Clause 51 - Use of different accounting practices

Finance Bill – in a Public Bill Committee at 10:15 am on 13th May 2004.

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Photo of John Butterfill John Butterfill Conservative, Bournemouth West

With this it will be convenient to discuss amendment No. 97, in

clause 51, page 58, line 14, at end insert

', and

(e) the sole or main benefit of the transaction or the series of transactions was the obtaining of the tax advantage.'.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury

Hon. Members have raised one or two technical issues. Once international accounting standards—IAS—are in force, companies will be required to prepare consolidated accounts, and hence the accounts of the holding company, under IAS. However, they may choose to continue to prepare UK generally accepted accounting practice—GAAP—accounts for some or all subsidiaries. They may well choose to do that for non-tax reasons, such as the level of work involved.

The clause is broadly welcomed by business. It is seen as the inevitable price of allowing companies a free choice to use GAAP at solo company level—a sort of burden on business. The clause applies a mechanical test to determine whether a transaction between two companies that use different accounting practices should be adjusted for tax purposes. I believe that the Revenue has already been asked to explain why the test should not be whether there are genuine commercial reasons for the adoption of different accounting practices.

The clause is a necessary response to the decision to allow companies the choice to use GAAP at a solo level, but it has been pointed out that it could have been better drafted. Where it applies, it forces a company using IAS back on to UK GAAP for tax purposes if a tax advantage would otherwise be obtained. There is no motive test, so the taxpayer gets the worst of both worlds. For example, suppose that two group companies undertake a derivative transaction and accruals are accounted by one company under UK GAAP, but marked to market by the other under IAS. If the difference produces a tax disadvantage, it stands, but if it produces an advantage, it is cancelled by forcing the second company on to UK GAAP.

It has been argued that that aspect could be removed by introducing a test that the advantage had to be one of the main foreseeable benefits when the transaction was implemented. That is what we seek to do with the amendments.

The point has also been made that, although what I have just described is unfair on the innocent, the measures are potentially weak against a determined avoider, as they apply only between two companies in the same capital gains tax group. They could be de-grouped quite easily while remaining under the same effective ownership and control. The arrangement leaves out an intra-IAS arbitrage opportunity deriving from clause 50(3) and applies only to transactions or series of transactions, not to companies with different existing profiles, which can be used as the basis for arbitrage.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford 10:30 am, 13th May 2004

On a point of order, Sir John. I should be grateful for your guidance about whether this is one

of those occasions on which you intend the substantive discussion of the purpose of the clause to take place under the heading of the amendment. I have been listening to my hon. Friend carefully and his amendment goes to the heart of the purpose of the clause. Alternatively, do you intend that there should be a clause stand part debate?

Photo of John Butterfill John Butterfill Conservative, Bournemouth West

I do not think that the hon. Member for Arundel and South Downs strayed particularly wide, in his remarks, of amendments Nos. 96 and 97, although those do, as the hon. Gentleman suggests, go to the heart of clause 51. I am perfectly happy, if the Committee wishes, to allow remarks on the amendments to be extended a little further, on the basis that we shall then have no stand part debate. I see nods of assent, so we shall proceed on that basis.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

Thank you, Sir John.

First, I apologise, because last week—purely as a result of a slip in memory—I did not, as I did on Second Reading, declare my interests, in so far as they might be considered relevant to the Finance Bill. I am, and have been for a number of years, an adviser to the Chartered Institute of Taxation. The institute of course has no position on or interest in any particular tax measure, but nevertheless I should declare that interest.

I am also a director of Vinci—both the main board, Vinci SA, and the UK subsidiary, Vinci plc. As a result I shall not be making any contribution on matters relating to the construction industry, which we shall reach shortly. I am also a member of the council to the governing board of Lloyd's, so I shall have to restrain my intellectual interest in that subject too, when we get to it. I have no interest as an underwriter—I am not and never have been a name.

The clause is interesting in several ways. As my hon. Friend the Member for Arundel and South Downs explained, it has the curious effect that, although the Government have introduced legislation—following a European directive—giving non-listed companies the option of moving to IAS or staying with GAAP, there is clearly, in this case, a one-way bet in favour of the Revenue. If the option is exercised so that within a group of companies a tax advantage might arise, the clause will override it; if it is exercised so that a tax disadvantage arises to a company, the tax disadvantage remains. That is a slightly curious state of affairs.

What I have described highlights the artificiality of tax accounting in this country. That is a very wide subject, which I am sure the House should have an opportunity to debate—not this morning, of course. It is clearly at the heart of the economic impact of the tax system in this country. The system is in many cases perverse and I remind the Committee that other EU countries—Germany, for example, which is a very sophisticated economy—base their tax accounting on normal accounting standards. For a long time, and before the introduction of IAS, German companies have been expected to present to the tax office—Finanzamt, in their case—exactly the same accounts as they present to their shareholders. Those accounts are based on accounting principles, which are taken,

expected, hoped and intended to be principles that follow economic reality as far as possible, because that is the object of good accounting.

That system is an enormous advantage, whereas in this country we continue to have the absurd artificiality in which people must produce completely separate accounts on a completely different basis for the tax system, which has nothing to do with economic reality. Now we have an even greater anomaly whereby, even if people present accounts using an option allowed under accounting law, they can be left at a disadvantage if a disadvantage arises, and without any benefit if some benefit arises. There is no doubt that it is an anomalous and curious situation.

I have two questions for the Paymaster General, which need to be answered before the Committee takes a decision on the clause. One is about a practical consequence and the other is a matter of interpretation on something that I do not understand. I hope that when I have heard the explanation in a few minutes I shall do.

First, what is to stop companies getting round the clause by de-grouping for capital gains tax purposes? It is perfectly possible and not difficult, and they would get the benefit—if there was a tax benefit to be obtained—of exercising the options of GAAP and IAS. Are the Government wasting their time drafting the clause? In practice, is it not true that if a group of companies could obtain a tax advantage by exercising that option, they would simply de-group to do so?

Secondly, there is a question of interpretation of the text.

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

There could be considerable tax difficulties if the companies de-grouped and held-over, roll-over or inter-group gains were brought into charge.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

Certainly. A company faced with the application of this clause to its tax affairs would have to take a view on balance of its aggregate tax position and the extent to which that position would be improved by exercising the options of whether to move to IAS or stay with GAAP and whether to stay grouped or to de-group. It would have to take a rational decision.

Companies have a responsibility to their shareholders to take a rational decision in light of any change in the law. The provision will constitute a change in tax law that might be very material to them. The hon. Gentleman is absolutely right: they will have to take those other considerations into account.

The existence of the option will negate the impact or the benefit to the Revenue, which is presumably the purpose of loading already extremely complicated Finance Acts with this new provision. We ought to hear the Paymaster General's response to that.

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

I am getting at the fact that the ability to circumvent the clause will be very limited. It is wrong in principle that the Revenue gets both ends of the stick and a hunk out of the middle. Does the hon. Gentleman agree with that?

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

Yes, I totally agree. There is far too much of that one-sided drafting in Finance Acts, and

the hon. Gentleman and I are at one in questioning the good sense of introducing the clause. A transformation cannot take place overnight, but if I were ever in a position to influence matters I would want to move in this direction: our tax law should be gradually aligned with economic reality.

Where we introduce IAS—an extremely good move—compulsorily for listed companies, and voluntarily for other companies, which is right because we do not want to impose additional compliance burdens on the broad mass of companies in this country, and the move to IAS should be evolutionary not revolutionary, we should allow companies to benefit from an increasingly rational accounting system.

Companies should be taxed on real economic profits and not on artificial profits computed by the Revenue—or compulsorily computed by companies for the benefit for the Revenue—on the basis of what is, as I have said, an artificial system. I make it clear that that is my agenda. It seems to me from the body language that I am not alone in the Committee in feeling that way. I am reassured that that is the case.

This is a matter of pure interpretation, and I may be being extremely stupid about it, which the Paymaster General will enjoy telling me if that is the case, but I must assume that I am not alone among the 56 million people in this country who may be affected by tax law at some stage in finding the clause difficult to understand. I refer to subsection (4), which says:

''A series of transactions is not prevented from being a series of transactions involving company A and company B by reason only of the fact that one or more of the following is the case—

(a) there is no transaction in the series to which both those companies are parties''.

That is reasonable. It may well be, if only one of the relevant companies in a group is a party to a transaction, but not the other, that some tax benefit is generated.

The subsection continues:

''(b) that parties to any arrangement in pursuance of which the transactions in the series are entered into do not include one or both of those companies''.

That is most extraordinary. In other words, there could be a transaction not involving either of those group companies, or any company in that group, that would give rise to a tax charge. That must be an absurdity. The Paymaster General is about to tell me that I am being stupid and have misunderstood the clause, but I repeat that it says:

''A series of transactions is not prevented from being''

taxable in that way, or having the clause applied to it, even if neither of the companies involved has been a party to that transaction. That seems to me most extraordinary and I hope that the Economic Secretary can clarify.

Photo of John Healey John Healey The Economic Secretary to the Treasury

I welcome the fact that the hon. Member for Arundel and South Downs has confirmed that the clause is broadly welcomed by the industry. I am aware of the concerns that he raises about its being too wide. Amendments Nos. 96 and 97 reflect those

worries. I say to him that it is not as wide as it looks or as weak as he fears.

I turn to the points that the hon. Gentleman and the hon. Member for Grantham and Stamford (Mr. Davies) raised about the provisions being potentially weak. The concern was that they might allow companies to de-group while remaining under the same ownership and control. Our view is that it is unlikely that companies would de-group simply to exploit any benefit that might arise from using both the IAS and the UK GAAP, because any such rearrangement might have other, possibly disadvantageous, tax consequences in the first place. In any event, UK GAAP will soon be converging with the IAS, making any possible benefit from de-grouping potentially expensive and certainly short-lived.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

The Economic Secretary has made two comments that I must take him up on. One is that he thinks it unlikely that companies would de-group, because they might have other reasons not to do so. That is precisely the point already put to me by the hon. Member for Torridge and West Devon. I have already answered it.

The second point is a particularly curious one, because if it is true that, since everybody is moving rapidly to IAS, it is very unlikely that the situation will arise that there could be a profitable arbitrage to be made by deciding to remain on GAAP, rather than moving to IAS, the clause is not necessary. The Economic Secretary produces a good argument for saving the public from this additional burden of tax legislation. If he believes his own argument, that the opportunity for such tax arbitrage and tax shopping-around is going to be limited in time, why is he introducing the clause in the first place? If his argument is an argument against mine, it is even more strongly one against his own.

Photo of John Healey John Healey The Economic Secretary to the Treasury 10:45 am, 13th May 2004

The move to international accounting standards is supported across the board by Government and by industry. We are in a transitionary phase, and the clause is necessary to manage that. The answer to the hon. Gentleman's question about de-grouping is that the phase is likely to be brief. Any relative tax advantage that might be gained by using the two standards will be short-lived. The situation that he and the hon. Member for Arundel and South Downs fear is unlikely to arise.

Photo of Michael Jack Michael Jack Conservative, Fylde

On a point of detail, would the Economic Secretary touch on the phenomenon of a company that, as a result of these provisions, gains an advantage in one tax area that is cancelled out in another? Does the clause apply?

Photo of John Healey John Healey The Economic Secretary to the Treasury

The short answer is no. The clause would not apply in such circumstances.

I turn to the other concerns that the amendments address. For the clause to apply, the disparity in treatment of the transaction has to be as a result of the use of the two different accounting frameworks—IAS for one company and UK GAAP for the other. An

example that is often given is the one cited by the hon. Member for Arundel and South Downs—one company uses mark-to-market or fair value accounting for its end of transaction, such as a loan, and the other uses cost accounting. The difference exists under current UK GAAP and within IAS. It is not caught by the clause. The cases in which IAS and UK GAAP provide a clear difference in accounting treatment of the same transaction are difficult to find. In many ways the legislation is a backstop in case such differences emerge.

Amendment No. 97 would create another hurdle that had to be climbed before the clause could operate. It requires that the sole or main benefit of the transaction is the obtaining of the tax advantage. However, the obtaining of a tax advantage from the transaction is not the problem: the mischief comes from the obtaining of a tax advantage from the different accounting treatment of each end of the transaction. The amendment technically misfires. On that basis, I hope that the hon. Gentleman will not insist on it.

More generally, may I give some words of comfort to the Committee? The Inland Revenue's guidance on the clause will make it clear when and in what circumstances it expects the test to operate. The guidance will be developed through further discussion with the industry and professional interests, as part of the consultation group and process that the Revenue has established.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

May I remind the Economic Secretary that I asked him another question that he has not answered? Can he explain the meaning of subsection (4)? As I understand it, it has the perverse effect that companies could be made liable for tax in relation to a transaction to which they are not party. I might own a group of companies, none of which is involved in a transaction, but become liable for tax because a company owned by you, Sir John, undertakes a transaction. That would be absurd, but the Economic Secretary has not explained how the wording of the subsection does not give rise to that interpretation.

Photo of John Healey John Healey The Economic Secretary to the Treasury

The wording in subsection (4) is the standard wording that is used in transfer pricing. Transfer pricing was thoroughly discussed under another part of the Bill.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury

For a brief period, I was a director of a company that adopted IAS. I thought that it was a disastrous way of communicating information to shareholders. It added some 10 pages of notes to the accounts because of the need to explain to people how they could relate the figures that emerged under IAS to the format that they were generally used to. I agree that the accounting profession and many others welcome the introduction of IAS and some of the principles behind it, but many aspects of it are less than helpful to an understanding of what is going on in a business.

I am slightly out of my depth in these matters as I am not an accountant, but it seems to me that the Minister is endeavouring to say that the scenario that concerns me, as well as many others, is pretty unlikely

to arise, and that the amendments, which might go too far in the other direction, are not justified. I am not entirely clear whether he is also saying that if the situation that I describe were to arise, the intent is that the Inland Revenue guidance should deal with the issue to stop the undesirable double taxation-type effects to which I referred. If he is saying that, there is clearly no need for amendments. If he is not saying that, it is unsatisfactory to put into law a situation of considerable unfairness that may be unlikely but that could, in rare circumstances, come to be.

Before I make my final comments on the amendments, I would be grateful if the Minister could clarify his remarks about the Inland Revenue guidance.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

I was very unsatisfied by the Minister's reply to me about subsection (4). He did not attempt to defend his wording, and did not give the Committee any explanation. Nor did he tell me why my interpretation was wrong. He merely said that the wording replicated the wording somewhere else in tax legislation. I presume that when we come to that wording, we shall be told that we cannot discuss it because it appears in section 170 of the Taxation of Chargeable Gains Act 1992 as amended by the clause. We are going round in circles, with the Government avoiding their fundamental responsibility to explain the rationale behind the wording to the Committee and to the public. I explained why I believe that the wording is susceptible to an extremely perverse interpretation. Indeed, a very perverse understanding of it is the natural reading of the words. I repeat my question: will he explain why the words that I quoted do not bear the interpretation that they appear to have?

Photo of John Healey John Healey The Economic Secretary to the Treasury

The rationale is simply that the wording in subsection (4) is the standard wording used in the transfer pricing provisions, which the Committee discussed in full at an earlier sitting that the hon. Gentleman unfortunately did not attend. Had he done so, he might not have needed to raise this point.

On the narrow and more serious point made by the hon. Member for Arundel and South Downs, his concerns have been raised by others involved in the consultation that the Revenue set up through the consultative groups. We will take account of those concerns. Indeed, the guidance that we will publish following the Committee's deliberations can deal with them.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury

I am sad that the concerns expressed by my hon. Friend the Member for Grantham and Stamford have still not been specifically addressed, but I am glad that the Minister has confirmed that the issue that we raise will be dealt with. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendment made: No. 89, in

clause 51, page 58, line 12, leave out 'paragraph' and insert 'section'.—[John Healey.]

Clause 51, as amended, ordered to stand part of the Bill.