Tax underlying dividends

I beg to move amendment 206, in clause 57, page 27, line 27, leave out subsection (2).

It might be convenient for the Committee to treat this as one debate on a technical matter, rather than to debate the amendment and then clause stand part.

I, too, welcome you back for this morning’s deliberations Mr. Atkinson.

After the giddy heights of political drama in our debate on clause 56, we reach a substantial set of clauses that aimed mainly at scams of various kinds  designed to facilitate tax avoidance. I think that we will find some drama in these clauses as well, although not so much in clause 57.

The clause changes how the amount of double taxation relief available to UK companies is calculated. Subject to certain criteria, UK companies in receipt of dividends paid from abroad are entitled to relief for tax charged on the original profits out of which the dividends have been paid; that is relieved against the UK corporation tax due on receipt of those profits. The recent reduction in the corporation tax rate caused a mismatch in how the relief is calculated. The clause corrects that by ensuring that the amount of relief available to UK companies is calculated by reference to the actual rate of corporation tax suffered on their UK profits.

An HMRC review of the clause found that subsection (2), which restricts the change to corporation tax cases, simply restates a restriction already contained in the Finance Act 2000, which first introduced the relevant legislation. The amendment removes the unnecessary duplication, which would otherwise have created some uncertainty and could have given rise to tax avoidance opportunities. I hope that the Committee is satisfied with the amendment.

The problem addressed by the clause was recognised last year, on Third Reading of the 2008 Finance Bill. My predecessor as Financial Secretary committed to rectifying the problem, after consulting with interested parties. HMRC has discussed the draft clause with business representatives, and the simple solution provided by the clause ensures that credit is given in line with my predecessor’s commitment.

The clause is retrospective and applies from 1 April 2008. The retrospective action is such that it can only apply to the benefit of companies by increasing the amount of foreign tax credit available. The clause is likely to have limited application after 1 July this year, because of the introduction of legislation that exempts from UK tax almost all foreign dividends, which we have already debated.

We agree with the Government’s amendment. I will talk mainly about the general issues that arise from the clause.

The clause is a result of the changes enacted in the Finance Act 2008 that changed the corporation tax rate in the middle of a company’s accounting year, and the unforeseen consequences of that. As the Financial Secretary has said, the clause deals with foreign source dividends, which are subject to corporation tax at the effective rate applicable for the accounting period in which they were received. Companies with accounting periods straddling 1 April 2008 have an effective corporation tax rate between 30 and 28 per cent.—29.5 per cent., for example—depending on how much of the tax year is in the relevant accounting year. However, the double tax relief mixer cap formula, which limits the amount of credit relief available for foreign dividends, operates by reference to the statutory rate of corporation tax in force on the payment date—either 30 or 28 per cent. in that particular tax year, but not a combination of the two. That potentially results in an unintended restriction on the amount of double tax relief that might be available.

HMRC first acknowledged that mismatch in September 2007 and confirmed in July 2008 that the rules would be amended with retrospective effect from 1 April 2008, as  introduced in the Bill. The impact of the discrepancy is to be eliminated by calculating the mixer cap by reference to the blended effective rate for the period. My understanding is that the formula used would be: (actual number of days in period 1 divided by 365, multiplied by the corporation tax rate effective in period 1) plus (actual number of days in period two divided by 365 multiplied by the corporate tax rate effective in period 2).

Foreign dividends are chargeable to UK corporation tax and in calculating the relevant income one has to show the dividend gross of all taxes suffered. Dividends received may have also suffered withholding tax. Withholding tax is always recoverable, subject to the limits for credit relief. However, in addition, as dividends are paid out of post-tax profits, the dividend will also have suffered what is called underlying tax. A credit for underlying tax can be claimed only when a company holds, directly or indirectly, 10 per cent. of the voting power of the company paying the dividend, or is a subsidiary of such a company.

The underlying tax, which is referred to as U in the legislation, is initially calculated by using the following formula: (dividend paid divided by relevant profits) multiplied by actual tax paid. The relevant profits are the profits of any period shown as available for distribution in the company accounts; they are not taxable profits. The underlying tax available for relief is found by using the formula: (D + U) x M, where D is the dividend—the amount received plus withholding tax; U is the underlying tax; and M is the relevant rate of UK corporation tax at that time, which is 28 per cent. The (D + U) x 28 per cent. formula is referred to as the mixer cap.

The clause has been welcomed by tax commentators, but I have one immediate question and one that is more fundamental. First, it is not entirely clear to me why subsection (5) is to take effect immediately, while all the other subsections are backdated to 1 April 2008. I thought the whole provision was supposed to be backdated to 1 April 2008. Perhaps I am just misreading the clause.

There is another important and technical question. The clause and everything that the Minister and I have mentioned so far refers to dividends, by which I assume that we mean dividends on all financial instruments, not just equities. If it were to refer to coupons or the interest rate payable on bonds or other fixed income instruments, an important consideration may arise on the precise day count used in those fixed rate instruments. For example, in this country the day count convention used is actual over 365 fixed, whereas in Japan it is actual over 365, and most eurobonds are denominated on a 30 over 360 basis.

When calculating the relevant corporation tax using the blended rate, what consideration will need to be given to the accounting method of the coupon—or, in this case, what the clause calls a dividend but is effectively a fixed income coupon—and the different day count conventions that may be involved in those coupons? What effect might that have on the blended mixer cap rate? As I said, we broadly welcome the clause and I await the Minister’s response to those two questions.

I rise to agree with the Minister that we have come to an important and surprisingly interesting set of clauses. A bit like the dull books of the Bible,  such as Leviticus, which contain all the things that Hebrews got up to, some of the clauses reveal the dodges and scams that companies get up to.

I seek clarification on a simple point. I understand that the clause is about the interaction of something called the mixer cap—a terms I had only associated with bathroom showers—and corporation tax. Essentially it deals with the unintended consequences of lowering corporation tax in 2008. The clause is meant to have retrospective effect. The explanatory notes make it clear that a concerted effort has been made to limit any potential disadvantages, and I thought I heard the Minister say that the effect of the clause was wholly to the benefit of companies—that nobody is disadvantaged by the original change in corporation tax. Can the right hon. Gentleman confirm that? If he cannot, can he tell us who was disadvantaged and who is still disadvantaged?

I welcome the support that has been expressed for the clause and the fact that it has commended itself to the Committee. The change to the rate of corporation tax took effect from 1 April 2008, so it is right that the change takes effect from that date as well. The hon. Member for Hammersmith and Fulham asked me why subsection (5) is not retrospective. In very rare situations subsection (5) can have a negative impact on business and that is why we are not applying it retrospectively. Nevertheless, I can confirm for the hon. Member for Southport my previous comments about the overall benefit for business from the change that we are making.

The circumstances where there could be an increased burden for companies are rare. There could be an increased burden for some companies, but only where dividends paid between foreign companies were paid before the change in the corporation tax rate. The subsequent case 5 dividend is paid after 5 April 2009 and is not exempt. Given the introduction of the dividend exemption with effect from 1 July 2009, that would occur only in very rare situations. Indeed, that aspect of the legislation is not retrospective so as to ensure that there is not an unfair negative retrospective impact on business.

I understand the Minister’s point that the provision is entirely for the benefit of business and will in no way disadvantage business. My question is simply this: as a result of the decision to alter corporation tax in 2008 and the difficulty that has occurred with the mixer cap, is it now the case that no one has lost out at all?

Yes, it is. There will, no doubt, need to be some adjustments in the light of the clause, but I can give the hon. Gentleman that reassurance.

The hon. Member for Hammersmith and Fulham asked about some detailed aspects of the profit calculations. There are two steps involved: calculation of profit and taxation of profit. The blended rate applies to all profits, however calculated, and there is no need to consider the precise details of the calculation when considering the relevant tax rate.

To press the Financial Secretary a little on that point, can he be absolutely clear that the clause also relates to bond coupons and payments on fixed income instruments? It is surely the case that, if the accounting basis of the bond and the day count convention is different, calculating the mixed rate, where one looks at the actual number of days over 365, times each of the relevant corporation tax rates, will in turn depend on whether the coupon rate, for example, has changed during that time. If there is a step-up bond, and if the coupon rate has changed during that time, surely the corporation tax calculation would have to be aligned in accordance with the way in which the bond is paid.

The clause is about correcting an unintended hit to double taxation relief and it is effective, whichever way the profit is achieved. The clause is not specific to one particular form of profit.

Amendment 206 agreed to.

Clause 57, as amended, ordered to stand part of the Bill.