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8.45 pm

Dawn Primarolo: I shall clear up a couple of points before I turn to the issue of acquisition. It was, I believe, the hon. Member for Kingston and Surbiton (Mr. Davey), as well as the hon. Member for West Dorset (Mr. Letwin), who raised the issue of whether the motive test was appealable. The answer is yes. Under self-assessment, it is for companies to assess whether their controlled foreign companies pass the motive test. They have been capable of doing that since 1984, as I explained. If the Inland Revenue disagrees with the self-assessment, it can amend it. As in any other case in which the Inland Revenue

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makes such an amendment, the company can appeal against it. The case goes to the commissioners and can then go to the courts.

Mr. Letwin: That is helpful.

Dawn Primarolo: Thus far, but no further. I have a feeling that we will have to agree to disagree on the rest, because we do not accept the amendment. To remove in their entirety the anti-avoidance measures on controlled foreign companies would be crazy. I am a little surprised that the hon. Gentleman suggests doing so because he is otherwise clear on the issues of avoidance. The amendment is reckless and the beneficiaries would be those multinationals which wish to avoid paying their fair share of UK tax. The losers would be the hard-working families of this country and other companies which would face increased taxation or poorer services because of lower tax receipts. I am sure that the hon. Gentleman does not wish to be seen to support the corporate tax scams and wheezes that the amendment would allow.

The hon. Gentleman will be familiar with the opinion in the International Tax Review, which in September 1998 specifically highlighted the fact that the use of the controlled foreign company and exempt international holding companies was

Indeed, the article expressed surprise that the arrangements were not being blocked and it was written by none other than the leading accountant at the then Price Waterhouse, which the Opposition have been keen to quote during these debates.

On the issue of acquisition, I shall make a few preliminary points and then deal specifically with debt transfer.

There are four sets of changes in the arrangements for controlled foreign companies, and the point about acquisition is pertinent to the fourth. That change stops the automatic exemption for holding companies from being abused to avoid UK tax on intra-group interests and royalties. As we have discussed, holding companies are generally outside the controlled foreign company rules if at least 90 per cent. of their income comes from companies that meet one or more of the controlled foreign company exemptions.

Generally speaking, that makes sense when the income is a dividend paid out of post-tax profits. There is a logic in saying that, from the point of view of the UK Exchequer, it is largely immaterial whether the post-tax profits of a non-resident subsidiary are held in the subsidiary or in the non-resident holding company. However, the current rules are not restricted to holding companies that receive their income from post-tax profits. They apply equally where the income consists of interest and royalties paid from pre-tax profits. In those circumstances, pre-tax profits are shifted from the subsidiary to the holding company. There is a tax deduction in the subsidiary, and a new source of income in the holding company.

The current exemption distorts the way in which some investments are structured, and is leading to a loss of tax for the UK. Multinational companies use offshore holding companies to extract tax-free profit from overseas subsidiaries. They then keep those profits outside the UK tax net. That is part of the problem that the Government

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are dealing with, but I hope that the hon. Member for West Dorset will accept that several relationships are involved.

The Bill will ensure that the automatic exemption for holding companies is passed only when more than 90 per cent. of the holding company's income is received in the form of a dividend that is not tax deductible. The change does not introduce any new principle to the controlled foreign company rules. Other ways of diverting the pre-tax profits of overseas subsidiaries into tax havens and preferential regimes are already covered. The Bill will introduce a logical and coherent set of rules by applying to the holding company exemption the same principles that apply to the rest of the controlled foreign company legislation introduced by the Conservatives in 1984.

It has been suggested that some multinationals--I shall not name them for reasons of taxpayer confidentiality--are using loans from holding companies to reduce foreign tax, rather than UK tax. That is the point that the hon. Member for West Dorset is focusing on, and I hope that he will be happy with what I have to say next. If a company is not seeking to avoid UK tax it will, of course, get through the motive test--end of story. However, holding companies typically use debt finance to reduce both foreign tax and UK tax. It is in those circumstances that the controlled foreign company legislation would bite.

I hope that the hon. Gentleman appreciates the distinction. He said that he does not agree with avoidance of UK tax, and that he was talking about the transfer of debt into foreign jurisdictions. As long as that transfer does not lead to a reduction in UK tax liability, the CFC legislation will not bite.

Mr. Letwin: That is helpful, but although the main purpose of the manoeuvre that we are talking about was to reduce costs through reducing tax in a foreign jurisdiction, the by-product was that tax in the UK was also reduced. Does not the Paymaster General think that it would be wrong retrospectively to clobber people who had made plans based on legitimate expectations regarding the law as it previously existed?

Dawn Primarolo: With respect, I do not understand how the hon. Gentleman can say that the Bill will clobber such people retrospectively. The rules have made it clear that companies could not use controlled foreign companies to reduce their UK tax liability, or to avoid it completely. The Bill proposes amendments to our controlled foreign company legislation because some have sought to circumvent the clear intent of that legislation.

The hon. Member for West Dorset will know that controlled foreign company legislation is used throughout Europe and north America. The UK is the only country in the world that has a motive test, and we recognise that it can be commercially legitimate to use such companies. However, a company that is avoiding its UK tax liability will be caught by the controlled foreign company legislation. I make no apology for that, as such a company should pay to the Government the tax for which it is liable.

Mr. Letwin: I persist in believing that the Paymaster General is missing a point. The fundamental purpose of the manoeuvre that we have been discussing is to obtain

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a reduction in the foreign jurisdiction tax by displacing the debt to the subsidiary; in that case, the CFC is being used not to avoid UK tax, but to reduce tax in the other jurisdiction. However, it may be that a by-product is to reduce UK tax liability, and in that case it seems quite unfair retrospectively to deal a blow.

Dawn Primarolo: I do not agree. As we discussed in our previous debate, there has been much comment and many representations on the double taxation relief set out in schedule 30. We have received far fewer observations on the controlled foreign company provisions in schedule 31. Indeed, without breaking any confidences about which companies were involved, it is accurate to say that the majority of companies that made representations on the double taxation relief entirely supported our measures in respect of legislation on CFCs--in fact, some thought that we should go further than we have done. A small number of companies were attempting to use CFC legislation to avoid UK tax, and they have, of course, been quite vocal, but their comments are not representative of the far larger number of companies and professional advisers who have discussed these matters with us. The hon. Gentleman should not expect us to make legislation for the exceptions that attempt to reduce their tax liability in the UK when every other multinational is paying that liability. Therefore, should the hon. Gentleman push his amendment to a vote, I shall ask my hon. Friends to reject it.

Mr. Letwin: Although I appreciate that the Paymaster General is attempting to block off a species of tax avoidance that we agree should be blocked off, she is also blocking off manoeuvres that are perfectly legitimate, and I am bound to say that I persist in believing that she is doing so retrospectively and unfairly. In the circumstances, we shall press the amendment to a vote and I urge my right hon. and hon. Friends to vote against the schedule and in favour of our amendment. I hope that the Paymaster General will reconsider the measure, as she has on double taxation relief, because its long-term effects will be severely deleterious to our industry.

Dawn Primarolo: I shall urge my hon. Friends to support the Government amendments, including Government amendment No. 91, because I am not persuaded by the hon. Gentleman's arguments. We shall not be able to reach agreement on the matter.

Question put, That the amendment be made:--

The House divided: Ayes 120, Noes 344.

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