With this it will be convenient to discuss the following: Government amendments 92, 93 and 99.
Amendment 48, in schedule 14, page 140, line 36, leave out is in and insert
was in the accounting period ending immediately before.
Government amendments 101 and 102.
I shall speak to amendment 43 first. This touches on a point I raised in the clause stand part debate about the treatment of UK to UK dividends. Under existing rules all distributions from UK companies are non-taxable, but new section 930A presumes that they are taxable unless they are exempt. The Minister acknowledged that it was the threat of challenge under EU rules that gave rise to that equality of treatment between UK and non-UK distributions. That is a topic that I will come back to under the next clause as well.
Having established that all distributions are taxable, there is then a series of exemptions from that tax. If an exemption is met, no tax is payable on those dividends. That is very straightforward. Where the problem arises is that in some cases there is a difference in treatment between distributions and dividends. The titles of the five exempt classes demonstrate that. There are three related distributions, which relate to controlled companies, non-redeemable ordinary shares and portfolio holdings, but also limited dividends from transactions not designed to reduce tax and dividends in respect of shares accounted for as liabilities.
The issue stems from the exclusion, in new section 930A(2), of a distribution of a capital nature. The feedback I have received is that the principles for that exclusion are relatively untested. To determine whether a distribution is of a capital nature, they would have to be tested against some very unclear case law. There are certainly some cases where distributions that were previously exempt will no longer be so under the new provisions and that will increase uncertainty in some fairly common transactions. Amendment 43 says that all distributions currently falling under section 209 of the Income and Corporation Taxes Act 1988 should continue to be exempt, so that there is a continuity of treatment between the old regime and the current regime.
Amendment 48, which I have also tabled in this group, deals with a small companies exemption. Schedule 14 provides for two regimes: one for small companies and one for medium and large companies. Schedule 14 provides a definition of a small company in new section 930R. However, it creates a degree of uncertainty as to whether a small company is a small company in the year of the dividend accounting period. My amendment seeks to create some certainty by referring back to the accounts of the previous accounting period to determine whether a small company is a small company. Rather than the uncertainty of new section 930R inserted by the schedule, which looks at the current accounting period, amendment 48 refers to the previous accounting period to give the taxpayer greater certainty.
Schedule 14 provides the new exemption, which we have been discussing, from corporation tax for dividends and other distributions from foreign companies. It amends the rules on taxation of distributions received from UK companies. The exemption will remove the need for groups to make complex double tax relief calculations and will allow profits to be repatriated, even in circumstances in which there would not have been enough double tax relief to eliminate a UK tax liability. Until now, when there was insufficient credit for foreign tax, overseas profits would typically stay offshore, with cash possibly being returned in the form of an upstream loan. Alternatively, groups might have adopted complicated, artificial ways of repatriating such profits other than through a dividend. Exemption will sweep all that away and allow for immediate repatriation of profits and the return of cash by dividend. That will enhance the attractiveness of the UK as a location for the headquarters of multinational businesses.
The rules will apply to distributions received by all companies in the UK, including small companies, which was not part of the original proposal. The rules for small companies are distinct from the rules for medium and large companies, but, in each case, the vast majority of all dividends and other distributions will benefit from the exemption. That protection, alongside that contained in clause 40 and schedule 19, which deal with personal dividend taxation, are a proportionate response to the risk of abuse of the exemption by small companiesthe protection set out in the schedule. However, we will keep a close eye on the matter and take immediate action if any avoidance activity is identified.
The hon. Member for Fareham moved amendment 43 on capital distribution. Schedule 14 applies only to distributions of an income nature. The amendment would increase its scope so that it applied to most capital distributions as well. However, schedule 14 is concerned only with the taxation of distributions that represent income. Nothing in the schedule will cause any capital distribution that is currently exempt to become taxable, so there is no reason to extend the scope of the exemption as suggested. The legislation does nothing to alter the taxation of capital distributions that are excluded from the scope of proposed new part 9A of the Corporation Tax Act 2009. There is already an exemption for capital distributions, known as the substantial shareholdings exemption. It is not part of this Bill to change in any way the scope of that exemption, so I hope that he will accept that the amendment is not appropriate.
As the hon. Gentleman explained, amendment 48 would alter the definition of a small company. However, in doing so, it would change the standard definition used to determine whether exemption follows the small company rules or the rules applicable to larger companies. The legislation uses the standard European Commission definition of a small company, which includes a time lag whereby a company that changes from small to medium sized retains the status of small in the transition year but becomes a medium company the following year. A similar rule applies if a company moves down in size from medium to small. The amendment would delay the change of status by a further full year. That would be an additional complication and make it less likely that the appropriate legislation for that size of company was applied. I hope the hon. Gentleman will accept that that is an unhelpful additional complication.
Several Government amendments in this group are concerned with a rule that denies exemption if a foreign tax deduction is given for the distribution, on the basis that a distribution that is tax deductible represents a deduction from taxable profits rather than distribution of those profits. Therefore, it is closer to an interest receipt than a distribution and would be expected to give rise to a taxable receipt for the recipient. The rule denying exemption is extended to cases where amounts determined by reference to a distribution are tax deductible. That ensures that the rule cannot be side-stepped by the use of indirect tax deductions obtained through avoidance schemes. The change will also enable some simplification of the manufactured dividend rules, which no longer require a specific exception. I therefore recommend that Government amendments 92, 93, 99,101 and 102 to schedule 14 be accepted. I hope that the hon. Gentleman will not press amendments 43 and 48.
I am grateful to the Minister for his comments, particularly on amendment 48 and the transitional year which dealt with the issue that I was seeking to tease out. I have a residual concern about amendment 43. My understanding is that certain distributions that would have been untaxed under the existing rules, because of the UK to UK rules, are taxable now. I will go back and think carefully about whether any issues ought to be drawn to the Ministers attention and be the subject of further debate on Report. I beg to ask leave to withdraw the amendment.
With this it will be convenient to discuss the following: amendment 45, in schedule 14, page 135, line 36, leave out from of to end of line 38 and insert an ordinary share..
Amendment 170, in schedule 14, page 136, line 19, after dividend, insert or other distribution.
Amendment 49, in schedule 14, page 141, leave out lines 29 to 34.
The amendments cover several issues. Amendment 44 deals with the exemptions in proposed new section 930EDistributions from controlled companies. I am concerned that in introducing this measure the Government have omitted some of the existing tests for controlled companies. It refers to holdings which, for a variety of reasons, may be split between various groups of companies but in aggregate mean that the company has control.
The existing tests read:
(c) if the person is resident in the United Kingdom, rights and powers of any person who is resident in the United Kingdom and connected with the person; and
(d) if the person is resident in the United Kingdom, rights and powers which for the purposes of subsection (5) above would be attributed to a person who is resident in the United Kingdom and connected with the person (a UK connected person) if the UK connected person were himself the person.
The situation here is that the ownership of subsidiaries may be split so that neither of the owners have control within the basic provisions of controlled foreign companies legislation, but taken together they would have control. If we do not replicate this in subsections 6(c) and (d), those dividends would fall outside the exemption and would therefore be taxable. It is not clear why the change has taken place. The explanatory notes suggest that the definitions replicate the CFC rules, but this exclusion for indirect ownerships suggests that that is not the case. The amendments try to address that by enabling shareholdings held through non-resident affiliates to be aggregated together.
Amendment 49 refers to the issue of redeemable shares. In the UK ordinary shares are assumed not to be redeemable. One concern is that the law in other jurisdictions is not as clear as in the UK, so there would be a risk that a distribution might be taxable when it should not be. My amendments seek to clarify that point and I would be grateful for the Ministers comments. If there is an issue about people using redeemable ordinary shares, is it not better to tackle it through an anti-avoidance route rather than the provisions in proposed new section 930F?
Amendment 170 is a drafting amendment that seeks alignment: subsection (1) of proposed new section 930H refers to a dividend only, whereas subsection (1) of proposed new section 930G refers to a dividend or other distribution. Assuming that there is no reason for this difference, the amendment would simply correct a drafting error.
is resident in the United Kingdom and person who. This is undesirable because the vagueness of UK residency requirements can lead to individuals exploiting distributions from controlled foreign companies and achieving tax advantages. The legislation is best left as it stands. I understand that there are difficulties at the moment in equating certain well-known Tory donors residency with their tax situation, and bringing residency into this is unsatisfactory.
Chapter 3 of the schedule introduces a set of exempt classes, and the amendments in this group, as we have heard, all act to increase the scope of the exempt classes in various ways. The idea of the exempt classes is to give exemption in circumstances where the risk of avoidance is low. The benefit is that the anti-avoidance rules can be targeted at narrow situations rather than being of general application. That is a significant benefit and I am cautious about extending exempt classes because of the risk of losing some of that benefit.
Amendment 44 would increase the scope of the exempt class for controlled companies in a way that would allow a distribution to fall within an exempt class even if the payer of the distribution was not within the scope of the CFC legislation. That exempt class gives exemption to more than 90 per cent. of dividends by value. It takes a simple and direct route to exemption for controlled companies, which is possible because the CFC rules protect against artificial diversion of profits. The protection reduces the risk that this exempt class might be abused by avoidance schemes and allows it to be free of any other conditions for exemption.
The effect of the amendment would be to allow the rights and powers of a connected foreign company to be taken into account in determining whether the payer of a distribution is a controlled company. Therefore, a distribution paid by a company controlled outside the UKand therefore outside the scope of CFC defencescould be brought within this exempt class, so there is a potential danger of an unacceptable fiscal risk. The attribution was limited to UK companies, and that brought the risk of another EU legal challenge. The extension of that to all companies would have brought unacceptable risks and hence we removed it altogether.
Is the Minister certain that a significant risk is attached? I understand that the rules were in place under the existing regime. They allowed non-UK affiliates to be taken into account in determining whether the basic control rules were met. We seem to have shifted away from that. I am concerned that the Minister is taking a potential threat and using it in support of the changes, rather than recognising that the rules currently permit that aggregation to assess whether control has been in place. He has not justified as robustly as we would expect why we should move away from that position.
What I understand the hon. Gentleman to be asking is whether there is a real risk of EU challenge from the arrangement as it was. We have been very careful throughout the exercise to ensure that we are absolutely secure from any challenge under EU law, because such a challenge would create uncertainty which would be in nobodys interest. I am not aware of anyone proposing to mount a challenge, but the way in which we have arranged this now means that we can be absolutely certain that there will not be a challenge. That is an important bolstering of the confidence with which people will be able to operate once the arrangements are in place, and is a worthwhile protection against challenge.
Amendments 45 and 49 would remove one of the two conditions required for exemption in the second class, which applies to distributions paid on non-redeemable ordinary shares. This class is relevant where the first class is unavailable because the CFC rules do not apply. An ordinary share is one that carries no preferential rights. The reason for the restriction is that in the absence of CFC defences, preferential rights attached to shares may be used to allow distribution exemption to be used to convert what would otherwise be taxable profits into exempt dividends. We need that when ordinary shares are not redeemable, since the right to redeem share capital might otherwise be used to provide an alternative form of preference for the shareholders, and we think that that would represent an unacceptable fiscal risk.
I should remind the Committee that a dividend that does not fall into the exempt class can still qualify for exemption. A dividend will always be exempt if it is not derived from transactions designed to reduce UK tax. That is the effect of the later part of chapter 3. The exempt class provides a simple route to exemption for many dividends, but it is not the only routethere is also a fall-back. I suggest that the amendments are not necessary and would create a significant avoidance risk.
Finally, turning to amendment 170, I should say again that there is a fall-back exempt class that ensures that dividends paid in wholly commercial circumstances are always exempt. The exempt class is based on a test of the profits out of which a dividend is paid. Exemption is given, provided that the profits do not derive from transactions designed to reduce UK tax. A dividend is necessarily paid out of profits, but the same cannot be said for other types of distribution. Since the class is a test of profits and not directly a test of the distribution, it is limited to dividends.
I am satisfied that amendment 170 is not necessary to enable all commercially derived profits to be repatriated in a tax-free form, which is our aim. The extension to non-dividend distribution would create risks because of the lack of a necessary link between the distribution and the profits. I hope that on that basis the hon. Gentleman feels able to withdraw the amendment.
The areas that we are seeking to legislate on are obviously complex. The Financial Secretary has said that there are fall-backs that would allow distributions to be exempt in particular circumstances. It would have been helpful, where possible, to have drawn together on that. I do not understand why he objects to amendment 170; if a distribution is not designed to reduce tax, why is that not part of the clause? There is a danger that the dividing line that the Minister is seeking to draw between what should and should not be exempt will become quite complex.
The Financial Secretary is yet to give a robust explanation for why it is not appropriate, in relation to amendment 44 for example, to repeat the foreign affiliates rules in the existing CFC legislation, but we will not dwell on that. Part of the challenge with schedules 14 and 15 is that they have been heavily amended in the past few days, and I think that people need more time to think through some of the consequences. I am sure that that will be one of the themes that will emerge in later consideration. We are in danger of giving outside bodies insufficient time to think about the consequences of those changes and the knock-on effects. Having said that, I beg to ask leave to withdraw the amendment.
I beg to move amendment 94, in schedule 14, page 136, line 30, leave out apart from and insert otherwise than by virtue of.
With this it will be convenient to discuss the following: Government amendments 95 to 98.
Amendment 46, in schedule 14, page 139, line 43, leave out dividend and insert distribution.
Amendment 47, in schedule 14, page 140, line 2, leave out dividend and insert distribution.
Amendment 51, in schedule 14, page 147, line 30, leave out expenditure and insert territory.
Government amendments 103 and 104.
Amendment 59, in schedule 15, page 172, line 33, leave out Part and insert Schedule.
Government amendment 100.
Amendment 50, in schedule 14, page 143, line 20, leave out paragraph 9 and insert
9 In section 806J, after subsection (7) insert
(8) Sections 806A to 806K shall not apply to any distribution paid after 1 July 2009 other than a distribution in respect of which an election has been made under section 930Q of CTA 2009..
This is a mixed group of Opposition and Government amendments, all of which address relatively minor drafting points. I have so far resisted amendments from Opposition Members, but I am pleased to say that on this occasion I will be urging my hon. Friends to support the amendments tabled by the hon. Member for Fareham, which I am happy to accept. [Interruption.]
I was rather hoping that we might have had a little oratory from the hon. Member for Fareham in support of the amendments, but even without the oratory I am happy to accept them and hope that the Committee will accept the Government amendments as well.
Well, I am almost overwhelmed to the point of speechlessness by the acceptance of the amendments. I just wish that they were of a more substantive nature, as that would have shown that the time of change had come after all. They correct drafting errors where the Government have inappropriately used the word dividend instead of distribution. Proposed new section 930P refers to distributions in the context of diversion of trade income, but the drafting refers intermittently to dividends and distributions, and we have already discussed circumstances in which either dividends or distributions might be appropriate.
Amendment 51 corrects a different typo: the line should have referred to territory, but currently refers to expenditure. The amendments are fairly straightforward. I wish I could claim authorship, but someone more eagle-eyed than me identified the issues. I am grateful to the Minister for accepting them.
Amendments made: 95, in schedule 14, page 136, line 33, leave out from beginning to is in line 34 and insert Any other dividend.
96, in schedule 14, page 137, line 14, leave out apart from and insert otherwise than by virtue of.
97, in schedule 14, page 137, line 17, leave out from beginning to is in line 18 and insert Any other dividend.
98, in schedule 14, page 138, line 18, leave out from that to end of line 20 and insert
does not fall into an exempt class by virtue of section 930E but would, apart from this section, fall into an exempt class otherwise than by virtue of that section..
99, in schedule 14, page 138, line 46, at end insert
930MA Schemes involving distributions for which deductions are given
(1) This section applies to a dividend or other distribution that would, apart from this section, fall into an exempt class.
(2) The distribution does not fall into an exempt class if
(a) the distribution is made as part of a tax advantage scheme, and
(b) the following condition is met.
(3) The condition is that a deduction is allowed to a resident of any territory outside the United Kingdom under the law of that territory in respect of an amount determined by reference to the distribution..(Mr. Timms.)
I beg to move amendment 100, in schedule 14, page 143, line 9, leave out sub-paragraphs (2) and (3) and insert
() In subsection (3) (as it has effect as amended by paragraph 8 of Schedule 30 to FA 2000)
(a) before paragraph (a), insert
(za) if the dividend is received in an accounting period of the recipient in which the recipient is not a small company, and the dividend is a relevant dividend, the profits in respect of which the dividend is paid;,
(b) in paragraph (a), at the beginning, insert in a case not falling under paragraph (za),, and
(c) in paragraph (c), at the beginning, insert in a case not falling under paragraph (za),.
() After subsection (3) insert
(3A) For the purposes of subsection (3)
(a) small company has the same meaning as in Part 9A of CTA 2009 (company distributions),
(b) relevant dividend means a dividend that, for the purposes of section 930H of that Act (dividends derived from transactions not designed to reduce tax), is treated as paid in respect of profits other than relevant profits (see subsection (4) of that section), and
(c) the profits in respect of which a dividend is paid are the profits in respect of which the dividend is treated as paid for the purposes of that section..
With this it will be convenient to discuss amendment 50, in schedule 14, page 143, line 20, leave out paragraph 9 and insert
9 In section 806J, after subsection (7) insert
(8) Sections 806A to 806K shall not apply to any distribution paid after 1 July 2009 other than a distribution in respect of which an election has been made under section 930Q of CTA 2009..
Amendments 50 and 100 centre on the way in which double taxation relief is given in the rare cases in which a dividend is taxable. Government amendment 100 deals with the interaction between the rules in part 9A that apply to taxable dividends and the double taxation relief rules. If a dividend is paid out of profits that have been subject to foreign tax, the double taxation relief rules allow the foreign tax to be given as a credit against the UK tax due on the dividend to ensure that the same income is not taxed twice. The rules currently allow a large amount of choice in the specification of the profits out of which the dividend is paid, which is important because the foreign tax paid on the specified profits determines the amount of foreign tax credit available. The distribution exemption schedule includes an anti-avoidance rule that considers the source of the profits out of which a dividend is paid. If those profits result from transactions designed to reduce UK tax, the dividend will be taxable in the UK.
Since the Bill was published, it has been brought to our attention that there is a risk that avoidance schemes might exploit the mismatch between how profits are specified for the purpose of the anti-avoidance rule and how they are specified for the purpose of double tax relief rules. The amendment therefore overrules the usual choice available in the double tax relief rules. It will ensure that, where a dividend is taxable in the UK because it is paid out of the profits of tax avoidance, double tax relief available on that dividend will be calculated by reference to those same profits. The amendment will remove a significant risk of tax avoidance exploiting a mismatch whereby a dividend intended to be taxed would escape any effective taxation.
Perhaps if the hon. Member for Fareham speaks to amendment 50, I will be able to respond later.
Amendment 50 deals with new section 930Q, which allows a company to make an election that a particular distribution that would otherwise be exempt should instead be taxable. The explanatory notes state that the two reasons why a company might wish to make such an exemption are that
dividends can only be taken into account for the purposes of the CFC acceptable distribution policy (ADP) exemption if they are subject to tax and
it is possible that exemption could lead to an increased rate of withholding tax.
Paragraph 9 of schedule 14 amends the Income and Corporation Taxes Act 1988 to delete the onshore pooling rules and the rules that allow for relief in relation to eligible unrelieved foreign tax. The provisions are an integral part of the credit system of taxation and it is appropriate that they should no longer apply to dividends following the introduction of the exemption regime; there is logic in that.
However, a taxpayer may elect for dividends to fall outside the exemption regime. Therefore, a corporate taxpayer may elect for a dividend to be taxable in the UK if it is paid by a company resident in a territory with which the UK has a double tax treaty. The provisions that reduce or eliminate foreign withholding tax apply only if the dividend is subject to tax in the UKthe sort of scheme where one might want to have a taxable rather than an exempt dividend. The expectation is that where people take advantage of that election, they should also be able to take advantage of the existing rules on onshore pooling and the use of eligible unrelieved foreign tax. Amendment 50 would enable people who take the election under new section 930Q to take advantage of the rules on onshore pooling and the use of unrelieved foreign tax.
A principal purpose of the legislation is to simplify the process of paying dividends to the UK. Amendment 50 would retain a significant body of complicated legislation on onshore pooling rules. I hope that I can persuade the hon. Gentleman that it would do so with little, or possibly no, benefit. It would retain the onshore pooling rules solely for the benefit of those dividends that a company elects to be taxable. Why would a company do that? The two most likely reasons are to obtain lower rates of foreign withholding tax and, during a transitional period, to allow dividends to qualify for the ADP exemption from controlled foreign company legislation, which we will come to later.
Although the onshore pooling rules can apply to withholding tax, by far their main application is in connection with underlying tax. It is rare that dividends that qualify for underlying tax credit also suffer withholding tax, because intra-group dividends are generally exempt from such taxes. ADP dividends are in all cases excluded from onshore pooling. It is not justified to retain onshore pooling and the significant amount of legislation on that for that very limited purpose. The rules were introduced in 2001 to balance the introduction of the so-called mixer cap. That need has been removed by dividend exemption, so the rationale for the onshore pooling rules will end as well. I hope that the hon. Gentleman feels that he can withdraw his amendment.
Amendments made: 101, in schedule 14, page 144, line 24, leave out from beginning to modification in line 32 and insert modification.
Amendment 102, in schedule 14, page 145, line 36, leave out from following to modification in line 44 and insert modification.
(4B) The.(Mr. Timms.)
I want clarification on some of the technical aspects of the schedule that we have not touched on. The schedule comes into effect on 1 July 2009, which is slightly odd. It will be difficult to do given that the Bill will not receive Royal Assent until after that date, but that is how we are making tax policy. There have been concerns about the impact of that date. Does the commencement date make it more difficult for foreign companies to meet the acceptable distribution policy?
The proposed changes to the Corporation Tax Act 2009 mean that from 1 July 2009, dividends can only be specified as being paid from the profits of the current period. When no profits are specified, the dividend will be treated as having been paid from the profits of the last period for which accounts were drawn up. That suggests that it be difficult for companies to qualify for the acceptable distribution exemption. In addition, a company accounting period that straddles 1 July 2009 will be, as a whole, under the controlled foreign companies rules. That may end up with CFCs trying to run other exemptions to get their dividends through.
PricewaterhouseCoopers suggested that a straddled period should be treated as split only in cases when a company pursues an acceptable distribution policy in respect of the first period, or for which an exempt activity holding company is claimed in the first period but not thereafter. Will the Minister clarify how the commencement date impacts on companies seeking to use the existing rules?
There is a disconnect between the sourcing rules in part 2 and other rules on the treatment of dividends. Are the rules consistent with the acceptable distribution policy? Will the Minister comment on the taxation of foreign permanent establishments, which has not yet been fully addressed? Where are the Government in that process?
We have had a helpful discussion on the schedule and the amendments. The new exemption from corporation tax for dividends and other distributions received from foreign companies which is introduced by the schedule is a key element of the package to enhance the attractiveness of the UK as a location for multinational businesses. As the hon. Gentleman said, it takes effect from 1 July 2009.
I say in passing that we have thought very carefully about the implementation dates of the various parts of the package. Therefore, as we will discuss shortly, we are introducing the debt cap for an accounting period which will begin on or after 1 January 2010, so that businesses have time to prepare. That the measure is being introduced later than the dividend exemption has been widely welcomed.
The hon. Gentleman asked about transitional arrangements. Any profits accrued in a foreign subsidiary before the package comes into force can be paid out as an ADP dividend and remain subject to the current rules, which may be a helpful clarification.
Considering the tax treatment of branches would have raised more issues and diverted attention away from the main point, which is the taxation of foreign dividends. We will bear branches in mind when we look at future options for controlled foreign companies, but we will not consider the treatment of foreign branches in detail until after the consideration and reform of the CFC rules.
I have one further point to make about the interaction with the ADP exemption. Amendment 100 removes the restriction on double taxation relief. Amendment to the CFC changes in schedule 16, which we will come to, will allow the split period to also be treated as split for the purpose of double taxation relief. There was indeed a problem in the area highlighted by the hon. Gentleman when the Bill was initially drafted, but I think that that has been solved by the various changes that we will debate today.