Schedule 42 - Controlled foreign companies: exempt activities

Finance Bill – in a Public Bill Committee at 5:45 pm on 17th June 2003.

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Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury 5:45 pm, 17th June 2003

I beg to move amendment No. 318, in

schedule 42, page 431, line 36, leave out 'branch or agency' and insert 'permanent establishment'.

Photo of Nicholas Winterton Nicholas Winterton Conservative, Macclesfield

With this it will be convenient to discuss the following:

Amendment No. 319, in

schedule 42, page 432, line 16, leave out 'branch or agency' and insert 'permanent establishment'.

Amendment No. 316, in

schedule 42, page 432, line 44, leave out 'business' and insert 'trade'.

Amendment No. 320, in

schedule 42, page 432, line 45, leave out 'branch or agency' and insert 'permanent establishment'.

Amendment No. 317, in

schedule 42, page 432, line 46, leave out 'habitually' and insert 'ordinarily'.

Amendment No. 321, in

schedule 42, page 433, line 3, leave out 'branch or agency' and insert 'permanent establishment'.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury

The Committee may be aware of the concerns expressed by the Institute of Chartered Accountants and other professional bodies about schedule 42. Clause 197 and schedule 42 extend the controlled foreign company provisions to payment protection companies. The effect of that is wide. Any UK-owned business carried on via a controlled foreign company that has a wide retail customer base with a large proportion of UK customers will be caught

unless engaged in long-term or large-risk insurance. There are concerns about the complexity of the new provisions, which introduce a new test of persons who are ''habitually resident'' in the UK.

Aside from the complexity, we have yet another example of provisions that could be contrary to EC law. In so far as, for example, the payment protection companies are Irish international financial service companies, or 12.5 per cent. companies, the provision appears to ignore the EC treaty and European Court of Justice case law by targeting the establishment of payment protection businesses in another, lower tax member state. In respect of companies located in Ireland, the problem is compounded by the removal of Ireland from the excluded countries regulation. We also question whether that step is legal under EC law.

Amendments Nos. 318, 319, 320 and 321 are intended to ensure that the correct term is used to take into account the repeal of the definition of ''branch or agency''. The provisions inserted into paragraphs 6 and 11 of schedule 25 of the Income and Corporation Taxes Act 1988 persist in the use of the term ''branch or agency'', rather than using the term ''permanent establishment''. Table (6) in schedule 43 repeals the definition of ''branch or agency''. Might it not be easier for the user of the legislation if the provisions were amended to reflect the correct terminology?

Amendments Nos. 316 and 317—these are all Law Society points, as Members will be aware—are intended to insert the readily understood term ''ordinarily'' resident. Proposed new paragraph 11(3), which will be inserted in schedule 25 of the 1988 Act, refers to carrying on a ''business''. That is a wider concept than used in existing legislation and should perhaps be amended to refer to carrying on a ''trade''. Proposed new paragraph 11(3)(c)(iii) uses the same term ''habitually resident'', which is not defined in the Bill or in the Income and Corporation Taxes Act 1988. Perhaps the provision should use the term ''ordinary resident'', which is known and more easily understood.

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

I shall ask my hon. Friends to oppose the amendments. The controlled foreign company legislation targets the avoidance of UK tax by companies that divert profits offshore. Schedule 42 withdraws exemption from the CFC rules in cases where a significant proportion of a company's income is derived from UK persons.

Amendment No. 316 would restrict the application of schedule 42 in the context of the special rules for companies whose activities constitute banking and similar business. It would mean that in the case of such a company only income from a branch through which it carried on trade in the UK would be caught, but not income from a branch through which it carried on business in the UK. That is not acceptable.

Amendment No. 317 would replace the term ''habitually resident'' with ''ordinarily resident'' in that part of the schedule that is designed to identify UK profits that may no longer benefit from exemptions from the CFC rules. Far from

simplifying the rules, the change would introduce complexity and make them more difficult to operate.

Amendments Nos. 318 to 321 are unnecessary. Clause 197 brings schedule 42 into effect for accounting periods commencing on or after 27 November 2002. The changes to the CFC rules take effect ahead of the replacement of ''branch or agency'' with ''permanent establishment'' throughout the Taxes Act. That replacement is brought into effect by clause 152 only for accounting periods beginning on or after 1 January 2003. It will then apply to the CFC rules already in force and to the new rules introduced by schedule 42. Therefore, it is correct to use the term ''branch or agency'' in schedule 42, consistent with the legislation in force at the time from which it applies.

I reject the hon. Gentleman's suggestion that the clause is too wide. The rules are properly targeted against an identified loophole. In one of the CFC exemptions, companies that are no longer able to use the exemption will still be able, where appropriate, to claim one of the remaining five exemptions, including the motive test.

We do not envisage that the proposed changes will materially increase compliance burdens across the board. Most companies will be at one end or the other of the spectrum in dealing directly or indirectly with UK persons.

The UK CFC legislation has not been the subject of challenge under European Union law. The CFC rules contain significant elements that are not found in other countries' CFC rules, but the Government do not accept that the CFC legislation is no longer compatible. I commend the schedule to members of the Committee and ask them to reject the amendments.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary to the Treasury

I do not know whether I am convinced but, in the interest of time, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 42 agreed to.

Clauses 198 and 199 ordered to stand part of the Bill.