First Standing Committee
on Delegated Legislation
Monday 28 October 2002
[Mr. Eric Illsley in the Chair]
Draft Double Taxation Relief
(Taxes on Income)
(The United States of America)
The Paymaster General (Dawn Primarolo): I beg to move,
That the Committee has considered the draft Double Taxation Relief (Taxes on Income) (The United States of America) Order 2002.
The Chairman: With this it will be convenient to consider the draft Double Taxation Relief (Taxes on Income) (Lithuania) Order 2002.
Dawn Primarolo: Welcome to chairing this important debate on the draft double taxation order on the United States of America and the protocol on Lithuania, Mr. Illsley. I hope that you enjoy chairing this afternoon's proceedings, and that you ensure that we proceed in good order.
I welcome the hon. Member for Eddisbury (Mr. O'Brien) to the Opposition Front Bench. I think that this is the first Committee that he has attended since his promotion, and I look forward to many interesting, invigorating and frank exchanges of views with him in the coming months. I was sorry to hear that his son has been unwell over the weekend; I understand that his mind might be on other things. I am sure that the Committee wishes his son a speedy recovery and hopes that he will be back to full health as quickly as possible.
I am pleased to introduce the order on the USA. The schedule to it contains several comprehensive changes to the double taxation convention with the United States that was signed in London on 24 July 2001 by my right hon. Friend the Chancellor of the Exchequer and the United States Treasury Secretary, Paul O'Neill. The order also contains the protocol signed on 19 July which makes amendments to the new convention.
Double tax treaties promote international trade and investment. They relieve double taxation, which occurs when income from one country is paid to a resident of another country and is taxable in both countries. Under the treaty, each country limits its taxing rights and gives credit for the other country's tax. Tax treaties also help businesses to plan their investments by providing certainty about their tax treatment. They set rules governing the exchange of information between the tax authorities, and provide a framework for consultation to resolve difficult cases.
The economic relationship between the United Kingdom and the United States is one of the strongest in the world. Income flows and the movement of business people and workers are
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significant. The tax treaty between the two countries is our most important one. Like all new tax treaties, it follows the principles set out in the Organisation for Economic Co-operation and Development model convention. It resembles certain treaties that the United States has concluded with other countries, but has an important difference: for the first time, the United States has given up withholding tax on US-source dividends.
Currently, dividends paid from a United States company to its UK parent are subject to a US tax of 5 per cent. A zero rate of withholding tax is therefore a great and welcome benefit to UK businesses. Despite such benefits, several issues have arisen since the treaty was signed. The draft order therefore includes the text of an amending protocol. I recognise that the delay between signature and ratification has caused concern both in the House and outside it, but it was important that we took our time with our American colleagues to ensure that we properly addressed the issues that had arisen.
Let me turn, therefore, to the protocol. The current treaty provides that a teacher from one country on a short-term assignment in another country shall not be subject to tax in that host country. The UK and US Governments have decided, on reflection, to preserve that benefit in the new treaty, in order to help teachers overcome the costs of establishing themselves in a host country for a short period.
The protocol also deals with a few technical defects and an oversight in the new treaty. We took the opportunity to put those right. We have, for example, corrected an oversight that would have denied UK pension funds the benefits of zero withholding tax if they held US equities through certain pooled investment vehicles. The other matter is the removal of a provision in the ''Limitation on benefits'' article 23(7)(d)(ii) that did two things. First, when a European Union parent company could receive income from its UK subsidiary that was free of withholding tax under a EU directive, a US company that was interposed in the ownership chain would not also be subject to UK withholding tax. Secondly, when income flowed from a US company to its UK parent company, which was in turn owned by a company that was resident in another EU member state, automatic treaty benefits would be available from the US for that UK company.
Following the signing of the treaty, it became clear that the US did not share our view of how the relevant provision worked. Although those in the US wanted it to operate in the first way that I have described, they did not accept that it operated in the second way that I have mentioned. We discussed the matter with the United States Government, but we were unable to reach an agreement on how to interpret the provision. In any treaty negotiation one must accept that the benefits that another country is prepared to offer to UK companies are, ultimately, a matter for that country. In this case, the US decided that it would go no further. We therefore concluded that the best solution would be to delete the provision. The protocol does that.
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The treaty enables UK companies, subject to some basic conditions, to receive dividends without any US withholding tax. When companies are owned by UK residents, that will happen automatically. When companies are not owned by UK residents, they will have to apply separately to the United States as the competent authority. I am confident that the conclusion of the treaty will be welcomed by British business and that it will aid competitiveness and stimulate greater investment and trade between the United Kingdom and the United States of America. I commend the treaty to the Committee, and will be happy to answer any specific questions on it that the hon. Member for Eddisbury might want to ask.
The protocol with Lithuania was signed on behalf of the Government by my right hon. Friend the Secretary of State for Foreign and Commonwealth Affairs during the visit to this country of the Lithuanian Finance Minister in May 2001. The purpose of the protocol is to bring about an early implementation of the convention with Lithuania, which was considered in Committee in December 2001. The statutory instrument is a short one; its substantive provisions do nothing more than amend the article of the original convention that relates to entry into force.
It was always our intention to implement the UK-Lithuanian convention in 2002. Unfortunately, our Lithuanian counterparts ran into several procedural difficulties and were unable to complete their constitutional process in time. The Lithuanian Government asked for the protocol and we were happy to agree to it. The convention will be beneficial to UK businesses, so it makes sense to implement it this year rather than waiting until 2003.
I do not want to try Committee members' patience by repeating everything that I said last year about the convention with Lithuania. I simply confirm that the convention brought into effect by the protocol, like the convention with the United States of America, follows OECD principles and covers such types of income as property rents, business profits, income from international transport, dividends, interest, royalties, capital gains, employment income, pensions and annuities. I am confident that the conclusion of the treaties will be welcomed by British business and will, as I have said before, aid competitiveness and stimulate greater investment and trade between the United Kingdom and Lithuania.
I commend the orders to the Committee. I shall be happy to respond to any questions that hon. Members may have on the details of the provisions.
Mr. Stephen O'Brien (Eddisbury): I also welcome you to the Chair, Mr. Illsley. As this is my first outing as a Front Bencher, I shall no doubt be kept in good order to ensure that no precedents are set for my straying out of order in future. I thank the Minister for her kind remarks. I also thank her for the meeting that I was kindly allowed with her officials, which was helpful in illuminating several of the issues that I wanted to raise following a preliminary reading of the orders. That long-standing practice goes back to when
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the participants—our predecessors—were on opposite sides of the House to those that they occupy now. I was grateful for the meeting: it allowed me to focus my mind on the issues rather than simply trying to understand them.
I note that the Liberal Democrats are not represented in Committee. The Minister and I will no doubt be on common ground in our opinion of their priorities. The needs of business, which require international recognition in an increasingly global marketplace, do not seem to be important to that party.
The title of the order quite rightly refers to income tax. I believe that the previous time that the issue was discussed at length was in 1980, and that was on the Floor of the House. I believe that the original treaty was signed in 1975. That raises the question why we are considering the matter in Committee rather than on the Floor of the House. The answer might simply be the way in which business has been arranged, or that these discussions seemed to be a continuation and amendment of the previous arrangements rather than something more substantive.
I have read many good speeches from the previous debate. Having the present debate on the Floor of the House might have led to opportunities to be constructive. We know the importance of recognising the primary level of trade between the US and the UK, as clearly represented by the double taxation treaty.
As the Minister said, we have been waiting for this measure for a little while. I am perfectly happy to take her reasons for that at face value. However, it might have been a touch more helpful if the answer to the question that was tabled on 14 March by my hon. Friend the Member for Arundel and South Downs (Mr. Flight), who is now shadow Chief Secretary to the Treasury, had not been:
''The intention is to submit the convention to Parliament on completion of these considerations.''—[Official Report, 14 March 2002; Vol. 381, c. 1228W.]
A timetable might have been more helpful. As the Minister rightly indicated, there was concern that the issue was dragging and might create uncertainty in the minds of those affected by it. I should say, however, that we have no plans to oppose the order.
There was initial concern that the delay might have been to do with concerns that were raised by other European Union member states. My briefing with the Minister's officials helped to clarify issues, and I will develop some points in relation to article 23 on the limitation on benefits, which the Minister rightly highlighted in her opening remarks.
The Conservative party supports the principle of double taxation treaties. Indeed, the Conservative Government built a network of more than 100 such treaties. We continue to support the network's development because it benefits not only businesses, individuals and entrepreneurs, but the country as a whole. The bilateral arrangement is of utmost importance to our economic relations with the United States, especially because direct investment assets and stock for 2000 are estimated to have a value of £180 billion.
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The arrangement follows schematically the 1980 treaty, but includes amendments, clarifications and expansions on which the Minister touched. However, the explanatory memorandum was not available in the Vote Office when the order was. I tell the Minister that it is important for the explanatory memorandum to be available as early as possible when considering such complex orders that are written in statutory language because it is often more useful—although not in all cases.
The answer to my next question might be readily available, and the fact that I ask it might indicate that this is my first Committee in my current role. Why are several items in the explanatory memorandum printed in italics rather than normal print? I tried to apply logic to decide whether that was because the italicised phrases are changes since 1980 or it was because of the expansion of the amendments due to the protocol. Neither explanation seems to fit, but there is a relevance to regulatory impact and residence. There might be a plain and easy answer to my question, but that does not deflect me from making my points.
In general, the convention follows the OECD model tax convention on income and on capital. As the Minister said, the convention in part I of the schedule was amended by the protocol in part II, which was entered into 360 days later. Although the document is not a candidate for the crystal mark for plain English and it is difficult to master, the exchange of notes that are detailed in part III of the order—which were signed on 24 July 2001, the same day as the convention—and the explanatory memorandum were helpful. However, one would not regard the exchange of notes as personal correspondence because they were technical.
The convention outlined under article 2 covers income tax, capital gains tax, corporation tax and petroleum revenue tax. The competent authorities are the US Department of the Treasury and the UK Inland Revenue. I note, although it is not relevant to those taxes, that Customs and Excise is not involved because the article does not relate to value added tax, which is not applicable to the treaty.
I was worried about part of the exchange of notes about article 2 that relates to ships or aircraft in international traffic. The notes say that there would be a reliance on best endeavours between the contracting states to persuade a political sub-division or local authority to refrain from imposing tax, which would occur if a subsidiary entity had a tax-raising power. That is a weakness in the agreement. Will the Minister assure us that that will be addressed in future, or will she tell us whether it is normal to have no direct federal-national Government responsibilities? [Interruption.] I see that the Liberal Democrat spokesman, the hon. Member for Twickenham (Dr. Cable), has turned up. I am worried that the provision might encourage the concept of local income tax at state level—God forbid. A subsidiary political entity might see the provision as a precedent for a measure that it wished to impose. The Conservative party—and, I believe, the Government—thinks that
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such a measure would narrow the tax base and be inequitable throughout the broad population.
Article 3 covers the United States of America, excluding Puerto Rico, the Virgin Islands, Guam and other such territories. It refers to Great Britain and Northern Ireland, but I believe that that does not include the Channel Islands and the Isle of Man—although that is not said in the paperwork that we have received. It is my understanding that the Income and Corporation Taxes Act 1988, section 790, subsection 5(a) relieves the Channel Islands and the Isle of Man from being covered, but it would be helpful if that could be confirmed for the record.
On article 4, apart from my question as to why the text was in italics and whether that signified anything, I have an interesting point to make. Paragraph 6 enables an American wife of a man who is domiciled in the UK to have her domiciliary status for UK tax purposes determined separately from that of her husband. I recognise that that probably emanates from the position under UK tax law, but it raises the question of whether this is one of those provisions that is, in effect, one-way traffic, because there is not a reciprocal item in United States law. That also raises the question of whether this represents built-in discrimination against partners in relation to married people and, in particular, whether the American system recognises partnership as a status as well as marriage. I do not seek to make any moral judgment about that matter, but it seemed to me that there was a lack of reciprocity, and if clarification were available at this stage, it would be helpful if we could receive it.
The Minister rightly devoted some of her opening remarks to article 10 on dividends—which has then been expanded under the protocol—and in particular to pooled investment vehicles. I have struggled to understand the concept of dividend-equivalent amounts, and how they operate. It would be helpful if the Minister could expand on the complex new design proposed in the arrangements, because that seems to me to be central to the overall argument that lies behind the new treaty, and the new arrangements that support it, in relation to the changes in United States withholding tax, and what benefits that might bring. I will develop that point a little more later on.
Article 11 contains a provision in relation to interest that appears to suggest that a stop should be put to over-investing by an individual or an entity in mortgage repayment vehicles. I assume that that attempt is a part of the anti-avoidance provisions, in relation to interest. That might be an over-interpretation—or even a misinterpretation. However, it was not clear to me why that provision was highlighted in that article, and any clarification that can be given would be appreciated.
Article 12 deals with royalties. It is apparent from the way that I am touching on points in each article that most of the treaty is clear and that it draws on past practice; that has given a context in which business people can operate with clarity, and they have become used to the processes. With regard to royalties however, I know from my experience as an international manufacturing industrialist who particularly focused in the past on roof tiles, bricks
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and aggregates for a UK FTSE 100 public limited company, that royalties were desirable if one had the technology to be able to licence. However, there was a difficulty with striking the rate at which those royalties would be levied within subsidiary groups and, more importantly, in transactions between third parties and those who were able to convey the technology overseas.
I am glad to report that my experience has taught me that a lot of that flows from the UK to the United States, and that should be seen as a major value export for our country. However, with regard to this treaty, it is important that there should be a clear understanding as to what the royalties represent. Are they simply a market rate as against competitors and what exploitation can be made of that in a local market, or—this must be distinguished from that first criterion—is it the value to individual businesses?
A large group that has a licence from a technology supplier would find that it was no more than a constituent part of its business and that its risk was therefore limited accordingly. However, it would be a massive value to business in a small company that was wholly dependent upon that technology. Therefore, given that the royalty has normally to be struck at a percentage rate of sales—usually defined as net sales—it will be a significant part of the value that is carried under the article. That is always covered by contract, but it would be helpful to know what is regarded as in excess under that article and who would strike through an agreement that was contracted between two private commercial parties.
In relation to article 14, the exchange of notes refers to income from employment, focusing particularly on share and stock options. Business is increasingly international. Businessmen and women travel across the world and, despite the opportunities of information technology, spend an enormous amount of time in countries other than their home base, and rightly so. However, the article did not make it entirely clear that there would be no penalty for just visiting even if that visit were a long one. I could not find any guidance to help me to determine whether there is any risk to an employee from the UK who spends a lot of time in the US and is subject to the potential benefit of share options in the UK and of US stock options in a subsidiary company, especially in a joint venture and where an incentive is built into the increase in the stock of the joint venture company. The proposed arrangements claim that they will remove obstacles, and, especially in relation to IT businesses, in which much of the remuneration is, in a large proportion, measured by these types of capital incentive, but it would be helpful to ensure that there is no danger that someone visiting for a prolonged period on an IT-related project, for example, could be caught adversely by the provision.
I have read the Official Report of previous debates on the treaty and on what preceded the current proposals. There appear to have been attempts to inject some jocularity into a somewhat dry subject by changing the provision in article 17 in the 1980 treaty from ''artistes and athletes'' to ''entertainers and sportsmen''. I make no point about ''sportsmen'' as I
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think that in the context of Treasury legislation men means women. However, in the last debate, the question was whether footballers were sportsmen who had been athletes or whether they had never been athletes and were now included. Given the way that the Olympic games seem to be progressing in terms of what is included as a sport, there will be some interesting definitions to contend with in due course.
I will not go further in respect of article 20A in relation to teachers because I am satisfied with what the Minister had to say on that subject in her opening remarks.
One provision in article 21 on offshore exploitation does not necessarily strike at the real world of offshore exploitation and exploration. Leading companies in this country, not least BP, make it a world leader in oil exploration. Although I have had no representations from that company or any other on the matter I was surprised to read that there was a limitation of 30 days after which it appears that a business would be deemed to have been established in that territory. My concern is for oil exploration. There is a risk that 30 days will be regarded as not being in the real world. It may be lowest common denominator of agreement between the two contracting nations and there may be another explanation, but on the face of it I am unable to see that it would necessarily would be likely to carry a certain logic in the context of the business world and offshore exploration as we know it today.
I shall return to article 23 later and complete my remarks on the rest of the convention by referring to article 26. The exchange of notes on the mutual agreement procedure talks about the tax and penalties should apply, even if the Inland Revenue and the United States Treasury are in dispute about the interpretation or meaning of some provisions. My only concern relates to the fact that that shows that there must be a payment of the tax none the less, and that surcharges and penalties would run in any event, even if there were such a dispute. A discussion may take place between the authorities and the officials. Indeed, on so complex a matter, it would be surprising if there were not a number of discussions about interpretation and meaning over the years. In addition, there may be changes that those who drafted these orders may not necessarily have envisaged.
If the penalties are different either side of the Atlantic and applicable to any taxpayer, the only let-out that I can see in the wording is that the taxes would continue to be applied and be payable at that stage, with interest and penalties running, unless they were regarded as not necessary, if that were appropriate. However, it is important on tax issues for businesses to be as certain as possible and, particularly where the Treasury is concerned, for it to provide the certainty that is within its power. It would be helpful if some help could be given on what is meant in those circumstances by the phrase ''if appropriate''. Otherwise, the burden will fall on the taxpayer, even though the difference in interpretation or dispute could be a result of the officials not being in agreement and not the fault of the taxpayer or tax-paying corporate entity.
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Article 27 also relates to the exchange of information. Patently, as part of the culture of double taxation treaties, it is crucial to have exchanges of information and the protection that does exist. However, there is always a concern about the destiny of information, so any assurance that the Minister can offer would be helpful.
Taxpayers in this country know when communicating with the Inland Revenue that, subject to a few exceptions, there is direct dialogue between themselves and the Revenue. They do not expect that information to be handed across Government to other Departments. Likewise, that protection needs to be afforded in the double taxation environment, so that information provided to other countries' authorities cannot be used across another country's Departments of State or, more importantly, flow back into other organs of the Government of the correspondent country.
It would be helpful not only to understand where the destiny of information lies and what controls exist, but to reassure businesses by ensuring that the destruction of information policy is well articulated and reciprocal in terms of the number of years for which the information is kept.
Naturally, there will be a loud cry of ''When will these arrangements come into force?'' As I have said, all businesses need as much certainty as possible. Under the provisions that are helpfully listed in the explanatory memorandum under the protocol in relation to article 4, there are transitional arrangements whereby certain people may be perceived to be better off under the old arrangements. The examples at the end of the document were certainly helpful in considering anti-avoidance, but I could not understand where the benefits came in of moving from where we were to where we propose to be. I raised that question in discussions with the Minister's officials. She touched on a few aspects, and the limitation of benefits clearly has an effect, but I did give warning that I wanted the issue to be articulated during today's proceedings. What are the precise benefits of moving to the proposed arrangements?
The reason for my question is the theoretical risk that the biggest benefit of the new arrangements—the fact that the United States has laudably decided to move for the first time from a 5 per cent. to a zero withholding tax regime—might be seen as a signal for others to follow suit. Many dividends flow from the US to the UK. There will be benefits to companies and to the Exchequer as no credit will be required to be given. Most importantly, companies will have to deal with only one authority. There should therefore be a lightening of the regulatory burden. That is to be welcomed.
My concern was about the effect of a higher withholding tax position in relation to other countries within the EU. The Minister rightly addressed that point in her opening remarks. I have had some reassurance about the dividend withholding rates on direct investment in the United States' treaties
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with the other 14 member states and with Canada, Mexico, Japan, Australia, Norway and Switzerland. However, there is no provision in the United States-Greece treaty that governs US source dividends and they are therefore subject to the full US withholding tax rate of 30 per cent. The treaty with Japan, which is being renegotiated, and the treaties with Norway and Spain have a rate of 10 per cent. In all other cases the rate is 5 per cent. There is therefore no incentive for residents of those countries to route their United States holdings through the UK.
I know that the Minister will have readily grasped the point. If there were great differences in the rates of withholding tax between other countries and the US, it might be tempting to route the dividend payments through the UK, particularly where UK companies were owned by someone from another EU country. Significant provisions within the treaty give a high degree of assurance on that, but a watch needs to be kept on the workings of these provisions so that the ability of the US to offer the zero rate withholding tax to UK businesses and UK taxpayers cannot damage the significant advance in the arrangements between our two countries. I hope that it will prove successful and will be seen as a competitive element that needs to be followed by others and that we will not have to help the United States plug a growing hole.
Detailed provisions are contained in the documentation. It would be helpful if the Minister could give some greater clarity on the point about the equivalent beneficiaries, which is what helps on the limitations of benefits and ensures that there is no ''pass through'' the UK. The Minister will have been forewarned of my interest in that subject as it formed the focus of the discussions that she helpfully allowed me to have with her officials.
The only thing that I would say about the regulatory burden is that there will hopefully be a net benefit. Because of the way that the ''pass through avoidance'' provisions apply, there will have to be a different process to the current one. In certain circumstances it will be necessary for people to go to the Internal Revenue Service in the United States to test that companies are genuinely in business in this country.
Will the change in the balance of the burden of proof increase or decrease the regulatory burden? Only practice will tell. Placing it on the record will help us to keep a close watch on the position. It helps businesses when they have the least regulation imposed on them. Too much regulation gets in the way of promoting British business and the national interest.
I hope that those few questions will help to shed light on the US treaty with Lithuania. Lithuania was discussed before, so there is no need to rehearse the arguments again. I could not agree more with the Minister about the importance of entering the treaty with Lithuania, an important Baltic state—with respect to UK trade, perhaps the most important. My party is keen to treat all candidate countries of the EU as future colleagues, certainly not as second-class European countries. The treaty will go a long way to ensure that that happens. I fully understand the timing
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and it follows OECD principles. Some questions remain about whether the US treaty is applicable.
On a previous occasion, the Paymaster General had to deal with the position when one of my predecessors in opposition chose not to make any points on the double taxation treaty. He is now the Prime Minister. It is for him to decide whether the position was so perfect under a Conservative Government that no points needed to be made.
I have one technical question. Does the fact that we are dealing with Lithuania today mean that the Order in Council was revoked nearly a year ago? That is my reading of section 788(9) of the Income and Corporation Taxes Act 1988, as amended by section 277 of the Taxation of Chargeable Gains Act 1992. If it has been revoked, we have a new Order in Council. I look forward to hearing the Minister's response.