John Butterfill (Bournemouth West, Conservative)

With this it will be convenient to discuss Government amendments Nos. 67 to 70.

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

I wish to raise some worries that the Chartered Institute of Taxation had about the original paragraph 6 that the amendment would delete and I wish to clarify whether those worries have been addressed by the amendments tabled by the Paymaster General. The institute is worried about the way in which the measures relate to sub-participations in loans and how they are dealt with. For the sake of clarity, I shall set out how matters work. What usually happens in respect of a funded sub-participation is that the originator would derecognise part of its assets for accounting purposes. Let us suppose that a loan of £100 is originated, of which 40 per cent. is sub-participated. The originator only shows a loan of £60 on its balance sheet, the profit and loss account only shows income of £60 and nothing is recorded for the remaining 40 per cent. asset or the 40 per cent. liability under the sub-participation agreement.

The Chartered Institute of Taxation believed that, under the original paragraph 6, the proposed new section 85C of the Finance Act 1996 will now require an originator to recognise income on the full £100 of the loan asset. When the sub-participation agreement is a loan relationship under proposed new section 85C, the originator will, in addition to taxing the debits and credits on the whole £100 of the loan asset, be able to recognise the debits and credits on the loan liability of £40, so the net result is that it still shows an asset of£60 and it shows the income of £60 on its profit and loss account.

The Chartered Institute of Taxation’s worry about the matter and the Government’s original proposals was that, when the sub-participation agreement is not a loan relationship under proposed new section 85C, the originator seems to be taxed on the income of£100 from the loan asset, but there is no mechanism to give relief to the amounts paid away on the sub-participation agreement. Therefore, it would be taxed on £100 in its profit and loss account, but it would have no relief on the interest it pays on the 40 per cent. ithas given away—as it were—to someone involvedin sub-participation, unless of course the “fairly represent” provision in section 84 of the FinanceAct 1996 overrides that position. I should be grateful if the Paymaster General would say whether she believes that the “fairly represent” provision in section 84 does override the treatment of the sub-participation where there is not a loan relationship in accordance with proposed new section 85C.

There are a couple of other issues to do with this relationship that I ought to go through. Under proposed new section 85C, there are potential consequences for originators in relation to what might happen where the underlying asset is impaired. Proposed new section 85C requires the originator to recognise the entire loss. The originator would also be entitled to recognise the gain under the sub-participation agreement. There should be no impact overall in respect of this, unless one of two conditions are met. Either the section 209 “results dependent” provision of the Income and Corporation Taxes Act 1988 applies to deny interest deductions, or the sub-participant is a connected party. Section 209

“could apply wherever the sub-participation counterparty is not within charge to corporation tax (eg neither a UK bank nor a UK branch)”

and that would then deny the interest deductions required to balance out the interest of £100 on this sub-participation.

Rob Marris (Wolverhampton South West, Labour)

I am perhaps becoming forgetful, but could the hon. Gentleman remind me what section 209 of the Income and Corporation Taxes Act 1988 actually says?

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

I am not going to go into that because it distracts from our purpose. A problem I have detected with our adumbrations is that sometimes too much detail gets in the way of the thrust. It is important for those outside this debate to have their minds focused on the essence of the argument, rather than be distracted by the hon. Member for Wolverhampton, South-West (Rob Marris) down the highways and byways of the voluminous legislation that underpins our proceedings today.

That deals with section 209. [Interruption.] Letme come back to the second issue, where the sub-participation is to a connected party. There are some issues around the timing of interest payments and whether that is a timing difference, and there are some issues around transfer payments, but in the view of the Chartered Institute of Taxation that is neither here nor there. However, there is a concern that where a connected party is involved there may be no relief available for impairments due to the denial of connected party impairments. Its belief is that in the original drafting this appears to be unintentional; I would be grateful if the Paymaster General were to confirm that that is indeed the case—or that her Government amendments Nos. 66 to 70 address this concern.

David Gauke (South West Hertfordshire, Conservative)

In a similar spirit, may I just raise a couple of points that the Law Society has highlighted in respect of schedule 6, and ask whether the new wording introduced by the Paymaster General will address those concerns? The first relates to basic principles of loan relationship legislation. I assure the House that the Law Society guidance was not produced by my wife, although it was produced by my former law firm—I stress the “former”, so I have no financial interest to declare. According to the Law Society brief,

“The general rule is that the items that are brought into account and the timing of any tax charge or relief are determined in accordance with the company’s accounting treatment”,

but the view is that the original wording of schedule 6 undermined that principle. The Law Society states:

“The effect is that once a company has determined the relevant profits and losses on its loan relationships that are reflected in its accounts, it will have to consider separately whether those credits and debits ‘fairly represent’ its profits and losses”.

The Law Society’s concern is about the degree of uncertainty, because there does not appear to be any guidance on how a firm should make that assessment.

My second point is similar to one mentioned by my hon. Friend the Member for Fareham (Mr. Hoban). It is about whether the new provision will catch all forms of intra-group lending. The Law Society does not believe that that is the intention, but perhaps clarification would be helpful.

John Butterfill (Bournemouth West, Conservative)

I hope that the Paymaster General will not be tempted to respond to the question asked by the hon. Member for Wolverhampton, South-West, because I have just checked, and the relevant section covers no fewer than five pages.

Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

Thank you, Sir John; I shall be brief, then. First, as the hon. Member for Fareham (Mr. Hoban) identifies, amendment No. 66 relates to a measure dealing with avoidance schemes that rely on accounting rules to cause profits on loan relationships to be de-recognised, and so fall out of tax charges. He is quite right that concern was expressed about the original drafting, which would have meant that the measure applied to certain types of normal, commercial transactions such as hedging arrangements and sub-participations entered into by banks. The Government listened very carefully to representations and accepted that the original drafting may have gone too far. Amendment No. 66 has effectively rewritten the measure so that it is more narrowly focused on the avoidance scheme at which it is aimed, and ensures that it does not catch commercial activities.

As for the hon. Gentleman’s two points on certain banking sub-participations, the measure will not affect the banking sub-participation market. The complaint was in connection with the application of the connected party rules on impairment losses, but the measure will not make banks and their associates any worse off. The hon. Gentleman made a further point about connected party bad debt rules. The anti-avoidance measure in the Bill does not actually deal with that, and if there is a problem, this is not the place in the Bill in which to try to solve it. I say to the hon. Gentleman and those who read our deliberations that if banks consider there to be a serious problem on that issue, I will ensure that my officials discuss those issues with the banking industry very quickly. I do not believe that the matter is specifically connected to the clause, but if that subject is being raised as an issue, the industry needs to come forward formally with it in discussions. We would be happy to hear what it has to say.

Amendments Nos. 67 to 70 make small but important changes that modify the shares as debts rules introduced last year. I think that they are straightforward, and perhaps I do not need to reflect on them. The hon. Member for South-West Hertfordshire (Mr. Gauke) asked about loan relationships, and I touched on that under contracts.

As I said, having listened carefully, the Government are undertaking in the amendments to put beyond doubt what they believe the position always has been in respect of this matter. Most commentators now accept it, but a few have argued that tax computational laws, which rely on accounting recognition of profits, override the basic requirement that amounts brought in to charge for tax are those that fairly represent profits and gains arising to companies.

The measure does not undermine the principles of the two regimes—that is the important message. In fact, it supports them by basing the tax measure of income on normal commercial accounting, which we would expect fairly to represent accruals profits and gains arising to the company, so there is no need for uncertainty. That is the long answer. Basically, we listened to the points that were made and amended the legislation accordingly.

There seems to be one further point in respect of connected party bad debt rules, which was not part of the submissions from others. It would not be dealt with in the schedule anyway, as it is not relevant. However, as I said, if there are particular issues outstanding, I would be more than happy to ensure that they are passed on, and to arrange for officials to meet the industry to discuss them.

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

I wish to raise some issues about schedule 6 that have been brought to my attention, principally by the Law Society. The first is a change introduced in the Budget and proposed in paragraph 4 to the rules concerning mandatory convertible securities and the deemed disposal of those securities on 2 March 2006. There is concern that intra-group reorganisations or transfers might lead to a tax charge being payable, despite the fact that the group had not sold the security.

I shall go into more detail. As the Bill stands, a company that holds the benefit of a mandatory convertible security on 22 March 2006 is treated as making the disposable security at its market value on that date. The  resulting gain or loss is brought into charge to tax when the company ceases to hold the security. The provision would bring the deferred gain or loss into charge to tax on any disposal in paragraph 4(6)—even on an intra-group transfer or reorganisation, when a company, or group of which it is a member, has not realised any economic benefit from the disposal.

Will the Paymaster General confirm that in such circumstances the deferred gain or loss would actually be deferred, and that no tax would be payable until there was a real economic disposal of the mandatory convertible security? I understand that such an approach would be consistent with that adopted for money debts that were chargeable assets when the loan relationship rules under the Finance Act 1996 were introduced. That is my first point.

Paragraph 5 is the subject of my second point, on which my hon. Friend the Member for South-West Hertfordshire may have touched during the debate on Government amendment No. 66. Again, the concern is that the paragraph, which looks relatively innocuous, states that

“Section 85A of FA 1996...is amended as follows...In subsection (1) (amounts to be brought into account are those recognised in determining company’s profit or loss) after “Subject to the provisions of this Chapter” insert “(including, in particular, section 84(1))”.

The Paymaster General touched on the issue during her response on the last group of amendments. The concern is that the paragraph seems to change the basis on which interest and other aspects of the loan relationship are treated. Historically, they have been treated in accordance with accounting principles. There is concern that paragraph 5 changes that so that when companies have drawn up their accounts in line with generally accepted UK accounting practice, they have to work out what “fairly represent” means, without having the guidance to enable them to do so. There is concern that if there is such a change, more guidance ought to be provided to taxpayers to help them understand what “fairly represent” means in the circumstances and why it overrides general UK accounting practice.

My third point relates to paragraph 10 of the schedule and to intra-group lending. I think that my hon. Friend touched on the issue earlier; perhaps the Paymaster General does not need to refer to that point, but I should be grateful for her thoughts on the treatment of deemed disposals on mandatory convertible securities.

Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

The transitional rules work in a fair way. When a mandatory convertible is first brought within the loans relationship regime, a capital gain is calculated by reference to fair value at that time. However, that gain is not taxed until the company disposes of the convertible. Any amount of tax under the loan relationship rules cannot be brought into accounting in any other way, so it cannot be included in the working out of capital gain; it is not clear how it is thought that there would be a problem.

As most mandatory convertibles appear to be used for tax avoidance purposes, there is unlikely to be any commercial reason why they should need to be subject to a group reorganisation and there is no reason for a more generous regime than is in the Bill. I dealt with the  hon. Gentleman’s second point in answering his hon. Friend the hon. Member for South-West Hertfordshire. It is the Government’s view that the measures before us are a fair representation of what we always believed was the case. However, some commentators argued to the contrary, so the change will put the matter beyond doubt. The measures will reassert the Government’s view on how the rules should work.

I remind the hon. Member for Fareham that we are trying to deal with avoidance. A great deal of care has been taken to consider specifically how to target and deter avoidance without causing problems for legitimate commercial relationships. I hope that he will accept that.