Finance Bill

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Mr. Burnett: I repeat the point that I made earlier. I stress to the Paymaster General that I do not want companies to avoid the transfer pricing rules, but if a company innocently goes over the threshold into the large company regime, and for various reasons—it may not have much experience or it may be an international trading group that has a bonanza profit in one year that takes it over the threshold—I hope that the Inland Revenue would, to use the words that I used earlier, be merciful and mitigate the penalties.

I have also had a submission from the Confederation of British Industry, which says:

    ''The transitional period to April 2006 only provides for the remission of penalties arising from inadequate records, and not for any other reason. The Inland Revenue Technical Note published with the Autumn 2003 Pre-Budget report said that the transitional rules 'are designed to give businesses more time to develop an understanding of transfer pricing requirements, and to adopt appropriate systems, before being exposed to penalties for failure to do so.' The remission of penalties for inadequate records only would not achieve this. A general remission of penalties is needed if the introduction of the new regime is not to place unreasonable burdens on taxpayers, particularly those mainly UK larger businesses, such as retailers, which have had little or no experience of transfer pricing issues to date.''

I had hoped to hear from the Paymaster General on both the former and latter points. On the former, I am not trying to wriggle out of the transfer pricing rules. I am just asking whether the Revenue will mitigate the penalties regime in relation to a company that quite

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innocently goes over the threshold into the larger company regime for transfer pricing.

4 pm

Dawn Primarolo: The clause introduces a temporary waiver of penalties for inadequate documentation of transfer pricing for the tax years 2004–05 and 2005–06. As we have discussed, the transfer pricing rules were the most straightforward way to address current uncertainty for business. However, we recognise that it will take some businesses some time to adapt their record keeping fully to the new rules. I think that the hon. Gentleman would agree that the penalty waiver is a pragmatic measure to ensure that businesses have the time that they need to change their systems, and to minimise compliance costs.

The relaxation of the penalty regime for a transitional period of two years will give businesses time to adjust to the new rules. It will apply to all businesses, large and small, and to all transactions, cross-border and domestic. During this period, businesses will not be exposed to the risk of penalties for failing to keep records that demonstrate that results are arm's-length results for transfer pricing purposes.

Of course, businesses still need to make a reasonable attempt to establish an arm's-length result for transactions with connected businesses. Businesses can use the information currently available to them to meet the requirement from the start. However, as I have said, we recognise that it will take time to adapt the record-keeping systems to the new rules, which is why we are making provisions in this area. In effect, the penalty rules will not apply automatically; the Inland Revenue will investigate and use its discretion. In applying that discretion, the Inland Revenue will take account of the circumstances, including any mitigating circumstances. That is the point that the hon. Gentleman was pressing me on earlier.

We want to be reasonable. At the end of the two years—at the end of the 2005–06 period—we want the transition to be made in the best way and the transfer pricing rules to run smoothly. That is our aim. In getting there, the Revenue will take mitigating circumstances into account. The records to be included are those that demonstrate that a price is arm's length. The Inland Revenue will not be prescriptive about the precise nature of the records. They are simply to establish the arm's-length price.

I hope that the hon. Gentleman can see that there is a generous relaxation across the board with regard to the penalty regime. In the transition period, businesses will not be exposed to the risk of penalty for failing to keep records that demonstrate that the results are at arm's length for the transfer pricing. That is an important point, and I hope that my response satisfies the Committee.

Mr. Burnett: I hope that I heard the Paymaster General correctly. Did she say that, after the two-year period is over, the Revenue will take account of mitigating factors when it applies the penalty regime? My experience has been mainly with small and

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medium-sized companies, and I know that she is conscious of the fact that such companies do not have the in-house expertise that larger companies have.

Dawn Primarolo: I can confirm that Revenue discretion is always a feature of penalties, regardless of this clause, and there will be an additional waiver of penalties for record keeping during the transitional period. We are strengthening that and including additional provisions to respond to the points made in both this and previous debates. I hope that that satisfies the Committee, and I stress again that the Revenue will take the appropriate and understanding approach that I have outlined.

Question put and agreed to.

Clause 33 ordered to stand part of the Bill.

Clause 34

Payments of excessive interest etc

Mr. Prisk: I beg to move amendment No. 12, in

    clause 34, page 35, line 29, at end insert—

    '(fa) in sub-paragraph (4)(c) after ''would apart from section 84A(2) to (10) of this Act'' insert ''and disregarding any adjustment which might otherwise arise under the provisions of this paragraph''.'.

This is a probing amendment to deal with an anomaly concerning intra-group loans. It was tabled with the support of both the Law Society and the Chartered Institute of Taxation. The effect of subsection (4), which is an integral part of the clause, is that, when an intra-group loan is made on an interest-free basis, no exchange gains or losses will be disregarded on the debtor or creditor loan relationship. In many people's opinion, that does not go far enough, because it does not deal with cases in which an intra-group loan is advanced on interest-bearing terms to enable the borrower to obtain the benefit of matching treatment.

When the loan is treated as matched in such circumstances, there is nothing to prevent all or some of the exchange gains or losses from being ignored for tax purposes. Paragraph 11A(4)(c) and (5)(c) of schedule 9 to the Finance Act 1996 currently provides that no adjustment would arise on the exchange gains or losses when—this is the important point—there is a corresponding debt loan relationship and exchanged gains and losses are taken into account.

In plain English, the problem arises when the borrowing exceeds the amount that the borrower could have borrowed if it were dealing at arm's length and the loan were interest bearing. In those cases, but for matching treatment, an adjustment would arise on the borrower by virtue of the amended provisions in paragraph 11A(4)(c) and (5)(c). There is nothing to prevent an adjustment from arising under that paragraph. The danger is that that would leave the lender of the intra-group loan exposed to tax on, for example, exchange movements when it borrows in a foreign currency and on-lends an equivalent amount in foreign currency to a thinly capitalised UK subsidiary in order to finance the acquisition of that subsidiary.

The amendment is designed to draw from the Paymaster General the reasoning behind the

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Government's decision and to deal with the anomaly that I have tried to explain. It is a complex issue and relates to different parts of legislation. It matters simply because many UK companies are increasingly and regularly investing overseas. The purpose of the amendment is to remove the anomaly that could prove to be a barrier to that. I hope that the Paymaster General can enlighten us on the thinking that the Government have applied to the measure.

Dawn Primarolo: I certainly do not want the hon. Gentleman to labour under any misunderstandings about the Government's approach to matching. We agree with him that the matching principle for exchange gains and losses should be preserved. To see that, he need look only at the Finance Act 2002, in which the Government strengthened the matching rules to allow more assets to be matched. We included in that Act paragraph 11A of schedule 9 to the Finance Act 1996 to ensure that transfer pricing and thin capitalisation considerations did not prevent matching from working. The matching arrangements that we are dealing with, and which his party introduced in 1993, are about interest-free loans between two companies in the same group. Our changes in 2002 preserved those arrangements, and nothing in the Bill or the transfer pricing proposals changes any of that.

The Inland Revenue has been asked about this issue repeatedly and has published guidance on its website. It has explained the position to the firms that have asked, and the position is clear. If the loan is interest-free, there is no change. If interest is charged on the loan at the arm's-length rate, there is no change. Only if for some reason interest is charged at an excessive rate might there be an issue. That was the case under the thin capitalisation rules, too. We are dealing with a clause that is taking out thin capitalisation and putting the same arrangements within transfer pricing.

I hope that, with all those assurances, the hon. Gentleman will see that the amendment is unnecessary, because the matter is dealt with to ensure that groups are still able to match.

Mr. Prisk: The Paymaster General has moved us an important step forward. Can she just clarify what ''excessive rate'' means? That is not simply a point of parliamentary pedantry; it is an important point for those seeking to understand the intention of the legislation.

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