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The Financial Secretary to the Treasury (John Healey): I pay tribute to the reflective and serious way in which the hon. Member for Runnymede and Weybridge (Mr. Hammond) moved the amendments and introduced a fairly wide range of general remarks on the nature and principle of the provisions. The clause gives effect to schedule 8.

The purpose of the legislation is to make the tax treatment of company finances fair between all companies regardless of their ownership and of their financing structures. The clause gives effect to changes in transfer pricing and loan relationship rules that will provide a more even playing field for business. The legislation should help to ensure that changes in companies' ownership and financing happen for the right reasons—in other words, to deliver real economic benefits rather than just to chase tax advantage. I think that the hon. Gentleman was clear about that.

When applied to a company's financing arrangements, transfer pricing rules limit deductions for interest payments to the amount that the company would be entitled to had it borrowed at arm's length to an independent vendor. The hon. Gentleman said that these transfer pricing rules are well established and, as he said, properly so. However, existing transfer pricing rules apply only if one of the parties to the arrangement has control of the other or if both are under common control.
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We became aware that companies and their investors were being advised by some professional advisers to put in place financing and ownership structures specifically designed to get around the rules so as to achieve an unfair tax advantage. The schedule anticipates such problems on a wider scale and seeks to close the loophole. It will ensure that the transfer pricing rules also apply if two or more parties who together control a business act together in relation to its financing arrangements.

In addition, transfer pricing rules are extended to cover financing arrangements put in place after six months before a control relationship between the parties involved. The schedule also tightens loan relationships that regulate deductions for late-paid interest and discounts owed to connected parties.

I was interested that what seemed to drive the amendments was not entirely what was obvious from reading them. What seemed to drive them was the hon. Gentleman's concern that the Bill and the schedule might be too narrowly drawn, or too narrowly focused. The group of amendments generally appear to seek to change the scope of the transactions that are affected by the rules as they apply where persons act together in relation to the financing arrangements of a business.

The hon. Gentleman said that the rules seemed tightly to relate to financial arrangements. The measures relate to transactions related to financing and not only to the financing itself. Where there is abuse—for instance, with related activity perhaps such as consultancy or management fees—HMRC will act to challenge that as well.

Mr. Philip Hammond: Is the Financial Secretary saying that, where parties act together in the financing arrangements for a company, any transaction that those parties enter into with that company will be a transaction relating to the financing arrangement? Is that his position?

John Healey: The hon. Gentleman is drawing too wide a definition. The provisions of the schedule are for transactions related to the finance arrangements. Rather than the wider span that transfer pricing rules can bite on, this is a narrower focus relating to financial arrangements. The rules will have no tax consequences for transactions made on an arm's length basis, so there is no reason why the scope of the rules should cause any real problems for ordinary commercial transactions.

Mr. Hammond: A specific example came to me as the Financial Secretary was answering my intervention. Were the investing group to purchase real estate that was then rented to the target company as its premises, would he regard that transaction as related to the financing arrangements, or would it be too remote, so that a non-arm's length rental would not be caught by the inclusion of such people within the transfer pricing rules?

John Healey: No, such a transaction would, in my judgment, be well beyond those related to the financing of the company, and would not therefore fall under this clause and schedule.

Generally, we have tried to limit the scope of the rules to transactions that relate to financing arrangements and to target changes for particular avoidance risks that
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we have identified, which is the route of the provisions in the schedule. We know that some professional advisers are beginning to advise some clients to structure their affairs in that way. The reason that we are extending the rules is that some of those advisers are promoting ways for companies to get around the existing rules and we want to ensure that that cannot happen in the future.

The other substantive amendment that the hon. Gentleman tabled was what he described as a probing amendment, amendment No. 19. It would create the power to make regulations specifying the criteria that determine whether or not financing arrangements are on an arm's length basis. What constitutes an arm's length financing arrangement depends, as he will appreciate, on all the facts and circumstances relating to the particular provision of finance. He is creating a problem if he believes that that can somehow be determined by a formula set out in regulations. The problem with looking for a formula, particularly one codified in regulations, is that it simply could not take into account the facts and circumstances that are likely to exist in a range of situations. To that extent, the danger is that it would become inflexible.

If we had a standard formula, which I understand to be envisaged under regulations that could be laid under amendment No. 19, it would inevitably be too generous to some and too tight and mean to others. Those who were treated generously would make use of that to avoid the impact of the new rules. The practical effect for some companies of having such a set of rules would be that financing could still be set up on a non-arm's length basis and still stay outside the scope of the transfer pricing rules, which is the purpose of schedule 8 brought in by clause 40. Such companies could therefore continue to obtain tax deductions for excessive interest with impunity, which is precisely what we wish to stop.

Mr. Hammond: Is not the other practical effect that, without clear guidelines, people entering into such relationships or transactions will simply not know whether they are deemed arm's length transactions until later, so they will have to price in an additional measure of risk and uncertainty?

John Healey: I appreciate the general argument that business prefers certainty and that businesses are looking for guidance. I will come to that in a moment. What I am saying, in direct response to the hon. Gentleman's probing amendment, is that to try to codify that in regulations is likely to introduce, first, an inflexibility into arrangements, and secondly, a formula that will inevitably be too generous and allow the sort of avoidance and arrangements that we are keen to close down under this schedule.

Let me give the hon. Gentleman more reassurance on certainty and guidance. Many existing companies, such as members of groups of companies, must already apply transfer pricing rules to their financing arrangements as a matter of routine, so there is considerable existing guidance on the application of such rules to loans, which is equally relevant to the application of the new rules. That guidance, which is available on Her Majesty's Revenue and Customs website, was comprehensively updated and expanded in 2004. In addition, since the announcement of the new rules on 4 March this year, we
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have set up and been operating a central hotline, which investors or companies can contact to discuss the implications of the new rules for particular investment deals. As the hon. Gentleman might be aware, details of that hotline are also on the website.

Mr. Hammond: The Financial Secretary referred to the existing rules and guidance and said that they will apply equally. Is not he making any concession to the private equity financing model? Is he saying that the same criteria will apply to a private equity finance deal through the traditional private equity finance route as would apply to any other corporate financing?

John Healey: No, I am making a more general point that there is plenty of guidance and experience on the operation of such rules and, to that extent, amendment No. 19 is misconceived. I therefore ask the hon. Gentleman to withdraw his amendments.

Mrs. Villiers: Transfer pricing is horrendously complex and we have heard that it is one of the most common areas of dispute between companies and the Revenue. Given its complexity, it comes as no surprise that it boasts such an unfortunate statistic.

We must not lose sight of the vital importance of the venture capital industry. We must bear in mind its enormous importance in economic efficiency, not only as an incubator for encouraging small businesses, but in taking over ailing businesses and turning them into profit-making enterprises. We are extremely lucky to have a flourishing and healthy private equity sector in this country—many western nations would give their eye teeth for such a successful sector. It is worth reminding the Committee that it was one of the Chancellor's favourite areas a few years ago. He has stopped talking about it, but he used to like to cite the private equity and venture capital industry as a model to be encouraged. He sought to introduce that model in a range of different areas and I recall him lecturing some of our European partners on the importance of the private equity sector. That makes it doubly important for us to examine these provisions with great care. In this part of the debate, I am reminded very much of some of the issues that we discussed in relation to real estate investment trusts: the Government talk about the importance of enterprise and of creating the right climate to encourage enterprises, yet fail to deliver on the detail.

Of course, like everyone else in the Committee, I agree completely with the overall aim of closing down tax loopholes that enable companies to avoid an excessive amount of tax. I can agree with the spirit of what the Government are trying to do, but as other Conservative Members said, these anti-avoidance provisions are drawn too widely. I therefore appeal to the Government to consider with great care the clarifications and limits proposed in the amendments. I would not say exactly that the Treasury is taking a sledgehammer to the private equity industry, but the proposals as drafted in the Bill are too wide-ranging and would impact negatively on the venture capital industry without commensurate benefit to the Treasury and taxpayer.
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7.30 pm

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