Clause 11

Finance (No. 2) Bill – in a Public Bill Committee at 10:30 am on 26th October 2010.

Alert me about debates like this

Question proposed, That the clause stand part of the Bill.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

Good morning, Mr Chope. What a pleasure it is to be back at the apex of our national debate on financial matters.

It is an honour to have the opportunity to talk about clause 11, which refers to the financing costs and income of group companies. Hon. Members will be aware that the worldwide debt cap rules came into effect on 1 January 2010. They overhaul the taxation of multinationals, restricting the UK tax deduction for interest costs of UK companies that form part of a large group. Broadly, the purpose of the rules is to ensure that the aggregate UK corporation tax deductions for financing costs do not exceed a group’s external financing costs on a worldwide basis. As far as I can tell, the rules are primarily aimed at cash-rich, non-UK parented groups that fund their UK operations via debt, and UK-parented groups with upstream loans into the UK from overseas subsidiaries. Of course, as with many changes, other groups of companies may also be affected.

Specialist lawyers and accountants have pointed out that the debt cap rules will result in additional administration, or perhaps a significant change in tax costs for many large groups, although, quite rightly, it is a measure designed to guard against excessive debt funding of UK companies. Obviously, the measure was framed and devised when we were under a different Administration—a happier Administration under which the sun tended to shine far more frequently than it does today.

The application of the rules can be complex. I am told that the basic working of the debt cap remains unaltered from the 2009 changes. As I said, the changes take effect from the beginning of the calendar year, which is the start date for the debt cap rules as a whole.

The clause makes about 14 separate changes to the worldwide debt cap rules, perhaps the most important of which is the new addition to the proposal of a gateway test. In essence, if a group passes the gateway test, it will not suffer any restriction of interest expense due to the debt cap, and it will not have to prepare debt cap calculations. The gateway is passed when the net debt of the UK-resident members of the group is less than 75% of the group’s worldwide gross debt. However, the gateway test is limited in its application. For instance, it is unlikely to exempt wholly UK groups with intra-group debt from the rules.

Further changes are made in the clause, such as ensuring that when a UK figure is being compared with a worldwide figure, the same amount is included in both figures in respect of the same borrowing. There are exclusions for certain securitisation companies. Another change ensures that long-term arrangements that have the economic effect of loans are taken into account for the gateway test. Those arrangements have been made in the clause as well.

I understand that there are specific arrangements for industrial and provident societies, which are of particular interest to me. From my perspective, they are companies that the Treasury should encourage and support. Will the Minster tell the Committee what those differential arrangements for industrial and provident societies will be? As a Labour and Co-operative Member, I am particularly interested in those, and other Members might be similarly interested.

I gather that all but one of the rules will apply retrospectively, and issues always crop up when legislation applies retrospectively. Schedule 5, which is linked to the clause, contains a lot of detail. I will not dwell on the Government amendments to schedule 5, but they might address the concerns raised by organisations such as Deloitte, which is concerned that the amendments proposed under clause 11 and schedule 5 offer only a partial solution. Deloitte has been disappointed that Her Majesty’s Revenue and Customs has not addressed what it regards as some of the consequential issues regarding the retrospective nature of the legislation. What further areas of improvement might the Minister consider for future finance legislation, because the Government amendments might not deal with all the concerns that Deloitte has raised?

Given that the measure represents significant tax changes, I wonder whether there has been a regulatory assessment of the accountancy and legal advice costs to the affected companies. On balance, the changes are probably favourable rather than burdensome but, setting aside the net tax impact of the changes, company treasurers and directors of finance are bound to face a steep learning curve, so I wonder whether the provision has undergone a regulatory impact assessment, as used to be the case under the previous Administration.

Will the Minister consider passive income, which is when multinational foreign subsidiaries generate income from assets that are—arguably—UK assets, but are artificially located offshore for tax reasons? We are discussing the global movement of capital, and many of our constituents who have written to us recently about tax changes and tax avoidance in general might not know the intricacies of such arrangements. Whenever offshore tax sheltering is raised, however, they are interested. There might be a loophole here that the Treasury has considered in the past, and I should be grateful if the Minister sets out the thought he has given to targeting passive income.

My final question for the Minister concerns whether financial services groups are to be excluded from the debt cap rules. I understand that HMRC has accepted that the proposed legislation would be “unworkable” in respect of financial services companies. That raises an eyebrow, however, because if it is unworkable for one set of companies and in one set of circumstances, why is it not so for others? There was a rumour or suggestion—I do not know where I picked this up from—that there might be another attempt to produce legislation to  bring financial services groups into the debt cap rules. If so, when will that happen? Is such a measure likely to crop up as early as Report, or will it be for general future legislation?

Photo of David Gauke David Gauke The Exchequer Secretary

It is a pleasure to serve under your chairmanship, Mr Chope.

I am grateful for the various questions that have been raised by the hon. Member for Nottingham East. They ranged broadly over the debt cap and concerned clause 11 and schedule 5, both of which I hope to address in my remarks, although we will deal with the Government amendments in a separate debate.

Clause 11 introduces schedule 5, which makes a number of changes to the worldwide debt cap legislation that was introduced last year. The basic working of the debt cap rules remains unaltered by such changes. The consultation with businesses and their advisers identified a number of situations in which the debt cap rules do not easily apply. The amendments made by the Bill can be divided into four main categories: to address mismatches between the worldwide and the UK measure of the same debt; to address the effect of the debt cap on securitisation companies; to deal with transactions that have the economic effect of loans but are not lending; and some miscellaneous, minor changes. The amendments will have effect from 1 January 2010, which was the start date of the debt cap rules. They are a response to ongoing consultation with a working group of interested parties and separate discussions with the private finance initiative industry.

I shall go through the schedule in more detail. Paragraphs 3 to 7 set out changes to the gateway test to which the hon. Gentleman referred. It is the initial calculation undertaken by the worldwide group each year to establish whether the debt cap rules apply. The main changes are the inclusion of financial arrangements that provide a return that is economically equivalent to interest and the exclusion of share capital. Paragraph 7 of the schedule removes a mismatch when different amounts are taken into account for the same liability by the worldwide group and a United Kingdom company. Paragraphs 8 and 9 amend the qualifying financial services group exemption and clarify the meaning of “financial instrument”. Paragraph 12 defines a group securitisation company and is one of the amendments that work to exclude securitisation companies from main debt cap rules.

Dual-resident investing companies are dealt with under paragraphs 13 to 16. Such companies are prevented from surrendering losses as group relief, and restricting the debt cap disallowance prevents them from using the disallowance to replicate the effects of group relief. The amendment in the schedule prevents the group from voluntarily allocating a disallowance to a dual-resident investing company and ensures that a default allocation is made first to other group companies. Paragraphs 18 and 19 include as financing income guarantee fees paid or imputed between companies. Guarantee fees are already included as a financing expense. Paragraph 21 amends the test for group treasury companies so that it applies to each company separately rather than to the financing income of the companies that is being aggregated.

Paragraph 22 prevents certain distributions of profit by industrial and provident societies from being treated as financing expense or income. Paragraph 23 removes  a regulation-making power concerned with short-term debt, which was not practicable because it did not set up machinery to govern its use. Paragraph 24 adds relevant public bodies to those excluded from the debt cap rules. Paragraph 25 provides a new regulation-making power to amend the calculation of the tested expense or tested income amount if there is a mismatch between the accounts amount and the tax amount. Paragraph 26 clarifies the meaning of ancillary expenses in the available amount. The computation of the available amount is amended by paragraph 27, which excludes securitisation companies from the worldwide group while dealing with mismatches on interest and costs paid by a member of the worldwide group that is also a partner in a partnership.

Paragraph 28 provides a new regulation-making power to amend the available amount if there is a mismatch between the accounts amount and the tax amount. We shall return to that issue under the next group of amendments. Paragraph 30 excludes as the ultimate parent of a worldwide group limited liability partnerships and some collective investment schemes. Paragraph 31 amends the definitions of “UK group company” and “relevant group company” to accommodate securitisation companies. Paragraph 33 deals with companies that are party to capital market arrangements. It provides a regulation-making power so that such a company can jointly elect with another company to transfer its tax liability.

Paragraphs 36 and 37 provide that the commencement date for the amendments is 1 January 2010. Regulations made under the powers in paragraph 33 can apply only to tax liabilities due and payable after Royal Assent. A group may elect that certain amendments to the gateway test apply only prospectively. I hope that it was of help to the Committee for me to provide an outline of the schedule.

I turn now to some of the questions asked by the hon. Member for Nottingham East, such as whether any thought has been given to targeting passive income. It is worth highlighting the fact that the Government are looking more broadly at corporation tax reform. Later in the autumn, we will publish further details on possible areas of its reform. We might look at that among our consideration of many issues, and any further changes will be considered as part of that wider corporation tax reform programme. I note his concerns, and he will be aware that the Government are keen to reduce avoidance at every opportunity.

The hon. Gentleman also raised the issue of financial groups not being part of the debt cap rules. There are no plans to make further changes this year, but we will keep the matter under review. There is an issue with financial services companies and interest, because of course interest is part of what they do, as opposed to being merely a means of financing their own business. That is why there have always been particular complications in that area. As I have said, we do not intend to make any changes at the moment, but we will keep the matter under review.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury) 10:45 am, 26th October 2010

It is useful to know that the Minister will keep the matter under review. Clearly, there have been concerns about certain quarters of the financial services sector that have been highly leveraged or have  debt-finance arrangements that swirl around into complex sets of circumstances. If the clause is designed to guard against cash-rich, non-UK parented groups funding UK operations in a debt context, that would seem to be relevant in many ways to parts of the financial services sector. Will he give a commitment not only that this is a matter for review, but that there is a broad intention at some point to extend such rules to financial services, because that would give a useful indication of his direction of travel? I entirely understand the complexity, but it would be worth knowing whether such complexity makes it impossible to cover the sector, or whether the Treasury will endeavour to find ways to settle the matter.

Photo of David Gauke David Gauke The Exchequer Secretary

I do not want to go any further than I already have this morning. There will be a wider review of corporation tax and how we go forward on this area. With the treatment of debt, there are particular issues with financial services companies and groups containing them that mean that we need to look at the issue carefully. I note the hon. Gentleman’s comments and we will take them into account.

The hon. Gentleman asked about the retrospective nature of the legislation. The original commencement date of the debt cap legislation was 1 January 2010. The regulations are made under the regulation-making power contained in that legislation, and so have the same commencement date as the primary legislation. That provides certainty and reduces the need for transitional arrangements. Because some of the legislative changes were announced in November 2009, there was an expectation that the rules would apply from 1 January 2010. To ensure that that does not add unfairly to the compliance burdens of groups, there is an opportunity to elect that those parts of the debt cap rules affected by the regulations do not apply until the regulations are laid.

The hon. Gentleman asked about the regulatory burdens more generally, and whether businesses and HMRC would have additional costs as a consequence of the changes. The cost of the changes in the debt cap legislation are negligible for both businesses and HMRC, which reflects the fact that the proposed changes do not fundamentally alter the operation of the debt cap rules, but ensure that they operate in the way originally intended. Most of the changes do not make a difference at all to the costs for groups, while others provide a small saving, such as the exclusion of securitisation companies from the debt cap and the changes to partnership costs.

The hon. Gentleman raised the issue of the debt cap working group. It will meet before the end of the year to continue discussions. It is made up of tax professionals and representatives from business, including the big four accountancy firms, major commercial law firms and the CBI. He also asked about further areas of improvement and highlighted concerns raised by Deloitte. HMRC will continue to work with Deloitte and other representatives, via the debt cap working group, to identify concerns and solutions.

The hon. Gentleman asked about industrial and provident societies. There is a question of why payments by industrial and provident societies are not already treated as interest under a loan relationship. There is a special rule for industrial and provident societies that treats the payments that they make to shareholders as  interest under a loan relationship, whether or not those payments are legally interest. That means that, for an industrial and provident society, dividends and bonuses paid to shareholders are treated as interest. A company’s relationship with its shareholder is not one of borrower and lender, and so it is not correct that such payments are included as financing expense or income in the debt cap calculations of the company, and hence the changes contained within the schedule. I hope that that is a helpful summary of the contents of not only clause 11, but schedule 5.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I thank the Minister for those explanations and I am content with the points that he makes. These reforms form part of a wider range of changes, and I am interested that further thought will be given to corporation tax applicability and reforms more generally in the autumn. I look forward to debating that with the Minister. I am particularly pleased with his helpful explanation of industrial and provident society arrangements. I have no objections to clause 11.

Question put and agreed to.

Clause 11 accordingly ordered to stand part of the Bill.