Dr.
Pugh: I thank the hon. Gentleman for that useful lesson. I
shall now test my understanding of this fairly complex schedule and
clause. As
I understand it, it is intended that manufactured overseas dividends
will qualify for exemptions from double taxation, as real dividends do.
Manufactured overseas dividends are characteristics, as the hon.
Gentleman has said, of repo deals. I believe that the scam to be
targeted involves one might call an illusory repo deal between two
companies in the same group—phantom dividends, an allowance for
foreign tax liability but no actual foreign tax liability. If I am
correct that that is what the Minister wishes to target, my only
question is: how prevalent is the scam and what are the savings to the
Exchequer in closing that
loophole?
Mr.
Timms: I am grateful to both the Opposition spokesmen for
their
support. The
clause and schedule 29 counter a complex tax avoidance scheme whereby
the recipient of a manufactured overseas dividend claims relief for
overseas tax that he has not paid, as the hon. Member for Southport
described. The description of what is going on given by the hon. Member
for Hammersmith and Fulham is broadly correct. The manufactured
payments arise under repo or stock-lending transactions. They are
payments that are representative of interest or dividends paid on
securities such as gilts or shares, and are intended to compensate the
transferor of the securities for not receiving the real interest or
dividends.
Nearly all
manufactured payments are made by companies under routine transactions
involving banks, securities houses and insurance companies. Earlier
this year, we became aware of a complex tax-driven scheme involving the
sale and repurchase of a foreign shareholding between two group
companies. Part of the repo agreement involves what is, in substance,
an obligation to pay a manufactured overseas dividend, which does not
bear any overseas tax and is equal in amount to the gross overseas
dividend. Despite that, the recipient claims relief as if overseas tax
had been deducted. That is the heart of the scam.
The hon.
Member for Southport asked about the potential losses from the scheme.
Our assessment is that more than £150 million per year would be
at risk if the measure was not put in place. Tax avoidance is unfair to
the majority of taxpayers. It can undermine the funding of public
services, and we are determined to take appropriate and prompt action
to counter it. The set of clauses before us contain a number of
instances of such action being
taken. The
hon. Member for Hammersmith and Fulham asked about the extent to which
the measure is applicable in slightly wider circumstances. Other
non-avoidance legislation deals with transactions other than repos, but
repos cover sale and buyback transactions, and the legislation will
apply to those. Only dividend repo transactions are affected by the
avoidance legislation in the clause and schedule, because only
dividends can give rise to double taxation relief. I therefore commend
the clause and the schedule to the
Committee. 12.15pm Question
put and agreed to.
Clause 58
accordingly ordered to stand part of the Bill.
Schedule
29 agreed
to.
Clause
59Payments
by reference to foreign tax
etc Question
proposed, That the clause stand part of the
Bill.
Mr.
Timms: The clause contains a provision to counter an
avoidance scheme that abuses the double taxation relief rules. The
provision will not bring in substantive additional corporation tax, but
it is estimated that it will prevent losses to the Exchequer that would
be up to £100 million a year if the abuse continued unchecked.
The double taxation relief rules are designed to give relief in the UK
for foreign tax paid on the same income or profits charged to UK tax.
If any of that foreign tax is reduced, UK tax should be reduced by the
same
amount. HMRC
has become aware that in some circumstances it is possible for a UK
parent company to obtain a payment by reference to the foreign tax paid
by a subsidiary company. The payment is made when the subsidiary pays a
dividend, so the parent company receives the profits with little or no
foreign tax suffered. That has been exploited by groups in an avoidance
scheme that seeks to obtain relief for foreign tax where the group has
not borne the economic cost of that
tax. It
is a long-standing principle that if foreign tax is repaid, credit for
foreign tax should be reduced by the amount of the repayment. The
clause ensures that the same reduction in credit occurs if the payment,
by reference to the foreign tax, is made not only to the company that
originally paid the tax, but to a different person connected with that
company. Typically, that will be the parent company. However, it has
been brought to our attention following the publication of the Bill
that the clause may affect the operation of commercial cross-border
loan arrangements arising from the London loan market.
The Government
amendments would have provided that the clause applied only to payments
made under the laws of a territory outside the UK. Opposition amendment
217 addresses the same point differently and perfectly appropriately,
although not, technically, in the correct way. The Government
amendments reflected agreement that HMRC reached with industry legal
advisers and had the advantage of following existing legal precedent
that applies for the purposes of controlled foreign company
legislation. The Government amendments would have covered the
overwhelming majority of cases where refund of foreign tax might arise
from commercial contracts. However, since formulating the Government
amendments, we have received further representations—I am
grateful to the Chartered Institute of Taxation for those—which
show that there may remain situations where the amendments do not go
far enough to ensure that the clause does not hit any unintended
targets. Although these are unusual circumstances, it is right that we
should take account of
them. The
Opposition amendment would restrict the operation of the clause across
a wider range of circumstances than the Government amendments because
it limits the clause to those cases where the repayment is made by the
foreign tax authority only. By contrast, the Government amendments
would have left the clause in operation whenever the repayment arose
out of the application of foreign law. In view of the further
representations that we have received, I accept that the Government
amendments would not have gone far enough in restricting the scope of
the clause. Therefore, I have not moved the Government amendments. I
will reconsider the position and return to the matter with further
Government amendments on Report.
The
Opposition amendment is broader in scope but has some technical
difficulties. The reference to a taxing authority would be novel in tax
law and its effect is not altogether clear. Although I am grateful to
hon. Members for tabling it, there needs to be further reflection in
order to get this right on
Report.
Mr.
Hands: I reiterate that we broadly support
clause 59. As the Minister said, it targets a specific
avoidance scheme. In essence, as I understand it, this relates to where
the UK gives credit for tax paid elsewhere but where separate relief
has already been granted to a connected party. The Minister used the
term “group” and I would be interested to hear from him
what sort of groups he means. Would they typically be financial
institutions, as with the last clause, or would another type of
corporate structure be involved in this sort of scheme?
Currently, a
UK company which has claimed double tax relief in respect of foreign
tax paid must notify HMRC and amend its claim if there is a subsequent
change in the amount of foreign tax, for example, as a result of a
repayment. However, if the tax is repaid to a person other than the
claimant, it is arguable that there is no obligation to amend the
double tax relief claim. This can arise, for example, because in some
foreign territories when a resident company pays a dividend, a refund
of tax paid by that company is made to the recipient of the dividend
rather than to the company. Clause 59 ensures that a double tax relief
claim will
have to be withdrawn or amended where there is a repayment of a foreign
tax to a person other than the company that made the claim—that
is, to a connected party, as the Minister described another party
within that same group. Relief will then be given only for the net
amount of foreign tax paid, less the payment to the connected person.
As we know, the clause is effective for payments made on or after
Budget day, 22 April 2009. We very much agree with that
point. I
am going to explain our amendment and consider where we would go from
here in relation to the three amendments. In our view—and I
think the Minister is saying the same thing—the clause does not
specify that the payment must come from a taxation
authority. There are situations between private companies where one
company may pay another in respect of foreign tax. For example, on the
simple sale of a company, the selling company will normally indemnify
the purchaser against any outstanding tax liabilities, which would
include foreign tax. Under the current drafting of subsection
(2) —the proposed new section 804G of the Income and
Corporation Taxes Act 1988—the person making the payment is not
specified. Therefore, in our view it has great potential to catch
unintended matters that are entirely commercial and at which the
legislation is not aimed.
The Minister
said that our amendment does not deal with these matters in technically
the same way. I am slightly at a loss. I think he is
probably right and I am going to take his word for it in this
circumstance. I am slightly disturbed that we are now going to have to
come back to this on Report. We have had two Government amendments, two
attempts to get this right, since the Finance Bill was published. I
must minute our disappointment that we are going to have to bring back
this measure on Report, even after today’s reasonably full
debate. However, we will not oppose either the clause or the
Government’s intention to return to
it. Question
put and agreed
to. Clause
59 accordingly ordered to stand part of the
Bill.
Clause
60Anti-fragmentation
Mr.
Hands: I beg to move amendment 218, in clause 60,
page 29, line 34, after
‘costs’, insert ‘,
and ‘(c) the taxpayer has entered
into a scheme or arrangement a main purpose of which is to secure that
the included funding costs are less than the national funding
costs’.’.
The
Chairman: With this it will be convenient to discuss
Government amendments 209 to
212.
Mr.
Hands: The clause deals with anti-fragmentation, a term I
had not heard of until I started working on the Bill. However, I have
been trying to get my head around the term and I will give it the best
that I can.
The clause is
another anti-avoidance measure that has our support. In essence, it is
about banks, and in particular how they might find ways to book income
and expenses in different accounting units to avoid tax. Following the
decision in a 2005 court case, Legal and General Assurance Ltd
v. Thomas, in front of the special commissioners, the
Finance Act 2005 introduced legislation restricting the availability of
double taxation relief for foreign taxes paid on schedule D case 1
income, which now of course are treated just as “trading
income” under the Corporation Tax Act 2009, or income computed on
a similar basis for UK tax purposes. The rules aim to ensure that the
double taxation relief claimed cannot exceed the equivalent corporation
tax on the net profits attributable to that source of income, after
deducting an appropriate allocation of expenses, and are often referred
to as a “mini-D1 computation”. HMRC believes
that certain banks have sought to avoid the impact of this legislation,
either by routing loans through subsidiaries, which are taxed
differently, or by financing in such a way that funding costs are not
directly attributable to the income and therefore are not deducted in
calculating the double taxation relief restriction. Although HMRC
considers that the existing legislation should already have the desired
effect, clause 60 is intended to put the matter beyond
doubt. The
current rules provide that, where income that would otherwise have
formed part of the trade receipts of a bank but instead is received by
an affiliate that is differently taxed and can claim double tax relief
without the restrictions affecting the bank, the income is treated as
trade income of the subsidiary. With effect from Budget day, the new
measures will extend the existing wording, with the intention that its
scope mirrors HMRC’s interpretation of the current rules.
Furthermore, when allocating bank funding costs in calculating the
relief due, this must now be done on the basis of a proportion of
average funding costs, even when specific funds are used to finance an
investment.
My
understanding is that, if one has a pool of investments and a pool of
different vehicles funding those investments, one would have to
allocate things on a proportion of the average funding cost for the
whole portfolio rather than specific funds underlying a specific asset
and how that asset in particular has been funded. That is my
understanding of the situation; I would be grateful if the Minister
could confirm whether that is correct. These changes have effect from
22 April
2009. Amendment
218 was suggested to me by the Law Society, which believes that both
sets of amendments, as they are aimed at artificial manipulation of
double tax relief, should be subject to a tax avoidance motive test.
The basic rules, as they stand, already contain provisions relating to
the allocation of expenses and these rules should apply over and above
those rules only in exceptional cases where there has been deliberate
manipulation for tax
reasons. That
is what our amendment seeks to do. My understanding is that the
language used is entirely normal for these tax avoidance motive tests
and I would be grateful for the Minister’s view on whether he
will accept the amendment and on the importance of attaching motive to
tax avoidance in this case.
Dr.
Pugh: I rise to test my understanding of the term
“anti-fragmentation” in the clause. It seems to me that
the term restricts the banks in two ways. First, it restricts them in
how they proportion the cost of overseas transactions under the Finance
Act 2005. Secondly, it curtails their ability to dodge that regime by
arranging income to be received by a non-banking company under their
control. The explanatory notes say that clause
60 “will
clarify the existing legislation that prevents banks avoiding the
intention of the DTR legislation by artificially arranging for income
to be received by a non-banking company”.
That rather
creates the perception of the banks as a slightly slippery customer, if
one considers what might be behind it. It certainly makes the case for
HMRC vigilance and Treasury intelligence. It also endorses the strong
public suspicion over banking behaviour in general. Can I tempt the
Minister to indicate which bank’s behaviour is being targeted
and how many banks are in receipt of taxpayer
funds? 12.30
pm
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