Clause 35
Finance Bill
12:15 pm
Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)
This is an important clause. A number of issues have emerged since it was tabled, including the number of Government amendments to it. The extensive nature of the new rules on anti-avoidance and financial services groups is also important and needs to be addressed. However, I want to say something more broadly about the debt cap, because it is has given rise to some concern about what sort of behaviour it will incentivise. Is it the best way to tackle the issue that concerns the Government? Are we at risk of introducing a cumbersome process that will add to the compliance cost of business? Let me talk through some of those issues.
As the Minister indicated in the debate on clause 34 stand part, some of the cost of the dividend exemption has been offset by the introduction of the debt cap. That leads to interesting issues as to whether those reforms are linked, in the sense that if clause 34 is introduced, does clause 35 have to be introduced, or are the reforms taking place in parallel, with one raising revenue and one leading to a loss of revenue just a matter of convenience rather than a matter of planning how the tax structure will work? Clearly, when the debate about the taxation of foreign profits started in 2007, the Government had other ideas about how to tackle some of the behavioural challenges that arose from it. It was only when the original ideas on the control of companies ran into a degree of flak that they then moved on to the debt cap.
The aim of the worldwide debt cap is to target situations in which a UK group bears more debt than is required to finance the worldwide group. In addition, the measure could provide an effective means of targeting many upstream loans to the UK that are used to repatriate overseas cash. However, in order to protect those groups that are temporarily cash rich, the Government intend to allow the worldwide debt cap measure to be set aside where the group is in a short-term cash-rich position. Of course, that stems from the point that has been quite widely debated over several years that the UK has a very generous regime for interest expense—it is fully deductible. It is one of the issues that has perhaps led to an increase in leverage among a number of companies over the course of recent years and has certainly led to concern about whether it has incentivised a particular type of behaviour.
Although the Government flagged up last year that that is what they wanted to do, there is still concern about the workability of the proposals. Deloitte said:
“Unfortunately the provisions remain very complex and represent a major compliance burden for groups even if they will have no ultimate disallowance of interest.”
Adding 32 pages of tax codes could make the risk overly burdensome. The Institute of Chartered Accountants believes this matter could have been addressed in other ways:
“We believe that the same policy objectives, which are to prevent the ‘dumping’ of debt into the UK part of worldwide operations and the penalisation of upstream loans to the UK, could equally well be achieved by tightening up the existing thin capitalisation regime and introducing targeted rules against upstream loans.”
Could other policy routes have been used to tackle unnecessary upstreaming that would not have added to the compliance burden on businesses? In the brief stand part debate, the Minister referred to the different commencement date for the debt cap arrangements. Will the gap between commencement dates be used for further consultation and to explore the alternative solutions, or are the Government determined to take this route?
Since the original proposals were published in draft last year, there has been movement by the Government and some of the complexity has been ironed out. However, UK-only groups will still be caught by the measure and will have to go through some compliance steps, which is regrettable. The proposals are meant to deal with debt that is incurred outside the UK by international groups, yet it appears from the drafting that UK companies will have to pay unnecessary additional taxes.
The debt cap places restrictions on the relief given to UK companies that form part of a worldwide group relating to the interest and finance expenses on transactions with related companies. The extent of that restriction on the intra-group interest and finance costs will depend on the external financing costs of the worldwide group. The Chartered Institute of Taxation questions why those restrictions are required, saying that
“It is not clear to us why these provisions are required at all in addition to the many existing rules which are intended to restrict interest relief in certain situations, including transfer pricing, arbitrage provisions and”
provisions of the Finance Act 1996. Both CIOT and ICAEW have concerns about the Government’s approach.
The Minister suggested that the proposal was a move towards a more territorial system of taxation, and he is right: it is only a move towards that. It has not been fully articulated as the end point. Will he clarify whether we should move to a territorial system of taxation and whether the proposal is a staging post along that route or the end of such movement? If it is a staging post, what does he think the next moves should be?
There is a more fundamental concern about the impact of the measures on businesses. I have talked about compliance costs and about whether there are other ways to tackle the concern about loading UK-based companies with high levels of debt. There have been a number of comments from business and outside advisers about how the proposal will affect the way in which companies are structured and financed.
The Law Society has suggested that the proposals might encourage UK groups to incur more debt; encourage multinationals to transfer assets out of the UK; discourage inward investment into the UK; put over-leveraged companies at an advantage over cash-rich companies in making acquisitions in the UK; and discourage outward investment. I shall illustrate just one of those points, as it is quite important to reflect on the potential outcome. We could have a situation in which a UK-based company is being targeted by two potential acquirers. One could be an overseas company that is cash rich, but it would seek to finance its acquisition of the company through intra-group loans. Alternatively, there could be a highly-leveraged private equity situation, where there is quite a high level of external debt. Again, the company in that situation would use debt to finance the acquisition of the original UK-based company.
The concern that has been expressed to me is that, because the overseas parent company is cash rich, it has low levels of external debt or, as in this case, no external debt. The restriction on debt interest—the worldwide debt cap—would kick in on that company. By contrast, if the UK company was acquired by a highly-leveraged private equity fund that had external debt, the fund would be able to use debt; it would not face the restriction on the deductibility of interest that the cash-rich non-UK company would face. As a consequence, it could borrow more to fund that acquisition; it could pay a higher price to acquire that other company.
Given that one of the concerns expressed recently has been about over-leverage in the markets, we seem to have a situation here whereby the proposed measures could encourage more leverage, rather than encourage companies to have significant cash resources, whether those resources are acquired through the retention of profits or through arranging money via share issues. The behavioural issues are causing some concern to outside bodies, and this could be an opportunity for the Minister to explain the Treasury’s view.
As I understand it—I am sure the Minister will correct me if I am wrong—we are the only country that has introduced a worldwide debt cap. Other jurisdictions have considered introducing some cap on tax deductibility debt within their own jurisdiction, but not outside it. Deloitte suggests:
“The introduction of the debt cap cannot be regarded as a move which will enhance and support UK competitiveness and this aspect of the policy design of the debt cap seems more likely to damage the UK’s competitive position than to enhance it.”
Is the Minister prepared to comment on that assessment?
The second issue that I want to touch on relates to the compliance cost. I alluded to the fact that purely UK groups would also have to go through the process of calculating what their external financing is, even though they do not have any non-UK business. As I understand it, the problem is the gateway test that has been used. When the measures were originally consulted on, it was suggested that there would be a number of gateway tests, one of which would enable a purely UK group to avoid going through that process of calculating external finance. Will the Minister explain why there is to be only one gateway test?
The Chartered Institute of Taxation suggests that the reason why there is only one gateway test is our old friend, EU law, which we discussed in relation to the last schedule. It was said that EU law aims to ensure that the arrangements are waterproof and free of the possibility of legal challenge, which would mean that we will end up putting an additional burden on UK-only groups that should not really apply, given the nature of the debt cap rules. I should be grateful if the Minister explained why we have only one gateway test.
Three themes run through the general commentary on the measure. First, is it the best way to tackle the issue of the upstreaming of loans into the UK? Secondly, is the compliance cost too great? That partly links back to the fact that there is only one gateway test, which means that UK-only groups are caught by the measure. Thirdly—the problem that exercises a number of people—the measure could perversely lead to companies taking on more external debt, but would be to the detriment of inbound investment into the UK and perhaps outbound investment, too.