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

I hope that the Committee will bear with me as I introduce clause 78. It is important that I put some points on the record to assist everybody using our deliberations and the Government’s clarifications.

Clause 78 deals with controlled foreign company legislation and is designed to prevent UK companies from diverting profits to low-tax regimes. It is important to remember that the only companies that face a charge under CFC legislation are those that divert profits from the UK to avoid UK tax. Unfortunately, CFC legislation is constantly under attack from those who seek to avoid Parliament’s intentions. This Government and previous Governments have had to add additional anti-avoidance rules to ensure that it remains fit for purpose.

Clause 78 will block a loophole in one such piece of anti-avoidance legislation, section 90 of the Finance Act 2002. The particular mischief that concerned the Government then and now was that companies can artificially migrate to another country simply to avoid the effect of the CFC rules by using the provisions of a double taxation treaty.

It was widely accepted at the time that such migrations might have become possible as a consequence of the exemption from corporation tax of companies’ chargeable gains from substantial shareholdings, which came into effect on 1 April 2002. The exemption was welcomed by business, which was also fully involved in developing section 90. Companies that migrated before 1 April 2002 were excluded from section 90, not least because they did not have the benefit of the substantial shareholdings exemption when they migrated.

The Government have since become aware that some excluded companies are being used in tax avoidance schemes, and clause 78 seeks to counter such schemes. We have targeted the clause as tightly as possible to avoid leaving open unacceptable risks of continued avoidance on one hand and, on the other, to continue  to exclude companies not involved in tax avoidance. The clause does so by focusing mainly on the type of company used in marketed tax avoidance schemes.

Condition A focuses on companies that have never owned any subsidiaries and are available to use as special purpose vehicles in avoidance schemes. If we left it there, we suspect that, such is the ingenuity of tax planners’ imaginations, it would not be long before companies that happened to own a subsidiary or two were used instead, so condition B aims to forestall all such manipulation.

Condition B is designed specifically not to catch migrated companies that are already the parent of multinational groups and continue to act as the parent of the same group. Such companies are outside the scope of the clause and will not be affected by it when the group makes acquisitions, including sizeable acquisitions, within its own sector in the normal course of its business. Any company that is in doubt as to how the clause will apply should seek clarification from HMRC, but I hope that I have put clearly on the record what is outside the scope of the clause and that no further clarification will be required.

The changes introduced in the clause ensure that from 22 March 2006 the position is returned to that intended in 2002. The clause will prevent tax avoidance and ensure greater consistency between companies that became non-resident at any date. I commend the clause to the Committee.

David Gauke (South West Hertfordshire, Conservative)

I am grateful for the Paymaster General’s comments and particularly her comment that the controlled foreign companies law is constantly under attack from those seeking to undermine Parliament’s will. She will be aware of an attack on that law in the current Cadbury Schweppes case, which is proceeding through the European Court of Justice. The Advocate-General has already determined against the Government. I merely ask whether anything in the clause anticipates a judgment in that case and, if not, what is the likelihood of the legislation having to be reformed next year or the year after in consequence of an adverse judgment from the ECJ. Has the Treasury reached an estimate of the likely cost of the Cadbury Schweppes case if the ECJ finds against the Government?

John Butterfill (Bournemouth West, Conservative)

Order. I do not think an estimate of the cost of the Cadbury Schweppes case is relevant to the clause.

David Gauke (South West Hertfordshire, Conservative)

I am grateful, Sir John. I withdraw that question and have no further comments.

Philip Dunne (Ludlow, Conservative)

I was interested to note that the Paymaster General referred specifically to acquisitions abroad within the sector of operation of the UK resident company or parent entity. I shall be grateful if she could clarify whether she is ruling out international diversification as a means of tax avoidance when there may be a bona fide reason for a UK-based company to acquire a company in a different sector but with some similarities. Is that intended to be caught by the measure?

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

I shall briefly make one or two points. I am grateful to the Paymaster General for her clarification of the clause. I know that people outside the House will appreciate her comments and clarity. I want to be clear about one point. She suggested that companies should seek advice before entering into one of those transactions, but I was not clear whether that was a form of pre-clearance mechanism or a form of guidance that they could receive from the HMRC prior to entering into a transaction. I would be grateful for clarification from her on that.

The Paymaster General referred to examples, and although I do not wish to ask for specific examples, will she state how many companies migrated offshore prior to 1 April 2002? That will tell us whether she is addressing a small problem or trying to close a large loophole.

As my hon. Friend the Member for South-West Hertfordshire said, we are conscious of the issue relating to the threat posed to CFC legislation by European Court judgments. He referred to the Cadbury Schweppes case. There appears potentially to be an issue when the UK-incorporated company has migrated to within the European economic area: the loophole that the Paymaster General is trying to plug will not be plugged if the judgment goes against the UK Government, whereas companies outside the EEA will find the loophole being closed down. I would be grateful if she would address the issues relating to the ECJ and its thoughts on the CFC legislation. To what extent can protection be gained to prevent more companies from trying to avoid tax by locating outside the EEA?

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

I shall deal first with the question on the Advocate-General’s opinion. As the hon. Gentleman knows better than I do, it is an opinion; it advises the Court and it is not a final judgment. I am sure that he would not expect me to go any further. He will have seen from the Advocate-General’s opinion that CFC rules were considered to be compatible with the treaty freedoms and that compliance with such regimes does not represent, in the Advocate-General’s view, an unacceptable burden on companies. However, I have made it clear that that is his opinion and it would be unwise for me to go any further until we have a judgment from the Court.

On the specific points, I do not have a figure in respect of migrated companies—I am unsure whether one exists. It would be substantial, and we can see that in the flows. I wonder whether the hon. Gentleman would find it acceptable for me to write to him, members of the Committee and to you, Sir John, to outline the scope of the problem. We believed that it was not insignificant and a potentially difficult issue.

The hon. Gentleman made a point about clearance. I was not suggesting a statutory clearance procedure in my opening remarks on the clause: I was saying exactly what we thought was outside. If companies wished still to seek clarification from the HMRC on a case in this area, they could do so and the HMRC would consider itself bound, as is normal, by what it then advised.

Let me turn to the other questions. Bona fide acquisitions are not caught. Diversifications are not ruled out, but they can be complex. The hon. Member for Fareham will understand from my opening remarks  the specific points that we are trying to address. I do not want this to be a cumbersome process, because it is no good for the companies either. They are taking decisions on this matter and need to do so at a relatively fast rate. However, if a company were in any doubt, the offer relating to the seeking of clearance and advice in the informal procedures, to which I referred, would be open and the same points would stand with regard to the advice given.

We have tried to return the legislation to the 2002 intent. It is difficult, given the ingenuity of tax planners, but at every opportunity we must recognise legitimate activities and place them outside the scope of the clause. When that is not clearly done, I suggest that companies speak directly to the HMRC to get its response to their particular case.