Dawn Primarolo: The clause introduces an exemption for small and medium-sized enterprises in order to ensure that the change in the scope of transfer pricing does not lead to increased regulatory burdens for companies. For that purpose, the legislation draws on an updated European Union definition of small and medium-sized enterprises. The EU definition considers the characteristics of an enterprise in the preceding period to establish whether it is small or medium-sized in the current period.
For the purpose of the clause, however, we need to consider the current period. I want to explain why we need to do that. To do otherwise would create an unacceptable risk of abuse. I have been through the matter in some detail with my officials to ensure that there really is an issue and the requirements are reasonable.
Mr. Prisk: I am sure that the Paymaster General has been assiduous. Could she establish for us the scale of the risk, as it is difficult to judge?
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Dawn Primarolo: I was going to do that. The first thing that the hon. Gentleman must remember is that transfer pricing involves vast amounts of money that can be moved around within a group. Although I am not able to say to him that the amount would be x—obviously, the amount would depend on how quickly tax planning developed—I wish to explain how transfer pricing works. It really is quite simple and straightforward, and the risk is clear.
A large group of companies might acquire a small company from outside the group. If the exemption remained in place for a further year after the acquisition, the group would be in a position to exploit it by routing transactions through the new company, which would still be treated as a small company under the exemption. The whole point of transfer pricing is to prevent such things from happening. I kept asking my officials whether that would really happen, and they kept saying yes. What is more, with the amount of money at stake being so vast, it would be worth while for a large group to do that to achieve a tax saving.
The existence of the exemption would create a simple means for groups to sidestep transfer pricing rules, at least for that year. Clearly, it would not be acceptable to introduce a weakness into the rules that would provide a vehicle for removing profit without paying tax in the UK. I am sure that the hon. Gentleman would agree with that. As difficult as it may be to accept that such things happen, I assure him that they do. The reason for looking at the current year is that it is important to know the company's position at a given time.
Mr. Burnett: How will small companies on the threshold of growth operate under such a system? Will they have to make a monthly check to determine whether they fall within or without the small and medium-sized exemption?
Dawn Primarolo: I am grateful to the hon. Gentleman for continuing to anticipate what I am going to say next. I am becoming more and more convinced that he is sitting on the wrong side of the Room. Before I answer his question, does he accept that it would be unfair to other companies that apply the rules and do not seek to indulge in such tax planning to leave that loophole? It would be unacceptable for the Government even to contemplate introducing a set of rules if they knew that such activities were possible.
The hon. Gentleman asked how a small or medium-sized company would know when it crossed the threshold. We will come to that again on later clauses. The Government recognised that changes to record keeping cannot be achieved overnight and provided the temporary relaxation of the penalties for that reason. It is incorrect to suggest that those companies whose financial data show that they are close to the threshold—that they are not miles away—but choose not to account for all their transactions on an arm's-length basis will be caught unawares during an accounting period. Such companies must take account of their forecast growth—and they will—to ensure that their record keeping remains adequate for a whole range of reasons as well as transfer pricing.
Column Number: 123They will, therefore, have done so well before the period in which the SME exemption is lost. We shall discuss later the relaxation of the penalties.
The only other possibility, which was touched on by the hon. Member for Hertford and Stortford, is a hostile takeover. Hostile takeovers are not a feature of small and medium-sized enterprises: any takeover would be the result of negotiations over a reasonable period, during which the larger company will have fully acquainted itself with the business it is acquiring. The acquiring group will have acquainted itself fully with the business for a host of tax and non-tax reasons, and that process will include reviewing the appropriate documentation and record-keeping systems required. The position the Government have taken is to strike a fair and reasonable balance in, wherever possible, removing small and medium-sized companies from the provisions by providing exemptions, while not leaving in place a mechanism whereby such companies could be used as a vehicle by larger groups to extract profit from the UK without the payment of UK tax.
Mr. Prisk: The Paymaster General has rightly highlighted the potential risk when a larger company acquires a smaller one for the purposes she describes. However, I referred to another aspect, which is the natural growth of a small company that may find itself tipped over the threshold. Clearly, in that situation no larger company is involved that is seeking to use that acquisition for the purpose of avoiding the rules, as she puts it. Is it not the case that that is a different set of circumstances to the one that she described? The risk that she ascribed to that situation is not appropriate in relation to the natural growth of a small company.
Dawn Primarolo: No. The hon. Gentleman perhaps misunderstands my point.
Sitting suspended for a Division in the House.
Dawn Primarolo: The hon. Member for Hertford and Stortford asked about companies that tip over the threshold into loss of exemption. We are not discussing tiny companies, and by the time they are moving through the threshold they are substantial in terms of the number of employees, turnover and balance sheet assets. I made the point that with their planning, forecasting and use of data, they will not accidentally trip over that threshold. They will know when they are approaching it, and other issues will arise when moving from being small and medium-sized companies—for instance, the full corporate tax rate will apply. It is not unreasonable to assert that companies will track that closely in their forecasts.
A second point, which goes back to the Government's starting point in their discussions with businesses, is that, at each point, we have attempted to put in a simple arrangement for exemption to enable businesses to deal with the majority problem that has been identified, particularly for small and medium-sized companies. The European Union definition does
Column Number: 124not distinguish between growth and takeover. However, it is a widely recognised and very generous identification, and the limit for exemption is likewise generous to companies. Without devoting many pages of legislation to our own definition to address the point, it is simply not possible to make the distinction that the hon. Gentleman is driving at. We have relied on penalties and relaxation of penalties, information given to companies and the transition period, building on what we know companies will already be doing in their growth forecasts. That is the sensible way in which to proceed. As I said in my opening comments, something like 95 per cent. of companies that will be designated as small and medium-sized will be well within the exemption and it will work very well.
Mr. Prisk: I understand the point that the Paymaster General is making in legislation, and that is absolutely right, but it would help those companies—I accept that it will be a small group—that have naturally grown over the threshold and found themselves caught by the problem that I identified in the amendment if she would say that the Revenue would look that with due care and attention. I am talking not about companies that have been taken over by larger companies—the risk that she highlighted earlier was correct—but about those that have grown naturally. If she would confirm that the Revenue will deal with that sensitively and carefully, that would be very persuasive.
Dawn Primarolo: The Revenue always deals with transfer pricing matters and any other matter carefully. That is precisely recognised by the clauses on penalties under which there is a relaxation for the transition period. Penalties will not be imposed on record keeping within the limits that we shall discuss when we come to that debate. The balance is already being struck, not only on how the Revenue will respond at the time, but on the preparations that it is making in guidance and the specifics in the clauses to help that transition period for those companies so that everything has been provided for that sensibly could have been provided for, given the balance that we are trying to strike with maximum assistance and minimum requirements across the whole range of companies from micro to multinational to comply with the transfer pricing laws. I am satisfied that that is the best balance that we could achieve.
Mr. Burnett: I have had a quick look at clause 33. I do not believe that I am out of order, Sir John, because it is relevant to the point that the hon. Member for Hertford and Stortford is making. The Paymaster General is referring to the transitional period of the Bill. I believe that the hon. Gentleman is saying that there is also a transitional period for a particular company. If a company, during an accounting period, innocently goes over the limit, we hope that the Inland Revenue, in 10 years or whatever, will be relaxed and merciful in relation to penalties and so on.
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