Permanent establishments: preparatory or auxiliary activities

Finance (No. 3) Bill – in a Public Bill Committee at 2:15 pm on 29th November 2018.

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Photo of Anneliese Dodds Anneliese Dodds Shadow Minister (Treasury) 2:15 pm, 29th November 2018

I beg to move amendment 47, in clause 21, page 13, line 35, at end insert—

“(7) The Chancellor of the Exchequer must review the revenue effects of the preceding provisions of this section and lay a report of that review before the House of Commons within six months of the passing of this Act.”

This amendment would require the Chancellor of the Exchequer to review the revenue effects of the changes made by Clause 21.

Photo of George Howarth George Howarth Labour, Knowsley

With this it will be convenient to discuss the following:

Amendment 48, in clause 21, page 13, line 35, at end insert—

“(7) The Chancellor of the Exchequer must, within 3 months of the passing of this Act, publish a list of additional non-UK resident companies that are classified as having permanent establishments as a result of restricting the application of section 1143 of the CTA 2010.

(8) The list in subsection (7) must be updated annually.”

This amendment would require the Chancellor of the Exchequer to publish a list of all additional permanent establishments created as a result of the changes made by Clause 21 three months after the passing of the Act and annually thereafter.

Clause stand part.

Photo of Anneliese Dodds Anneliese Dodds Shadow Minister (Treasury)

The clause focuses on attempts to wriggle out of triggering permanent establishment status by maintaining that economic activity is preparatory or auxiliary. Currently, certain so-called preparatory or auxiliary activities are understandably exempt from being classified as indicating a permanent establishment. They tend to be of low value and include storing products for the company involved, purchasing goods for it and collecting information for it.

Action 7 in the OECD’s BEPS—base erosion and profit shifting—process included a range of measures to tighten up in the OECD’s model tax treaty section 5, including in this area. The model tax treaty includes a far-reaching anti-fragmentation rule to prevent activities in a jurisdiction from being intentionally, artificially fragmented between different companies in a group merely so that those activities will not trigger permanent establishment status because they can be classified as preparatory or auxiliary.

The OECD rules prevent the preparatory and auxiliary exemption from applying in situations where there is already a permanent establishment in the country, and where the overall activity carried out both by the company concerned and by companies that are closely related to it are not preparatory or auxiliary. In both cases, however, the activities must constitute part of a so-called “cohesive business operation”. In practice, the measure puts into UK law what the UK has already signed up to via its ratification of the OECD’s multilateral instrument for the amendment and updating of tax treaties, which is now sequentially being applied to our existing tax treaties, as we have discussed on a number of occasions just along the Committee corridor.

We seek to amend the clause in a number of ways. First, amendment 48 requires the Chancellor to publish a list of all additional permanent establishments created by the clause, and to do so annually. There is a serious problem of accountability in our tax system. Those who have engaged in tax avoidance are not publicly held responsible. In response to the debate on Second Reading, it looks very clear what tax avoidance is and what it is not. It is behaviour that is legal, but although it may follow the letter of tax law, it does not follow its spirit.

Contrary to what was argued in the previous debate in the Chamber, individual savings accounts do not constitute tax avoidance because their creation was intended and promoted by legislators. On the contrary, artificial arrangements are tax avoidance, because policy makers, whether in the UK or elsewhere—such as for the Dutch and Irish sandwiches—did not indicate that they wished their tax law to be used by those schemes to exploit loopholes.

Relying purely on the spirit of the law or treaties, rather than their letter, leaves our system open to tax avoidance, which is one of the many reasons the Opposition support the introduction of a general anti-avoidance rule—not just anti-abuse. We have talked about that in this Committee. In any case, we must understand which firms profited from these forms of artificial fragmentation. Our amendment asks for that.

It is particularly important to have that analysis at a time when the US approach to corporate taxation and determining where permanent establishment lies is in flux. The corporate tax rate in the US is going down, but that problem is compounded by tightening up in a range of areas, including the adoption of many elements of the BEPS process relating to permanent establishments. It is important to assess the efficacy of measures put forward here in relation to what is occurring in the US, where claims have been made that the situation will lead to onshoring of activity. That remains to be seen, but it will be useful to have an analysis so that we can perform that assessment.

Amendment 47 would require a review of the revenue effect of clause 21. It is not possible to judge its likely efficacy without understanding the extent to which it will promote the correct payment of corporation tax. I note that some jurisdictions, such as Argentina, have included what appear to be more stringent requirements in their permanent establishment roles, going beyond the OECD requirements.

It is important that we properly understand the likely impact of the proposed rules. There has been a debate about this issue at OECD level for quite a long period—since about 2013. There are very different views about whether the OECD approach is sufficiently stringent. It is important to listen to some alternative views that were referenced when this particular action in the BEPS process was investigated, particularly from the BEPS monitoring group in 2015. That group is composed of a variety of experts looking at international tax law and a number of civil society organisations—I will not try to pronounce their names because some are in Spanish and I would get it humiliatingly wrong.

In response to a call for evidence in relation to changes in the OECD tax treaty chapter 5, the group maintained that although an anti-fragmentation rule was proposed by the OECD, it was

“only in relation to pre-sales related activities, such as storage, display or delivery”,

as delivered by this clause. The group suggested that was problematic and did not go far enough because:

“These proposed changes would therefore not affect other types of structures which fragment functions such as manufacturing, purchasing, design, marketing and customer support.”

It continued:

“Moreover, the current proposals would have limited application to services.”

It felt that there was a particular problem for developing countries—I appreciate that we are not in that situation. It said that for the countries it works with often there was also a particular problem from “stripped-risk contract manufacturers”. It argued that, as an alternative to the BEPS anti-fragmentation proposals,

“One way to deal with this would be for the Commentary to make clear that where decisions are made locally in a country by personnel of any group member or agent that affect the commercial risks borne by any group member, then that group member will be considered to maintain a ‘place of management’ within that country within the meaning of Paragraph 2 of Article 5.”

That is quite a different approach from assessing whether fragmentation is occurring, and it would be helpful to understand why the Government believe their approach is sufficiently stringent in the light of critiques such as that one. That is another reason why I think our amendment is necessary.

Photo of Mel Stride Mel Stride Financial Secretary to the Treasury and Paymaster General 2:30 pm, 29th November 2018

The clause makes changes to ensure that foreign businesses operating in the UK cannot avoid creating a taxable presence by splitting up their activities between different locations and companies. A non-resident company is liable to UK corporation tax only if it has a permanent establishment here—I shall use the abbreviation PE for permanent establishment. A PE may be a fixed place of business, also referred to as a branch, or the activity of an agent. We are mostly concerned here with branches.

As the hon. Member for Oxford East has outlined, certain preparatory or auxiliary activities, which are normally low value, such as storing the company’s own products, purchasing goods or collecting information for the non-resident company, are classed as exempt activities and do not create a permanent establishment. Some foreign businesses could artificially split their operations among different group companies or between different locations to take advantage of those exemptions and so avoid being liable to corporation tax.

To counter that, the OECD and G20 recommended modifying the definition of permanent establishment. The UK has adopted that change in its tax treaties, the bilateral tax arrangements that divide up taxing rights between countries, with which the hon. Lady and I are most familiar, having taken a series of pieces of secondary legislation through this House on those matters. It has given effect to that change through the BEPS multilateral instrument, as she pointed out, which entered into force for the UK on 1 October 2018.

Clause 21 replicates that treaty change in UK domestic law to make the change to tax treaties effective. It is most likely to affect non-resident manufacturing and distribution businesses that might try to structure their UK operations in order to minimise their UK tax footprint. The measure sends a signal that the UK Government are determined to tackle tax avoidance by foreign multinationals.

Turning to the two amendments tabled by the Opposition, amendment 47 would require the Chancellor of the Exchequer to review the revenue effects of the changes made by this clause within six months of the Bill becoming law. I cannot support this amendment. Information on revenue effects will not be available six months after the passing of the Act, given that the first accounting periods likely to be affected are those ending on 31 March 2019, for which the filing date of company tax returns will be 31 March 2020.

The Government also cannot support amendment 48, which would require publication three months after the passing of the Act of a list of all additional PEs created as a result of this measure. HMRC would not know, as a company is not required to disclose, whether a declared PE has occurred as a result of this measure or for some other reason. The information would be available to HMRC only if it opened an inquiry into every non-resident company that newly declared a permanent establishment. That, as I hope the Committee would agree, is impractical. It would not be an appropriate use of inquiry powers and it would impose a significant burden on HMRC and the taxpayer for little revenue benefit. The Exchequer impact assessment has scored this measure as likely to have negligible yield. I therefore commend the clause to the Committee and invite Members to reject the amendments.

Photo of Anneliese Dodds Anneliese Dodds Shadow Minister (Treasury)

I am grateful to the Minister for his clarifications and comments. I think we would be willing to withdraw the amendment, but I note that he did not refer to the critique that I mentioned by the BEPS monitoring group on whether the definition of fragmentation coming within the OECD process was sufficient. I do not want to detain the Committee on that point any longer, but I ask him to bear that critique in mind as we go through any additional tax treaties; I am sure we will come to some in the future with developing countries, because arguably this is a significant problem for them. It can be difficult for them to apply even the conventions in the model tax treaty to capture economic activity within their boundaries when they need to build up their tax base. Of course, we give many of those countries development aid.

As I said, I am willing to withdraw the amendment, but I would be grateful if the Minister kept those points in mind. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 21 ordered to stand part of the Bill.

Clause 24