I beg to move amendment No. 12, in
clause 34, page 35, line 29, at end insert—
'(fa) in sub-paragraph (4)(c) after ''would apart from section 84A(2) to (10) of this Act'' insert ''and disregarding any adjustment which might otherwise arise under the provisions of this paragraph''.'.
This is a probing amendment to deal with an anomaly concerning intra-group loans. It was tabled with the support of both the Law Society and the Chartered Institute of Taxation. The effect of subsection (4), which is an integral part of the clause, is that, when an intra-group loan is made on an interest-free basis, no exchange gains or losses will be disregarded on the debtor or creditor loan relationship. In many people's opinion, that does not go far enough, because it does not deal with cases in which an intra-group loan is advanced on interest-bearing terms to enable the borrower to obtain the benefit of matching treatment.
When the loan is treated as matched in such circumstances, there is nothing to prevent all or some of the exchange gains or losses from being ignored for tax purposes. Paragraph 11A(4)(c) and (5)(c) of schedule 9 to the Finance Act 1996 currently provides that no adjustment would arise on the exchange gains or losses when—this is the important point—there is a corresponding debt loan relationship and exchanged gains and losses are taken into account.
In plain English, the problem arises when the borrowing exceeds the amount that the borrower could have borrowed if it were dealing at arm's length and the loan were interest bearing. In those cases, but for matching treatment, an adjustment would arise on the borrower by virtue of the amended provisions in paragraph 11A(4)(c) and (5)(c). There is nothing to prevent an adjustment from arising under that paragraph. The danger is that that would leave the lender of the intra-group loan exposed to tax on, for example, exchange movements when it borrows in a foreign currency and on-lends an equivalent amount in foreign currency to a thinly capitalised UK subsidiary in order to finance the acquisition of that subsidiary.
The amendment is designed to draw from the Paymaster General the reasoning behind the
Government's decision and to deal with the anomaly that I have tried to explain. It is a complex issue and relates to different parts of legislation. It matters simply because many UK companies are increasingly and regularly investing overseas. The purpose of the amendment is to remove the anomaly that could prove to be a barrier to that. I hope that the Paymaster General can enlighten us on the thinking that the Government have applied to the measure.
I certainly do not want the hon. Gentleman to labour under any misunderstandings about the Government's approach to matching. We agree with him that the matching principle for exchange gains and losses should be preserved. To see that, he need look only at the Finance Act 2002, in which the Government strengthened the matching rules to allow more assets to be matched. We included in that Act paragraph 11A of schedule 9 to the Finance Act 1996 to ensure that transfer pricing and thin capitalisation considerations did not prevent matching from working. The matching arrangements that we are dealing with, and which his party introduced in 1993, are about interest-free loans between two companies in the same group. Our changes in 2002 preserved those arrangements, and nothing in the Bill or the transfer pricing proposals changes any of that.
The Inland Revenue has been asked about this issue repeatedly and has published guidance on its website. It has explained the position to the firms that have asked, and the position is clear. If the loan is interest-free, there is no change. If interest is charged on the loan at the arm's-length rate, there is no change. Only if for some reason interest is charged at an excessive rate might there be an issue. That was the case under the thin capitalisation rules, too. We are dealing with a clause that is taking out thin capitalisation and putting the same arrangements within transfer pricing.
I hope that, with all those assurances, the hon. Gentleman will see that the amendment is unnecessary, because the matter is dealt with to ensure that groups are still able to match.
The thin capitalisation rules disallowed excessive interest paid between companies in the same group if the amount of the loan exceeded the amount that could have been borrowed from an unconnected lender, or if the rate of interest were too high. Those rules have been in operation for some time, and companies' understanding of what is meant by ''excessive'' will still apply. Even if interest is charged at an excessive rate within the understood operation of the thin capitalisation rules, if the group as a whole could have coped with that amount of interest, the guaranteed rules that we have introduced may apply to remove the problem. Nothing really changes. The position is the same as it would have been under the thin capitalisation proposals. The
clause puts in place within transfer pricing the ability to deal with such loans.
It is a double-edged sword. I just wonder whether the Paymaster General will put on the record the fact that, presumably, if the matching rules are breached or if matching is not permitted for the reasons that she has set out, and if there are exchange rate losses rather than gains, they can be set against corporation tax.
The hon. Gentleman tempts me into the incredibly complex area of transfer pricing. I want to focus his attention on the provisions in the clause, which will enable the group to match transactions so that its exchange gains and losses cancel each other. The rules work perfectly well now and will work perfectly well in the new environment of UK-UK transfer pricing if interest-free loans are involved. The Government sought to make no changes in their operation. I shall reflect on the issue that he raised in the more detailed question and perhaps, with your leave, Sir John, write to him and to other members of the Committee if I feel that I have not given a complete answer.
Would the hon. Gentleman also be interested in knowing the answer to the question that I asked on exchange rate losses being set against corporation tax?
I am not entirely sure whether I should comment on that intervention. Clearly, there is a web of relationships into which it would be better for us not to pry further. As I was about to say, given the discussion—indeed, the exchange—I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
Question proposed, That the clause stand part of the Bill.
The clause deals with thin capitalisation and how it is incorporated in general transfer pricing requirements. We discussed under earlier clauses some of the broader issues that affect both transfer pricing and thin capitalisation, but there are a few points for clarification and information that may be helpful to the Committee, if the Minister can assist. The Institute of Chartered Accountants, among others, asked why in subsection (3) no account is taken of a guarantee if the guarantee is made on commercial terms; that is, the guarantor receives a fee in the same way that a bank might. Was that an intentional change, or does the Paymaster General recognise that it is an oversight? If it is an oversight, does she intend to amend it at a later stage?
Several legal experts have asked about the possibility for elections to be made prior to the submission of corporate tax returns. The Paymaster
General may wish to reflect on that after our deliberations. Such a change would enable rating agencies to rate the issuing company on the same basis as the election. I believe that we all appreciate the important role that rating agencies play and therefore that when they undertake their task they should be able to make their consideration on the same basis as an impending election for an issuing company.
There are some problems with inconsistent language in subsection (3) on page 33. There is a reference to ''security'' on line 5 of new paragraph 1A but to ''the loan'' on line 9. The language is inconsistent. Some people would argue that the word ''security'' is inappropriate. Some outside experts have suggested that ''money debt'' might be a more appropriate phrase; I confess that that area is on the very edge of my understanding. I am led to understand that that is an important distinction, so perhaps the Minister could clarify that.
Lastly, I turn to subsection (4), on page 33. I shall not detain the Committee by reading out the relevant sub-paragraph at length—[Interruption.] Well, I may be tempted. The problem is that it is unclear generally, but there is a particular, important aspect of its lack of clarity, and that is whether it is concerned with a single company or a sub-group. I am sure that the Committee would appreciate it if the Minister could clarify that.
First, perhaps the questions of early election before a return is submitted would be more appropriately dealt with on clause 36, which has to do with elections. I think that we shall find it easier to deal with the matter in that context, and I am happy to come back to it.
The hon. Gentleman asked whether the guarantor receives the same fee. That would undermine the effect of the thin capitalisation rule. A foreign-owned company could support a large amount of debt in a UK subsidiary through a guarantee, and the role of the thin capitalisation rule is to restrict interest deduction in line with the debt that the borrower could support through its own income and assets, not those of the entire group. The clause makes changes to the thin capitalisation rules that run parallel with the changes made to transfer pricing. The existing thin capitalisation rule is repealed and its equivalent is brought into the main transfer pricing framework. Consequently, as for other aspects of transfer pricing, the rules will apply to transactions wholly within the UK.
Thin capitalisation rules deal with a particular aspect of transfer pricing. As we discussed earlier, they exist to prevent companies from reducing taxable profits unfairly by means of excessive interest deductions. To do that, they deny interest deductions on loans to the extent that they exceed the amount that the company would borrow from, or would have paid in interest to, an unconnected lender. That approach is consistent with the arm's-length principle that forms the basis for transfer pricing legislation and bilateral tax treaties. It is therefore appropriate that thin capitalisation should be dealt with alongside transfer
pricing and to do that, the clause introduces two new paragraphs to the transfer pricing rules.
Those changes have been made following intensive consultation. Many features of the legislation follow directly from representations made during that process, and I am grateful to those who participated. In particular, there is a special rule to give a compensation adjustment to a loan guarantor, in clause 35, and a special rule to meet the particular needs of securitisations, which the hon. Gentleman touched on, in clause 36.
The loan guarantee rule provides a strong and necessary defence against dumping of excessive debt in the UK. At the same time, the compensating adjustment rule for loan guarantors ensures fairness and allows existing financial structures to remain undisturbed. For inward investment, it will ensure that all UK assets and income are taken into account in the determination. The clause is fairly based on practices, so I hope that I have dealt with the hon. Gentleman's queries. Perhaps we can pick up on his other points as we move onto clauses 35 and 36.
Question put and agreed to.
Clause 34 ordered to stand part of the Bill.