Finance Bill

Public Bill Committee, 9 June 2009.

(Except clauses 7, 8, 9, 11, 14, 16, 20 and 92)

Jimmy Hood (Labour, Lanark and Hamilton East)

I welcome the hon. Member for Burnley to the Committee. Congratulations on your appointment.

Clause 30

Kitty Ussher (Labour, Burnley)

Thank you very much, Mr. Hood. It is a real pleasure to be once again, if somewhat surprisingly, serving under your chairmanship in my third consecutive year on the Finance Bill. I have learnt one thing in the last 24 hours, which is that there are Finance Bill gods. It seems that they are slightly vengeful and playful gods, because roughly 24 hours ago I was, I confess, teasing one of my hon. Friends, who shall remain nameless, for saying that their entire life had, yet again, been taken over by the Finance Bill. I was glorying in the fact that, although I served on it in the last two years, I was not required to serve this year. So there are Finance Bill gods and they are vengeful—only one swift phone call later, I found myself here again. However, the pleasure is no less diminished for serving under your chairmanship, Mr. Hood.

I have risen to speak on clause 30, although there are no amendments to it, because it introduces schedule 11, and I thought it might be helpful to the Committee to have an explanation of what we are trying to achieve. We are comprehensively reforming the rules on tax relief for business expenditure on cars. There are two incentives for change. The first incentive is simplification, on which we have responded to lobbying from the industry. Secondly, we wish to ensure that the rules on tax relief for business expenditure on cars also help us to achieve our environmental objectives.

The current rules require capital expenditure on cars costing more than £12,000 to be accountable for in single asset pools—that means one asset pool per car so that the writing-down allowances can be capped. Businesses that hire, rather than buy, cars costing more than £12,000 are also restricted in the amount of hire expenses that may be deducted from their profits. Businesses therefore need to track expenditure on those more expensive cars on an individual basis for the purposes of their tax computations, but for larger businesses, the number of such car pools can run into hundreds—in some automotive sectors, thousands. Stakeholders consider that the rules are outdated and impose a disproportionate compliance burden, and we agree.

It is, however, important that any reform is consistent with our environmental objectives. Carbon dioxide is the most important greenhouse gas contributing to climate change, and road transport is one of its major producers. The reform aims to contribute towards our targeted reduction in CO2 emissions. Following extensive consultation, an outline of the reform was announced at Budget 2008; further detail was published in December 2008. The Government have considered stakeholders’ responses in designing a new regime that will not only reduce compliance costs, but help to meet the UK’s targets for reduction in greenhouse gas emissions.

The generous 100 per cent. first year allowances for expenditure on cars with very low CO2 emissions are unchanged. They were made available for a further five years until 2013 in the Finance Act 2008. Consistent with that, under the new rules, the rate of writing down allowances that businesses can claim in respect of all cars will depend on the car’s CO2 emissions. Expenditure on cars will generally be pooled in one of two plant and machinery pools. Where the car’s emissions are 160 g/km or less, the expenditure will be allocated to the main capital allowances pool and will attract the same rate of 20 per cent. per annum of writing down allowances, as applies to most other plant and machinery. However, expenditure on cars with emissions above 160 g/km will be allocated to the special rate pool and attract a lower writing down allowance of 10 per cent. per annum. There will therefore be a clear incentive to buy a lower CO2-emitting car.

The rules restricting the deductions from profits that businesses may claim in respect of car hire costs are also being reformed to act as a disincentive to using high CO2—emitting vehicles. For leases that commence after April 2009, there will be a restriction of allowable expenses only where the hired car has CO2 emissions exceeding 160 g/km. In addition, and as a simplification measure rather than an environmental one, the proposed rules ensure that only one lessee in a chain of leases for a car will be subject to the lease rental restrictions. Respondents have agreed that the reduction in the proportion of cars in a single asset capital allowance pool and the application of the lease rental restriction to a smaller population of leases will achieve a welcome reduction in compliance costs. As an additional simplification, motorcycles will no longer be treated as cars for capital allowances purposes. That change, too, has been welcomed by business.

We think that the move to a CO2 emissions basis for capital allowances will act as an additional fiscal measure to motivate business to redesign their car policies and actively select lower emitting cars. While the new rules deliver the reform that businesses pressed for, in order to ensure fairness, the provision introduces transitional rules to guarantee that there is no change to the treatment of cars owned before the date of introduction of the new rules. The old rules are being retained for those vehicles for five years.

As I said at the outset, these provisions have been the subject of considerable consultation and are broadly welcomed by stakeholders.

Schedule 11

Mark Hoban (Conservative, Fareham)

I beg to move amendment 19, in schedule 11, page 108, line 30, at end insert—

‘2A In section 45D(4) for “110” insert “160”’.

Mark Hoban (Conservative, Fareham)

Is it a pleasure to serve under your chairmanship again, Mr. Hood. May I congratulate the hon. Member for Burnley on her return to the Treasury team? There is potentially one more Finance Bill left in this Parliament. She might decide whether to put some odds on serving on that too, having done three so far. I should also like to congratulate, in her absence, the hon. Member for Wallasey (Angela Eagle) on her promotion. Clearly, the prospect of my hon. Friend the Member for Hammersmith and Fulham making another speech about white label cigarettes manufactured in eastern European states led to her to put in a transfer bid. I am sure she will enjoy her work in the Department for Work and Pensions.

Amendment 19 is very much a probing amendment. We want to understand why in schedule 11 the Government use a different definition for a car with low carbon emissions from that used in section 45D of the Capital Allowances Act 2001, which defines cars with low CO2 emissions as those falling below a CO2 emission threshold of 110 g/km, whereas the schedule’s threshold is 160g/km. The amendment would increase the threshold in section 45D(4) from 110g/km to 160g/km. We are not arguing that that is the right threshold, We simply want to understand why one rate is used in one area and a different rate is used in the schedule for exactly the same definition. We are concerned that it might lead to some confusion among advisers about the definition of a car with low carbon emissions. That is the purpose behind this probing amendment.

Kitty Ussher (Labour, Burnley)

The answer is quite simple. We have 100 per cent. capital allowance for cars with emissions at or below 110 g/km; then, we propose a 20 per cent. allowance for cars with emissions up to 160 g/km and a 10 per cent. allowance for cars with emissions in excess of that. The legal definition is extremely clear. The purpose of our legislation is to encourage companies to purchase cars that are progressively more environmentally friendly. If they want to go straight away for cars emitting 110 g/km or less, that is fantastic and they will reap a reward for doing so. We are trying to shift the bell curve all the way down to encourage the use of lower emitting vehicles.

Mark Hoban (Conservative, Fareham)

This is a slightly unfair question to ask the Minister, given her recent arrival in the Treasury, but was any thought given to using a different term? That is where the confusion arises. The 2001 Act uses the term to describe a car with emissions of 110 g/km or less; the same term is used in the Bill in reference to a 160 g/km threshold. To give clarity to taxpayers and their advisers, it would have been sensible to use a slightly different definition in schedule 11 to avoid confusion in the future.

Kitty Ussher (Labour, Burnley)

I can safely say that, as far as I am aware, no consideration was given to that. I am sorry if the hon. Gentleman is confused, but we think the intention is clear.

Mark Hoban (Conservative, Fareham)

As I said, the amendment is probing. It would have been better for clarity if the Government had come up with a different term, to prevent confusion and to ensure that taxpayers understand the Government’s aim exactly. Given that the Government do not wish to move on this, however, I beg to ask leave to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I beg to move amendment 20, in schedule 11, page 109, line 32, at end insert—

‘(5A) An order under subsection (5) may not be made until 2 years after this Act has passed and any subsequent change will be subject to a 2 year notice period.’.

The purpose of the amendment is straightforward. We want to ensure some certainty for taxpayers and that, where an amendment is made to the thresholds, businesses are given some notice, so that changes are not simply made overnight. We want to ensure that businesses can plan how to meet the downward trend of emissions—shifting the bell curve down, as the Minister described it earlier. The amendment introduces a two-year waiting period for any changes made under new section 104AA(5) of the Capital Allowances Act 2001, inserted by the schedule, so that businesses can properly prepare.

Kitty Ussher (Labour, Burnley)

In a sense, I accept the spirit behind the amendment. We try to give businesses as much notice as possible. We understand that is important and we have no plans not to do that. However, as I said in my remarks on clause 30, the proposals have been consulted on extensively—indeed the first consultation took place more than three years ago, which is a longer period than the two years’ notice proposed in the amendment.

We accept that planning and certainty are important to business, but we do not accept that a statutory requirement to wait for two years and always give two years’ notice is necessary or always desirable. I can think of circumstances where, for example, our policy proves to be more effective than we expected, leaving us with a policy that has achieved its design, but which we are unable to ratchet further for environmental purposes because of a provision such as this in the Bill. At the same time, I do not want to send a signal that we intend to change the capital allowances system arbitrarily. We think it important to consult properly, and the Government benefit from that.

I assure the Committee that we have no secret plan to change anything and that we are always committed to good consultation. However, I do not think it right to tie the Government’s hands—I am sure that the hon. Gentleman would agree—in case different external factors come into play, such that government and policy would be better served by not being tied down in that way. The Government recognise the need to give business time to plan for changes, so I ask the hon. Gentleman to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I am grateful for the hon. Lady’s assurance that there is no secret plan to make changes. It would not have been a secret if it had been announced in this Committee—although, on the other hand, it might well have been, given the extent of reporting of events in Committee.

Although the Treasury has made some progress towards improving consultation before making announcements, it does not have a perfect record. There are clauses, such as clause 92, on which no consultation was undertaken before an announcement was made. I am sure that, in the new mood that seems to be suffusing the Government right from the very top in relation to consultation and discussion—not that we have not heard that before—the Minister will ensure that, where there are changes, proper consultation is conducted. I beg to ask leave to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I have two questions to raise about schedule 11. They are detailed points that have been raised with us by the Low Incomes Tax Reform Group, which has done a good job of examining how the Bill’s provisions will affect vulnerable people.

The first question the group has drawn to my attention is whether an impact assessment has been undertaken for the schedule addressing the impact on people with disability. A feature of Her Majesty’s Revenue and Customs’ disability equality scheme is that there should always be an assessment of the impact on people with disability. The Low Incomes Tax Reform Group’s point is that disabled drivers might need to purchase larger and generally less CO2-efficient vehicles to accommodate their needs. They are not only faced with a potentially higher cost for the vehicle itself, but might receive only the lower special capital allowance rate of 10 per cent. Given the costs that many people with disability face, the group is concerned that the low capital allowance rate would put them in a worse position than they are in now, so it has asked the Minister to consult on the issue to see whether an exemption could be made.

The group’s second point relates to the change in treatment of exempt hire cars for disabled people. The previous regime allowed hire companies to claim the writing down allowance on the full cost of those cars, rather than on the limited £12,000. It was believed that the Government were going to provide a similar exemption by allowing cars hired to disabled people to qualify for the higher 20 per cent. rate of capital allowances, regardless of CO2 emissions, but a technical note produced last year suggests that the Government have reached an agreement with the main UK supplier of such cars to disabled people whereby they will defer an application under state aid rules and look at other initiatives to increase the availability of cars with lower emissions for leasing to disabled people. Although the intention might be to increase the availability of those lease cars to people with disability, the concern is that, in the short term, hire companies might face higher costs, taking into account the loss of tax relief, and that those costs will be passed on to people with disability.

My final comment relates to a definition in paragraph 22 of schedule 11, which, in proposed new section 268D(2) of the 2001 Act, sets out four criteria people can use to determine whether they qualify as disabled people in relation to hire cars. Those criteria are quite complex, and I was asked why they cannot be simplified to include someone who is a disabled badge holder, rather than seeking to assess whether someone is a disabled person by reference to several different allowances.

Peter Bone (Conservative, Wellingborough)

It is a great pleasure to serve under your chairmanship, Mr. Hood, and I welcome the hon. Member for Burnley to her new ministerial role.

On the basic issue dealt with by the schedule, if I understand it correctly, there is a low emission rate of 100 per cent. capital allowance. I wonder if the Minister knows to what cars that rate applies and how many of those cars are actually bought. I also wonder if the change to a 10 per cent. allowance for cars with high emissions and 20 per cent. for those with lower emissions is revenue-neutral, given the abolition of the separate pool.

Of course, we are dealing with a timing difference. It is not a case of money being given away. Capital allowances are recouped when the vehicle is sold, so there is either the balancing charge or the balancing allowance. What I would have expected to see in the schedule, given the state of the car industry, is the Government bringing forward 100 per cent. relief for fleet cars to encourage the purchase of new vehicles. After all, it is only a timing difference. That change to 100 per cent. relief would encourage companies to spend money. At the end of the day, the Government would get their money back when the vehicle was sold. That change would be an incentive that would help car manufacturing in this country. I wonder why the Government rejected that approach.

Kitty Ussher (Labour, Burnley)

I will take the questions in the order in which they were put. Yes, there is an impact assessment that specifically considers the impact on disabled people. I am sure that the hon. Member for Fareham will have that impact assessment in his papers. Although the Finance Bill can achieve many things, the policy intention behind the measure was to simplify the arrangements and ensure that they are consistent with environmental objectives, not to widen the scope of the policy. We wanted to ensure that the provisions and exemptions that are available for disabled drivers are replicated in the new legislation. As he rightly said, and as we have made clear several times, it is our intention, subject to state aid rules, to ensure that the exemptions are carried over into the new system. That remains our intention. The timing has been agreed with all the players.

The hon. Gentleman then asked specifically why in paragraph 22 we do not simply use the qualification criterion of a person holding a disabled badge. The answer quite simply is that the power to award a badge is devolved to local authorities and we wanted to ensure that we had a comprehensible and tighter set of criteria, so that the system and the resources are properly targeted on those people who need our support.

Mark Hoban (Conservative, Fareham)

On the point about the blue badge, does the hon. Lady accept the argument that the Low Incomes Tax Reform Group made that, as a consequence of these changes, high costs may be imposed on people with disability who need larger cars?

Kitty Ussher (Labour, Burnley)

I am not entirely sure that the evidence points towards that conclusion, although I think that the Low Incomes Tax Reform Group is an effective lobby group and I commend it on the work that it does. The market is sufficiently dynamic that there is a large number of models available to suit people’s needs, so I do not think that these measures will create an extra cadre of people who will face additional financial hurdles. We are just seeking to replicate the current criteria in a new system that is simpler and that has greater environmental incentives for those who are leasing and purchasing cars.

It is a pleasure to serve again on the same Committee as the hon. Member for Wellingborough. To his question whether the policy is revenue-neutral, the answer is no. The impact assessment shows that, assuming that there is no change in behaviour, which is the crucial point, the policy would yield revenue to the Treasury of £485 million over five years. That figure is broken down year by year in the impact assessment.

The hon. Gentleman then suggested that we could have used the policy to boost the automotive industry. In his previous ministerial incarnation, my hon. Friend the Economic Secretary has been extremely closely involved in measures designed to have that effect. We hope very much that the effect of the policy will be a change in behaviour, precisely because of the new financial incentives that we are putting in place that will cause large companies with large fleets in particular to purchase more environmentally efficient vehicles, and thus to avoid paying the revenue that would otherwise accrue to us. That will provide precisely the spur for the green technology and green automotive industry that we want.

Peter Bone (Conservative, Wellingborough)

My point was more that we have missed an opportunity to have an incentive. Yes, there is the stick to encourage us to switch to more environmentally friendly cars, but we then get only the standard writing down allowance. If we extended the allowance to 100 per cent., more cars would be bought and that would be better for our manufacturing industry.

Kitty Ussher (Labour, Burnley)

We could use the policy simply to pass over cash to the manufacturing industry. The Government do that in various ways, but it is more appropriate to have a targeted policy that seeks simultaneously to simplify the system, which is what business wants, and to provide a spur for investment in environmentally efficient vehicles. There will also be a third effect, which is to boost the development of those vehicles. In a sense, therefore, the hon. Gentleman and I agree.

Schedule 12

Ian Pearson (Labour, Dudley South)

I beg to move amendment 18, in schedule 12, page 128, line 5, at end insert—

‘(1A) In determining for the purposes of subsection (1)(c) whether subsection (1) of section 171 would have applied, it is to be assumed that subsection (1A)(b) of that section read—

“(b) that, at the time of the disposal, company B is resident in the United Kingdom, or carrying on a trade in the United Kingdom through a permanent establishment there.” ’.

It is a real pleasure to serve under your chairmanship, Mr. Hood. At the 2007 pre-Budget report the Chancellor launched three reviews involving the Treasury and Her Majesty’s Revenue and Customs working in partnership with business to evaluate how a range of tax legislation could be simplified. Clause 31 and schedule 12 deliver the first simplification measure from one strand of that project, which deals with the capital gains of groups of companies.

The corporation tax system allows limited offsetting of the capital losses of one company against the gains of another when calculating their taxable profits. In the Finance Act 2000 that procedure was liberalised, so that an asset could be deemed to have been transferred within the group before an onward sale. That saved the administrative burden and expense of making an actual intra-group transfer. However, those rules do not allow all gains and losses to be deemed as transferred within a group; they only apply to the sale of an asset to a third party. That means that the rules do not apply when a gain or loss results from the liquidation of a group company or when a loss arises on the making of a negligible value claim. Losses on assets that have been destroyed, or gains from insurance receipts in such a situation, are also outside the scope of this otherwise useful tax measure.

The CBI in particular highlighted in its recent Budget representations that those restrictions can be administratively burdensome. Schedule 12 provides groups of companies with a simpler procedure to offset chargeable gains with allowable losses by removing those restrictions. Rather than deeming assets to be transferred intra-group prior to a third-party sale, companies will be able to elect for a capital gain or loss to be reallocated to another group company that is within the charge to corporation tax.

Amendment 18 addresses one area in which we have received representations that, because of a technical defect in the schedule, the policy aim might not be achieved. The issue only affects groups that wish to transfer a gain or loss to a non-resident company in a group that trades in the UK through a permanent establishment—a branch or agency here. Since 2000, non-resident companies have been treated as part of the capital gains group. Tax-neutral transfers of assets can be made to a non-resident company if it has a permanent establishment in the UK and the assets are used for the business of that establishment. That rule ensures that the treatment applies only to those assets on which the non-resident company will be chargeable to corporation tax on gains made from their disposal. That same condition is imported into the rules in schedule 12, but we have received representations from the Law Society that the new rule needs to be adapted further to operate properly when a non-resident company is involved.

When an election is made to transfer a gain or loss from the disposal of an asset to a non-resident company, the schedule already has a rule to ensure that a gain or loss on the asset will be a chargeable gain or an allowable loss to the non-resident company. That applies even where the asset would not otherwise be a chargeable asset for the non-resident company. However, the representations that we have received point out that one condition to be satisfied before an election can be made is that the asset is used in the UK trade of the permanent establishment, which is unnecessary in this context. Amendment 18, therefore, adapts the rule about when companies can make an election, to remove any doubt that non-resident companies with UK permanent establishments can always fulfil the conditions. I am grateful for the Law Society’s representation, which is one that the Government are happy to act on.

The changes made by the schedule sweep away some restrictions that have prevented the full matching of capital gains and losses within groups and simplify the complex rules that deal with group relationships. That is the kind of simplifying change that the CBI and other representative bodies have long sought. I commend the amendment to the Committee.

Mark Hoban (Conservative, Fareham)

I have a couple of quick questions for the Minister about the schedule, which arise from representations made by outside bodies. The first is about capital gains and losses that arise as a consequence of the operation of foreign exchange matching rules. The Institute of Chartered Accountants has expressed the concern that these seem to fall outside the scope of the schedule. It believes that they should fall within it, as those gains and losses accrue as a result of the operation of statutory provisions. Can the Minister comment on that?

There is concern about the drafting of new sections 171A(5) and 179A(5) to the Taxation of Chargeable Gains Act 1992 inserted by schedule 12. We have received comments that they would totally negate an election. We would have thought that the correct result would be that they would negate an election to the extent that it took the total amount over the actual gain or loss. There would be a difficulty if there were two or more simultaneous elections that transferred parts of the same gain or loss to two or more different companies, so there would be a choice as to which election to negate, but where there is no choice, surely the election should be reduced rather then simply negated.

Ian Pearson (Labour, Dudley South)

On the question of foreign exchange, the reference in the schedule to “in respect of an asset” will exclude chargeable gains or losses in respect of liabilities such as those arising from forex hedging from the provision. The treatment of such gains and losses within the Exchange Gains and Losses (Bringing into Account Gains or Losses) Regulations is already under consideration in the forex matching discussions that are ongoing between HMRC and business representatives, and we have talked to business representatives about this. We intend to address that point in the next round of forex matching changes later in the year. Proceeding in that way will ensure that the whole regime is considered, rather than that one item being taken out of context. The industry is satisfied with the approach that we are taking.

The hon. Gentleman’s second question was on multiple elections. It is correct that where two or more elections are made simultaneously that specify more than the gain or loss, none of those elections has effect, as a result of the new wording of new section 179A(5). The main issue that the new subsection addresses is the possibility of simultaneous elections where a subsequent election is made in respect of the same gain or loss. HMRC expects that it will be very rare for a group to make such an oversight. On the rare occasions that an oversight may happen, it is right that the group is able to submit correct elections that specify where it wants the gain or loss to go, rather than be subject to a statutory rule that may not achieve the best result on a case-by-case basis.

Schedule 13

Ian Pearson (Labour, Dudley South)

I beg to move amendment 90, in schedule 13, page 131, line 28, after ‘treated’ insert ‘under subsection (5)’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss Government amendment 91.

Ian Pearson (Labour, Dudley South)

The new rules in schedule 13 provide that, to the extent that collateral is inadequate to replace all the lent securities lost in the event of a borrower’s insolvency, the lender is treated as making a disposal but receiving no consideration so that, effectively, a capital loss arises. The borrower then has a debt to the lender for the remaining value of the securities at the time of the insolvency, but because of that insolvency the debt is likely to be bad. In certain circumstances, it is possible that, in addition to the capital loss provided for by the schedule, a life insurance company’s profits might be reduced by the amount of that bad debt, which results from the interaction of special rules for computing the profits of life insurance companies and the rules relating to the debts of companies, which are known as the loan relationships rules. The schedule contains a provision that intends to stop a debt being classed as a loan relationship if it results from the insolvency of a stock borrower and an inadequacy of collateral to fully replace stock. The effect is to prevent an unintentional double allowance for life insurance companies as a capital loss and as a bad debt.

The provision in the Bill as drafted contains an error. The drafting provides a formula for arriving at the amount of the debt that is not to be treated as a loan relationship, but unfortunately the formula does not produce the correct result. The cross-references to the rest of the provision do not work as they should. Government amendments 90 and 91 correct that error. Government amendment 90 adds a cross-reference to clarify the effect of another part of the change made to the capital gains rules. Government amendment 91 replaces the incorrect formula for arriving at the debt in question with a reference to a description of that debt elsewhere in the new legislation. The amendments do not change the legislation’s intended effect; they merely correct a drafting error.

Clause 33

Mark Hoban (Conservative, Fareham)

I have a quick question. I understand the clause’s intentions; the Minister and I have discussed the Financial Services Compensation Scheme in other arenas on more occasions than I care to remember.

The clause centres on the tax treatment of interest and assumes that a depositor will get back their funds in full from the FSCS, which is the way in which the scheme has operated during the current financial crisis; in effect, the Government have issued an unlimited guarantee where the scheme has been called upon for retail depositors. However, the scheme’s rules, as outlined in the Financial Services Authority’s handbook, actually limit compensation to £50,000. If we return to a more stable financial climate and the £50,000 rule applies, a depositor with a deposit of £60,000 will only get £50,000 back, but will earn some interest on that money from the date that the scheme comes into force, in respect of their institution, and the date that the money is paid to the depositor. Will the interest they receive be treated as compensation, and therefore free of tax, or as interest and be taxable?

Ian Pearson (Labour, Dudley South)

This clause deals with one aftermath of the default of a number of banks. Because of these bank failures the Financial Services Compensation Scheme has paid out more than £3 billion of compensation to bank customers. The hon. Gentleman is correct. We have discussed a number of the general principles surrounding this on many occasions. The compensation paid included not only the principal on the accounts but also a sum representing interest that the customers would have received had the bank not defaulted. The sum representing interest is the subject of this clause.

To ensure that customers are in the same position as they would have been in had the bank not defaulted, it is necessary to tax the sum representing interest as if it were interest for tax purposes. Without this clause the sum representing interest paid by the FSCS would not be taxed in the same way as interest paid by the banks is taxed. This would lead to unfairness between those customers of the defaulted bank whose accounts had been transferred to another bank or building society and those who receive FSCS compensation. The customers whose accounts were transferred would still be taxed on interest received from their new bank or building society but the customers receiving compensation from the FSCS would not be taxed on the sum relating to interest.

The FSCS has rightly calculated the compensation it has paid by taking into account whether or not the customer was a taxpayer. If they were, then it deducted from the amount equivalent to interest, a sum equivalent to income tax, just as tax is deducted from interest paid by the bank. Without this clause non-taxpayers will not be able to claim repayment of the amount deducted by the FSCS, and customers of the defaulted bank, who are liable to higher rate tax, cannot be charged that higher rate tax. That is why the clause is needed.

The hon. Member for Fareham asked whether, if an FSCS payment is less than the original capital, any part of that payment will be treated as interest. Whether the original capital has been repaid is an issue that falls outside the scope of the clause. The amount and nature of the compensation paid by the FSCS is a matter for the rules of the FSCS. He will be well aware of that.

Mark Hoban (Conservative, Fareham)

The clause affects the tax treatment of payments made by the FSCS. While the amount of compensation is a matter for the FSCS, where the payment received by the depositor is less than the amount they originally deposited, is it possible to treat the interest payable as being effectively not subject to tax because they have lost so much money? Should not the interest be seen as a form of compensation rather than a receipt to be taxed?

Ian Pearson (Labour, Dudley South)

Our aim in the clause is to put depositors back in the situation that they would have been in, had the bank not defaulted. There is obviously a technical definition of compensation and how it applies. It is right to say that when the FSCS pays interest it is taxable, just as interest is. We are simply trying to bring people back to the circumstances that they would have been in. It is for the FSCS to determine the rules of its own compensation scheme and whether there should be a £50,000 limit or a higher one, as the hon. Gentleman understands.

Clause 34

Stephen Timms (Labour, East Ham)

I add my welcome to you, Mr. Hood, as Chair of the Committee’s deliberations this morning.

Clauses 34 to 37 introduce a significant package that modernises corporate tax rules for foreign profits. It will make the UK a more attractive headquarters location for multinational businesses by enabling a group’s worldwide profits to be repatriated to the UK without tax being charged and without need for complex double taxation relief calculations. It is a major change to a more territorial system of business taxation in which we are essentially concerned with applying tax to profits earned in the UK and not to profits earned overseas. The key element of the package offers generous dividend exemptions compared with competitor jurisdictions, available to all companies regardless of the level of shareholding.

The package comprises four linked parts with one in each of the four clauses: first, a broad exemption for company distribution; secondly, a reasonable restriction on our generous interest-relief rules in the UK; thirdly, consequential changes to the controlled foreign company rules, and fourthly, the replacement of the Treasury consent rules with a much simpler reporting requirement. These have all been subject to substantial widespread consultation which has shaped what is before the Committee.

I shall say a little more about each of the four elements. Clause 34 introduces schedule 14, which provides exemption from tax for foreign profits. It reduces administrative costs and it meets business’s call for exemption in the Finance Bill. The result of these rules is that the great majority of distributions for small, medium and large companies will be exempt from corporation tax. That change has been widely welcomed, as has the fact that we have been able to deliver it in this Bill.

Clause 35 introduces schedule 15, which prevents excessive advantage being taken of our interest-relief rules, particularly in the context of dividend exemption. This debt cap applies only where groups put more debt in the UK than they borrowed for their entire worldwide business. It is a reasonable restriction and will allow generous tax deductions for interest, notwithstanding the move to dividend exemption.

Clause 36 introduces schedule 16, which makes three consequential changes to the controlled foreign company rules. The first two relate to introduction of dividend exemption and remove some of the exemptions within the controlled foreign company regime, which will no longer be appropriate. Part 3 of the schedule includes a provision to ensure that the debt cap cannot interact with the controlled foreign company rules in a way as to cause double taxation.

Clause 37, introducing schedule 17, removes existing Treasury consent legislation and replaces it with a modernised, post-transaction reporting requirement targeted at transactions where there is a substantial risk of tax avoidance activity. The old rules have been replaced because they are out of date and are not in line with modern practice. The new requirement will apply to material transactions that pose significant risk of tax avoidance, reducing the administrative burden on business but ensuring that HMRC can focus on serious avoidance. We have also committed to examine the controlled foreign company rules in more detail separately. The review aims to modernise the current rules. It will be consistent with the move that I have described towards a more territorial approach of taxing foreign subsidiaries.

This package represents the outcome of nearly two years of extensive and constructive consultation. I want to thank all those who have contributed in the past couple of years. Businesses have consistently said to us that it is important for the UK to have dividend exemption. They have asked for it to be included in this Finance Bill rather than being delayed any further, to enhance the competitiveness of the UK tax system. I am very glad that we have been able to do that.

John Pugh (Liberal Democrat, Southport)

This is a very important part of the Bill, as the Minister has underlined; it is very technical but also very important. I want to congratulate him on having introduced this package of measures. It is a crucial package, as it is an attempt to show how a modern taxation system can cope with the global nature of modern commerce.

I want to start by being wholly positive, because I am afraid that I will have to be just a little bit critical later on. Schedule 14 immediately follows and I will make a few general remarks about it. It is definitional and loophole-closing; it is based on a study of real-time transactions, and it definitely has an eye on preventing further abuses of similar ilk.

The effectiveness of this type of legislation depends on the post-hoc scrutiny, the retrospective examination by people within the Treasury who must have adequate skills and abilities to do so. I am a little encouraged, not only by what the Minister has said but by the endeavours of HMRC to recruit appropriate people to police the type of activity that we are discussing on a more regular basis.

In one way, we are looking at a game of chess. On the companies’ side there are very clever people trying to make the best of the exemptions that are available and on the Government’s side there are people trying to close every conceivable loophole. Life has been made enormously more difficult for those people who want to avoid tax by the Government’s imposition of an obligation on businesses that insists that they must declare any tax schemes well in advance. However, the real test of the Bill is whether or not adequate ground rules are laid down to prevent further abuse and further misuse of tax exemptions. We will have to judge whether the Bill has passed that test when we look at the next clauses.

Mark Hoban (Conservative, Fareham)

As the Financial Secretary said, the Government have undertaken quite a thorough consultation process on this issue in the past couple of years. As a consequence of that consultation process, there have been a number of changes of tack by the Government on the taxation of foreign profits. I just wanted to explore that issue a little further.

When the Government published their consultation in 2007, they produced a fair summary of the issue that we face when they said:

“The current system of taxing foreign dividends and relieving double taxation through crediting foreign tax produces only a modest amount of direct tax yield, but together with the Controlled Foreign Companies (CFC) regime, provides safeguards to ensure that profits from economic activity are properly taxed in the UK.”

It is a question of getting that balance right, which provides a link to some of the later thoughts that the Government had. The document went on to say:

“The case for change rests largely on supporting large and medium business operating in rapidly growing global markets by simplifying and modernising the current regime”.

The challenge that the Government had to face was that a number of multinationals were taking the view that the UK was not a good place for them to be based and they were exploring whether or not they could move to other jurisdictions where there was a better regime for the treatment of foreign dividends.

The consultation process also hit upon the issue of ensuring that profits from economic activity were properly taxed in the UK. That led the Government to consider the issue of a proposed controlled companies regime to avoid the potential mischief of companies seeking to shift income streams offshore, particularly what were described as mobile income streams, which are financing income and royalties. When the Government floated that idea, however, there was a significant outcry from industry about the consequences, certainly about the administrative cost, and it triggered a further wave of concern from companies that look to redomicile overseas. The further concern was about whether the rules that the clause seeks to change led to a sub-optimal allocation of capital in an international group—that when it was not necessary for an overseas subsidiary to pay a dividend to its UK parent for the purpose of making a dividend, those dividends and that capital would be trapped in an offshore location. There was concern that the Government’s rules got in the way of the efficient use of capital in businesses because businesses felt that it would be better to keep profits in a low-tax jurisdiction rather than repatriate them to the UK.

One of the issues that has most exercised the Government, and on which I would be grateful for further clarification from the Minister, is cost. Cost was a feature of the technical note published in July last year by the Minister’s predecessor, the right hon. Member for Liverpool, Wavertree (Jane Kennedy), who expressed concern that the potential cost of the dividend exemption would act as a barrier to taking it forward. That technical note, published at the conclusion of our deliberations on the Finance Bill 2008, set out that in 2005-06 £200 million was collected in corporation tax paid on foreign dividends, £100 million was paid on portfolio dividends and £100 million was paid on direct dividends. The assessment was that by 2012 the yield on foreign dividends would be about £300 million. However, the technical note suggested that the tax loss to the Exchequer that could arise from introducing the dividend exemption had a central estimate of about £600 million, within a range of £200 million to £1.1 billion, depending on the behavioural responses. There was a suggestion that the tax take could increase because of the repatriation of cash to the UK, which would then be used to reduce indebtedness. The Government were sceptical that that was an issue, and felt that there were ways in which companies could repatriate those profits without incurring a corporation tax charge.

Cost was clearly a barrier at that point, but it no longer appears to be a barrier to the Government’s changes. The impact assessment published after last year’s pre-Budget report suggested that the package of measures would cost about £275 million. That is a significant shift from the estimate that the Government produced in July last year, and I shall be grateful if the Minister can provide a breakdown of the figures, to explain the sources of revenue. I suspect that the cost of the dividend exemption remains broadly unchanged but that the changes the Minister referred to in his opening remarks to things such as the debt cap and Treasury consent may be yielding more income. It is important that there be greater clarity about how the Government were able produce a revised estimate that made the dividend exemption more affordable.

As I mentioned earlier, the proposals set out in 2007 looked at a move to an income-based regime, to ensure that businesses did not use the opportunity of the dividend exemption to restructure their operations and move various sources of income overseas for tax purposes, rather than as a consequence of how their businesses operated. That led to a significant outcry from businesses. Deloitte stated that

“in our view, this could significantly detract from the UK’s competitiveness, both from a financial and an administrative point of view, and could dissuade companies from locating holding companies here”.

Ernst and Young commented on the potential compliance burden that would arise from that, stating that the proposals would

“neither improve clarity and transparency, nor make the rules more certain and straightforward in application—they are in fact a significant move in the opposite direction”.

The outcry prompted the Government to move, as there was a big concern that moving from an entity-based stream to an income-based stream would require businesses to rework the basis on which they submit information to the Treasury. Companies currently account on an entity basis and so would have to revisit how they structure their reporting to deal with it on an income basis. Clearly, the concern that businesses will seek to move certain income streams offshore to lower-tax jurisdictions still exists, as there might be a particular incentive in relation, for example, to intellectual property rights or to finance income. Is the Minister content that the anti-avoidance measures in schedule 14 are sufficient to tackle those issues relating to mobile income streams, or is that still a potential gap that will need to be addressed later?

Another point I want to raise relates to the structure of the exemption and the way in which it is given. Schedule 14 starts with the premise, as set out in proposed new section 930A, that all distributions received will be subject to tax. The existing legislation is framed differently: the assumption is that all distributions received in relation to UK shares are not taxed, but those in relation to overseas shares are taxed. We have now moved to a basis on which all dividends and distributions are taxed unless there is an exemption. Could the Minister explain why that change has been made? It has been suggested to me that, given the increased importance of the European Union in matters of direct taxation, because of issues relating to the freedom to establish and freedom of movement, that means it is difficult to distinguish the dividends and distributions of UK companies from those of non-UK companies.

Therefore, we have made the regime more challenging for UK companies than it was before, and I shall be grateful if the Minister can provide some clarification on that. Will that change, which we will debate in greater detail when we come to schedule 14, increase the compliance cost to UK business as a consequence? There is a concern about how the legislation has been structured, so it would be helpful if the Minister would explain why that move from a distinction between UK and non-UK distributions has been changed, because I think that that will have a knock-on effect, as we will debate later.

We are broadly content with the concept to which the Government have moved: that there should be a dividend exemption for foreign dividends. I think that that will help to address the issues of competitiveness that the UK faces as a location for holding companies. It has taken a long time to get that—two years—and at one stage last year I thought we might never see it. It is good that the exemption will make it on to the statute book, but an understanding of how the Government’s objections on the grounds of cost have been overcome would be helpful.

Stephen Timms (Labour, East Ham)

I am grateful to both Opposition spokesmen for their support for the principle of what we are doing and the approach we have taken. Consultation has been broad, and as the hon. Member for Fareham pointed out, the proposals have been substantially modified in the light of our discussions. As we go through this part of the Bill there will be several technical discussions on the details, which will be important, but I am glad that the principle has been so strongly supported. The hon. Member for Southport was right to highlight the importance of our ability to continue to bear down on avoidance, and we will debate the issue later.

The hon. Member for Fareham asked about the costs involved. He is right to say that our initial intention was to make the change in a fiscally neutral way. As he indicated, there is a degree of uncertainty about precisely how companies will react to the changed framework introduced by the clause, so one cannot be too definitive about exactly what the fiscal impacts will be. However, as discussions have developed and as we have listened to the concerns that have been raised, we have relaxed the requirement that the change should be fiscally neutral. Consequently, while the initial intention was for the package to be revenue-neutral, it now has a cost.

On next year’s expectation, dividend exemption will lead to a tax reduction of £500 million and we expect that to be offset by £200 million from the impact of the debt cap, which we will discuss in relation to the changes to the controlled foreign companies rules in clause 36. We also expect a loss of revenue of £50 million as a result of the abolition of the Treasury consents rule. All of those changes mean that we expect an overall loss of revenue of £150 million, which will grow as time goes by and companies increasingly reorganise their activities in the light of the changes.

The big difference is that, whereas we initially envisaged the debt cap as centring on a company’s net debt, it now centres on gross debt. That is the big change both in the structure of our proposals and in the fiscal impact.

Mark Hoban (Conservative, Fareham)

The right hon. Gentleman says he expects the cost of the package to increase over time. I assume that there will be a tax loss as companies restructure their activities and repatriate profits. Does he anticipate that businesses will also look at the way in which they structure their financing to reduce the additional tax, or will they pay the consequence of the introduction of the debt cap?

Stephen Timms (Labour, East Ham)

I am not sure whether the hon. Gentleman is thinking about a particular kind of change, but I am certain that, with a substantial change of this kind, companies will want to look at potential opportunities for them to change the way in which they organise themselves in order to take advantage of the provision. That is perfectly appropriate. He was right to raise concerns about potential avoidance opportunities and we will debate a general anti-avoidance rule later in relation to a Government amendment. We certainly need to keep a close eye on avoidance activity, but in response to an earlier question of his, I believe that the measures under consideration will do the job.

The hon. Gentleman asked why some UK to UK dividends will be taxed for the first time. We need to provide equality of treatment for UK and non-UK dividends, as the previous inequality was not appropriate. In fact, the impact of the proposals on UK dividends will be pretty minor. We need to be certain that there is no risk of a challenge under EU law, because challenges of that kind lead to damaging uncertainty that is in nobody’s interest. The legislation’s structure gives us a helpful guarantee on that front.

Schedule 14

Mark Hoban (Conservative, Fareham)

I beg to move amendment 43, in schedule 14, page 133, line 15, after ‘nature’, insert

‘other than in the case of a distribution within the meaning of section 209(2) of ICTA.’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: Government amendments 92, 93 and 99.

Amendment 48, in schedule 14, page 140, line 36, leave out ‘is in’ and insert

‘was in the accounting period ending immediately before’.

Government amendments 101 and 102.

Mark Hoban (Conservative, Fareham)

I shall speak to amendment 43 first. This touches on a point I raised in the clause stand part debate about the treatment of UK to UK dividends. Under existing rules all distributions from UK companies are non-taxable, but new section 930A presumes that they are taxable unless they are exempt. The Minister acknowledged that it was the threat of challenge under EU rules that gave rise to that equality of treatment between UK and non-UK distributions. That is a topic that I will come back to under the next clause as well.

Having established that all distributions are taxable, there is then a series of exemptions from that tax. If an exemption is met, no tax is payable on those dividends. That is very straightforward. Where the problem arises is that in some cases there is a difference in treatment between distributions and dividends. The titles of the five exempt classes demonstrate that. There are three related distributions, which relate to controlled companies, non-redeemable ordinary shares and portfolio holdings, but also limited dividends from transactions not designed to reduce tax and dividends in respect of shares accounted for as liabilities.

The issue stems from the exclusion, in new section 930A(2), of a distribution of a capital nature. The feedback I have received is that the principles for that exclusion are relatively untested. To determine whether a distribution is of a capital nature, they would have to be tested against some very unclear case law. There are certainly some cases where distributions that were previously exempt will no longer be so under the new provisions and that will increase uncertainty in some fairly common transactions. Amendment 43 says that all distributions currently falling under section 209 of the Income and Corporation Taxes Act 1988 should continue to be exempt, so that there is a continuity of treatment between the old regime and the current regime.

Amendment 48, which I have also tabled in this group, deals with a small companies exemption. Schedule 14 provides for two regimes: one for small companies and one for medium and large companies. Schedule 14 provides a definition of a small company in new section 930R. However, it creates a degree of uncertainty as to whether a small company is a small company in the year of the dividend accounting period. My amendment seeks to create some certainty by referring back to the accounts of the previous accounting period to determine whether a small company is a small company. Rather than the uncertainty of new section 930R inserted by the schedule, which looks at the current accounting period, amendment 48 refers to the previous accounting period to give the taxpayer greater certainty.

Stephen Timms (Labour, East Ham)

Schedule 14 provides the new exemption, which we have been discussing, from corporation tax for dividends and other distributions from foreign companies. It amends the rules on taxation of distributions received from UK companies. The exemption will remove the need for groups to make complex double tax relief calculations and will allow profits to be repatriated, even in circumstances in which there would not have been enough double tax relief to eliminate a UK tax liability. Until now, when there was insufficient credit for foreign tax, overseas profits would typically stay offshore, with cash possibly being returned in the form of an upstream loan. Alternatively, groups might have adopted complicated, artificial ways of repatriating such profits other than through a dividend. Exemption will sweep all that away and allow for immediate repatriation of profits and the return of cash by dividend. That will enhance the attractiveness of the UK as a location for the headquarters of multinational businesses.

The rules will apply to distributions received by all companies in the UK, including small companies, which was not part of the original proposal. The rules for small companies are distinct from the rules for medium and large companies, but, in each case, the vast majority of all dividends and other distributions will benefit from the exemption. That protection, alongside that contained in clause 40 and schedule 19, which deal with personal dividend taxation, are a proportionate response to the risk of abuse of the exemption by small companies—the protection set out in the schedule. However, we will keep a close eye on the matter and take immediate action if any avoidance activity is identified.

The hon. Member for Fareham moved amendment 43 on capital distribution. Schedule 14 applies only to distributions of an income nature. The amendment would increase its scope so that it applied to most capital distributions as well. However, schedule 14 is concerned only with the taxation of distributions that represent income. Nothing in the schedule will cause any capital distribution that is currently exempt to become taxable, so there is no reason to extend the scope of the exemption as suggested. The legislation does nothing to alter the taxation of capital distributions that are excluded from the scope of proposed new part 9A of the Corporation Tax Act 2009. There is already an exemption for capital distributions, known as the substantial shareholdings exemption. It is not part of this Bill to change in any way the scope of that exemption, so I hope that he will accept that the amendment is not appropriate.

As the hon. Gentleman explained, amendment 48 would alter the definition of a small company. However, in doing so, it would change the standard definition used to determine whether exemption follows the small company rules or the rules applicable to larger companies. The legislation uses the standard European Commission definition of a small company, which includes a time lag whereby a company that changes from small to medium sized retains the status of “small” in the transition year but becomes a medium company the following year. A similar rule applies if a company moves down in size from medium to small. The amendment would delay the change of status by a further full year. That would be an additional complication and make it less likely that the appropriate legislation for that size of company was applied. I hope the hon. Gentleman will accept that that is an unhelpful additional complication.

Several Government amendments in this group are concerned with a rule that denies exemption if a foreign tax deduction is given for the distribution, on the basis that a distribution that is tax deductible represents a deduction from taxable profits rather than distribution of those profits. Therefore, it is closer to an interest receipt than a distribution and would be expected to give rise to a taxable receipt for the recipient. The rule denying exemption is extended to cases where amounts determined by reference to a distribution are tax deductible. That ensures that the rule cannot be side-stepped by the use of indirect tax deductions obtained through avoidance schemes. The change will also enable some simplification of the manufactured dividend rules, which no longer require a specific exception. I therefore recommend that Government amendments 92, 93, 99,101 and 102 to schedule 14 be accepted. I hope that the hon. Gentleman will not press amendments 43 and 48.

Mark Hoban (Conservative, Fareham)

I am grateful to the Minister for his comments, particularly on amendment 48 and the transitional year which dealt with the issue that I was seeking to tease out. I have a residual concern about amendment 43. My understanding is that certain distributions that would have been untaxed under the existing rules, because of the UK to UK rules, are taxable now. I will go back and think carefully about whether any issues ought to be drawn to the Minister’s attention and be the subject of further debate on Report. I beg to ask leave to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I beg to move amendment 44, in schedule 14, page 135, line 32, leave out ‘subsection 6(c) and (d)’ and insert

‘the words “is resident in the United Kingdom and” after “person who” in each of paragraphs (c) and (d) of subsection (6)’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: amendment 45, in schedule 14, page 135, line 36, leave out from ‘of’ to end of line 38 and insert ‘an ordinary share.’.

Amendment 170, in schedule 14, page 136, line 19, after ‘dividend’, insert ‘or other distribution’.

Amendment 49, in schedule 14, page 141, leave out lines 29 to 34.

Mark Hoban (Conservative, Fareham)

The amendments cover several issues. Amendment 44 deals with the exemptions in proposed new section 930E—“Distributions from controlled companies”. I am concerned that in introducing this measure the Government have omitted some of the existing tests for controlled companies. It refers to holdings which, for a variety of reasons, may be split between various groups of companies but in aggregate mean that the company has control.

The existing tests read:

“(c) if the person is resident in the United Kingdom, rights and powers of any person who is resident in the United Kingdom and connected with the person; and

(d) if the person is resident in the United Kingdom, rights and powers which for the purposes of subsection (5) above would be attributed to a person who is resident in the United Kingdom and connected with the person (a ‘UK connected person’) if the UK connected person were himself the person.”

The situation here is that the ownership of subsidiaries may be split so that neither of the owners have control within the basic provisions of controlled foreign companies legislation, but taken together they would have control. If we do not replicate this in subsections 6(c) and (d), those dividends would fall outside the exemption and would therefore be taxable. It is not clear why the change has taken place. The explanatory notes suggest that the definitions replicate the CFC rules, but this exclusion for indirect ownerships suggests that that is not the case. The amendments try to address that by enabling shareholdings held through non-resident affiliates to be aggregated together.

Amendment 49 refers to the issue of redeemable shares. In the UK ordinary shares are assumed not to be redeemable. One concern is that the law in other jurisdictions is not as clear as in the UK, so there would be a risk that a distribution might be taxable when it should not be. My amendments seek to clarify that point and I would be grateful for the Minister’s comments. If there is an issue about people using redeemable ordinary shares, is it not better to tackle it through an anti-avoidance route rather than the provisions in proposed new section 930F?

Amendment 170 is a drafting amendment that seeks alignment: subsection (1) of proposed new section 930H refers to a dividend only, whereas subsection (1) of proposed new section 930G refers to a “dividend or other distribution”. Assuming that there is no reason for this difference, the amendment would simply correct a drafting error.

John Pugh (Liberal Democrat, Southport)

I wish to speak against amendment 44. I understand that it replaces reference to Income and Corporation Taxes Act 1988 provisions with the words,

“is resident in the United Kingdom”

and “person who”. This is undesirable because the vagueness of UK residency requirements can lead to individuals exploiting distributions from controlled foreign companies and achieving tax advantages. The legislation is best left as it stands. I understand that there are difficulties at the moment in equating certain well-known Tory donors’ residency with their tax situation, and bringing residency into this is unsatisfactory.

Stephen Timms (Labour, East Ham)

Chapter 3 of the schedule introduces a set of exempt classes, and the amendments in this group, as we have heard, all act to increase the scope of the exempt classes in various ways. The idea of the exempt classes is to give exemption in circumstances where the risk of avoidance is low. The benefit is that the anti-avoidance rules can be targeted at narrow situations rather than being of general application. That is a significant benefit and I am cautious about extending exempt classes because of the risk of losing some of that benefit.

Amendment 44 would increase the scope of the exempt class for controlled companies in a way that would allow a distribution to fall within an exempt class even if the payer of the distribution was not within the scope of the CFC legislation. That exempt class gives exemption to more than 90 per cent. of dividends by value. It takes a simple and direct route to exemption for controlled companies, which is possible because the CFC rules protect against artificial diversion of profits. The protection reduces the risk that this exempt class might be abused by avoidance schemes and allows it to be free of any other conditions for exemption.

The effect of the amendment would be to allow the rights and powers of a connected foreign company to be taken into account in determining whether the payer of a distribution is a controlled company. Therefore, a distribution paid by a company controlled outside the UK—and therefore outside the scope of CFC defences—could be brought within this exempt class, so there is a potential danger of an unacceptable fiscal risk. The attribution was limited to UK companies, and that brought the risk of another EU legal challenge. The extension of that to all companies would have brought unacceptable risks and hence we removed it altogether.

Mark Hoban (Conservative, Fareham)

Is the Minister certain that a significant risk is attached? I understand that the rules were in place under the existing regime. They allowed non-UK affiliates to be taken into account in determining whether the basic control rules were met. We seem to have shifted away from that. I am concerned that the Minister is taking a potential threat and using it in support of the changes, rather than recognising that the rules currently permit that aggregation to assess whether control has been in place. He has not justified as robustly as we would expect why we should move away from that position.

Stephen Timms (Labour, East Ham)

What I understand the hon. Gentleman to be asking is whether there is a real risk of EU challenge from the arrangement as it was. We have been very careful throughout the exercise to ensure that we are absolutely secure from any challenge under EU law, because such a challenge would create uncertainty which would be in nobody’s interest. I am not aware of anyone proposing to mount a challenge, but the way in which we have arranged this now means that we can be absolutely certain that there will not be a challenge. That is an important bolstering of the confidence with which people will be able to operate once the arrangements are in place, and is a worthwhile protection against challenge.

Amendments 45 and 49 would remove one of the two conditions required for exemption in the second class, which applies to distributions paid on non-redeemable ordinary shares. This class is relevant where the first class is unavailable because the CFC rules do not apply. An ordinary share is one that carries no preferential rights. The reason for the restriction is that in the absence of CFC defences, preferential rights attached to shares may be used to allow distribution exemption to be used to convert what would otherwise be taxable profits into exempt dividends. We need that when ordinary shares are not redeemable, since the right to redeem share capital might otherwise be used to provide an alternative form of preference for the shareholders, and we think that that would represent an unacceptable fiscal risk.

I should remind the Committee that a dividend that does not fall into the exempt class can still qualify for exemption. A dividend will always be exempt if it is not derived from transactions designed to reduce UK tax. That is the effect of the later part of chapter 3. The exempt class provides a simple route to exemption for many dividends, but it is not the only route—there is also a fall-back. I suggest that the amendments are not necessary and would create a significant avoidance risk.

Finally, turning to amendment 170, I should say again that there is a fall-back exempt class that ensures that dividends paid in wholly commercial circumstances are always exempt. The exempt class is based on a test of the profits out of which a dividend is paid. Exemption is given, provided that the profits do not derive from transactions designed to reduce UK tax. A dividend is necessarily paid out of profits, but the same cannot be said for other types of distribution. Since the class is a test of profits and not directly a test of the distribution, it is limited to dividends.

I am satisfied that amendment 170 is not necessary to enable all commercially derived profits to be repatriated in a tax-free form, which is our aim. The extension to non-dividend distribution would create risks because of the lack of a necessary link between the distribution and the profits. I hope that on that basis the hon. Gentleman feels able to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

The areas that we are seeking to legislate on are obviously complex. The Financial Secretary has said that there are fall-backs that would allow distributions to be exempt in particular circumstances. It would have been helpful, where possible, to have drawn together on that. I do not understand why he objects to amendment 170; if a distribution is not designed to reduce tax, why is that not part of the clause? There is a danger that the dividing line that the Minister is seeking to draw between what should and should not be exempt will become quite complex.

The Financial Secretary is yet to give a robust explanation for why it is not appropriate, in relation to amendment 44 for example, to repeat the foreign affiliates rules in the existing CFC legislation, but we will not dwell on that. Part of the challenge with schedules 14 and 15 is that they have been heavily amended in the past few days, and I think that people need more time to think through some of the consequences. I am sure that that will be one of the themes that will emerge in later consideration. We are in danger of giving outside bodies insufficient time to think about the consequences of those changes and the knock-on effects. Having said that, I beg to ask leave to withdraw the amendment.

Stephen Timms (Labour, East Ham)

I beg to move amendment 94, in schedule 14, page 136, line 30, leave out ‘apart from’ and insert ‘otherwise than by virtue of’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: Government amendments 95 to 98.

Amendment 46, in schedule 14, page 139, line 43, leave out ‘dividend’ and insert ‘distribution’.

Amendment 47, in schedule 14, page 140, line 2, leave out ‘dividend’ and insert ‘distribution’.

Amendment 51, in schedule 14, page 147, line 30, leave out ‘expenditure’ and insert ‘territory’.

Government amendments 103 and 104.

Amendment 59, in schedule 15, page 172, line 33, leave out ‘Part’ and insert ‘Schedule’.

Government amendment 100.

Amendment 50, in schedule 14, page 143, line 20, leave out paragraph 9 and insert—

‘9 In section 806J, after subsection (7) insert—

(8) Sections 806A to 806K shall not apply to any distribution paid after 1 July 2009 other than a distribution in respect of which an election has been made under section 930Q of CTA 2009.”’.

Stephen Timms (Labour, East Ham)

This is a mixed group of Opposition and Government amendments, all of which address relatively minor drafting points. I have so far resisted amendments from Opposition Members, but I am pleased to say that on this occasion I will be urging my hon. Friends to support the amendments tabled by the hon. Member for Fareham, which I am happy to accept. [Interruption.]

Jimmy Hood (Labour, Lanark and Hamilton East)

Order. Calm down.

Stephen Timms (Labour, East Ham)

I was rather hoping that we might have had a little oratory from the hon. Member for Fareham in support of the amendments, but even without the oratory I am happy to accept them and hope that the Committee will accept the Government amendments as well.

Mark Hoban (Conservative, Fareham)

Well, I am almost overwhelmed to the point of speechlessness by the acceptance of the amendments. I just wish that they were of a more substantive nature, as that would have shown that the time of change had come after all. They correct drafting errors where the Government have inappropriately used the word “dividend” instead of “distribution.” Proposed new section 930P refers to distributions in the context of diversion of trade income, but the drafting refers intermittently to “dividends” and “distributions”, and we have already discussed circumstances in which either “dividends” or “distributions” might be appropriate.

Amendment 51 corrects a different typo: the line should have referred to “territory”, but currently refers to “expenditure”. The amendments are fairly straightforward. I wish I could claim authorship, but someone more eagle-eyed than me identified the issues. I am grateful to the Minister for accepting them.

Stephen Timms (Labour, East Ham)

I beg to move amendment 100, in schedule 14, page 143, line 9, leave out sub-paragraphs (2) and (3) and insert—

‘() In subsection (3) (as it has effect as amended by paragraph 8 of Schedule 30 to FA 2000)—

(a) before paragraph (a), insert—

“(za) if the dividend is received in an accounting period of the recipient in which the recipient is not a small company, and the dividend is a relevant dividend, the profits in respect of which the dividend is paid;’,

(b) in paragraph (a), at the beginning, insert “in a case not falling under paragraph (za),”, and

(c) in paragraph (c), at the beginning, insert “in a case not falling under paragraph (za),”.

() After subsection (3) insert—

“(3A) For the purposes of subsection (3)—

(a) “small company” has the same meaning as in Part 9A of CTA 2009 (company distributions),

(b) “relevant dividend” means a dividend that, for the purposes of section 930H of that Act (dividends derived from transactions not designed to reduce tax), is treated as paid in respect of profits other than relevant profits (see subsection (4) of that section), and

(c) the profits in respect of which a dividend is paid are the profits in respect of which the dividend is treated as paid for the purposes of that section.”’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss amendment 50, in schedule 14, page 143, line 20, leave out paragraph 9 and insert—

‘9 In section 806J, after subsection (7) insert—

(8) Sections 806A to 806K shall not apply to any distribution paid after 1 July 2009 other than a distribution in respect of which an election has been made under section 930Q of CTA 2009.”’.

Stephen Timms (Labour, East Ham)

Amendments 50 and 100 centre on the way in which double taxation relief is given in the rare cases in which a dividend is taxable. Government amendment 100 deals with the interaction between the rules in part 9A that apply to taxable dividends and the double taxation relief rules. If a dividend is paid out of profits that have been subject to foreign tax, the double taxation relief rules allow the foreign tax to be given as a credit against the UK tax due on the dividend to ensure that the same income is not taxed twice. The rules currently allow a large amount of choice in the specification of the profits out of which the dividend is paid, which is important because the foreign tax paid on the specified profits determines the amount of foreign tax credit available. The distribution exemption schedule includes an anti-avoidance rule that considers the source of the profits out of which a dividend is paid. If those profits result from transactions designed to reduce UK tax, the dividend will be taxable in the UK.

Since the Bill was published, it has been brought to our attention that there is a risk that avoidance schemes might exploit the mismatch between how profits are specified for the purpose of the anti-avoidance rule and how they are specified for the purpose of double tax relief rules. The amendment therefore overrules the usual choice available in the double tax relief rules. It will ensure that, where a dividend is taxable in the UK because it is paid out of the profits of tax avoidance, double tax relief available on that dividend will be calculated by reference to those same profits. The amendment will remove a significant risk of tax avoidance exploiting a mismatch whereby a dividend intended to be taxed would escape any effective taxation.

Perhaps if the hon. Member for Fareham speaks to amendment 50, I will be able to respond later.

Mark Hoban (Conservative, Fareham)

Amendment 50 deals with new section 930Q, which allows a company to make an election that a particular distribution that would otherwise be exempt should instead be taxable. The explanatory notes state that the two reasons why a company might wish to make such an exemption are that

“dividends can only be taken into account for the purposes of the CFC acceptable distribution policy (ADP) exemption if they are subject to tax”

and

“it is possible that exemption could lead to an increased rate of withholding tax.”

Paragraph 9 of schedule 14 amends the Income and Corporation Taxes Act 1988 to delete the onshore pooling rules and the rules that allow for relief in relation to eligible unrelieved foreign tax. The provisions are an integral part of the credit system of taxation and it is appropriate that they should no longer apply to dividends following the introduction of the exemption regime; there is logic in that.

However, a taxpayer may elect for dividends to fall outside the exemption regime. Therefore, a corporate taxpayer may elect for a dividend to be taxable in the UK if it is paid by a company resident in a territory with which the UK has a double tax treaty. The provisions that reduce or eliminate foreign withholding tax apply only if the dividend is subject to tax in the UK—the sort of scheme where one might want to have a taxable rather than an exempt dividend. The expectation is that where people take advantage of that election, they should also be able to take advantage of the existing rules on onshore pooling and the use of eligible unrelieved foreign tax. Amendment 50 would enable people who take the election under new section 930Q to take advantage of the rules on onshore pooling and the use of unrelieved foreign tax.

Stephen Timms (Labour, East Ham)

A principal purpose of the legislation is to simplify the process of paying dividends to the UK. Amendment 50 would retain a significant body of complicated legislation on onshore pooling rules. I hope that I can persuade the hon. Gentleman that it would do so with little, or possibly no, benefit. It would retain the onshore pooling rules solely for the benefit of those dividends that a company elects to be taxable. Why would a company do that? The two most likely reasons are to obtain lower rates of foreign withholding tax and, during a transitional period, to allow dividends to qualify for the ADP exemption from controlled foreign company legislation, which we will come to later.

Although the onshore pooling rules can apply to withholding tax, by far their main application is in connection with underlying tax. It is rare that dividends that qualify for underlying tax credit also suffer withholding tax, because intra-group dividends are generally exempt from such taxes. ADP dividends are in all cases excluded from onshore pooling. It is not justified to retain onshore pooling and the significant amount of legislation on that for that very limited purpose. The rules were introduced in 2001 to balance the introduction of the so-called mixer cap. That need has been removed by dividend exemption, so the rationale for the onshore pooling rules will end as well. I hope that the hon. Gentleman feels that he can withdraw his amendment.

Mark Hoban (Conservative, Fareham)

The Minister has given a satisfactory explanation and his point about the change to the mixer cap arrangements suggests that the onshore pooling arrangements are no longer necessary. Although I have not moved amendment 50, when the time comes I will not press it to a Division.

Mark Hoban (Conservative, Fareham)

I want clarification on some of the technical aspects of the schedule that we have not touched on. The schedule comes into effect on 1 July 2009, which is slightly odd. It will be difficult to do given that the Bill will not receive Royal Assent until after that date, but that is how we are making tax policy. There have been concerns about the impact of that date. Does the commencement date make it more difficult for foreign companies to meet the acceptable distribution policy?

The proposed changes to the Corporation Tax Act 2009 mean that from 1 July 2009, dividends can only be specified as being paid from the profits of the current period. When no profits are specified, the dividend will be treated as having been paid from the profits of the last period for which accounts were drawn up. That suggests that it be difficult for companies to qualify for the acceptable distribution exemption. In addition, a company accounting period that straddles 1 July 2009 will be, as a whole, under the controlled foreign companies rules. That may end up with CFCs trying to run other exemptions to get their dividends through.

PricewaterhouseCoopers suggested that a straddled period should be treated as split only in cases when a company pursues an acceptable distribution policy in respect of the first period, or for which an exempt activity holding company is claimed in the first period but not thereafter. Will the Minister clarify how the commencement date impacts on companies seeking to use the existing rules?

There is a disconnect between the sourcing rules in part 2 and other rules on the treatment of dividends. Are the rules consistent with the acceptable distribution policy? Will the Minister comment on the taxation of foreign permanent establishments, which has not yet been fully addressed? Where are the Government in that process?

Stephen Timms (Labour, East Ham)

We have had a helpful discussion on the schedule and the amendments. The new exemption from corporation tax for dividends and other distributions received from foreign companies which is introduced by the schedule is a key element of the package to enhance the attractiveness of the UK as a location for multinational businesses. As the hon. Gentleman said, it takes effect from 1 July 2009.

I say in passing that we have thought very carefully about the implementation dates of the various parts of the package. Therefore, as we will discuss shortly, we are introducing the debt cap for an accounting period which will begin on or after 1 January 2010, so that businesses have time to prepare. That the measure is being introduced later than the dividend exemption has been widely welcomed.

The hon. Gentleman asked about transitional arrangements. Any profits accrued in a foreign subsidiary before the package comes into force can be paid out as an ADP dividend and remain subject to the current rules, which may be a helpful clarification.

Considering the tax treatment of branches would have raised more issues and diverted attention away from the main point, which is the taxation of foreign dividends. We will bear branches in mind when we look at future options for controlled foreign companies, but we will not consider the treatment of foreign branches in detail until after the consideration and reform of the CFC rules.

I have one further point to make about the interaction with the ADP exemption. Amendment 100 removes the restriction on double taxation relief. Amendment to the CFC changes in schedule 16, which we will come to, will allow the split period to also be treated as split for the purpose of double taxation relief. There was indeed a problem in the area highlighted by the hon. Gentleman when the Bill was initially drafted, but I think that that has been solved by the various changes that we will debate today.

Clause 35

Mark Hoban (Conservative, Fareham)

This is an important clause. A number of issues have emerged since it was tabled, including the number of Government amendments to it. The extensive nature of the new rules on anti-avoidance and financial services groups is also important and needs to be addressed. However, I want to say something more broadly about the debt cap, because it is has given rise to some concern about what sort of behaviour it will incentivise. Is it the best way to tackle the issue that concerns the Government? Are we at risk of introducing a cumbersome process that will add to the compliance cost of business? Let me talk through some of those issues.

As the Minister indicated in the debate on clause 34 stand part, some of the cost of the dividend exemption has been offset by the introduction of the debt cap. That leads to interesting issues as to whether those reforms are linked, in the sense that if clause 34 is introduced, does clause 35 have to be introduced, or are the reforms taking place in parallel, with one raising revenue and one leading to a loss of revenue just a matter of convenience rather than a matter of planning how the tax structure will work? Clearly, when the debate about the taxation of foreign profits started in 2007, the Government had other ideas about how to tackle some of the behavioural challenges that arose from it. It was only when the original ideas on the control of companies ran into a degree of flak that they then moved on to the debt cap.

The aim of the worldwide debt cap is to target situations in which a UK group bears more debt than is required to finance the worldwide group. In addition, the measure could provide an effective means of targeting many upstream loans to the UK that are used to repatriate overseas cash. However, in order to protect those groups that are temporarily cash rich, the Government intend to allow the worldwide debt cap measure to be set aside where the group is in a short-term cash-rich position. Of course, that stems from the point that has been quite widely debated over several years that the UK has a very generous regime for interest expense—it is fully deductible. It is one of the issues that has perhaps led to an increase in leverage among a number of companies over the course of recent years and has certainly led to concern about whether it has incentivised a particular type of behaviour.

Although the Government flagged up last year that that is what they wanted to do, there is still concern about the workability of the proposals. Deloitte said:

“Unfortunately the provisions remain very complex and represent a major compliance burden for groups even if they will have no ultimate disallowance of interest.”

Adding 32 pages of tax codes could make the risk overly burdensome. The Institute of Chartered Accountants believes this matter could have been addressed in other ways:

“We believe that the same policy objectives, which are to prevent the ‘dumping’ of debt into the UK part of worldwide operations and the penalisation of upstream loans to the UK, could equally well be achieved by tightening up the existing thin capitalisation regime and introducing targeted rules against upstream loans.”

Could other policy routes have been used to tackle unnecessary upstreaming that would not have added to the compliance burden on businesses? In the brief stand part debate, the Minister referred to the different commencement date for the debt cap arrangements. Will the gap between commencement dates be used for further consultation and to explore the alternative solutions, or are the Government determined to take this route?

Since the original proposals were published in draft last year, there has been movement by the Government and some of the complexity has been ironed out. However, UK-only groups will still be caught by the measure and will have to go through some compliance steps, which is regrettable. The proposals are meant to deal with debt that is incurred outside the UK by international groups, yet it appears from the drafting that UK companies will have to pay unnecessary additional taxes.

The debt cap places restrictions on the relief given to UK companies that form part of a worldwide group relating to the interest and finance expenses on transactions with related companies. The extent of that restriction on the intra-group interest and finance costs will depend on the external financing costs of the worldwide group. The Chartered Institute of Taxation questions why those restrictions are required, saying that

“It is not clear to us why these provisions are required at all in addition to the many existing rules which are intended to restrict interest relief in certain situations, including transfer pricing, arbitrage provisions and”

provisions of the Finance Act 1996. Both CIOT and ICAEW have concerns about the Government’s approach.

The Minister suggested that the proposal was a move towards a more territorial system of taxation, and he is right: it is only a move towards that. It has not been fully articulated as the end point. Will he clarify whether we should move to a territorial system of taxation and whether the proposal is a staging post along that route or the end of such movement? If it is a staging post, what does he think the next moves should be?

There is a more fundamental concern about the impact of the measures on businesses. I have talked about compliance costs and about whether there are other ways to tackle the concern about loading UK-based companies with high levels of debt. There have been a number of comments from business and outside advisers about how the proposal will affect the way in which companies are structured and financed.

The Law Society has suggested that the proposals might encourage UK groups to incur more debt; encourage multinationals to transfer assets out of the UK; discourage inward investment into the UK; put over-leveraged companies at an advantage over cash-rich companies in making acquisitions in the UK; and discourage outward investment. I shall illustrate just one of those points, as it is quite important to reflect on the potential outcome. We could have a situation in which a UK-based company is being targeted by two potential acquirers. One could be an overseas company that is cash rich, but it would seek to finance its acquisition of the company through intra-group loans. Alternatively, there could be a highly-leveraged private equity situation, where there is quite a high level of external debt. Again, the company in that situation would use debt to finance the acquisition of the original UK-based company.

The concern that has been expressed to me is that, because the overseas parent company is cash rich, it has low levels of external debt or, as in this case, no external debt. The restriction on debt interest—the worldwide debt cap—would kick in on that company. By contrast, if the UK company was acquired by a highly-leveraged private equity fund that had external debt, the fund would be able to use debt; it would not face the restriction on the deductibility of interest that the cash-rich non-UK company would face. As a consequence, it could borrow more to fund that acquisition; it could pay a higher price to acquire that other company.

Given that one of the concerns expressed recently has been about over-leverage in the markets, we seem to have a situation here whereby the proposed measures could encourage more leverage, rather than encourage companies to have significant cash resources, whether those resources are acquired through the retention of profits or through arranging money via share issues. The behavioural issues are causing some concern to outside bodies, and this could be an opportunity for the Minister to explain the Treasury’s view.

As I understand it—I am sure the Minister will correct me if I am wrong—we are the only country that has introduced a worldwide debt cap. Other jurisdictions have considered introducing some cap on tax deductibility debt within their own jurisdiction, but not outside it. Deloitte suggests:

“The introduction of the debt cap cannot be regarded as a move which will enhance and support UK competitiveness and this aspect of the policy design of the debt cap seems more likely to damage the UK’s competitive position than to enhance it.”

Is the Minister prepared to comment on that assessment?

The second issue that I want to touch on relates to the compliance cost. I alluded to the fact that purely UK groups would also have to go through the process of calculating what their external financing is, even though they do not have any non-UK business. As I understand it, the problem is the gateway test that has been used. When the measures were originally consulted on, it was suggested that there would be a number of gateway tests, one of which would enable a purely UK group to avoid going through that process of calculating external finance. Will the Minister explain why there is to be only one gateway test?

The Chartered Institute of Taxation suggests that the reason why there is only one gateway test is our old friend, EU law, which we discussed in relation to the last schedule. It was said that EU law aims to ensure that the arrangements are waterproof and free of the possibility of legal challenge, which would mean that we will end up putting an additional burden on UK-only groups that should not really apply, given the nature of the debt cap rules. I should be grateful if the Minister explained why we have only one gateway test.

Three themes run through the general commentary on the measure. First, is it the best way to tackle the issue of the upstreaming of loans into the UK? Secondly, is the compliance cost too great? That partly links back to the fact that there is only one gateway test, which means that UK-only groups are caught by the measure. Thirdly—the problem that exercises a number of people—the measure could perversely lead to companies taking on more external debt, but would be to the detriment of inbound investment into the UK and perhaps outbound investment, too.

Mark Field (Conservative, Cities of London and Westminster)

I echo the words of my hon. Friend in introducing the subject. I ask the Minister for an indication of the Treasury’s broader thinking. No one can dispute that it is quite acceptable at times to utilise the tax system to incentivise or disincentivise certain behaviours. However, my concern is that the worldwide debt cap that has been put in place in the whole regime, rather short-sightedly, simply reacts to the specific economic problems of today, instead of looking at the long-term future.

We have a Finance Bill every year and I suppose that it is quite legitimate for any Government on a short-term basis to put such a regime in place to deal with the problems of the day, which can then be done away with in a year or two’s time, but the proposed regime obviously adds an extra layer of complexity, not least because the worldwide debt cap applies to global companies—companies with significant interests here in the UK, but which also have operations overseas. Given that it is a worldwide debt cap, I would be interested to have some indication from the Treasury as to precisely what negotiations have taken place with other countries and whether the measure is part and parcel of a concerted international process.

I worry that the measure may have been put in place because of the present problems. I accept that the genesis may not lie in September 2008, but may be found a little bit before that. That raises the obvious question that my hon. Friend mentioned in relation to the private equity industry. In many ways, we have seen a skewing of the tax system over the past decade or so: extremely low tax rates have made the putting of debt on to the balance sheet a much more attractive proposition. We are moving away from that now, and the Minister will rightly point out that, in the present climate, he wants to disincentivise having a hell of a lot of debt on the balance sheet. That may be an academic point, because I suspect that many private equity providers will not be able to get that much debt on their balance sheet, even if they want to. Many private equity players have problems, but because of the lack of liquidity they are trying to raise relatively small sums of money for debt-for-equity swaps. That is probably a more desirable way to run those businesses in the longer term.

Above all, I am keen to know what the Treasury’s broad thinking is. Is this a short-term measure given our specific problems at the moment, or is it part of a longer-term regime to incentivise longer-term behaviours in relation to debt?

John Pugh (Liberal Democrat, Southport)

I rise to be constructive about clause 35 and the schedule that follows. It seems to be about the understanding of complex companies and their financial footprint. That is highly desirable. It ensures that profits are appropriately taxed and placed. It ensures that parent companies are identified. It is not always easy to find the parent company of a subsidiary. It is also mindful of the need to avoid double taxation. It is an exceptionally difficult area. The difficulty is well illustrated by the number of Treasury amendments that have appeared since the legislation was put before us. It also seems to me to be about an area on which most of us cannot directly comment. It is highly technical. Schedule 15 refers to things such as staple companies and stranded deficits. It also incorporates a fair amount of algebra, which other Members may be able to explain, but I certainly cannot.

It is also fundamentally about imposing international accountancy standards fairly rigorously, which I welcome. That is a recipe for business efficiency. People talk about tax efficiency as though it is the same as business efficiency, but when companies such as Amazon export things to Jersey in order to import them back into the country, one realises that the pursuit of tax efficiency can be quite different from efficient business practice.

The arguments and concerns with clause 35 are ones that we will hear in connection with any clause of this nature. People always talk about compliance benefits and capital flow. Those arguments are used so often that it is almost like crying wolf. One wants to know whether there is any credibility attached to the complaints here. It seems that some of the more vocal people voicing these concerns are those who are prepared to pay huge sums of money on tax advisers. Surely that could go some way towards meeting the client’s costs.

Stephen Timms (Labour, East Ham)

In the previous clause we discussed the dividend exemption—the cornerstone of this package—and the benefits to business of its introduction. The dividend exemption will come at a cost of tax forgone and could also lead to multinational groups taking undue advantage of those generous UK interest relief rules referred to by the hon. Member for Fareham. Clause 35 in schedule 15 introduces a limited restriction on the deductibility of interest in computing taxable profits.

Mark Hoban (Conservative, Fareham)

Will the Minister explain a little further the link that he perceives between the dividend exemption rules and this particular clause? If this is about a group trying to transfer money into the UK, it could now make a distribution or pay a dividend that was tax free. How does he think that that is going to lead to greater use of upstreaming of loans into the UK?

Stephen Timms (Labour, East Ham)

I will respond directly to the point and argue that these two measures do indeed belong together. I will explain why in a moment and will also answer the hon. Member for Cities of London and Westminster. We are introducing a clear and fair principle to be applied to the treatment of interest for UK tax purposes. The UK is prepared to allow finance expense in calculating the UK profits of a group up to the amount of the group’s entire worldwide external finance cost. That is a very generous rule by international standards, but it does prevent groups putting more debt into the UK than they have borrowed externally for their worldwide business. I want to be sure that the Committee has grasped that fundamental point. We are saying that companies will not be permitted under this arrangement to put more debt into the UK than they have actually borrowed across the whole world in gross terms. It is clear that that is a pretty generous constraint compared to others that we might have applied.

How and why does that measure belong with the dividend exemption? There are a couple of points on that. First, as we discussed earlier, there is a revenue gain from the debt cap to offset from the revenue loss resulting from dividend exemption; but dividend exemption would also open up potentially large avoidance opportunities, and the debt cap provides the limitation in a principled and relatively straightforward way to address that. It is certainly a simple idea in principle: a company should not charge in the UK more debt than it has across the whole world. The conclusion that we drew from the consultation over the past couple of years is that it is the most straightforward in practice as well as in principle. I do not claim that the measure has no complexity or that it is absolutely obvious how it applies in every case, but it is more straightforward than the alternatives.

The hon. Member for Cities of London and Westminster raised an interesting point. I do not see this as a short-term measure. It is certainly not part of our fiscal consolidation, for example, if that is what he was suggesting. It addresses a general problem of companies putting too much debt into the UK, which could become more prevalent once dividend exemption applies. So, the two measures belong logically together, and not just from the point of view of the measure providing some additional revenue that will be forgone as a result of dividend exemption.

Mark Hoban (Conservative, Fareham)

I am still at a loss as to exactly where the link is between the two. I understand completely why the increased revenue that will come from the worldwide debt cap is there, and why it could be used to offset the losses that arise from the dividend exemption. However, the Minister is yet to demonstrate the linkage. What mischief will be created by introducing a dividend exemption policy that could be made worse by the tax deductibility of interest in the UK? The Minister has asserted strongly that there is a link, but has not given an example of a transaction that could suffer—he might have one in his hands as we speak. It would help to know exactly how he sees the two things linked, other than simply through offsetting losses and gains of tax.

Stephen Timms (Labour, East Ham)

What we have generally seen in the current regime is that companies use upstream loans to offset their tax liability on foreign dividends. With dividends to the UK exempt from UK tax, there is no case for allowing interest relief for loans to the UK because dividends can be paid instead. The two things belong together: dividend exemption could lead to business reorganisations that take advantage of both dividend exemption and the generous UK interest relief rules. We need to have measures in place to prevent that.

Mark Hoban (Conservative, Fareham)

Will the Minister tell the Committee what proportion of intra-group loans upstream of the UK is there to tackle the issue of the tax payable on dividends in the existing regime, and what proportion is there for normal financing arrangements, for when an acquisition has been funded for example? A more factual basis for the Minister’s argument would help if we are to be convinced that there is a real reason why the two measures are linked, other than simply to offset revenue.

Stephen Timms (Labour, East Ham)

I do not have those figures. From the point of view of HMRC, it is not always clear—there is no particular reason why it should be—why a company is doing a particular thing. What is certainly true is that a large amount of tax that would otherwise, under the current regime, be payable on foreign dividends is offset by the effect of upstream loans. I perfectly accept the point that there are other reasons for having those loans, but it is a substantial feature of multinational taxation currently that upstream loans offset what would otherwise be tax paid on dividends.

John Howell (Conservative, Henley)

Will the Minister give way?

Stephen Timms (Labour, East Ham)

Let me just respond to some of the other questions that the hon. Member for Fareham raised, and then I shall gladly give way to his hon. Friend.

The hon. Member for Fareham and a number of other people have made the point that perhaps we could have achieved the constraint that we need in other ways. It is true that there are alternative approaches that can be adopted to address what you might call “debt dumping”, but each would imply compliance burdens on business. Before deciding that the debt cap was the right answer, we looked at other possible approaches and found that each of them presented its own challenges, and we concluded that the debt cap was the best way to proceed. Other countries adopt other approaches, and the hon. Member for Fareham has made the point that the UK is the first country to adopt an arrangement of this kind, which is probably true. However, if we look at the way such matters are handled in the US, our arrangement is much more straightforward and its attractiveness may well become apparent to other jurisdictions.

The hon. Gentleman asked whether the gap in the commencement date between 1 July and 1 January would be used for further consultation. After much consultation, we believe that the rules being introduced are appropriate. It is, of course, true that we can use the period between now and 1 January to listen to any remaining concerns, although I think that all the material issues have been addressed. If there are any other issues, people have the opportunity to raise them.

Peter Bone (Conservative, Wellingborough)

Will the Minister give way?

Stephen Timms (Labour, East Ham)

Let me pause in answering the questions asked by the hon. Member for Fareham. I will first give way to the hon. Member for Henley before giving way to the hon. Member for Wellingborough.

John Howell (Conservative, Henley)

I thank the Minister for his generosity in giving way. He has said that it is not always possible to ascertain why companies do something, yet there is a test in the provisions to decide whether a loan has been taken out for a genuine commercial purpose. What are the parameters of the test? The complexity of the issue has also been raised. We have seen it go through a number of iterations in draft legislation, and it is quite clear that we are still on a journey. Will he tell us more about how that journey will be concluded? Clearly, a lot of things in the provisions are still inadequate.

Stephen Timms (Labour, East Ham)

I do not agree with the hon. Gentleman at all. There certainly was concern at one stage with our proposals. We discussed those concerns extensively and, in the discussions in which I have been involved, there has been a general welcome for the progress that has been made, and an acceptance that we now have a solution. Indeed, on Second Reading, the shadow Chief Secretary generously paid tribute to the consultation that had taken place and the conclusions that we reached as a result of it.

So I certainly do not agree with the hon. Member for Henley that the relevant clauses, together with our amendments today, leave us with legislation that is not ready—it most certainly is ready. My only point is that there will be a pause between Royal Assent for the legislation and the debt cap taking effect. It is open to people to raise concerns if they have any, but I underline very strongly that I think that we now have the answer that we need.

John Howell (Conservative, Henley)

Will the Minister give way?

Peter Bone (Conservative, Wellingborough)

Will the Minister give way?

Stephen Timms (Labour, East Ham)

I will give way to the hon. Member for Henley again before giving way to the hon. Member for Wellingborough, just so we do not lose our train of thought.

John Howell (Conservative, Henley)

My point picked up on the comment made by the Chartered Institution of Taxation that, without the full picture, it is difficult to comment on whether we think that the whole package will work. CIOT clearly does not think that it has the full picture.

Stephen Timms (Labour, East Ham)

Well, in terms of dividend exemption and the debt cap, it does. As I have repeatedly made clear, we want to complete the review of the CFC rules, which is an important next step. In response to the hon. Gentleman’s question about our journey towards a territorial system of taxation, that review will be the next step in that direction. On the narrow topics with which the four clauses under discussion deal, the full picture is complete and in good shape.

Peter Bone (Conservative, Wellingborough)

I am very grateful—

(Except clauses 7, 8, 9, 11, 14, 16, 20 and 92)

Jimmy Hood (Labour, Lanark and Hamilton East)

When we adjourned, the Financial Secretary had just given way to an intervention from the hon. Member for Wellingborough.

Clause 35

Peter Bone (Conservative, Wellingborough)

I am grateful to the Minister for giving way over such an extended period. We were talking about the different dates: 1 July and 1 January. The Minister had linked the two issues of the treatment of dividends and the debt cap. I wondered why the dates had not been coterminous. The subsequent point about 1 July is that this will come into effect before the Bill is enacted. If we get past that date and the Government call a general election, where does that leave people? Is it law or not?

Stephen Timms (Labour, East Ham)

Welcome back, Mr. Hood. I can reassure the hon. Gentleman that I do not expect that that will happen. But the Bill will not become law until it secures Royal Assent. He asked why we do not have the same date for the implementation of dividend exemption and the new debt cap requirement. It was the original intention, but in our discussions with businesses there was a strong sense that it would be helpful if there was a period between the two. They will undoubtedly want to make some changes and introducing the six months between the two gives a period of grace that enables them to do that. That has been widely welcomed. It is one of the improvements that we have made as a result of the consultation over the last few months.

I was answering a number of questions raised by the hon. Member for Fareham about the thinking behind the changes that we have made. As he said, there would have been a number of ways to tackle the issue that we are dealing with in the schedule. In terms of moving towards a territorial tax system, one view would be that as a matter of principle, interest to fund foreign equity investment should not be relieved when the dividends from those investments are exempt. Taking that view would suggest that dividend exemption should be accompanied by strict interest allocation or a limitation of interest for outward investment.

Either of those would have a very big impact on multinational companies, particularly on UK-headed groups. We discussed them both with businesses. Both were disliked, particularly interest allocation and the associated complexity and administrative burden that accompanies it, as has been found in the operation of that arrangement in the United States. Companies were very keen that we should not go down that road. So the debt cap measure is a less far-reaching but principled measure to accompany dividend exemption.

The hon. Gentleman suggested that another way might have been to tighten the thin capitalisation rules. That is where, typically, a UK subsidiary of a foreign multinational is funded with too little share capital and too much debt, thereby attracting a higher tax allowance than would otherwise be the case. That is countered at the moment using the UK transfer pricing rules which adjust the profits of a company that is thinly capitalised to reflect the profits it would have made if it had been capitalised in accordance with the arm’s length principle. A tightening of the UK rules to counter cases where there is excessive debt in the UK would mean abandoning the arm’s length principle. Instead we could have looked to counter thin capitalisation using different rules, but the alternative methods would have an impact on many more cases than the debt cap measure does.

In the end, we concluded that this is a principled and effective approach that deals with the problem. It is a clear principle. It is readily understood. In December, following the pre-Budget report, we issued draft legislation on the foreign profits package, so that people could see our intentions. There were concerns and lots of discussions arose.

At the beginning of April, Her Majesty’s Revenue and Customs published a technical note setting out current thinking on the debt cap with high level design changes, which have been welcomed. When the Finance Bill was published at the end of April, large parts of the debt cap legislation had been revised, but there were areas that required more time to ensure that the proposals were appropriate, so they were not in the Bill. There have been further discussions with interested parties since then. That is the background to the Government amendments to schedule 15.

The hon. Member for Fareham’s final question was about the gateways for outbound investors for UK-headed groups. He is right; we had hoped to have more than one gateway to keep administrative burdens on business as small and as light as possible. He anticipated part of my answer: throughout the package, as I have mentioned, we have had to take European Union legal requirements into account, and consequently we could only make one gateway available. However, the improvements to the debt cap design, particularly the switch from net debt to gross debt, exclude more groups from the debt cap anyway. Other changes reduce the administrative burden on any group that has to comply with the rules.

Mark Hoban (Conservative, Fareham)

Is there a workaround that HMRC could introduce? As I said in my remarks, a purely UK company would still have to work out whether it passed the gateway test even though it had no overseas parent or overseas external debt. Is there guidance? I hate asking for HMRC guidance and I argued against it last year. Is there a pragmatic solution that would say that a UK-only group need not go through the calculations set out in the gateway test?

Stephen Timms (Labour, East Ham)

We have taken steps to reduce to a minimum the administrative burden that any group will have to assume to meet the requirements. Certainly, we are open to doing what we can to help. I do not want to give the impression that there will not be an administrative burden; there clearly will be, but we have taken the steps that we can to keep it to a minimum.

Peter Bone (Conservative, Wellingborough)

To be clear, is the Minister saying that if it were not for EU regulations, things would be better, more efficient and less bureaucratic for British companies?

Stephen Timms (Labour, East Ham)

No, that is not what I was saying. I am aware that the hon. Gentleman’s party is heading rapidly to the outer extremes of the European Parliament. That is not a sensible or wise view. It is important that the arrangements are safe from challenge under European law, which these are. We have designed them carefully with that in mind.

Mark Hoban (Conservative, Fareham)

I do not want to extend the debate unnecessarily, but a philosophical point arises from the discussion that we have had on the previous clause and schedule and from other aspects of Finance Bills in recent years. The Marks and Spencer case, for example, was another case in which EU law about freedom of movement and freedom of establishment principles came into play. Have the Government looked more broadly at how aspects of UK tax law need to be reformed to take into account the growing trend of businesses to consider opportunities to arbitrage UK tax and the broader principles underpinning EU laws generally?

Stephen Timms (Labour, East Ham)

No, there is no general review going on, although we increasingly have to take account of issues that might be raised by European law when we design our legislation, as we have in this case.

Going back to the hon. Gentleman’s point about a light touch for UK companies, there could be a danger of that kind because it appeared that UK companies and EU companies were treated differently. We might have run into difficulties on that and we need to ensure that we do not. As he may have been suggesting, from time to time, issues that are raised by court decisions require us to look again at features of the legislation.

I hope that I have satisfied the Committee that the clause is an appropriate measure to sit alongside the dividend exemption that we debated before lunch and I commend it to the Committee.

Schedule 15

Stephen Timms (Labour, East Ham)

I beg to move amendment 105, in schedule 15, page 149, line 20, at end insert—

‘(4A) Part 5A contains rules connected with tax avoidance.’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss Government amendments 116, 138, 139, 151 to 153 and 157.

Stephen Timms (Labour, East Ham)

In my remarks a few moments ago, I indicated the background to this series of Government amendments. I apologise to you, Mr. Hood, and to the Committee, because I will need to take a little time to explain what is happening and the reasons for the measures.

The debt cap principle is simple in concept, as we discussed. It requires comparison of the interest and other finance expense payable in the UK by a group’s net interest-paying companies, which is referred to as the tested expense, with the consolidated gross finance expense payable by the worldwide group, which is referred to as the available amount. When the tested expense amount exceeds the available amount, the excess is disallowed for tax purposes. If other UK group companies have net interest receipts, the equivalent amount of those receipts becomes non-taxable, to prevent, effectively, double taxation.

The legislation is targeted at abuse of generous UK rules on deductibility of interest by multinational businesses. For that reason, it applies only to large businesses and companies for which the net interest expense exceeds £500,000, so many companies will not need to consider the debt cap legislation at all.

The debt cap can apply to both inbound and outbound investors, but it can also count as exploitation of the interest relief rules when upstream loans are made to the UK parent by its subsidiaries. Not all upstream loans are offensive, as we were saying before lunch, but some are tax-driven, with the interest payment removing profits from the scope of UK taxation and with the interest receipt arising in a company where it is effectively either not taxed or taxed at a low rate.

The legislation contains a number of exclusions which, taken with the other changes that we have made, ensure that the debt cap is carefully targeted. I will go into some of those in more detail, but I shall first list them. First, the financial services exclusion recognises that the different role of debt in financial groups is being introduced by amending the Bill. Secondly, there is a group treasury exclusion, which applies where group companies lend money to a UK group treasury company and that company then lends on the money at profit. Thirdly, there is a short-term debt exclusion, which recognises that short-term upstream loans are not likely to be tax-driven but are made to enable groups to manage their short-term cash position better, for example by allowing a group to operate a cash pooling arrangement to reduce banking costs.

Fourthly, there are exclusions for companies within the ring-fenced oil regime, the shipping tonnage tax regime and the real estate investment trust regime, as the regimes already address the taxation of those activities. Finally, there are exclusions to deal with payments of finance expense by trading subsidiaries to their UK parent where that is a charity or some other exempt body.

Two of the exclusions deserve a bit more explanation. The financial services exclusion applies when substantially all of a group’s income or the income of UK members of the group derives from a particular financial services activity. Banks, for example, borrow at interest so they can lend to their customers, and it would be inappropriate to apply the debt cap to them. As I said in my letter of 30 April, the financial services exclusion was not included in the Bill at publication, as we wanted more time to ensure that our proposals were effective and discuss them with those affected. The exclusion is now being introduced by way of Government amendments.

The group treasury exclusion is appropriate because in cases where group companies provide internal lending facilities for other members of the group and manage cash pooling arrangements on behalf of the group, the facilities provided by the group treasury company generate UK-taxable profits rather than removing profits from the scope of UK taxation. The exclusion is therefore appropriate.

Schedule 15, as we were discussing, includes a gateway test. If it is satisfied, a group need not consider the application of the debt cap rules any further for the accounting period concerned. I should mention in passing that the legislation requires anti-avoidance rules to deter companies from entering into or being party to schemes that seek to prevent the operation of the debt cap. The rules were not included in the Bill on publication, again so that we could have more time for discussion. They, too, are now being introduced by way of Government amendments.

Earlier, we discussed the implementation date for the debt cap. As I said, after discussions with business, the debt cap legislation will apply to accounting periods beginning on or after 1 January 2010. I should make that point clear: it applies to accounting periods starting on or after that date. That means that we have removed the need for companies to apportion the results of an accounting period, as would be required if the debt cap legislation simply applied with effect from a particular date. If it applied from 1 January 2010, any accounting period straddling that date would require apportionment, which would be complicated. We have avoided that difficulty. The implementation date also provides an interval following the introduction of dividend exemption that enables groups to pay up dividends and then unwind upstream loans, and it allows businesses time to become familiar with the legislation.

Our amendments to the design of the debt cap, which I am about to explain in more detail, will result in a simpler regime with greater scope for business to avoid the impact of the debt cap. Without anti-avoidance rules, groups that would pay additional corporation tax as a result of the debt cap might rearrange their borrowings to avoid the rules. Although the same borrowings might remain in substance, the form of the borrowing and other arrangements could reduce the UK net finance expense amounts or increase the worldwide figure of gross finance expense.

The anti-avoidance rules are split into three parts. The first part counters schemes intended to arrange for the group to satisfy the gateway test. The second part counters schemes intended to secure that the available amount, the worldwide group gross finance expense, is greater than it otherwise would be; or that the tested expense amount is less than it would otherwise be; or that the amount of financing income exempted for UK group companies is greater than it would otherwise be. It also counters schemes where a UK company is a beneficiary of the scheme but is not actually a party that has transactions that make up the scheme. Again to ensure that the debt rules are compliant with EU law, the debt cap allows UK companies to exempt financing income received from another group company resident in another part of the European economic area, where that company is subject to a disallowance or that payment in its own country of residence. The third part of the anti-avoidance rules ensures that the amount of financing income that can be exempted by a UK company cannot be increased as a result of an avoidance scheme.

Each of these anti-avoidance rules incorporates a purpose test, providing that the rules apply only where the main purpose, or one of the main purposes, of the scheme is to secure a result that frustrates the intention of the debt cap rules. The scope of the schemes potentially caught by the rules is necessarily wide. The alternative would be to attempt to define the schemes that might be put in place to frustrate the debt cap rules, but it would be very difficult to anticipate all the potential avoidance schemes. The approach we have taken is the right one, but we recognise that some schemes will feature arrangements that are not designed to frustrate the debt cap rules. We have addressed that by providing that if the profits of the UK members of the group are greater or the losses lower than they would be if the arrangements were not in place, the anti-avoidance rules will not apply.

HMRC will be available to define, by regulation, schemes that consist of particular types of arrangements or schemes bearing particular hallmarks that will not be subject to the anti-avoidance rules. HMRC expects to develop those in discussion with companies. The new targeted anti-avoidance rules for the debt cap are inserted by way of a new part to schedule 15, requiring Government amendment 105 to update the overview in part 1 and Government amendment 116 to insert the new part.

The provisions as published already contain a targeted anti-avoidance rule, at paragraph 68(7) and (9), to prevent a UK group company from being artificially removed from the scope of the debt cap. I have mentioned that such a scheme will be caught by rules introduced through Government amendment 116. That allows for the existing rule to be removed, and Government amendments 138 and 139 achieve that.

In response to calls from business, the debt cap now applies to a group for its first accounting period beginning on or after 1 January 2010. We would expect a group with an accounting period due to end on 31 December 2009 to apply the debt cap measures with effect from 1 January 2010. However, such a group could shorten its accounting period by one day to 30 December 2009 and the debt cap would not apply till the following accounting period, which starts on 31 December 2009. We want to stop such forestalling activity. The change to the commencement date made to accommodate businesses therefore requires us to introduce Government amendments 152 and 153 to counter such activity. The amendments move the commencement day for the debt cap rules forward where a group changes its accounting period and the main purpose, or one of the main purposes, of doing so is to delay the application of the debt cap.

On Government amendment 157, consequential changes are required to prevent double taxation. The debt cap disallows some finance expense where the net finance expense of the UK members of a group exceeds the group’s gross external finance expense. In some cases, the finance expense disallowed may be interest payable to an overseas subsidiary of a UK group company that is taxable on the UK parent company under the controlled foreign company rules. To prevent effective double taxation, Government amendment 157 adds new rules to the CFC legislation that will allow a group to apply for otherwise taxable CFC profits that are apportioned to a UK group company to be consequentially reduced.

Government amendment 151, on UK transfer pricing rules, applies the arm’s-length principle so that finance expense payable by a UK group company to another group company can be claimed as a deduction only if it is the amount that would have been payable to a third party. Equally, financing income receivable by a UK group company from another group company must reflect the amount that would have been receivable if it had come from a third party.

The debt cap can result in finance expense being disallowed and financing income exempted. It is possible in some cases that the transfer pricing rules could reinstate such adjustments. To address that problem, we need to make clear that the debt cap rules operate after any necessary adjustments under the transfer pricing rules have been made. Government amendment 151 makes a change to the transfer pricing rules that makes the primacy of the debt cap rules explicit.

I apologise to the Committee for having taken up so much time with that explanation, but I hope that I have made clear our reasons for tabling the new anti-avoidance provisions at this stage. They have been widely discussed and considered, and I hope that the Committee will be happy to accept the Government amendments.

Mark Hoban (Conservative, Fareham)

I am grateful to the Minister for his explanation of the amendments and the general background. I wish to put one point on record at the start. It is a complaint widely voiced by professional advisers, who are concerned about the raft of amendments being tabled at this stage. I understand that some were circulated in draft form in the middle of last week, but they were tabled formally only on Thursday. A number of people to whom I have spoken over the past few days expressed concern that they have not necessarily got to the bottom of the changes, and that further issues may need to be resolved. It is a pity that we have to discuss the amendments so soon after their publication. I suspect that we may see further amendments being made on Report, or even that the matter will have to be revisited in next year’s Finance Bill, as people work their way through some of the changes.

I shall speak first about the anti-avoidance measures. The Minister says that they are targeted measures, but there is some concern they are not targeted—that they are instead quite broad in their approach. The Minister said that the Treasury wanted to avoid being too specific, so that people did not try to get around detailed provisions, but I wonder whether we have gone to the other extreme. What sort of activities can businesses undertake to reduce their tax charge that will be deemed reasonable by HMRC? One expects taxpayers, when confronted with a higher tax bill as a consequence of such provisions, to take steps to reduce their tax bill. It is something that most of us would do, and I believe that companies will look to restructure their external debt to reflect the provisions.

A number of issues create the backdrop to the change. The fact that the gateway test is much narrower than anticipated is a problem, as is the fact that the net receivables of a company cannot be offset against net debt in other group companies. I believe that people would try to structure their activities so that they could be netted off in the same company if no exemption were available to match those amounts in the group as a whole. Would HMRC expect to see and be happy with that level of restructuring in the run-up to commencement, with tidying up going on to get net receivables under the maximum debt in the same company in order to enable that offset?

The other aspect is the exemptions referred to by the Minister in the anti-avoidance clause to be inserted under Government amendment 116. New paragraphs 38B to 38E will prevent groups from structuring their financing so as to minimise any disallowance that they could suffer as a result of applying the debt cap legislation, unless the arrangement meets the definition of an excluded scheme. In trying to get to that point, however, some of the decisions that businesses need to review require a group to look at some hypothetical comparator transactions and deduce which of them it would be more likely to undertake in the absence of the debt cap rules and then calculate the test of debt expense, the available amount, the test of income amount and the group’s profits chargeable to tax that would arise if the hypothetical transaction had taken place. That is covered in new paragraph 38D(2)(b), which says:

“instead, anything that is more likely than not would have been done or not done had this Schedule not had effect in relation to the relevant period of account, was done or not done.”

That may be perfect drafting from a parliamentary draftsman’s point of view, but I am not entirely sure what would be required unless someone explained it to me. However, there appears to be a test of looking at how a company might have acted if the rules had not been in place. I question whether the anti-avoidance measures are sufficiently opaque—sorry, I mean sufficiently transparent, although they are certainly opaque—to enable businesses to take reasonable decisions on how to restructure their affairs legitimately to take the new rules into account. There may be a raft of potential comparative transactions that a business could undertake, so how can a business prove to HMRC that it can satisfy the provisions outlined in new paragraph 38D(2)(b)? I think that the measure will cause some problems to business.

We need to think about quite carefully the breadth of the measure, including what sort of transactions it might inadvertently capture. For example, there might be a scheme whereby an inbound investor is debt financing a machinery replacement programme in its UK subsidiary to increase production and thereby increase UK profits. However, if an investor decides to reduce the amount of financing that is to be provided so that the cost of capital is not increased by a disallowance under the debt cap, conditions A and B of new paragraph 38B might well have been met, because one of the investor’s main purposes was to ensure that there was no disallowance under the debt cap, and UK profits would be lower than they would otherwise have been because less machinery is in place and consequently production and profits are not as high as they would have been if the full replacement programme had been implemented.

We assume that such a transaction is not the target of the anti-avoidance provisions. It is not an unreasonable transaction to undertake, but it would appear to satisfy conditions A and B of new paragraph 38B, so one would assume that it would fall within the definition of an excluded scheme. Again, the breadth of the measures is causing part of the problem. The definition of an excluded scheme is actually quite important in establishing what is intended to be targeted by the anti-avoidance provisions and what is not intended to be targeted.

We understand that the excluded schemes will appear in secondary legislation. However, until we have a chance to look properly at that secondary legislation, which is being consulted upon, it is very hard to know what schemes will fall inside or outside the anti-avoidance provisions of the Bill. This is an important issue, because a number of groups will seek to use the period between now and the commencement of the regime to look at the nature of their activities, to decide what their financial arrangements should be and to see whether they may be caught by what appears to be quite a broad-brush anti-avoidance rule.

Stephen Timms (Labour, East Ham)

There has been a great deal of discussion with businesses over the past couple of years about everything that we are considering this afternoon, including how anti-avoidance should be handled. I do not want the Committee to get the impression that this measure has come out of nowhere, hence my statement that there has been a lot of discussion leading up to this point in the process.

The anti-avoidance rules have indeed been designed with a wide scope. That is to ensure that all schemes designed to frustrate the intention of the debt cap rules are caught. I made the point earlier that the alternative would have been to identify specific schemes that would be caught by the rules, but that would have run the risk of not catching schemes that nobody had thought of, or because specified schemes were changed before being used. However, the anti-avoidance rules contain filters that will ensure that they apply only to those schemes that are intended to frustrate the debt cap rules.

The hon. Member for Fareham asked how a company is supposed to establish the most likely outcome if the anti-avoidance rules apply, and what its profits ought to be. In many cases it will be straightforward to work out the most likely outcome. For example, when the avoidance is targeted at increasing the gross consolidated finance expense of the group while leaving the borrowing costs associated with that scheme more or less unchanged, the most likely alternative outcome will be to ignore the increase in those expenses. I do not know whether the hon. Gentleman will find this reassuring, but HMRC will in due course publish guidance to help to explain the factors that need to be taken into account and assessed when establishing the most likely alternative outcome. As it develops the guidance, HMRC will certainly talk to businesses about that, and in cases of real difficulty, which I think will be rare, it will be happy to discuss the most likely outcome with the group.

We cannot allow set-off between group companies because that would not be EU-law compliant. However, putting receipts of interest into the company with expense is not offensive, because the company then does not have so much interest expense to claim as a deduction.

As I said, we will publish detailed draft guidance before the Bill receives Royal Assent, and will discuss it with businesses. That will help us to come up with specific examples that should not be caught, which might be helpful in some of the situations that the hon. Gentleman has in mind.

Mark Hoban (Conservative, Fareham)

I am not hugely reassured by the statement that HMRC will produce guidance. There were various attempts during last year’s Finance Bill to get HMRC to produce guidance, which effectively would have enabled people to be taxed by legislation but untaxed by guidance. There is a lot of concern about that approach among tax professionals more broadly. They are concerned that guidance does not have statutory force, does not necessarily have to go through a proper consultation process, and offers less security to taxpayers than primary or even secondary legislation.

The Minister should not be in any doubt that people will be content if guidance is published, but it is better to get primary and secondary legislation right than to tax people by guidance. Will he reassure the Committee that regulations will be introduced to define excluded schemes and that the guidance will give the context of what schemes are deemed to be excluded? It might give a bit more certainty to taxpayers if the guidance is simply an elaboration of what is in secondary legislation, rather than something that exists independent of it.

Stephen Timms (Labour, East Ham)

We will publish the detailed draft guidance before Royal Assent and discuss the content with business. HMRC will consult with business to consider particular schemes that are not intended to frustrate the debt cap rules. It will then consider whether such a scheme can be defined by, for example, particular hallmarks that characterise a scheme, which we can set out up front by outcome or by other criteria, and then publish draft regulations for comment. The intention is to achieve a progressive process with excluded schemes added over a period.

Peter Bone (Conservative, Wellingborough)

On the general principle of specifically outlawing schemes rather than having a wider catch-all, is it not better to have specifically outlawed schemes, so that taxpayers know where they stand? Is it not the role of Government to outwit the accountants each year? What will happen is that accountants will look at the provision and try and get round it, and we will be back here again next year outlawing schemes in the next Finance Bill. By specifying schemes, one can at least argue with some certainty, rather than going off to tribunals or court cases.

Stephen Timms (Labour, East Ham)

I think the hon. Gentleman’s argument actually supports the approach that we have taken. He is absolutely right: some very ingenious people will no doubt try to find a way round some of the provisions. However, if the approach we took was to try to work out what kind of schemes might be dreamt up and then list them all or set them all out in the legislation, that would be an invitation to someone to think of a slightly different version, or to come up with something new. It is therefore better to design the anti-avoidance rules as we have done, with a wide scope, so that all schemes that are designed to frustrate the intention of the debt cap rules are caught. He is right about the ingenuity that will be applied, but I think that the conclusion he draws is not correct. It is better to have the wide scope that allows us to deal with whatever is invented.

Stephen Timms (Labour, East Ham)

I beg to move amendment 106, in schedule 15, page 150, line 1, at end insert—

‘(1A) But a period of account that is within sub-paragraph (1) is not a period of account to which this Schedule applies if the worldwide group is a qualifying financial services group in that period (see paragraph 6A).’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss Government amendments 110 and 150.

Stephen Timms (Labour, East Ham)

I can be a bit briefer with this group of amendments, as I have already set out the aim of the debt cap legislation. I mentioned that some businesses cannot operate without the use of debt—for example, banks borrow from their depositors to lend on to customers—and the debt cap has never been intended to apply to businesses for which debt is integral to what they do. The draft clauses published in December contained exclusions for financial business where debt was an integral part of that business, but subsequent discussions established that those rules, as set out at that time, would have been very difficult to operate in practice.

In my 30 April letter, we explained to the financial services industry why the Bill would not exclude this exclusion on publication. We have been working with business to develop workable solutions since then. The new financial services exclusion rules work by excluding a group as a whole from being subject to the debt cap where substantially all of the group’s income, or the income of UK members of the group taken together as a mini consolidated group, is derived from qualifying activities. In that context, “substantially all” will be taken to mean around 90 per cent. Qualifying activities are lending business, insurance businesses and trading in financial instruments. The rules recognise the need for flexibility so that they can be applied by financial services groups in a straightforward way. The rules allow groups to take account of other types of income generated by way of the qualifying activities and deal with cases in which some of those activities might produce losses. The amendments introduce the financial services exclusion in a form that delivers the intended policy, while rightly excluding financial services businesses. It is also practical for the industry.

Mark Hoban (Conservative, Fareham)

The Minister is right that these are important amendments. Last year, when I discussed the debt cap with those in the banking sector, this was identified as being an important issue to get right, because of the nature of their financing. I want to raise some issues that have been brought to my attention in the relatively short time since these clauses were published. Some of them have been discussed with the Treasury already.

The first issue relates to qualifying activities. To qualify for the exemption, all or a substantial amount of a group’s income must be aimed at qualifying activities. The Minister said that that means 90 per cent. of the group’s income must be in a qualifying activity—a proportion used elsewhere, I think. However, that means that groups with a combination of qualifying and non-qualifying activities might have a problem. Let us consider how some businesses in the financial services sector are currently developing. For example, retailers are increasingly moving into financial services. The financial services income might constitute a relatively small proportion of a group’s total income, which means that it would not qualify under this exemption because neither all nor a substantial part of its income will derive from a qualifying activity. The vast majority will come from retailing, selling petrol or whatever. This provision might place an extra burden on groups seeking to diversify into financial services and act as a barrier, or a further disincentive, to them doing so.

I understood that, at one stage, the Treasury or HMRC were considering an exemption that would enable them to ring-fence sub-groups wholly engaged in qualifying activities as a means of getting around this particular issue. I would be grateful if the Minister could explain why that route has not been pursued and why the level has been set at such a high level of 90 per cent. I hope that this does not, as has been suggested, take us back to our old friend “EU rules”. My first concern, therefore, is about what happens with hybrid groups. Can the rules be amended to reflect the diversity of some groups involved in some financial services and other activities?

The second concern relates to the treatment of insurance premiums. The Minister will be aware that premiums on investment contracts will be accounted for in a group’s balance sheet, rather than its income statement. Will those premiums be included in the gross income test under proposed new paragraph 6G(3)(B)? My understanding is that that point has been made and accepted by HMRC but is not reflected in the drafting of the amendment.

My second point on insurance premiums relates to the way in which they are disclosed in sets of accounts. Looking at the gross income for the debt cap test, will the Treasury expect insurers to report their premiums gross of reinsurance premiums, as that would be the appropriate measure for discerning the gross income test? As I understand it, as a matter of presentation several insurers show their turnover net of reinsurance premiums but disclose by way of note the gross premium. Could the Minister clarify how insurance companies will be able to calculate their gross income? The substantive point that concerns me at present is the question of how the exemption for financial services will take into account those groups whose financial services activity is perhaps a significant element but nowhere near the 90 per cent. test the Government have set out in the schedule and in the amendments.

Stephen Timms (Labour, East Ham)

I will deal first with the 90 per cent. limit and the substantial requirement. As the hon. Gentleman has said, that proportion is referred to elsewhere. It is needed is ensure that the exclusion is not treated as a state aid under EU rules. Some groups could well be in the position he described by essentially having a retailing business, but also an identifiable finance arm. When groups are in that position, it is possible that the whole group will be excluded through the application of the gateway test. Therefore, we took the view that introducing rules to deal with such cases in the legislation would be pretty complicated if we were to ensure that those rules were not then used for avoidance purposes. It is likely that no such groups will have to apply the main rules, so we do not think that there is a need to introduce additional rules.

With regard to income from insurance premiums taken as income that is gross before any reinsurance or net after reinsurance, for the purposes of calculating the trading income and income from qualifying activities the income is taken as gross, before any premiums ceded in respect of reinsurance. On the question of what happens if income is not normally reported as income in the income statement profit and loss account but is taken to the balance sheet, for example with premiums from investment contracts, the rules refer to income that is accounted for as such under accounting practice or principles where amounts receivable have the nature of income but for particular insurance accounting purposes are taken to the balance sheet. Those amounts will be treated as income for the purposes of applying the financial services exclusion rules.

Going back to the hybrid point, and the question of whether we could ring-fence sub-groups, that would require very complicated rules to achieve that and also to ensure that the exclusion was not exploited by groups for whom it was not intended. That is the reason we have not set out rules to ring-fence finance sub-groups.

Stephen Timms (Labour, East Ham)

I beg to move amendment 107, in schedule 15, page 151, line 10, leave out ‘finance income payable’ and insert ‘liabilities’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss Government amendments 108, 109 and 111 to 113.

Stephen Timms (Labour, East Ham)

The gateway test we mentioned is a comparison of specific amounts of debt and cash and loan receivables from balance sheets of the UK members of a group and of the group itself. Each figure is the average of the opening and closing balance sheet figures. If the measure of total net debt of the UK members of the group that themselves have net debt is less than 75 per cent. of the gross debt of the group, the group does not have to apply the rest of the debt count rules for that accounting period. If a UK company has net debt of less than £3 million, it is not included in the calculation of UK net debt either.

In making the comparison, the terms that define liabilities and receivables in respect of finance leases do not work as intended. Amendments 107 to 109 put that right.

In some circumstances groups prepare accounts in a currency other than sterling, so the gateway test can be applied by reference to a group’s functional currency rather than sterling. Amendments 111 to 113 in the grouping address how, in that case, the £3 million de minimis is translated to the functional currency.

The amendments ensure that the gateway test works as intended in those cases in which a group is involved in financial leasing businesses and where a group has adopted a functional currency other than sterling.

Stephen Timms (Labour, East Ham)

I beg to move amendment 114, in schedule 15, page 161, leave out line 9 and insert—

‘(b) the lower of—

(i) the total disallowed amount, and

(ii) the tested income amount.’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: Government amendments 117 to 124.

Amendment 52, in schedule 15, page 168, line 18, after ‘A’, insert ‘or condition B’.

Amendment 53, in schedule 15, page 168, line 20, after ‘A’, insert ‘or condition B’.

Government amendment 125.

Amendment 54, in schedule 15, page 170, line 19, leave out ‘from the finance arrangement’.

Amendment 55, in schedule 15, page 171, line 10, leave out ‘an investment company’ and insert ‘a company with investment business’.

Amendment 56, in schedule 15, page 171, line 11, leave out ‘4 of ICTA’ and insert ‘16 of CTA 2009’.

Amendment 57, in schedule 15, page 171, line 17, leave out ‘75 of ICTA’ and insert ‘1219 of CTA 2009’.

Government amendments 128 and 129.

Amendment 58, in schedule 15, page 172, line 25, leave out from first ‘that’ to first ‘a’ in line 26 and insert ‘is referable to’.

Amendment 60, in schedule 15, page 173, line 1, leave out from first ‘that’ to first ‘a’ in line 2 and insert ‘is referable to’.

Government amendments 130 to 137, 140 to 149 and 154.

Stephen Timms (Labour, East Ham)

This is a rather large set of Government amendments, all of them necessary to address issues arising in respect of the debt cap calculation, and to ensure that the debt cap achieves its policy aims in particular areas.

Amendment 114 concerns limiting the amount of financing income that can be exempted. Amendment 154 concerns the finance expense and income accrued before the introduction of debt cap rules. Amendments 130, 132 to 134, 140, 141 and 149 relate to capitalised borrowing costs.

There are amendments relating to the exclusion of some expenses or income from the debt cap calculations. Amendment 124 applies to real estate investment trusts, for which it has been the intention, from the outset, to exempt from corporation tax.

Amendments 117 and 118 relate to group treasury companies, amendments 119 to 123 to group treasury services and amendment 129 to already exempt non-departmental public bodies.

In addition to the Government amendments, there are a number of Opposition amendments. I shall be happy to respond to the hon. Member for Fareham after he speaks to them.

Mark Hoban (Conservative, Fareham)

Before I move on to my amendments, I want to raise a question that has been put to me about the group treasury exemption. The Minister will doubtless be aware that in a number of groups, trading companies will participate in a cash pooling arrangement whereby balances are swept from that company into a central account overnight and transferred back. Such arrangements are considered necessary to undertake treasury activities. The income would then be allocated to that company. One of the concerns expressed to me is that, in such a situation, the trading income is likely to swamp the treasury income and probably would also swamp the income of the pure treasury company within a group in such a way that no group company would be able to qualify as a group treasury company.

It has been suggested that paragraph 42(6) should be amended so that whereas at present it includes any company that undertakes treasury activities for the worldwide group, whether or not it also undertakes other activities, that should be replaced with the exclusion

“except where the main activity of that company is conducting trade.”

That would reflect the fact that people may be undertaking cash pooling operations as an adjunct to the trading activity, and might be a way of ensuring that the very valuable exemption for group treasury companies is capable of being taken advantage of in those companies in which there are cash pooling arrangements.

I come now to my own amendments. Amendments 52 and 53 are quite simple. I shall explain the issue that I am trying to address. Paragraph 39 of schedule 15 defines “financing expense amounts” to include loan relationship debits—condition A—finance lease rentals, which is condition B, and costs payable on debt factoring, which is condition C. The definition of finance income amounts of the company includes income arising from similar transactions.

For companies engaged in oil extraction activities, finance expense takes into account amounts that are limited to loan relationship debits, and financing income takes into account only loan relationship credits. Is there a reason why companies involved in oil extraction should not be able to bring into account expenses and income relating to finance lease rentals—condition B? I should be grateful for the Minister’s comments on that.

With regard to amendment 54, sub-paragraph (6) of paragraph 47 on page 170 provides for the conditions in the provision to apply to elections relating to finance expenses. It relates to carrying forward non-trading deficits “from the finance arrangement”. My understanding is that that is technically incorrect and should be amended. Deficits under the loan relationship regime are not specific to a relationship; they are part of a general calculation.

Amendment 55 is another fairly technical amendment. The rules that applied to the expenses of management of investment companies in part IV of the Income and Corporation Taxes Act 1988 were amended in 2004 to apply to companies with investment business as opposed to just “investment companies”. My amendment would insert the more up-to-date language.

Amendments 56 and 57 are drafting amendments. The references are to the Income and Corporation Taxes Act 1988. That has now been rewritten through the Corporation Tax Act 2009 and my amendments would make the cross-reference to the 2009 Act rather than the 1988 Act. The draft legislation that was published in December last year did not take into account the fact that there needs to be a proper cross-reference to the new Act.

Amendments 58 and 60 relate to the definitions in paragraphs 52 and 53 of the tested expense amount and the tested income amount of relevant group companies. The amounts covered by the definitions are not supposed to refer to periods when a company is not a member of the group. However, the relevant provisions refer to transactions that take place when a company is not a member of the relevant group and do not take account of the fact that either the income or the expense amount are calculated with reference to entries in the accounts which would normally be determined on an accruals basis. The amendments are designed to ensure that the accrued amounts are taken into account or excluded from the two definitions of tested income amount and tested expense amount, as appropriate.

Amendment 59 is another drafting amendment. The suggestion is that the definitions should refer to the whole of the schedule rather than simply to part 7. I would be grateful for the Minister’s clarification of whether the drafting in the Bill is correct, or whether it should refer to the schedule rather than the part.

Stephen Timms (Labour, East Ham)

I am grateful to the hon. Gentleman for several of the amendments that he has proposed, and I would be happy to accept some of them. It always was our intention, as I mentioned earlier, to exclude companies undertaking oil exploration activities that are subject to specific rules from the scope of the debt cap. There was a drafting oversight, and so the provisions do not exclude finance lease charges from the operation of the debt cap. Amendments 52 and 53 put that right. I am grateful to the hon. Gentleman for them and am happy to accept them.

Amendment 54 is also helpful. It removes an erroneous limitation on identifying the deficits that can be used to determine the amount of finance expense that can be excluded from the calculation under the debt cap. I tabled an amendment that was identical in form but that was not selected. Therefore, I am delighted to accept amendment 54 and again am grateful to the hon. Gentleman for tabling it.

On amendments 55 and 56, other rules in the current clauses deal similarly with excluding financing expense amounts that are payable to group companies with excess management expenses. The rules incorrectly refer to legislation in ICTA rather than CTA 2009, as is now appropriate following consolidation. I am grateful to Opposition Members for picking up on that point and for tabling amendment 57. However, as it does not include the whole of the cross-reference required, I would be grateful if the hon. Gentleman did not press it. Amendments 55 and 56 do insert the correct cross-references.

The hon. Member for Fareham spoke to amendments 58 and 60, which relate to Government amendments 135 to 137. Some groups have interests in companies that are not controlled by the group, but the group is nevertheless entitled to more than 75 per cent. of the profits of those companies. Such a company will not form part of the group for accounting purposes, so its results will not be included in the group’s consolidated financial statements. At the moment, such a company would be treated as a member of the group for the purposes of calculating the UK measure of net finance expenses. Government amendment 137 ensures that such a company will be included in the UK measure of net finance expenses only if it is a member of the group for accounting purposes.

The draft clauses as published also contain a rule in paragraph 62(2) that was intended to deal with a particular consequence affecting the general partner of a partnership that owns UK companies. That rule is now redundant due to amendment 137 and could provide avoidance planning opportunities if not removed, so amendments 135 and 136 will remove the measures.

Amendments 58 and 60 are intended to deal with a concern about the finance expense amounts payable and financing income amounts receivable by a UK group company that relates to a period before or after that company is a member of the group. The concern is, for example, that where an amount of financing income relating to a loan made by a UK company before it joined a group continues to be received by the company when it is a member of the group, financing income would not be taken into account in applying the debt cap rules.

I do not agree that the current rules provide for that outcome. Although different statutory language might achieve the same result, I do not think that the amendments are successful. However, it might be helpful for me to put on record a reassurance that the rules in paragraphs 52(3) and 53(3) are intended to work so that only finance expense amounts and financing income amounts that accrue to a UK company while it is a member of the group under consideration are taken into account when calculating any disallowance of finance expenses and any exemption of financing income for the purposes of the debt cap. I hope that on the basis of that reassurance, the hon. Gentleman will feel able to withdraw his amendments. Amendment 59 was dealt with under schedule 14 and accepted this morning.

Finally, the hon. Gentleman expressed a concern at the beginning of his remarks that there was a danger of trading income swamping treasury income in group treasury companies. I do not think that there is a problem, because the amendments proposed ensure that activities traditionally undertaken by treasury companies can be excluded. That includes receiving deposits, making loans, managing cash management schemes and investing surplus funds. In that way, the danger about which he was concerned has been dealt with.

Stephen Timms (Labour, East Ham)

I beg to move amendment 115, in schedule 15, page 161, line 38, at end insert—

Stephen Timms (Labour, East Ham)

On a point of order, Mr. Hood. I am concerned that I may have become somewhat confused in the measures that we have just taken. My advice to the Committee would not be to accept amendments 57, 58 and 60, as I said earlier.

Jimmy Hood (Labour, Lanark and Hamilton East)

The amendments to which the Minister refers were not taken.

Stephen Timms (Labour, East Ham)

I am grateful for that, Mr. Hood.

Jimmy Hood (Labour, Lanark and Hamilton East)

I appreciate the Minister’s gratitude.

Mark Hoban (Conservative, Fareham)

Not wishing anyone to think that I had exhausted schedule 15—I have been overwhelmed by the Minister’s generosity in accepting some of the amendments that I tabled—I want to explore one or two points that I think are important. The Minister probably addressed one of them when we debated the last but one group of amendments.

One issue about the construction of the measure is the use of the “available amount” that is defined in part 8 and the “tested expense amount” or “tested income amount” that is defined in part 7. Calculations of the former are based on financial statements, whereas calculations of the latter are based on tax computations. That would not be a problem if there were a perfect alignment between UK generally accepted accounting practice and international financial reporting standards and the basis on which tax computations are prepared. Life would be fantastic if it were that simple, but it is not, and there are gaps. That creates a tension when those differences are important in the calculation of either the tested amount or the available amount.

One issue that the Minister referred to when we debated the penultimate group of amendments was deadlocked joint venture companies. One party may have 75 per cent. of the ordinary share capital but 51 per cent. of the income, but because of the arrangements between the two owners, there is deadlock, so it does not count towards control when it comes to the consolidated results of either partner in the venture.

The tested expense amount is defined as

“the sum of net financing deduction of each relevant group company”

in paragraph 52(1), but according to paragraph 68(6), a relevant group company would be a “75% subsidiary”. The situation is that the tested amount would include the expenses of a relevant group company, but the available amount would not take that into account because of the deadlock arrangements between two shareholders in a joint venture such as the one I described. I should be grateful if the Minister could tell us whether that anomaly was resolved by the last but one group of amendments or whether further work needs to be done to get the two calculations into line.

Another issue arises on the same point in connection with financial instruments by virtue of paragraph 39(2). Where a company has borrowed in dollars and then swapped the loan into sterling, if the contract rate accounts for the arrangement of the UK GAAP there would be a synthetic sterling interest which would be a finance expense account. However, where the accounts and the arrangements are under FRS 26 or IFRS, the US dollar interest would be included with the swap being ignored. Is this the result that is intended here?

Under paragraph 39(3), where a company accounts for a loan on a fair value basis, fair value movements are included within the finance expense account and therefore the tested amount. However, the equivalent amounts are not included in the available amounts. So a gap—that is perhaps the wrong word to use in this context—is opening up. Another issue may arise on partnerships because of the way they are dealt with and the question whether they are transparent for tax purposes. It is difficult to assess how significant these issues are, but I should be grateful if the Minister could share his thoughts with the Committee on how the differences between accounting and tax treatment work.

Stephen Timms (Labour, East Ham)

I think that some of the amendments that we have been debating will address some of the hon. Gentleman’s concerns. Amendment 137, which ensures that a UK company must be a member of the group for accounting purposes, would deal with the problem of deadlocked joint ventures. On his concern about available versus total calculations, several potential mismatches created by the different treatment of more complex financial arrangements have been raised with us. The draft clauses published in December included a wider definition of finance expenses and finance income which would have prevented some of those mismatches, but there was a strong view from businesses that we should remove the impact of foreign currency adjustments and payments and receipts from derivative contracts from the debt rules.

I accept that narrowing the definitions might raise some problems, but I am cautious about introducing a quick solution to reintroduce other complexities that we wanted to eliminate. We will continue to look at these, consulting with interested parties. If we can find suitable solutions, we can announce additional rules at the time of the PBR which could take effect from 1 January 2010, although the legislation would follow shortly afterwards.

Peter Bone (Conservative, Wellingborough)

On a point of order, Mr Hood. We have just agreed the schedule: when will Hansard be produced so that we can check which amendments were accepted? I share the same concern as the Chief Secretary about what we went through and voted on.

Jimmy Hood (Labour, Lanark and Hamilton East)

I thank the hon. Gentleman for his point of order, which is really a point of clarification. I have the script in front of me, and I can assure him that he and the Minister are wrong.

Schedule 16

Stephen Timms (Labour, East Ham)

I beg to move amendment 155, in schedule 16, page 182, line 32, at end insert ‘and

( ) in this Act, section 57(6).’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss Government amendment 156.

Stephen Timms (Labour, East Ham)

I am, again, grateful for your clarification.

Schedule 16 makes consequential changes arising from what we have just agreed to the controlled foreign company rules designed to stop UK groups from artificially diverting profits to low-tax territories in order to avoid paying UK tax on those profits. The controlled foreign company rules counter this by charging UK tax on the diverted profits. The controlled foreign company legislation is subject to a series of exemptions, two of which are the subject of this schedule. Those are, first, the acceptable distribution policy and, secondly, exemptions for holding companies. Following the introduction of an exemption regime for foreign dividends, these exemptions are no longer appropriate and are removed.

Amendment 155 is tabled to repeal clause 57(6) of this Bill with effect for accounting periods of controlled foreign companies beginning on or after 1 July 2009. This clause contains double taxation provisions that come into effect for dividends paid on or after 1 April 2008, but subsection (6) will no longer be needed from 1 July 2009 as the ADP exemption is repealed on that day as a consequence of the introduction of dividend exemption.

Amendment 156 is tabled to remove a mismatch between the controlled foreign company and double taxation rules to ensure that there is consistent treatment of profits arising before and after commencement. Although scope for abuse does exist, this mismatch is more likely to produce the wrong result and therefore needs to be corrected. It reflects an omission that unfortunately did not come to light during earlier consultation. On that basis, I hope that the Committee will accept the amendments.

John Pugh (Liberal Democrat, Southport)

I do not have a problem with the amendments, but I want to probe the Minister on one point. Controlled foreign companies, being controlled foreign holding companies, are obviously a good thing and international commerce creates sundry types and forms, and various structures will exist internationally, and that is all to the good. There is a natural moral distinction between legitimate companies as part of ordinary business development and illegitimate companies that are set up expressly for the purpose of tax avoidance. There seems to be a parallel distinction in schedule 16 between local holding companies, which enjoy exemptions, and non-local holding companies, which have their exemptions withdrawn—as is also the case with superior holding companies. I support that; I support all the changes in corporate taxation that have been identified by the Minister. The acid test, and it seems a fair test, is always identifying the ultimate corporate parent or beneficiary.

I admit that it is slightly tangential, but I would like to ask the Financial Secretary about the Tesco case. I am not familiar with its exact techniques, but the Minister will be aware that it set up a controlled foreign company in Liechtenstein. This was not to avoid corporation tax, which it was accused of by The Guardian and which it exonerateditself from, but in order to avoid stamp duty. Do the provisions in schedule 16 have any implications for such tax loopholes?

Stephen Timms (Labour, East Ham)

Mr. Atkinson, I welcome you to our deliberations this afternoon. I shall respond to the points that the hon. Gentleman made in my clause stand part speech. I do not think that the question arises specifically from the amendments.

John Pugh (Liberal Democrat, Southport)

I apologise for that. I thought that we were not having a clause stand part debate.

Stephen Timms (Labour, East Ham)

I am happy to speak more generally about the schedule, if that would be helpful to the Committee, having moved the Government amendments as well.

Schedule 16 amends the controlled foreign company rules. The rules work by apportioning the profits of the foreign subsidiary back to the UK, therefore subjecting those profits to a UK tax charge. The impact of the present legislation is limited by a series of exemptions, which are designed to exclude from charge those foreign subsidiaries that can reasonably be assumed to exist for reasons other than to divert profits artificially from the UK. Two of those exemptions are subject to the provisions of the clause and schedule; they are the acceptable distribution policy—the ADP exemption—and holding company exemptions. Following the introduction of an exemption regime for foreign dividends, those two exemptions from the rules are no longer appropriate and are therefore removed.

The acceptable distribution policy exemption applies when 90 per cent. or more of the foreign subsidiary’s profits are paid back to the UK as dividends. The premise underlying the ADP exemption was that, as dividends were taxable in the UK, there was no significant UK tax avoidance. However, introducing an exemption regime means that most dividend payments from foreign subsidiaries will no longer be taxable, so the exemption becomes redundant. The ADP rules are therefore repealed on 1 July 2009, the same day that the dividend exemption is to be introduced. Schedule 16 makes provisions for accounting periods straddling that date to be split into two. That will ensure that profits accruing prior to the introduction of the dividend exemption can still qualify for the ADP exemption.

Peter Bone (Conservative, Wellingborough)

In my copy of the amendment paper, Government amendment 155 states

“line 32, at end insert ‘and”.

That is followed by two brackets and

“in this Act, section 57(6).”

What on earth do those two brackets mean?

Stephen Timms (Labour, East Ham)

I imagine that those two brackets refer to a continuation of the numbering system, but I may come back to that point.

I was explaining the ADP exemption. I shall now move on to the holding company exemption. The other exemption that we are reforming is that for foreign subsidiaries that qualify as holding companies. Generally, the exemptions allow companies that receive mainly the specified types of income, and little other income, to be exempt from the CFC rules. There are different categories of holding companies, depending on the specified types of income. Schedule 16 removes the superior and non-local holding company exemptions, as most foreign dividends will now be exempt. Retaining those exemptions in such circumstances represents an unacceptable risk to the Exchequer. Groups could abuse the exemptions by recycling dividends within the group, resulting in increased amounts of profit and tax on those profits being diverted from the UK.

To allow companies time to adapt to the rules, we are introducing a two-year transitional period. During that time, the exemptions will be available only in a restricted form to mitigate Exchequer risk. The transition period will also overlap with the longer term CFC review, allowing business to consider the outcome of this change alongside the removal of the holding company exemptions.

Mark Hoban (Conservative, Fareham)

The Minister referred to a transitional period, but one of the issues that I see being flagged up is that some exemptions will continue through the transitional period so long as the company continues to be held within the group and there is no change of ownership. I can understand the Government wishing to prevent a change of ownership arising as part of a tax planning device, but in some cases the change of control will be for legitimate commercial reasons. Why, in such cases, should legitimate commercial transactions lose the benefit of the transitional relief?

Stephen Timms (Labour, East Ham)

The hon. Gentleman is right that the exemption will be available only in the restricted form to mitigate Exchequer risk during that two-year period. If I may, I shall reflect on the hon. Gentleman’s precise question, and come back to him before finishing.

The local holding companies exemption will be retained, as it is typically required for commercial reasons and retaining the rules does not pose a significant risk to the Exchequer.

I think that I am now in a position to answer the question that the hon. Member for Fareham asked about whether condition A is too stringent, if I understood it correctly. The condition means that groups cannot sell companies defined as qualifying holding companies to another group and take advantage of the transitional rules. That prevents groups from buying qualifying holding companies to shelter income from the UK. The definition of “control” allows groups to move those companies intra-group so that they can restructure if they wish.

Mark Hoban (Conservative, Fareham)

The Minister gets the point exactly. I understand that the restriction is to prevent that sort of tax structure to shelter profits, but there may be a sensible commercial reason why a group decides to sell a holding company and the activities that sit beneath it. It may decide that it wants to sell its tobacco interests in Spain, for example, and sell that group of companies to another business. The acquirer will lose the exemption where there is a legitimate commercial reason for the sale. It is not a transaction to avoid or reduce the tax bill; it is a legitimate commercial transaction with solid commercial substance to it, but the benefit of the transitional relief is lost as a consequence of the sale.

Stephen Timms (Labour, East Ham)

It may be that the most helpful thing I can do is reflect on the hon. Gentleman’s point and write to him setting out my conclusions.

Two other points were made in the debate. The hon. Member for Southport asked about implications for stamp duty. It is difficult for me to comment on a particular company. Although I was interested by The Guardianseries, I do not recall the case that he referred to. The purpose of the controlled foreign company rules is to protect against corporate tax avoidance of the kind that the series discussed. The changes have no implications for stamp duty, as far as I am aware. That may answer the hon. Gentleman’s question, but he will appreciate that I cannot comment on the particular case.

John Pugh (Liberal Democrat, Southport)

It is slightly anomalous to create a regime that prevents people from setting up holding companies to avoid corporation tax and leaves open loopholes through which they can avoid other sorts of taxation by similar methods.

Stephen Timms (Labour, East Ham)

I do not think that we are opening any loopholes. We are not making any changes to stamp duty.

Finally, in response to the hon. Member for Peterborough, as I suggested, the brackets are there to continue the numbering on from whatever the previous numbering was.

Peter Bone (Conservative, Wellingborough)

I am Wellingborough, but never mind.

Stephen Timms (Labour, East Ham)

I apologise.

John Howell (Conservative, Henley)

The Minister sat down before I could intervene on him, but I had a question about the changes in the schedule. I am aware of the extent to which the CFC legislation is being revised, and that a group is advising HMRC and the Treasury on this matter. I seek some guidance from him, however. It is envisaged that the measures will not take effect for some time, and further changes to CFC legislation are likely to be made as we go along. Is this not premature and destabilising with regards to the long-term view of how the CFC legislation should emerge?

Stephen Timms (Labour, East Ham)

I think that I can reassure the hon. Gentleman. He is right that we are introducing a two-year transitional period, which I think is right to enable companies to make adjustments. In the early part of the period, we will review the CFC rules, but will do so in the light of the legislation before us. He is right to say that a number of things are going on here with the CFC rules, but we will need to ensure that they are properly co-ordinated and that we do not run into problems of the kind that he perfectly reasonably warns us about.

Clause 37

Mark Hoban (Conservative, Fareham)

I welcome you to the Chair, Mr. Atkinson, for the graveyard slot—well, I hope it is the graveyard slot—of today’s sitting.

Clause 37 cropped up in the Chamber, earlier today, during Treasury questions, when the hon. Member for North-West Leicestershire (David Taylor) raised a concern about whether the clause would make it easier for businesses to participate in tax avoidance schemes by being able to engage in transactions that move businesses offshore without letting the Treasury know. He asked whether we were in danger of making it easier for people to engage in the sort of transactions about which the hon. Member for Southport seemed to be concerned during the previous debate. In a sense, the arguments of the hon. Member for North-West Leicestershire have been lent some support. Tax advisers have told me that they welcome clause 37 and schedule 17, which must instantly cause those considering such matters from the other side of the debate to think, “There must be something here to think about. Will this be a charter for encouraging such activity?”

My understanding is that the existing regime for Treasury consent will be swept away. However, one issue that comes up in the correspondence and debate on this matter is whether the regime that the Treasury is considering will be effective in helping businesses to comply and in helping to promote certainty for taxpayers. The existing regime had a set of general consents—document M03/88—and if someone is taking part in one of those transactions, there is no requirement to notify the Treasury or to gain its consent. Clause 37 paves the way for the repeal of that legislation. We now have a new set of reporting requirements for certain transactions exceeding £110 million. On one level, the Government are saying that they will remove the Treasury consent regime and that there will be no replacement for the general consents. However, HMRC has a regulatory power under the Bill to designate excluded transactions, augmenting the list of excluded transactions in paragraph 9 of schedule 17. Until HMRC exercises its powers though, taxpayers will have to report more transactions than at present.

The list of transactions in paragraph 9 is not as broad as that in the current general consents, and there is a concern that many common commercial situations will need to be reported, resulting in a greater compliance burden. That runs counter to the Government’s aim and to the expectation of the hon. Member for North-West Leicestershire and others.

I have a short list—you will be pleased to note, Mr. Atkinson—of those existing consents that people have said they would like to see under the new regime. They include the issue of shares by a non-UK company to a UK company, the issue of shares by non-UK companies to a third party, rights issues, the issue of debentures and the issue of shares by Commonwealth countries. I would be grateful for the Minister’s thoughts as to where the excluded transactions regime will get to.

There is also an issue relating to private equity funds and limited liability partnerships. The new rules, in paragraph 5 of schedule 17, require reporting by UK bodies corporate that control non-UK companies. However, in certain situations a UK body corporate might be considered to control non-UK companies, but reporting might be considered inappropriate. For example, many private equity structures include a UK body corporate such as a limited company or a limited liability partnership as the fund’s general partner. If that fund holds UK investments, the general partner might be required to report transactions over which it has little or no influence. There could be an amendment to the effect that bodies corporate that are general partners of collective investment schemes, as defined by the Financial Services and Markets Act 2000, could be exempted. That would avoid inappropriate reporting requirements.

It would help if the Minister gave a bit more background to the proposals in clause 37 and schedule 17, to provide a clearer understanding of how he expects the new regime to work. How can he reassure his hon. Friends that this is not a tax avoidance charter and at the same time give comfort to businesses that it will not lead to a much more onerous regime?

Stephen Timms (Labour, East Ham)

Clause 37 introduces schedule 17, which removes the existing Treasury consents legislation—dating from 1951—and replaces it with a modernised post-transaction reporting requirement. The existing rules are out of date and are not in line with current business practice. We are committed to having information available for the detection and countering of tax avoidance. There is absolutely no weakening of our resolve on that front, which is reflected here, and which I will set out perhaps in more detail when we debate the amendments tabled by the hon. Member for Southport.

We want to maintain a corporate tax regime that keeps pace with how businesses operate today, so the new reporting requirement will apply only to material from transactions that pose a significant risk of tax avoidance, with a value in excess of £100 million. That will give HMRC the information that it needs to detect tax avoidance, and, as we will discuss when we come to those amendments, by targeting the report the administrative burden for businesses is reduced.

The new rules remove the need to apply to the Treasury before entering into commercial transactions. That decision will be left to businesses, making it easier for them to operate. The administrative burdens will be significantly reduced by introducing the £100 million threshold, reducing the number of reportable transactions and reducing the amount of information that needs to be reported.

We are also removing the rather outdated criminal penalty that was attached to the Treasury consents rules. In response to representations, we have extended the exclusions to include a number of the general consents that are available in the Treasury consents rules. The draft legislation published in December included a number of exclusions from the new reporting requirement in addition to the de minimis limit of £100 million and in the consultation it became clear that without additional exclusions, the rules could generate reports that were of little value to HMRC. We have added a number of further exclusions to the draft regulations, which are essentially a replication of the existing general consents—although we have removed some of the more dated elements.

In drafting the regulations, we have deliberately copied the language because it is already familiar to businesses and, together with a new exclusion for cash pooling arrangements, these measures will address the concerns expressed about recurring transactions. The draft regulations will be published on the HMRC website. In that way, we have both provided the safeguards against avoidance, which were rightly of concern to my hon. Friend the Member for North-West Leicestershire, the hon. Member for Southport and, I imagine, to Conservative Members, while significantly easing the regulatory burden on businesses in a helpful way. We have got that balance right, and I hope that the Committee as a whole will work on that.

Schedule 17

John Pugh (Liberal Democrat, Southport)

I beg to move amendment 41, in schedule 17, page 189, line 41, leave out ‘£100’ and insert ‘£1’.

Peter Atkinson (Conservative, Hexham)

With this it will be convenient to discuss: amendment 42, in schedule 17, page 190, line 34, leave out paragraphs (a) and (b).

John Pugh (Liberal Democrat, Southport)

I have supported the legislation up to now, but I cannot help thinking that, having done some sterling work, the Minister has with this schedule snatched defeat from the jaws of victory. I would like to put that in some context.

In clause 37 schedule 17, we are repealing section 765 of the Income and Corporation Taxes Act 1988. The provision, which has existed in various forms for 58 years, demands that companies enacting schemes whereby they move funds out of the EU—and, obviously, the UK before that—receive consent to do so from the Revenue. As the Minister undoubtedly explained, that is a hangover from the days of exchange control, when people worried about sterling leaving the country and so on. The provision is very broadly drafted and it encourages firms to notify the Treasury of anything that is to its detriment. As the Minister said, the provision has some old-fashioned, but severe—and, I suppose, effective—criminal sanctions attached.

The reality is that the retention of section 765 over the years has been fairly useful. It has forced companies to disclose schemes to the Revenue before undertaking them. The fact that the measure is backed up by draconian measures, even though they are unlikely to be used, adds to its force. It gives UK revenue authorities some real-time information about the activities of multinational companies. That is a good thing because state revenue authorities normally play a constant game of catch-up—corporations undertake schemes and then the revenue body finds out about them. Section 765 is virtually unique in tax law because it allows the Revenue to know what companies plan to do before they do it. It has been a major anti-avoidance measure because it forces multinationals to receive Government consent and, presumably, as a result many tax avoidance schemes are stopped before they are started.

I know that we cannot quantify the benefits of section 765, but they have been real. Do not take my word for it: four years ago, the former Paymaster General, now the Minister for Children, the right hon. Member for Bristol, South (Dawn Primarolo), said: “the section was introduced”—and presumably kept—

“to counter tax avoidance; it has done that successfully and should not be repealed, as it protects a great deal of revenue.”—[Official Report, Standing Committee B, 30 June 2005; c. 319.]

In modern business terms, I accept that there is a case for pensioning off section 765 and replacing it with something better. However, the provisions in the Bill do not inspire confidence that we have something better. There are a couple of reasons for that. First, at £100 million, the threshold is high. Companies, such as multinationals, that wish to avoid breaching that threshold can simply parcel transactions into smaller units of £10 million or whatever, which is within their wit to do. Secondly, the penalties for companies that do not comply with the legislation are feeble. If a company gets away with a major bit of tax evasion or tax avoidance, they face a fine of £300 if they have not reported after six months. I cannot see that frightening anyone who is serious about tax avoidance. The penalty for every further day of non-reportage is £60. I suggest that the new set of provisions does not have the teeth that it should have.

Amendment 41 considers the requirement for reporting transactions of £100 million or more and suggests that it is absurd as it stands. I cannot see any reason why we should choose that figure, which seems unreasonably high. My amendment—it is a probing amendment—reduces the limit drastically to £1 million for the purposes of the schedule. That is the point about the threshold.

If we look at exemptions—the Minister has talked about exemptions and about how they oil the wheels of commerce, how they are a good thing and how they avoid undue compliance costs and so on—we see that they are extraordinarily generous when they are read in the literal sense. For example, if someone is in difficulties and the Revenue comes after them and there is a suggestion of tax avoidance, they can plead that the transaction

“is carried out in the ordinary course of a trade”.

That strikes me as an extraordinarily vague provision—almost a licence for abuse. One can almost see tax planning advisers preparing the excuse well in advance. I am not at all comfortable with retaining that provision, because it is broad, colloquial and it seems a catch-all excuse that almost anyone can use when challenged by the Revenue. As far as I am concerned, it can only help tax avoidance and it does not really have a significantly beneficial purpose for the schedule as a whole.

The second exemption is, if anything, worse. It says that the transaction is exempt if

“all the parties to the transaction are, at the time the transaction is carried out, resident in the same territory”.

Therefore, if all transactions are carried out in the Cayman Islands, they would be exempt from reporting. That is an open invitation to use secrecy jurisdictions—a licence and an invitation to go in for tax avoidance. Therefore, although I support almost everything that the Minister has done hitherto, I think that we have here a schedule that opens the door to a new wave of tax avoidance. The Minister should seriously address the weaknesses in schedule 17. The fact that many people who are involved in tax law welcome it adds to the concern.

Peter Atkinson (Conservative, Hexham)

Amendment proposed in schedule 17, page 189, line 41, leave out ‘£100’ and insert ‘£1’.

John Pugh (Liberal Democrat, Southport)

On a point of order, Mr. Hood. I was speaking to both amendments at the same time.

Peter Atkinson (Conservative, Hexham)

Had you finished speaking on amendments 41 and 42?

John Pugh (Liberal Democrat, Southport)

I have spoken on both amendments, yes.

Stephen Timms (Labour, East Ham)

I am grateful for the support that the hon. Member for Southport has given to the changes that we have made so far today to foreign profits taxation, and I will endeavour to persuade him that he should support this element of the Bill as well.

Schedule 17 repeals the existing Treasury consents rules, which are at sections 765 to 767 of the Income and Corporation Tax Act 1988, and replaces them with a targeted reporting requirement. At the moment, the rules require companies to seek advance consent from the Treasury before undertaking certain transactions involving foreign subsidiaries, and they include a criminal penalty of imprisonment for non-compliance, although that has never been used, as the hon. Gentleman rightly said, in the 58 years during which the rules have been in place.

In 1951, the rules were aimed mainly at controlling company migrations at a time of foreign exchange control. Over the decades, in response to changes in UK tax law and changing business practice, the situations to which the rules apply have changed. Their aim is to prevent groups from entering into transactions that could result in a loss of tax to the Exchequer.

It might reassure the hon. Gentleman to know that as far as I am aware, no other country has such a regime in place. He is right to refer to what the then Paymaster General, my right hon. Friend the Member for Bristol, South—she is much missed from this Committee’s debates—said during debate on the Finance Act 2005 about the Treasury consent rules protecting a great deal of revenue, but she went on to say that we would consider section 765, the relevant section,

“in the context of work on the wider international context of the corporation tax system”.—[Official Report, Standing Committee B, 30 June 2005; c. 320.]

The culmination of that work is what we are debating today.

Consent is very rarely refused these days, but the rules impose a significant administrative burden, which is why we think that the time has come to repeal them. However, the hon. Gentleman is absolutely right: we need to ensure that HMRC gets the information that it needs to detect and prevent tax avoidance. HMRC monitors tax avoidance closely using a range of different tools. We have been taking steps consistently to tackle avoidance by reforming the tax system, closing loopholes and introducing the disclosure regime that he mentioned. Anti-avoidance measures introduced in recent years have closed more than £11 billion in avoidance opportunities.

We will certainly need to stay energetically on the case, as the pressure from would-be avoiders does not diminish. Continuous action is needed to mitigate the effects of tax avoidance, particularly at a time of global economic difficulties. The hon. Gentleman will know that some of the discussions that we had at the G20 summit on that topic reflected concerns about tax avoidance outside the UK, not least on the part of President Barack Obama.

We are therefore putting in place a modernised post-transaction reporting requirement targeted at changes in the capital structure of multinational groups. It will provide an early warning if multinational groups enter into large cross-border capital reorganisations that could give rise to tax avoidance and ensure that, having been alerted early, we can monitor what happens closely.

Brian Binley (Conservative, Northampton South)

I am listening intently to the Minister. We have here a measure that is designed to give forewarning of sizeable transactions that the Department needs to look at more closely. Will he touch on the business of people who might wish to avoid paying sizeable amounts of tax being fined £300? That worried me, too. I just do not see the connection. Can he explain the thinking behind that level of fine?

Stephen Timms (Labour, East Ham)

I will certainly address the points raised specifically about the amendments, including that one.

The hon. Member for Southport is right: the new reporting requirement applies to transactions involving foreign investments with a value in excess of £100 million. Transactions above that are reportable, so we are targeting the transactions about which HMRC most needs information. The rules are targeted in that way as a result of HMRC’s experience with high-value cross-border transactions, to ensure that it can concentrate its time and effort most productively.

Amendments 41 and 42 both seek to widen the scope of the new rules. Amendment 41, as we have heard, proposes reducing the de minimis limit from £100 million to £1 million. The difficulty is that that would result in a large number of relatively low-value transactions that are not the target of the provision coming within its scope. That would significantly increase the administrative burden without generating the kind of really useful information that HMRC needs. The new reporting requirement focuses on changes to the capital structure of multinational groups. Those are the kind of changes featured, for example, in The Guardian series referred to earlier by the hon. Member for Southport, where large amounts of tax are at stake and where we need to concentrate our efforts. As can be seen from the FTSE 100, the net market capitalisation of such businesses runs into many billions of pounds. We need to target material changes or restructurings and not divert HMRC energy away from those high-risk areas of potential tax avoidance to low-risk areas.

I remind the Committee that the Government have a lot of tools available for detecting and countering tax avoidance, such as the disclosure regime, risk assessments and annual fining requirements. The £100 million limit does not mean that we are giving up on avoidance activity below that level. The other measures at our disposal that I have mentioned can target other types of avoidance activity as well, but the new requirement will complement existing measures that are compliant with how businesses work these days and provide the necessary information to monitor the potential substantial avoidance activity.

Amendment 42 proposes to remove the exclusion for transactions carried out in the ordinary course of trade and those between parties resident in the same territory. We have included those exclusions because, as I have already said, the focus of the schedule is on cross-border restructurings undertaken by multinational groups where the biggest avoidance risks arise. Trading and same-country transactions are relatively low risk and are not the target of the provision. We should not be focusing our avoidance efforts on them, so I think that exclusion is appropriate. The same argument applies to transactions in the same territory, which are, of course, not cross-border and pose a lower risk of avoidance.

The problem with the amendments is that they would result in a very big increase in the administrative burden in return for very little benefit in countering avoidance. We want to focus the rules on large-value, cross-border transactions. Other avoidance measures, particularly the disclosure regime, are available to target other types of avoidance.

I hope I have given the hon. Member for Southport some reassurance. I should add that when we talk about transactions between parties in the same territory, the CFC rules that we debated would tackle the problem of profits being moved offshore to the Cayman Islands in the way that he, perfectly properly, expressed concern about.

John Howell (Conservative, Henley)

Will the Minister give way?

Stephen Timms (Labour, East Ham)

I will just respond to the point made by the hon. Member for Northampton, South regarding the penalty. A monetary penalty to up to £300 would apply for the initial sum and up to £60 per day thereafter for each day that the report is late. That is in line with the wider penalty regime currently applicable. We have done a lot of thinking about where the penalties from different parts of the tax system should be applied and the level at which they should be applied, and that is a value that is consistent with the wider arrangements. Of course, the penalty attached to the Treasury consent rules was, in theory at least, imprisonment. However, as I said earlier, in 58 years that has never been used. So I think that this is going to be an effective measure. It is going to be simpler to operate and will provide the information that we need.

Brian Binley (Conservative, Northampton South)

One assumes that a fine is a deterrent: the whole concept of fining someone for not doing something is to ensure that they do what you wish them to do. I need to understand how much of a deterrent a fine of £300 will be to international financiers, because I do not get it. Perhaps the Minister could explain how that will act as a deterrent to stop someone failing to report what the Government want them to report.

Stephen Timms (Labour, East Ham)

That is an obligation in law with which companies must comply. The hon. Gentleman will know that the various reporting obligations we have imposed to tackle avoidance have been effective and, I am glad to say, people have complied with the rules. Of course, there is a pretty big incentive for the kind of companies we are talking about to comply with rules clearly set out in statute, not least because of the embarrassment for major organisations when they do not comply with rules of that kind. He will know that we propose to name and shame in some circumstances where tax is underpaid. That will be a powerful incentive not only for individuals, but for companies.

If someone avoids tax, they are at risk of a tax-geared penalty for tax not paid as a result of the underlying transaction, and that can be up to 100 per cent. of the tax avoided. With regard to the level of £300, it is appropriate that that penalty should be consistent with the rest of the penalty system that is in place. I would not want the hon. Gentleman to think, however, that that is the only downside of not meeting the obligation being imposed.

John Pugh (Liberal Democrat, Southport)

I thank the Minister for that thoughtful response. I totally accept that we have to move away from a consent system to a reporting system in an age when millions of pounds can be transacted at the touch of a computer button. I also accept that modern business needs a different system and agree with him that it needs to be a robust and stringent system that ensures that everyone pays due tax and that, none the less, business functions as efficiently as it can.

As for pathetic nature of the fine, we explored the possibility of tabling an amendment on that. I understand that there are some technical reasons why that might be difficult, but it is still a preposterous penalty. Although we were unable to table an amendment, we might need to take another look at what we can do to beef up the penalties for people who flagrantly disregard the legislation as the Minister wishes it to work. I do not think he really responded to my point that the reporting regime is lax, and nor did he really respond to my point that in paragraph 9 we are not so much closing loopholes as drilling more. We will have to revisit that topic on Report.

The Minister has made some interesting points that are pertinent to my amendments. He discussed how HMRC is best to conduct itself when investigating tax avoidance and what is the most efficient use of the Revenue. That is certainly an issue that has cropped up in the Public Accounts Committee. I am aware that HMRC wants to target those areas where it will get the best results, although it remains the case that tax avoidance, at any level, should be prevented, and big companies should certainly be prevented from parcelling up their businesses into smaller units to avoid the reporting restrictions.

Underlying that is the other question of how business and the taxation system can best exist in the modern world, and the Minister, reasonably, is trying to suggest that he has the recipe right, but I am not completely convinced. He has pointed out that some of the evils to which I am drawing attention and that appear to be omitted by schedule 17 are addressed in some way and in other parts of Bill. I will have to go away and investigate that and consider whether that claim is fairly or adequately made. For the moment, however, I beg to ask leave to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I beg to move amendment 161, in schedule 17, page 190, line 10, at end insert ‘or’.

Peter Atkinson (Conservative, Hexham)

With this it will be convenient to discuss the following: amendment 160, in schedule 17, page 190, line 12, leave out from ‘partnership’ to end of line 14.

Amendment 162, in schedule 17, page 190, line 33, leave out ‘a’ and insert ‘an event or’.

Amendment 163, in schedule 17, page 191, line 38, at end insert—

‘“debenture” does not include a guarantee;

“transfer” does not include a transfer by way of security.’.

Amendment 164, in schedule 17, page 192, line 9, at end insert

‘or six months after the regulations referred to in paragraph 4(2) are made, whichever is the later’.

Amendment 165, in schedule 17, page 192, line 10, after ‘Schedule’, insert

‘(with exception of those made under paragraph 8(2)(e))’.

Mark Hoban (Conservative, Fareham)

These are relatively small amendments, so I will not spend a huge amount of time talking about them. The objective of the group of amendments is to try to tighten the rules for reporting transactions and to be clear about the circumstances in which transactions will be reported.

Amendment 161 would simply insert the word “or” between sub-paragraph (2)(c) and (d) in paragraph 8 on page 190. Sub-paragraph (2)(c) and (d) refer to a transfer of an economic interest. It would be one type of transfer or another, rather than (c) and (d) applying sequentially.

Amendment 160 would create some certainty that commissioners will not seek to expand the event or transaction set out in paragraph 8(2)(a) to (d) unless they do so through primary legislation. This is a probing amendment. I am interested in understanding a bit more from the Minister as to why he feels that the power in sub-paragraph (2)(e) is necessary.

Amendment 162 is a drafting amendment. Paragraph 4(2) refers to an “event or transaction”, whereas paragraph 9 on page 190 refers to a transaction. Should it refer to an “event or transaction”? This is very much a drafting amendment.

Amendment 163 would provide some clarity that there is no obligation to report the creation of a legal or equitable mortgage over the shares of a foreign subsidiary or the giving of a guarantee to a foreign subsidiary. If they were specifically excluded, it might reduce the number of transactions that could be reported. The Minister may suggest that such an exemption might give rise to some tax-paying opportunities. I would like to hear his thoughts on the matter.

Amendments 164 and 165 relate to the transitional provision in paragraph 14. I would like to hear from the Minister how he expects it to work in practice. On amendment 164, the problem is that companies have six months from the day on which transactions took place to report them. Regulations may be introduced that lead to that reporting period being eroded. It may be less than six months—in effect, a kind of technical retrospection. I am not sure whether that is the Government’s intention in paragraph 14(1).

Amendment 165 seeks to tighten up reporting on the transition, again in respect of regulations that are made under the schedule. In part, these are probing amendments, to see if we can focus on the schedule to try to reduce the volume of transactions that can be reported and to ensure that companies are not caught out having to report transactions in less than a six-month period because of regulations that may be made.

Stephen Timms (Labour, East Ham)

I shall be brief. Amendments 160 to 162 concern the regulation-making powers in the schedule. The first two would remove HMRC’s power to widen the scope of the reporting requirement in the light of commercial or legal developments. The new post-transaction reporting requirement is targeted at areas that pose a significant risk of tax avoidance in order to ensure that HMRC receives the information that it needs to deal with tax avoidance, but amendments 160 and 161 would remove the ability to ensure that those provisions track commercial or legal changes. That could give rise to new tax avoidance opportunities and undermine the purpose of the requirement. We want to be sure that the schedule can target areas of significant avoidance risk, and that it can be used for future avoidance opportunities as they arise.

Amendment 162 would give HMRC additional powers to narrow the scope of the reporting requirement by extending the excluding power in paragraph 9 to cover events as well as transactions, but the only event reportable under schedule 17 is a foreign subsidiary entering into a partnership. For the provision to be effective, HMRC would first have to introduce new reportable events using the regulatory power in paragraph 8(2)(e). In effect, the amendment would give a circular result, which makes it unnecessary.

Amendment 163 seeks to insert two additional definitions in the schedule that would exclude guarantees and transfers by way of security from the reporting transactions. The schedule already contains exclusions for giving securities to financial institutions, including guarantees and transfers of securities in that context, so the additional definitions are not necessary.

As the hon. Member for Fareham explained, amendments 164 and 165 are about the transitional provisions in paragraph 14 of schedule 17. Amendment 164 would ensure that companies have at least six months to make a report under the new rules in the event that regulations are not in force by 1 July. I reassure the hon. Gentleman that the amendment is not necessary. The regulations have been drafted and were sent to the House last Thursday, after the amendment was tabled. We can therefore be confident that the regulations will come into force on 1 July, when the schedule’s provisions commence. The transitional provision also allows for regulations made under the schedule within one year of the Bill’s enactment to have effect from 1 July 2009. Amendment 165 would prevent that from applying to additional categories of reportable transactions specified by the regulations. However, it is appropriate for the transitional provision to apply evenly to all the regulation-making powers in the event that a new avoidance opportunity was detected by HMRC in the next year, which is quite possible.

How will the retrospection interact with the deadlines for reports if HMRC included a new reportable transaction? We would be happy to abide by the six-month time limit. For example, if the regulations were amended on 1 June 2010 to include a new reportable transaction, it would apply only to transactions undertaken after 1 December 2009. That might be of some reassurance. In practice, I would not expect new reportable transactions to be added in the next 12 months, but we need to be sure that we can address tax avoidance and protect the Exchequer if the need arises.

Mark Hoban (Conservative, Fareham)

I am grateful to the Minister for his comments on the various amendments. He has made a reasonable case for me not to press the amendment to a vote. I beg to ask leave to withdraw the amendment.

Clause 39

Mark Hoban (Conservative, Fareham)

I beg to move amendment 171, in clause 39, page 19, line 14, at end insert

‘and accordingly section 397A shall not apply in respect of such dividend’.

Peter Atkinson (Conservative, Hexham)

With this it will be convenient to discuss the following: amendment 174, in clause 39, page 19, leave out lines 15 to 18 and insert—

‘(3) For the purposes of this section and subject to subsections (3A) and (3B) below, an offshore fund satisfies the qualifying investments test if, on the last day of each quarter of the offshore fund’s relevant period of account, the market value of the fund’s qualifying investments does not exceed 60% of the market value of all of the assets of the fund (excluding cash awaiting investment).

(3A) The offshore fund shall not satisfy the qualifying investments test if it makes any arrangements with regard to its investments where the purpose of such arrangements is wholly or mainly to satisfy the qualifying investments test on such relevant quarter date and where, having regard to the offshore fund’s overall investment strategy, the offshore fund would have been unlikely to satisfy the qualifying investments test had the test been applied on any other date.

(3B) Where any of the investments held by the offshore fund are “qualifying holdings” (as defined in section 495 of the CTA 2009), such qualifying holding shall not constitute a qualifying investment if the company, scheme or fund which might otherwise constitute the qualifying holding has, for the 12 month period preceding the date that the dividend is paid, provided written confirmation on a quarterly basis to the offshore fund that its investment strategy is to invest in assets which the company, scheme or fund anticipates will meet the qualifying investments test and it is not aware that this strategy has been breached.’.

Amendment 175, in clause 39, page 19, line 23, leave out from ‘means’ to end of line 31 and insert

‘the accounting period ending prior to payment of the dividend.’.

Government amendment 89.

Amendment 172, in schedule 19, page 200, line 28, after ‘(6)’, insert ‘, section 378A’.

Mark Hoban (Conservative, Fareham)

I will give some background before dealing with the individual amendments. Clause 39 deals with a technical aspect of the rules and is meant to tackle the issue that certain distributions from offshore funds are economically similar to payments of interest. It is intended to ensure that distributions of that type are taxed as if they are payments of interest.

The issue arises because of the differential in the tax rates for UK residents and domiciled individuals between dividends, which are taxed at 32.5 per cent., and other forms of income, which are taxed at 40 per cent. Until now, offshore funds, particularly those formed as corporates, were able to pay out a dividend to UK investors that would be taxed at 32.5 per cent. That was the case even when the offshore fund was invested primarily in debt assets that in substance paid out an interest return. In contrast, UK funds are required to distinguish between dividend distributions and interest distributions, with interest distributions being taxed at 40 per cent.

Clause 39 seeks to address that disparity by introducing a bond fund test for offshore funds. Individual UK investors will be required to distinguish between distributions received from bond funds and from non-bond funds for any distributions paid on or after 22 April 2009. The bond fund test is derived from the test that UK corporates are required to apply to their investments. Broadly, an offshore fund that at any point during an accounting period has more than 60 per cent. of its assets invested in interest-bearing securities will be deemed a bond fund. The impact of that is that any decision made by a bond fund in relation to the profits of that period will be deemed an interest distribution. That will help the UK investment management industry by reducing the disparities in the taxation of distributions from onshore and offshore funds.

Budget notes 21 and 22, which underpin this measure, state that the intentions behind these changes are to enable individuals with holdings of 10 per cent. or more in non-UK resident companies to become entitled to a non-payable tax credit on dividends from such holdings, and to restore the non-payable dividend tax credit for offshore funds that are largely invested in equities, subject to certain conditions. However, as the clause is drafted, it is not clear whether the tax credit is available in respect of a distribution from an offshore fund that fails to meet a non-qualifying investments test where a distribution is made to a minority shareholder in an offshore fund with authorised share capital—that is condition A—or an offshore fund in a qualifying territory—that is condition C. Amendment 171 would make clear the application of that.

Amendment 174 addresses the problem that requirements to measure whether an offshore fund fails to meet the qualifying investments test at any time during an accounting period are over-burdensome. It is likely to prove impossible for funds to comply with those requirements in practice. It is the “at any time” point that I am trying to address with the amendment. It is quite a lengthy amendment because it would introduce new subsections (3), (3A) and (3B) to try to make the process smoother.

New section 378A will introduce to the Income Tax (Trading and Other Income) Act 2005 a tax credit for dividends paid by offshore funds. However, as I said, the tax rate is not available if the offshore fund fails the qualifying investments test at any time during the accounting period. If the test is failed, the dividend will be taxed at the income tax rates applicable to interest. As I said earlier, the offshore fund will fail the qualifying assets test if, at any time during its accounting period, the market value of the qualifying investments exceeds 60 per cent. of the market value of all its investments.

“Qualifying investments” means interest-bearing instruments and instruments such as derivatives that relate to the performance of interest-bearing investments. The definition of qualifying investment also includes interest on funds that could fail the qualifying investments test. When paying a dividend, an offshore fund will need to let its shareholders know whether the test has been failed so that it can file proper tax returns and pay the appropriate rate of tax.

An offshore fund may hold a complex, extensive and constantly changing portfolio of assets. To ensure that the qualified investment test is met at any time, the fund will have to ascertain daily the market value of each underlying asset, which is over-burdensome. For a fund of funds, such a level of monitoring would prove impossible. It will not have the information on the underlying funds.

A similar test exists in relation to offshore funds held by UK companies. In practice, that may be invoked relatively infrequently, because a UK company is not a common vehicle through which investments in offshore funds are made. Extending a test to apply to all shareholders in an offshore fund will require many more funds to operate those requirements. The amendment would impose a workable monitoring requirement that remains sufficiently rigorous to leave little or no scope for abuse.

Amendment 175 asks whether a requirement to measure whether an offshore fund fails to meet the qualifying investments test during a relevant accounting period is over-complicated. In this case, the problem stems from the definition of a relevant period of accounting, which is either the accounting period ending prior to the payment of the dividend if there are undistributed profits available to that period or, otherwise, the accounting period in which the dividend is paid. That is quite a complex definition because it will require significant record keeping on the part of the offshore fund. It may result, in relation to the second limb of the test, in a mismatch between the data on which the fund is able to inform its shareholder that the qualifying test has been met or failed, and the data on which an investor must file a tax return.

To use 2009 as an example, if a fund had a calendar-based accounting period and paid a dividend in January 2009, it will not know until some time after 31 December 2009 whether the qualifying investments test was met for the period. However, the dividend must be included in the tax return for the year ending 5 April 2009. That could give rise to a situation in which a fund is not given enough time in which to carry out its calculations and report to investors before the tax return is due.

Amendment 175 would alter the Bill so that an offshore fund could measure whether it has satisfied the qualifying investment test by reference to its investment strategy in the accounting period immediately prior to the payment of the dividend. We are trying, with the amendments, to simplify things for investors in the funds while maintaining the spirit and purpose of the clause.

Ian Pearson (Labour, Dudley South)

Briefly, by way of background, during the process of extending the dividend tax credit to portfolio investments last year, it became apparent that some funds were seeking to exploit the measure by locating their cash or bond fund ranges offshore to gain a tax advantage for their UK investors. The Government amended last year’s Bill to prevent investors in offshore funds from receiving the dividend tax credit and said that we would continue to examine the issue in the context of reform of personal dividend taxation and modernisation of the offshore funds regime.

Following further work, the Government are making further changes to the treatment of distributions from offshore funds as part of the personal dividends tax reform package. Clause 39 addresses distributions made by offshore funds when more than 60 per cent. is invested in interest-bearing assets. Distributed income from such funds will be taxed at the same rate as income from interest-bearing assets held directly, and income from interest-bearing assets held through a UK fund.

I will respond to the group of amendments to which the hon. Gentleman spoke in a few moments. Government amendment 89 has been tabled to ensure that clause 39 operates as intended. That does not represent a change in Government policy. However, after the Bill was published last month, technical questions were raised about whether the clause fully achieved its purpose.

Amendment 89 is to ensure that dividends received from an offshore fund that holds more than 60 per cent. of its assets in interest-bearing assets, are taxed as interests and not as dividends which would be eligible for the dividend tax credit. Specifically, doubt was raised as to whether the charged tax as interest took priority over the charged tax as a dividend, and whether the tax credit had been disapplied. The amendment puts the matter beyond doubt. It introduces a technical, consequential subsection to a section that determines the priority of various taxing provisions, and ensures that the clause operates as intended.

We recognise that the amendments tabled by the hon. Gentleman seek to address potential ambiguities in the current text of the clause. In relation to amendment 171, the Government agree that the dividend tax credit should not be available to income from offshore funds that are mainly invested in interest-bearing assets. In practice, however, the Government believe that the amendment required is a little broader, ensuring that the treatment of dividends paid by the funds as interest for tax purposes must displace any treatment as a dividend that would otherwise apply. That is achieved by the Government’s amendment, as I have explained.

I also welcome the hon. Gentleman’s attempt to clarify the legislation in schedule 19, with the signposting suggested in amendment 172. However, that amendment is unnecessary, we believe, because Government amendment 89 should provide the clarity that it seeks to effect.

Amendment 174 seeks to dilute the test for offshore funds not being treated as paying interest to UK investors. However, the amendment would mean that the test, in relation to qualifying investments for investors liable to income tax, would be out of line with the test applying to corporate investors in both offshore and onshore funds. That would add to complexity, rather than reduce it. The Government are willing to consider changes that would be beneficial, but any change must be consistent and we do not believe that that change is. We would be happy to receive representations on how the test could be further improved, provided that the improvements would apply the principles equally to individual and corporate holders, as well as onshore and offshore holdings. Those that follow these deliberations closely will, I am sure, want to make representations to us on the matter.

Although amendment 175 attempts to simplify subsection (5), we do not believe that it works. If accepted, the amendment would mean that an interim dividend paid out of current period income would have to be related to an earlier period of account even though the income distributed arose in the current period. That makes the targeting of the legislation ineffective.

With regard to amendment 174, the hon. Gentleman raised a point about the “any time” requirement, saying that it was too strict. The requirement is built in to ensure that funds cannot spend some or most of the relevant period invested in interest-bearing assets, and then exploit the rules for their investors by switching their investments. It is closely modelled on the existing test applying to corporate investors in a fund, whether onshore or offshore, so we do not believe that it will present any difficulty.

The hon. Gentleman raised the point that a fund would not know until after 31 December 2009 whether it applied, but that the information would need to be in the tax return and there was not enough time to check. Tax returns for individuals for the tax year 2009-10 do not have to be submitted until 31 January 2011, if they are sent online, so there is sufficient time for investors to get the right amount on their tax returns.

The hon. Gentleman suggested that the test for onshore might be unworkable. The onshore test is slightly different, but it does have an “at any time” provision, which we believe will work well. Funds generally value their investments on a regular basis, so that investors know the value of their investments. Therefore, I do not believe that there is any additional significant administrative burden as a result of the measures that we are introducing.

Mark Hoban (Conservative, Fareham)

The Minister makes an important point about the regular valuation of funds. Clearly, any investor wishing to sell their holding in a fund would look for a valuation at the point of sale. Let us say that a fund is valued on a weekly basis for the purpose of enabling investors to sell their holding or to acquire further units in a fund. So long as it was measured at the point at which there was a valuation, would that be sufficiently often to cover the “at any time” basis? There may be funds that are valued on a daily basis, a weekly basis or a monthly basis. I imagine that so long as the fund was in compliance at the date at which it did its valuation for normal commercial practice, that would satisfy the “at any time” point.

Ian Pearson (Labour, Dudley South)

My understanding is that that is indeed the case. However, if I have any further information, I will be happy to supply it. I hope that I have explained why the hon. Gentleman’s amendments, although well intentioned, are not required. I am happy to confirm that the answer to his question is yes, so my officials advise me, unless evidence showed that that did not reflect the truth. I therefore urge the hon. Gentleman to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

That was a helpful explanation from the Minister about the flaws in the drafting of my amendments. It is important that there is consistency between corporate and personal investors where possible and between on and offshore funds. He has reassured me that the “at any time” issue, which came out quite strongly in the representations that we received, is not insurmountable so long as valuations take place on a regular basis, and clearly investors will drive the frequency of valuation for their own purposes. With those reassurances, I beg to ask leave to withdraw the amendment.