Clause 30 - Provision not at arm's length: transactions between UK taxpayers

Finance Bill – in a Public Bill Committee at 10:45 am on 11th May 2004.

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Question proposed, That the clause stand part of the Bill.

Photo of Mark Prisk Mark Prisk Shadow Paymaster General

We come now to the important, if not easily comprehensible, issue of transfer pricing and thin capitalisation. Clause 30 and schedule 5 change the way in which prices are set between associated businesses for transactions within the United Kingdom. The clause will require arm's-length pricing, and the whole process, of course, will have to be supported by extensive documentation. Committee members will immediately recognise—as I am sure do you, Mr. McWilliam—that that represents, potentially, a huge compliance burden. Given the complexity of UK-UK transfer pricing, I shall give some examples to illustrate my point.

Let us consider head office costs. Most groups of companies do not make arrangements for each and every transaction or transfer between companies to be priced in the manner required by the legislation, so there will be significant change there, in terms of recharging. UK groups often find that it is easier not to charge interest on intra-group loans; or, at least, if they do charge interest, there is no need to charge at market rates. That will have to change because of the clause. Committee members will realise that it could have a significant adverse effect if loans have to be charged on an arm's-length basis within groups, as is required in this and subsequent clauses.

Another example—and a problem that is particularly difficult to resolve—is that of intellectual property. Companies may have to value their intellectual property and start charging royalties to UK-group companies for that use. We can all think of a number of market sectors in which that will be particularly relevant. Examples include oil and gas, and the pharmaceutical industry.

The Chairman's attention having been called to the fact that eleven Members were not present, he suspended the proceedings.

Other Members having come into the Room and eleven Members being present, the proceedings were resumed.

Photo of Mark Prisk Mark Prisk Shadow Paymaster General 12:00 pm, 11th May 2004

One could get a complex. The moment one starts to talk about UK-UK transfer pricing and thin capitalisation, Committee members' attention wanders.

Photo of Steve Pound Steve Pound Labour, Ealing North

So does the Committee.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

Provided that my attention does not wander, we will be all right.

Photo of Mark Prisk Mark Prisk Shadow Paymaster General

Thank you, Mr. McWilliam. I have no doubt that there will be a lengthy and, as always, intellectual discourse on the issue from the hon. Member for Ealing, North.

The hon. Gentleman's attention, and that of the Committee, has been grasped by the question of intellectual property. Companies face the possibility of needing to value their intellectual property and therefore of starting to charge the respective royalties to companies in the group. I tried to refer to that question in relation to the oil, gas and pharmaceutical industries.

To take an example from my constituency area, we have an outstanding research and development facility in the GlaxoSmithKline operation at Ware. In Hertfordshire, and in Harlow in neighbouring Essex, there is a number of related companies within the group.

As we can imagine, one of the problems is the complexity of trying to value the intellectual property developed at the company based in Ware, and establishing whether as an organisation it needs to charge royalties to the other companies for that development and assessment. That is one of industry's worries. Hopefully, the Minister will be able to put minds at rest.

Head office costs, intra-group loans and intellectual property are just three potential elements of a significant compliance burdens that the clause would seek to impose. Therefore, we are talking not simply about another set of files, a little more paperwork or an adjustment to a software program but, possibly, for many organisations, the need to reorganise their structure or to restructure financially how they operate.

Photo of Mr John Burnett Mr John Burnett Shadow Minister, Home Affairs, Shadow Solicitor General, Law Officers (Constitutional Affairs)

I do not want to be unhelpful, but I hope that the hon. Gentleman will deprecate artificial transactions—transactions that artificially invest intellectual property in low tax regime countries.

Photo of Mark Prisk Mark Prisk Shadow Paymaster General

I am grateful to the hon. Gentleman but that is not the point that we are examining, which is whether the new arrangements in the clause would force organisations to make that change. I understand the situation elsewhere, but the question is whether there is a compliance burden that would otherwise not be expected. That is the essence of my concern.

Photo of Mr John Burnett Mr John Burnett Shadow Minister, Home Affairs, Shadow Solicitor General, Law Officers (Constitutional Affairs)

I take the point that without anti-avoidance provisions on transfer pricing we could have severe leaching, or loss, which is the word that I should use, of tax revenue. The hon. Gentleman is right on the

nail when he talks about bureaucracy and if I am fortunate enough to catch your eye, Mr. McWilliam, I will say a few words on that point as well.

Photo of Mark Prisk Mark Prisk Shadow Paymaster General

I am grateful to the hon. Gentleman. Just when we thought that his smooth tongue was about to ingratiate himself with all of us, he moves us on to a different aspect of his scrutiny capabilities. He is right to highlight the fact that there is a danger of leaching and I will discuss that in a moment.

At the heart of my first point is the potential compliance burden that is a consequence of the change in this clause and related ones. That is why the policy has met with quite a lot of concern among the business community. I fully accept that the Government have made some useful concessions. However, many experts, including the Confederation of British Industry, feel that business needs more time in terms of implementation. I will quote one leading expert in the field. Mr. Steve Hasson, who is the head of transfer pricing at PricewaterhouseCoopers, said:

''It's understandable that the Government wants to put its house in order, but one has to question why they have to put so much pressure on business in such a short timescale. Our clients have voiced their opinion—over 50% would like to see the start date delayed by more than a year.''

That was based on a quite detailed survey of that company's clients in January.

It seems peculiar that companies are being required to produce documentation that would not have been required for any commercial reason. Yet, in many cases, although not all, there may be no additional UK tax at stake. The clauses represent a big administrative outlay and some businesses will ask the question: for what purpose?

I am sure that the Committee will wish to consider the background to that, which is the Inland Revenue's concern about the possible implications for the sustainability of UK tax law following the decision in the Lankhorst v. Hohorst case at the European Court of Justice. Many experts have informed me, both from the taxation and from the legal point of view, that the Inland Revenue has been advised that it would not be possible to return to what I think is termed a direction base regime without the threat of action for non-compliance with EU law at the ECJ.

Will the Paymaster General tell the Committee what her understanding is of such a potential challenge? Is she certain that the proposed changes in this and the related clauses, and in schedule 5, and their implementation will not also be open to challenge? There seems to be considerable expert opinion that devising something that is not open to challenge will be extremely difficult. Obviously, the key element is the question of discrimination. I am sure that she will want to respond.

Many representative bodies have highlighted that the United Kingdom's approach is the equivalent of what I believe is termed downward harmonisation. I refer briefly to the view of the Institute of Chartered Accountants:

''Our concern is that this will reduce the competitiveness of the UK and is not consistent with the stated EU Lisbon Agenda''—

on which the Chancellor is keen—

''which is to create in Europe the most dynamic knowledge-based economy in the world by 2010.''

The Confederation of British Industry stated in a briefing that it supplied to members of the Committee that it is

''very concerned that the measures on transfer pricing and thin capitalisation are being taken forward too quickly, and in isolation from other aspects of the corporation tax system such as group relief which are similarly potentially subject to intervention by the ECJ.''

The CBI goes on to an important related point:

''As the issues arising from ECJ decisions are so inter-related, it would have been much better to take more time to devise a coherent holistic approach to addressing incompatibilities between the UK corporation tax and the EU treaties.''

It then deals with other aspects, but I shall not stretch your patience too much with the broader questions, Mr. McWilliam.

The point is that other EU countries have taken different approaches, some of which have merit, some of which do not. Spain, for example, has chosen to disapply its thin capitalisation and related provisions for all intra-EU transactions. Can the Paymaster General explain her Department's views on alternative approaches? That would help inform us as to the basis, or the foundation, of the clause.

Photo of Mr John Burnett Mr John Burnett Shadow Minister, Home Affairs, Shadow Solicitor General, Law Officers (Constitutional Affairs)

I do not want to make too contentious a point. Nevertheless, I noted the comments in briefings on the Bill about the attitude of the Spanish. I am concerned that that approach, if adopted, would accelerate the trend to European Union tax harmonisation, which I would personally deprecate. In addition, does the hon. Gentleman agree that courts would give some weight to the steps taken by the Spanish Government and that EU courts are already encroaching far too much, especially on our corporation tax?

Photo of Mark Prisk Mark Prisk Shadow Paymaster General

I can understand why the hon. Member for Torridge and West Devon is not with his leader at his party's launch of its European election campaign today.

Photo of Mark Prisk Mark Prisk Shadow Paymaster General

I am sure that the Committee will note those last two words, ''Certainly not''.

I share the hon. Gentleman's concern about the danger of leaching, which leads to my next point. Conservatives—and, evidently, some Liberal Democrats—recognise the natural wish of the Treasury to maintain national sovereign control over our tax base. However, significant compliance burdens are being created in the clause and elsewhere. We have therefore tabled amendments that seek to relieve those burdens.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

Order. May I just bring the Committee's attention to the fact that the provision in clause 30 is purely for transactions between UK taxpayers, not Spanish taxpayers or any other variety?

Photo of Mark Prisk Mark Prisk Shadow Paymaster General

I am grateful to you, Mr. McWilliam, for reminding us of that. I am sure that the Paymaster General will follow your guidance, as I intend to.

Conservative Members are concerned about the piecemeal way in which the Government are dealing with the anomaly for UK transfers, which has been drawn forward by the case to which I referred. The worry is that no real strategy underpins their approach. In essence, our concern is that, although it is important to control any potential leaching, it is also important that the Government are able to respond to outside legal challenges through the changes in the Bill and that undue burdens are not placed on business. I look forward to the Paymaster General's response to those points.

Photo of Mr John Burnett Mr John Burnett Shadow Minister, Home Affairs, Shadow Solicitor General, Law Officers (Constitutional Affairs) 11:15 am, 11th May 2004

I do not want to detain the Committee too long or steal the thunder of the hon. Member for Ealing, North.

What I am concerned about—and what should concern the entire Committee—is that the clause will cause considerable additional bureaucracy with no apparent gain for the Exchequer. The new rules will place a huge compliance burden on larger UK companies, which will be required to maintain transfer pricing documentation for transactions with other UK companies. There will be little or no benefit to the Exchequer, so I ask the Paymaster General to answer the simple question: why are these steps being taken? Why are additional burdens being imposed on our larger companies?

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

May I start by making a couple of general points about the changes which were made by the hon. Members for Torridge and West Devon and for Hertford and Stortford? I shall state our position from the outset. The hon. Member for Hertford and Stortford implied—nay asserted—that this was something that the Government were rushing to do. However, we need to set the matter in the context of what business has been saying and doing as a result of what, it believed, produced uncertainty in the operation of transfer and, in particular, thin capitalisation.

The Government are confident that our existing rules can and will be defended. They are consistent with internationally accepted principles of taxation, as promoted by the Organisation for Economic Co-operation and Development and reflected in the United Kingdom's bilateral treaties. We will continue to defend UK law against challenges in the courts. However, business tells us that there is uncertainty in the taxation position. That results from recent decisions in the European Court of Justice, and the interaction of those principles with European law—the hon. Gentleman referred to the Lankhorst case.

The uncertainty is such that many companies are at present actively keeping past tax computations open. The Government, not unreasonably, want to ensure that the corporation taxation system is robust and gives business certainty. Let us be clear therefore that the starting point is the interaction of certain judgments, business's perception of those interactions and consequent uncertainty leading to many companies leaving their tax affairs open or pursuing litigation. The Government are trying, in extensive consultation with business, to ensure that the taxation

system is robust and gives business certainty, which it says it does not have at the moment. That is all underpinned by the Government assertion that our system is defendable.

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

May I dispose of the Spanish issue before I give way to the hon. Gentleman?

I assume that the hon. Gentleman was drawing a comparison, but it was not a good one to draw because Spain already applies transfer pricing to domestic legislation. It has also made some other changes that we do not think appropriate; nor did business when we consulted it. What we have is widely accepted. We will come on to discuss the counterbalancing measures in the management expenses. Business identified uncertainty and wanted that clarified, but no organisations or representatives came forward with suggestions on how we could move back to a position of certainty in any other way.

I want to make sure that this is understood: the changes set aside clearly, once and for all, the uncertainty about the compatibility of transfer price and thin capitalisation laws with European law. It is a specific problem that business has described to us and it is the reason for the changes.

Photo of Mark Prisk Mark Prisk Shadow Paymaster General

The Paymaster General is right. The whole purpose of raising the question of the Spanish approach was to try to identify and shade in the thinking behind the Government's decision. Certainly we would not wish to pursue the matter. I come back to the awkward question of discrimination, which is central to whether the clause will work or whether it can be challenged again. Can she confirm the thinking behind the clause and its compliance with EU law, so that we can understand her confidence that it will not be open to challenge?

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

That is appropriate. Having dealt with the general points that both hon. Gentlemen made in their contributions, I want to move to the clause, its provisions and the subsequent clauses to which the hon. Member for Hertford and Stortford referred in his opening remarks.

Photo of Mr John Burnett Mr John Burnett Shadow Minister, Home Affairs, Shadow Solicitor General, Law Officers (Constitutional Affairs)

It is beyond my comprehension that a transaction within the UK should be recorded. Perhaps the right hon. Lady can explain the logic because it escapes me. Cannot large companies operate under the medium-sized company regime?

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

That difficulty arises because clauses 30 to 37 pick up each of the different points that have been identified, be that securitisation or the role of small and medium-sized companies and whether they require transfers within groups. All those matters are dealt with as we progress through the clauses. I have noted the hon. Gentleman's point, and I am sure that he will make it again on the relevant clause. Certainly I want to make it clear as we progress through these clauses that the Government are taking all possible steps and will require consultation with business.

Finally, I stress to the Committee the fact that groups can adopt arm's-length principles. There is no need to restructure; it is not a requirement. Some may choose to do so. The hon. Member for Hertford and Stortford mentioned companies in his constituency. Companies are already trading across borders. They are already coping with the operation of transfer pricing and the arm's-length principle. They use it daily in running their businesses within their groups of companies both in the UK and across borders.

The Committee must keep focused on the principles of transfer pricing and why they need to be arm's length. This is not about investment, but about profit and where it occurs. It is a very compact set of principles, internationally accepted and well operated by the UK. They are principles that can be established on a UK-to-UK business, but we need exceptions and we need to assist small and medium-sized companies. I will return to that when we resume this afternoon.

It being twenty-five minutes past Eleven o'clock, The Chairman adjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Two o'clock.