Clause 68 - Qualifying contracts for unallowable purposes

Finance Bill – in a Public Bill Committee at 6:00 pm on 11th June 2002.

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Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs 6:00 pm, 11th June 2002

I beg to move amendment No. 114, in page 45, line 41, at end insert—

'(8A) A qualifying contract shall not be regarded as having an unallowable purpose in regard to a company where, on the application of that company, the Board have notified the company that the Board are satisfied that the contract does not have an unallowable purpose.

(8B) Any application under subsection (8) shall be in writing and shall contain particulars of the contract to be entered into by the applicant and the Board may, within 30 days of the receipt of the application or of any further particulars previously required under this subsection, by notice require the applicant to furnish further particulars for the purpose of enabling the Board to make their decision; and if any such notice is not complied with within 30 days or such longer period as the Board may allow, the Board need not proceed further on the application.

(8C) The Board shall notify their decision to the applicant within 30 days of receiving the application or, if they give a notice under subsection (8A) above, within 30 days of the notice being complied with.

(8D) If the Board notify the applicant that they are not satisfied as mentioned in subsection (8) or do not notify their decision to the applicant within the time required by subsection (8B), the applicant may within 30 days of the notification or of that time require the Board to transmit the application, together with any notice given and further particulars furnished under subsection (8A), to the Special Commissioners; and in that event any notification by the Special Commissioners shall have effect for the purposes of subsection (8) as if it were a notification by the Board.

(8E) If any particulars furnished under this section do not fully and accurately disclose all facts and considerations material for the decisions of the Board or the Special Commissioners, any resulting notification that the Board or Commissioners are satisfied as mentioned in subsection (8) shall be void.'.

Photo of Joe Benton Joe Benton Labour, Bootle

With this it will be convenient to take the following amendments: No. 115, in schedule 25, page 303, line 23, at end insert—

'30A In paragraph 13 of Schedule 9, after subparagraph (5) insert—

''(5A) A loan relationship shall not be regarded as having an unallowable purpose in regard to a company where, on the application of that company, the Board have notified the company that the Board are satisfied that the loan relationship does not have an unallowable purpose.

(5B) Any application under subparagraph (5A) above shall be in writing and shall contain particulars of the loan relationship to be entered into by the applicant and the Board may, within 30 days of the receipt of the application or of any further particulars previously required under this subparagraph, by notice require the applicant to furnish further particulars for the purpose of enabling the Board to make their decision; and if any such notice is not complied with within 30 days or such longer period as the Board may allow, the Board need not proceed further on the application.

(5C) The Board shall notify their decision to the applicant within 30 days of receiving the application or, if they give a notice under subparagraph (5B) above, within 30 days of the notice being complied with.

(5D) If the Board notify the applicant that they are not satisfied as mentioned in subparagraph (5A) above or do not notify their decision to the applicant within the time required by subparagraph (5C) above, the applicant may within 30 days of the notification or of that time require the Board to transmit the application, together with any notice given and further particulars furnished under subparagraph (5B) above, to the Special Commissioners; and in that event any notification by the Special Commissioners shall have effect for the purposes of subparagraph (5A) above as if it were a notification by the Board.

(5E) If any particulars furnished under this paragraph do not fully and accurately disclose all facts and considerations material for the decision of the Board or the Special Commissioners, any resulting notification that the Board or Commissioners are satisfied as mentioned in subparagraph (5A) above shall be void.''.'.

No. 116, in schedule 26, page 344, line 23, at end insert—

'(3A) A derivative contract shall not be regarded as having an unallowable purpose in regard to a company where, on the application of that company, the Board have notified the company that the Board are satisfied that the derivative contract does not have an unallowable purpose.

(3B) Any application under subparagraph (3A) above shall be in writing and shall contain particulars of the contract to be entered into by the applicant and the Board may, within 30 days of the receipt of the application or of any further particulars previously required under this subsection, by notice require the applicant to furnish further particulars for the purpose of enabling the Board to make their decision; and if any such notice is not complied with within 30 days or such longer period as the Board may allow, the Board need not proceed further on the application.

(3C) The Board shall notify their decision to the applicant within 30 days of receiving the application or, if they give a notice under subparagraph (3B) above, within 30 days of the notice being complied with.

(3D) If the Board notify the applicant that they are not satisfied as mentioned in subparagraph (3A) above or do not notify their decision to the applicant within the time required by subparagraph (3C) above, the applicant may within 30 days of the notification or of that time require the Board to transmit the application, together with any notice given and further particulars furnished under subparagraph (3B) above, to the Special Commissioners; and in that event any notification by the Special Commissioners shall have effect for the purposes of subparagraph (3A) above as if it were a notification by the Board.

(3E) If any particulars furnished under this paragraph do not fully and accurately disclose all facts and considerations material for the decision of the Board or the Special Commissioners, any resulting notification that the Board or Commissioners are satisfied as mentioned in subparagraph (3A) above shall be void.'.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

The clause inserts an unallowable purpose, anti-avoidance clause in the financial instrument rules and mirrors the existing rule for corporate debt purposes, the paragraph 13 rule. There is a general acceptance that that rule is unclear and untested in the courts. We propose that a statutory clearance procedure should be included in the legislation as an option to give companies certainty when entering into complicated commercial arrangements.

The unallowable purpose rule in the corporate debt legislation has been the subject of widespread criticism. Introducing a mirror image rule in the financial instruments legislation will, potentially, exacerbate rather than ease the situation. The Institute of Directors has made the point that

''This new rule amounts to a general anti-avoidance rule within its limited field. A general anti-avoidance rule ranging over the whole of income tax and corporation tax was carefully considered in 1998. It was decided not to introduce such a rule, for perfectly good reasons. We do not believe that comparable rules should be introduced in limited fields: they generate uncertainty and allow the Revenue to block new tax planning measures retrospectively.''

Ideally, the whole clause should be amended to target the tax avoidance schemes that the Treasury regards as unacceptable. Given that the Treasury does not publish details of such schemes, it is not possible to suggest an amendment that covers that. We therefore suggest that, at the very least, the Treasury should offer advance clearance of the transaction to give certainty to business.

When we suggested that a statutory clearance procedure be included in the substantial shareholdings legislation, the Minister told us that it would be inappropriate for the Inland Revenue to provide a

statutory clearance mechanism due to cost and that businesses would not want it if there was one. That was said to be because the rules on substantial shareholdings had been subject to extensive consultation and we were told that the Inland Revenue guidance notes would clarify any uncertainties.

Throughout the consultation process on substantial shareholdings, there were repeated calls for advance clearance procedures, and the same point applies to this clause. Taking first the cost argument and the suggestion that many clearances are obtained simply because the facility exists rather than because there is serious uncertainty, we do not think that that would be the case with the clearance arrangements that we propose. The amendment asks specifically for confirmation that the contract does not have an unallowable purpose--that is, that it meets the requirements of the legislation.

The clearance procedures contained in section 707 of the Income and Corporation Taxes Act 1988 and section 138 of the Taxation on Chargeable Gains Act 1992, the two most widely used Inland Revenue clearances, give the taxpayer certainty on whether a transaction is being carried out for what the Treasury consider to be bona fide commercial reasons, not whether the transaction meets the requirements of clearly worded and tested legislation. Clearly, there is a difference between a clearance that comments on the motivation for the transaction as a whole and one that gives certainty on the imposition of inherently ambiguous and untested legislation. If existing clearances are obtained unnecessarily, perhaps the Treasury should consider the problems with them, rather than dismissing out of hand the need for new clearance procedures in other parts of the tax law.

The Minister also stated that one of the reasons for excessive costs is that the position might change and the facts might be different when the transaction takes place. However, one of the conditions of the clearance is that the facts are unchanged. If they are not, taxpayers lose their certainty. That is not in the interest of taxpayers, and it is difficult to imagine why a taxpayer who went to the effort of obtaining a clearance would choose to change the facts. If that were a real concern, an additional condition could be included in the clearance procedure that the onus is on the taxpayer to notify the Treasury about any changes in facts or circumstances.

Finally, there is the argument that the legislation has been widely consulted on. I draw the Committee's attention to the response of the Chartered Institute of Taxation, which was submitted to the Inland Revenue last October:

''The total disregard of the unanimous opposition to extension of Sch 9 para 13 FA 1996 is regrettable. It is no doubt correct that most of the objections were based on dissatisfaction with para 13 itself. This is because these objections are well-founded. The provision is so obscurely drafted as to be unpredictable in its application. A retrospective application of the provision back to the beginning of the accounting period containing 26 July 2001 is unreasonable. Some transactions would not have been entered into with such legislation in place, not because they were tax avoidance transactions in any reasonable sense of the word, but

because they might have come within some interpretations of the section because a reduction in tax was a consequence of real business expenditure. At the very least the section should not affect any losses or expenses arising before 26 July 2001. Further we consider that it will be essential for the Inland Revenue to be in a position to offer advance transaction guidance to taxpayers as is proposed in the consultative document.''

That is, manifestly, the purpose of our amendment.

Given the above comments, it is clear that just because there is a consultation process, it neither means that the resulting legislation will be perfect nor that the Treasury will actually listen to all the consultation responses. The Minister said that there were informal methods of obtaining guidance. That is agreed and accepted, but how often a taxpayer would be prepared to bring his tax inspector into discussions when he is considering entering into a complicated commercial arrangement on an informal basis is debatable for obvious reasons. Surely, a statutory clearance procedure would help the Treasury help the Revenue, because it would have the full facts in advance, and it would help businesses and taxpayers by providing certainty.

Photo of Ruth Kelly Ruth Kelly Financial Secretary, HM Treasury 6:15 pm, 11th June 2002

Clause 68 is the first of 18 clauses and six schedules that form a package to modernise the structure of the taxation of corporate debt and derivative contracts, and to protect the Exchequer against avoidance schemes in the period before the structural reforms take effect.

It might help hon. Members if I put the reforms in an overall context before dealing specifically with the clause and the amendment. I gave prior notice to the hon. Member for Arundel and South Downs of my intention to do that. I shall start with a brief account of the background to the reforms as a whole, an outline of what we seek to achieve and an indication of how the clauses fit together.

The existing legislation is as follows: first, the foreign exchange gains and losses—or forex—legislation enacted in the Finance Act 1993, which introduced a statutory regime for taxing companies' foreign exchange gains and losses. Secondly, there is the financial instruments legislation enacted in the Finance Act 1994, which introduced another statutory regime for taxing companies' profits and losses from interest rate and foreign currency swaps, options and futures. Thirdly, the corporate and Government debt—or loan relationships—legislation enacted in the Finance Act 1996, which brought in a new statutory regime for taxing gilts and corporate debt instruments, including ordinary borrowing and lending.

Although all three regimes were thought radical in their time, they have suffered from two main problems: complexity and lack of fairness. The 1993 forex legislation was particularly complex. Companies and tax professionals have long complained about the incomprehensibility of some of its drafting. Few will mourn its passing. The 1994 financial instruments rules were prescriptive, and do not cover all the derivative instruments now available in the markets.

The 1996 loan relationships legislation was drafted in a more user-friendly way, in most cases following companies' accounts. However, it was criticised even before the Act had passed its parliamentary stages

because its detailed rules for determining when bad debt relief is available were unduly harsh. With the passage of time, it has become apparent that those rules can act as a disincentive to lend, especially to smaller companies, or to participate in corporate rescues. All three regimes have proved to be highly susceptible to artificial avoidance arrangements. The Government are determined to remove avoidance opportunities as far as possible, so that all companies pay their fair share of tax and compete on a level playing field.

The Government's objectives in formulating these reforms are those that underlie our strategy for corporate tax reform generally. We aim to create a coherent regime governing the taxation of debt and derivative contracts that is generally as applicable as possible, minimises departures from the profit or loss shown in the accounts, is comprehensive—retaining exclusions only where they can be fully justified—and is based on principles that will provide stability for business in the longer term.

The clauses introduce three structural reforms, all taking place concurrently. First, we are repealing the existing financial instruments regime and replacing it with a new regime that covers a far wider range of derivative contracts, is aligned more closely with accounting practice, and is more user-friendly. Secondly, we are repealing the current regime for foreign exchange gains and losses, and merging the necessary rules into the legislation for loan relationships and derivative contracts. Thirdly, we are changing the loan relationships rules, mainly to make them fairer by allowing bad debt relief in a range of circumstances where relief is not available at present.

Those structural reforms will take effect from a company's first accounting period to start on or after 1 October 2002, giving companies the time they need to plan properly for their implementation. The design of the structural reforms is intended to minimise avoidance opportunities, but in advance of their implementation the Government are not prepared to allow tax avoidance to undermine the corporate tax system. We are, therefore, bolstering the existing regimes with a series of measures intended to stop particular avoidance arrangements. To be effective, those need to operate from the dates they were announced.

The hon. Member for Arundel and South Downs queried why we could not delay their implementation, but if we did that, significant sums would leak from the Exchequer during the interim period. We have published draft clauses to allow companies to implement and take on board the changes from the date on which they were published. The reforms have been the subject of extensive consultation since November 2000. Three consultation documents have been issued--the latest, which contained the draft clauses, in December 2001.

In addition, there have been substantial informal discussions, which have been very constructive and helpful in developing the legislation, among the

Revenue, representative bodies and tax practitioners. Many companies have participated in the consultation process both individually and through the CBI and other representative bodies. I should like to take this opportunity to thank all those who took part in the consultations, which resulted in widespread agreement that the reforms should be implemented.

Before I deal with the amendments tabled by the hon. Member for Arundel and South Downs, I shall turn to the clause itself, which will insert a new anti-avoidance rule into the 1994 financial instruments legislation. It is closely modelled on the unallowable purposes rules that the loan relationships legislation has contained since its enactment in 1996. The clause will allow tax deductions where the main purpose, or one of the main purposes, of a company being party to a financial instrument is not commercial. A purpose related to activities outside the corporation tax net will not be considered as a commercial purpose. The clause is aimed at stopping certain types of artificial tax avoidance. To the extent that tax avoidance is a main motive behind a company becoming party to a financial instrument, it will be denied tax deductions, thereby defeating the avoidance.

As was noted in 1996 when the original loan relationships and allowable purposes rules were introduced, companies that enter into schemes with the primary aim of avoiding tax will inevitably be aware of that fact. The transactions at which the rule is aimed are not those into which companies stumble inadvertently. As a top tax adviser said at the time, ''Companies will know when they are entering serious tax avoidance. Apart from anything else, they are likely to be paying fat fees for clever tax advice and there will commonly be wads of documentation.'' Consequently, provided that companies enter into financial instruments with genuine commercial activities or investments, they should have nothing at all to fear from the unallowable purposes rules, but if they go in for artificial tax-driven arrangements, they may find themselves caught.

Amendments Nos. 114 to 116 seek to introduce clearance procedures for the unallowable purposes rules. There are three amendments because the Bill introduces unallowable purposes rules in three places. Clause 68 will add an unallowable purposes rule to the existing financial instruments rules, which will be replaced by the new derivative contracts rules in clause 82 that include their own unallowable purposes rule.

The abolition of the separate forex rules means that foreign exchange gains and losses will become subject to the existing unallowable purposes rule in the loan relationships rules. As the hon. Member for Arundel and South Downs has explained, the amendments would each provide a clearance procedure so that a company could apply to the Inland Revenue for confirmation, or otherwise, that the relevant unallowable purposes rule would not apply to any transaction for which the company obtained clearance. For reasons that I shall explain--they bear some similarity to the debates that the Committee has already had on other aspects of the Finance Bill--such clearance procedures would be both unnecessary and

undesirable. I therefore have to tell the hon. Gentleman that I shall not recommend that the Committee accept the amendment.

First, the clearance procedure is unnecessary. It is modelled on existing clearance mechanisms, but such statutory clearances are relatively rare in tax law. Where they do exist, it is normally for historical reasons. Tax law contains a large number of anti-avoidance provisions, most of which do not have a statutory clearance procedure because they do not need one. The main exceptions to the rule that anti-avoidance provisions do not contain clearance procedures are the anti-avoidance provisions on transactions in securities contained in section 703 and those on mergers and reconstructions in section 138.

The amendments are based on provisions introduced in 1960 and 1977 respectively, when the idea of anti-avoidance provisions was novel. Section 703 is often said to be the first anti-avoidance provision, and it is understandable that a statutory clearance procedure was thought necessary to allay fears. We have come on a long way since then. Anti-avoidance provisions are now commonplace and well understood, so that more modern provisions do not have clearance procedures. That is true of the unallowable purposes rule for loan relationships, which is commonly known as paragraph 13 and was enacted in 1996. It has existed for six years without a clearance procedure.

Although this provision is said to give rise to some uncertainty, we are not aware of its having constituted a significant barrier to legitimate commercial activity. However, it has been a significant and effective inhibition on tax avoidance. We see no reason why the new provisions should cause the damaging level of uncertainty that the hon. Gentleman foresees.

The second reason for rejecting the amendment is that a statutory clearance procedure would be undesirable in practice, partly because of the resource implications. The number of qualifying contracts and loan relationships for which clearance might be sought is huge. Today's sophisticated financial markets trade many thousands of derivative contracts every day and many thousands of loans are taken out and debt instruments issued every day. That may be contrasted with the situation in which there is already, in practice, a statutory clearance procedure. The Inland Revenue receives a substantial number of applications--around 4,000 a year for company reconstructions--but the number of reconstructions is far fewer than the number of derivatives or loan relationships.

It may be argued that a statutory clearance procedure would not be needed for every derivative transaction or loan relationship. That is so, but nevertheless, clearance procedures add unnecessary administrative and compliance costs. If there is a statutory procedure, applications must be made, if only as an insurance, even when there is no realistic likelihood that the provision could apply. The resources that would be devoted to clearance

applications by companies and their advisers and within the Inland Revenue make that an impractical proposition.

A statutory clearance procedure would also be undesirable if it was abused, as I fear it could be, by the minority of companies that seek to avoid paying a fair share of tax. Artificial, marketed avoidance schemes have been a feature of the financial instruments regime. That is one reason for replacing the existing financial instruments regime with a new derivative contracts regime. The ability to test the limits of acceptability, perhaps by using a series of clearance applications, could facilitate yet more avoidance.

Having said all that, I fully accept that companies and their advisers need to have some idea of what transactions are likely to come within the unallowable purposes rule. Most companies that enter into avoidance schemes will inevitably be aware of that fact. Companies do not stumble inadvertently into the sort of transactions at which the rule is aimed. If they enter into transactions for genuine commercial activities or investments, they should have nothing to fear.

To assist them even further, the Inland Revenue has already published guidance based on its experience of operating paragraph 13, to which the hon. Member for Arundel and South Downs referred, and the existing loan relationships unallowable purposes rule. Companies should be able to take comfort from the fact that, if they stay within that guidance, they will not fall foul of the anti-avoidance test. If they are in any doubt, they can of course approach their tax inspector informally. The hon. Gentleman said that companies may be reluctant to ask their tax inspector whether what they are doing is legitimate, but perhaps he agrees that if there is real tax avoidance, companies will have sought professional advice on how to avoid tax in a particular circumstance. If their activities are genuinely commercial, they have nothing to fear from the provisions and should have no hesitation in discussing what they are doing with their local tax inspector.

For all those reasons, it is both cheaper and more effective to have no formal statutory clearance mechanism. I therefore urge the Committee to reject the amendment.

Photo of Mark Field Mark Field Conservative, Cities of London and Westminster 6:30 pm, 11th June 2002

I rise to speak to the clause, because I am sure that we shall not have a stand part debate, and to the amendments.

I give credit to the Government for the significant consultation exercise. I have been in touch with a number of institutions in the City of London and we have tabled few amendments on the provisions because, as was rightly pointed out, there have been at least three stages of consultation during the past 18 months or so. For that, the Government must be congratulated.

Equally, past legislation in this area has not been unimpeachable. We have a moving goal because of fast-moving, globalised finance, and the subject is technical so amendments must be made from time to time. The advice that I have received from several institutions suggests that at this juncture they are at

least comfortable with most of what is proposed in the clause. The proof will be in the pudding. The concerns that have been expressed by my hon. Friend the Member for Arundel and South Downs and others, here and elsewhere, is that the Treasury has a tendency to meddle in so many areas. Although certain aspects of its work will be welcomed, other bits will be seen as tampering for the sake of it.

The City of London is an important financial centre and a centre of invisible earnings for this country. I have a philosophical concern that a feeling exists that taxes must be raised, and that banks and other financial institution must go about their business ensuring that they pay a fair amount of tax; it is somehow seen as illegitimate to avoid tax and utilise the tax system. The idea that financial institutions should be willing to take everything on the chin and not use the system to their benefit is a matter of concern.

The Financial Secretary assured us that it will be up to a financial institution to go to the local tax inspector for advice in advance. However, the area is extremely technical, so I wonder whether in practical terms that will give much comfort to financial institutions, which could find themselves in a difficult position when acting on behalf of clients—they may find that a structure that they have put in place collapses and becomes tax liable. A difficulty that the hon. Lady pointed out was that institutions will receive tax advice from a leading tax QC or law firm, but that tax advisers must give balanced advice. My concern is that, likewise, the local tax office would give an on-balance decision only. When large sums of money are at stake in some of the more complex structures that have been introduced to the financial services sphere, that is not good enough.

Some of the amendments should be welcomed. The City institutions to which I have spoken feel that there has been a significant and acceptable level of consultation. I hope only that we will not have to unpick everything in the next two or three years when some of the implications become apparent.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I thank the Financial Secretary for her response, and I echo the point just made that everyone is well aware that there has been extensive consultation. Although, I cannot resist commenting that the number of Government amendments is substantial—clearly, consultation was not completely complete—I welcome the fact that amendments have been tabled late in the day to address some of the problems presented by certain causes.

As my hon. Friend the Member for Cities of London and Westminster (Mr. Field) said, we do not have a great deal to say as we proceed through clause 82. I simply make the point that the issue of informal versus formal statutory clearance needs in-depth consideration. I have known circumstances where there has been a problem with informal clearance and it has never been given because inspectors of taxes feel

that they are out of their depth or they do not want to give an opinion. However, as far as possible we wish to retain the sharpest of clarity in our tax law.

I question whether the informal clearance mechanism will actually work. In the co-operative spirit of the Revenue, it is potentially better than statutory clearance in that it is more flexible. However, it will need to be kept under review and if, in such complex anti-avoidance areas, informal clearance were found not to be satisfactory, any Government would need to consider formal statutory clearance arrangements.

Clearance is the main issue in the clauses and although the amendments are tabled to clause 68, they relate to several other clauses in this group. We will not press the matter to a vote, but our view is that an open mind must be kept as to whether the informal clearance arrangements are delivering what is needed economically. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 68 ordered to stand part of the Bill.