Schedule 15
Finance Bill
4:30 pm
Stephen Timms (Financial Secretary, HM Treasury; East Ham, Labour)
In my remarks a few moments ago, I indicated the background to this series of Government amendments. I apologise to you, Mr. Hood, and to the Committee, because I will need to take a little time to explain what is happening and the reasons for the measures.
The debt cap principle is simple in concept, as we discussed. It requires comparison of the interest and other finance expense payable in the UK by a group’s net interest-paying companies, which is referred to as the tested expense, with the consolidated gross finance expense payable by the worldwide group, which is referred to as the available amount. When the tested expense amount exceeds the available amount, the excess is disallowed for tax purposes. If other UK group companies have net interest receipts, the equivalent amount of those receipts becomes non-taxable, to prevent, effectively, double taxation.
The legislation is targeted at abuse of generous UK rules on deductibility of interest by multinational businesses. For that reason, it applies only to large businesses and companies for which the net interest expense exceeds £500,000, so many companies will not need to consider the debt cap legislation at all.
The debt cap can apply to both inbound and outbound investors, but it can also count as exploitation of the interest relief rules when upstream loans are made to the UK parent by its subsidiaries. Not all upstream loans are offensive, as we were saying before lunch, but some are tax-driven, with the interest payment removing profits from the scope of UK taxation and with the interest receipt arising in a company where it is effectively either not taxed or taxed at a low rate.
The legislation contains a number of exclusions which, taken with the other changes that we have made, ensure that the debt cap is carefully targeted. I will go into some of those in more detail, but I shall first list them. First, the financial services exclusion recognises that the different role of debt in financial groups is being introduced by amending the Bill. Secondly, there is a group treasury exclusion, which applies where group companies lend money to a UK group treasury company and that company then lends on the money at profit. Thirdly, there is a short-term debt exclusion, which recognises that short-term upstream loans are not likely to be tax-driven but are made to enable groups to manage their short-term cash position better, for example by allowing a group to operate a cash pooling arrangement to reduce banking costs.
Fourthly, there are exclusions for companies within the ring-fenced oil regime, the shipping tonnage tax regime and the real estate investment trust regime, as the regimes already address the taxation of those activities. Finally, there are exclusions to deal with payments of finance expense by trading subsidiaries to their UK parent where that is a charity or some other exempt body.
Two of the exclusions deserve a bit more explanation. The financial services exclusion applies when substantially all of a group’s income or the income of UK members of the group derives from a particular financial services activity. Banks, for example, borrow at interest so they can lend to their customers, and it would be inappropriate to apply the debt cap to them. As I said in my letter of 30 April, the financial services exclusion was not included in the Bill at publication, as we wanted more time to ensure that our proposals were effective and discuss them with those affected. The exclusion is now being introduced by way of Government amendments.
The group treasury exclusion is appropriate because in cases where group companies provide internal lending facilities for other members of the group and manage cash pooling arrangements on behalf of the group, the facilities provided by the group treasury company generate UK-taxable profits rather than removing profits from the scope of UK taxation. The exclusion is therefore appropriate.
Schedule 15, as we were discussing, includes a gateway test. If it is satisfied, a group need not consider the application of the debt cap rules any further for the accounting period concerned. I should mention in passing that the legislation requires anti-avoidance rules to deter companies from entering into or being party to schemes that seek to prevent the operation of the debt cap. The rules were not included in the Bill on publication, again so that we could have more time for discussion. They, too, are now being introduced by way of Government amendments.
Earlier, we discussed the implementation date for the debt cap. As I said, after discussions with business, the debt cap legislation will apply to accounting periods beginning on or after 1 January 2010. I should make that point clear: it applies to accounting periods starting on or after that date. That means that we have removed the need for companies to apportion the results of an accounting period, as would be required if the debt cap legislation simply applied with effect from a particular date. If it applied from 1 January 2010, any accounting period straddling that date would require apportionment, which would be complicated. We have avoided that difficulty. The implementation date also provides an interval following the introduction of dividend exemption that enables groups to pay up dividends and then unwind upstream loans, and it allows businesses time to become familiar with the legislation.
Our amendments to the design of the debt cap, which I am about to explain in more detail, will result in a simpler regime with greater scope for business to avoid the impact of the debt cap. Without anti-avoidance rules, groups that would pay additional corporation tax as a result of the debt cap might rearrange their borrowings to avoid the rules. Although the same borrowings might remain in substance, the form of the borrowing and other arrangements could reduce the UK net finance expense amounts or increase the worldwide figure of gross finance expense.
The anti-avoidance rules are split into three parts. The first part counters schemes intended to arrange for the group to satisfy the gateway test. The second part counters schemes intended to secure that the available amount, the worldwide group gross finance expense, is greater than it otherwise would be; or that the tested expense amount is less than it would otherwise be; or that the amount of financing income exempted for UK group companies is greater than it would otherwise be. It also counters schemes where a UK company is a beneficiary of the scheme but is not actually a party that has transactions that make up the scheme. Again to ensure that the debt rules are compliant with EU law, the debt cap allows UK companies to exempt financing income received from another group company resident in another part of the European economic area, where that company is subject to a disallowance or that payment in its own country of residence. The third part of the anti-avoidance rules ensures that the amount of financing income that can be exempted by a UK company cannot be increased as a result of an avoidance scheme.
Each of these anti-avoidance rules incorporates a purpose test, providing that the rules apply only where the main purpose, or one of the main purposes, of the scheme is to secure a result that frustrates the intention of the debt cap rules. The scope of the schemes potentially caught by the rules is necessarily wide. The alternative would be to attempt to define the schemes that might be put in place to frustrate the debt cap rules, but it would be very difficult to anticipate all the potential avoidance schemes. The approach we have taken is the right one, but we recognise that some schemes will feature arrangements that are not designed to frustrate the debt cap rules. We have addressed that by providing that if the profits of the UK members of the group are greater or the losses lower than they would be if the arrangements were not in place, the anti-avoidance rules will not apply.
HMRC will be available to define, by regulation, schemes that consist of particular types of arrangements or schemes bearing particular hallmarks that will not be subject to the anti-avoidance rules. HMRC expects to develop those in discussion with companies. The new targeted anti-avoidance rules for the debt cap are inserted by way of a new part to schedule 15, requiring Government amendment 105 to update the overview in part 1 and Government amendment 116 to insert the new part.
The provisions as published already contain a targeted anti-avoidance rule, at paragraph 68(7) and (9), to prevent a UK group company from being artificially removed from the scope of the debt cap. I have mentioned that such a scheme will be caught by rules introduced through Government amendment 116. That allows for the existing rule to be removed, and Government amendments 138 and 139 achieve that.
In response to calls from business, the debt cap now applies to a group for its first accounting period beginning on or after 1 January 2010. We would expect a group with an accounting period due to end on 31 December 2009 to apply the debt cap measures with effect from 1 January 2010. However, such a group could shorten its accounting period by one day to 30 December 2009 and the debt cap would not apply till the following accounting period, which starts on 31 December 2009. We want to stop such forestalling activity. The change to the commencement date made to accommodate businesses therefore requires us to introduce Government amendments 152 and 153 to counter such activity. The amendments move the commencement day for the debt cap rules forward where a group changes its accounting period and the main purpose, or one of the main purposes, of doing so is to delay the application of the debt cap.
On Government amendment 157, consequential changes are required to prevent double taxation. The debt cap disallows some finance expense where the net finance expense of the UK members of a group exceeds the group’s gross external finance expense. In some cases, the finance expense disallowed may be interest payable to an overseas subsidiary of a UK group company that is taxable on the UK parent company under the controlled foreign company rules. To prevent effective double taxation, Government amendment 157 adds new rules to the CFC legislation that will allow a group to apply for otherwise taxable CFC profits that are apportioned to a UK group company to be consequentially reduced.
Government amendment 151, on UK transfer pricing rules, applies the arm’s-length principle so that finance expense payable by a UK group company to another group company can be claimed as a deduction only if it is the amount that would have been payable to a third party. Equally, financing income receivable by a UK group company from another group company must reflect the amount that would have been receivable if it had come from a third party.
The debt cap can result in finance expense being disallowed and financing income exempted. It is possible in some cases that the transfer pricing rules could reinstate such adjustments. To address that problem, we need to make clear that the debt cap rules operate after any necessary adjustments under the transfer pricing rules have been made. Government amendment 151 makes a change to the transfer pricing rules that makes the primacy of the debt cap rules explicit.
I apologise to the Committee for having taken up so much time with that explanation, but I hope that I have made clear our reasons for tabling the new anti-avoidance provisions at this stage. They have been widely discussed and considered, and I hope that the Committee will be happy to accept the Government amendments.