I beg to move amendment No. 46, in schedule 3, page 69, line 18, at end insert

'in so far as it applies to profits or gains not of a capital nature'.

With this it will be convenient to discuss amendment No. 47, in schedule 3, page 69, line 19, after third 'tax', insert

'in so far as it applies to profits or gains not of a capital nature'.

The amendments would clarify the definition of schemes involving hybrid entities. Schedule 3 deals with the definition of qualifying schemes. The words in the amendments would be inserted after the reference to corporation tax. The purpose of the definition of a hybrid is to define entities that are characterised by different treatment in different jurisdictions. Because of the widely differing treatment of capital gains or corporations in different jurisdictions, the amendments aim merely to achieve standardisation by defining relevant taxes more tightly for the purposes of the legislation—to include corporation tax only in so far as it applies other than to capital gains.

Schedule 3 lists the deductions rules for arbitrage, which apply where there is a qualifying scheme. They do not cover all possible instances of arbitrage, but instead concentrate on certain instances of the scheme that are likely to give rise to the greatest risk. The schedule defines a qualifying scheme as one that contains either a hybrid entity or has a hybrid effect. A hybrid entity is recognised for tax purposes as a person in its own right, but for some reason is also recognised as part of a separate person under a different tax code, be that a UK tax code or a foreign one. Any scheme including such an entity will be a qualifying scheme for the purposes of the arbitrage rule.

Amendments Nos. 46 and 47 would amend the definition of hybrid entity so that the profits of a capital nature are excluded. Those changes would create a considerable risk that items classified as capital under one system but not under another will no longer be caught by the legislation. That deliberate exploitation of the differences in classification in order to gain a UK tax advantage is precisely the sort of thing that gives rise to the mischief that the Government are trying to counter, so we cannot accept the amendments. For the reasons that I have given, if the hon. Gentleman wants to press the amendments to a vote, I will ask my hon. Friends to oppose them.

I am a little puzzled by the Paymaster General's brief reply. I assure her that the amendments were not designed as wrecking amendments, which is more or less the inference I draw from her comments. Rather than to cut through the heart of the Bill, they were intended to ensure comparable treatment in different jurisdictions because of the strange ways in which capital gains are treated in corporate tax regimes in different jurisdictions.  

I confess to the Committee that the amendments are not the product of my original thought. Others who have expressed concerns will undoubtedly read what the Paymaster General has said and consider her views. If there are issues that need to be further explored, I am sure that we will have an opportunity on a later occasion. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

I beg to move amendment No. 48, in schedule 3, page 69, line 25, at end insert

'and the instrument, shares, securities or debt instrument involved is not of a class of instrument, share, security or debt instrument which is traded upon a recognised stock exchange or upon a recognised investment exchange within the meaning of section 841 of ICTA,'.

Paragraph 4 of schedule 3 deals with schemes that achieve the hybrid effect by the use of convertible debt instruments. The purpose of including such instruments in the rules is that although they are an equity-type investment in terms of their risk and return, the coupon is deductible interest and not dividend from the UK company's tax perspective. The amendment, which I stress is probing, would provide an exclusion for publicly listed instruments.

I am assured that similar provisions exist in relation to UK group relief rules so that quoted instruments—listed instruments—cannot be treated as quasi-equity by the Revenue for the purpose of arguing a dilution of percentage shareholdings and thus denying group relief to a taxpayer. Our aim is to narrow the scope and limit the legislation to clearly contrived schemes, which I suggest would not use listed instruments. The amendment uses the definition of recognised stock exchange in the section 841 of the Income and Corporation Taxes Act 1988.

I accept that the amendment may be slightly widely drawn, in that it refers to any instrument that is listed on a recognised stock exchange, and I accept that there may be an argument that some such instruments could be used in such a scheme. However, will the Paymaster General address the substance of the argument? Would the fact that an instrument is listed—she might like to tighten the wording to ''actively traded''—be a reason for not applying the definition in paragraph 4, rather than simply a material consideration in determining an individual case? I realise that the question of whether or not the instrument is traded will be a material consideration in determining the case, but I hope that she can say that in certain circumstances it will be apparent in advance, where an instrument is listed or perhaps traded, that it does not come under the legislation. That would give us more certainty and clarity.

I shall respond to the hon. Gentleman's probing amendment and try to give him the reassurance he seeks. First, I shall explain why the Government will not accept amendment No. 48. The amendment would change the part of schedule 3 that deals with schemes having a hybrid effect. Schemes will have a hybrid effect for the purpose of the arbitrage rules if they include a hybrid instrument or a defined type of share interest. Schedule 3 is, in effect, a list of those instruments. The amendment would exclude from the range of instruments identified,   those of a type that are traded on a recognised exchange. The Government cannot accept the restriction of the definition for two reasons. First, the list of instruments having a hybrid effect covers the kind of instruments that have been shown to lend themselves to use in schemes designed to avoid UK tax. Many of those instruments are traded on a recognised stock exchange, but that does not mean that they cannot be used for tax avoidance. The automatic exclusion of a traded instrument, as proposed by the amendment, would simply mean that avoidance could continue through the simple expedient of listing instruments on any recognised stock exchange. That is probably not what the hon. Gentleman wants to happen.

The Government's second concern is that the wording of the amendment does not even require the instrument to be traded itself—it refers simply to a class of such instruments. The effect of the amendment would be to remove most hybrid instruments from the scope of the provisions, even though they form part of a scheme that is designed to give rise to a UK tax advantage. Consequently, that could be rather expensive, as I am sure the hon. Gentleman will accept.

I assure the hon. Gentleman that the genuine placement of an instrument into the market will not normally be caught by the arbitrage deduction rules, as the instrument is unlikely to be part of a scheme that had a main purpose of obtaining a UK tax advantage. Further details on the issue can be found in the guidance issued by HMRC. I appreciate from earlier comments by the hon. Gentleman about an error in the guidance that he will want to check that—it is draft guidance that is still under discussion.

For the reasons that I have set out, I hope that the hon. Gentleman will understand why the Government will not accept the amendment and go down that route—he said that it is a probing amendment so he will no doubt not push for a vote. I hope that he accepts my reassurance that the provision is not a blanket approach but is fairly specific to avoidance within the arbitrage regime.

I accept what the Minister says. It may not have been my thought when I originally tabled the amendment, but I hoped that the amendment would give her the opportunity to say something about traded instruments in general. She has done that, which I am grateful for, so I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That this schedule be the Third schedule to the Bill.

I have a question to put to the Minister on paragraph 3. For clause 24 to bite, four conditions have to be met, including condition A, which is that the scheme is a qualifying scheme as defined in schedule 3. The schedule is then broken down into different parts dealing with hybrid entities, schemes involving hybrid effect and schemes involving hybrid effect through connected persons.

''under the tax law of any territory, the entity is regarded as being a person''.

It has been suggested to me that that is clearly intended to mean ''under the tax law of any relevant or pertinent territory''—that is, a territory in which the entity is taxed because it is resident there or a territory that taxes the members of the entity because they reside there.

Given how the paragraph is drafted, it is arguable that regard should be had to the tax law of every territory in the world to ascertain whether an entity is regarded as a person. Clearly, that would be an almost impossible test to fulfil and would introduce huge uncertainty. Taxpayers would have to keep an eye on the changing tax laws of remote territories and emerging countries that have legislation that is not widely scrutinised in this country. It has been suggested to me that if that were the correct interpretation, every entity would be a hybrid entity, including all UK companies, as it would not be possible to conclude confidently that either A or B were not satisfied where it is known that B or A is satisfied.

I hope that the Minister can confirm—I am sure that she can—that the paragraph is intended to mean ''under the tax law of any pertinent or relevant territory'', which in this case would mean territory in which the entity is resident or in which any of the partners in the entity are resident and are taxed. We have not tabled any amendments to this effect, but will she consider whether clarification is needed to make it clear that the paragraph does not mean any territory whatever, anywhere in the world?

My answer to the hon. Gentleman's first concern is yes, it means any relevant territory. On his second point—that I should reflect on whether that needs to be spelt out in greater detail—I should say that it has not been raised with us as a problem of interpretation. It seems clear from the presentations, the open day and the submissions received by the Department, that the paragraph is understood to mean ''relevant'' territory.

If for any reason there is confusion outside the House or clarification is sought as a result of scrutiny of today's Hansard, I will be happy to consider the hon. Gentleman's suggestion. However, I am not minded to commit myself to doing something when there does not appear to be a problem. However, I shall reflect on his point in case the issue is raised.

Question put and agreed to.

Schedule 3 agreed to.