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Mr. Burnett: Is the Paymaster General talking about the profits of the branch operating in the UK?
Dawn Primarolo: I am talking now about the ability of the branch in the UK to raise loan moneys at cheaper cost, because it has the credit rating of its parent company. The whole clause refers to the profits of branches raised specifically from their UK operation.
Mr. Burnett: Is that described as "the rating" in the legislation?
Dawn Primarolo: Yes. We are seeking to ensure that the profits accumulated in the UK are correctly taxed within the UK net.
The question of guarantee fees is complex and it should be noted that the assumption of the same credit rating is also in line with the current OECD view. If the UK were to take a different view on credit rating, it would be out of line with international consensus, which could lead to double taxation for the foreign branches of UK banks.
Various representations have suggested that a permanent establishment should not be regarded as having the same credit rating as the company of which it is part and that guarantee fees should be allowed, but it is difficult to justify that both logically and legally. All parts of the same company will have the same credit rating. The permanent establishment will therefore have
a certain actual cost of funding. It would be inconsistent with the arm's-length principle to treat the permanent establishment as funded at anything other than the actual rate at which it could borrow funds from third parties. Guarantee fees paid by one part of the same company to another will have no legal effect, and as the permanent establishment can access funds at a certain cost, it is difficult to see why it would pay such a fee.The hon. Member for Arundel and South Downs also raised the question of whether the proposals are incompatible with European law.
Mr. Baron: Will the Paymaster General give way?
The aim of the legislation is not to treat branches and subsidiaries as though they were exactly the same. There are clear economic and legal consequences to adopting one or the other structure. Branches and subsidiaries are not the same, and we cannot pretend that they are. For instance, a branch is able to access the capital of the company as a whole to support its business, and that is why banks often choose to trade through branches. If a bank chose instead to trade as a bank in another country through a separate company, it would need to raise further capital to support the activities of that subsidiary, rather than being able to benefit from the capital and credit rating that it already held. The Bill will create a more level playing field between branches and subsidiaries, so that the way in which the profits of branches are computed reflects the commercial reality: that they have access to company capital to support their business. The Bill will mean that UK branches of foreign banks will now pay a fairer share of corporation tax. That does not mean that branches are being treated more harshly than subsidiaries.
The new provisions require consideration of the amount of equity and loan capital that the branch would have at arm's length. The Bill adopts a capitalisation approach, which produces a more level playing field between the branches and subsidiaries of foreign banks, and so removes discrimination. That is entirely in line with current practice.
Mr. Baron: Will the Minister give way?
Dawn Primarolo: No, I will not.
The hon. Member for Arundel and South Downs asked why the terms "equity capital" and "loan capital" were not defined. The Inland Revenue saw no need for those terms to be defined in the Bill. Although some have commented that the terms should have been defined, other respondents have agreed that there was no need. The hon. Gentleman recognised that the terms are well established among the banks that form the main group of foreign companies affected by the changes made by the clause.
I turn now to the issue of decisions with regard to European law, and to the points raised on that matter by the hon. Member for Arundel and South Downs.
Mr. Baron: Will the Minister give way?
Dawn Primarolo: No. I want to continue to make my points.
The Committee will no doubt be aware that there have been recent judgments in the European Court of
Justice, and there are ongoing challenges under European law. The particular case to which the hon. Member for Arundel and South Downs referred was in fact a ruling against the German tax system, not the UK's. As a result, the Government are of course aware that some uncertainty may have developed.We accept that there is a need to restore certainty as quickly as possible. That point is reflected in the Red Book, in the proposals on corporation tax reforms and the next stage of consultation. The hon. Member for Arundel and South Downs will be well aware of the excellent relationships that have existed between this Government and interests in the City of London, especially in connection, for example, with matters arising from discussion of the draft directive on the taxation of savings. At every point, the Government have discussed—with business in general and with those sectors that have a specific interest in the matter—the developments that we want to secure. We want to ensure that we continue to have a corporation tax system and a general tax system that enhance the Government's objectives of establishing fair tax competition, increasing productivity and ensuring that the UK is the most competitive place to do business.
Mr. Baron: Will the Minister give way?
Dawn Primarolo: No, I will not give way. The hon. Gentleman has stood up repeatedly, but I will not be giving way to him.
This summer's forthcoming consultation on corporation tax reform will provide an opportunity for the Government to consult business on the legislative options to achieve our objectives of continuing to modernise and develop our tax system with regard to the objectives that I set out. We look forward to receiving input from the companies involved. It would be foolish in the extreme to speculate on what might be in the consultation document, and I am sure that the hon. Member for Arundel and South Downs does not seriously expect me to address those points, or to prejudge consultations with the very businesses with which we have worked so closely and in such detailed partnership.
The final points related to whether the measure would damage the City of London. The Government's credentials for acting in the best interests of the City and for defending its competitive advantage cannot be challenged either in Parliament or in the City itself. Indeed, our credentials are not challenged: we continue to receive accolades from all concerned on our exemplary conduct of the debates.
Mr. Baron: Will the right hon. Lady give way?
Dawn Primarolo: No, I will not give way.
It is clearly not the case that the measure will drive foreign banks from the City of London. Those banks are there for good business reasons. The City is one of the world's premier locations for conducting business of that type. The banks are there because of the crucial networks and support systems. There is nothing to rival the City in the rest of the European Union, and foreign banks will continue to do business there, but they will do so on the same competitive basis as UK banks, which is entirely fair and correct.
I ask the Committee to reject the amendments, and urge hon. Members to support the clause when we reach that point in today's business.
Mr. Flight: There are two key points on which I want to put further questions to the Paymaster General. I also want to respond to her comments about the ingredients for the continuing prosperity of the City of London.
I went into the first point at some length when I asked the Paymaster General whether the judgments of the European Court of Justice to date, and the principles on which they were based, pose an inherent threat to what clause 148 and schedule 25 seek to achieve. As I pointed out, the recent Lankhorst decision could undermine the clause, as interest payments to other EU members of a group would still be deemed to be deductible. If any EU banks or a significant number of foreign banks in the City of London are based in other EU countries, the whole issue of not allowing the charging of wider interest, which the clause is substantially about, could be undermined by the ECJ's principles and rulings.
Secondly, although I acknowledge the fact that the Government have consulted widely, and in the main effectively, with the City on a number of issues and that, in fighting our patch with the EU, there has by and large been effective collaboration between the Government and enterprise, I passionately believe that it is a mistake to think that the continuing prosperity of the City relies purely on geography, networks and established talent. Having lived through 30 years of history, I have to point out to the Paymaster General that that prosperity always related fundamentally to tax.
In 1970, the City of London was a dead duck. It was too large for the UK economy, and it came to life only when the then Labour Government agreed with the Governor of the Bank of England on what amounted to tax-free Euro-banking, which thus took off in London rather than in Zurich or any other location. There is a mixture: the City has to be competitive tax-wise and regulatory-wise, and it has to be attractive tax-wise and regulatory-wise, as well as using its inherent advantage of a pool of talented people. If the City becomes uncompetitive regulatory-wise or tax-wise, business will go to New York, Zurich and other places, as sure as eggs are eggs. We must thus consider how we tax overseas businesses in London in comparison with how they are taxed in New York, Zurich and so forth. As I said earlier, I am well aware that the provisions have been consulted on and that they appear broadly comparable to the arrangements in New York and other locations and therefore are not immediately a threat.
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