Clause 61 - Attribution of gains to members of non-resident companies

Finance Bill – in a Public Bill Committee at 10:45 am on 11 June 2013.

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

Photo of Catherine McKinnell Catherine McKinnell Shadow Minister (Treasury) 11:00, 11 June 2013

This clause, like clauses 26 and 30, provides us with an example of the Government’s approach to making legislation EU-compliant that even the leading bodies for the tax professionals have stated is not up to the mark. I will not repeat the damning assessment by the Chartered Institute of Taxation, which I have quoted previously, but I would be grateful if hon. Members bore it in mind when I put the points it raised to the Minister and ask him a few questions on the measure.

Of course we support the anti-avoidance aims of section 13, but concern has been expressed that the clause and the Government’s attempts to make the legislation EU-compliant will not achieve their stated aim. As I mentioned, the Chartered Institute of Taxation said in February:

“We have our doubts that the proposed exclusion for ‘economically significant activities’ is wide enough. We doubt whether the revised draft legislation would be EU compliant.”

It then set out in some detail its reasons for believing that. Although it welcomed the raising of the minimum participation threshold from 10% to 25%, the CIOT said:

“Because the proposed 25% threshold not only looks at holdings directly owned by the individual but also holdings owned by a wide range of other connected persons, it is far from clear that the increase in the threshold will by itself will prevent the freedom to move capital being also potentially engaged.”

Those concerns about clause 61 remain, as they do regarding clause 26, and the CIOT has publicly queried the basis on which the Government rejected its analysis of the provisions.

It is not only the CIOT that is concerned; the Institute of Chartered Accountants in England and Wales is concerned as well. In its response to the draft legislation, it said:

“It is our view that the amendments made to the draft legislation…do not increase the likelihood of the UK law being EU compliant; if anything the position is worse than previously.”

Clearly, it is imperative that the Government get this right. If they do not, we will be discussing it again in Finance Bill 2014 and, I am sure, many people hope we will be discussing the matter again in Finance Bill 2015. Although I appreciate that the Minister is not in a position to discuss at length the legal advice he may have received, can he at least explain the grounds upon which he has discounted the views of the Chartered Institute of Taxation and the Institute of Chartered Accountants?

Although clause 61 modifies section 13 of the Taxation of Chargeable Gains Act 1992 to make it EU-compliant, he will be aware of a number of concerns about section 13 that have not been addressed in the Bill. The Charity Tax Group, which represents more than 400 members, has highlighted three main issues with section 13 that affect charities with investment portfolios. It believes that section 13 is discriminatory because: it allows a charity to invest in a UK company but prohibits investment in, for example, a German company; charities are exempt from taxation on gains, so to be covered by section 13 is perverse, because there is no tax to avoid; and, finally, that it is often impossible to determine whether a charity has exceeded the 25%—previously 10%—limit, because its co-investors in a fund are treated as connected and  therefore have to be aware of the collective holding. Given that a charity often does not know who the other investors are, let alone their tax residence status, it may be impossible for the charity to determine whether it falls within the scope of section 13. I understand that the Charity Tax Group has been in discussions with HMRC regarding its section 13 concerns, so I would be grateful if the Minister provided some assurance that these matters are at least under review.

Photo of David Gauke David Gauke The Exchequer Secretary

Clause 61 amends anti-avoidance legislation in section 13 of the Taxation of Chargeable Gains Act 1992. In broad terms, it ensures that a UK-resident person cannot arrange the artificial placement of assets overseas to avoid UK tax on gains. Let me explain a little of the background to the clause.

Section 13 attributes gains arising from the disposal of assets by an overseas closely controlled company to a UK-resident person that has an interest in that company. The UK-resident person would otherwise be taxed on such gains had they disposed of the asset and realised a gain themselves. The measure is intended to apply only where a UK-resident person has a significant interest in the overseas company and only in relation to tax avoidance, with genuine commercial activity excluded from charge.

On 16 February 2011, however, we received a reasoned opinion from the European Commission in which it contends that our existing legislation does not go far enough to ensure that genuine commercial activity is excluded from charge, and is therefore incompatible with EU treaty freedoms. The Commission made several points in support of its analysis. First, it would not be possible for a UK-resident person participating in business with an overseas company to avoid a tax charge by proving that the relevant transaction was bona fide and carried out for genuine commercial reasons and lacked any avoidance purpose. Secondly, UK rules appear to go beyond addressing what UK law refers to as wholly artificial arrangements, because the rules apply to any capital gains realised on the disposal of assets by a non-resident company in which the UK resident has an interest, but they do not explicitly enable the UK resident to remove the potential charge by establishing that the transactions are carried out for genuine commercial reasons and do not constitute artificial arrangements set up for tax-avoidance purposes only. EU law recognises that a restriction on the fundamental freedoms is permissible if it is justified by overriding reasons for public interest in preventing tax avoidance and is appropriate and proportionate to that aim. The changes made by clause 61 are intended to address the concerns raised by the European Commission.

Subsection (2) raises from 10% to 25% the interest that a participator or connected person may have in the overseas company before gains are attributed under the provision. That simplification is helpful and reduces the exposure to a possible breach of treaty freedoms.

Subsection (3) introduces two new exemptions. One is for economically significant activities, the definition of which follows the language of European case law and requires the activities to involve the use of staff, premises and equipment and the addition of economic value commensurate with the size and nature of those activities. The test is broad enough to cover also the  making of investments where they are not aimed at avoidance. Secondly, it provides a motive test that enables UK members of a non-resident company to avoid any charge to tax where they can show that the activity was genuinely commercial and that the main purpose of the activity was not the avoidance of tax.

Subsection (4) defines economically significant activities for the purposes of the exemption and clarifies that provision of furnished holiday accommodation is to be interpreted as a legitimate disposal of an asset under section 13(5)(b) of the 1992 Act and therefore excluded from the charge under section 13. The legislation will apply to disposal taking place on or after 6 April 2012.

There was broad agreement among respondents to the consultation that an effort should be made to distinguish carefully between arrangements designed to avoid tax and those carried out for genuine commercial reasons, but views differed on how to achieve that. In particular, the use of the term “active management” as a barometer of genuine economic activity caused concern. Some in the investment and financial services sectors commented that active management would mean different things in different businesses and expressed concern that if the wording were used, it might inadvertently bring businesses within the scope of the charge simply because of their structure, even though they do not carry on economically significant activities.

It was also suggested that the blanket exclusion of “making of investments” from economically significant activities does not sit comfortably with the broad aim of the changes. Investment activity that serves the aims of the treaty should not be excluded from the exemption, because it does not, for example, provide goods or services in the way originally proposed. We have listened to those concerns, and, as a result, we have removed the requirement for active management. We accept that the making of investments can represent economically significant activity.

Let me pick up some of the points raised by the hon. Member for Newcastle upon Tyne North. The first point was whether there should be a specific exemption for charities. We do not believe that would be appropriate. The vast majority of charities are genuine but, regrettably, the generosity of reliefs and exemptions afforded to charities can make them targets for those who wish to avoid UK tax. It is important that we protect the positive connotations of the word “charity” in the public mind. An exemption for charities could encourage determined tax avoiders to set up sham charities to avoid UK tax. In practice, it will not be difficult for charities to comply with section 13.

Let me turn now to the broad question whether the changes make the legislation compliant and to the concerns raised by the likes of the CIOT and the ICAEW. As I said when we discussed clause 26, EU law in this area is not well defined and is still developing. The European Commission may therefore wish to test the application of EU law in this area through proceedings in the European Court of Justice. The Government believe the changes we have made ensure that the legislation complies with our European obligations.

On whether the burden of proof that tax avoidance was not the motivation should fall on the taxpayer, section 13 of the 1992 Act requires the participant to self-assess whether tax is due. HMRC can of course open an inquiry where it thinks tax should have been  paid; in doing so, it will need to show why it thinks tax should have been paid. If an inquiry is opened, the participant will need to be able to satisfy HMRC that avoidance was not the main motivation, and any disputes may be taken to the independent tax tribunal.

Our priority must be to maintain the effectiveness of this anti-avoidance provision as a defence against abusive cross-border arrangements and to do so without impeding genuine commercial activity. The amendments we have made—increasing the participation threshold, introducing an exemption for economically significant activities and introducing a motive test—achieve that aim. I therefore hope the clause can stand part of the Bill.

Question put and agreed to.

Clause 61 accordingly ordered to stand part of the Bill.

Clauses 62 and 63 ordered to stand part of the Bill.

Schedule 23 agreed to.

Clauses 65 and 66 ordered to stand part of the Bill.