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

Part of Finance Bill – in a Public Bill Committee at 11:00 am on 11 June 2013.

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Photo of David Gauke David Gauke The Exchequer Secretary 11:00, 11 June 2013

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.