The clause is targeted at so-called “booster” schemes designed to increase the amount of tax attributable to a foreign subsidiary and so increase the amount of double taxation relief that can be obtained. The Opposition have some sympathy with the objectives of the clause and certainly will not oppose it. However, I have some questions on how the clause operates and on the longer-term prospects for the reform of double taxation relief.
Which of paragraphs 2 to 6 of schedule 28AB to the Income and Corporation Taxes Act 1988 did the Government have in mind when amending section 804ZA, as proposed in the clause? Will the Chief Secretary outline which scheme is targeted, bearing in mind that the change in law was triggered by the disclosure regime? Will he also explain why this problem was not picked up at an earlier stage, as boosting by using UK as well as overseas tax has been known about since 2005? Why does clauses 34(4) refer to foreign tax paid
“on or after 6th December 2006”?
Does that mean that when a UK company pays a dividend to an overseas company out of profits on which tax was paid before 6 December 2006—tax paid in 2005, for example, or the first two quarterly instalments of 2006—these rules do not apply, even if the overseas company pays the dividends onward after that date?
On the longer-term prospects, the Committee should note that the clause and the provisions it will amend may soon be redundant along with the controlled foreign company rules to be amended by clause 47. Paragraph 3.39 of the Red Book states that the Government are shortly to publish a consultation document on the future of the rules on the taxation of foreign dividends. We welcome the Government’s indication that they are considering a general reform of the taxation of foreign profits, as there is a pressing case for reform and simplification of the law in that area. The rules on the taxation of foreign profits that we are considering—double taxation relief and the controlled foreign companies regime—are ferociously complicated, and one of the most difficult areas of our tax law, which has been subjected to frequent amendment over the last few years and involves significant levels of uncertainty. It can take several years for the foreign tax position to be finalised.
There are a number of technical flaws in the legislation. For example, it struggles to deal with situations where overseas companies pay tax as part of a consolidated group. There are also question marks as to whether the DTR rules are fully compatible with EU law. Chris Sanger of Ernst and Young said:
“The current system is cumbersome and acts as a deterrent to businesses seeking to invest in the UK.”
The Institute for Fiscal Studies, too, has questioned the effectiveness of the DTR rules:
“Overall, the trade off between the costs and benefits of the credit system compared with the exemption system is unclear, and the theoretical case for retaining the credit system does not appear to be compelling.”
Some illumination on that trade-off can be found in the Red Book. Table A3.1 discloses that the Government pay out about £10 billion in double taxation relief. The revenue collected through the taxation of foreign profits, while not de minimis, is certainly low enough to prompt the question of whether that revenue is worth the competitive disadvantage of requiring increasingly mobile multinationals to jump through all the relevant, highly complex hoops to ensure that they meet the requirements of the UK’s double taxation regime—a regime made just that bit more complex by the measures in the Bill.
The Committee might usefully consider whether the present rules get the trade-off between revenue collected and competitiveness right. There are some attractive arguments for simplifying that part of the tax system to incentivise the repatriation of foreign profits. That could make the UK tax system more competitive and boost investment in the UK. It could also make the UK more attractive as a destination for corporate headquarters and holding companies, which could strengthen foreign direct investment.
Recent studies by the International Monetary Fund have shown that there is considerable potential benefit in cases where companies are encouraged to repatriate their foreign profits. Changes in US law to facilitate bringing foreign profits back onshore have also proved successful. When looking at those matters, we should bear in mind the decision by companies such as Yahoo, Google and Amazon to locate their headquarters in Ireland rather than in the UK. Taking those factors on board, the Opposition have been looking at the merits of moving to a participation exemption for foreign profits, along the lines of those used in a number of countries in mainland Europe.
With that in mind, I have a series of questions for the Chief Secretary about the process of reforming DTR that the Government envisage undertaking. First, when will the consultation document promised in the Red Book be published? The Red Book refers to it being published “later in the Spring.” I am of course aware that climate change is doing some odd things to our seasons, but one would have thought that “later in the Spring” would mean by now, or by the end of the month at the latest. Do the Government expect to publish the document before the end of the Committee’s deliberations, as it would be useful in assessing the merits of this clause and clause 47.
My second series of questions concerns the options for reform and the long-term replacement of the DTR rules. Will the Government assess the potential that a sensible reform might in the longer term have to increase tax revenues as a result of the UK becoming a more attractive place for investment and for corporate headquarters? Have they carried out studies on the impact of the introduction of participation exemptions in countries such as Spain and Australia? Did they consider a participation exemption when they introduced the major legislative change in 2000 that governs the taxation of foreign profits? Why did the Government reject that at the time, and given that they are now apparently considering such an exemption, do they believe that it was a mistake to reject that option in 2000?
Thirdly, in embarking on the reform process, what constraints are placed on the Government by the EU? I understand that the Primarolo group criticised aspects of the Dutch participation exemption. Do the Government expect the Paymaster General’s work in Brussels to constrain their choices in reforming the UK’s system of taxation of foreign profits? Lastly, it would be useful for the Committee if the Chief Secretary expanded on the statement in paragraph 3.39 of the Red Book that the Government’s consultation document on the issue
“will also consider the implications of any such reform for other aspects of the UK tax regime, such as interest relief.”
Are the Government planning to abolish relief for interest on borrowing used to invest in foreign shareholdings, or only to restrict it? Is that move inevitable if a participation exemption is introduced? If so, what sort of impact assessment have the Government carried out on the effect of such a move?
One should also bear in mind the fact that the effect of abolishing relief on interest on borrowing to finance overseas investments would raise considerably more than the revenue that would be lost as a result of introducing a participation exemption. Does the Chief Secretary regard the upcoming reform process as a revenue-raising exercise? I would counsel a cautious approach. While moving to an exemption system would offer attractions in terms of simplicity, some of which I have outlined, we do not want to replace the highly complex DTR and CFC rules with another highly complex set of rules for determining when relief will be given on interest.
I close by referring to the Institute for Fiscal Studies, which carried out an interesting study on the issue:
“There are various ways in which the UK government could seek to recoup any significant amount of revenue lost by replacing the credit system with an exemption system. One suggestion would be to restrict the extent to which interest payments on debt that is used to finance overseas investments could be deducted against profits in the computation of UK corporation tax liabilities, along the lines of interest allocation rules used in the US. Unfortunately, since it is extremely difficult, if not impossible, to determine which particular borrowing funds which particular expenditures, restrictions of this kind run the risk of becoming both complex and arbitrary. It would be difficult to be confident that the combination of an exemption system with interest allocation rules would result in a system that would be significantly simpler than the current credit system. It is also very hard to estimate the net revenue consequences and precisely who the winners and losers would be”.
A well-structured programme of reform and simplification in that area of taxation could have a significant positive impact on the competitiveness of UK plc. In reaching the conclusion on the best option for reform, I hope that the Government will have full regard for the headaches that the current complexity of the DTR and CFC rules cause business, and their negative impact on our competitiveness in the increasingly globalised world economy.
First, may I reiterate a point made by my hon. Friend the Member for Chipping Barnet about the date of publication of the consultation document on the taxation of foreign profits? I know that there is considerable interest in that document, particularly in the City, and it would be helpful to know when it will be published.
Secondly, may I press the Chief Secretary on whether the clause is merely a clarification of the current law or a change? The reason I ask that question is that when flicking through the explanatory notes I found that such is the insistence that the provision is a clarification and no more that it is difficult not to be suspicious. We are told that the clause confirms that foreign tax
“includes UK tax for which double taxation relief is claimed.”
The explanatory notes go on to state that subsection (2) removes “any doubt” about that particular matter; subsection (3) “removes any doubt”; subsection (5) is a “clarification”; subsection (6) “makes it clear” that a particular point is the case; and finally, the background note states:
“The amendments put it beyond doubt that ‘foreign tax’ in this context includes UK tax.”
Such is the Treasury’s insistence on that point in the explanatory notes that one cannot help but being a little suspicious.
It is particularly important that the measure is a clarification and no more, in part because the commencement is backdated to 6 December 2006—the date of the pre-Budget report. I assume that an announcement of such measures was made at the same time. Given that it is in a sense backdated, it clearly should be a clarification and no more. Will the Chief Secretary confirm that the current law really does intend that UK tax should be treated as foreign tax for those purposes, that the Government are not simply trying to change the law to address a genuine loophole that had not been addressed, and that that is not a new point?
Mr. Gale, I bid you a warm welcome back to the Chair and welcome all Committee members back to a new day of scrutiny.
As the hon. Member for Chipping Barnet rightly said, the clause will introduce changes to section 804ZA of the Income and Corporation Taxes Act 1988. That section is anti-avoidance legislation, introduced in the Finance Act 2005 and aimed at schemes and arrangements designed to increase double taxation relief. Picking up the point made by the hon. Member for South-West Hertfordshire, I confirm that the aim of the measure is to put beyond doubt the issue of what should be regarded as foreign tax for the purposes of the legislation, rather than to introduce a change.
We were confident that the measure in the 2005 Act covered the point, but disclosures made to Her Majesty’s Revenue and Customs have cast some doubt on that—there is clearly doubt in the minds of some people—so the aim of the clause is to put the matter beyond doubt and to remove any uncertainty. HMRC has received disclosures of schemes that purport to avoid the effects of the 2005 legislation on the basis that the tax in respect of which DTR is claimed is UK tax rather than foreign tax. That is the point that the clause will clarify. We have always taken the view that such tax should be regarded as foreign tax and should therefore be included. The clause puts it beyond doubt that, in this context, the term “foreign tax” includes UK tax. It clarifies the fact that any reference to foreign tax in the DTR anti-avoidance legislation includes UK tax, ensuring that the anti-avoidance legislation works as originally intended.
The hon. Member for Chipping Barnet asked me which paragraphs of section 804ZA of the Income and Corporation Taxes Act 1988 are affected by the clause. It will cover section 804ZA as a whole; the booster scheme in question is countered by paragraph 4 of schedule 28AB to the 1988 Act. That may be the particular reference that she was asking about. Quite a number of avoidance schemes have been closed down following the introduction of the 2005 legislation, resulting in considerable tax savings to the Exchequer, so those measures were effective. However, we need the clause to put the original intention of the legislation beyond doubt. It is worth underlining the point that we will continue to challenge robustly any schemes that emerge where, in our view, the 2005 legislation has effect.
The hon. Lady has made the point, and the hon. Member for South-West Hertfordshire also referred to it, that we will be setting out our options for change for the taxation of foreign profits in the near future, and the consultation document will be published shortly. Any changes that may be made will, quite rightly, require extensive consultation and discussion. There will be a lot of interest in the matter and it is important that we get the details right. The change introduced by the clause is needed to put beyond doubt the application of the 2005 targeted anti-avoidance rules. The longer-term reform is a separate exercise and the measure before us cannot wait until the outcome of that review.
I have noted the points that the hon. Member for Chipping Barnet made about the long-term reform of taxation of foreign profits. She asked a number of questions about that consultation, but all I can say at this stage is that she must await publication of the consultation document for the launch of that debate. I am sure that there will be many who advance points of view along the lines of those she set out and others will no doubt have other perspectives to contribute to that debate. I can reassure the Committee that it will not be long before that document appears. Finally, picking up the point correctly made by the hon. Member for South-West Hertfordshire, we published draft legislation along with the pre-Budget report, which is why the changes will take effect from that date. No adverse comments have been received in response, so I commend the clause to the Committee.