The clause deals with anti-fragmentation, a term I had not heard of until I started working on the Bill. However, I have been trying to get my head around the term and I will give it the best that I can.
The clause is another anti-avoidance measure that has our support. In essence, it is about banks, and in particular how they might find ways to book income and expenses in different accounting units to avoid tax. Following the decision in a 2005 court case, Legal and General Assurance Ltd v.Thomas, in front of the special commissioners, the Finance Act 2005 introduced legislation restricting the availability of double taxation relief for foreign taxes paid on schedule D case 1 income, which now of course are treated just as trading income under the Corporation Tax Act 2009, or income computed on a similar basis for UK tax purposes. The rules aim to ensure that the double taxation relief claimed cannot exceed the equivalent corporation tax on the net profits attributable to that source of income, after deducting an appropriate allocation of expenses, and are often referred to as a mini-D1 computation.
HMRC believes that certain banks have sought to avoid the impact of this legislation, either by routing loans through subsidiaries, which are taxed differently, or by financing in such a way that funding costs are not directly attributable to the income and therefore are not deducted in calculating the double taxation relief restriction. Although HMRC considers that the existing legislation should already have the desired effect, clause 60 is intended to put the matter beyond doubt.
The current rules provide that, where income that would otherwise have formed part of the trade receipts of a bank but instead is received by an affiliate that is differently taxed and can claim double tax relief without the restrictions affecting the bank, the income is treated as trade income of the subsidiary. With effect from Budget day, the new measures will extend the existing wording, with the intention that its scope mirrors HMRCs interpretation of the current rules. Furthermore, when allocating bank funding costs in calculating the relief due, this must now be done on the basis of a proportion of average funding costs, even when specific funds are used to finance an investment.
My understanding is that, if one has a pool of investments and a pool of different vehicles funding those investments, one would have to allocate things on a proportion of the average funding cost for the whole portfolio rather than specific funds underlying a specific asset and how that asset in particular has been funded. That is my understanding of the situation; I would be grateful if the Minister could confirm whether that is correct. These changes have effect from 22 April 2009.
Amendment 218 was suggested to me by the Law Society, which believes that both sets of amendments, as they are aimed at artificial manipulation of double tax relief, should be subject to a tax avoidance motive test. The basic rules, as they stand, already contain provisions relating to the allocation of expenses and these rules should apply over and above those rules only in exceptional cases where there has been deliberate manipulation for tax reasons.
That is what our amendment seeks to do. My understanding is that the language used is entirely normal for these tax avoidance motive tests and I would be grateful for the Ministers view on whether he will accept the amendment and on the importance of attaching motive to tax avoidance in this case.
I rise to test my understanding of the term anti-fragmentation in the clause. It seems to me that the term restricts the banks in two ways. First, it restricts them in how they proportion the cost of overseas transactions under the Finance Act 2005. Secondly, it curtails their ability to dodge that regime by arranging income to be received by a non-banking company under their control. The explanatory notes say that clause 60
will clarify the existing legislation that prevents banks avoiding the intention of the DTR legislation by artificially arranging for income to be received by a non-banking company.
That rather creates the perception of the banks as a slightly slippery customer, if one considers what might be behind it. It certainly makes the case for HMRC vigilance and Treasury intelligence. It also endorses the strong public suspicion over banking behaviour in general. Can I tempt the Minister to indicate which banks behaviour is being targeted and how many banks are in receipt of taxpayer funds?
Again, I welcome the support of both Opposition spokesmen for the clause. It contains further clarification of the double taxation relief rules to prevent the abuse of those rules by banks through tax avoidance schemes. This is the last of the four clauses that deal with double taxation relief. The double taxation relief rules are designed to give relief in the UK for foreign tax paid on foreign profits and to ensure that UK tax paid on profits earned in the UK is not reduced by foreign tax. Some companies, banks in particular, devised sophisticated schemes to abuse those rules by using foreign tax to reduce the UK tax payable on profits.
The hon. Member for Southport has drawn attention to the general public view of behaviour of that kind. There has been some press coverage of it in recent months, which the banks are sensitive to. I am not able to name names in this debate, as he knows, but the Chancellor has announced that we will publish for consultation a code of conduct for banks in this area in the hope of changing some of the practices that have grown up over the years.
The code of conduct will be published shortly. The intention is that all banks will sign up to it. It will be a voluntary code, but I am pleased to say that broad support has been indicated across all banks.
Some banks have attempted to avoid the intention of the double taxation relief legislation by separating foreign receipts from the expenses of earning them to maximise their double taxation relief claims, hence the fragmentation. One method has been to divert what is in substance trade income into investment subsidiaries that are not subject to the same requirements. Another is to purport to fund avoidance schemes involving receipt of foreign income with money that does not have an associated funding cost, such as customers deposits in non-interest bearing current accounts.
The clause will amend rules introduced in the Finance Act 2005, as hon. Members have said. That legislation is working well, but the clause will clarify its intention by putting two matters beyond doubt. First, where there is an avoidance scheme, the assumption is that any income received by a member of a banking group is trade income, unless that assumption is not reasonable. Secondly, a banks funding costs should always be taken into account when calculating the double taxation relief due.
The clause will apply to avoidance schemes, and I believe only to avoidance schemes. Its effect in all cases will be to ensure that a fair amount of tax credit is given. There are no circumstances in which double taxation relief should be given without regard to bank funding costs, so a restriction to avoidance schemes or arrangements is not necessary. My concern about amendment 218 is that, since the aim of the clause is to put the matter wholly beyond doubt, the additional requirement that it applies only in cases of avoidance would be an unnecessary obstacle to its proper implementation.
I expect that the Minister knows more about motive clauses than I do. Given the fact that there are a lot of motive clauses on anti-avoidance measures, what kind of parameters have the Government used? I think that he is saying that it would be too burdensome or difficult to have the motive clause in the case under discussion. Is there a particular point at which the motive clause makes sense and another point at which it becomes too administratively difficult?
The hon. Gentleman is right that those tests are appropriate in a range of circumstances, but they are not appropriate in the case under discussion because the purpose of the clause is to make things absolutely clear. To apply a test in this case would add uncertainty, which the clause exists to remove. To add an avoidance purpose test risks undermining the clauses aim of ensuring that the point is unarguable.
The Minister, in the course of our discussions on this and previous clauses on double taxation and avoidance, has referred to avoidance as undesirable, and he has also referred to the abuse of rules. We are trying to clarify the Treasurys position. One of our concerns, both moral and ethical, is also a concern that we hear loud and clear from outside interest groups, and it does not relate to a lack of certainty. I appreciate that our amendment adds an element of uncertainty by discussing the main purpose, but the issue is surely that some emphasis should be placed on intentions, as well as outcomes.
The Governments strong view on the undesirability of any sort of tax avoidance, which has manifested itself in some of the retrospective and retroactive legislation of recent years, effectively centres just on outcomes, rather than on intentions. Is it the case that the Treasury, not only in relation to clauses such as this but also more generally, wants to remove motive-type clauses in order to produce total certainty? If that is the case, no attention whatever is being paid to the intention of the main purpose; it is being paid, rather, towards the outcome of the avoidance of tax, which is wholly undesirable from the Governments perspective.
I do not think that that is an accurate description of what has happened. For example, we have had a debate about principles-based legislation in relation to the Bill, and a very clear statement has been included in it about the intended principles. We had a debate about whether uncertainty was being created by that, so I do not think that the general direction described by the hon. Gentleman is right. However, in the case under discussion, the clause will apply to avoidance schemes only. There may well need to be a motive test in a case in which there might be a risk of inappropriate application, but there is no such risk in this particular case. It is a fair result in all cases, so there is no need for the test to be added.
I think I understand what the Minister is saying, but there seem to be two ways of looking at the issue. Option A is that such practice never happens unless it is done through deliberate anti-avoidance, and option B is that, if such practice does happen, the party involved may have innocently carried out the transaction, but such transactions should be forbidden to prevent similar avoidance schemes. The clause seems to conform to option A, which states that such transactions never happen unless they are wilful and deliberate avoidance.
Double taxation relief for a bank should always take account of the banks cost of funding. The clause does no more than ensure that that is the case. If the qualification was added, it would give tax avoiders an excuse for arguing that the legislation should not apply and, for as long as they carried on arguing the point, they would not be paying their tax. I therefore hope that the hon. Gentleman will withdraw the amendment.
The Government amendments avert a risk of an excessive reduction in tax credit. The clause requires a bank or a company associated with a bank to use the average costs that the bank would incur to fund a transaction, known as its notional funding costs, for the purposes of its DTR claim, rather than the funding costs actually used in its calculations, where the notional funding costs are significantly higher. Normally, banks fund all their transactions from a single undifferentiated pool of assets, but in very limited circumstances a company associated with a bank may fund a particular transaction with a loan taken out for that specific purpose and thus have legitimate direct funding costs.
The amendments ensure that all funding costs, whether direct or indirect, will be taken into account in the DTR calculation, so relief will not be restricted where companies associated with banks have incurred legitimate direct funding costs. I hope that the Committee will feel able to accept the Government amendments and the clause.
Amendments made: 209, in clause 60, page 29, line 36, leave out paragraph (b) and (c) and insert subsection (3).
Amendment 210, in clause 60, page 30, line 4, leave out paragraph (b) and (c) total and insert
subsection (3) total (before the application of subsection (3B)).
Amendment 211, in clause 60, page 30, leave out lines 11 to 13.
Amendment 212, in clause 60, page 30, line 15, at end insert
subsection (3) total means the amount to be taken into account under subsection (3) for the purposes of section 797(1)..(Mr. Timms.)