committee.

John McWilliam (Labour, Blaydon)

Provided that my attention does not wander, we will be all right.

Mark Prisk (Conservative, Hertford and Stortford)

Thank you, Mr. McWilliam. I have no doubt that there will be a lengthy and, as always, intellectual discourse on the issue from the hon. Member for Ealing, North.

The hon. Gentleman's attention, and that of the Committee, has been grasped by the question of intellectual property. Companies face the possibility of needing to value their intellectual property and therefore of starting to charge the respective royalties to companies in the group. I tried to refer to that question in relation to the oil, gas and pharmaceutical industries.

To take an example from my constituency area, we have an outstanding research and development facility in the GlaxoSmithKline operation at Ware. In Hertfordshire, and in Harlow in neighbouring Essex, there is a number of related companies within the group.

As we can imagine, one of the problems is the complexity of trying to value the intellectual property developed at the company based in Ware, and establishing whether as an organisation it needs to charge royalties to the other companies for that development and assessment. That is one of industry's worries. Hopefully, the Minister will be able to put minds at rest.

Head office costs, intra-group loans and intellectual property are just three potential elements of a significant compliance burdens that the clause would seek to impose. Therefore, we are talking not simply about another set of files, a little more paperwork or an adjustment to a software program but, possibly, for many organisations, the need to reorganise their structure or to restructure financially how they operate.

John Burnett (Liberal Democrat, Torridge and West Devon)

I do not want to be unhelpful, but I hope that the hon. Gentleman will deprecate artificial transactions—transactions that artificially invest intellectual property in low tax regime countries.

Mark Prisk (Conservative, Hertford and Stortford)

I am grateful to the hon. Gentleman but that is not the point that we are examining, which is whether the new arrangements in the clause would force organisations to make that change. I understand the situation elsewhere, but the question is whether there is a compliance burden that would otherwise not be expected. That is the essence of my concern.

John Burnett (Liberal Democrat, Torridge and West Devon)

I take the point that without anti-avoidance provisions on transfer pricing we could have severe leaching, or loss, which is the word that I should use, of tax revenue. The hon. Gentleman is right on the

nail when he talks about bureaucracy and if I am fortunate enough to catch your eye, Mr. McWilliam, I will say a few words on that point as well.

Mark Prisk (Conservative, Hertford and Stortford)

I am grateful to the hon. Gentleman. Just when we thought that his smooth tongue was about to ingratiate himself with all of us, he moves us on to a different aspect of his scrutiny capabilities. He is right to highlight the fact that there is a danger of leaching and I will discuss that in a moment.

At the heart of my first point is the potential compliance burden that is a consequence of the change in this clause and related ones. That is why the policy has met with quite a lot of concern among the business community. I fully accept that the Government have made some useful concessions. However, many experts, including the Confederation of British Industry, feel that business needs more time in terms of implementation. I will quote one leading expert in the field. Mr. Steve Hasson, who is the head of transfer pricing at PricewaterhouseCoopers, said:

''It's understandable that the Government wants to put its house in order, but one has to question why they have to put so much pressure on business in such a short timescale. Our clients have voiced their opinion—over 50% would like to see the start date delayed by more than a year.''

That was based on a quite detailed survey of that company's clients in January.

It seems peculiar that companies are being required to produce documentation that would not have been required for any commercial reason. Yet, in many cases, although not all, there may be no additional UK tax at stake. The clauses represent a big administrative outlay and some businesses will ask the question: for what purpose?

I am sure that the Committee will wish to consider the background to that, which is the Inland Revenue's concern about the possible implications for the sustainability of UK tax law following the decision in the Lankhorst v. Hohorst case at the European Court of Justice. Many experts have informed me, both from the taxation and from the legal point of view, that the Inland Revenue has been advised that it would not be possible to return to what I think is termed a direction base regime without the threat of action for non-compliance with EU law at the ECJ.

Will the Paymaster General tell the Committee what her understanding is of such a potential challenge? Is she certain that the proposed changes in this and the related clauses, and in schedule 5, and their implementation will not also be open to challenge? There seems to be considerable expert opinion that devising something that is not open to challenge will be extremely difficult. Obviously, the key element is the question of discrimination. I am sure that she will want to respond.

Many representative bodies have highlighted that the United Kingdom's approach is the equivalent of what I believe is termed downward harmonisation. I refer briefly to the view of the Institute of Chartered Accountants:

''Our concern is that this will reduce the competitiveness of the UK and is not consistent with the stated EU Lisbon Agenda''—

on which the Chancellor is keen—

''which is to create in Europe the most dynamic knowledge-based economy in the world by 2010.''

The Confederation of British Industry stated in a briefing that it supplied to members of the Committee that it is

''very concerned that the measures on transfer pricing and thin capitalisation are being taken forward too quickly, and in isolation from other aspects of the corporation tax system such as group relief which are similarly potentially subject to intervention by the ECJ.''

The CBI goes on to an important related point:

''As the issues arising from ECJ decisions are so inter-related, it would have been much better to take more time to devise a coherent holistic approach to addressing incompatibilities between the UK corporation tax and the EU treaties.''

It then deals with other aspects, but I shall not stretch your patience too much with the broader questions, Mr. McWilliam.

The point is that other EU countries have taken different approaches, some of which have merit, some of which do not. Spain, for example, has chosen to disapply its thin capitalisation and related provisions for all intra-EU transactions. Can the Paymaster General explain her Department's views on alternative approaches? That would help inform us as to the basis, or the foundation, of the clause.

John Burnett (Liberal Democrat, Torridge and West Devon)

I do not want to make too contentious a point. Nevertheless, I noted the comments in briefings on the Bill about the attitude of the Spanish. I am concerned that that approach, if adopted, would accelerate the trend to European Union tax harmonisation, which I would personally deprecate. In addition, does the hon. Gentleman agree that courts would give some weight to the steps taken by the Spanish Government and that EU courts are already encroaching far too much, especially on our corporation tax?

Mark Prisk (Conservative, Hertford and Stortford)

I can understand why the hon. Member for Torridge and West Devon is not with his leader at his party's launch of its European election campaign today.

John Burnett (Liberal Democrat, Torridge and West Devon)

Certainly not.

Mark Prisk (Conservative, Hertford and Stortford)

I am sure that the Committee will note those last two words, ''Certainly not''.

I share the hon. Gentleman's concern about the danger of leaching, which leads to my next point. Conservatives—and, evidently, some Liberal Democrats—recognise the natural wish of the Treasury to maintain national sovereign control over our tax base. However, significant compliance burdens are being created in the clause and elsewhere. We have therefore tabled amendments that seek to relieve those burdens.

John McWilliam (Labour, Blaydon)

Order. May I just bring the Committee's attention to the fact that the provision in clause 30 is purely for transactions between UK taxpayers, not Spanish taxpayers or any other variety?

Mark Prisk (Conservative, Hertford and Stortford)

I am grateful to you, Mr. McWilliam, for reminding us of that. I am sure that the Paymaster General will follow your guidance, as I intend to.

Conservative Members are concerned about the piecemeal way in which the Government are dealing with the anomaly for UK transfers, which has been drawn forward by the case to which I referred. The worry is that no real strategy underpins their approach. In essence, our concern is that, although it is important to control any potential leaching, it is also important that the Government are able to respond to outside legal challenges through the changes in the Bill and that undue burdens are not placed on business. I look forward to the Paymaster General's response to those points.

John Burnett (Liberal Democrat, Torridge and West Devon)

I do not want to detain the Committee too long or steal the thunder of the hon. Member for Ealing, North.

What I am concerned about—and what should concern the entire Committee—is that the clause will cause considerable additional bureaucracy with no apparent gain for the Exchequer. The new rules will place a huge compliance burden on larger UK companies, which will be required to maintain transfer pricing documentation for transactions with other UK companies. There will be little or no benefit to the Exchequer, so I ask the Paymaster General to answer the simple question: why are these steps being taken? Why are additional burdens being imposed on our larger companies?

Dawn Primarolo (Labour, Bristol South)

May I start by making a couple of general points about the changes which were made by the hon. Members for Torridge and West Devon and for Hertford and Stortford? I shall state our position from the outset. The hon. Member for Hertford and Stortford implied—nay asserted—that this was something that the Government were rushing to do. However, we need to set the matter in the context of what business has been saying and doing as a result of what, it believed, produced uncertainty in the operation of transfer and, in particular, thin capitalisation.

The Government are confident that our existing rules can and will be defended. They are consistent with internationally accepted principles of taxation, as promoted by the Organisation for Economic Co-operation and Development and reflected in the United Kingdom's bilateral treaties. We will continue to defend UK law against challenges in the courts. However, business tells us that there is uncertainty in the taxation position. That results from recent decisions in the European Court of Justice, and the interaction of those principles with European law—the hon. Gentleman referred to the Lankhorst case.

The uncertainty is such that many companies are at present actively keeping past tax computations open. The Government, not unreasonably, want to ensure that the corporation taxation system is robust and gives business certainty. Let us be clear therefore that the starting point is the interaction of certain judgments, business's perception of those interactions and consequent uncertainty leading to many companies leaving their tax affairs open or pursuing litigation. The Government are trying, in extensive consultation with business, to ensure that the taxation

system is robust and gives business certainty, which it says it does not have at the moment. That is all underpinned by the Government assertion that our system is defendable.

Mark Prisk (Conservative, Hertford and Stortford)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

May I dispose of the Spanish issue before I give way to the hon. Gentleman?

I assume that the hon. Gentleman was drawing a comparison, but it was not a good one to draw because Spain already applies transfer pricing to domestic legislation. It has also made some other changes that we do not think appropriate; nor did business when we consulted it. What we have is widely accepted. We will come on to discuss the counterbalancing measures in the management expenses. Business identified uncertainty and wanted that clarified, but no organisations or representatives came forward with suggestions on how we could move back to a position of certainty in any other way.

I want to make sure that this is understood: the changes set aside clearly, once and for all, the uncertainty about the compatibility of transfer price and thin capitalisation laws with European law. It is a specific problem that business has described to us and it is the reason for the changes.

Mark Prisk (Conservative, Hertford and Stortford)

The Paymaster General is right. The whole purpose of raising the question of the Spanish approach was to try to identify and shade in the thinking behind the Government's decision. Certainly we would not wish to pursue the matter. I come back to the awkward question of discrimination, which is central to whether the clause will work or whether it can be challenged again. Can she confirm the thinking behind the clause and its compliance with EU law, so that we can understand her confidence that it will not be open to challenge?

Dawn Primarolo (Labour, Bristol South)

That is appropriate. Having dealt with the general points that both hon. Gentlemen made in their contributions, I want to move to the clause, its provisions and the subsequent clauses to which the hon. Member for Hertford and Stortford referred in his opening remarks.

John Burnett (Liberal Democrat, Torridge and West Devon)

It is beyond my comprehension that a transaction within the UK should be recorded. Perhaps the right hon. Lady can explain the logic because it escapes me. Cannot large companies operate under the medium-sized company regime?

Dawn Primarolo (Labour, Bristol South)

That difficulty arises because clauses 30 to 37 pick up each of the different points that have been identified, be that securitisation or the role of small and medium-sized companies and whether they require transfers within groups. All those matters are dealt with as we progress through the clauses. I have noted the hon. Gentleman's point, and I am sure that he will make it again on the relevant clause. Certainly I want to make it clear as we progress through these clauses that the Government are taking all possible steps and will require consultation with business.

Finally, I stress to the Committee the fact that groups can adopt arm's-length principles. There is no need to restructure; it is not a requirement. Some may choose to do so. The hon. Member for Hertford and Stortford mentioned companies in his constituency. Companies are already trading across borders. They are already coping with the operation of transfer pricing and the arm's-length principle. They use it daily in running their businesses within their groups of companies both in the UK and across borders.

The Committee must keep focused on the principles of transfer pricing and why they need to be arm's length. This is not about investment, but about profit and where it occurs. It is a very compact set of principles, internationally accepted and well operated by the UK. They are principles that can be established on a UK-to-UK business, but we need exceptions and we need to assist small and medium-sized companies. I will return to that when we resume this afternoon.

It being twenty-five minutes past Eleven o'clock, The Chairman adjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Two o'clock.

Standing Committee A

(except clauses 4, 5, 20, 28, 57 to 77, 86, 111 and 282 to 289, and schedules 1, 3, 11, 12, 21 and 37 to 39) - Clause 30 - Provision not at arm's length: transations between UK taxpayers

Dawn Primarolo (Labour, Bristol South)

I welcome you to the chair for our deliberations this afternoon, Sir John. It is a pleasure to see you, and I will be extremely careful, as always, because you will be paying close attention to the many areas of discussion on which you are very knowledgeable.

Before we broke from this morning's sitting, we were considering clause 30 on transfer pricing. I have dealt with the specifics in the questions from the hon. Member for Hertford and Stortford (Mr. Prisk), and in my closing remarks I wish to clarify the purpose of the clause.

This morning we discussed issues around transfer pricing. The rules are vital to ensure that businesses, especially multinationals, are taxed fairly in respect of their activities in the United Kingdom. Until now, taxes have applied only to cross-border transactions. Doubt had been thrown on their effectiveness because of decisions made in the European Court of Justice on the tax rules of other countries. Clauses 30 to 37 address the uncertainties that business has identified.

I also made it clear this morning that, although the Government are responding to those uncertainties, we will defend any challenges to existing UK legislation. I am perfectly at ease with the proposal, and I explained to the Committee that we are content. My officials advise me that the proposals cause no further uncertainty; rather they provide the structure that the companies concerned wish to see.

John Burnett (Liberal Democrat, Torridge and West Devon)

I, too, welcome you, Sir John. The Paymaster General is, as usual, being patient. She will recall that this morning I alluded to tax harmonisation, to which I am utterly opposed, in the points that I made about what the Spanish Government are doing about transfer pricing and thin capitalisation.

I have received a brief from the Institute of Directors, which I am sure the Paymaster General has seen. The institute makes an excellent point, which is very relevant to what she has just said about the encroachment on our independent, sovereign power to tax. It reluctantly concludes that

''the Government had little choice but to pass this legislation, although we continue to call for an amendment to the European Treaties''—

it splits an infinitive but I will not—explicitly to allow

''member states to ''discriminate'' in tax matters.''

I would very much favour that, and I look forward to hearing the right hon. Lady's views on such an amendment to the treaty.

Dawn Primarolo (Labour, Bristol South)

Transfer pricing regulations and tax guidance are not the subject of amendments to the treaty. As I explained this morning, the UK has operated those provisions for some time, following the principles laid down and recommended by the Organisation for Economic Co-operation and Development. The Inland Revenue operates them with some aplomb. Transfer pricing regulations and rules are about insuring and protecting the corporate tax base of this country. As I said a number of times this morning, the Government and the Inland Revenue considered that our legislation was compatible, but we also recognised that it was essential, because of the response of business and its view that there was uncertainty, that we put these matters beyond doubt. That is what clauses 30 to 37 do.

The Government have repeatedly made clear their views on tax harmonisation. On behalf of the Government, I have in various Committees of this House and in different debates made it clear that they do not subscribe to tax harmonisation and that they continue to argue in every forum for the right of member states to determine their own tax rates.

As tempted as I am to probe whether the hon. Gentleman may be more at ease on the Government Benches with regard to policies on tax and the European Union, I fear that you will say that I am going beyond the scope of the clause, Sir John. Perhaps I should stick to clause 30, unless the hon. Gentleman wishes to stand up and declare himself so in support of this Government that we can welcome him to our Benches.

John Burnett (Liberal Democrat, Torridge and West Devon)

I am certainly not going to make the intervention that the Paymaster General invites me to make, but—

Steve Pound (Labour, Ealing North)

It is seductive.

John Burnett (Liberal Democrat, Torridge and West Devon)

We come back to seduction. I am being led astray by the hon. Gentleman again.

Regrettably, a growing body of EU legal cases continues to encroach on our ability to set our own taxes and to have our own UK competitive tax system. That is especially so in the corporate sector. Will the Paymaster General and her erudite and eminent colleagues at the Treasury consider an amendment to the EU treaties enabling—

John Butterfill (Conservative, Bournemouth West)

Order. The hon. Gentleman is straying way beyond the scope of the clause. However fascinating the Government's opinion on this subject may be, the Paymaster General has already made their view clear and I would be grateful if she was not tempted down that route again when responding to the intervention.

Dawn Primarolo (Labour, Bristol South)

In that case, I will return to the discussion on the impact of clause 30. The hon. Member for Torridge and West Devon (Mr. Burnett) touched on the following point this morning. Clauses 30 to 37 deal with each element involved. As a combination, the clauses are broadly revenue-neutral. I am responding to points that hon. Members have made, but it is probably more relevant to discuss this matter as we go through the clauses.

However, the Government recognise that the extension of the transfer pricing requirements has the potential to increase administrative requirements on companies, so following discussions with business the clauses implement a package of measures to mitigate the effect of the change. Examples include the exemption for small and medium-sized companies under clause 31, which we will be able to probe later, and considerations involving dormant companies for the 1 April 2004 period.

The hon. Member for Hertford and Stortford touched on administrative pressure. Clause 33 relates to the relaxation of penalties for record keeping for a transitional period. That touches on the question that the hon. Gentleman raised, namely why we do not delay. I have explained why delay is not possible, given the uncertainty. Therefore, in consultation with business, the Government sought other arrangements to provide that transition period. The hon. Gentleman also touched on the question of loans. As he knows, we deal with the question of securitisation in later clauses, so he will forgive me if I do not deal with those specific points now.

Clause 30 extends the scope of transfer pricing requirements to include United Kingdom transactions, in order to address the uncertainty that has arisen in the existing legislation. The clause also extends the scope of the existing rules for compensating adjustments, which enables double taxation to be addressed, so that an increase in the taxable profits of one company can be reflected in a compensatory adjustment of taxable profits in another. The clause introduces a new system of balancing payments. Where a transfer pricing adjustment has been made for tax purposes, a group can make a payment with no further tax consequences, either for the payer or the recipient, to keep its cash position in line with its tax position. Finally, clause 30 gives effect to schedule 5, which makes the detailed consequential amendments to the existing legislation. So, clause 30 deals with the scope of the existing rules, their extension to UK transactions, compensatory adjustments and the introduction of balancing payments.

As I said, the uncertainty must be addressed because of its consequences for business at present. I touched on that this morning with regard to keeping open accounts. That is why, in giving business time to adapt fully to the system, we are, first, relaxing penalties for a transition period of two years, and secondly taking steps to minimise the effect on business. The hon. Gentleman touched on the question of investment. It is important to remember that there will be no effect on investment because the question that transfer pricing deals with is which

company a profit arises in, not what the overall level of taxable profit is.

The hon. Gentleman also touched on the question of royalties in a group. Groups of companies are used to charging royalties on cross-border transactions. It is true that those will, in some cases, become a requirement under UK law. That is an example of what transfer pricing means. We are acting to restore certainty about the effectiveness of the rules, which are essential to defend the corporate tax base of the UK, and we have taken important steps to mitigate the increased requirement on some companies. As I said, we will come to various other requirements in subsequent clauses and, in particular, to the exemption that will cover 95 per cent. of small and medium-sized companies.

The hon. Gentleman said that we were responding to corporate tax reform on a piecemeal basis. He will not be surprised to hear that I do not agree with that suggestion. We recognise the need to have a wide-ranging dialogue with business concerning all the implications of the corporate tax system, including recent developments in European law, and, in particular, considering our corporate tax system and whether it has responded, and is relevant, to the changing needs of companies, the economy and the world economy. That commitment to a dialogue was clearly set out in both the pre-Budget report and the Budget. The issue for the Government, based on what companies were saying to us, was that ongoing dialogue, which covers a wide range of areas, does not remove the urgent need for action on transfer pricing.

Mark Prisk (Conservative, Hertford and Stortford)

My concern is that there should be a strategic view underscoring the provisions. Without wishing to stretch your patience too far, Sir John, we were hoping for a glimpse of that strategy. We would be happy for the Government to adopt a broad view on where the lines can be drawn vis-à-vis the scope and remit of the ECJ. I understand that that would go too far beyond the scope of the debate, but it would be helpful if the Minister told us that such a strategy is being considered, and whether there will be an opportunity in the not-too-distant future for the House to consider that strategy.

Dawn Primarolo (Labour, Bristol South)

With respect, the corporate tax review and the dialogue that has been going on for nearly two years address a more fundamental question: the appropriateness of, and the response to, a whole range of measures in the corporate tax system ranging from capital allowances to schedules. The review raises the question of how to assist investment, and the consultation on that was published at the time of the pre-Budget report on assisting companies with equity finance.

There is a much more fundamental debate concerning how we ensure that our corporate tax system is responsive and secures revenue, but is also broad-based, intervenes at the correct time where there is market failure and ensures that companies are able

to develop and grow while meeting the challenges of the UK and global economy.

On the question of ECJ rulings, the hon. Gentleman will have to accept that it would be foolish of the Government to try to assume what the ECJ may say in future about cases which may or may not come before it. The Government's purpose is to develop a robust, active corporate tax system which is on all fours with the legal requirements, and that is precisely what we are doing. The hon. Gentleman's obsession with the ECJ blurs a more strategic focus on what the corporate tax system should look like.

The discussion with business has been very productive and is continuing, but it has far-reaching consequences for changes in the tax system. The hon. Gentleman should remember the changes to intellectual property rights, research and development tax credits, and capital gains tax or the improvements to the taper, where we moved away from indexation. There is a question of the speed at which agreement is achieved by business and Government as we take on these changes.

Mr. Prisk rose—

John Butterfill (Conservative, Bournemouth West)

Order. With great respect to the hon. Gentleman and the right hon. Lady, I think that she has been tempted down this road quite far enough. It is well removed from the scope of the clause. It is perhaps an important matter for another debate at another time, perhaps in a different place, but not in this Committee.

Dawn Primarolo (Labour, Bristol South)

Forgive me, Sir John. I was trying to assist the Committee, but I realise that I have gone way beyond my focus on clause 30, and I am grateful to you for drawing me back to the subject.

It is a requirement of any Government to ensure that uncertainties, real or otherwise, that business identifies as affecting its behaviour are dealt with. The clauses, of which clause 30 is the first, will remove all doubt identified by business, regardless of whether the Government believed that there should have been any uncertainty.

I hope that as the debate progresses the Committee will accept not only that the Government work closely with business in discussing the issues—and have responded to its requests in several places in the clauses—but that we made it very clear that there were no other suggestions or possibilities for dealing with the matter, and no other suggestions were advanced. I commend clause 30 to the Committee.

Question put and agreed to.

Clause 30 ordered to stand part of the Bill.

Schedule 5 agreed to.

Clause 31 - Exemptions for dormant companies and

Mark Prisk (Conservative, Hertford and Stortford)

I beg to move amendment No. 9, in

clause 31, page 26, line 9, at end insert—

'5AA(1) Paragraph 1(2) above does not apply in computing for any chargeable period the profits and losses of a potentially

advantaged person if that person is a company which is dormant but which does not satisfy the condition in paragraph 5A(2).

(2) Sub-paragraph (1) above does not apply in respect of any accounting period of a company if the Board gives the company a notice under this sub-paragraph requiring the company to compute the profits and losses of that accounting period in accordance with paragraph 1(2) above.

(3) A notice may be given in accordance with sub-paragraph (2) above only if the Board has reasonable grounds to believe that in that accounting period the company has been party to any transaction in respect of which provision has been made or imposed otherwise than for bona fide commercial reasons or as part of a scheme or arrangements for the avoidance of tax.

(4) In this paragraph ''dormant'' has the same meaning as in section 249AA of the Companies Act 1985 (see subsections (4) to (7) of that section).'.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss the following:

Amendment No. 10, in

clause 31, page 26, line 9, at end insert—

'5AB(1) Paragraph 1(2) above does not apply in computing for any chargeable period the profits and losses of a potentially advantaged person if that person is a company which satisfies the condition in sub-paragraph (2) below.

(2) The condition is that either—

(a) the company is in insolvent liquidation;

(b) the company is in insolvent administration;

(c) an appointment of a provisional liquidator is in force in relation to the company under section 135 of the Insolvency Act 1986 or Article 115 of the Insolvency (Northern Ireland) Order 1989;

(d) the company is in insolvent administrative receivership; or

(e) under the law of a country or territory outside the United Kingdom, circumstances exist corresponding to any of those described in paragraphs (a) to (d) above.

(3) For the purposes of this paragraph, the company is in insolvent liquidation, in insolvent administration or in insolvent administrative receivership if it is in insolvent liquidation, insolvent administration or insolvent administrative receivership for the purposes of paragraph 6A of Schedule 9 to the Finance Act 1996.'.

Mark Prisk (Conservative, Hertford and Stortford)

This is my first speech this afternoon and I am pleased to welcome you to the Chair, Sir John. I am sure that you will continue to guide us and keep us on the straight and narrow.

The clause seeks to provide a range of exemptions for dormant companies and small and medium-sized enterprises in the context of transfer pricing. The amendments are probing.

The purpose of amendment No. 9 is to extend the exemption for dormant companies to include those that become dormant after 1 April this year. A company is dormant and, therefore, exempt from the requirement to prepare a report and accounts during any period for which it has no significant accounting transaction. The imposition on such enterprises of the proposed transfer pricing adjustments for UK companies would give rise to accounting transactions that would cause many currently dormant companies to lose that status. The effect would be to require UK groups to prepare a report and accounts for those companies.

The Government have sought to address the issue by providing an exemption from the transfer pricing rules for companies that were dormant prior to the commencement of the new regime. The current

exemption will not extend to companies that become dormant after 1 April 2004. Many companies cannot be liquidated, whether for tax, name protection or other reasons, and unless the exemption is extended those companies could be brought within the regime and be required to prepare a report and accounts under existing company law rules.

I appreciate that the Inland Revenue's concern is that dormant companies might—I emphasise ''might''—be used as a conduit for transactions that might otherwise be caught by the rules and that that might be inappropriate in some circumstances. Many people believe and have argued—I understand this, although I am no tax expert in this context—that there could be a reserve power to bring such companies within the scope of the rules in tax avoidance cases. I would be grateful if the Minister commented on that because that might solve the problem that has been identified.

Under amendment No. 10, companies that are in insolvent liquidation, administrative receivership or administration would be excluded from the rules. Many people believe that such companies should be excluded and that the obligation to prepare the documentation should be removed for a number of reasons. First, in most cases, those companies will be part of a group and their debtors will also be insolvent and, therefore, unable to make adjustments to, or, for that matter, even to repay, debt that is outstanding at the date on which the process begins. Secondly, an insolvent company is limited by insolvency law in the transactions that it can enter into, and that is relevant. The arm's-length principle at the heart of the transfer pricing mechanism cannot be readily applied in those circumstances. Thirdly, there is a danger that the cost of compliance will fall on creditors, who in such circumstances will already have suffered considerable losses. The idea behind the amendment is to establish the Government's response to the argument that insolvent companies should be exempt.

I hope that with those explanations we can look forward to a positive response from the Minister.

John Burnett (Liberal Democrat, Torridge and West Devon)

I do not want to repeat the points made by the hon. Gentleman, although I have sympathy with what he asserted. The lack of amendment No. 9 will provide simplicity, but there is no real reason why the benefit of simplification should be significantly denied if we agree to it. To avoid unnecessary compliance burdens, exemption should be available to companies whenever they become dormant. The number of companies that become dormant after 31 March is not likely to be great, and any potential risk to the Exchequer could be eliminated by introducing a clearance procedure as a precondition of exemption for newly dormant companies. That comes to me in a briefing from the Confederation of British Industry. It would enable a smoother and fairer operation of the transfer pricing rules. I shall not repeat the remarks about how difficult it is to debate the subject, given the straitjacket of EU rules. I look forward to hearing

the Paymaster General's comments on the amendment.

Dawn Primarolo (Labour, Bristol South)

In the consultation before the Budget, we received many representations that a consequence of extending the transfer pricing rules to domestic transactions would be to cause many companies to cease to be dormant. As the hon. Gentlemen pointed out, that would cause significant administrative costs.

The Government are sympathetic to the representations, but there are two important constraints on what we can do. First, we must ensure that we do not create uncertainty under European law. We cannot treat dormant companies with a foreign parent less favourably than dormant companies with a UK parent. Secondly, we must ensure that we do not create an opportunity for dormant companies to be used as a conduit for extracting profits from the UK without paying tax. That is by far the greater danger to the corporate tax base, in that it would be possible for a group to transfer income-generating assets to a company and then allow that company to become dormant. Such planning cannot be done if the exemption is limited to companies that are dormant at 1 April 2004. I am sure that neither hon. Gentleman needs to engage in a leap of the imagination to understand that the opportunity to create dormant companies at any time would also create the opportunity to extract profits from the UK without paying tax in the UK.

John Burnett (Liberal Democrat, Torridge and West Devon)

I think I referred the Paymaster General to the fact that the problem of loss to the Exchequer resulting from use of a post-31 March 2004 dormant company could be avoided if the Government were to introduce a clearance procedure as a precondition for exemption of newly dormant companies.

Dawn Primarolo (Labour, Bristol South)

This is the problem. Groups might be able to use insolvent companies as a means of washing out tax liabilities in the same way as for companies that became dormant. That is a real problem. I find it a little odd that, in a situation in which there is such a risk to the corporate tax base, the hon. Gentleman, who normally impresses on the Government that they should aim for simplicity and not add complexity, seeks to put more layers into the tax system in order to prevent what he knows will happen without that protection. It seems better not to provide the opportunity in the first place.

The Government's proposals provide that companies that are dormant on 1 April 2004, but not those that subsequently become dormant, satisfy the two constraints that I have identified. The hon. Member for Hertford and Stortford suggested that a reserve power in the amendment might be able to be operated. That is not a practical alternative. A dormant company is not required to provide a return to the Inland Revenue. It would be impossible to police any special rules using a reserve power because the Inland Revenue would never see the information in the first place, unless—this is not provided for in the Bill—we had another battery of arrangements to

specify when and how it should be notified. We would require all that because, as the hon. Gentleman recognises, there is the potential for dormants to be used to extract profit. It seems much more sensible not to provide the opportunity in the first place.

Mark Prisk (Conservative, Hertford and Stortford)

I fully appreciate what the Paymaster General is saying, although the call is perhaps slightly closer than she suggests. Inevitably, a number of innocent enterprises will be caught. Was any consideration given, before the legislation was prepared, to making the date 1 May, or even 1 June? In other words, does she recognise that the sudden cut-off—there is no time gap: the Bill was published seven days after the date we are discussing—made it very difficult for any enterprise, however innocent, to take advantage of the provision?

Dawn Primarolo (Labour, Bristol South)

We are not talking about innocents—we are talking about using dormant companies to extract profit without paying tax. Any delay or any period that opened up the possibility of removing profit and therefore escaping UK tax would not be acceptable.

All these routes lead to mischief, not to a practical reason why what the hon. Gentleman proposes is necessary. Why would we knowingly allow in the system an opportunity for mischief and then say, ''Well, we hope that you won't undertake this mischief, but just in case you do we're going to do X, Y and Z''? Why would we have even more complicated rules when hon. Members have already rightly pointed out, only two clauses into this chapter, how complex transfer pricing is in the first place?

The problem with the measure being triggered, as the hon. Gentleman would like, by some sort of reserve power, is deciding when that reserve power would be used. Would it be used only when the Revenue believed mischief was being undertaken? Given that the Board would identify any such practice as mischief, we come back to the same argument. Even if the Government were prepared to allow it, which we are not, there would be huge difficulty in drawing the distinction between cross-border and UK. The uncertainty—the very thing that we are designing out of the system in response to business—would be reinserted in a different dimension with a different set of rules.

The hon. Gentleman has not made a case for the necessity of his proposal. What business function does it provide for? We dealt with dormants in a certain way up until 1 April 2004. There would have been administrative pressure where the companies were dormant, and we were responding to business and trying to be helpful.

The question of insolvency is very important. Insolvency rules serve to protect the position of creditors and other interested parties when a company becomes insolvent. Insolvency is not a reason to relieve a company of transfer pricing requirements; the reverse should be true. Transfer pricing requirements ensure that the transactions between associated enterprises are priced on an arm's-length basis for tax purposes. If insolvent companies within a group were removed from

transfer pricing requirements, which is what the hon. Gentleman seeks to do through his amendments, there would be opportunities for the group to use them to reduce taxable profits in the UK. As a Minister, I am not prepared to allow the Exchequer risk that goes with that.

I understand the importance of the questions around dormant companies. In the clause, we have responded very positively to business by making sensible arrangements up to 1 April 2004. I am not prepared to take the next step that the hon. Gentleman suggests I might consider, which would be to leave a gap in the rules with the possibility of profit being extracted and escaping UK tax. That is not acceptable, so I hope that he now understands why we chose the dates that we did, and on that basis will refrain from pressing his amendments. If he does not, I will ask my hon. Friends to oppose them should there be a Division.

Mark Prisk (Conservative, Hertford and Stortford)

We have had a useful discussion on an essential element of the rules. I concur with the Paymaster General that certainty is crucial, but I am not clear that the date chosen was the best date for the benefit of business. The debate about amendments Nos. 9 and 10 revealed that the Minister assumed that all business activity in that area is mischief. That is an unfortunate assumption. I understand that it might be the case—who knows, were I to be in her position, I might come to that view. However, it is not the right view.

I accept that lines have to be drawn, but the danger is that that assumption is more revealing about the Government's position on tax avoidance and their confusion between avoidance and evasion than about anything else. However, I stated that the proposals were probing, and I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Prisk (Conservative, Hertford and Stortford)

I beg to move amendment No. 11, in

clause 31, page 29, leave out lines 7 to 13.

This probing amendment is essentially about time. The definitions of small enterprise and medium-sized enterprise should be determined by the results of the prior period rather than by reference to the chargeable period in question.

Under the drafting of paragraph 5D of schedule 28AA to the Taxes Act 1988, the definitions of small and of medium-sized enterprises in the Commission's recommendation are amended for the purposes of the rules so that the various tests are applied by reference to the chargeable period in question and not by reference to a prior period.

I am sure that there are many circumstances that Committee members can remember when companies in their constituencies crossed that threshold in the course of an accounting period. Companies may not be aware that they need to maintain the relevant records in preparing documentation on transactions entered into in that period. They will realise that they need to do so in the subsequent period, but perhaps not during that taxable year. That could arise as a

result of the natural growth of the company, but it might be something else—for example, a takeover.

The provisions of new paragraph 5D amend the definition of small and medium-sized enterprises so that they are determined by reference to the chargeable period in question. As I said, the purpose of the amendment is to recognise that potential confusion and remove it from the Bill.

John Burnett (Liberal Democrat, Torridge and West Devon)

I, too, have read the brief on this matter that was produced by the Law Society. It is useful and compelling. To protect revenue and to ensure compliance, we will have to use the immediately prior accounting period, as the hon. Gentleman made clear. To use the rules in the existing paragraph 5 would put taxpayer companies in jeopardy of breaking the law when they do not have any idea that that is what they are doing. Companies grow organically and for other reasons, as has been described. It is fair to taxpayer companies to ensure that they can apply their rules and flag up the problem just after an accounting period has ended.

As the Paymaster General knows, it is important that we have a vibrant corporate and corporation tax system. One of the things that I used to be involved in before coming to the House was the acquisition and sale of companies. Having the rules as the Government have outlined would inhibit such transactions because it would provide another hurdle for the company to overcome and to give warranties over when a share sale is being agreed and transacted.

For simplicity's sake—the Paymaster General has always persuaded me that simplicity is frequently if not invariably important, and I am sympathetic to that idea—it would be wiser to take out paragraph 5, as the amendment would do. It is a case of simplification, it would enable the smooth running of the corporation tax system and it would reduce yet another burden on business.

Dawn Primarolo (Labour, Bristol South)

The clause introduces an exemption for small and medium-sized enterprises in order to ensure that the change in the scope of transfer pricing does not lead to increased regulatory burdens for companies. For that purpose, the legislation draws on an updated European Union definition of small and medium-sized enterprises. The EU definition considers the characteristics of an enterprise in the preceding period to establish whether it is small or medium-sized in the current period.

For the purpose of the clause, however, we need to consider the current period. I want to explain why we need to do that. To do otherwise would create an unacceptable risk of abuse. I have been through the matter in some detail with my officials to ensure that there really is an issue and the requirements are reasonable.

Mark Prisk (Conservative, Hertford and Stortford)

I am sure that the Paymaster General has been assiduous. Could she establish for us the scale of the risk, as it is difficult to judge?

Dawn Primarolo (Labour, Bristol South)

I was going to do that. The first thing that the hon. Gentleman must remember is that transfer pricing involves vast amounts of money that can be moved around within a group. Although I am not able to say to him that the amount would be x—obviously, the amount would depend on how quickly tax planning developed—I wish to explain how transfer pricing works. It really is quite simple and straightforward, and the risk is clear.

A large group of companies might acquire a small company from outside the group. If the exemption remained in place for a further year after the acquisition, the group would be in a position to exploit it by routing transactions through the new company, which would still be treated as a small company under the exemption. The whole point of transfer pricing is to prevent such things from happening. I kept asking my officials whether that would really happen, and they kept saying yes. What is more, with the amount of money at stake being so vast, it would be worth while for a large group to do that to achieve a tax saving.

The existence of the exemption would create a simple means for groups to sidestep transfer pricing rules, at least for that year. Clearly, it would not be acceptable to introduce a weakness into the rules that would provide a vehicle for removing profit without paying tax in the UK. I am sure that the hon. Gentleman would agree with that. As difficult as it may be to accept that such things happen, I assure him that they do. The reason for looking at the current year is that it is important to know the company's position at a given time.

John Burnett (Liberal Democrat, Torridge and West Devon)

How will small companies on the threshold of growth operate under such a system? Will they have to make a monthly check to determine whether they fall within or without the small and medium-sized exemption?

Dawn Primarolo (Labour, Bristol South)

I am grateful to the hon. Gentleman for continuing to anticipate what I am going to say next. I am becoming more and more convinced that he is sitting on the wrong side of the Room. Before I answer his question, does he accept that it would be unfair to other companies that apply the rules and do not seek to indulge in such tax planning to leave that loophole? It would be unacceptable for the Government even to contemplate introducing a set of rules if they knew that such activities were possible.

The hon. Gentleman asked how a small or medium-sized company would know when it crossed the threshold. We will come to that again on later clauses. The Government recognised that changes to record keeping cannot be achieved overnight and provided the temporary relaxation of the penalties for that reason. It is incorrect to suggest that those companies whose financial data show that they are close to the threshold—that they are not miles away—but choose not to account for all their transactions on an arm's-length basis will be caught unawares during an accounting period. Such companies must take account of their forecast growth—and they will—to ensure that their record keeping remains adequate for a whole range of reasons as well as transfer pricing.

They will, therefore, have done so well before the period in which the SME exemption is lost. We shall discuss later the relaxation of the penalties.

The only other possibility, which was touched on by the hon. Member for Hertford and Stortford, is a hostile takeover. Hostile takeovers are not a feature of small and medium-sized enterprises: any takeover would be the result of negotiations over a reasonable period, during which the larger company will have fully acquainted itself with the business it is acquiring. The acquiring group will have acquainted itself fully with the business for a host of tax and non-tax reasons, and that process will include reviewing the appropriate documentation and record-keeping systems required. The position the Government have taken is to strike a fair and reasonable balance in, wherever possible, removing small and medium-sized companies from the provisions by providing exemptions, while not leaving in place a mechanism whereby such companies could be used as a vehicle by larger groups to extract profit from the UK without the payment of UK tax.

Mark Prisk (Conservative, Hertford and Stortford)

The Paymaster General has rightly highlighted the potential risk when a larger company acquires a smaller one for the purposes she describes. However, I referred to another aspect, which is the natural growth of a small company that may find itself tipped over the threshold. Clearly, in that situation no larger company is involved that is seeking to use that acquisition for the purpose of avoiding the rules, as she puts it. Is it not the case that that is a different set of circumstances to the one that she described? The risk that she ascribed to that situation is not appropriate in relation to the natural growth of a small company.

Dawn Primarolo (Labour, Bristol South)

No. The hon. Gentleman perhaps misunderstands my point.

Sitting suspended for a Division in the House.

On resuming—

Dawn Primarolo (Labour, Bristol South)

The hon. Member for Hertford and Stortford asked about companies that tip over the threshold into loss of exemption. We are not discussing tiny companies, and by the time they are moving through the threshold they are substantial in terms of the number of employees, turnover and balance sheet assets. I made the point that with their planning, forecasting and use of data, they will not accidentally trip over that threshold. They will know when they are approaching it, and other issues will arise when moving from being small and medium-sized companies—for instance, the full corporate tax rate will apply. It is not unreasonable to assert that companies will track that closely in their forecasts.

A second point, which goes back to the Government's starting point in their discussions with businesses, is that, at each point, we have attempted to put in a simple arrangement for exemption to enable businesses to deal with the majority problem that has been identified, particularly for small and medium-sized companies. The European Union definition does

not distinguish between growth and takeover. However, it is a widely recognised and very generous identification, and the limit for exemption is likewise generous to companies. Without devoting many pages of legislation to our own definition to address the point, it is simply not possible to make the distinction that the hon. Gentleman is driving at. We have relied on penalties and relaxation of penalties, information given to companies and the transition period, building on what we know companies will already be doing in their growth forecasts. That is the sensible way in which to proceed. As I said in my opening comments, something like 95 per cent. of companies that will be designated as small and medium-sized will be well within the exemption and it will work very well.

Mark Prisk (Conservative, Hertford and Stortford)

I understand the point that the Paymaster General is making in legislation, and that is absolutely right, but it would help those companies—I accept that it will be a small group—that have naturally grown over the threshold and found themselves caught by the problem that I identified in the amendment if she would say that the Revenue would look that with due care and attention. I am talking not about companies that have been taken over by larger companies—the risk that she highlighted earlier was correct—but about those that have grown naturally. If she would confirm that the Revenue will deal with that sensitively and carefully, that would be very persuasive.

Dawn Primarolo (Labour, Bristol South)

The Revenue always deals with transfer pricing matters and any other matter carefully. That is precisely recognised by the clauses on penalties under which there is a relaxation for the transition period. Penalties will not be imposed on record keeping within the limits that we shall discuss when we come to that debate. The balance is already being struck, not only on how the Revenue will respond at the time, but on the preparations that it is making in guidance and the specifics in the clauses to help that transition period for those companies so that everything has been provided for that sensibly could have been provided for, given the balance that we are trying to strike with maximum assistance and minimum requirements across the whole range of companies from micro to multinational to comply with the transfer pricing laws. I am satisfied that that is the best balance that we could achieve.

John Burnett (Liberal Democrat, Torridge and West Devon)

I have had a quick look at clause 33. I do not believe that I am out of order, Sir John, because it is relevant to the point that the hon. Member for Hertford and Stortford is making. The Paymaster General is referring to the transitional period of the Bill. I believe that the hon. Gentleman is saying that there is also a transitional period for a particular company. If a company, during an accounting period, innocently goes over the limit, we hope that the Inland Revenue, in 10 years or whatever, will be relaxed and merciful in relation to penalties and so on.

Dawn Primarolo (Labour, Bristol South)

I am talking about the transitional period that is provided in the clause on penalties, which we shall come to, to give a period for companies to adjust. I have confirmed that the Inland Revenue deals with such matters carefully at present, and if the hon. Gentleman is trying to tease me down the route

of saying that it might relax the transfer pricing rules, the answer is no. If the transfer pricing rules apply, they apply on an arm's-length principle and the company, having crossed the threshold, will be required to comply with them.

The point of the penalties and, therefore, their relaxation for that period is the sensitive approach that the hon. Gentleman is seeking. The transitional period of moving from a small or medium-sized company to a large company is a separate point, and I have already dealt with that. To be honest, I find incredible the hon. Gentleman's suggestion that an already quite large company might not realise that its profit had increased dramatically, it was employing more people and its turnover had greatly increased. Somehow that is supposed to have come as a great surprise, and its forecasts did not show those things. Under those circumstances, I do not see his point.

John Burnett (Liberal Democrat, Torridge and West Devon)

It can happen. Having spent most of my time in the private sector, I know that a company can, completely innocently, and without knowing anything about the transfer pricing regulations, make a bonanza profit in a year and find itself in a vulnerable position.

Dawn Primarolo (Labour, Bristol South)

We are talking about transfer pricing, transfer between companies, and how that profit is moved around within a group. We are not talking about individual companies. We are now moving a long way away from the point, which relates to transfer pricing, the arm's-length principle and ensuring that profit is taxed in the appropriate place. It is not unreasonable, given all the guidance and information that is available—such as the specialist advice those companies will already be receiving from their advisers—to assume that companies know about the transfer pricing requirements. The Government are doing all they can to ease the transition and recognise that we need to provide for it. Exemption from transfer pricing, if it applies, is not one of the exemptions that we are about to provide for.

Mark Prisk (Conservative, Hertford and Stortford)

This has been an instructive and surprisingly extended debate, but nevertheless a useful one. The Paymaster General has been persuasive on the question of takeovers of companies. She rightly highlighted that, and I entirely concur with what she said—without wanting to encroach on the territory of the hon. Member for Torridge and West Devon in making the most ingratiating remarks to a Minister. I am less persuaded of the argument relating to natural growth, but it has been a useful debate.

John Burnett (Liberal Democrat, Torridge and West Devon)

I do not want to extend the debate any longer than usual. I have an up-and-down relationship with the Paymaster General. Sometimes it goes terribly well, and sometimes not quite so well. Does the hon. Gentleman take the point that I made in my last intervention on her, that I was not seeking to avoid the transfer pricing rules coming into play, but the penalty regime? A small group of companies exporting could

make a bonanza profit and fall under the regime. We have to take her point—transfer pricing rules come into play—but what about the penalties? Does the hon. Gentleman agree that an innocent getting into the transfer pricing rules regime should not attract untoward penalties?

Mark Prisk (Conservative, Hertford and Stortford)

I concur with the hon. Gentleman, but we are coming to clause 33, which deals specifically with penalties, and we shall be able to consider that matter more closely. I would not wish to get in the way of the relationship of the Paymaster General and the hon. Gentleman, and we are getting much further away from the issue of transfer pricing than you would like, Sir John. However, having listened to the arguments and learned of the apparent relationships, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the clause stand part of the Bill.

Mark Prisk (Conservative, Hertford and Stortford)

I shall not detain the Committee for very long. I have one simple point that I was not able to raise in the context of an amendment. It relates to the question—and I put in no more strongly than that—whether the clause would adversely affect charities. I suspect that several members of the Committee have received, as I have, representations from charities, including the Charities Tax Reform group. I hope that the Paymaster General will be able to clarify the purpose of the clause in her response, because the concern is that it is in danger of affecting those charities that work in consortiums, purchasing services or using agency personnel. The concern is that in those circumstances they might inadvertently get caught up in the provisions.

I received a very late offer of a potential amendment, but it arrived too late and I was not able to table it. I hope that the Minister will be able to clarify the matter for the peace of mind of those charitable groups concerned.

Dawn Primarolo (Labour, Bristol South)

I am happy to reassure the hon. Gentleman. The Inland Revenue recently issued guidance on the matter, which I hope will set hon. Members' minds at rest. Where a charity is acting in the normal way and pursuing its charitable objectives, it is not acting as an enterprise and so is outside the scope of the transfer pricing rules, which apply only to enterprises.

Only in exceptional circumstances, in which a charity is engaging in commercial activity with a view to profit or gain, would it cross the line and become an enterprise. Re-charging of expenses for the purposes of offsetting costs would not fall into that category. The guidance sets that out in greater detail and it is now available on the Inland Revenue website. I became aware of some concerns yesterday evening, and I hope that that absolute reassurance will put minds at rest. I hope that for those concerned I have provided clarification on the record, and I urge them to see the detail on the website, which they will find very helpful.

Question put and agreed to.

Clause 31 ordered to stand part of the Bill.

Clause 32 - Special applications of paragraph 6 of

Dawn Primarolo (Labour, Bristol South)

I beg to move amendment No. 73, in

clause 32, page 30, line 33, leave out '6(3)(a)' and insert '6(2)(a)'.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss Government amendment No. 74.

Dawn Primarolo (Labour, Bristol South)

The amendments make detailed corrections to the numbering in the clause of two cross-references to existing provisions in the Income and Corporation Taxes Act 1988. The first amendment ensures that the transfer pricing rules work appropriately where trading stock is transferred from one company to an associated person at less than an arm's-length price. The amendment corrects the problem by altering the existing paragraph 6(3)(a) to paragraph 6(2)(a) of schedule 28AA to the 1988 Act, to which new paragraph 6A should have referred.

The second amendment corrects a similar cross-reference to the controlled foreign company rules by changing the reference in new paragraph 6B(1)(c) to section 747(3) of the 1988 Act, which is the relevant part of the controlled foreign company rules.

Unfortunately those errors have only just been identified. They must be corrected in order for the clause to have its intended effect, and I apologise to hon. Members for the need to amend the Bill as published. It needed to be done immediately, as they were straight errors, and I hope that with the indulgence of the Committee the amendments will be accepted.

Mark Prisk (Conservative, Hertford and Stortford)

I accept the Paymaster General's apology. I am sure that errors of that nature do occur, and having examined the potential impact of the amendment prior to our deliberations, we fully accept that the purpose is solely to correct errors.

Amendment agreed to.

Amendment made: No. 74, in

clause 32, page 31, line 12, leave out '747(4)' and insert '747(3)'.—[Dawn Primarolo.]

Clause 32, as amended, ordered to stand part of the Bill.

Clause 33 - Provision not at arm's length:

John Butterfill (Conservative, Bournemouth West)

Order. The hon. Gentleman was slow to rise, and we nearly agreed to the clause formally. I do not have supernatural powers and I cannot anticipate what people want to do unless they indicate it to me.

Question proposed, That the clause stand part of the Bill.

Mark Prisk (Conservative, Hertford and Stortford)

Thank you, Sir John. You can see why I would not make a good contestant on ''University Challenge''—my starter for 10 would obviously not make it at all.

Steve Pound (Labour, Ealing North)

That is only one reason.

Mark Prisk (Conservative, Hertford and Stortford)

I thank the hon. Gentleman for highlighting many of my failings. He is very kind.

Clause 33 relates to what we were discussing earlier regarding those affected, and the temporary relaxation of penalty liabilities. During the consultation on the issue—it is fair to say that it was a thorough consultation—everybody accepted that the relaxation identified here was welcome. We certainly add our support to that.

The crucial requirement here is for clarity. The Paymaster General rightly highlighted the need for clarity in previous debates. Although much of the clause is somewhat convoluted, there is one particular aspect that I would appreciate her confirmation of. After several attempts to read it, I am still unclear about what it means. I refer to subsection (2). It starts:

''In this section 'records relating to an arm's length provision' means such records as might have been requisite for the purpose of making and delivering a correct and complete return,''

which may seem clear, but it goes on:

''so far as relating to the determination of the provision asserted to be the arm's length provision for the purposes of Schedule 28AA to the Taxes Act 1988 in a case where that Schedule applies.''

I confess that, having read that for the eighth time, I am not entirely sure that I am any clearer about what it means. I would appreciate it if the Paymaster General could guide us through that. If the clause is to provide any benefit, it must be crystal clear. The question as to which documents and records are included must be clear. Given that, and given the related information offered in the guidance to taxpayers, will she put firmly on the record which documents are included and which are not?

John Burnett (Liberal Democrat, Torridge and West Devon)

I repeat the point that I made earlier. I stress to the Paymaster General that I do not want companies to avoid the transfer pricing rules, but if a company innocently goes over the threshold into the large company regime, and for various reasons—it may not have much experience or it may be an international trading group that has a bonanza profit in one year that takes it over the threshold—I hope that the Inland Revenue would, to use the words that I used earlier, be merciful and mitigate the penalties.

I have also had a submission from the Confederation of British Industry, which says:

''The transitional period to April 2006 only provides for the remission of penalties arising from inadequate records, and not for any other reason. The Inland Revenue Technical Note published with the Autumn 2003 Pre-Budget report said that the transitional rules 'are designed to give businesses more time to develop an understanding of transfer pricing requirements, and to adopt appropriate systems, before being exposed to penalties for failure to do so.' The remission of penalties for inadequate records only would not achieve this. A general remission of penalties is needed if the introduction of the new regime is not to place unreasonable burdens on taxpayers, particularly those mainly UK larger businesses, such as retailers, which have had little or no experience of transfer pricing issues to date.''

I had hoped to hear from the Paymaster General on both the former and latter points. On the former, I am not trying to wriggle out of the transfer pricing rules. I am just asking whether the Revenue will mitigate the penalties regime in relation to a company that quite

innocently goes over the threshold into the larger company regime for transfer pricing.

Dawn Primarolo (Labour, Bristol South)

The clause introduces a temporary waiver of penalties for inadequate documentation of transfer pricing for the tax years 2004–05 and 2005–06. As we have discussed, the transfer pricing rules were the most straightforward way to address current uncertainty for business. However, we recognise that it will take some businesses some time to adapt their record keeping fully to the new rules. I think that the hon. Gentleman would agree that the penalty waiver is a pragmatic measure to ensure that businesses have the time that they need to change their systems, and to minimise compliance costs.

The relaxation of the penalty regime for a transitional period of two years will give businesses time to adjust to the new rules. It will apply to all businesses, large and small, and to all transactions, cross-border and domestic. During this period, businesses will not be exposed to the risk of penalties for failing to keep records that demonstrate that results are arm's-length results for transfer pricing purposes.

Of course, businesses still need to make a reasonable attempt to establish an arm's-length result for transactions with connected businesses. Businesses can use the information currently available to them to meet the requirement from the start. However, as I have said, we recognise that it will take time to adapt the record-keeping systems to the new rules, which is why we are making provisions in this area. In effect, the penalty rules will not apply automatically; the Inland Revenue will investigate and use its discretion. In applying that discretion, the Inland Revenue will take account of the circumstances, including any mitigating circumstances. That is the point that the hon. Gentleman was pressing me on earlier.

We want to be reasonable. At the end of the two years—at the end of the 2005–06 period—we want the transition to be made in the best way and the transfer pricing rules to run smoothly. That is our aim. In getting there, the Revenue will take mitigating circumstances into account. The records to be included are those that demonstrate that a price is arm's length. The Inland Revenue will not be prescriptive about the precise nature of the records. They are simply to establish the arm's-length price.

I hope that the hon. Gentleman can see that there is a generous relaxation across the board with regard to the penalty regime. In the transition period, businesses will not be exposed to the risk of penalty for failing to keep records that demonstrate that the results are at arm's length for the transfer pricing. That is an important point, and I hope that my response satisfies the Committee.

John Burnett (Liberal Democrat, Torridge and West Devon)

I hope that I heard the Paymaster General correctly. Did she say that, after the two-year period is over, the Revenue will take account of mitigating factors when it applies the penalty regime? My experience has been mainly with small and

medium-sized companies, and I know that she is conscious of the fact that such companies do not have the in-house expertise that larger companies have.

Dawn Primarolo (Labour, Bristol South)

I can confirm that Revenue discretion is always a feature of penalties, regardless of this clause, and there will be an additional waiver of penalties for record keeping during the transitional period. We are strengthening that and including additional provisions to respond to the points made in both this and previous debates. I hope that that satisfies the Committee, and I stress again that the Revenue will take the appropriate and understanding approach that I have outlined.

Question put and agreed to.

Clause 33 ordered to stand part of the Bill.

Clause 34 - Payments of excessive interest etc

Mark Prisk (Conservative, Hertford and Stortford)

I beg to move amendment No. 12, in

clause 34, page 35, line 29, at end insert—

'(fa) in sub-paragraph (4)(c) after ''would apart from section 84A(2) to (10) of this Act'' insert ''and disregarding any adjustment which might otherwise arise under the provisions of this paragraph''.'.

This is a probing amendment to deal with an anomaly concerning intra-group loans. It was tabled with the support of both the Law Society and the Chartered Institute of Taxation. The effect of subsection (4), which is an integral part of the clause, is that, when an intra-group loan is made on an interest-free basis, no exchange gains or losses will be disregarded on the debtor or creditor loan relationship. In many people's opinion, that does not go far enough, because it does not deal with cases in which an intra-group loan is advanced on interest-bearing terms to enable the borrower to obtain the benefit of matching treatment.

When the loan is treated as matched in such circumstances, there is nothing to prevent all or some of the exchange gains or losses from being ignored for tax purposes. Paragraph 11A(4)(c) and (5)(c) of schedule 9 to the Finance Act 1996 currently provides that no adjustment would arise on the exchange gains or losses when—this is the important point—there is a corresponding debt loan relationship and exchanged gains and losses are taken into account.

In plain English, the problem arises when the borrowing exceeds the amount that the borrower could have borrowed if it were dealing at arm's length and the loan were interest bearing. In those cases, but for matching treatment, an adjustment would arise on the borrower by virtue of the amended provisions in paragraph 11A(4)(c) and (5)(c). There is nothing to prevent an adjustment from arising under that paragraph. The danger is that that would leave the lender of the intra-group loan exposed to tax on, for example, exchange movements when it borrows in a foreign currency and on-lends an equivalent amount in foreign currency to a thinly capitalised UK subsidiary in order to finance the acquisition of that subsidiary.

The amendment is designed to draw from the Paymaster General the reasoning behind the

Government's decision and to deal with the anomaly that I have tried to explain. It is a complex issue and relates to different parts of legislation. It matters simply because many UK companies are increasingly and regularly investing overseas. The purpose of the amendment is to remove the anomaly that could prove to be a barrier to that. I hope that the Paymaster General can enlighten us on the thinking that the Government have applied to the measure.

Dawn Primarolo (Labour, Bristol South)

I certainly do not want the hon. Gentleman to labour under any misunderstandings about the Government's approach to matching. We agree with him that the matching principle for exchange gains and losses should be preserved. To see that, he need look only at the Finance Act 2002, in which the Government strengthened the matching rules to allow more assets to be matched. We included in that Act paragraph 11A of schedule 9 to the Finance Act 1996 to ensure that transfer pricing and thin capitalisation considerations did not prevent matching from working. The matching arrangements that we are dealing with, and which his party introduced in 1993, are about interest-free loans between two companies in the same group. Our changes in 2002 preserved those arrangements, and nothing in the Bill or the transfer pricing proposals changes any of that.

The Inland Revenue has been asked about this issue repeatedly and has published guidance on its website. It has explained the position to the firms that have asked, and the position is clear. If the loan is interest-free, there is no change. If interest is charged on the loan at the arm's-length rate, there is no change. Only if for some reason interest is charged at an excessive rate might there be an issue. That was the case under the thin capitalisation rules, too. We are dealing with a clause that is taking out thin capitalisation and putting the same arrangements within transfer pricing.

I hope that, with all those assurances, the hon. Gentleman will see that the amendment is unnecessary, because the matter is dealt with to ensure that groups are still able to match.

Mark Prisk (Conservative, Hertford and Stortford)

The Paymaster General has moved us an important step forward. Can she just clarify what ''excessive rate'' means? That is not simply a point of parliamentary pedantry; it is an important point for those seeking to understand the intention of the legislation.

Dawn Primarolo (Labour, Bristol South)

The thin capitalisation rules disallowed excessive interest paid between companies in the same group if the amount of the loan exceeded the amount that could have been borrowed from an unconnected lender, or if the rate of interest were too high. Those rules have been in operation for some time, and companies' understanding of what is meant by ''excessive'' will still apply. Even if interest is charged at an excessive rate within the understood operation of the thin capitalisation rules, if the group as a whole could have coped with that amount of interest, the guaranteed rules that we have introduced may apply to remove the problem. Nothing really changes. The position is the same as it would have been under the thin capitalisation proposals. The

clause puts in place within transfer pricing the ability to deal with such loans.

John Burnett (Liberal Democrat, Torridge and West Devon)

It is a double-edged sword. I just wonder whether the Paymaster General will put on the record the fact that, presumably, if the matching rules are breached or if matching is not permitted for the reasons that she has set out, and if there are exchange rate losses rather than gains, they can be set against corporation tax.

Dawn Primarolo (Labour, Bristol South)

The hon. Gentleman tempts me into the incredibly complex area of transfer pricing. I want to focus his attention on the provisions in the clause, which will enable the group to match transactions so that its exchange gains and losses cancel each other. The rules work perfectly well now and will work perfectly well in the new environment of UK-UK transfer pricing if interest-free loans are involved. The Government sought to make no changes in their operation. I shall reflect on the issue that he raised in the more detailed question and perhaps, with your leave, Sir John, write to him and to other members of the Committee if I feel that I have not given a complete answer.

Mark Prisk (Conservative, Hertford and Stortford)

We have had a useful exchange, as several areas, not least that of excessive rates, were not clear to me and to some outside bodies that are affected.

John Burnett (Liberal Democrat, Torridge and West Devon)

Would the hon. Gentleman also be interested in knowing the answer to the question that I asked on exchange rate losses being set against corporation tax?

Dawn Primarolo (Labour, Bristol South)

I replied to it.

John Burnett (Liberal Democrat, Torridge and West Devon)

That is fine.

Mark Prisk (Conservative, Hertford and Stortford)

I am not entirely sure whether I should comment on that intervention. Clearly, there is a web of relationships into which it would be better for us not to pry further. As I was about to say, given the discussion—indeed, the exchange—I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the clause stand part of the Bill.

Mark Prisk (Conservative, Hertford and Stortford)

The clause deals with thin capitalisation and how it is incorporated in general transfer pricing requirements. We discussed under earlier clauses some of the broader issues that affect both transfer pricing and thin capitalisation, but there are a few points for clarification and information that may be helpful to the Committee, if the Minister can assist. The Institute of Chartered Accountants, among others, asked why in subsection (3) no account is taken of a guarantee if the guarantee is made on commercial terms; that is, the guarantor receives a fee in the same way that a bank might. Was that an intentional change, or does the Paymaster General recognise that it is an oversight? If it is an oversight, does she intend to amend it at a later stage?

Several legal experts have asked about the possibility for elections to be made prior to the submission of corporate tax returns. The Paymaster

General may wish to reflect on that after our deliberations. Such a change would enable rating agencies to rate the issuing company on the same basis as the election. I believe that we all appreciate the important role that rating agencies play and therefore that when they undertake their task they should be able to make their consideration on the same basis as an impending election for an issuing company.

There are some problems with inconsistent language in subsection (3) on page 33. There is a reference to ''security'' on line 5 of new paragraph 1A but to ''the loan'' on line 9. The language is inconsistent. Some people would argue that the word ''security'' is inappropriate. Some outside experts have suggested that ''money debt'' might be a more appropriate phrase; I confess that that area is on the very edge of my understanding. I am led to understand that that is an important distinction, so perhaps the Minister could clarify that.

Lastly, I turn to subsection (4), on page 33. I shall not detain the Committee by reading out the relevant sub-paragraph at length—[Interruption.] Well, I may be tempted. The problem is that it is unclear generally, but there is a particular, important aspect of its lack of clarity, and that is whether it is concerned with a single company or a sub-group. I am sure that the Committee would appreciate it if the Minister could clarify that.

Dawn Primarolo (Labour, Bristol South)

First, perhaps the questions of early election before a return is submitted would be more appropriately dealt with on clause 36, which has to do with elections. I think that we shall find it easier to deal with the matter in that context, and I am happy to come back to it.

The hon. Gentleman asked whether the guarantor receives the same fee. That would undermine the effect of the thin capitalisation rule. A foreign-owned company could support a large amount of debt in a UK subsidiary through a guarantee, and the role of the thin capitalisation rule is to restrict interest deduction in line with the debt that the borrower could support through its own income and assets, not those of the entire group. The clause makes changes to the thin capitalisation rules that run parallel with the changes made to transfer pricing. The existing thin capitalisation rule is repealed and its equivalent is brought into the main transfer pricing framework. Consequently, as for other aspects of transfer pricing, the rules will apply to transactions wholly within the UK.

Thin capitalisation rules deal with a particular aspect of transfer pricing. As we discussed earlier, they exist to prevent companies from reducing taxable profits unfairly by means of excessive interest deductions. To do that, they deny interest deductions on loans to the extent that they exceed the amount that the company would borrow from, or would have paid in interest to, an unconnected lender. That approach is consistent with the arm's-length principle that forms the basis for transfer pricing legislation and bilateral tax treaties. It is therefore appropriate that thin capitalisation should be dealt with alongside transfer

pricing and to do that, the clause introduces two new paragraphs to the transfer pricing rules.

Those changes have been made following intensive consultation. Many features of the legislation follow directly from representations made during that process, and I am grateful to those who participated. In particular, there is a special rule to give a compensation adjustment to a loan guarantor, in clause 35, and a special rule to meet the particular needs of securitisations, which the hon. Gentleman touched on, in clause 36.

The loan guarantee rule provides a strong and necessary defence against dumping of excessive debt in the UK. At the same time, the compensating adjustment rule for loan guarantors ensures fairness and allows existing financial structures to remain undisturbed. For inward investment, it will ensure that all UK assets and income are taken into account in the determination. The clause is fairly based on practices, so I hope that I have dealt with the hon. Gentleman's queries. Perhaps we can pick up on his other points as we move onto clauses 35 and 36.

Question put and agreed to.

Clause 34 ordered to stand part of the Bill.

Clause 35 - Elimination of double counting etc

Dawn Primarolo (Labour, Bristol South)

I beg to move amendment No. 75, in

clause 35, page 36, line 1, leave out first 'paragraph' and insert 'Schedule'.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss Government amendments Nos. 76 to 78.

Dawn Primarolo (Labour, Bristol South)

Briefly, the amendments make detailed corrections to the clause to correct errors noticed since the Bill was published and to ensure that the clause has the intended effect. Amendments Nos. 75, 77 and 78 ensure that the definition of a paragraph 6C claim applies for the purposes of schedule 28AA as a whole. They correct the mechanism that allows lenders to make early claims for gross payment of interest. The correction is no more than a matter of terminology.

Amendment No. 76 corrects a detailed cross-reference. It inserts a cross-reference into a rule that will allow a company to make a late claim to a compensating adjustment when the need arises. That is part of ensuring that the extension of transfer pricing rules does not lead to double taxation.

I apologise to the Committee for the need to make the corrections, but they have been identified since the Bill's publication, and they will enable it to operate as intended. I commend them to the Committee.

Mark Prisk (Conservative, Hertford and Stortford)

I welcome the amendments. It is quite clear that they are intended to correct errors in the body of the legislation. Accordingly, we have no objections to them.

Amendment agreed to.

Amendments made: No. 76, in

clause 35, page 36, line 15, leave out

'109(3)(b) of the Taxes Act 1988'

and insert

'111(3)(b) of the Finance Act 1998'.

No. 77, in

clause 35, page 39, line 4, leave out 'or 6C above' and insert

'above or a paragraph 6C claim'.

No. 78, in

clause 35, page 39, line 8, at end insert—

'(5) In paragraph 14(1) (general interpretation) insert the following definition at the appropriate place—

'' ''paragraph 6C claim'' has the meaning given by paragraph 6C(2) above;''.'.—[Dawn Primarolo.]

Clause 35, as amended, ordered to stand part of the Bill.

Clause 36 - Balancing payments and elections to

Dawn Primarolo (Labour, Bristol South)

I beg to move amendment No. 79, in

clause 36, page 39, line 18, leave out

'issued by the advantaged person'.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss the following amendments: No. 13, in

clause 36, page 39, line 19, leave out 'The disadvantaged person' and insert

'Any company other than the advantaged person (''the electing company'')'.

No. 14, in

clause 36, page 39, line 20, leave out

'condition in sub-paragraph (3) below is'

and insert

'conditions in both of sub-paragraph (3) and sub-paragraph (3A) below are'.

No. 15, in

clause 36, page 39, line 22, after 'condition', insert 'in this sub-paragraph'.

No. 16, in

clause 36, page 39, line 31, at end insert—

'(3A) The condition in this sub-paragraph is that arrangements are made by the electing company for securing the payment of any tax which, but for the election under this paragraph, would have been payable by the advantaged person in respect of the application of paragraph 1(2) above in relation to the relevant security by virtue of paragraph 1A above and those arrangements are approved by the Board for the purposes of this paragraph.

(3B) If any information furnished by the electing company for the purpose of securing the approval of the Board under sub-paragraph (3A) above does not fully and accurately describe all the facts and considerations material for the decision of the Board under that sub-paragraph, any resulting approval of the Board shall be void.'.

No. 17, in

clause 36, page 39, line 33, leave out 'the disadvantaged person'.

No. 18, in

clause 36, page 39, line 34, after '(a)', insert 'the disadvantaged person'.

No. 19, in

clause 36, page 39, line 36, leave out 'a chargeable period' and insert

'any chargeable period ending on or after the date of the election'.

No. 20, in

clause 36, page 39, line 38, after 'instead', insert 'the electing company'.

No. 21, in

clause 36, page 39, line 39, leave out 'that period' and insert

'any chargeable period ending on or after the date of the election'.

No. 22, in

clause 36, page 40, line 1, leave out 'disadvantaged person' and insert 'electing company'.

No. 23, in

clause 36, page 40, leave out lines 7 to 10 and insert—

'(aa) must be made no later than twelve months from the end of the chargeable period in which the relevant security is issued.'.

No. 24, in

clause 36, page 40, leave out lines 18 to 23.

Dawn Primarolo (Labour, Bristol South)

I will briefly introduce amendment No. 79, but I will not talk about amendments Nos. 13 to 24 until the hon. Member for Hertford and Stortford has had the opportunity to speak to them.

Amendment No. 79 extends the range of circumstances in which a special provision for securitisation may apply. As drafted, the Bill allows the securitisation rule to apply only where a transfer pricing adjustment is made to a company that is a borrower of a loan. The amendment allows the rule to apply whether the adjustment is made to a lender or a borrower. All the other conditions for the application of the rule remain the same. The amendment is being made following representations made since the Bill's publication which argued that there are circumstances in which transfer pricing potentially applies to a lender in the context of a securitisation, and that that might affect the rating of bonds issued under securitisation. The amendment will allow the special rule to apply in all circumstances, subject to the other conditions that are set out in the clause being met.

The Government consulted widely with the City before publication of the Bill, but other specialist representative groups made points following publication; hence the need for the amendment. I hope that the Committee will agree that it is a sensible solution and will support it.

Mark Prisk (Conservative, Hertford and Stortford)

I would welcome your guidance, Sir John, on whether I am correct in assuming that in addressing amendments Nos. 13 to 24, which overlap with the Government's amendment, I can respond to some of the points made by the Paymaster General.

John Butterfill (Conservative, Bournemouth West)

Absolutely. The proposal is that we should debate the Government amendment together with the hon. Gentleman's amendments, because they apply to the same issue. It would, of course, be possible to have a separate vote should the hon. Gentleman so wish.

Mark Prisk (Conservative, Hertford and Stortford)

Thank you, Sir John. I asked because, in considering a number of linked amendments, we might stray beyond the scope of Government amendment No. 79, although securitisation and ratings are at the heart of the matter.

The neatest way to summarise the amendments is to say that their aim is to help the clause to achieve its purpose. They may overlap with the Government amendment, which has a similarly benign intention, but that will help us to draw out the meaning behind the clause. I take the point that the question raised in a previous deliberation about the interplay between securitisation and rating agencies is more appropriate to this discussion.

The securitisation market, to which the amendments refer, lays great emphasis on ratings given to securitisation and debt by rating agencies. I mentioned those earlier. The agencies have stringent requirements regarding the creditworthiness of the securitisation structure. If the new transfer pricing regime applied in full to companies within securitisation structures, there would be a risk that one or more of the companies concerned might not obtain tax relief for all interest payments. That would have an adverse effect on such things as cash flow. The existence of such a risk would have to be reflected in the legal opinions given to the rating agencies, and that might result in a downgrading of the securitisation debt.

The amendments deal with linked concerns arising from the current provisions relating to elections under new paragraph 7B. The election referred to in that paragraph is available only to the disadvantaged person, and part of that issue is addressed by the Government amendment. The disadvantaged person is a related person who is also involved in the transaction and is subject to UK tax in relation to it. Securitisation structures typically involve a group of companies, each of which has a specific role within the group. Limiting the election to the disadvantaged person might mean that the tax cannot be borne by the appropriate company within the group. The election should be capable of being made by any person, not just the disadvantaged person, with the important condition that the Inland Revenue is satisfied that the electing company will be in a position to meet the relevant tax liabilities; hence one of the amendments.

The election is capable of being revoked by the Revenue on notice, subject, of course, to paragraph 7. No time limit is imposed on the Revenue's ability to give such notice, and its right of revocation could be problematic in some cases, because the rating agencies will assume that the election is revoked and that some of the interest on the securitisation debt is not deductible. Part of the intention of the amendments is to try to ensure that groups are able to enter into arrangements with the Revenue with the result that the securitisation group is removed for all time from its liability under the transfer pricing rules. That would enable the Revenue to review the proposals in advance, but there would not be the risk of an election being revoked respectively.

Finally, an election under new paragraph 7B will be included in the tax return of the company making it for the tax accounting period in which the debt is issued. That could leave a period between a debt being issued and the return being made in which there is no

certainty that the election would be made. That happens sometimes, and it is a risk factor that rating agencies would need to take into account. One of the purposes of the amendments is to enable those elections to be made prior to the submission of the corporation tax return.

I fully understand that the Government amendment, which I saw after tabling my amendments, relates particularly to the question of advantaged or disadvantaged people. I welcome the Minister's comments on that. That in essence is the subject of the amendments—I say that having taken so long to explain them.

John Burnett (Liberal Democrat, Torridge and West Devon)

I think that the debate can be distilled to a relatively straightforward point. The rating agencies, which are crucial in these matters—

Sitting suspended for a Division in the House.

On resuming—

John Burnett (Liberal Democrat, Torridge and West Devon)

I was saying that rating agencies in the securitisation market want certainty. The Paymaster General is aware how important these transactions are to the economy and that we want to make Britain the home for as many of them as possible.

I shall dwell briefly on the three simple points made by the hon. Member for Hertford and Stortford. First, the election provision is in clause 36(2). Limiting the election to the disadvantaged person may mean that the tax cannot be borne by the appropriate company. I am sure that the Paymaster General will concede that that is unfortunate, given that certainty is very important at the start of these transactions, for the reasons I gave earlier.

Secondly, clause 36(7) states:

''An election under this paragraph by a person is of no effect if the Board give that person a notice under this sub-paragraph refusing to accept the election.''

It is a fairly simple point, balancing up the taxpayer's position; no time limit is imposed on the Inland Revenue's ability to give such a notice. Surely, there should be a time limit on the Inland Revenue for the purposes of certainty and in the interests of a fair and equitable tax system.

Thirdly, the hon. Gentleman made the point that the elections under new paragraph 7B are to be included in the tax return of the company making it for the tax accounting period in which the securitisation debt is issued. That will leave a period between issue of the securitisation debt and making a return when there is not complete certainty that the election will be made. That third point is, again, an issue of certainty. I hope that the Paymaster General will consider the important amendments suggested by the Law Society, in the interests of fairness to the taxpayers and in the interests of our economy.

Dawn Primarolo (Labour, Bristol South)

In response to the hon. Member for Hertford and Stortford's amendments and to the three points made by him and the hon. Member for Torridge and West Devon, I have to say that the amendments would alter the way in which the rules

dealing with a special case of securitisation finance worked. In short, where the effect of transfer pricing is to move tax liability from company A to company B, the Bill will allow an election to be made to transfer the tax liability from B back to A. The amendments would allow a group of companies to take a tax liability that had moved from company A to company B and move it to a third company, C. There is no need for such a change. By moving a tax liability back to where it came from, the rule will enable the impact of transfer pricing to be negated within the securitisation structure. It is not necessary to go further than that and to allow tax liabilities to be moved at a group's discretion.

Secondly, the amendments would also remove the Inland Revenue's right of refusal of an election into the scope of the special rule.

John Burnett (Liberal Democrat, Torridge and West Devon)

Before the Paymaster General goes on to the second point, may I just say that I cannot see what the problem is with the first amendment? The Revenue will get the money and the fact is that it will not allow an election and that provisions can be drawn in if there is any risk that the third company will not pay the tax. If the Revenue is going to get the tax anyway, why bother? Why is the Inland Revenue concerned?

Dawn Primarolo (Labour, Bristol South)

There is simply no need for such arrangements. As I explained to the hon. Gentleman, there is no need within the questions of securitisation raised by the clause to make arrangements to move tax liabilities to a third company. There is no need for such a change, so why make it? That is what I have been trying to make clear to the hon. Gentleman. No case has been made as to why it would be necessary to go further and to allow the tax liabilities to be moved at the group's discretion. That is how the transfer pricing rules have operated before and that is how we intend to proceed now.

Secondly, the amendments would remove the Inland Revenue's right of refusal of an election into the scope of the special rule, and so remove an important safeguard against abuse of the election. That safeguard is necessary in transferring thin capitalisation rules by taking them out and by using transfer pricing and the special provisions from the Bill for securitisation. No case has been made as to why this or the earlier amendment concerning moving to company C should be allowed. Nobody else has that provision; why should it be necessary in this case?

Thirdly, the amendments propose an election that can be made and accepted by the Revenue after a loan has been issued, but before the tax return is made. Again, the amendments are not necessary. The election to opt into the special securitisation arrangements is automatically effective unless the Revenue opposes it. It concerns the tax liability for a return period and so it is appropriate that it is made on a return. It is effective for the entire lifetime of the loan or loans to which it relates. It is sensible.

The Revenue has published draft guidance on circumstances in which it might refuse an election. They are circumstances in which the arrangements are a sham or might lead to loss of tax. In other cases, I

can confirm that the Revenue will discuss prospective arrangements with the group and will give a reassurance where possible that an election will not be opposed. Therefore amendments Nos. 13 to 24 are not necessary: some are undesirable and others are unjustified. If the hon. Member for Hertford and Stortford decides to push his amendments to a Division, I will ask my hon. Friends to oppose them.

John Burnett (Liberal Democrat, Torridge and West Devon)

I shall endeavour to pick up the challenge on clause 36(2) and who can make the appropriate election. These transactions are often complex and often involve groups of companies. The answer to the Paymaster General's question is that if one has a group of companies one wants an election to be made by the company that will bear the tax. There is no reason why that should not be possible. Provided that the company is in a position to meet those tax liabilities, the Revenue has nothing to lose. These matters are complex. The corporate structures themselves are complex. A little bit of flexibility is being requested to enable the market to function more satisfactorily.

Dawn Primarolo (Labour, Bristol South)

I do not agree with the hon. Gentleman. He still has not made the case. The Bill will put tax liability back where it would be in the absence of the transfer pricing rules. That is sufficient to ensure that transfer pricing changes do not adversely affect securitisation. There is no need to go any further, as the amendment seeks to do, which is why I ask the Committee to reject it.

Mark Prisk (Conservative, Hertford and Stortford)

It has been useful to table these probing amendments to try to elicit from the Minister a greater understanding of the Government's thinking. The benefits that might accrue in these circumstances are limited. The hon. Member for Torridge and West Devon has rightly added to the issue by trying to tease that out. While I understand that in one or two circumstances there is a legitimate risk about which the Revenue may have concerns, I am not entirely convinced by the Minister's argument as to the distinction between disadvantaged and other parties being able to participate or about the potential retrospectivity of the elections being revoked. That is a cause for concern.

This will be only the beginning of the debate on the securitisation. The Minister has not responded thoroughly enough to the wrinkles and problems addressed by the amendments, but they are probing amendments and I will not press them to a vote.

Amendment agreed to.

Dawn Primarolo (Labour, Bristol South)

I beg to move amendment No. 80, in

clause 36, page 41, line 14, at end add—

'(4) After paragraph 7C insert—

''Guarantees etc: election to discharge tax liability instead of making balancing payments

7D (1) This paragraph applies where the following conditions are satisfied—

(a) both of the affected persons are companies,

(b) the circumstances are as described in paragraph 6(1) above,

(c) the actual provision falls within paragraph 1B(1) above.

(2) Sub-paragraphs (2) to (8) of paragraph 7B above apply in a case where this paragraph applies as they apply in a case where that paragraph applies, but with the modifications in sub-paragraphs (3) and (4) below.

(3) The relevant security is the security in paragraph 1B(1)(a) above.

(4) In sub-paragraph (4) (nature of the election)—

(a) for ''paragraph 7A above'' substitute ''paragraph 7C below'';

(b) for ''paragraph 1A'', in both places, substitute ''paragraph 1B''.''.'.

The amendment extends the range of circumstances in which special provisions for securitisation may apply. It is made following representations received since the publication of the Bill. Thin capitalisation restrictions can apply to loans made between two connected companies or they can apply to loans from independent lenders if the loan is guaranteed by a connected company.

The Bill allows a securitisation rule to apply only where a transfer pricing adjustment is made to a loan made between two connected companies, and not to guaranteed loans. As I said, the amendment has been tabled following representations made since the Bill was published. Those representations concern circumstances in which thin capitalisation rules might apply to a guaranteed loan from an independent lender in the context of a securitisation, and might affect the rating of bonds issued under the securitisation. The amendment will allow the special rule to apply to such a loan, subject to the other conditions in the clause. The amendment therefore provides further protection for existing and future financing arrangements, and I commend it to the Committee.

Amendment agreed to.

Clause 36, as amended, ordered to stand part of the Bill.

Clause 37 - Commencement and transitional provisions

Mark Prisk (Conservative, Hertford and Stortford)

I beg to move amendment No. 26, in

clause 37, page 41, line 36, leave out '6th' and insert '1st'.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss Government amendments Nos. 81 and 82.

Mark Prisk (Conservative, Hertford and Stortford)

Amendment No. 26 would correct what I believe to be a potential error in the transitional provisions: line 36 of the clause refers to 6 April 2004, but it should refer to 1 April 2004. If it does not, the transitional provisions will not operate correctly for periods of account beginning on or after 1 April. I am aware of the Government's amendment, but it relates to a line further down. However, the fact that they have tabled the amendment suggests that the mention of 6 April was intentional, so I look forward to hearing the purpose behind that.

Dawn Primarolo (Labour, Bristol South)

I am grateful to the hon. Gentleman for proposing a change to the commencement provisions in order to improve the

consistency of their application. However, his amendment would make the commencement date different from the start of the assessment year. The year of assessment starts on 6 April, in contrast to the financial year, which begins on 1 April. However, Government amendments Nos. 81 and 82 would achieve the same objective as amendment No. 26, but in a way that keeps the introduction of the new rules as simple as possible by aligning the commencement date with the start of the assessment year. In those circumstances, I ask the hon. Gentleman to withdraw his amendment and count this debate as a score draw. I commend the Government amendments to the Committee.

Mark Prisk (Conservative, Hertford and Stortford)

Minor victories have to be taken when possible. I must confess that when I read the Government amendments, I was even more bamboozled than before as to what was right and what wrong. While I am momentarily ahead, I will take the good advice and beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendments made: No. 81, in

clause 37, page 41, line 41, leave out '31st March' and insert '5th April'.

No. 82, in

clause 37, page 41, line 42, leave out '1st' and insert '6th'.—[Dawn Primarolo.]

Clause 37, as amended, ordered to stand part of the Bill.

Clause 38 - Expenses of management:

Mark Prisk (Conservative, Hertford and Stortford)

I beg to move amendment No. 58, in

clause 38, page 42, leave out lines 15 to 19.

We now move on to the question of management expenses, which is not quite as it sounds. Those members of the Committee who, perhaps, were hoping that this might be something more personal may be disappointed.

Generally, we welcome the new ''expense of management'' rules, as we might reasonably call them. The amendment relates to what we consider to be the one retrograde step in the clause. I hope, Sir John, to catch your eye in the stand part debate, so that I can examine the broader issue.

The amendment relates to subsection (1), which provides that expenditure of a capital nature generally does not count as management expenses. For a long time there has been a fairly grey area in relation to management and expenses, but there has always been quite a clear set of rules governing capital and revenue, particularly in terms of trading expenses.

At one extreme, there are the day-to-day expenses of managing investments, which are clearly allowable, both under the old and the new rules. At the other extreme are the costs directly associated with the sale or purchase of a capital investment, which have been commonly accepted as capital, and for which relief is potentially available under the capital gains rule. In

between those two extremes are the costs incurred in considering investment strategy or deciding which investments to buy and sell. The treatment of that activity becomes crucial when a transaction falls through, and particularly when it produces abortive, and often substantial, transaction costs. Under new section 75(3), such costs would be capital and no tax relief would be available for them. In other words they would be—this will be of particular interest to those who follow tax matters closely—a tax ''nothing''.

From reading the clause, and from a cursory glance at the Revenue's draft ''Guidance for Management Expenses'', it appears that the Government's line is that despite the absence of specific capital exclusion in the old rules, the view has always been that such costs were not management expenses so no relief was available. I hope that the Minister will confirm that that is the view of the Revenue and the Government and, if not, that she will explain the provision.

If that is the Government's view, most independent experts in the field would regard it as directly undermining a long-held distinction in which all costs of managing investments are allowable, but those incurred in acquiring an investment are not. There should not be a middle ground.

I shall refer briefly to the representations made by the CBI regarding this matter. It stated:

''There is widespread concern over the proposed blanket disallowance of expenditure of a capital nature, which CBI members believe is both unnecessary and inappropriate, given the very different features of trades and investment businesses.''

The issue has reached the courts, notably in the case of Camas plc v. Atkinson in 2003, which involved the substantial costs of evaluating a projected acquisition that did not proceed. The Revenue lost the case in the High Court in July 2003, and I understand that the decision was upheld in the Court of Appeal in April this year.

The Minister will realise, and I hope that she will comment on the matter, that the independent view of the vast majority of experts is that the loss of the case provoked the introduction of new section 75(3). That is why they dispute—they have good reason for doing so—the Revenue's assertion that the provision is reinstating a long-held and generally accepted view of the law. They genuinely believe, and the evidence seems to support their belief, that the case was reaffirmed only two or three weeks ago and that is the reason for the clause.

The purpose of the amendment is to try to remove what is generally perceived as being a retrograde step in what is otherwise a generally welcome reform. I hope that the Minister will reflect carefully on the points that I have raised on behalf of those who are directly affected by the legislation.

John Burnett (Liberal Democrat, Torridge and West Devon)

May I make a quick point? I wonder whether the Paymaster General will clarify the position of capital allowances in relation to the expenses of management companies and companies with investment businesses. When such a company invests in computers and suchlike, presumably the effect of subsection (3) of new section 75 is not to

gainsay the ability of the company to claim capital allowances on such purchases. I hope that the Paymaster General can give us the necessary reassurance that that is not the case.

Dawn Primarolo (Labour, Bristol South)

The Inland Revenue has always argued that under current law capital expenditure does not form part of allowable management expenses. In line with that view, the clause is not intended to restrict relief.

This provision, by stating that capital expenditure is excluded from relief, will ensure that relief for the expenses of managing investments in the context of an investment business is aligned with the rules for trading expenditure. Capital expenditure cannot be deducted when calculating the profits of a trade for tax purposes and it would be inconsistent and unfair to trading companies to allow a more advantageous treatment for investment business.

The general issue of relief for capital expenditure across the corporation tax system is best considered in the wider context of the corporation tax reform programme so that a consistent approach can be maintained. That exercise is continuing, and we have had a great deal of help from business, for which we are very grateful. Indeed, I referred earlier to that continuing debate on corporate tax reform.

The rule is one that I am sure companies will be able to apply in practice without undue difficulty. The distinction between capital expenditure and revenue expenditure has been developed by the courts over a long period and is fundamental to our direct tax code. The Inland Revenue has published draft guidance on how the test will be applied, and it will revise the guidance when it has fully considered the implications of the Camas case.

The rule on capital expenditure is but one aspect of the new management expenses regime. The Government are modernising the rules in response to representations received over a period of years, to extend relief for managing investments. That broadening of the scope of relief has been widely welcomed by business. The new regime will enable more companies to gain relief for the expenses incurred in managing their investments. It will also make it easier for companies to calculate the deductions to which they are entitled.

Mark Prisk (Conservative, Hertford and Stortford)

I accept the broader points, and we may have an opportunity to consider them in a moment, but does the Paymaster General accept that the provision creates a tax nothing? Given that the Government's shared objective with business is to reduce, if not eliminate, tax nothings, does that not conflict with the Government's overall aims?

Dawn Primarolo (Labour, Bristol South)

The TUC—that was a Freudian slip. The CBI has made representations on management expenses.

To make the deletion requested by the hon. Gentleman would double the costs to the Exchequer of introducing the change. It is more appropriate to deal with the matter in the review that I have explained to him, so that we can see the system developing in the round.

The CBI's comments yesterday were submitted to each member of the Committee, and I am delighted that the CBI welcomes the extension of tax relief for the expenses of management investment, because it will benefit companies. It is new, and the Government are giving up tax revenue to provide that support to companies. As the CBI recognises, that removes a barrier that has created difficulties for holding companies that manage their subsidiaries and have their own trading activities.

The hon. Gentleman, referring to the CBI, said that it thought that the disallowance of capital expenditure was unnecessary and inappropriate because trading and investment businesses have different features. We cannot accept that there is a relevant difference; traders and investors will buy capital assets that yield income. Why? They are retained by the business. Traders will buy premises and machines, and investors will buy shares that yield dividends in properties from rents. It is right to make it clear in legislation that the rules for trading expenses and expenses for management investments are aligned.

On intervention, the hon. Gentleman said that the CBI thought that a nothing would arise from the new tax. In fact, the changes being made will remove the tax nothing and the potential for expenses of management investment to be denied relief because they are incurred by a company that does not qualify as an investment company. Although I understand that the CBI would like more, the proposals are very generous towards management expenses, and I ask the Committee to reject the hon. Gentleman's amendment should he press it to a Division.

Mark Prisk (Conservative, Hertford and Stortford)

It has been a useful discussion. The Paymaster General rightly quoted the CBI welcoming the broad principle of the provisions, and I entirely concur with that point. However, she sought to suggest somehow that the CBI's supporting evidence could be put to one side. I am not entirely sure that one can accept that welcome but reject the awkward parts of it.

The Paymaster General also seemed to say, ''Yes, there is a new tax nothing, but the good news is that we have got rid of a different one, so the net result is that we have merely replaced one tax nothing with another.'' If she wishes to correct that assumption, I am more than happy to give way.

Dawn Primarolo (Labour, Bristol South)

I was going to respond to all the hon. Gentleman's points in one go, but I said that the changes being made would remove a tax nothing. I thought that that was quite clear. I did not say that the provisions created it and then removed it; I said that they removed a tax nothing.

Mark Prisk (Conservative, Hertford and Stortford)

I am glad that the Paymaster General has clarified her view because from her original statement it was unclear whether she accepted that there was a new tax nothing but that the benefit of the general proposals was that a different tax nothing was being lost, and that therefore there was a net balance. It is important to stress that because industry is working towards the reform of corporate taxes, and

merely to move forward but then take two steps back, or perhaps to be fair, one step back—

Dawn Primarolo (Labour, Bristol South)

It has been a good debate but the hon. Gentleman is being somewhat unfair and so is business. Earlier, we heard the argument that we should not introduce provisions piecemeal; now we hear that we should introduce piecemeal the provisions that business definitely wants and take them out of the review. The management expenses are specific to the transfer pricing as well as the other arrangements that recognise the pressure on companies. I have made it clear that the corporate tax review of capital expenditure is the correct place to take the matter forward. Detailed discussions are taking place, and I thought that business wanted that rather than a rushed patch now.

Mark Prisk (Conservative, Hertford and Stortford)

I hope that we will not have any rushed patches at all. I suspect that we will have to agree to disagree in this area. The purpose of the amendment, as far as I was concerned, was to probe and to test the Paymaster General's exact view. I think that we have succeeded in doing that. I do not intend to press the matter to a vote. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the clause stand part of the Bill.

Mark Prisk (Conservative, Hertford and Stortford)

A moment ago, we debated an amendment looking at a retrograde step that is part of the proposals; we turn now to their broader aspect. As I said earlier, we welcome the generality of what the clause represents. The clause, and the supporting clauses from 39 onwards, removes the requirement to be an investment company—in other words, one not involved in the trade—in order to claim the deduction from management expenses under section 75 of the Income and Corporation Taxes Act 1988.

It is fair to say that a number of difficulties have tended to arise when a company's activities are a mixture of trading and investment. That occurs most commonly in a group situation with holding companies that not only own subsidiary company's shares but carry on a trade at the same time. In larger groups, holding companies may well not carry on any—or any significant—trading activity, to avoid that problem. Sometimes no tax relief has been available to a mixed investment and trading company for any of the investment and management expenses, where the extent of the trading activities means that it is not an investment company for tax purposes. From talking to a number of those affected by the changes, and, indeed, from considering the responses to the Government's management expenses consultation, it is clear to me that, in most respects, the legislation before us reflects a successful consultation and a positive dialogue, subject to the specific difficulty that we just debated.

I also understand that the Association of British Insurers—to name but one example—is broadly content with the legislation of life assurance company-related management expenses. I think that comes a little further on; nevertheless it is an important part of the overall statement.

I think that if there is one area that is questioned, it is that relating to unallowable purposes, which is also referred to in the Government's draft guidance for management expenses. I conclude by saying that it would be helpful for the Committee, and for those organisations affected by the legislation, if the Paymaster General clarified exactly what is meant by an unallowable purpose.

Dawn Primarolo (Labour, Bristol South)

The hon. Gentleman has covered the clause fairly adequately in that, first, it extends the range of companies able to obtain the tax deduction for the expenses management. Secondly, it puts the time of the reduction in a clear and modern basis; and thirdly, it recasts the complex rules for similar deductions for life assurance companies into a free-standing logical code. There has been consultation on those matters, and it has been widely welcomed by business.

The only point on which the hon. Gentleman seeks further clarification is the unallowable purpose test. He says that it needs clarification, perhaps in relation to management and investments in subsidiaries, especially—perhaps this was in the submissions sent by the Chartered Institute of Taxation—with regard to overseas subsidiaries. The point is clarified in the explanatory notes and the draft guidance published on the Inland Revenue's website. It is not relevant to the application of the test that a subsidiary company whose shares are held by a company that is seeking management expenses relief is not within the corporation tax charge.

If the hon. Gentleman wants to raise any further issues once he has read the draft guidance published on the Inland Revenue's website, I will be more than happy to receive his representations. I can assure him that the concern that the unallowable purposes test is too restrictive is without foundation, which I hope is shown in the explanatory notes and the draft guidance. I accept that the hon. Gentleman may not have had time to consider these matters, but, given that the guidance is draft and we are receiving comments on it, I will be more than happy to receive his if he feels that the guidance does not adequately deal with his points.

Question put and agreed to.

Clause 38 ordered to stand part of the Bill.

Clauses 39 to 41 ordered to stand part of the Bill.

Schedule 6 - Expenses of companies with

Dawn Primarolo (Labour, Bristol South)

I beg to move amendment No. 83, in

schedule 6, page 277, leave out lines 41 to 45 and insert

'for ''an investment company'', wherever occurring, substitute ''a company with investment business''.'.

Schedule 60—I am sorry. I will start again; it has been a long day. I know that I often put lots of noughts on the end of things, but on this occasion it is inappropriate.

Schedule 6 contains the more important consequential adjustments arising from the changes to management expense rules. The amendment affects a provision dealing with an avoidance device known as loss buying. That is when a company changes ownership so that the new proprietors can take advantage of its unused management expenses. The amendment removes a misleading description of the provision being amended as a consequence of the reform of management expenses rules. It also ensures that the necessary change of wording is made each time that the words that need amendment occur in the provision—three in all.

The amendment is slightly more substantial than previous Government amendments, but it is designed to clarify and ensure that the descriptions of the provisions are accurate. I commend it to the Committee.

Amendment agreed to.

Schedule 6, as amended, agreed to.

Clause 42 ordered to stand part of the Bill.

Clause 43 - Companies with investment business:

Dawn Primarolo (Labour, Bristol South)

I beg to move amendment No. 84, in

clause 43, page 51, line 22, leave out '41' and insert '46'.

The amendment changes an incorrect reference, which became clear after the Bill was published. I apologise for the error. The amendment makes the necessary adjustment, and I hope that the Committee will agree to it.

Amendment agreed to.

Clause 43, as amended, ordered to stand part of the Bill.

Clause 44 - Insurance companies:

Dawn Primarolo (Labour, Bristol South)

I beg to move amendment No. 85, in

clause 44, page 53, line 29, at beginning insert 'the old'.

The amendment is a minor, clarifying one. It makes it clear that when the straddling period rule for insurance company expenses refers to a section that is replaced by a new version under clause 38, the reference is to the old version in the section. It is a minor change, but important as it ensures that the Bill reads correctly.

Amendment agreed to.

Clause 44, as amended, ordered to stand part of the Bill.

Clause 45 ordered to stand part of the Bill.

Clause 46 - Power to make consequential amendments

Mark Prisk (Conservative, Hertford and Stortford)

I simply want to make one brief comment. The Paymaster General has kindly written to the Committee about clause 46 because it contains a regulation-making power. She has sought to supply us with a 23-page statutory instrument of delegated powers in order to help us have an informed debate. I welcome that and I am grateful to her. Unfortunately, it arrived at 9.30 this morning. I expect Committee members will have been disappointed not to have had the opportunity to deal with it, and I hope that the Paymaster General will recognise that that is a problem. I have one simple question for her: will she confirm that the statutory instrument will be debated on an affirmative basis, which will allow us to consider the elements within it?

The rest of the debate is in Hansard.