Clause 25 - Rules relating to deductions

Finance Bill – in a Public Bill Committee am 4:00 pm ar 23 Mehefin 2005.

Danfonwch hysbysiad imi am ddadleuon fel hyn

Photo of Philip Hammond Philip Hammond Shadow Chief Secretary to the Treasury 4:00, 23 Mehefin 2005

I beg to move amendment No. 32, in clause 25, page 22, line 3, leave out 'no amount is' and insert 'an amount'.  

Photo of Frank Cook Frank Cook Llafur, Stockton North

With this we may discuss the following: Amendment No. 33, in clause 25, page 22, line 4, after 'Acts', insert 'is reduced'.

Government amendments Nos. 70 and 71.

Amendment No. 34, in clause 25, page 22, line 10, at end insert—

'and to the extent that the entitlement to such deduction or allowance had arisen as a result of a scheme the main purpose of which is to achieve a UK tax advantage.'.

Amendment No. 35, in clause 25, page 22, line 11, leave out subsections (4) and (5).

Government amendments Nos. 72 to 74.

Photo of Philip Hammond Philip Hammond Shadow Chief Secretary to the Treasury

I shall address the amendments in two sub-groups and then make passing comments on the Government's amendments, which the Minister will no doubt explain in greater detail.

On amendments Nos. 32, 33, 34 and 35, as the Bill is drafted, the taxpayer has two options on receipt of a notice. Either he can disclaim part or all of the deduction that he is claiming, or he can apply the rules in clause 25 to his self-assessment, which would mean the disallowance of the whole of the interest deduction to the extent that a deduction had been made. We are arguing that the taxpayer who chooses not to disclaim should not be penalised, but should be required to make a proportionate reduction of the claimed allowance or deduction as he would if he disclaimed, so that he is placed in the same position as he would have been had he disclaimed part or all of the allowance.

We suggest that equity requires that the amount disallowed under subsection (3) should be the amount attributable purely to the UK tax advantage delivered as a result of the qualifying scheme and nothing more. I hope that the Minister accepts that principle. No doubt she will have something to say about the amendment itself, but if she can accept the principle, and explain, if she does not think that the amendment is necessary, why not, that would be helpful.

Amendment No. 35 seeks to omit subsections (4) and (5), because they raise the possibility of an amount being treated as deducted or otherwise allowed, where it is not actually so allowed, as a result of the operation of a rule similar to that used in an overseas jurisdiction. That could give rise to a double hit on the taxpayer if he is deemed to be operating a double deduction and the amount in question in the overseas jurisdiction is not allowed to be deducted. I can see no reason why, if the deduction in an overseas jurisdiction is not allowed, the requirements for falling within the scope of this legislation should not be deemed to have failed. Again, an equitable interpretation would be that if the taxpayer, for any reason, does not get the double deduction, he should not be penalised. If I have missed something here, no doubt the Minister will tell me in due course.

Government amendments Nos. 70 to 72 look, on the face of it, to be harmless tidying-up exercises. We are slightly more interested in Government amendment No. 73, which seems to make a substantive change. It turns the subsection in question from providing a limiting definition of   reduction of liability to adding circumstances of liability. That is a rather big turnaround in what it is intended to do. I shall wait to hear what the Minister says about the Government amendments and then question her further on them.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

Clause 25 sets out how the legislation restricts the amount of deductions allowable for corporation tax purposes with deduction rules, where all the conditions in clause 24 are met. The clause contains two rules that can reduce or deny deductions. The first of those—rule A—applies if two deductions are available for the same expense, and limits the amount of the deduction for corporation tax to an amount that is not allowed or deducted elsewhere. Rule A also applies where there would be double deduction but for the fact that another country has similar legislation. As drafted, the rule makes no identification as to the person to whom the deduction rules arise. However, the context of rule A could be construed as requiring that both the deductions must arise in the same country. That is clearly not how rule A should operate and it is not in keeping with the published guidance.

Government amendments Nos. 71 and 72 put the matter beyond doubt by making it clear that the additional deductions can arise for another person. Rule A also refers to the same expense, although it does not directly link that reference to the deduction that is the subject of the rule.

Parliamentary counsel advised on the tabling of amendment No. 70. The advice was provided to the Government on the basis that there was an ambiguity which needed to be removed. As drafted, amendment No. 70 does that.

The second rule—rule B—applies when a payment gives rise to a tax deduction but the matching receipt is not taxable and the receipt is normally taxable on its income or gains. However, where rule B applies, it will reduce the amount of the UK tax deduction to the extent that the recipient is not taxable. Rule B will not apply, however, where the recipient is exempt from tax due to a statutory exemption—for example, charities and pension funds.

The draft guidance issued by HMRC on 16 March 2005 made it clear that rule B also applies where the recipient has reduced their liability by using tax credits or other deductions that may arise under the scheme. The clause as drafted covers that, but it also includes a paragraph that clarifies how the clause will operate in the case of deductions. I give credit to the Law Society, which was very helpful in pointing out to the Government that the explanatory paragraph could be read as restricting the intended operation of the clause. Amendments Nos. 73 and 74 therefore ensure that the clause continues to operate as intended and in accordance with the guidance already issued. I hope the Committee accepts that the Bill has benefited from our discussions and that the Government amendments improve it. I commend them to the Committee.

The Opposition amendments would alter rule A, which, as I explained, denies the deduction to the extent that it is available under another tax code, often referred to as double dips because two deductions are   obtained for just one expense. It appears that amendments Nos. 32 to 34 are intended to limit the effect of rule A in two ways. First, to restrict the extent to which the rule cancels deductions to no more than is necessary to cancel the tax avoidance and, secondly, to restrict the application of the rule to cases in which the UK tax advantage represents the main purpose, excluding cases where that is one of the main purposes.

The first of those two changes is not necessary because subsections (14) to (16) allow a company to make an adjustment to its self-assessment in order to cancel out that part of the deduction that relates to tax avoidance purposes. That prevents the clause from having any further effect while ensuring that the UK tax avoidance has been effectively cancelled out. That approach ensures that the legislation is properly targeted on avoidance of UK tax.

The second change would limit rule A to cases where UK tax avoidance is the main purpose of a scheme, excluding cases where it is one of the main purposes. I have explained why such an amendment is inappropriate in the context of clause 24; we had a long debate about it. The same reasons for rejecting such an amendment apply in this case and I will not repeat them.

Putting that aside, the amendments would not be effective in limiting the scope of rule A, because amendment No. 34 refers to all the deductions arising from the scheme. By contrast, as I mentioned, the clause already goes further than that by limiting the scope of the rule so that it only goes as far as is necessary to counteract tax avoidance.

Amendment No. 35 would remove the subsection relating to the interaction of the arbitrage rule with any equivalent provision enacted elsewhere. It is rather strange for the Opposition to try to link our tax system and make it consequential on tax systems outside the UK. As it stands, the clause ensures that the legislation applies where there is UK tax avoidance. The amendment would mean that the deduction provisions would become dependent on laws passed in other countries, and so UK deductions intended to gain a UK tax advantage would not be restricted if another country passed legislation similar to that introduced in the UK. That is clearly not acceptable—not even, I would have thought, to the Opposition. The counteraction of UK tax avoidance is a matter for our own law, not that of other countries. It is a matter for us to decide, and that is provided for in the rules.

In summary, amendments Nos. 32 to 34 are unacceptable as they would weaken the clause, and amendment No. 35 is not acceptable because it would make the counteraction of UK tax avoidance dependent on other countries' laws. I commend the Government amendments to the Committee, and if the hon. Gentleman seeks to press his amendment to a Division, I shall ask my hon. Friends to oppose it.

Photo of Philip Hammond Philip Hammond Shadow Chief Secretary to the Treasury 4:15, 23 Mehefin 2005

I am a little surprised by what the Paymaster General said about amendment No. 35. She said that it was unacceptable and outrageous to suggest that the operation of our legislation should be made dependent on legislation   in other jurisdictions, but surely the clause is necessarily dependent on the regime operating in other jurisdictions. What if a double deduction is occurring, and thus a disallowance of deduction occurs under the Bill, but the other jurisdiction—that in which the other half of the double dip occurs—changes its law, so that no deduction is allowed in the other jurisdiction? Surely, logically, the Bill will cease to apply to that transaction, because there has to be a double dip before there is a tax advantage.

The Government are clearly happy to contemplate making law that applies only as a consequence of a regime that exists elsewhere. The specific question in relation to amendment No. 35 is whether it is equitable that the taxpayer is penalised in the UK because he is deemed to have enjoyed a deduction elsewhere when in fact he has not done so because a law—not some terrible tin-pot country's law, but one broadly similar to the Bill, the merits of which the Minister is trying to persuade us—is in force in that other jurisdiction. That seems a little odd. Unless I have misunderstood, it would result in the taxpayer's effectively being double taxed. Instead of having a double deduction, he would have no deduction in either jurisdiction. I am a little surprised that the Paymaster General considers that acceptable. As she intends to return to such matters, I shall carefully read what she said in the record. I am grateful for her explanation of the Government's amendments.

Government amendment No. 73 represents a substantive change. It would expand the scope of the subsection. It does not seem to me to cause a problem, but one thing that I have learned about the Bill is that the most minute change can apparently have enormous consequences. It will therefore be important to see whether people outside the House have anything further to say about the matter in response to the right hon. Lady's explanation. For the moment, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendments made: No. 70, in clause 25, page 22, line 5, leave out 'same expense' and insert 'expense in question'.

No. 71, in clause 25, page 22, line 5, leave out from 'be' to 'for' in line 6 and insert

'otherwise deducted or allowed in computing the income, profits or losses of any person'.

No. 72, in clause 25, page 22, line 11, leave out from 'amount' to 'for' in line 12 and insert

'otherwise deducted or allowed in computing the income, profits or losses of any person'.

No. 73, in clause 25, page 22, line 34, leave out 'For the purposes' and insert

'Without prejudice to the generality'.

No. 74, in clause 25, page 22, line 36, leave out 'is' and insert

'shall be treated for the purposes of subsection (6)(c) as'.—[Dawn Primarolo.]  

Question proposed, That the clause, as amended, stand part of the Bill.

Photo of Philip Hammond Philip Hammond Shadow Chief Secretary to the Treasury

The clause deals with the rules to be applied when a notice is issued. I draw attention again to the different requirements for a notice to be issued and for a taxpayer to have to comply with it or do anything under it. A notice can be issued if the Revenue considers that conditions A to D may be satisfied. The Government are placing the onus on the taxpayer to determine whether the conditions apply under subsection (1)(b). The Paymaster General has not yet reassured us that there is not scope for the provision to become the basis for fishing expeditions by the Revenue.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

That matter has come up a couple of times. I have explained the position, but I shall try once more. There is no provision in the clause that will allow, encourage or lead to Her Majesty's Revenue and Customs going on what the hon. Gentleman described as a fishing expedition.

Photo of Philip Hammond Philip Hammond Shadow Chief Secretary to the Treasury

I am grateful to the Paymaster General for placing such matters on the record. I must confess that I cannot see anything in the Bill that prevents such action from happening, although I am willing to accept her assurance that that is not her intention. No doubt her words will be scrutinised carefully.

Subsection (2) requires that any amount that is deducted outside the United Kingdom or that would have been deducted were it not for the operation of a similar set of rules is disallowed in the company's tax computation. Notwithstanding the Minister's protestations to the contrary, it looks to us as if the UK is setting itself up as the world's arbitrage policeman. I will not go through the arguments again, but I am still concerned to get a clear answer to this question.

Would the provision apply even in a straightforward structure, in which the US parent company received a deduction for the interest cost incurred by its UK subsidiary, but also consolidated into its US income the income received by that UK subsidiary? I have still not received a clear answer. It seems to me that a circumstance like that—a straightforward deduction of the interest cost in the UK and then a consolidation in the US that involves a deduction of the interest cost against the consolidation of the UK income in the US—is a perfectly acceptable transaction, and that it should not be considered to have given rise to a tax advantage and therefore should not provoke any action under the Bill. I shall be grateful if the Paymaster General will confirm that.

I have another question for the Paymaster General. Given that she said a few minutes ago that it was wholly unacceptable for UK legislation to depend for its effect on what is done in another jurisdiction, why is an exemption given under subsection (10)(2), under which an exemption qualifies

''if it is conferred by a provision contained in or having the force of an Act or by a provision of the tax law of any territory outside the United Kingdom.''?

That seems to be the very thing that the right hon. Lady said was not acceptable.  

A change in the tax law of another jurisdiction could determine the way the UK tax law was applied. As I read it, an entity could become exempt by virtue of being made exempt in another jurisdiction. Is that not a potential loophole that tax planners would seek to exploit if another jurisdiction, perhaps less prudent than the UK, were to facilitate tax planning arrangements by granting appropriate exemptions? The Paymaster General may say that other anti-avoidance legislation would deal with that situation, but it seems a rather obvious gap in our armoury.

The basis on which a company must assess its tax advantage is dependent on an assessment of what it would have done had the hybrid structure or instrument not been used. We have touched on that essential question before, but we still have not established how in practice that calculation will be done. Where are the comparables to come from? They have to be outside the arbitrage rules; those inside explicitly cannot be used. How can companies document their procedures so that if challenged later to make that computation—that calculation of tax advantage—they can do so properly? Is it not an open invitation to contrived decision-making processes, with people holding meetings about things that they want to be on the record, while the things that it is inconvenient to have on the record are discussed off the record?

Such things happen in other areas. I am sure that in today's freedom of information environment, they probably happen in Government Departments; certain things are not discussed in case they fall foul of disclosure rules under freedom of information legislation. It seems quite a burden to impose on businesses. Even in the early stages of evaluating an investment project, they will have to be very careful about how to phrase reports of discussions. At worst, it will invite contrived and cumbersome recording of the decision-making process. At best, it will impose an additional burden on companies by not allowing them to discuss openly the issues that a well-advised board needs to discuss to make proper investment decisions. The danger is that the board will discuss the things that will look good on a piece of paper in the future, rather than the things that need to be discussed to make a proper and well-informed business decision.

I say to the Minister again that our fear is that that danger of dealing in the United Kingdom jurisdiction might, at the margin, persuade some investors to seek an alternative location for their investment. That is the unintended damage that we are trying to avoid.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury) 4:30, 23 Mehefin 2005

The hon. Gentleman has a dim and gloomy view about the practices of companies operating in the UK. He suggested that they might manipulate their records to conceal the true design of their decisions. If a company is not using its structures, for the main purpose, for UK tax avoidance, it need worry about nothing.

I am sure—because he said so—that the hon. Gentleman does not mean to imply that companies will doctor their minutes to make it appear that they have done one thing when they have actually done   something else. The points that he is making are not being made to HMRC. It could be argued that companies would not come forward and that we were driving them to falsify the record of their decision-making process. This is reaching the point of being ridiculous, if the hon. Gentleman will excuse me for saying so.

The rules require that when a notice is issued for the purposes of arbitrage legislation—as we debated under clause 24—and a company is told that it must take account of the arbitrage rules when conducting its self-assessment, the decisions are made when the return comes in. It is clear from all the discussions that we have had that consequences would follow, and we are trying to indicate how that would happen in subsequent clauses. That is perfectly straightforward.

It is difficult to carry on answering hypothetical examples that outside bodies are not telling the Government are occurring, as the hon. Gentleman said they were, in the real world. He is raising highly complex propositions in Committee without our knowing what all the connected relationships are and expecting the Minister in 30 seconds to give the tax advice on what the multinational could do. He has done that again with his example of the US parent and its deduction.

I am going to spare the hon. Gentleman's blushes by not pointing out that a lot of other tax considerations would also impinge on any decision that such a company might make—I shall take the example at face value. If the same income and deductions are double counted, it is difficult to see what the UK tax avoidance is. Depending on the exact circumstances of the case, if no UK tax advantage were being obtained, the legislation would not apply. That is precisely how all these clauses link together. However, the hon. Gentleman should not leave the Room thinking that that is the answer to the case, because it would have to be caveated, as I am sure the hon. Member for Braintree knows, by what else the parent was doing and how it was structured and how it interacted with the tax system.

In relation to arbitrage and the rules, a notice is issued and a company is basically told, ''This is an extra prompt to you. Take note of this legislation. These are the contrived schemes we know about. Do not fall foul of them. Make sure that the company does not use those contrived mechanisms when it conducts its self-assessment.''

Photo of Philip Hammond Philip Hammond Shadow Chief Secretary to the Treasury

I have to set the record straight. Of course I was not suggesting that companies would falsify their records. Actually, the situation is much worse than that. I take it that the companies probably would not be companies in the UK; they would be companies outside the UK considering making investments in the UK. Proper debate and appraisal might become difficult or impossible, with the consequence that it was decided that it was better to appraise an investment opportunity in another jurisdiction.

I cannot remember whether the right hon. Lady used the term ''ridiculous'' or ''absurd'', but if she thinks that it is a ridiculous proposition that the   passing of legislation that gives specific relevance to an historical discussion of alternatives will colour the nature of those discussions, she is not living in the real world. If I told her tomorrow that her discussions with officials about the response that she intended to make to our amendments next Tuesday would be published on her departmental website, they would be different discussions from the frank and open discussions that she usually has, and quite rightly. I do not blame her for that.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

I will not rise to the point about the Government, but the fundamental difference with the tax system is that it is predicated on confidentiality. Anything that transpires between the tax authorities and the company is a matter for them only. Ministers and the public do not have access to the information; it is protected. Any information that is confidential and not relevant to the tax authorities is also protected by statute, so there is no way a company would have anything to fear from disclosing the correct information to the Revenue. It cannot be used in any other way. That is clear and is how the department has operated over generations.

Photo of Philip Hammond Philip Hammond Shadow Chief Secretary to the Treasury

My understanding is that, in computing the correct amount to show on its self-assessment, having received a notice, the company will properly look at the UK tax advantage that it has gained. To compute the UK tax advantage—the Paymaster General will correct me if I am wrong—the company will be required to consider what it would have done had it not used the hybrid qualifying structure. That will require it to consider how it made its investment decision in the first place, whether alternative structures were considered and what the tax consequences of those structures would have been. I do not think that that is particularly controversial. Our concern is that, if there is a requirement to compare what has been done or is being done with what might have been done, it will inevitably be necessary to look at the historical records relating to the original decisions.

If the Paymaster General is telling me that the Revenue would not seek to see those records, or would not expect a company to produce them in order to substantiate the approach that it took in reaching what it considered to be correct self-assessment of its liability after having the deduction partially disallowed, that is another matter, but I do not think that she is saying that.

This is an important issue. I cannot say why other people have not raised it with the Paymaster General before, but this is a Standing Committee, and we must consider these matters. Of course we take advice from outside. The Paymaster General will have many other sources of information and comment on the Bill, but it would not be good if we could not raise issues in Committee, or if we were browbeaten into not raising them in Committee, simply because people outside the Committee have not raised them with Ministers before.

I conclude my remarks, but I still do not believe that the issue has been fully addressed.  

Photo of Frank Cook Frank Cook Llafur, Stockton North

I am afraid that I am forced to comment. The questions that it has been felt necessary to raise are on record, and I have allowed them. The Minister's responses have been heard and are recorded, too. That is all that the Chairman must do in this regard, and there should be no question about that.

Question put and agreed to.

Clause 25, as amended, ordered to stand part of the Bill.