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We recognise the importance of speed, but we are equally determined to get things right. I do not accept the Opposition's contention that this country is losing out as a consequence of delay. If one examines all the indicators, this country is doing very well. However, the reform of REITs is an integral part of our economic objectives for the near future.
Mr. Spring: Incompetence has nothing to do with macro-economic policyit concerns putting things in the Library. The Minister should understand that that is not the way in which to treat this Committee.
My hon. Friends the Members for Braintree (Mr. Newmark) and for Chipping Barnet (Mrs. Villiers) have discussed the central issue of REITs in some detail. The matter has been under discussion for many years, and I understand that the Government have made a commitment that the reform of REITs should be implemented by 2006. However, the industry is anxious, and people in the financial services industry who are involved with investment have told us that money that
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should be coming into the United Kingdom is going abroad because of delay, vagueness and the Treasury's inability to do what so many other Governments have done successfully. I will not press the amendment to a vote, but the Minister must understand the legitimate concern of the industry and others in the City that we are missing out. He has not satisfactorily addressed that point, and I hope that he will take our concerns on board and reconsider the need to move on.
On the other issue, I accept the point made by the hon. Member for Eastleigh (Chris Huhne) on tax neutrality. There is also the matter of the different tax treatment of classes, but the point has been made and I hope that the Minister will reflect on it. I beg to ask leave to withdraw the amendment.
Mr. Francois: On a point of order, Mrs. Heal. In our earlier debate on clause 11, I cited Mr. Bill Ferris as the chairman of the Association of Independent Museums. In his response, the Minister sought to correct me and said that Mr. Sam Mullins is the chairman of AIM. I have double checked the situation, and AIM recently held its annual general meeting, where those responsibilities were changed and Mr. Ferris became chairman. I have received this e-mail from Mr. Mullins:
Mr. Ivan Lewis: Further to that point of order, Mrs. Heal. I thank the hon. Gentleman for that clarification. In this case, however, the words of the vice chairman are as important as those of the chairman.
13B (1) Where, for an accounting period, the financing arrangements of a company or group of companies come within the parameters set in the regulations made in accordance with paragraph 13A then paragraph 5(1) of this Schedule shall not apply to such financing arrangements unless they differ from the financing arrangements that would have been made as between independent enterprises.
Mr. Hammond: Schedule 8 is complicatedit deals with the financing of private equity finance companies and the loan relationships that typically underpin themand we want to explore a number of issues with the Government over the next couple of hours.
Schedule 8 amends the scope and the effect of application of the transfer pricing rules, which are well-established in our tax law to deal with situations in which parties who are not at arm's length might manipulate pricing arrangements. That might involve the pricing of interest rates in relation to loans, the terms of such loans or, at an altogether different level, the price at which goods are transferred between a parent company and a subsidiary or a subsidiary and a parent company, which could, if left unchecked, give rise to considerable distortions in tax charges. Tax experts have told me that transfer pricing is, perhaps unsurprisingly, the most common area of dispute between taxpayers and the Revenue.
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Schedule 8 attempts to address an area of transfer pricing that has not hitherto been caught by the snappily titled schedule 28AA to the Income and Corporation Taxes Act 1988. As I said on Second ReadingI am sure that the Financial Secretary knows thisthere is a considerable degree of resentment in the private equity venture capital industry at how a change to the arrangements affecting that industry is being badged as anti-avoidance legislation, when the industry has clearly asserted that its practices have hitherto been in pursuance of a model well known to and agreed with the Revenue and the Treasury.
The industry accepts that the Government and the Treasury can determine that it must change its arrangements, which were acceptable in the past, but it would send a positive signal to the industry if the Minister were to acknowledge that schedule 8 is about changing the rules rather than addressing an avoidance mechanism that has been used in the past, which is part of the industry's problem with how those issues are being presented. The Minister should acknowledge that the model used by most of the private equity industry is long-established and has been subject to regular discussions between the industry, the Treasury and the Revenue and that the legislation relating to schedule 8 was amended at the request of the industry, and with the agreement of the Revenue, as recently as the Finance Act 2004.
The Government say that they want to address narrow concerns. The industry's fear is that the Bill is potentially wide-ranging and that it could have significant negative impacts on both the UK private equity and venture capital industry and UK businesses that are financed by private equity or venture capital.
Paragraph 1 of schedule 8 amends the definition in paragraph 4 of schedule 28AA, which defines persons who are deemed to be participating in the management, capital or control of a company. Paragraphs 1(2) and 1(3) of schedule 8 deal with a situation which is not covered by schedule 28AA and which the Government clearly feel needs to be addressed. Schedule 28AA deals with transactions between a parent and a subsidiary and with the situation in which a transaction is between two parties and a third party controls both those two parties, but it does not deal with transactions that fall within what might be deemed the normal private equity financing model, whereby a number of unconnected parties act through a common investment vehicle, none of whom individually has control, as defined in tax legislation, but all of whom have an aligned interest in their relationship with the operating company, and all of whom collectively, were they to act collectively, have control.
Typically, such a structure will involve a limited partnership that is probably not in the United Kingdom. There will be several private equity investors who are partners in that limited partnership, and the partnership will invest in an acquisition vehicle, typically a company, which will then acquire the business ultimately to be financed. That might be a young, dynamic, growing business that seeks an injection of private equity, perhaps to get it to the next stage through a rapid phase of growth to the point where it can go to the public markets. It might be a larger business that has
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hit troubled times and is crying out for an injection of private capital to allow it to be restructured and its management to be refocusedthat needs, as it were, to go into the intensive care ward that private equity funds can often provide. Or it might be a non-core business of a large conglomerate that has been ignored or on to which the focus of its parent has not been properly directed, and where the management are willing and able to take the business forward to ensure that it grows and venture capitalists or private equity investors can see the opportunity to come in behind the management team and allow the business to grow. It is very important, from the point of view of UK plc, to help the most dynamic businesses in our economy to grow and to help established businesses that may not be performing as they should to get themselves turned around. It would be a great shame were the Government inadvertently to introduce legislation that damaged the way in which the private equity venture capital model operates.
Paragraph 1(3) introduces new paragraph 4A into schedule 28AA to try to deal with the problem identified by the Government by creating a wider definition of control. This is fairly complex and tortuous stuff, but I shall try to get it right. A person, P, will be deemed to have control of a company, A, where P and others have "acted together" in relation to financing arrangements for A. That is very legalistic, but I take it to mean that where P has been involved in setting up the private equity funding deal that backs company A, P will be taken to have control of A if it is not a requirement that P has control over A, but if P and the other parties with whom he acted together in setting up the financing arrangements for A, taken together, have control of Ain other words, the rights and powers of each of those investors, when pooled, amount to controlthen P will be taken to have control of A, and that will be sufficient to bring the private equity limited partnership transactions within the scope of the existing transfer pricing rules in schedule 28AA. That gives rise to several issues that we will explore later.
We recognise the problem that the Government have identified. Clearly, arms-length pricing of transactions is the proper way to proceed and the proper basis on which to levy tax, and if there is evidence of a serious abuse of arms-length pricing, it is right that anyone continuing such abuse should be brought within the scope of the transfer pricing regime. As I said earlier, where there is a group of parties who are technically unconnected in terms of the existing legislation but who have an absolute identity of interest because they all own the target company, A, it is equally likely that they will have the ability to manipulate the pricing arrangements in their transactions with A, as would be the case were it a single controlling entity.
We entirely accept that, but I must reiterate the point that I made on Second Reading about babies and bathwater. Of course we understand the Government's motivation, but the numbers that they have put forward suggest that relatively modest amounts of tax are at stake. The concern in the industry and more widely is that this measure is very widely targeted and could, if we are not careful, have a very detrimental effect on the industry as a whole, perhaps, ironically, even reducing the overall tax take over a period of time. For us, the point is to try to narrow the focus of any change in the
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rules to address the mischief that has been correctly identified while ensuring that it does not spill over to have unintended consequences elsewhere.
This group of amendments is intended to avoid a situation whereby the Government, in dealing with what they see as an abuse, inadvertently open up another loophole. Given that a group of investors has been identified as being outside the existing transfer pricing rules, and given that the Government want to bring those investors inside the existing transfer pricing rules, it might be thought that the simple way would be to define them and to say that they too are persons subject to those rules. However, that is not what the paragraph does. It limits the extent to which those parties are brought within the transfer pricing rules to "provision"that is, something that is donein relation, to any extent, to financing arrangements for A, which is the company that the investors, one of whom is P, collectively own. It is unusual for me to stand here saying that a provision might be too narrowly drafted, but in this case we are worried that the Bill, by narrowly drafting the extension of the transfer pricing rules to apply only to those matters that relate to any extent to financing arrangements, may not catch everything that it needs to catch. If it identifies peoplein this case, an investor groupwho should be subject to the transfer pricing rules through having acted together to arrange finance for the company, which is typically the company that does the borrowing, surely all transactions between those persons and the person of whom they are each deemed to have control, not only those that relate to the financing arrangements, should be subject to the transfer pricing rules.
For example, what about management fees that are charged between the parties to such an arrangement? What about consultancy fees or intellectual property licensing fees? All those matters should be of concern if the Government's fundamental anxiety is justified and there is evidence of non-arm's-length pricing between groups of parallel investors who invest in a target company and that company. An obvious avoidance route is open to those parties if the arrangements that the Government are extending are limited to matters that relate only to the financing arrangements.
The identity of interest between the parties creates the motive but, as drafted, the transfer pricing rules cannot be applied to transactions other than those that relate to the financing arrangements because schedule 28AA is amended to include people who have such indirect control only in respect of financing arrangements.
Sub-paragraph (2) deals with a position whereby a party has control of both parties to the transaction. Amendment No. 7 would delete (a). Amendment No. 12 would reword (b) and amendments Nos. 13 and 14 would reword (c).
The amendments seek the overall effect of ensuring that all transactions between parties deemed to have control under proposed new paragraph 4A of schedule 28AA would be subject to the transfer pricing rules. Presumably that is the Government's desired outcome. We see no reason for including the potential controlling party in respect of only one sort of transaction. I hope that the Financial Secretary understands what we are trying to achieve. Perhaps one of the weaknesses of the system is that we have to table amendments, to which a Minister has to prepare responses, guessing the arguments behind the amendments.
If the Financial Secretary will not accept the amendments or at least their thrust, he needs to explain how he can prevent the tax planners in the big accountancy and law firms from simply moving to exploit other transactions between the same parties that are now defined as being subject to the transfer pricing rules, thus perpetuating what he clearly perceives to be an abuse.
Amendment No. 17 deals with a small and technical point in proposed new paragraph 4A. Perhaps the Financial Secretary can throw some light on it. Sub-paragraph (2) deals with a party who, with the rest of the investor group, controls a borrower and a lenderin other words, a single party that is deemed to have control of both the borrower and the lender in a loan relationship. The amendment simply questions whether the word "person", which appears in line 9 on page 125, should be changed to "persons". Sub-paragraph (2)(d) reads:
That should be straightforward: B is the borrower and the other affected personin the singularis clearly the lender. They are the two parties to the transaction as paragraph 1(1)(a) of schedule 28AA defines them. It refers to a provision
However, now that we are introducing the concept of limited partnerships as one of the "affected persons" who can be subject to the transfer pricing rules, we are therefore including in those rules an entity that is tax transparent. Including the tax-transparent entitythe private equity funding partnershipin the rules is the purpose of the schedule. I understand that, when a tax-transparent partnership is introduced as the lender, tax law will look through that partnership and consider a loan relationship to be in place between each partner and the borrower. In those circumstances, the language of proposed new paragraph 4A(2)(d) and, indeed, of paragraph 1(1)(a) of schedule 28AA does not quite do the business any more.
The possibility of more than two affected personsmore than one lender for the one borrower who is caught by the transactionmust now be contemplated.
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If I am wrong, I am sure that the Financial Secretary will explain the reason. We are simply asking whether there could now be "B and other affected persons" in the plural. I am sure that, if that is the case, the Financial Secretary will consider whether some redrafting should take place of proposed new paragraph 4A(2)(d) and paragraph 1(1)(a) of schedule 28AA, where it specifically refers to affected persons being "any two persons" between whom provision is "made or imposed".
Amendment No. 19 again simply probes the Government on their willingness to lay down some rules about what constitutes arm's-length provision in different circumstances. If the Government accepted the amendment or something like itI say that in all humility because amendment No. 19 is not perfectly drafted and does not do what we want it to do but we hope that it is clear enough for the Government to take its pointit would create a safe harbour for investors who complied with the criteria or parameters that the Treasury set down. That would be helpful and I understand that it is common practice in other jurisdictions.
In amendment No. 19, we propose to introduce new wording at the end of section 28AAthat is the end of the effective provision in the sectionto provide that the Treasury may make regulations about, specifically, the minimum income cover in a financing arrangement and the maximum debt equity ratio in respect of a financing arrangement that would be acceptable to the Treasury so that an investor might know that, provided there was compliance with those ratios or criteria, as set down by the Treasury, it would not be deemed to be within the scope of paragraph 4A and thus subject to the transfer pricing rules. The idea is simply that provided that arrangements fall within defined parameters they will not be caught by the provision.
I hope that the Financial Secretary will concede that there is some merit in providing certainty by having these defined safe-harbour provisions. We accept that they would have to be defined to allow for different ratios in different circumstances and in different types of sector. For example, a service industry would clearly need to have different ratios and parameters laid down when compared with a capital-intensive business such as oil and gas production.
In the absence of safe-harbour type provisions, the danger is that nearly all private equity deals will face an additional and unwarranted degree of uncertainty, as it is necessary to consider for the given arrangements in any deal whether the Treasury or the Revenue commissioners are likely to treat them as being at arm's length or not. Who knows? I think that the Government are trying to send soothing signals to the industry that only the most blatant abuses will be targeted, using these provisions. However, I think that the Minister would acknowledge that the Treasury's scope, or that of the Revenue, for focusing its view and challenging arrangements at the margin is considerable within the schedule as drafted. That will inevitably introduce uncertainty.
The Chancellor is fond of reminding us how important stability is to the development and growth of the economy. Anything that tends to undermine
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certainty and predictabilityanything that looks like creating uncertainty, and certainly anything that looks like arbitrary or capricious unravelling of arrangements that have been put in place and agreed to over a long timeis likely, or even certain, to make the UK a less attractive climate for overseas private equity or venture capital investors, and is likely to make it thus commensurately more difficult for UK-based businesses seeking private equity or venture capital funding to obtain that funding.
We are talking about a very competitive area. It is a field in which, currently, the United Kingdom is a very major player. We are second only to the United States in the volume of private equity funded business. The British Venture Capital Association estimates that £127 billion worth of sales generated by businesses in the UK economy are backed by venture capital private equity and that some £23 billion worth of taxes that are payable to the Exchequer flow from these private equity and venture capital backed sectors of our economy.
I am sure that the Financial Secretary would be the first to confirm that the Government do not want to do anything that would destabilise what has proved to be an extremely successful model that has been financing businesses that on average grow faster than the economy as a whole. On average it has created jobs more quickly than the economy as a whole. I hope that the Financial Secretary will be able to respond to the intention behind amendment No. 19, even though I have acknowledged that, as drafted, it does not quite do what we would like it to do.
Amendments Nos. 15 and 39 were attempts to tighten the language of sub-paragraph (7). I do not think that they add a great deal of substance and I do not propose to detain the Committee by speaking to those amendments.
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