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Dawn Primarolo: If the hon. Gentleman looks at the Bill, he will see that the motive test would apply. He has described a situation that revolves around not an intent to avoid tax, but the structure of the joint venture. The motive test, and other exceptions, would exempt a case of non-avoidance.

I do not understand the hon. Gentleman's point. He says that he is against avoidance, but that there are some structures that do not fit the 50:50, 40:40 arrangement. Ours is the only country with the motive test and the other exemptions. If the purpose was not to avoid tax, presumably such structures would be all right.

Mr. Letwin: I hardly dare suggest it, but we may be making progress. If I tell the Paymaster General what I find worrying, perhaps she can lay my fears to rest for Pepper v. Hart purposes.

I freely admit that I only dimly understand how the motive test will be applied by the courts. Indeed, I am not convinced that the great lawyers understand that yet. As I

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dimly understand it, however, the test does not distinguish clearly between two things. We need such a distinction here, and if the Minister can make the right statement we may be able to achieve it.

The test does not distinguish clearly between manoeuvres designed purely to avoid tax--I agree that they should be clobbered--and arrangements of the kind I have described. While such arrangements are perfectly legitimate business manoeuvres, an element of them will have been the hope that--through onshore pooling and other legitimate means; by causing the subsidiary to be chosen to be in a low-tax jurisdiction--the net effect would be beneficial. That constitutes tax planning of a legitimate kind, not tax avoidance.

If the Paymaster General is saying that the motive test--not only as she plans it but, much more importantly, as she intends it to apply to this case--would mean that, in the type of circumstances I was describing, that would be regarded not as an avoidance mechanism but as legitimate tax planning, as part of legitimate business activity, I think that we probably do have a solution to this particular problem.

8.30 pm

Dawn Primarolo: The motive test has been in place since 1984, when the previous Government introduced it, and has consistently worked perfectly well without the problems that the hon. Gentleman is describing. I assure him that the type of structures that he is identifying are not new ones. He has advanced two arguments, the first of which deals with what would happen if the activity was not avoidance under the 40:40 test. As I told him, the motive test is the key to determining how to deal with the matter.

Secondly, the hon. Gentleman questioned whether the motive test was adequate. As I said, it has been working perfectly well since 1984 and has withstood the test of time. I think that I am right in saying that we use it also in transfer pricing. However, I shall double check on that to ensure that I am correct.

I apologise for making a rather long intervention. Nevertheless, both the hon. Gentleman's points are answered in the legislation.

Mr. Letwin: There is no need to apologise for the length of the intervention. I think--as long as I am thinking straight through the haze of my indisposition--that the Paymaster General is probably saying what needs to be said. We shall later entirely discover. However, I think that she may have succeeded in removing my anxiety on that score.

Dawn Primarolo: I think that we can certainly clear up these points, and it is important that the explanation is on the record. The motive test exempts controlled foreign companies that do not have United Kingdom tax avoidance as one of the main--I emphasis, the main--reasons for their existence or the transaction. I think that we can see a clear audit trail--involving motive, motive test, exemptions and current and past interpretation--that deals with the point that the hon. Gentleman is making. Clearly, CFC legislation takes account of legitimate activity, but--putting it very directly--nails those who are avoiding tax and for whom the CFC exists purely to help them to do that.

Mr. Letwin: If the hon. Lady is putting the emphasis that I think she is putting on the word "mainly", I think

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that it probably will capture the case that I was describing and similar cases, and that we probably will have a solution. Therefore, I think that we can probably rest easy on that--although, as I said, time will tell, as we go through the courts and hear how these matters are interpreted. Nevertheless, the hon. Lady's comments were very helpful.

Mr. Edward Davey: I believe that the Paymaster General is right on this point. My only concern with the motive test in the legislation is whether, in the Inland Revenue's examination of a company's motive, there should be an appeal procedure. There is an appeal procedure in other spheres in which the motive test operates. Does the hon. Gentleman think that the absence of such a procedure is a deficiency in the Bill?

Mr. Letwin: I agree with the hon. Gentleman that if the motive test is to have placed on it the weight that the Paymaster General has most helpfully placed on it, it would also be helpful if there were an appeal procedure within the Inland Revenue--as the courts already have one. I certainly agree on that point.

Let us turn to the second problem with schedule 31, which I think that the Paymaster General became aware of at a considerably earlier stage in our deliberations on the Bill. I think that she became aware of it through the representations of one particular company. In Committee, at a certain moment in the discussion of something quite else, the Paymaster General sounded as if she was saying that there was only one company in the whole of the United Kingdom that really was affected in the way that I am about to describe. I think that that was incautious and, in fact, false. Certainly, however, one company has brought to her attention the problem that I am about to bring to her attention. I can only assume that she thinks that the problem is not serious enough to worry about. It is serious enough to worry about.

What is this particular problem? It is the problem of the Swiss-Lux Finance Company being used as part of a structure whose basic intention is not to avoid United Kingdom tax, but to benefit from the tax shield on interest costs of a higher-tax jurisdiction where the subject of an acquisition resides in the higher-tax jurisdiction. Let me try to disentangle that absolutely ghastly sentence.

Dawn Primarolo: I think that I may be able to help the hon. Gentleman to untangle that ghastly sentence. Is he describing the transfer of losses into a country where the losses were not generated, to get the benefit of that country's relief?

Mr. Letwin: In a word, no. I am describing a situation in which a United Kingdom company, as a perfectly ordinary part of its business, acquires a company in another jurisdiction that has a higher corporate tax rate--it is a standard merger and acquisition by one trading company of another trading company; there is no question of any type of sheer financing manoeuvre--and in which it funds that acquisition, as many acquisitions are funded, partially or wholly through debt. Because company A, the United Kingdom company, is the acquirer, it will naturally fund the acquisition through debt raised by itself from its bankers. Therefore, stage 1 of the transaction is that the United Kingdom company--which was previously, for example, debt free--has acquired a huge

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lump of debt as a result of raising the money to buy company B in, shall we say, Germany, which has a high corporate tax rate.

So far, there would be nothing between the Paymaster General and the Opposition. Everyone would agree that that is a completely legitimate acquisition activity. It may even lead to the creation of a great United Kingdom company. In fact, there is one instance in recent British history when it has led precisely, as I have described, to the creation of a great United Kingdom trading company.

The next stage of the transaction is that the United Kingdom company in question--having acquired, first, the German subsidiary, and, secondly, the lump of debt in the United Kingdom--wants to find a way of refinancing that debt in the German subsidiary, so that--

Dawn Primarolo: It can transfer losses.

Mr. Letwin: No. We are talking about transferring not losses, but acquisition debt. There is no reason on earth why the United Kingdom tax authorities should object to the transfer of acquisition debt from a United Kingdom acquirer to a subsidiary in a higher-tax jurisdiction. I cannot see any reason at all why that should be something to which the United Kingdom Treasury objects.

I should point out that, if it really is something to which the United Kingdom Treasury and the Paymaster General object, they are signalling to all such potential acquirers in the United Kingdom that they should do reverse takeovers and end up with their headquarters in the higher-tax jurisdiction. I know that the Paymaster General is the chairman of an important--to my mind rather misguided, but, nevertheless, important--committee of the European Union that looks into these things, and I understand that she may have other interests and motives in the matter--which certainly are not illegitimate in any personal sense, but are part of an agenda that the Opposition do not share.

None the less, just dwelling on this particular type of case, I cannot see any United Kingdom interest in trying so to arrange things that, in the circumstance that I have described, the United Kingdom acquirer prefers to have headquarters located in the high-tax jurisdiction by doing a reverse takeover. Such an arrangement would be a great disadvantage to the United Kingdom, its financial institutions, its accountants, its lawyers, its office cleaners and all the rest. It is all part of the same syndrome that we thought we had got over when the Government reversed the double tax relief provisions. What we are all trying to achieve, I hope, is attracting--not repelling--companies from locating their headquarters here.

It is clear to me that I do not need to explain to the Paymaster General--I shall therefore only very briefly explain to the House--that, currently, the manoeuvre of locating acquisition debt in the high-tax jurisdiction subsidiary proceeds by means of having a Swiss-Lux Finance arrangement, whereby the Luxembourg company effectively lends money to the subsidiary in the high-tax jurisdiction and receives interest from it.

That money is then used by the subsidiary to purchase shares in the acquirer so that the acquirer can pay off its UK debt. By those means, the debt is effectively relocated to the high-tax jurisdiction. That manoeuvre will be prevented by schedule 31(7). However, it is not in the interests of the UK to arrange matters so that such a

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manoeuvre is illegitimate, because the effect will be to persuade companies to locate their headquarters in the high-tax jurisdictions, which are likely to be other European countries. That cannot be to our national advantage.

Having said all that, I am most preoccupied by the unfairness involved. Although the disadvantages are considerable, they are not as great as in the case of the double tax relief. Schedule 31(7) is an important, but not a catastrophic, mistake. What makes it necessary for us to oppose the provision is the fact that companies have already performed the manoeuvre in the legitimate expectation that it would not be clobbered retrospectively. The least that the Government should do--which would reduce the schedule from being appalling to merely very bad--is to agree that the provisions will not apply retrospectively. People will know in future that they need to plan around the provisions, but to apply them retrospectively is unfair and the Opposition cannot concur to that.

I expect that the Paymaster General has received intensive briefing and clear explanations from at least one company. I happen to know that it is not the only one that will be affected, but it is the only one that has stuck its head above the parapet. The Paymaster General will probably admit--while displaying the same delicacy as I am in not naming the company--that the company is a reputable company. It is not a fly-by-night tax avoidance mechanism, but one of Britain's great trading companies. I disagree with the Paymaster General on many things, but I know that we share the patriotism that means we wish to encourage business to locate here. I cannot think that she wants to send out the message that if companies based in the UK behave in certain ways based on legitimate expectations, they will be retrospectively clobbered by Acts of Parliament. That has not been part of the tradition of our tax legislation and the Paymaster General cannot wish to see it happen now.

If the Paymaster General can tell us, in the same tremendous spirit of co-operation and sympathy that she displayed in relation to earlier problems, that the legislation will not apply retrospectively, for some reason that I have missed, it will at least not be catastrophic, although it will militate against future acquirers locating in the UK. A much better solution would be to redo schedule 31(7) so that it would not have that effect. That is the solution that we seek and the reason why we shall push the amendment to a vote.


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