Group relief: preference shares

I beg to move amendment 23, in schedule 9, page 103, line 2, at end insert—

‘A1 (1) Section 832(1) of ICTA is amended as follows.

(2) For the definition of “ordinary share capital”, substitute—

“ordinary share capital”, in relation to a company, means all the issued share capital (by whatever name called) of the company, other than relevant preference shares (within the meaning of Schedule 18).’.

With this it will be convenient to discuss the following: Government amendments 10 to 12.

Amendment 24, in schedule 9, page 104, line 39, after ‘by’, insert ‘paragraphs 1 to 4 of’.

Amendment 25, in schedule 9, page 104, line 43, at end insert—

‘(6A) If a company so elects, the amendments made by paragraph (A1) of this Schedule, do not have effect in relation to shares issued by the company—

(a) before the date on which this Act is passed;

(b) on or after that date under an agreement entered into before that date.’.

Amendment 26, in schedule 9, page 104, line 44, after ‘6’, insert ‘or 6A’.

My amendments are dry and technical. They define “ordinary share capital” more closely by reference to another term in the Bill, “relevant preference shares”. The objective is to ensure that group relief is available when certain preference shares are issued. The holders of fixed rate preference shares are not usually treated as equity holders. Schedule 9 changes that, so holders of relevant preference shares will not be treated as equity holders. It is important because those determinations affect the entitlement to group relief from related companies for trading losses.

Amendments 23 to 26 tidy up the definition of “ordinary share capital”. The test of a grouping for many tax purposes involves two parts: an ordinary share capital test and an economic ownership test based on the provisions of schedule 18 of the Income and Corporation Taxes Act 1988. Ordinary share capital is defined in section 832(1) of the 1988 Act as

“all the issued share capital (by whatever name called) of the company, other than capital the holders of which have a right to a dividend at a fixed rate but have no other right to share in the profits of the company”.

According to the 1988 Act, if the holder does not have a fixed-rate preference share, they must have an ordinary share. The challenge arises because the rate on the preference share may vary. Although the definition of ordinary share capital includes an exclusion for shares that carry a dividend at a fixed rate and is similar to the definition of fixed rate preference shares in schedule 18 of the 1988 Act, the two are not the same. As a result, it is possible for a share to be treated as part of the ordinary share capital and as a fixed rate preference share for the purposes of schedule 18. The concern expressed to me is that the introduction of the definition of “relevant preference shares” would increase the circumstances that could give rise to that confusion. Amendments 23 to 26 bring the two definitions into line, so that an ordinary share is defined as something that is not a relevant preference share.

The Government beat us to the punch with amendments 10 to 12, in that we wanted to table amendments with a similar effect. We welcome the Govt amendments.

I feel that it would be beneficial to address the amendments in the name of my right hon. Friend the Financial Secretary, as they clarify the legislation. I welcome the fact that they have been widely welcomed across the Committee. I will then discuss the other amendments in the group.

The three Government amendments address representations made regarding the draft legislation for schedule 9. The schedule amends rules identifying how companies are to be regarded as belonging to the same group for tax purposes. The hon. Member for Fareham may be right to say that this is a technical and arcane matter, but it is important to a lot of grouped companies to be able to access the privileges that come with that status.

Currently, where a parent company of a group holds more than 75 per cent. of the equity in a subsidiary company, the group can benefit from rules that allow it to surrender or claim losses from companies in the group. A number of anti-avoidance rules also apply when a company or an asset leaves a tax group. The 75 per cent. equity rule was originally a straightforward test in the 1970s when the original tax rules were formed;  they were then consolidated in the 1980s and still govern those areas of taxation. That rule has had to evolve to prevent avoidance, as the financial affairs of groups of companies have become more complex over time. Now, the parent company also needs to enjoy the full rights of an equity holder. Usually, those are rights attached to the ordinary shares in a company, although they might also be subject to the rights of other shareholders and certain creditors. The limitations on the types of preference shares that can be issues to external investors without threatening the structure of a tax group creates a particular problem for financial groups that need to raise additional tier 1 regulatory capital.

The changes in the schedule resolve that problem, and I think that they have been welcomed. However, we have received representations stating that, because the only circumstances in which the rules are being relaxed relate to either regulatory capital constraints or companies in severe financial difficulty, that might not cover circumstances in which a company simply has insufficient retained profits to pay a full dividend on its preference shares. Therefore, the three Government amendments, taken together, remove any doubt that the circumstances in which dividends can be reduced or not paid refer only to the terms on which the shares are issued. Amendments 10 and 11 therefore refer specifically to the terms of the share issue. A consequent change is made by amendment 12, removing a now defunct reference to the payment of dividends.

The amendments clarify that relevant preference shares do not lose that status simply because the company has insufficient profits to pay the full dividend. That includes circumstances in which a company has no profits to distribute, so that any dividend would be ultra vires, and where a dividend paid by a regulated financial institution would breach rules on capital adequacy.

Amendments 23 to 26, which were tabled by the hon. Member for Fareham, would take the changes made to the rules for tax groups by schedule 9 outside that field and into all manner of other areas of the Tax Acts. It might not have been fully appreciated by the hon. Gentleman when he tabled the amendments, but section 832 of the Income and Corporation Taxes Act 1988 is headed, “Interpretation of the Tax Acts”. It is a general definition section, whose definitions are intended to apply to many rules throughout the Acts and in a variety of different circumstances. The definition of ordinary share capital is one of those which applies for many purposes throughout the Taxes Acts.

There are two principal arguments against amendments 23 to 26. First, they are unnecessary. The objective of schedule 9 is to address specific problems that some groups have experienced as a result of the turmoil in the global economy, particularly in the financial sector, over the past year. Those problems do not relate to section 832 of the Income and Corporation Taxes Act. The groups that lobbied for changes have no problems with that section: their problems relate purely to schedule 18 to that Act. We have received positive and welcome feedback on the changes contained in schedule 9, and the amendments I have tabled will achieve what is needed in that respect.

Secondly, as I have indicated, it seems to me to be dangerous to amend a definition that affects dozens of separate parts of the Taxes Acts purely to achieve a change in one part. Analysing the effects of such a  change would be a large undertaking, and I am pretty sure that it would throw up some undesirable and unintended consequences. That is not the right way to achieve a focus on the particular area about which the hon. Gentleman is worried.

If businesses are experiencing problems with the definition of ordinary share capital in other specific areas of taxation law, HMRC will be pleased to receive representations from them about it. Consideration will then be given to whether changes are necessary to the definition of ordinary share capital for those specific areas. I hope that the hon. Gentleman appreciates that undertaking. If other specific problems are brought to our attention we will certainly try to address them, but tackling a specific issue by attempting to change a general definition, which could have undesirable effects throughout the Taxes Acts, is a recipe for large numbers of unintended consequences that would make themselves known subsequently. They might have consequences for avoidance activity or a range of other undesirable outcomes, which I am sure the hon. Gentleman certainly did not intend when he tabled the amendments.

The changes brought about by schedule 9 provide companies with greater flexibility in how they raise capital from external investors, without compromising their right to the benefits of being part of a tax group. That will assist a number of banks that are seeking to bolster their regulatory capital and help to protect depositors. We will achieve our aim in ways that will not adversely affect any group or detract from the essential anti-avoidance purpose of the tax rule that is amended. I therefore urge the Committee to accept the Government amendments and the hon. Member for Fareham to not press his.

I am grateful for that explanation. It reflects part of the challenge of tax law in this country. To address one issue we create a new definition, which then throws up anomalies regarding other definitions. To use an architectural metaphor, we create a baroque monstrosity of a tax system rather than a classical building. I do not know if there is much scope to have a tax law in the current exhibition on the baroque at the Victoria and Albert Museum. It would be an interesting interpretation of baroque to have tax law exhibited there. Not wishing to digress too far, there is a tax museum in Siena, which has remarkable pieces of art depicting the business and commerce in Siena. I think that that is more renaissance than baroque.

Coming back to the topic, I understand the Minister’s point. This is a challenge that we face in trying to amend law. My amendment was over-ambitious for the occasion, and those who suggested it to me will have noted the Minister’s undertaking and will reflect on it. On that basis, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendments made: 10, in schedule 9, page 103, line 28, leave out ‘in any circumstances’ and insert

‘by virtue of any term subject to which the shares are issued or held’.

Amendment 11, in schedule 9, page 103, line 39, leave out ‘in any circumstances’ and insert

‘by virtue of any term subject to which the shares are issued or held’.

Amendment 12, in schedule 9, page 104, line 14, leave out sub-paragraph (i).—(Angela Eagle.)

I beg to move amendment 22, in schedule 9, page 104, line 21, at end insert—

‘(6A) An order under sub-paragraph (5) must specify that no company may be regarded as being or having been in severe financial difficulties in any accounting period during which it agrees or agreed to contribute to, or increases or increased the value of, the pension arrangements of any director or former director a sum in excess of £1 million.’.

This is the Fred Goodwin memorial amendment. Schedule 9 talks about a business reducing or failing to pay the dividend on a preference share in relevant circumstances, and it goes on to define those relevant circumstances as being when

“at the time the dividend is or would be payable, the company is in severe financial difficulties”.

The schedule does not define what severe financial difficulties are. I move the amendment as a probing one, to get the Government to set out more clearly what they see as severe financial difficulties. I think that the letter that has been placed in the Library in respect of the amendment says that the vast majority of businesses may clearly fall within or without the everyday meaning of that phrase. That is a perfectly fair thing to say, but we know that RBS was in severe financial difficulties and needed to be bailed out by the Government, not just once but twice. However, RBS’s financial difficulties were not that severe that it could not augment the pension of its chief executive. That makes it rather difficult to understand what severe financial difficulties means, and it would help to have some clarity from the Government. If banks are able to spend significant sums on discretionary activity, would that not suggest that they are not in severe financial difficulties? I would be grateful if the Minister could elaborate a bit more carefully on that phrase before I think about whether to press the amendment to a vote.

I congratulate the hon. Gentleman on the opportunistic nature of the amendment. It demonstrates that creativity lurks everywhere. [Laughter.] One day, I might ask him what his secret is.

Amendment 22 seeks to address matters that are not directly relevant to schedule 9 but are relevant to the content of regulations that the Treasury could make under the power contained in the proposed new section of the Income and Corporation Taxes Act 1988, which is inserted by paragraph 3 of the schedule. The amendment raises a topical issue—that of so-called rewards for failure, which none of us regard as a good thing. However, if it is aimed at directors who bear responsibility for the financial difficulties of a company, particularly directors who no longer work in the group, it will miss its target. The consequences of the amendment would fall on the current employees and shareholders of a business if it was denied the opportunity to have its group structure recognised by the tax system, rather than on those who had done the damage and fled bearing the rewards of failure.

The amendment would apply whenever pension benefits in excess of £1 million were granted to directors, irrespective of whether the company, the shareholders or anyone else believed that a particular director had been instrumental in the failure of the company. It would always be  possible, as I am sure the hon. Gentleman realises, to pay pension benefits of slightly less than £1 million, in which case the entire point of the amendment would be lost.

The hon. Gentleman asked what constituted “severe financial difficulties”. The phrase is fairly self-explanatory. It does not cover companies with temporary cash flow problems, or circumstances in which they could acquire funds from related companies or other sources. If there is genuine doubt, however, we are prepared to do whatever we can to provide companies with certainty of treatment.

The phrase does not cover contrived situations. If we were to become aware that some groups were attempting to use the relaxation provided by the change to manipulate tax group structures—in effect, to say who is entitled to claim group relief or some other tax relief—then we would be prepared to remove any doubt about whether the severe financial difficulty test was satisfied. In that context, it is important to apply common sense. Having demonstrated his creativity, I hope that the hon. Gentleman will withdraw the amendment.

I shall withdraw the amendment. I could try to be more creative, perhaps not limiting it to a sum in excess of £1 million in order to capture all situations.

The Minister says that the definition of severe financial difficulties is common sense. She is right; it is fairly apparent. However, I note that paragraph 6(6) includes the power for the Treasury to specify such circumstances by regulation. I hope that the Government’s intention is not to use the power, and note that draft regulations have not been drawn up. That is understandable; such regulation should be made on an ad hoc basis. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

I beg to move amendment 21, in schedule 9, page 104, line 33, at end insert—

‘1B Notwithstanding anything else in this Schedule, in determining whether two or more companies are members of the same group no account shall be taken of any interest held by UK Financial Investments Limited.”’.

The amendment was tabled to elicit clarification. UK Financial Investments is the holder of the Government’s interests in a number of financial institutions. The Minister, I am sure, will give us clarity in that context. The fact that two institutions are held by UKFI should not create an opportunity for group relief.

Having praised the hon. Gentleman for his creativity with the last amendment, I am going to disappoint him on his accuracy with this one. He is wrong to think that UKFI is the holder of Government shareholdings. It manages the investment, but does not hold the shares or other securities of any other groups in which the Government have taken equity stakes. The Government shareholdings are held by the Treasury through the Treasury Solicitor as nominee and the need to avoid the tax complications that could have resulted from a corporate entity holding the shares in otherwise unrelated groups is one of the reasons why we chose to follow that route when taking the stakes. So UKFI is  not a shareholder and the need for the amendment simply does not arise. I hope that, with that information, the hon. Gentleman will agree to withdraw the amendment.

I am grateful for that clarification. It provides what I was looking for—clarification. It may not have been the most accurate amendment, but it got the desired result, which I do not think is a bad thing, Mr. Hood.

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 9, as amended, agreed to.