Clause 40 - Derivative contracts: property total return swaps etc

Finance Bill – in a Public Bill Committee am 3:15 pm ar 4 Mehefin 2013.

Danfonwch hysbysiad imi am ddadleuon fel hyn

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

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

The clause—again, a very exciting one for hon. Members, I know—relates to derivative contracts and property total return swaps, which come up frequently in Chelsea and Fulham but no doubt more frequently in Gateshead and other parts of the country. I am sure my hon. Friend the Member for Gateshead is constantly dealing with such matters in his caseload.

Photo of Ian Mearns Ian Mearns Llafur, Gateshead

I have had to employ extra staff.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

As my hon. Friend says, he needs extra staff for that work load: I am sure the Independent Parliamentary Standards Authority will be supportive.

In a total return swap, the party receiving the total return will receive an income generated by the asset, as well as the benefit if the price of the asset appreciates over the life of the swap; in return, the total return receiver must pay the owner of the asset the set rate over the life of the swap. The clause, I am told, responds to tax avoidance schemes involving property return swaps and is designed to stop firms exploiting the property total return swaps legislation to convert capital losses into trading losses.

Companies are apparently abusing the current law by entering into swaps between different members of a group of companies in order to convert capital losses into income losses, even though the swap does not result in the group obtaining any net exposure to property. Clearly, therefore, the clause is important as it is needed to deal with that loophole. The clause rules out any capital return where the swaps are intra-group and limits any capital return to the actual return in the contract.

Tackling such opportunistic tax avoidance schemes is clearly an important goal and one which the Opposition support, especially given the context of the wider size of the derivatives market. When trying to keep track of financial innovation, as it is sometimes known, legislators and policy makers have often struggled to keep pace. Given that the derivatives market is now something of the order of $1.2 trillion, we have to get these matters right.

I have some questions for the Minister on the clause. First, there must surely be some enforcement complexities involved in watching and overseeing some of the derivative tax arrangements. How will HMRC—particularly given the pressures that it is under, with 10,000 staff lost and resources depleted across the organisation—police the arrangements in the clause? Who will be carrying out that enforcement activity—does responsibility for it fall to a particular unit in HMRC?

Will the Minister set out the extent of the current abuse of the loophole—did a particular case prompt the clause? How much do the Government anticipate gaining by closing the door on the practice? Finally, given that the United Kingdom is host to around 75% of the EU’s derivatives market, how will the clause apply to foreign companies with subsidiary operations in the UK? We are talking about intra-group arrangements, and so some cross-border issues crop up with regard to corporate form and corporate governance: have the Minister and his officials addressed the international dimension to the clause?

Photo of Steven Baker Steven Baker Ceidwadwyr, Wycombe

Notwithstanding the hon. Gentleman’s opening remarks, one of the things that has excited me over the course of my short parliamentary career has been the international financial reporting standard and its effect on derivatives: the mark-to-market accounting rules within it incentivised banks to transact in derivatives, in particular because they can up-front unrealised cash flows to manufacture profit and capital. Without going too deeply into that, I would refer the Minister to a book called “The Law of Opposites” by my colleague Gordon Kerr, who has created that kind of product. Have the Government assessed whether IFRS accounting is incentivising the creation of these derivative contracts? If so, will they look at amending those rules, not just to address this problem but in the interests of the wider banking system?

Photo of David Gauke David Gauke The Exchequer Secretary 3:30, 4 Mehefin 2013

Clause 40 makes changes to ensure that the legislation that applies to property total return swaps cannot be exploited for tax avoidance and that the tax outcome of the legislation matches genuine exposure to the property market.

I will briefly set out some background to the clause. Property return swaps can be used to give investors exposure to the property market without actually investing in properties, or to allow property investors to hedge their exposure. The tax legislation covering swaps aims to match the treatment of actual investment in property, in particular by providing that returns from swaps may be taxable as capital gains where they are linked to a property index.

Some avoidance schemes exploit this legislation with the use of contracts that do not give genuine exposure to movements in both directions in the property market, and that generate capital returns that exceed those that arise from movements in actual property values.

The aim of these schemes is artificially to convert capital losses into trading losses, which can then be set against other profits in ways not intended by the legislation. We do not accept that these schemes achieve the results claimed, but this legislation will put the tax position beyond doubt.

Changes made by clause 40 will prevent avoidance in three different ways. They will provide that capital gains treatment will not be available when swaps are entered into between companies in the same group. They will provide that any tax charges are linked to genuine movements in the property market, and not limited with the use of any artificial arrangements; and they will provide that capital gains treatment will not be available where tax avoidance is involved.

The hon. Member for Nottingham East asked whether HMRC would be able to cope with dealing with derivatives such as those we are talking about. Schemes would be disclosed under routine enforcement, and the changes are relatively minor in relation to the 2009 legislation. Those matters will be monitored by inspectors looking at company accounts and by specialist teams.

I am tempted to get into a debate with the hon. Gentleman about job reductions in HMRC, for which he quoted a number of 10,000. I do not know why he did not quote a number of 30,000, because that is what occurred under the previous Government. To be fair to the previous Government, there have been opportunities  to reduce the number of people working in HMRC in particular areas, with the use of new technology and improved efficiency. It is not just about numbers. That is the approach that we have certainly taken, and HMRC’s yield is increasing significantly over the course of this Parliament. However, I digress.

The hon. Gentleman also asked how overseas companies will be affected. Where foreign companies fall within the corporation tax regime, because they have a permanent establishment in the UK that is chargeable to corporation tax, normal corporation tax rules will apply. As for how many companies are likely to be involved and how much tax, HMRC is aware of three companies that have used the scheme four times in total. The estimated loss was in the region of £100 million per year.

My hon. Friend the Member for Wycombe asked about the application of the IFRS. I can assure him that HMRC is working actively on its adoption to ensure that legislation keeps up to date. I do not intend to discuss the wider issue to which he referred, but I hope that he is reassured by my remarks.

With those comments and, in summary, I want to make it clear to the Committee that the three changes will ensure that the tax treatment continues to provide a fair outcome for genuine users of swaps linked to the property market, but that the policy cannot be used for tax avoidance. I trust that the clause will stand part of the Bill.

Question put and agreed to.

Clause 40 accordingly ordered to stand part of the Bill.