Draft Double Taxation Relief and International Tax Enforcement (Hungary) Order 2011 etc.
The Committee consisted of the following Members:
Alison Groves, Committee Clerk
† attended the Committee
The Chair: With this it will be convenient to consider the draft Double Taxation Relief and International Tax Enforcement (Armenia) Order 2011, the draft Double Taxation Relief (Aircraft Crew) (Brazil) Order 2011, the draft Double Taxation Relief and International Tax Enforcement (Ethiopia) Order 2011 and the draft Double Taxation Relief and International Tax Enforcement (China) Order 2011.
Let me take this opportunity at the beginning of the debate officially to welcome the hon. Member for Pontypridd (Owen Smith) to his position on the Front Bench. I very much look forward to his lengthy questions and queries over the course of the afternoon and evening.
We are debating four comprehensive double taxation agreements and one limited agreement with Brazil. Let me deal first with the double taxation agreements. DTAs aim to relieve double taxation where income arising in one country flows to a resident of the other country and would otherwise be taxable in both countries. To relieve that double taxation, each country agrees to limit or forgo its taxing rights and, where appropriate, to give credit for the other country’s tax. Tax treaties also help businesses to plan their investments by providing certainty about their tax treatment. Furthermore, they provide for the exchange of information between two tax authorities and for consultation between tax authorities in order to try to resolve difficult cases by mutual agreement.
We are committed to maintaining and developing the UK’s network of double taxation conventions. We currently have comprehensive DTAs in force with 120 countries or territories—one of the world’s largest networks of DTAs—and the taxation orders before us address the UK’s DTAs with Armenia, China, Ethiopia and Hungary, and an aircraft crew agreement with Brazil.
The DTA with Armenia is a first-time, comprehensive agreement with that country. As part of the former Soviet Union, Armenia was previously covered by the UK’s treaty with the USSR, but it renounced the treaty following its independence. Armenia was keen to build up its own network of tax treaties, and it approached the UK to bring it into line with its neighbours in the Caucasus. The amount of UK investment in Armenia is limited, but business interests were keen for a treaty to fill the gap. Armenia has a broadly conventional tax system, which enabled us to reach an agreement quite quickly.
The new treaty contains many welcome provisions, including worthwhile reductions in the rates of withholding tax on dividends, interest and royalties compared with the rates applying under Armenia’s domestic law. There is also a measure protecting the UK’s taxing right over the dividends of real estate investment trusts, or REITs. The treaty naturally includes the latest OECD exchange-of-information article, as do all modern UK treaties. It also has anti-treaty-shopping provisions and an arbitration provision to assist the mutual agreement process.
I now turn to the new tax treaty with China. It was signed on 27 June by my right hon. Friend the Foreign Secretary and the Chinese Foreign Minister at the UK-China summit in London, and it marks another important step forward in UK-China bilateral relations. The current DTA with China dates from 1984, and although it was amended by protocol it had become quite outdated. Negotiations began in 2005, and over a five-year period we have agreed a text with China which meets many of the objectives that UK companies have put to us in recent years.
For UK multinationals, the most important change in the new treaty is the reduction to 5% of the withholding tax on dividends paid to direct investors, which compares with a rate of 10% in the present treaty. Other important features include a reduced withholding tax rate on royalties, the elimination of withholding tax on technical fees applicable under the present treaty, an updated capital gains article and a modern exchange-of-information article.
As with any DTA, the text is a compromise and of course contains features that reflect China’s treaty policy. I am sure the Committee will welcome the significant advancements we have made in this new treaty with China and the benefits that it will bring for UK companies and individuals doing business in a country that is one of the UK’s key economic partners. The UK continues to rank alongside Germany as one of the two leading EU investors in China and recipients of Chinese investment into Europe.
The agreement with Ethiopia is the first full agreement with that country, although we have had a limited agreement covering the profits of air transport since 1977, which this agreement replaces. Compared with the general pattern of the UK’s DTAs, it permits a greater degree of source taxation than is provided for in the OECD model, reflecting Ethiopia’s status as a developing nation and its understandable wish to receive the benefit of a greater share of the tax revenues on profits earned in its territory. The agreement is similar to Ethiopia’s other DTAs, particularly those it has signed in recent years.
The new treaty with Hungary replaces the previous DTA, which dates from 1977, and provides some important benefits to UK residents. In particular, the dividends article has zero withholding rates for direct dividends and for dividends paid to pension funds, and a 10% rate for portfolio investors. There is a 15% exception for real estate investment trusts, in line with the UK’s preferences, and there is also zero withholding tax on interest and royalties. Hungary does not currently levy withholding taxes, but the treaty provides valuable certainty to UK businesses should that ever change.
As the Committee would expect, the new treaty contains the latest OECD-style exchange-of-information article, covering all taxes, as well as the usual anti-treaty-shopping provisions that appear in all modern UK treaties. Pensions other than Government pensions will be taxed in the state of residence only, as is the case under the existing treaty, but we have agreed in a protocol to review the position in 2013—in the light of possible changes to Hungary’s rules. I am sure that the Committee will join me in welcoming the new treaty.
Finally, the agreement with Brazil to avoid the double taxation of air crew salaries was signed on 2 September 2010. It aims to eliminate the double taxation of income derived by a member of the crew of an aircraft operated in international traffic, and at the same time to ensure that they do not escape tax in both countries. That is done by allocating the taxing rights that each country has under its domestic law over the same income solely to the country of residence of the individual crew member.
Owen Smith (Pontypridd) (Lab): It is a pleasure to serve for the first time under your chairmanship, Mr Gray. I thank the Minister for his kind welcome and for the courtesy that he extended to me—I understand that previous Ministers have also done this for their shadows—in getting his team to brief me this morning at the Revenue on the content of these double taxation agreements. It was an instructive meeting, not least because I was taken for a coffee in the newly cashless canteen there. I am sure that that has nothing to do with the budget cuts being overseen by the Minister—nor, indeed, the administration of HMRC by the previous Government.
We support the DTAs. The agreements have been signed by the current Government, but they were negotiated over a long period and some of those negotiations started on the watch of the previous Government. The agreements are mostly similar. The Brazilian one is obviously rather shorter and more discrete in its focus, and the most important one relates to China. I will ask the Minister some questions about that and some of the other agreements.
First, the Minister said that the Chinese agreement replaces the pre-existing agreement that was signed in the early 1980s. He also noted that the most important change in the two agreements relates to article 10 and the application of new, lower rates of withholding tax for dividends—down from 10% to 5%—when the beneficial company holds at least 25% of the capital in said company. There is a similar provision in relation to royalties.
Those are important changes, which I think will be beneficial for British companies. Has the Minister made any assessment of the potential value of the changes, and does he anticipate an increased volume of activity between ourselves and China, which is what I am sure we would all hope for, as a result of them?
Secondly, the Minister will also know that article 10 further stipulates that if the company is wholly owned by the state of the other contracting country, the new rates do not apply. Has the Minister made any assessment of the volume of Chinese companies operating in the UK which are state-owned and, therefore, would not be caught by this important new measure?
Legal definitions are hugely important in such treaties if they are to be watertight and uncontested. One of the most important definitions to make clear relates to “permanent establishments”, and the point at which that status is taken on: when an agent, hitherto acting as an independent agent or broker on behalf of a company in another jurisdiction, which in this instance is China, begins to be deemed a permanent establishment.
HMRC obviously makes that distinction or judgment, but is the Minister assured that HMRC has the requisite resources in place, given the shrinking budget and constrained times, to undertake those complicated assessments? Will that situation change or need to change in the light of the potentially increased volume of trade between China and the UK, which, as I have said, we would all want?
Thirdly, on transparency, there is a welcome set of provisions in each double taxation agreement, and article 26 of the Chinese agreement relates to the exchange of information. We welcome that, because we agree with the Government that in such taxation agreements transparency is enormously important. What sort of powers does the Minister think the article confers on the relevant authorities in each jurisdiction in order to interrogate tax returns and to provide the degree of transparency that we would hope for; and, will it have an impact on transfer pricing? Transfer pricing between multinationals operating in both jurisdictions is obviously one of the most pressing concerns with regard to potential opacity.
Finally on transparency, Hungary, as part of the EU, is caught by the European savings tax directive. Does the Minister feel that that is sufficient, or is something additional captured under the exchange-of-information provisions, over and above what is in the directive? In other words, does he feel that the directive is not sufficiently robust, and that we need the additional provisions?
As the Minister said, the Armenia agreement replaces the previous agreement with the USSR. A process of gradual replacement for the new, post-USSR states has been under way for many years. In signing the agreement the Foreign Secretary referred, I believe, to his hope for increased trade between Armenia and the UK, particularly in the energy, banking and high-tech sectors, as a result of the agreement and, I presume, other arrangements. Has the Minister made any assessment of that prospect to date? Do we anticipate a significant volume of trade, and can he tell us any more?
Finally, the Minister noted that the DTA for Ethiopia includes provisions about tax sparing. I understand that that is the jargon for, effectively, allowances and exemptions that allow the developing country in question—in this
Mr Gauke: I thank the hon. Gentleman for his questions, and I am glad that he has been able to take up the opportunity traditionally offered to Opposition spokespersons to obtain a briefing on the double taxation agreements. I took that opportunity to experience the HMRC cashless café, and I can tell him that as far as that is concerned nothing has altered following the change of Administration.
The hon. Gentleman raises a number of detailed questions. Let me try to address them as best I can. His first question is part of the tradition of these debates, which is to ask how much will be saved and what the financial benefit is of these agreements. It is part of the tradition, because it is a question that I asked on several occasions, and, whoever has been standing in the Minister’s position, the answer has consistently been the same: it is not possible to give a precise number for the revenue effects of these agreements—or indeed of other double taxation agreements. The overall cost or benefit of an agreement is a function of the income flows between the two countries, and the agreement itself is likely to change both the volume and nature of those flows by encouraging cross-border investment. It can be somewhat difficult to make any predictions about the impact of any one agreement.
Clearly, there is consensus on the point that it is in the UK’s interest to have an extended number of double taxation agreements, and the fact that we have such an advanced set of agreements is one of the advantages that the UK offers to international—multinational—businesses, but, as I say, it is not possible to identify particular sums.
Owen Smith: I fully accept the Minister’s point about the difficulty of prospectively projecting precise revenues, but does he feel that taken together these agreements—the Chinese one in particular—are revenue-positive for the UK?
Mr Gauke: I can go so far as to say that, in the round, these agreements are beneficial to the UK as a place to do business, and that that in itself has revenue advantages, but it is difficult to say whether each individual agreement works out revenue-positive or negative. In truth, it is not a zero-sum game. As with all international trade, there are advantages to being an open, outward-looking economy and to trading with other countries. The UK will benefit from being able to do that, and our advanced set of double taxation agreements will play a role in it.
May I turn to the issue of state-owned companies in the context of China and article 10? It may be helpful to say that articles 10(3) and 11(3) provide that a Government or a Government-owned entity may receive dividend or interest income without the application of the withholding tax allowed for in paragraph 2 of each article. It is common for states to refrain from levelling tax on
In the case of dividends, the effect is limited because the UK has no general withholding tax on dividends. The provision in article 11 broadly follows a provision in the existing treaty, but again, although I acknowledge that the hon. Gentleman asks a perfectly reasonable question, I am afraid that it is not possible to give any precise figures on that point.
The issue of transfer pricing, and how it would work with these agreements, was raised. Article 9(1) of each DTA confirms that the state may adjust the profits of an enterprise of that state where profits are understated as a result of a failure to observe arm’s-length principles. Paragraph 2 of that article envisages that a state will make a corresponding adjustment to remove economic double taxation where the initial adjustment is valid.
In the case of a dispute regarding the validity of an adjustment, the mutual agreement procedure article allows the competent authorities to resolve it. Potential disputes can be avoided by creating advanced pricing agreements—APAs—where competent authorities and taxpayers consider pricing in advance in significant cases to establish the arm’s-length standard, and HMRC has an active APA programme that includes China.
The hon. Gentleman raised the issue of exchanging information and asked how it works. The exchange-of-information articles in the four DTAs are almost identical and follow the OECD’s model, and they therefore conform to what has become the international standard, as articulated by the OECD’s global forum on transparency and exchange of information. They are a briefer version of what one sometimes sees in bespoke tax information exchange agreements, but the standard is the same.
In the context of Hungary, the hon. Gentleman asked about the European Union savings directive. The OECD agreements can complement the EU directive, but they do not cover exactly the same areas, so it is still helpful to have separate provisions in these double taxation agreements.
The hon. Gentleman asked also about the definition of “permanent establishment”. The state in which the income is earned may consider that an agent creates a taxable presence for a non-resident of that state. Where the agent has and habitually exercises an authority to conclude contracts on behalf of a non-resident, and those contracts relate to the core business of the non-resident, a permanent establishment may be created. A commentary on article 5 of the OECD’s model provides guidance on what is meant by “habitually exercises” and other aspects of agency. Independent agents, such as brokers, do not create a permanent establishment. Where disputes arise, the provisions of the mutual agreement procedure may be invoked, and the competent authorities shall endeavour to resolve them.
I should also respond to the question that the hon. Gentleman raised regarding whether HMRC has the requisite resources to deal with such matters. The same point may be made regarding transfer pricing, which is an intensive area that requires some expertise, but I assure the Committee that HMRC has the resources in those areas. They are considered to be important, and we do not have any particular concerns on that front. It is always necessary to ensure that HMRC has appropriately skilled staff in those areas.
On Ethiopia and the issue of tax sparing, we have agreed to give so-called matching credit for Ethiopian tax given up under investment incentive legislation. Previous Governments, both Conservative and Labour, stated that the UK would give matching credit only to the poorest countries and only for a limited duration, and Ethiopia clearly fulfils both criteria. As the UK now has an exemption system for the taxation of UK companies’ overseas subsidiaries and permanent establishments, matching credit is of limited value, but Ethiopia saw it as an important point of principle, and we were happy to include it.
I hope that my remarks have been helpful to the Committee and have responded to the hon. Gentleman’s questions. I welcome his support for the agreements, and I hope that the Committee supports them today.
draft Double Taxation Relief and International Tax Enforcement (Armenia) Order 2011
draft Double Taxation Relief (aircraft crew) (brazil) Order 2011
draft Double Taxation Relief and International Tax Enforcement (Ethiopia) Order 2011
draft Double Taxation Relief and International Tax Enforcement (China) Order 2011