Clause 28 - Disguised interest

Finance Bill – in a Public Bill Committee am 4:45 pm ar 21 Mai 2013.

Danfonwch hysbysiad imi am ddadleuon fel hyn

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

Photo of David Crausby David Crausby Llafur, Bolton North East

With this it will be convenient to discuss that schedule 12 be the Twelfth schedule to the Bill.

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury)

Finally, in the grouping of clauses headed “Other provisions”, we turn to clause 28, which introduces schedule 12 as an anti-tax avoidance measure. That ensures that a person who receives an amount that is economically equivalent to interest will be charged income tax on that amount, thereby introducing a comprehensive income tax charge on disguised interest. The measure also enables the repeal of anti-avoidance legislation on guaranteed returns from futures and options, which is a form of disguised interest arrangement, and allows for the simplification of income tax rules that treat certain amounts arising on stock lending and repos as payments of interest. Under the measure, a return will be considered economically equivalent to interest if it arises by reference to the time value of money, at a rate comparable to a commercial rate of interest, and is practically certain to be produced.

I shall briefly explain the background to the measure to put my concerns in context. It was first announced at Budget 2012, and was consulted on last year. The tax information and impact note states:

“This measure will support fairness in the tax system by reinforcing the protection already afforded to the Exchequer against potential loss of tax as a result of avoidance arrangements intended to secure that interest-like returns escape income tax.”

The Opposition wholeheartedly back supporting fairness in the tax system and clamping down on avoidance activity, although it is inevitably frustrating that these measures are counterbalanced by the tax cuts being given to those earning the highest incomes. The reason why I raise that is that the concerns raised about this measure have again come from the Low Incomes Tax Reform Group, which has commented:

“We do not think there is a strong case for importing a similar ‘disguised interest’ rule for individuals as has been introduced for Corporate Finance…We note that HMRC current guidance on the legal concept of interest is as follows:

‘In common law the general rule is that interest is not payable on a debt or a loan; except where there is an express agreement to pay interest…an agreement to pay interest can be implied from a course of dealing between the parties, or from the nature of the transaction, or custom or usage of the trade or the profession concerned, or…in certain cases by way of damages for breach of a contract (other than a contract merely to pay money) where the contract, if performed, would to the knowledge of the parties have entitled the parties to receive interest.’

We think that the above, particularly the second bullet, gives HMRC room to contend that individuals have engaged in an arrangement in which interest is effectively changing hands, either in cash or in kind, without adding further anti-avoidance legislation along the lines of that for Corporate Finance…We fear that the above would extend HMRC’s powers too far, if one considers for example loan arrangements between family members which may not pay interest but may not be made on any clear legal footing. The unrepresented could find themselves open to challenge by HMRC officers that interest should be applied on monies lent between family, for example, even if there is no ‘legally enforceable’ arrangement in place or intention that interest should be paid…The idea of introducing such a rule is to counter schemes involving ‘highly structured products involving derivative contacts, warrants and other types of financial arrangement’…We therefore think that a better means of targeting such avoidance could be through the General Anti-Abuse Rule…without the need to add a further layer of specific anti-avoidance legislation here which carries the risk of unintended consequences.”

As ever, I would appreciate hearing the Minister’s comments in response to those concerns, particularly given the decision to legislate for this area separately from the general anti-abuse rule, which the Government seem confident will combat many forms of avoidance—certainly they have given that level of reassurance to members of the public.

Photo of David Gauke David Gauke The Exchequer Secretary

Clause 28 and schedule 12, like clause 27 and schedule 11, arise out of a consultation on aspects of the income tax treatment of interest, which HMRC conducted following last year’s Budget. The consultation brought together in one document a number of features relating to the taxation of interest. The clause follows from one particular strand of the consultation and establishes a general principle that a return that is economically equivalent to interest, regardless of its legal form, will be taxed as income. Income tax rules have, for many years, ensured that that is the case in  certain instances, for example in the case of the return from deeply discounted securities or the amount of accrued interest included in the sale price of securities.

There is also a limited number of now rather dated anti-avoidance rules in the area. They address, for example, schemes under which a number of derivatives are used in a structured and highly artificial way to produce a specific return. The effect is essentially the same as if the investor had put the money on deposit.

In keeping with Government’s overarching approach of simplifying tax rules and adopting a principles-based approach where practicable, the measure introduces for the first time a general rule on disguised interest for income tax purposes. The rule will provide a robust replacement for existing anti-avoidance rules and enable other existing income tax rules on matters such as manufactured interest and price differences on sale and repurchase agreements—known as repos—to be simplified.

The form of the legislation echoes the successful corporation tax legislation on disguised interest introduced in previous Finance Acts. In response to representations made after the publication of the draft legislation last December, the legislation contains an exemption for certain types of share, so that genuine investment returns will be taxed as capital gains.

The introduction of the rule will enable the immediate repeal of 12 pages of statute. Once the new rule has bedded in, HMRC will review other lengthy and complicated tax rules that concern the boundary between interest and capital gains, such as the rules on deeply discounted securities and the accrued income scheme, to determine whether those rules may be simplified.

A move away from prescriptive and mechanistic legislation towards a more principles-based approach necessarily requires more extensive guidance from HMRC, which has recently published draft guidance on the interpretation of the new rules. HMRC will work with interested parties to refine the guidance to ensure that both financial institutions and their customers have as much certainty as possible on how the legislation will apply to the sometimes genuinely difficult distinction between interest-like returns and capital gains in the area of complex financial instruments. At the same time, the legislation will provide robust defences against avoidance that seeks to exploit the boundary, and is a genuine simplification of the statute.

The hon. Member for Newcastle upon Tyne North was concerned that the legislation goes too far in extending what is taxable as interest. I do not accept that. For example, investments that are taxable as capital gains will remain taxed as such. The real issue in disguised interest is, first, the risk of avoidance where arrangements are dressed up to provide an interest-like return in a non-income form and, secondly, normal commercial but complex arrangements such as repair and stock lending arrangements that provide a return that is economically but not legally interest.

The measure provides better safeguards against avoidance and allows for a significant simplification of current legislation. A point was made that that should apply only to avoidance purposes and that the rule is too wide-ranging, but a general avoidance test for all types of disguised interest would limit the application of the legislation only to avoidance cases, so it can never be used to simplify legislation, which currently applies to interest-like returns that are not intrinsically avoidance. That is why we have taken the broader point. I wanted to say that in response to the argument that the issue should be dealt with by the general anti-abuse rule, which will tackle abusive avoidance schemes. Disguised interest arrangements are sometimes, but not necessarily, abusive avoidance. The GAAR will not typically apply to them. The Bill is complementary to the GAAR and the GAAR will ensure that there is no easy way of walking around the disguised interest rule. As the Aaronson report made clear, it will work most effectively where the principle behind the legislation is clearly set out.

Again, there is a similar point in relation to loans between family members. This is not just an anti-avoidance measure, but it will not catch loans between family members unless it is clear from the outset that an interest equivalent return will be paid. With those points, I want to underline the fact that these are sensible changes that will ensure that the income tax rules work more effectively for the majority of taxpayers.

Question put and agreed to.

Clause 28 accordingly ordered to stand part of the Bill.

Schedule 12 agreed to.

Ordered, That further consideration be now adjourned. —(Greg Hands.)

Adjourned till Tuesday 4 June at ten minutes past Nine o’clock.