The clause is designed to tidy up the legislative rules surrounding the corporate tax treatment of dividends and other distributions following major reforms in the Finance Act 2009. Careful work by the solicitors Freshfields Bruckhaus Deringer and others has pointed out a set of anomalies that appear to have provoked officials at the Treasury to generate a new framework in which to tie up some of the loose ends that were left behind, and to reiterate the original intentions of HMRC in making that 2009 amendment to the law.
Generally speaking, in this country we permit a company to make dividend distributions only up to the balance of earnings that are available for distribution according to its most recent audited accounts. Some exceptions exist, usually in respect of distributions of shares of the company for winding up and in other limited situations.
In 2009, new rules replaced the system for taxing dividends from UK and overseas companies following a legal ruling the year before in which, after the FII Group litigation in the High Court in 2008, the European Court decided to exempt EU and European economic area residents’ subsidiary distributions from tax in the UK rather than taking an approach to taxing dividends depending on the residency of the dividend payer. That decision raised the need for HMRC to become compliant with European Union law—here we are again, all good Europeans.
At that point, HMRC could have opted either to introduce an international or an EU exemption, or to remove the domestic exemption from UK to UK dividend distributions. In the Finance Act 2009 HMRC seemed to opt for the second option, placing both UK and non-UK companies within the charge to corporate tax on income, although there were extensive exemptions to those charges. A series of technical and unintended problems arose, however. The rules were made more complex because of the differing treatment of distributions, whether they were of an “income nature” or of a “capital nature”. Unfortunately the term “of a capital nature” was insufficiently defined in the legislation, and here we are, therefore, with clause 9.
I have a series of technical questions to ask the Minister. First, will he set out clearly the alterations in yield for the Exchequer compared with the original arrangements, for instance because of the change in treatment of foreign dividends? Is it really the case that about £200 million would otherwise have been collected had EU dividends not been exempted, or do I have an incorrect figure?
Secondly, why is it reasonable in paragraph 5 of schedule 3 to make those changes retrospective in respect of distributions made on or after 1 July 2009? Is there not a danger, as ever, in retrospective taxation arrangements, and how will the election to opt out of that retrospective arrangement operate in practice? Is that done for a particular reason, and if so can the Minister expand upon the reason?
The explanatory notes state that the current rules have created circumstances in which some
“UK companies in receipt of UK distributions faced an unexpected tax charge.”
What is the scale of those unexpected charges, and is the retrospective nature of the changes designed to compensate companies for those arrangements? In my reading, that seems to be the logic behind the schedule. Those are all technical points, and I would be grateful if the Minister addressed them.
The hon. Gentleman is right to say that the measure is highly technical, and it may help if I try to take the Committee through it. Clause 9 and schedule 3 address an anomaly that has arisen concerning the scope of distribution exemption. As the law stands, there is a risk of some very large, unexpected and unintended tax liabilities arising within groups of companies. This legislation will ensure that those potentially damaging tax liabilities do not arise either in future or in past periods.
To provide some background information, UK distributions have always been exempt from corporation tax. In 2009, a new regime was introduced that extended the exemption to foreign distributions. In common with its predecessor, the new distribution exemption regime applies only to distributions of an income nature and not to those of a capital nature. Instead, those of a capital nature fall within the legislation that taxes the capital gains of companies.
Following the introduction of the 2009 rules, HMRC and tax specialists in the legal and accountancy professions looked closely at the question of which distributions qualify for exemption and which do not. HMRC took legal advice and concluded that, in certain circumstances that are relatively common within groups of companies, amounts that had historically been considered as income distributions that qualified for exemption may, in fact, constitute repayments of capital. Those amounts cannot qualify for the distribution exemption.
Although those points came to light only after the introduction of the 2009 distribution exemption legislation, they were equally relevant to the UK distribution exemption before 2009. Therefore, HMRC concluded that unexpected tax liabilities have potentially arisen in respect of transactions undertaken both before and after the introduction of the new exemption rules in 2009. That view gave rise to considerable concern, because it affected the tax treatment of certain types of transaction that are quite commonly carried out in corporate reorganisations.
Clause 9 and schedule 3 simplify and expand the distribution exemption regime in two ways. First, the exemption regime for UK and foreign distributions is extended by removing the exclusion for distributions that are of a capital nature. Secondly, the legislation ensures that certain amounts that may be repayments of capital are instead brought into the scope of the term “distribution” for corporation tax purposes. That is in line with long-standing expectations about the status of those transactions and it enables the amounts to qualify for the exemption.
It has always been the case that in certain situations distributions from the company can be taken into account in calculating corporation tax liability on chargeable gains, and that will remain the case. However, the changes being made now will clarify which distributions are charged corporation tax on chargeable gains and which distributions are exempt from corporation tax, subject only to certain narrowly defined anti-avoidance rules.
Following the announcement of this measure at the June Budget, a significant number of detailed and very helpful comments have been made about the draft legislation. I want to thank all those who took the time to make those comments, as they have led to a number of significant improvements. One addition to the draft legislation is a small but significant extension to the scope of one part of the distribution exemption rules to accommodate distributions that are now brought within its scope. The exemption that is currently given for all dividends that are not associated with tax avoidance is now extended to any distribution, subject to the same tax avoidance condition.
Another change that was made following consultation was to restrict the scope of those changes to corporation tax only. The problems that I have described arose only in respect of corporation tax. There were some concerns that the changes might adversely affect some income tax payers, which had not been intended. Income tax payers will continue to pay income tax on all distributions received with very few exceptions, such as distributions received during the winding-up of a company and repayments of share capital.
Although the provision fully addresses the anomaly concerning the scope of the distribution exemption, some of the detailed comments received after its publication have raised other important questions about wider distributions legislation. I can inform the Committee that HMRC officials have proposed a joint working group with representatives of the tax profession. The group will aim to improve common understanding of the legislation with a view to improving guidance. That will build upon the constructive dialogue that has helped so much with the development of the Bill.
The hon. Gentleman raised a number of questions about how the clause will work. First, there is the question of yield and whether the changes will reduce the corporation tax take. The changes will not reduce the take because they merely restore expectations for UK companies. It has not been HMRC’s practice to charge tax on the distributions to which the changes apply. The clause will, if one likes, restore the status quo.
The hon. Gentleman also asked why the measure was retrospective. Its retrospective nature allows companies to take advantage of the benefits of the new rules at any time. The legislation is almost always beneficial, but the opt-out entitlement allows a company to elect for any distribution made before 22 June 2010 to be unaffected by the changes. The retrospective effect will not apply unless a company so chooses—the election is made through the tax return—and that merely preserves existing expectations. Large and unexpected liabilities would arise without those reforms, and that would create uncertainty within the tax system, which we do not want. If I may anticipate the hon. Gentleman’s next question, we do not have an estimate of the potential liabilities in aggregate but, none the less, there is a concern that there might be an unexpected tax liability. The clause seeks to prevent that from happening.
The provision will end the potentially damaging uncertainty that would have arisen due to the risk of very large and wholly unexpected tax liabilities. The changes make it clear that the potential liabilities will not arise in future, and they also remove them retrospectively.
I am grateful, Mr Caton, for your indulgence in letting me respond to the Minister.
It is helpful that the Minister has been able to address some of the specific questions that I have asked. It is also useful that he has announced the proposed working group of individuals from across the tax profession, which will burrow into the legislation and ensure common understanding. With those assurances, I am more than happy to support clause 9.
I do not profess to be a taxation expert, but, like many members of the Committee, I received a brief this morning from the Chartered Institute of Taxation highlighting its concern about the application of the new rules for distribution in specie, not in cash. The brief provides a number of examples that demonstrate how the Bill is insufficiently clear. Unless the Minister wants me to bore him to death by reading out the examples—[ Interruption. ] I shall read them out if he wants me to—[Hon. Members: “One or two.”] I shall read out all three. The first example states:
“A ‘dividend’ is declared in a specified amount, which is then satisfied by the issue of a loan note or similar instrument. In such a case it seems that there is a ‘distribution out of assets’ for the purposes of paragraph B of section 1000 but there is no ‘transfer’ within the meaning of section 1002(2), in which case section 1002(3) does not apply to disapply paragraph B. Clearly at a later time the loan note will be settled but this will be a separate transaction and should not affect this analysis.”
The second example states:
“A ‘dividend’ is declared in a specified amount, which is then satisfied by an entry in an inter-company account. Again, as for 1, it seems that there is a ‘distribution out of assets’ but there is no ‘transfer’ of an asset.”
The third example—I promise that this is the final one—states:
“A ‘dividend’ is declared in the specified amount, which is satisfied by the transfer of an asset already held by the company. This may be a financial asset such as a receivable issued to it at an earlier time by a group company, shares or land and buildings. Again there will be a 'distribution out of assets' but in this case there will also be a 'transfer'. In this case we assume that the legislation can be applied on that basis that because the amount was declared as a cash amount then it is regarded as a transfer of cash for the purpose of (amended) section 1002(2)(a) and so again section 1002(3) does not apply to disapply paragraph B.”
The institute goes on to say:
“We would welcome confirmation that our interpretation is correct.”
It also says:
“These three situations contrast with the probably much less common situation where a ‘dividend’ is declared of an asset”.
If the Minister can give a response to that, he definitely has my admiration.
I am very grateful to the hon. Gentleman for his comments. He is right to say that the Chartered Institute of Taxation has asked about the scope of existing legislation dealing with company distributions and whether the new legislation will apply for certain distributions made in specie. As we have heard, the points are very detailed and, to be honest, beyond the scope of the debate on this clause. However, I can confirm to the hon. Gentleman, in response to the CIOT’s questions, that HMRC is already discussing those matters with CIOT and others. It will continue to do so as it develops guidance to cover distribution legislation, which includes, but is not limited to, changes made in the Bill.
I hope that the hon. Gentleman will forgive me for not responding in detail to his particular examples, but I assure him that the matter is very much in hand and that we have our finest minds working on it.