Schedule 15
Finance Bill
5:00 pm
Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)
Thank you, Mr. Illsley, for that rapid canter through the provisions on insurance. Now I shall slow down the Bill’s progress—[Interruption.] Well, I shall slow it just a little, to ensure proper scrutiny of this important schedule about how the Government have chosen to effect their response to the Cadbury Schweppes judgment on controlled foreign companies.
It is worth starting with a general point about the whole interaction between our taxes and EU law; my hon. Friends will be keen for me to make it. We had a lengthy debate on the issue in last year’s Finance Bill Committee, although we do not intend to reprise that at any great length this year.
As the European Court of Justice judgment recognises, it is the sovereign right of member states to determine their policies on direct taxes. However, there are conflicts between that principle and other areas of EU policy; later, when we consider some of the changes to the rules on venture capital trusts, we shall come to another issue in which that conflict exists.
If I might summarise the European Court of Justice judgment on Cadbury Schweppes, it is that where a company was incorporated to undertake a genuine economic activity in another member state, the fact that the motivation to do so—or to use a more familiar term, one of the main purposes of so doing—is to enjoy the lower rates of tax in that territory does not mean that the company’s profits should be taxed at the higher rate applying in the UK. In particular, that issue emerges when the mainstream rate of corporation tax in the UK diverges from rates elsewhere in the EU.
The Court ruled that the profits of a business established in another European economic area state can be taxed at the UK rate only if the arrangements were wholly artificial. Let me quote from the Court judgment:
“If checking those factors leads to the finding that the CFC is a fictitious establishment not carrying out any genuine economic activity in the territory of the host Member State, the creation of that CFC must be regarded as having the characteristics of a wholly artificial arrangement. That could be so in particular in the case of a ‘letterbox’ or ‘front’ subsidiary.”
The Government have taken the Court judgment and sought to apply it to UK law; that is what schedule 15 seeks to achieve.
Indeed, when one examines the schedule and particularly the guidance that was published at the time of the pre-Budget report, one sees that the Government’s view is that the only form of legitimate economic activity in the context of CFC legislation is one that is based on labour, as it profits only from labour that can fall outside UK taxation. If the profits are generated by capital, then broadly they must be included within UK taxable profits. So a company that decides to manage its intellectual property in one member state rather than in the UK would find that its profits from that intellectual property were taxable at the UK rate.
Even the definition of what the Government consider to be labour for the purposes of the rules is tightly defined. If a UK company sets up a subsidiary in another EU state and that company outsources some of its functions, the value created by the outsourcing does not count towards genuine economic activities. It is to broaden that definition that we have tabled amendment No. 111. Furthermore, the schedule also assumes that seeking a lower tax charge is not a valid creator of economic value, which I suppose is rather odd to all those companies that have sought to leave the UK for lower tax rate jurisdictions elsewhere in the EU. Amendment No. 109 would remove the relevant subsection from the Bill.
In a way, it is odd that we have this quite narrow definition of what constitutes genuine economic activity, since it is predicated on the basis of labour. As the hon. Member for Wirral, West perceptively pointed out, the economy has changed somewhat since the second world war and we are now a more knowledge-based economy. There is much more intensive use of intellectual property and different types of assets to generate revenue, so it seems rather strange to create the distinction between profits from labour that is not outsourced, which is a good thing, and profits from outsourced labour and from the utilisation of capital and other assets, which are a bad thing.
What I have sought to do in tabling amendments Nos. 110 and 111 is broaden in two ways the range of activities that can be deemed to be genuine business activities. Amendment No. 110 would define general business activities by reference to the wording used in the Court judgment and amendment No. 111 would eliminate a rather artificial and old-fashioned distinction between staff employed by the company and other labour, in order to recognise that a large number of companies seek to outsource part of their activities as a way of maximising value.
Amendment No. 110 would also change the period from
“throughout the relevant accounting period”
to during the accounting period, to ensure that where, say, something has been set up or closed during the accounting period, its profits can be excluded from UK taxation for the purposes of this legislation.
The wording that I have chosen in amendment No. 110 comes from the ECJ judgment: it deals with an establishment having regard to premises staff, equipment and assets and also reflects the Government’s representations during the hearing. Let me quote from paragraph 66 of that judgment:
“That incorporation must correspond with an actual establishment intended to carry on genuine economic activities in the host Member State”.
It is also worth listening to the opening of the judgment. Paragraph 67 states:
“As suggested by the United Kingdom Government and the Commission at the hearing, that finding must be based on objective factors which are ascertainable by third parties with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment.”
My amendment No. 100 reflects Government representations made at the time. It is odd that they have not sought to reflect those representations in their definition of economic activities under schedule 15.
With your permission, Mr. Illsley, I should like to make two further comments to preclude the need for a stand part debate on schedule 15. The schedule changes procedure so that a UK company has to make an application for the profits of a EEA entity to be excluded from UK tax computation. Seeking that approval increases uncertainty and could be an impediment to reasonable tax planning. Could there not be a pre-transaction clearance procedure? In the previous debate we discussed one in respect of the insurance clause. The Government are not dogmatic in their opposition to pre-clearance procedures, so perhaps they could again demonstrate their flexibility by introducing one.
The schedule contains no deadlines setting out a time by which HMRC has to grant or refuse approval. The Chartered Institute of Taxation suggested in its submission that the onus should be on the tax authorities to show that the arrangements are artificial, rather than on the company to persuade the tax authorities that they are genuine. The CIOT also thinks that the list in the appendix to the explanatory notes of the 20 items that a business must provide to HMRC to get clearance is deliberately long and unduly onerous and almost suggests that it is a disincentive for people to apply for such clearance.
I shall conclude with an extract from the CIOT’s representations, which captures part of the problem with the measure. Last year, we discussed a similar problem when considering the treatment of group relief on the Marks and Spencer case, where the Government took a fairly narrow interpretation of the ECJ judgment which I think is now subject to challenge. The CIOT is probably right in saying:
“We think the whole approach is fundamentally defective and unacceptable, even as an interim measure pending conclusion of the discussions on the reform of...taxation”.
Even given the further reforms that my hon. Friend the Member for Chipping Barnet mentioned this morning, the schedule is defective and unacceptable in the eyes of industry experts.