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Session 1999-2000
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Standing Committee Debates
Finance Bill

Finance Bill

Standing Committee H

Tuesday 20 June 2000

(Afternoon)

[Dr. Michael Clark in the Chair]

Finance Bill

(Except clauses 1, 12, 30, 31, 59, 102 and 113)

4.30 pm

The Chairman: I understand that, before the Committee adjourned, after speaking for 40 minutes, Mr. Letwin was completing his introduction to the schedule, as amended, stand part debate.

Schedule 30

Double taxation relief

Question proposed [this day], That the schedule, as amended, be the Thirtieth schedule to the Bill.

Question again proposed.

Mr. Oliver Letwin (West Dorset): Thank you, Dr. Clark. You were right that I was completing my introduction before we adjourned. The main text of my speech is now to follow. I was answering my hon. Friend the Member for Arundel and South Downs (Mr. Flight) who said that, if the provisions under paragraph 8 allowed for double taxation purposes against profit were to be governed exclusively by provisions that were mandatory under local law, there would be a problem in relation to those countries. He was abundantly right. I shall cite an example. A privatised utility or telephone company in a less developed country would typically have large unpaid invoices that it had issued to the local Government. In such a classical case, the auditors would wish the company to provide for the unpaid invoices, perhaps because there could be little assurance that the Government would decide eventually to make good the deficiency. It is difficult, if not impossible, to imagine the company successfully pursuing the Government in court. The regulatory consequences alone might be sufficient to deter it from doing so.

Yet it is almost unimaginable that the Government in question should legislate to force one of their utilities or telephone companies to provide against their potential refusal or inability to meet their own telephone or utility bills. I know of no example in which such legislation has even been discussed, let alone enacted. In such a case, were a multinational corporation to headquarter itself in the United Kingdom in future or were one of the existing multinationals in the UK to buy an overseas subsidiary of that type in a less developed country, it would be unable for the purposes of double tax relief in the United Kingdom to include reference to the provisions that it had made against the local Government's unpaid telephone or utility bills because that would not have been mandatorily provided.

As a result, the declared VAT for UK double tax relief purposes of the subsidiary in question would be higher than it would otherwise be-and given the order of magnitude, it may be 50 per cent. higher and, in many cases, 70 per cent. higher. The proportion of the VAT represented by the dividends remitted to the UK by that subsidiary would diminish, as would the proportion of the underlying tax attributable to the profits that could be used as a credit against UK tax attached to the dividend, so the tax bill of the UK-headquartered multinational would rise.

That may sound abstruse, but not when combined with paragraph 6, whatever becomes of paragraph 10 and the provisions on controlled foreign companies in schedule 31. The combination provides a compelling case for multinational corporations thinking of establishing headquarters or intermediate headquarters in the UK, which would be of enormous importance to our economy, to consider moving elsewhere. I cannot see the justification for providing that disincentive in the case of paragraph 8.

I understand that, in cases such as that of the CFC legislation, a genuine mischief is being dealt with, albeit hamfistedly. At least I can see the logic of that, but I cannot see why one would want to make the ruling in paragraph 8 applicable. There is a clear way available to Ministers to solve the potential problem of a UK multinational subsidiary consciously over-providing and hence enabling itself to credit an excess of attributable underlying tax when seeking to relieve its UK tax bill. The obvious route is for the level of provisions to be counted towards the calculation of the profit only if it has been set in accordance with international accounting standards. Further guidance can be given, which suggests that the Revenue would want it established that the auditors had signed the level of provisions off as prudent and reasonable. Indeed, it could satisfy itself on that by demanding that the auditors be affiliated to one of the international auditing firms. That is a ready method in accounting terms.

There is no need to invoke mandatory regulations about provisions and reserves, which by and large do not exist. To do so would be a needless disincentive to companies to headquarter in this country. I think that a technical error has been made, but I do not know why. It desperately needs tidying. My point sounds small and abstruse, but cumulatively it is the beginning of the end of the UK as a place for headquartering.

I shall add one more point before I end my diatribe on paragraph 8, and it applies to everything that I want to go on to say about paragraph 10 and schedule 31. I urge the Paymaster General and her colleagues to attend to the fact that the judgments about the location of a headquarters are narrow. In the case of major multinationals, the decisions are made by lawyers, accountants and others concerned with quality of life and executive recruitment, after intensive scrutiny. They are multi-faceted decisions that are inevitably difficult to make.

The choice between Moscow and London is easy. No one dreams of putting a headquarters in Moscow, but the choice between Amsterdam and London is difficult. They are comparable cities with comparable access to highly skilled and educated labour and management. They have comparable networks of double tax treaties, comparable tax arrangements and clearly comparable access to the European Union and its markets. Notwithstanding the fact that Dutch is the language of Holland and English is the language of England, the work forces have comparable abilities to speak English, the universal language of business. In Holland, there is a straightforward exemption system on double tax relief, so no such problems arise. Therefore, the choice to move to London rather than to the Netherlands is extremely finely balanced. Paragraphs 6 and 8, the unamended paragraph 10 and the CFC legislation and mistakes in schedule 31 will tilt that balance remorselessly away from the United Kingdom. That is an economic disaster in the making.

Once it starts happening, there will be a vicious circle. One of the reasons why companies come here is that others are here, and it is because those companies are here that accountancy firms, lawyers, corporate services, telecommunications and other forms of support are in place. All the infrastructure required for a headquarters is here. If companies start not locating here, that support will gradually dwindle.

I need not exaggerate for effect. The skills base in the United Kingdom would slowly and steadily whittle down as the most talented professionals moved to places with headquarters, because the most talented professionals do not want to work for second, third or fourth-layer companies. They want to work at the top, where the most interesting and important financial and commercial decisions are made. Such apparently erudite and obscure little changes will gradually erode the entire base of the City of London, and with that, much else will flow.

Mr. Edward Davey (Kingston and Surbiton): While the hon. Gentleman is on that point, perhaps he could tell the Committee more about the other people who would be affected-not just the lawyers, the accountants, the bankers and so on, but the people who provide the ancillary services that headquarters require, from janitors to sandwich-makers. Does the hon. Gentleman agree that we must consider not only the large multinationals that represent faceless corporatism, but the small people too?

Mr. Letwin: The hon. Gentleman is right. We must consider more people than those that I mentioned. A wide range of people would be affected, because the measure would have second, third, fourth and fifth-round employment effects. When the multinational goes, its cleaners go. When the accounting or law firm diminishes, its cleaners go. Then the people who make the machines for the cleaners lose business, and multiplier effects take place.

Beyond that, some decisions would be made differently. That is a matter of human psychology. If one's headquarters are in the UK and one must decide where to buy new equipment, one's thoughts naturally turn to the UK first. I do not say that such a consideration is compelling. If the UK cannot compete, multinationals will buy elsewhere, but their first port of call will be local. It is easier for many UK suppliers to market to multinational headquarters in the UK. All those advantages would be gradually lost and could, for example, transfer to Amsterdam.

The long-term employment effects are incalculable, but large. Of course, they will not hit the Government in the next two years. They will not hit the country in the next five or 10 years, but they will make a huge difference over 20, 30 or 40 years. Only looking back will people be able to say, ``Alas if only that change had not been made! It was the villain of the piece. It did not matter much itself, but it started a snowball effect.'' That is what we are worried about. I hope that the Paymaster General, after her experiences and those of other Ministers on paragraph 10, which I shall shortly reach, will realise that we are raising an issue that we and British industry are serious about.

Before I come to paragraph 10, I will make two relatively minor points about other parts of the schedule. The discretion that paragraph 17 gives the Inland Revenue to decide whether royalties are at arm's length is too wide. A table or method for objectively assessing arm's-length royalty prices must be devised. Otherwise, some significant but needless disputes will arise.

Paragraph 19 on line 20 of page 516 is a mere amusement on my part. The Paymaster General and her officials may have noticed that sub-paragraph 6 should be relabelled as sub-paragraph 9. I make that observation merely for the sake of good order.

Having spent more time than I had intended to on previous paragraphs, I come to the critical matter of paragraph 10. I am tempted to rehearse the whole sorry history of how we got to the present position, but I shall resist, partly because I do not want to bore hon. Members even more than I have done already, but also because I know that with your eagle eye, Dr. Clark, you will have noticed that I made many of the relative points-the Paymaster General may say too many of them-when we discussed the underlying clause on the Floor of the House.

4.45 pm

Before moving on to the present situation, I should just like to say that the points that my right hon. Friend made this morning deserve to be taken seriously. It is human to err. We all do it. No blame attaches to the Government for having made an egregious mistake in paragraph 10, but it does if, having recognised the error, the Government do not make it plain that the needless, vindictive and false attack on one of Britain's most distinguished accountants has been shown to be false. The Government should make it abundantly plain that he and others who raised the issue performed a signal national service. Assertions were made at column 121 on 27 March that could not have been made except under the cloak of parliamentary privilege. The Chief Secretary or the Paymaster General, as his representative, should withdraw them unreservedly.

The character of the mistake that was made in relation to paragraph 10 is similar to that of the various other mistakes to which I have referred. It was overwhelmingly the most important subject and it is good that the Government have recognised that there is an error. But paragraph 10, as it was, together with all the other things that I have mentioned, had a cumulative effect. I hope that the change, if there is to be a substantive change to paragraph 10, will not make the Government think that they do not need to pay attention to all the other items that tend to diminish people's appetite for investment in the UK as a headquarters location.

With that preface, let me dwell on where I think we are at present. It will be most interesting to hear the Paymaster General's comments. It is an odd state of affairs because, unlike the many instances that we discussed this morning, we do not have before us a set of amendments that specify what is to be done to remedy the disastrous error in paragraph 10 which, if left unchanged, would prevent UK-headquartered multinationals from averaging out the tax rates of their overseas subsidiaries to claim the optimal tax relief under UK tax.

We do not have the amendments. We simply have a rather long press release from the Treasury. I will do it the honour of assuming that it has been carefully drafted. The explanation for the points that I am about to raise may turn out to be that it was not, but I doubt that. In the circumstances, with the Confederation of British Industry jumping up and down on its pogo stick, and most of British industry in revolt, I would have expected someone to have attended closely to the wording of this palimpsest. I propose to engage in a little exegesis of it, which is much needed, as it is all we have to go on.

The relevant paragraphs of the press release, which lie towards the end of the first page and at the top of the second, go, with an unconscious irony, under the title ``Details''-which are exactly what we do not have. They start with a statement that the following four points are the changes that the Government want to introduce. The first point that the Government want to change is that

    dividends paid by CFCs to satisfy an acceptable distribution policy, where none of the other CFC exemptions (including the motive test) are met, will not be able to be mixed with any other dividends.

The reference is to paragraph 6(2) of part II of schedule 25 to the Income and Corporation Taxes Act 1988, on page 953 of that Act, which, rightly, exempts bona fide trading subsidiaries from the CFC imputation rules. I assume that that is the motive test being referred to in that paragraph of the press release. If it is, that is the first step towards a genuine solution to the problem. So far, so good.

I assume that the Government want to exempt from the prohibition on mixing subsidiaries that are not Bermuda cash boxes or the like but genuine trading companies. It is entirely appropriate that the motive test should apply, and we have no complaints with the paragraph, although we shall want to see how it is incorporated into amendments.

The next paragraph is one of the minor masterpieces in the extraordinary document that is the press release: It states that

    underlying tax in relation to foreign dividends paid up through overseas subsidiaries will be capped at 30 per cent., as in the Bill currently.

That means that the Government do not acknowledge that a change is to be made. Things are to be as in the Bill, which was right all along. ``Yah-boo sucks; you've spent a lot of time, all you guys out there in industry, complaining, but we were right, and we are going to keep things exactly as they were.'' I assume that that was included to enable someone to refer back and say, ``We haven't really admitted that we got anything wrong.''

Mercifully, the next two paragraphs flatly deny that the second paragraph, to which I just referred, is true. They describe two respects in which underlying tax on foreign dividends will not be capped at 30 per cent. That is their precise purpose. I highlight those points because in a moment I shall discuss a more serious problem relating to the gap between reality and presentation in the press release.

Let us examine the two paragraphs in which the cap at 30 per cent. is to be breached in order to solve the problem that would otherwise have been introduced by paragraph 10 of schedule 30. The problem was that paragraph 10 specified that, in the case of two subsidiaries, one of which had a 10 per cent. tax rate and one of which had a 50 per cent. tax rate, it would be possible to claim only 30 per cent. tax credit for the one that had a 50 per cent. tax rate and 10 per cent. for the one that had a 10 per cent. tax rate, instead of being able to add the two together and claim the full 30 per cent. against UK tax. As a result, a UK headquartered multinational would pay a great deal more tax than it paid under the mixing system.

The third paragraph purports to resolve that problem. It states that

    underlying tax above the cap will

-and this is the single most important phrase in the press release-

    within certain limits

-it would have been better to have written ``within uncertain limits'', because the limits are precisely what we have not been told, but nevertheless-

    be able to be credited against UK tax payable on dividends other than dividends paid by CFCs as mentioned above

-that is, those that fail the motive test-

    and dividends where the underlying tax has already been capped.

The problem lies in the phrase ``within certain limits''. If the Paymaster General can tell us today or can present to the House on Report a wide definition of the certain limits, all will broadly be well, and mixing as we have always known it, possibly in an onshore form, to which we have never had the slightest objection-we agree that onshore is a more respectable version-will remain with us. If, however, certain limits are to be narrowly drawn, no significant change will have been introduced under paragraph 10. I shall now explain the position to those members of the Committee who are not as familiar with it as the Paymaster General must be by now. The issue is whether a company headquartered in the United Kingdom is allowed to average out tax rates between two foreign subsidiaries, one of which pays 10 per cent. tax, while the other pays 50 or 60 per cent. tax, or whether the averaging will apply only to those companies that pay between 25 and 35 per cent. tax.

The difference is hugely material. A huge number of multinationals is likely to have or to want to develop subsidiaries in countries with tax rates below 25 per cent. or above 35 per cent. If there were a range permitted for averaging only between 25 and 35 per cent., the effect in deterring multinationals from coming here would be broadly the same as that of the provisions in the paragraph. If, on the contrary, the limits range from 10 per cent. to 60 per cent.-one rumour is that that might be the chosen set of figures-everything that is legitimate is likely to be captured. There will be a minor nuisance in relation to tax-free jurisdictions.

There is a theoretical argument that there is no reason for the lower limit in the first place. I am dimly aware that the Paymaster General probably wants a lower limit because she feels that it is part of her crusade in the harmful tax competition group to do something about the nasty ways of Luxembourg. I do not share remotely her enthusiasm for such action, but I know that it is a preoccupation of hers. If that is how the Government feel about it, I suspect that British industry could heroically live with a 10 per cent. to 60 per cent. arrangement. If that is what we will be offered on Report, the main problem of parity will have been addressed. If the limit is tight, almost nothing will have been achieved.

The fourth sub-paragraph in the press release states:

    similar relief will be allowed for some foreign tax above 30 per cent. paid on dividends received by UK companies directly from foreign subsidiaries (onshore pooling).

I must admit that a good deal of thought and attention to the two sub-paragraphs to which I have referred most recently left me unclear about the meaning of that part of the press release. The Paymaster General may be able to elucidate that. All that I can imagine is that it relates to the withholding tax on dividends, whereas the previous sub-paragraph refers to the underlying tax.

If that is the case, it is odd that onshore pooling is described in relation to the fourth sub-paragraph, but not in relation to the third sub-paragraph. If the amendments go for onshore pooling as a method-of which we approve-I would have expected them to cover both the underlying tax and the withholding tax. That needs clarification but, to give a generous interpretation of the two sub-paragraphs, if both the withholding tax and the underlying tax will be dealt with on the basis of a relatively wide band of mixable, poolable tax rates via onshore pooling, we have the rudiments of a successful solution to the problem.

We are anxious to hear about the character of the amendments that will be tabled on Report but, before I leave such a vexed issue, I draw the Committee's attention to what is undoubtedly the most remarkable, although by no means the most important, bit of the press release. Alas, it tells us a lot about the progress of this series of errors and tergiversations. The paragraph lies just above the misleading subtitle ``details'', so we must regard it as a general paragraph. It states:

    Given the scale of the avoidance that has come to light since the Budget, the impact of the overall package described above-

that includes all the changes to paragraph 10 and the others-

    will be broadly similar to the estimates provided in the FSBR.

That is genuinely breathtaking. The paragraph invites us to believe that, before they introduced the Bill, the Government calculated, if I remember the figure correctly, that the fiscal advantage to be derived from the measures in the Bill, including paragraph 10, was 300 million. Many people-including me, although I merely followed the lead of others who are more expert-pointed out that the figure was almost certainly wrong as a first round approximation. If people paid up or did not respond by leaving the UK or not coming here, the extra tax gained would be a multiple of 300 million-pershaps even 3,000 million.

5 pm

The Government maintain that they have transformed their understanding of what is happening in the tax planning industry against a background of what would implicitly have been a much larger fiscal advantage if paragrpah 10, as it had been drafted, had been implemented, and had there been no response from the industry. By sheer coincidence, under the new proposals-the character of which we do not know, as we do not know the limits-the same figure that appeared in the ``Financial Statement and Budget Report'' for the old proposals will apply. Two elements boggle the imagination-one is that the Treasury have been able to calculate the fiscal effects of a measure the detail of which it has not decided. Therefore, without knowing what limits are going to be set, and without knowing how many of the companies involved will or will not be able to mix or to what extent, the Treasury has found a computer or a genius who can calculate the fiscal effect of the measure. On that basis, I assume that the Treasury can tell us the entire fiscal effect of the next Budget. If one does not have to know what the measures are to know their fiscal effects, one can presumably get the same brilliant person who invented this set of figures to invent the other set.

It is of course impossible to determine the fiscal effects of the measure until one knows what the measure is. Only two explanations therefore exist for the paragraph. First, after someone has carefully and conscientiously written a set of words to which I alluded earlier, a spin doctor has been set the task of trying to find a way of rescuing the Chancellor's figures. He has found a way that is, unfortunately, incoherent and implausible, and should be withdrawn. Alternatively, and much worse, the paragraph will be made true regardless of the policy effect. The Government will choose limits for its revised version of paragraph 10 that will, according to the Government's genuine best guess, produce the same number that appeared originally in the FSBR. That would be an absurd way to make public policy, but at least it would make the paragraph true. One way or the other, the Government stand convicted.

I raise the point-which is a debating point, unlike the others, which are on serious matters-because it shows what has happened. Once the Government had made the mistake-which, I repeat, we, or anyone else, could have made-they should have said, ``We got it wrong, we will take it away, produce a new draft, talk to industry about it, and introduce it at a later stage in the next Finance Bill in a proper form. We will then work out what, if anything, the fiscal effect will be.'' However, the Government are not doing that. They are still trying, or half trying, to pretend that nothing has changed, that they did not get anything wrong, and that, going back to the earlier point, they can still claim that

    underlying tax in relation to foreign dividends paid up through overseas subsidiaries will be capped at 30 per cent., as

the Bill currently states-which it will not-and maintain that the amounts to be raised will be the same as in the ``Financial Statement and Budget Report'', from which they will not be apart. It is an extraordinary coincidence or a distortion of policy.

That is needless, and it is not grown up. It is spin over substance, and the wrong way in which to take such action.

The problem arose because people were trying to be too clever in the first place, and they are now trying to be too clever about dealing with the effects of that, which multiplies the sin. It would be far better if we could get rid of all this and try to solve the underlying problem in a conscientious way. Whatever the details of paragraph 10 after the amendments have been introduced on Report, I hope that the Paymaster General can tell us that a sufficiently wide band will be provided for averaging, onshore and offshore, to ensure that this country remains, in respect of the underlying tax and the withholding tax on dividends, as attractive a location for multinational headquarters in terms of double tax relief as others in which either the exemption principle or the onshore pooling principle apply.

Although the episode has been a sorry one and we shall continue to make political capital out of it as the Opposition, the truth is that we- the industry, the Government and those of us who have opposed the measure from the start-will collectively have made a signal contribution to the preservation of our economy. It would be much furthered if the other deficiencies of schedule 30, to which I have alluded at too great length, were also remedied.

 
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