Clause 76 - Close companies

Finance Bill – in a Public Bill Committee am 3:30 pm ar 11 Mehefin 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 the following: Government amendments 65 to 69.

That schedule 28 be the Twenty-eighth schedule to the Bill.

Photo of David Gauke David Gauke The Exchequer Secretary

Clause 76 introduces schedule 28, which closes three loopholes exploiting perceived weaknesses in the legislation taxing loans made by close companies to individuals, known as participators, who have an interest or shares in the company. Tax avoidance is both unfair and unacceptable to the vast majority of taxpayers, who pay the right amount of tax. The schedule amends part 10 of the Corporation Tax Act 2010, to close down that avoidance with immediate effect from the Budget announcement on 20 March.

A close company is one owned and run by only a small number of participators, who have an interest or shares in the company. In certain circumstances, close companies are subject to a tax charge on loans they make to their participators. That charge is appropriate because a loan is a way to extract value from a company, albeit under the terms of a loan. Some people have attempted to circumvent legislation to deliberately avoid the tax charge. In many cases, the same people also seek to use the arrangements to avoid or minimise income tax and national insurance contributions. The vast majority of close companies and their participators are compliant and pay any tax due on value extracted from companies by the participators. Those who seek to exploit the rules gain an advantage, and that position is simply unfair.

The clause amends the legislation in three ways: first, the tax charge will apply to all loans made to a partnership or trust in which at least one partner, trustee or beneficiary is a participator in the close company making the loan. Unlike before, that is regardless of whether there is a corporate partner or trustee in the structure. Secondly, the clause introduces a targeted, purposive anti-avoidance rule to catch payments that are not strictly loans, which currently fall outside the rules for loans. The final change requires repayments of loans to remain with the company for at least 30 days, which will reduce scope for manipulation. Further, if there are arrangements in place to withdraw funds at the time the repayment is made, relief from the tax will be denied even if the new payment is outside the 30-day period.

The Government propose amendments 65 to 69 and schedule 28 to make final changes to the rule. Concerns were raised that the Bill did not focus closely enough on the policy objective, and that the new rules may unintentionally catch genuine commercial practice, rather than solely avoidance behaviour. The amendments will target the Bill more narrowly, and remove ambiguity by more clearly defining which loans and repayments should be taken into account in applying the first test on how such repayments should be treated. The second test will focus on arrangements that have been made to replace the original loan with a new loan when the repayment was made.

Amending the rules in such a way will aid both business and HMRC with their application. It will relieve small businesses, more closely focusing the new rules on the anti-avoidance function, and reduce any uncertainty and operational difficulties for both businesses and HMRC. We introduced the legislation in March immediately to counter avoidance of the tax charge. The changes will ensure that it works effectively in practice.

Most small businesses that incorporate are close companies. Although the tax charge on loans applies to them, if relevant, the vast majority will be completely unaffected by the closure of the loopholes. In many cases, the rules are being exploited by affluent individuals using avoidance arrangements to reduce their tax bills. The loophole closures are designed to minimise any undue burden on compliant businesses.

HMRC is pursuing an increasing number of those avoidance cases; some avoiders are seeking alternative ways of reducing their tax bills as loopholes are closed down elsewhere. The changes are just one element of the significant crackdown on avoidance by the Government to ensure that companies and individuals pay their fair share of tax. They complement what we are doing around avoidance using partnerships and intermediaries, will yield £270 million over the scorecard period, and further protect revenue; that is important protection for the Exchequer.

Although the rule changes go a long way towards countering avoidance of the tax charge on loans to participators, there is scope to strengthen the regime. Therefore, alongside the announcement, the Government have said that they will consult on options for broader reform of the regime with the aim of creating a fairer  and simpler system that will provide the opportunity for businesses, representative bodies and other stakeholders to present their views.

Attempts to exploit perceived weaknesses in the legislation relating to the taxation of loans made by close companies to their participators can give rise to an unlevel playing field between compliant and non-compliant taxpayers. Schedule 28 counters such avoidance, and results in companies and individuals paying the right amount of tax. I commend the clause to the Committee.

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury)

I thank the Minister for outlining the purpose of the clause and the Government’s amendments.

The tax information impact note suggests that the changes will result in additional receipts for the Exchequer of £65 million in 2014-15, £75 million in 2015-16, £70 million in 2016-17 and £60 million in 2017-18. Such additional receipts are of course absolutely welcome. However, I would like the Minister to clarify some of the key facts behind the schemes established to avoid the tax charge under section 455 of the Corporation Tax Act 2010. At what point did the Government become aware of the existence of such schemes, and how did they become aware of them? Were the schemes being marketed? To date, how many close companies have sought to use the loopholes? Over what time period, and at what cost to the Exchequer—if that can be assessed—has the avoidance occurred? What attempts has HMRC made to challenge the use of such schemes before the changes took effect on 20 March 2013?

I would also be grateful if the Minister addressed several technical concerns about the Government’s proposed changes. While welcoming attempts to counter avoidance of tax under section 455, the Chartered Institute of Taxation states that there are some situations where it considers that

“the changes will operate unfairly and have unintended consequences”.

In the CIOT’s words, those unintended consequences include

“the fact that the revised section 455(1)(c) CTA 2010 will mean that any loan from a close company to a partnership where there is a participator in the company who is also a partner in the partnership will result in section 455 tax. This seems to be regardless of whether the money lent is then taken for personal use of the partner/participator (which is the sort of abuse that needs to be tackled) or used for the business purpose of the partnership (which may be for valid commercial purposes). In particular loans to limited liability partnerships (LLP) are specifically brought within the scope of the charge.

There are circumstances where a close company sets up an LLP for sound commercial reasons, perhaps as an alternative to a subsidiary company. The LLP may need funds to start trading. If the close company lends the LLP funds for commercial reasons, it does not seem right to us that there will be a section 455 charge if the individual, who is a participator of the company and also a member of the LLP, is receiving no benefit.”

The Chartered Institute of Taxation is also concerned that the provisions introducing the new charge to counter other arrangements are widely drafted. We should therefore welcome clarification of the scope of the charge. The institute stated:

“Firstly, we would like the Government to confirm that the new charge, being introduced at Chapter 3A Corporation Tax 2010, will not apply to capital transactions (including circumstances  where a close company reduces its capital under section 641 CA 2006). Capital transactions have their own rules and anti-avoidance provisions, which are generally well understood, and they are not part of the mischief that Chapter 3A is targeting.

Secondly, both examples provided in the Finance Bill explanatory notes use hybrid structures, which seem to be the main aim of this provision. However, there appears to be nothing to prevent the rule virtually applying as a general anti avoidance rule to catch almost any instance where a company is party to a transaction with some tax planning, however benign, that has some indirect effect on a participator or his associate.

This is in effect a general anti avoidance rule for smaller companies and yet has none of the safeguards that surround the new General Anti Abuse Rule. In addition, the rule is already in effect—it took effect from Budget Day.

Unless the Minister is able to give categoric assurances about the scope of these new provisions, we think some amendments are required to the provision to set clear boundaries, e.g. to exclude transactions with a commercial motive as one of the motives. Otherwise it could catch many commercial transactions. Clear guidance will be required to demonstrate the areas that it may cover.”

As for new chapter 3B, which is intended to strengthen the rules that deal with repayment of loans, the institute stated:

“We support the objectives of the provisions in new section 464C(1), which apply where loans are repaid and new loans made within a period of 30 days. However, we have concerns about the drafting, which in some cases appear to lead to some unfortunate unintended results…The purpose of the new rule seems to be to deny relief for a repayment of the loan just before a cut-off date, such as the year-end or nine months after the year-end, where within 30 days that loan is taken out again. We agree with that purpose, but as drafted it also seems to deny relief for repayments of loans during the year if there is a further loan within the year, yet the tax is still payable on the further loan. This seems inequitable as in such cases even if a loan is fully repaid the tax could be payable…We think the reason that the legislation can produce an unintended result is that the drafting seems to be based upon an incorrect assumption of how the existing legislation works. It seems to assume that it was written using the ‘year-end approach’ rather than the ‘separate transaction approach’...Under the pre-Schedule 28 legislation the ‘year-end approach’ and ‘separate transaction approach’ lead to exactly the same amount of s455 tax and s458 repayments…The intention of the clause seems to be to match repayments and loans around the cut-off dates of the period end or the normal due date, so as to prevent any anti-avoidance through repaying a loan just before e.g. the due date, and re-borrowing it just after, but it seems that the clause goes much further than this.”

The institute goes on:

“Under new s464C the two approaches lead to different results, and in the case of the statutory ‘separate transaction’ approach it seems that the answer is often undesirable and unintended. It appears that the effect of the new legislation is that a s455 charge can arise on more than has been lent by the company”.

I accept that resolving those specific worries is the intention of amendments 65 to 69, but I shall be grateful if the Minister can also deal with the other concerns raised by the Chartered Institute of Taxation about the clause to ensure that all such matters are considered, and that we shall not return to Committee to deal with the unintended, unfortunate consequences of the anti-avoidance measure that have been described.

Photo of David Gauke David Gauke The Exchequer Secretary 3:45, 11 Mehefin 2013

I thank the hon. Lady for her questions. I will start with when the loopholes were identified. HMRC had been aware of the first two loopholes for some time. It has seen increasing numbers of cases and larger amounts of tax avoided using these structures. In the past three years, just 15 cases involving intermediaries accounted for nearly £7 million tax at stake.

Closing the loopholes is partly protective; clamping down on this avoidance immediately stems further loss of revenue. Some, but not all, of this avoidance is disclosable under the disclosure of tax-avoidance schemes regime, so a full scope of the evidence is difficult. However, closures of loopholes elsewhere and toughening economic conditions have meant that HMRC is seeing persistent avoiders looking for alternative ways to get round other loophole closures, and to save money by avoiding tax.

Exploitation of the repayment rules has been around for many years and become common practice. Leakage of tax through that route also needed plugging for the closure of the other loopholes to be effective. Further, just 15 cases over the past three years have accounted for tax at stake of more than £8 million.

As for how many incidences of avoidance these loophole-closing measures are addressing, for the first two loopholes, HMRC estimates that more than 5,000 companies have a relevant structure in place and loans from those companies to relevant partnerships are, on a central estimate, in the low hundreds of millions. On the third loophole, a recent article in Taxation magazine described the practice of repaying loans to prevent the tax from becoming payable followed shortly by a new loan as

“reasonably common practice among smaller private companies”.

Complete figures are not available because the avoidance can be difficult to detect. The nature of the structures means that only some instances were disclosable under DOTAS, as I mentioned earlier. With regard to whether the schemes are marketed, some are, but most are not.

The hon. Lady asked what attempts HMRC had made to challenge the schemes before the measures were introduced. HMRC has applied the statute as far as it can. Some arrangements have fallen outside the specific wording of the legislation and that is partly why there is a need to take further action.

The hon. Lady also referred to the concern raised by the Chartered Institute of Taxation that there is a targeting of LLPs and all partnerships with company partners. The rules regarding loans to partnerships are simply being aligned, so that a loan to any partnership that has a partner who is also a shareholder of the company making the loan will be caught. HMRC has become aware that increasingly structures were being put in place to minimise income tax, but the specific structure chosen was meant to ensure that the tax charge on loans to participators did not arise either.

Regarding the repayment rules in chapter 3B, the amendments that we have included address the queries relating to year-end. That is part of their purpose.

As for whether “benefit conferred” is rather wide in meaning, and the concern that innocent transactions might be caught and the safeguards that exist within the general anti-abuse rule do not apply in those circumstances, the meaning is necessarily wide as this is an anti-avoidance measure. It is aimed at any payment by a close company that ends up in the hands of an individual participator without an appropriate tax charge. Specifically it should catch capital contributions to partnerships and the company’s share of a partnership profit which are left undrawn by the company where participators then draw those funds out of the partnership. It will not catch innocent transactions as it requires there to be an  avoidance purpose. “Benefit conferred” does not have the same meaning as for the income tax legislation; it is aimed at any extraction of value from a company by a participator in a form which avoids the tax charge on loans made by close companies to their participators or creates a tax advantage to the participator. I hope that reassures the hon. Lady and the Committee as a whole.

Question put and agreed to.

Clause 76 accordingly ordered to stand part of the Bill.