With this it will be convenient to discuss amendment No. 66, in schedule 6, page 115, line 11, after ‘2006’, insert—
‘but where either the predecessor or the successor has no principal company as therein provided (because it is itself a principal company) it shall be deemed for the purposes of this section to be its own principal company’.
The provisions in clause 30 and schedule 6 are largely uncontroversial, as are a number of the matters that we will look at this afternoon. The two exceptions to that are highlighted in amendments Nos. 67 and 66. They would make changes to the definitions in proposed new section 343A of the Income and Corporation Taxes Act 1988, which concerns company reconstructions involving a business leasing plant or machinery.
Amendment No. 66 relates to the definition of the concept of the “principal company” contained in proposed new section 343A. The measure is designed to prevent companies from undermining the provisions in schedule 10 to the Finance Act 2006. Hon. Members may recall the debate on that—it dealt with avoidance involving the sale of leasing businesses. The schedule aims to counter a scheme that sought to use the tax-neutral transfer provisions in section 343(2) of the 1988 Act. Those provisions were intended to cover transfers within a group and to counter the schemes that sought to use them for transfers out of a group.
The proposed new section will prevent thesection 343(2) tax-neutral transfer from applying in certain situations in which a company reconstruction involves the leasing of plant or machinery, which is to say the transfer of leased assets between companies. Schedule 6 will essentially disapply the carry-over of capital allowances under 343(2) from one company to another unless certain conditions are met—the companies are called the “predecessor” and the “successor” respectively in the Bill. One of the conditions is set out in proposed new section 343A(2)(a), which provides that the principal company and the predecessor immediately before the transfer must be the same as the principal company of the successor immediately after the transfer.
That is not controversial, and does not cause problems that I am aware of in which one subsidiary transfers its leasing business to another subsidiary of the same parent. However, the section does not seem to work effectively where a subsidiary transfers its leasing business to its parent, as defined in paragraphs 11 and 12 in schedule 10 to the 2006 Act. That is because the provisions of the schedule that we are considering do not provide for any company to be its own principal company.
The best way to look at the issue is by an example. Adopting the terminology used in schedule 10 to the 2006 Act, where company B is the principal of company A, because A is B’s qualifying 75 per cent. subsidiary, if A hives up its leasing business to B, the condition contained in paragraph (a) of the new section 343A(2) is not met, because company B has no principal because it is itself the principal. The same problem would occur if a parent company hived down its leasing business to its own subsidiary. Horizontal transfers within the group are fine, and can use the tax-neutral provision in proposed section 343A(2), but vertical ones are not, and cannot use that tax-free transfer provision.
It seems to me that the legislation goes beyond the intent of preventing the transfer of a leasing portfolio out of the group, while still managing to use the tax-free transfer provisions in section 343A(2). That is the mischief that it is designed to address, but it goes beyond that. As well as targeting transfers out of the group, it also seems to prevent upstream or downstream transfers within a group from being tax-neutral. Thus, under the guise of preventing avoidance, the current drafting prevents a tax-neutral reorganisation within a group, even where there is no change in the ultimate beneficial ownership, when no tax advantage is being sought, and no economic profits being made.
There seems to be no rational reason that I can see to disapply the carry-over contained in proposed section 343A(2) in the vertical transfer situations, if the Government are prepared to apply it in the horizontal transfer situations. There may possibly have been a drafting error, which amendment No. 66 would correct, by amending the definition of “principal company” to provide that where the predecessor or successor has no principal company at the time of the transaction, it is deemed to be its own principal company. That minor change would ensure that hiving up a leasing business to a parent, or down to a subsidiary will be treated in the same way as transfers between subsidiaries in a group.
If the Chief Secretary is not happy to accept the amendment, perhaps he could explain why these two different types of transactions should be treated differently. It is a particularly important issue at present, because changes to the capital allowances regime in respect of leased assets have removed the requirement for lessor groups to have a number of subsidiaries with accounting periods spread throughout the year. As a result, many leasing groups are currently in the proves of rationalising their corporate structures to hide their leasing trades into two or three companies, having had a significant number before.
Some of those restructurings have already taken place, and some are under way at present, or took place between the effective date of the legislation, and the publication of the detailed rules. I am told that considerable disruption could be caused by the arbitrary distinction that the legislation seems to draw between vertical and horizontal transfers within the group. I would be grateful if the Chief Secretary could address that point.
Amendment No. 67 seeks to amend the definition of market value contained in subsection (5) of proposed new section 343A. It does not quite have the urgency and significance of the previous amendment, but it is important to give the Committee the opportunity to test the reasons behind the choice of definition contained in subsection (5) of the proposed new section 343A.
The relevance of the definition is contained insubsection (4), which provides that, where a carry-over in section 343A(2) is disapplied, the leasing business shall be treated as having been sold by the predecessor company to the successor for an amount equal to its market value on the day of the transfer. The definition of “market value” that is contained in subsection (5) of proposed new section 343A refers to paragraph 41(8) of schedule 10 to the Finance Act 2006, which is similar but not identical to the definition in section 70YI of the Capital Allowances Act 2001. Both are predicated on the idea of a notional disposal of the assets in the leasing portfolio by the absolute owner, free of any leases or encumbrances. So the focus is on the hypothetical market value of the underlying asset. However, realistically, that value could be difficult to determine.
Arguably, when one is considering leased assets, it is artificial to focus on the theoretical underlying value of the base assets, free of leasehold interest. The property in question here is the leased interest, not the absolute interest free of encumbrances. Arguably, the more appropriate definition of “market value” is contained in section 577 of the 2001 Act, which focuses on the price that the book of leased assets would fetch on the open market. Thus, amendment No. 67 would remove the reference to section 41(8) of the 2006 Act and replace it with a reference to section 577 of the 2001 Act, which would value the portfolio being transferred at its actual worth, rather than at a hypothetical base asset value. To deem assets to have different values for tax purposes than their actual value always risks creating anomalies and unfairness. I would be interested to hear the Chief Secretary’s rationale for choosing the definition from section 41(8) of the 2006 Act rather than the one from section 577(1) of the 2001 Act.
I close by emphasising that the leasing industry is a significant industry for the UK economy, therefore it is vital that we get this issue right and, in respect of these two amendments, if we do not, it could cause some disruption to the restructuring that is already under way.
I too welcome you back to the Chair, Mr. Gale.
Before setting out the background to clause 30 and schedule 6, I should like to acknowledge the point made by the hon. Lady about the importance of the leasing industry and the importance, therefore, of getting these matters right. As she told the Committee, schedule 6 introduces anti-avoidance legislation in response to disclosures that we have received about avoidance schemes being used that are designed to get round measures in the Finance Act 2006 to combat the loss of tax from the sale of companies leasing out plant or machinery.
In the early years of a profitable lease, lessor companies generated losses but in the later years the situation reversed: the lease became profitable, but tax was being lost because groups were selling lessor companies to loss-making groups at just the time that the leasing transaction was about to become tax-profitable. The relevant provisions in the 2006 Act prevent a loss of tax when a lessor company leaves a profit-making group and becomes a member of a loss-making group by bringing into charge an amount that prevents the loss of tax when a lessor company is sold.
The disclosures that we received indicated that groups were avoiding the rules in two ways. One type of scheme was using legislation that enables a group to transfer leasing businesses without tax effect, rather than selling the lessor company and the other manipulated the balance sheet value of leased assets in a way that would reduce or eliminate the charge that should be brought into account to prevent the loss of tax.
Schedule 6 stops both types of scheme. First, it makes changes to the rules allowing groups to transfer businesses without tax effect; those rules are in section 343 of the Income and Corporation Taxes Act 1988. Changes to section 343 will mean that only transfers of assets between subsidiaries of the same parent company—and certain transfers involving consortium companies and partnerships—will benefit from tax neutrality. Where the new rules apply so that a transfer falls outside the existing section 343 provisions, the disposal of the assets of the business is treated as taking place at a value equal to the value of the asset unencumbered by the lease: that is, as if the lease did not exist. That creates a charge broadly equivalent to the effect of schedule 10 to the Finance Act 2006.
Secondly, the schedule adds two new paragraphs to schedule 10 on the sale of lessors. New paragraph 38A requires a company to ignore the consequences of arrangements entered into to secure a tax advantage, and new paragraph 38B requires a company to ignore liabilities when determining the value of its assets. Those changes will ensure that the sale of lessors legislation works as intended.
The hon. Lady’s two amendments are directed at the first of those anti-avoidance measures introduced by the schedule on the action that limits tax-neutral transfers. Amendment No. 66, as she explained, seeks to preserve tax neutrality for transfers between a subsidiary and its ultimate parent company—a group’s principal company. I shall explain why I shall ask the Committee to reject it, but I assure her that it is not because of any drafting error.
I suggest that the amendment is unnecessary. In the vast majority of cases, leasing businesses are conducted via wholly-owned subsidiaries, and I am certainly not aware of any pressing commercial reasons for transferring a leasing business to a principal company. In contrast, the transfer of leasing businesses to a principal company increases the risk of tax avoidance for two reasons. First, while we are aware that some leasing is conducted through principal companies, we know that transfers of businesses to holding companies have featured, not uncommonly, in tax-motivated arrangements enabling groups to utilise tax losses more efficiently.
Secondly, the transfer of a leasing business to a principal company could dilute the leasing business so that the holding company would not be treated as a lessor company. If that were to happen, the sale of lessors legislation would not apply and the business could be transferred from the principal company without triggering the anti-avoidance rules. The amendment does not provide any protection against abuses along those lines.
The issue that the hon. Lady has raised was raised by us with the industry. We asked it in January to provide evidence that the restriction that is being introduced here on transfers to and from principal companies will hinder normal commercial transactions. No such evidence has been provided to us.
There are real worries about tax avoidance, and I shall give an example. For some foreign banking groups, the principal company is the main bank, and the UK branches are, not infrequently, loss making. Some such groups have purchased lessor companies, but rather than transferring the business to existing leasing subsidiaries, they transfer it to the branch so as to use its accumulated tax losses against the leasing profits. I have not seen any evidence that those transfers are anything other than tax motivated, and I do not think it would be right to preserve what are, in such instances, clearly tax avoidance opportunities. I have certainly not seen any evidence that transfers to and from holding companies are necessary for the commercial operation of a business, but in contrast, there is evidence that such transfers have offered and could continue to offer potential for avoidance. On those grounds, I hope that the Committee will reject the amendment.
Amendment No. 67 would, as the hon. Lady explained, change the value at which plant or machinery is treated as transferred for tax purposes, and the asset would be treated as transferred at the price it would fetch on the open market, encumbered by the lease, rather than the value of the asset unencumbered by the lease, which is the value provided for by the schedule as it stands. Those values are often similar, but the crucial problem is that it is possible that the value of the asset encumbered by a lease could be manipulated in a way that would reduce or even eliminate the impact of the anti-avoidance measure, whereas the market value unencumbered by the lease cannot be manipulated in that way. That is why we wanted that to be the value to which the legislation refers.
The amendment could, inadvertently, mean that the measure does not meet its aim. I hope that, given that explanation, the hon. Lady will feel able to withdraw it, but if not I will certainly ask the Committee to reject it.
I will ask leave to withdraw the amendment and I am grateful to the Chief Secretary for his exposition of the reasoning behind the schedule. I would consider coming back to the amendments on Report, perhaps after consideration of the evidence that he said he has not been supplied with. I may want to reflect on that, but in the light of what he has said it would not be appropriate to press the amendment to a vote. I beg to ask leave to withdraw the amendment.
Although there is broad consensus for schedule 6, it seems that we now have three and a half more pages of tax legislation prompted by the fact that some bright sparks have already found a way around the measures that were passed in, I think, schedule 10 to the Finance Act 2006. I pay tribute to their inventiveness, and it is part of the innovation that we salute in this country, in one sense, although I would rather it were channelled into scientific endeavour rather than finding tax loopholes. While the Opposition understandably frequently raise concerns about the length of what they now call the tax code—the number of pages in Tolley’s tax guide and so on—this is a classic example of how, within less than six months of passing fairly lengthy legislation, a loophole is found and we then have to pass another three and a half pages of loophole-closing legislation.