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Mr. Baron: Clause 148 could, I think, cause serious problems for the City of London and therefore for the country as a whole, as the City is a major contributor to our economic well-being. The clause alters the tax treatment of UK branches of non-UK companies, which will have a particularly adverse effect on overseas banks operating in the City. It could seriously jeopardise the City's position as the world's leading international financial and business centre, as foreign banks downsize their operations in London.

Let me say a little about the importance of the City to the kingdom as a whole. It is no exaggeration to say that it is a global powerhouse at the heart of the UK's financial services, a sector whose net contribution to the UK's current account has been over £13 billion, a significant amount of which has been generated within the square mile. There is a daily foreign exchange turnover of over $500 billion in London, and 56 per cent. of the global foreign equity market and 70 per cent. of eurobonds are traded there. London is the world's leading market for international insurers: the worldwide premium income reached £157 billion in 2001 alone.

I must declare an interest. I was a fund manager before entering the House, which enables me to testify to the importance of foreign banks to the City's prosperity and wealth generation. About 500 foreign banks currently operate in London, employing some 60,000 people. They contribute enormously to the City's pre-eminent financial position. I believe that this tax change will threaten that position, because it has been built on a false premise by a Government who misunderstand the way in which the City works—and, I suggest, misunderstand the economic facts of life. The Chancellor tries to justify this move by claiming that such changes in the tax treatment of foreign companies simply bring us into line with the US and with other European countries. However, he misses the point that this country's existing favourable tax treatment helps to compensate foreign companies for other factors that make doing business in London, in particular, less attractive when compared with other cities.

One example is the capital's transport infrastructure, which is a mess. Average journey times have increased by about 16 per cent. since 1998, and motorway congestion is up by 250 per cent. since 1997. Meanwhile, congestion charging has added a further marginal cost

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to businesses operating in London. At the same time, train punctuality has worsened each year under this Government. By withdrawing the advantage of a low-tax regime, they have made the decision whether to locate to London or elsewhere a more finely balanced one for foreign companies. This Government fail to understand that when it comes to the City, increasing mobility of labour and modern technology mean that business undertaken in the London branches of foreign banks can easily be done elsewhere.

Ian Mullen, chief executive of the British Bankers Association, said of the tax change last year, when it was first mooted:

In a letter to the Financial Times last year, Angus MacLennan, chairman of the Foreign Banks and Securities Houses Association, said that he guarantees that this tax change will result in business going abroad—in the first instance, by way of assets being moved to reduce additional tax, and afterwards as income follows the assets. He said:

He concluded his letter by saying:

Mr. Bercow: Does my hon. Friend agree that Ministers are especially short-sighted in this matter, given that they know, as we do, that this country has already sacrificed two thirds of its competitive tax advantage since 1997, relative to other members of the European Union?

Mr. Baron: I readily agree with those figures and that sentiment. What worries Conservative Members is that this country's competitiveness appears to be being continually eroded by these tax increases and regulations. Independent statistics suggest that we are slipping down the competitiveness league tables, which is causing a loss in productivity that will eventually result in the loss of our pre-eminent economic place.

It is true that these measures will generate income for the Treasury over the short term. Estimates vary, but it is suggested that some £350 million will be generated in the first year, with perhaps another £650 million being generated in 2004–05. However, as my hon. Friend the Member for Buckingham (Mr. Bercow) has just suggested, they will prove to be among the many tax measures that raise money in the short term but lead to a loss of revenue to the Treasury in the longer term—a loss that will far exceed any short-term gain, as foreign banks and employees quietly move out of London.

This issue is important to the country as a whole. By attacking the jewel in the UK industry's crown, the Chancellor is eating away at our competitiveness and longer-term prosperity. I urge the Government to reconsider their position, because, as sure as night follows day, the tax increase will result in a loss of prosperity and revenue in the longer term to the detriment of us all.

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Dawn Primarolo: The central issue at stake in clause 148 and its supporting schedule—the amendments are designed to attack and eradicate it—is whether it is fair that foreign banks operating in the City of London, which are competing with UK banks, should, on account of their structure, pay little or no corporation tax. Is it fair for UK banks to compete for business against foreign branches that pay no tax? That is the central issue.

Mr. Baron rose—

Dawn Primarolo : I am not posing a question for the hon. Gentleman to answer, but opening my case on the clause and the amendments. I shall urge the Committee to reject the amendments, comment on the key aspects of the clause and respond briefly to the hon. Member for Arundel and South Downs (Mr. Flight), who posed wider issues about the European Court of Justice, though I realise that that is strictly outside the remit of the amendments and I shall try to remain in order.

The amendments would remove the main charge introduced by clauses 147 to 155 and by schedules 25 to 27. The charge remedies what I would politely call a weakness in UK domestic law and ensures that UK branches of foreign companies will pay a fair share of UK corporation tax, reflecting the profits that they make from their UK activities. The bulk of clause 148 and schedule 25 set out in UK law the rules that the UK applies in taxing foreign companies. They also modernise the terminology used in UK law.

The one truly new element of clause 148 is set out in new section 11AA(3), which changes the way in which the taxable profits of branches are measured. For the first time, consideration will have to be given, for tax purposes, to the amount of equity and loan capital that a branch would have at arm's length. That is, consideration will need to be given to the capital that the branch would have if it were a separate entity carrying on the same or similar activities under the same or similar conditions.

Amendment No. 66 would remove that change. If it were accepted, the winners would be UK branches of foreign banks—it is primarily banks that operate through branches—which would continue to pay little or no corporation tax in the UK. The losers would be the UK Exchequer and UK incorporated banks that compete with foreign banks for their business.

It might be helpful briefly to explain the deficiency in the old legislation. Previously, there was no requirement for a UK branch to have regard to the amount of capital that it would require commercially in order to support its business. That meant that a UK branch of an overseas bank could, for tax purposes, borrow every pound that it lent to customers, and the interest cost of that borrowing would significantly reduce the UK profit. In contrast, a UK bank would need to have equity capital and would not borrow every pound that it lent, so it would have a smaller deduction for interest expense. The result was that nine out of 10 of the top foreign bank branches in the UK were paying no corporation tax on their UK profits, despite their large and long-standing UK operations.

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5.15 pm

Mr. Baron: Will the Paymaster General give way?

Dawn Primarolo: No.

Amendment No. 67 would remove the new provision in new section 11AA(5). That provision would give the Board of Inland Revenue the power to make regulations specifying how the new capital requirements are to apply to insurance companies. That will enable the new rules to be adapted for insurance companies, because their capital requirements are organised differently from those of banks and other companies.

The hon. Member for Arundel and South Downs raised several issues, the first of which was the question of guarantee fees paid to head offices. The new legislation specifies that when computing the profits of a permanent establishment, it should be treated for tax purposes both as if it were a distinct and separate enterprise and as if it were trading in the same or similar activities under the same or similar conditions. That is based on the wording used in article 7 of the OECD model tax convention. There is an inevitable tension here, which arises from the fact that a branch is clearly not the same as a subsidiary, and different economic and legal consequences arise from adopting one structure over another. If the permanent establishment is assumed to be acting under the same or similar conditions, that must logically apply to the actual cost at which it can raise funds. The cost at which it can raise funds will be dependent on the company's credit rating. While it is our view that the assumption of the same or similar conditions means that the permanent establishment must have the same credit rating as the rest of the company, that matter was specified in the legislation to provide clarity and put the matter beyond doubt.

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