Clause 100 - Distributions: reasonable commercial return for use of principal secured

Finance Bill – in a Public Bill Committee at 1:30 am on 18th June 2002.

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Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs 1:30 am, 18th June 2002

I beg to move amendment No. 236, in page 76, line 18, at end insert—

'(1A) In subsection (2)(e)(iii) of section 209 of the Taxes Act 1988 (meaning of ''distribution'') after the word ''securities'' insert—

''(other than securities in relation to which there exist hedging arrangements satisfying the conditions referred to in subsection (2) of section 209B)''.'.

The clause affects banks and other financial institutions that may issue or deal in asset-linked securities, where the value of the security is linked to the value of other unrelated assets. Companies are generally able to claim tax relief for interest expenditure, but where the amount of interest is considered excessive, the Taxes Act 1988 treats the excessive amount as being a distribution of profit. In such circumstances, tax relief is not available. The excessive test applies by reference to the amount guaranteed to be repaid on the security, but when the amount to be repaid is linked to the value of particular assets, the guaranteed repayment could be negligible as the assets might fall in value, which could mean that any interest paid would be treated as excessive.

Although that is a somewhat theoretical point, the clause is designed to deal with that problem, and determines that, when the asset has fallen in value, the principal secured is taken to be the original amount invested and not the amount repaid. That provides certainty for companies and investors affected, and helps redress a possible competitive disadvantage of the UK compared with other jurisdictions. The clause

has been broadly welcomed as being constructive, but it does raise an issue that the amendment is designed to address. The amendment deals with a concern that the determination of whether interest is excessive might in certain cases operate where the arrangements are genuine financing transactions linked to the value of the particular assets, commonly referred to as credit-linked notes.

A bank issuing credit-linked notes will usually hedge its obligations by holding the relevant assets, as referred to in the explanatory note. In such cases there is the concern—this is what the amendment is about—that the return to the investor might, within the provisions of section 209 (2)(e)(iii), be treated as dependent on the results of the bank's business because the assets held are part of its business and the interest it pays are related to it. In such circumstances, the interest would be treated as a dividend. Clause 100 has sorted out the problems of section 209, as it was designed to do, but the bank would find itself caught by other section 209 provisions. The problem is a particular concern if the bank uses a special-purpose company within its group to undertake such transactions, and there is a significant incentive to issue such instruments from non-UK vehicles.

The amendment seeks to make it clear that in such circumstances the payment of interest on the credit-linked notes would not be treated as a distribution. It adopts the concept of hedging arrangements introduced in the legislation by clause 100 and, using that concept, seeks to disapply the provision of section 209 to results-dependent payments.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

I hope that I shall be able to explain to the hon. Gentleman that his amendment is not necessary, as discussions with the industry have taken place. It is a complex matter, but I shall try to cover it. The hon. Gentleman explained in his introductory remarks the purpose of clause 100, and I am grateful for his comments.

The amendment would introduce a relaxation in the rules defining a distribution of profit. Where distribution treatment would otherwise apply to payments that to any extent depend on the results of the company's business, those payments would instead be deductible as interest in computing taxable profits if hedging arrangements exist. That is tantamount to providing interest relief for dividends. I am sure that that is not what the hon. Gentleman intends.

The Government believe that the clause provides carefully targeted changes that benefit the UK by making it more competitive while protecting the UK tax base. I assume that the hon. Gentleman is generally content with the clause, because the amendment does not change the way in which it operates. Instead, it uses the definition of hedging arrangements in the clause for a completely different purpose. The clause has been carefully drafted to include a specific type of security that is not motivated by UK tax considerations. It does little more than test the commerciality of the return on the investment by reference to the amount paid in, as the hon. Gentleman said. Any amount greater than a

reasonable commercial return will rightly continue to be treated as a distribution.

If payments under a security at least partly depend on the results of the company's business, there is no obvious reason why the simple presence or absence of hedging arrangements should determine whether there is a distribution of profit. Sums arising under hedging arrangements in such circumstances are already dealt with under the established tax code and are independent of the distributions legislation.

Having had legal advice and discussions with industry representatives, we are confident that hedging arrangements will not cause the returns on securities intended to gain the benefit of the clause to be treated as distributions under other legislation. In cases that do not involve the specific asset-linked securities at which the clause is targeted, other distributions legislation may apply in the normal way.

In discussions with the industry, it has been agreed that the Inland Revenue will provide detailed guidance in manuals that will be publicly available on the application of the clause and other relevant legislation, including the legislation referred to in the amendment, and that it will discuss the draft with industry representatives to ensure that the point is covered.

It is illogical for the presence or absence of hedging arrangements to influence the application of the distribution treatment in the circumstances set out in the amendment. We are confident that guidance will reassure on that matter. For those reasons, I hope that the hon. Gentleman will be satisfied that the point is now covered. Should he want to be involved, and should he have further comments to make, we could ensure that he had a draft copy of the regulations at the same time that it was provided to the industry.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs 11:45 am, 18th June 2002

I am very pleased to hear that that point has been picked up and will be covered in the guidance notes. I should be very grateful for a copy and, on that basis, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendment made: No. 211, in page 77, leave out lines 13 and 14 and insert—

''(6) For the purposes of subsection (5) above, ''control'', in relation to a company, means the power of a person to secure—

(a) by means of the holding of shares or the possession of voting power in or in relation to the company or any other company, or

(b) by virtue of any powers conferred by the articles of association or other document regulating the company or any other company,

that the affairs of the company are conducted in accordance with his wishes.

(7) There shall be left out of account for the purposes of subsection (6) above—

(a) any shares held by a company, and

(b) any voting power or other powers arising from shares held by a company,

if a profit on a sale of the shares would be treated as a trading receipt of a trade carried on by the company and the shares are not, within the meaning of Chapter 1 of Part 12, assets of an insurance company's long-term insurance fund (see section 431(2)).''.—[Dawn Primarolo.]

Clause 100, as amended, ordered to stand part of the Bill.

Clauses 106 and 107 ordered to stand part of the Bill.