Corporation tax treatment of company distributions received

Question proposed, that the clause stand part of the Bill.

I add my welcome to you, Mr. Hood, as Chair of the Committee’s deliberations this morning.

Clauses 34 to 37 introduce a significant package that modernises corporate tax rules for foreign profits. It will make the UK a more attractive headquarters location for multinational businesses by enabling a group’s worldwide profits to be repatriated to the UK without tax being charged and without need for complex double taxation relief calculations. It is a major change to a more territorial system of business taxation in which we are essentially concerned with applying tax to profits earned in the UK and not to profits earned overseas. The key element of the package offers generous dividend exemptions compared with competitor jurisdictions, available to all companies regardless of the level of shareholding.

The package comprises four linked parts with one in each of the four clauses: first, a broad exemption for company distribution; secondly, a reasonable restriction on our generous interest-relief rules in the UK; thirdly, consequential changes to the controlled foreign company rules, and fourthly, the replacement of the Treasury consent rules with a much simpler reporting requirement. These have all been subject to substantial widespread consultation which has shaped what is before the Committee.

I shall say a little more about each of the four elements. Clause 34 introduces schedule 14, which provides exemption from tax for foreign profits. It reduces administrative costs and it meets business’s call for exemption in the Finance Bill. The result of these rules is that the great majority of distributions for small, medium and large companies will be exempt from corporation tax. That change has been widely welcomed, as has the fact that we have been able to deliver it in this Bill.

Clause 35 introduces schedule 15, which prevents excessive advantage being taken of our interest-relief rules, particularly in the context of dividend exemption. This debt cap applies only where groups put more debt in the UK than they borrowed for their entire worldwide business. It is a reasonable restriction and will allow generous tax deductions for interest, notwithstanding the move to dividend exemption.

Clause 36 introduces schedule 16, which makes three consequential changes to the controlled foreign company rules. The first two relate to introduction of dividend exemption and remove some of the exemptions within the controlled foreign company regime, which will no longer be appropriate. Part 3 of the schedule includes a provision to ensure that the debt cap cannot interact with the controlled foreign company rules in a way as to cause double taxation.

Clause 37, introducing schedule 17, removes existing Treasury consent legislation and replaces it with a modernised, post-transaction reporting requirement targeted at transactions where there is a substantial risk of tax avoidance activity. The old rules have been replaced because they are out of date and are not in line with modern practice. The new requirement will apply to material transactions that pose significant risk of tax avoidance, reducing the administrative burden on business but ensuring that HMRC can focus on serious avoidance. We have also committed to examine the controlled foreign company rules in more detail separately. The review aims to modernise the current  rules. It will be consistent with the move that I have described towards a more territorial approach of taxing foreign subsidiaries.

This package represents the outcome of nearly two years of extensive and constructive consultation. I want to thank all those who have contributed in the past couple of years. Businesses have consistently said to us that it is important for the UK to have dividend exemption. They have asked for it to be included in this Finance Bill rather than being delayed any further, to enhance the competitiveness of the UK tax system. I am very glad that we have been able to do that.

This is a very important part of the Bill, as the Minister has underlined; it is very technical but also very important. I want to congratulate him on having introduced this package of measures. It is a crucial package, as it is an attempt to show how a modern taxation system can cope with the global nature of modern commerce.

I want to start by being wholly positive, because I am afraid that I will have to be just a little bit critical later on. Schedule 14 immediately follows and I will make a few general remarks about it. It is definitional and loophole-closing; it is based on a study of real-time transactions, and it definitely has an eye on preventing further abuses of similar ilk.

The effectiveness of this type of legislation depends on the post-hoc scrutiny, the retrospective examination by people within the Treasury who must have adequate skills and abilities to do so. I am a little encouraged, not only by what the Minister has said but by the endeavours of HMRC to recruit appropriate people to police the type of activity that we are discussing on a more regular basis.

In one way, we are looking at a game of chess. On the companies’ side there are very clever people trying to make the best of the exemptions that are available and on the Government’s side there are people trying to close every conceivable loophole. Life has been made enormously more difficult for those people who want to avoid tax by the Government’s imposition of an obligation on businesses that insists that they must declare any tax schemes well in advance. However, the real test of the Bill is whether or not adequate ground rules are laid down to prevent further abuse and further misuse of tax exemptions. We will have to judge whether the Bill has passed that test when we look at the next clauses.

As the Financial Secretary said, the Government have undertaken quite a thorough consultation process on this issue in the past couple of years. As a consequence of that consultation process, there have been a number of changes of tack by the Government on the taxation of foreign profits. I just wanted to explore that issue a little further.

When the Government published their consultation in 2007, they produced a fair summary of the issue that we face when they said:

“The current system of taxing foreign dividends and relieving double taxation through crediting foreign tax produces only a modest amount of direct tax yield, but together with the Controlled Foreign Companies (CFC) regime, provides safeguards to ensure that profits from economic activity are properly taxed in the UK.”

It is a question of getting that balance right, which provides a link to some of the later thoughts that the Government had. The document went on to say:

“The case for change rests largely on supporting large and medium business operating in rapidly growing global markets by simplifying and modernising the current regime”.

The challenge that the Government had to face was that a number of multinationals were taking the view that the UK was not a good place for them to be based and they were exploring whether or not they could move to other jurisdictions where there was a better regime for the treatment of foreign dividends.

The consultation process also hit upon the issue of ensuring that profits from economic activity were properly taxed in the UK. That led the Government to consider the issue of a proposed controlled companies regime to avoid the potential mischief of companies seeking to shift income streams offshore, particularly what were described as mobile income streams, which are financing income and royalties. When the Government floated that idea, however, there was a significant outcry from industry about the consequences, certainly about the administrative cost, and it triggered a further wave of concern from companies that look to redomicile overseas. The further concern was about whether the rules that the clause seeks to change led to a sub-optimal allocation of capital in an international group—that when it was not necessary for an overseas subsidiary to pay a dividend to its UK parent for the purpose of making a dividend, those dividends and that capital would be trapped in an offshore location. There was concern that the Government’s rules got in the way of the efficient use of capital in businesses because businesses felt that it would be better to keep profits in a low-tax jurisdiction rather than repatriate them to the UK.

One of the issues that has most exercised the Government, and on which I would be grateful for further clarification from the Minister, is cost. Cost was a feature of the technical note published in July last year by the Minister’s predecessor, the right hon. Member for Liverpool, Wavertree (Jane Kennedy), who expressed concern that the potential cost of the dividend exemption would act as a barrier to taking it forward. That technical note, published at the conclusion of our deliberations on the Finance Bill 2008, set out that in 2005-06 £200 million was collected in corporation tax paid on foreign dividends, £100 million was paid on portfolio dividends and £100 million was paid on direct dividends. The assessment was that by 2012 the yield on foreign dividends would be about £300 million. However, the technical note suggested that the tax loss to the Exchequer that could arise from introducing the dividend exemption had a central estimate of about £600 million, within a range of £200 million to £1.1 billion, depending on the behavioural responses. There was a suggestion that the tax take could increase because of the repatriation of cash to the UK, which would then be used to reduce indebtedness. The Government were sceptical that that was an issue, and felt that there were ways in which companies could repatriate those profits without incurring a corporation tax charge.

Cost was clearly a barrier at that point, but it no longer appears to be a barrier to the Government’s changes. The impact assessment published after last year’s pre-Budget report suggested that the package of  measures would cost about £275 million. That is a significant shift from the estimate that the Government produced in July last year, and I shall be grateful if the Minister can provide a breakdown of the figures, to explain the sources of revenue. I suspect that the cost of the dividend exemption remains broadly unchanged but that the changes the Minister referred to in his opening remarks to things such as the debt cap and Treasury consent may be yielding more income. It is important that there be greater clarity about how the Government were able produce a revised estimate that made the dividend exemption more affordable.

As I mentioned earlier, the proposals set out in 2007 looked at a move to an income-based regime, to ensure that businesses did not use the opportunity of the dividend exemption to restructure their operations and move various sources of income overseas for tax purposes, rather than as a consequence of how their businesses operated. That led to a significant outcry from businesses. Deloitte stated that

“in our view, this could significantly detract from the UK’s competitiveness, both from a financial and an administrative point of view, and could dissuade companies from locating holding companies here”.

Ernst and Young commented on the potential compliance burden that would arise from that, stating that the proposals would

“neither improve clarity and transparency, nor make the rules more certain and straightforward in application—they are in fact a significant move in the opposite direction”.

The outcry prompted the Government to move, as there was a big concern that moving from an entity-based stream to an income-based stream would require businesses to rework the basis on which they submit information to the Treasury. Companies currently account on an entity basis and so would have to revisit how they structure their reporting to deal with it on an income basis. Clearly, the concern that businesses will seek to move certain income streams offshore to lower-tax jurisdictions still exists, as there might be a particular incentive in relation, for example, to intellectual property rights or to finance income. Is the Minister content that the anti-avoidance measures in schedule 14 are sufficient to tackle those issues relating to mobile income streams, or is that still a potential gap that will need to be addressed later?

Another point I want to raise relates to the structure of the exemption and the way in which it is given. Schedule 14 starts with the premise, as set out in proposed new section 930A, that all distributions received will be subject to tax. The existing legislation is framed differently: the assumption is that all distributions received in relation to UK shares are not taxed, but those in relation to overseas shares are taxed. We have now moved to a basis on which all dividends and distributions are taxed unless there is an exemption. Could the Minister explain why that change has been made? It has been suggested to me that, given the increased importance of the European Union in matters of direct taxation, because of issues relating to the freedom to establish and freedom of movement, that means it is difficult to distinguish the dividends and distributions of UK companies from those of non-UK companies.

Therefore, we have made the regime more challenging for UK companies than it was before, and I shall be grateful if the Minister can provide some clarification on that. Will that change, which we will debate in greater detail when we come to schedule 14, increase the compliance cost to UK business as a consequence? There is a concern about how the legislation has been structured, so it would be helpful if the Minister would explain why that move from a distinction between UK and non-UK distributions has been changed, because I think that that will have a knock-on effect, as we will debate later.

We are broadly content with the concept to which the Government have moved: that there should be a dividend exemption for foreign dividends. I think that that will help to address the issues of competitiveness that the UK faces as a location for holding companies. It has taken a long time to get that—two years—and at one stage last year I thought we might never see it. It is good that the exemption will make it on to the statute book, but an understanding of how the Government’s objections on the grounds of cost have been overcome would be helpful.

I am grateful to both Opposition spokesmen for their support for the principle of what we are doing and the approach we have taken. Consultation has been broad, and as the hon. Member for Fareham pointed out, the proposals have been substantially modified in the light of our discussions. As we go through this part of the Bill there will be several technical discussions on the details, which will be important, but I am glad that the principle has been so strongly supported. The hon. Member for Southport was right to highlight the importance of our ability to continue to bear down on avoidance, and we will debate the issue later.

The hon. Member for Fareham asked about the costs involved. He is right to say that our initial intention was to make the change in a fiscally neutral way. As he indicated, there is a degree of uncertainty about precisely how companies will react to the changed framework introduced by the clause, so one cannot be too definitive about exactly what the fiscal impacts will be. However, as discussions have developed and as we have listened to the concerns that have been raised, we have relaxed the requirement that the change should be fiscally neutral. Consequently, while the initial intention was for the package to be revenue-neutral, it now has a cost.

On next year’s expectation, dividend exemption will lead to a tax reduction of £500 million and we expect that to be offset by £200 million from the impact of the debt cap, which we will discuss in relation to the changes to the controlled foreign companies rules in clause 36. We also expect a loss of revenue of £50 million as a result of the abolition of the Treasury consents rule. All of those changes mean that we expect an overall loss of revenue of £150 million, which will grow as time goes by and companies increasingly reorganise their activities in the light of the changes.

The big difference is that, whereas we initially envisaged the debt cap as centring on a company’s net debt, it now centres on gross debt. That is the big change both in the structure of our proposals and in the fiscal impact.

The right hon. Gentleman says he expects the cost of the package to increase over time. I assume that there will be a tax loss as companies restructure  their activities and repatriate profits. Does he anticipate that businesses will also look at the way in which they structure their financing to reduce the additional tax, or will they pay the consequence of the introduction of the debt cap?

I am not sure whether the hon. Gentleman is thinking about a particular kind of change, but I am certain that, with a substantial change of this kind, companies will want to look at potential opportunities for them to change the way in which they organise themselves in order to take advantage of the provision. That is perfectly appropriate. He was right to raise concerns about potential avoidance opportunities and we will debate a general anti-avoidance rule later in relation to a Government amendment. We certainly need to keep a close eye on avoidance activity, but in response to an earlier question of his, I believe that the measures under consideration will do the job.

The hon. Gentleman asked why some UK to UK dividends will be taxed for the first time. We need to provide equality of treatment for UK and non-UK dividends, as the previous inequality was not appropriate. In fact, the impact of the proposals on UK dividends will be pretty minor. We need to be certain that there is no risk of a challenge under EU law, because challenges of that kind lead to damaging uncertainty that is in nobody’s interest. The legislation’s structure gives us a helpful guarantee on that front.

Question put and agreed to.

Clause 34 accordingly ordered to stand part of the Bill.