Clause 35

Part of Finance Bill – in a Public Bill Committee at 4:30 pm on 9th June 2009.

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Photo of Stephen Timms Stephen Timms Financial Secretary (HM Treasury) (also in the Department for Business, Innovation and Skills) 4:30 pm, 9th June 2009

Welcome back, Mr. Hood. I can reassure the hon. Gentleman that I do not expect that that will happen. But the Bill will not become law until it secures Royal Assent. He asked why we do not have the same date for the implementation of dividend exemption and the new debt cap requirement. It was the original intention, but in our discussions with businesses there was a strong sense that it would be helpful if there was a period between the two. They will undoubtedly want to make some changes and introducing the six months between the two gives a period of grace that enables them to do that. That has been widely welcomed. It is one of the improvements that we have made as a result of the consultation over the last few months.

I was answering a number of questions raised by the hon. Member for Fareham about the thinking behind the changes that we have made. As he said, there would have been a number of ways to tackle the issue that we are dealing with in the schedule. In terms of moving towards a territorial tax system, one view would be that as a matter of principle, interest to fund foreign equity investment should not be relieved when the dividends from those investments are exempt. Taking that view would suggest that dividend exemption should be accompanied by strict interest allocation or a limitation of interest for outward investment.

Either of those would have a very big impact on multinational companies, particularly on UK-headed groups. We discussed them both with businesses. Both  were disliked, particularly interest allocation and the associated complexity and administrative burden that accompanies it, as has been found in the operation of that arrangement in the United States. Companies were very keen that we should not go down that road. So the debt cap measure is a less far-reaching but principled measure to accompany dividend exemption.

The hon. Gentleman suggested that another way might have been to tighten the thin capitalisation rules. That is where, typically, a UK subsidiary of a foreign multinational is funded with too little share capital and too much debt, thereby attracting a higher tax allowance than would otherwise be the case. That is countered at the moment using the UK transfer pricing rules which adjust the profits of a company that is thinly capitalised to reflect the profits it would have made if it had been capitalised in accordance with the arm’s length principle. A tightening of the UK rules to counter cases where there is excessive debt in the UK would mean abandoning the arm’s length principle. Instead we could have looked to counter thin capitalisation using different rules, but the alternative methods would have an impact on many more cases than the debt cap measure does.

In the end, we concluded that this is a principled and effective approach that deals with the problem. It is a clear principle. It is readily understood. In December, following the pre-Budget report, we issued draft legislation on the foreign profits package, so that people could see our intentions. There were concerns and lots of discussions arose.

At the beginning of April, Her Majesty’s Revenue and Customs published a technical note setting out current thinking on the debt cap with high level design changes, which have been welcomed. When the Finance Bill was published at the end of April, large parts of the debt cap legislation had been revised, but there were areas that required more time to ensure that the proposals were appropriate, so they were not in the Bill. There have been further discussions with interested parties since then. That is the background to the Government amendments to schedule 15.

The hon. Member for Fareham’s final question was about the gateways for outbound investors for UK-headed groups. He is right; we had hoped to have more than one gateway to keep administrative burdens on business as small and as light as possible. He anticipated part of my answer: throughout the package, as I have mentioned, we have had to take European Union legal requirements into account, and consequently we could only make one gateway available. However, the improvements to the debt cap design, particularly the switch from net debt to gross debt, exclude more groups from the debt cap anyway. Other changes reduce the administrative burden on any group that has to comply with the rules.