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Mr. Philip Hammond: My hon. Friend talks of people avoiding an excessive amount of tax. Whatever language we may use, does she agree that essentially we are in a competitive position? What matters, surely, is how this jurisdiction stacks up against other jurisdictions, either as a home for private equity and venture capital funds or as a destination for their investments.

Mrs. Villiers: Absolutely. One crucial aspect is the role played by the private sector in bringing investment into this country. Accepting a new framework that deterred that could significantly damage our competitiveness and the foreign direct investment of which the Government are so proud.

There is a slight undertone in the Bill suggesting that some of the structures commonly used in the venture capital industry are somehow dodgy because they have a foreign or offshore component. That is a misconception. Not only have those structures been in long-established use with the knowledge of the Revenue—after negotiations with the Revenue—but they are not, in the main, designed to avoid or reduce tax liability. They are simply convenient legal structures to facilitate foreign investment. On that ground alone, the Government are wrong to stigmatise such arrangements. Although it is not stated explicitly, there is an implicit suggestion that the use of special purpose vehicles or offshore holding companies is in some way nefarious. In fact, it has proved to be an efficient way of attracting the foreign direct investment that is so vital to the effective functioning of our economy.

Amendment No. 19, which the Minister discussed at some length, is one of the most important illustrations of a broader point that I have tried to make: that the provisions, while making a degree of sense in some ways, are too widely drawn. The Minister did not accept the need for further clarity and a more precise formula, which is the aim of the amendment. He said that he thought that there would be too much inflexibility, that some circumstances would not be covered properly by a black letter-type formula and that there should be a less prescriptive approach.

We need more certainty and clarity in tax legislation than in other legislation. It is a basic tenet of not just tax law but our constitutional settlement that, if the Government are to deprive citizens of their money, they must ensure that their legislation is very clear indeed. They are under more of a burden to provide clarity and certainty in that area than in any other area of our legal system. The background to that is Parliament's constitutional struggle with the Executive to ensure that citizens were not taxed without due constitutional process and the acceptance of Parliament.

On that ground alone, clarification of this fundamental part of the Bill is vital. How is it to be decided whether a transaction is on an arm's-length basis? I urge the Committee to look carefully at amendment No. 19. I hope that the Minister and the Government will deem it a constructive contribution to ensuring that venture capital funds have a better idea of what the Bill is designed to do and that the Bill does nothing to damage a vital sector: the flourishing investment sector that is so important to the health of our economy, the health of enterprise and the health of business start-ups.
 
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Mr. Philip Hammond: I apologise for my hesitation in rising. I had understood through the usual channels that more inspiration had come to the Minister in the last few moments, and that he wanted to share it with the Committee. Apparently, that is not the case. I listened carefully to my hon. Friend the Member for Chipping Barnet (Mrs. Villiers). She made some important points, which reinforced Conservative Members' concerns. I want, however, to concentrate on the Minister's remarks.

The Minister began by saying that the motive for schedule 8 was to create equality between different ownership structures. I take that to mean that the Government wanted to ensure that corporate bidders would not be routinely outbid by private equity bidders because of a structural advantage. I do not think that the Minister was suggesting that the structure had been adopted, or was being abused, specifically to gain a tax advantage. He was, I think, observing that it none the less delivers an advantage to private equity partnerships bidding for a UK company financing opportunity.

My problem with what the Minister said is that he has addressed his perception of inequality between corporate bidders and private equity partnership bidders by levelling down—by burdening private equity partnership bidders with some of the disadvantages that he says corporate bidders currently suffer. Like my hon. Friend the Member for Chipping Barnet, I fear that corporates cannot and will not do all the things that private equity funds and venture capitalists are very good at doing. It would be a terrible shame if, in levelling down to try and create a level playing field, we created a playing field that was level but, for the purposes of some transactions, was under water, and if those transactions were not completed, to the detriment of the economy as a whole.

The Minister said that some transactions had been set up with the use of limited partnerships to exploit the ability to charge or recover higher levels of interest and offset those charges against UK corporation tax liability in the acquiring vehicle. I agree with him that on some occasions transactions have been structured in that way for that purpose, but the point about mainstream private equity funds is that by and large, over the past 12 to 18 months, they have not been set up as a result of some dodgy scheme marketed by a tax planner to avoid taxation or to gain some taxation benefit.

I am no expert, but I understand that the model used by most private equity houses has been established and used for many years. Many private equity investments are made with underlying funds originating in the United States. It is natural and unexceptional for an offshore limited partnership vehicle to be used to channel those funds. I hope that the Minister will acknowledge what I think he came close to acknowledging—that the private equity industry as a whole structured itself in this way not to gain a tax advantage, but because it was the sensible structure for it to have as it grew up, financed primarily—at least initially—with funds from the United States.

On the amendments that seek to include arrangements between the parties other than those relating to the financing arrangements, the Minister did not deal effectively with the question of what would happen in the example that I gave of a property investment made by private equity finance partners. If
 
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they are engaged in the abuse that the Minister is talking about, and if their previous scam would have been to lend more money than is reasonable in order to have a larger interest deductible in the UK, it would be perfectly sensible, if proposed new paragraph 4A were then to slap them down, for them to consider as an alternative purchasing the real estate assets that the UK business needs to operate—the factories, offices and warehouses—and renting them to that business at exorbitant rates. Those rents would be deductible and would not be subject to the transfer pricing rules because one of the parties to the transaction would be a limited partnership that is not caught by schedule 28AA, except in so far as proposed new paragraph 4A brings them within the scope of the provision. Indeed, it does so only in relation to transactions connected to the financing arrangements.

I ask the Minister to think about that point. I have to say to him in all modesty that I have not laid awake at night dreaming up new ways of avoiding tax once proposed new paragraph 4A comes into force, but I have talked to people who are involved daily in these matters for a living. The fact that they see scope for avoiding the intended impact of that provision suggests that the Treasury should look at this issue.

I noticed that the Minister did not address what I confess was a fairly long and tortuous argument about whether "person" should be "persons" and about the effect of bringing tax-transparent limited partnerships into the scope of the transfer pricing rules. I do not know why he did not address it—I would expect inspiration to reach him—and if my argument was wrong, I would expect him to enjoy explaining why. We raised the issue not in an aggressive way, but simply in a spirit of inquiring whether the provision's drafting needs to be addressed. I am happy to let the matter pass for now if the Minister has no further comment to make, but perhaps he would be kind enough to write to me explaining why my point is wholly misconceived or, if it is not, what he intends to do about it.

On amendment No. 19, the Minister said that a formula would be too inflexible, but later on he gave the game away rather by saying that a formula would be too generous. What he really means is that a formula would be too generous because, if it is not going to be unreasonably constraining on the taxpayer, it would have to be set in such a way as to give the taxpayer the benefit of the doubt. I understand that point, but my understanding of the Treasury's explanation of the discrepancy between the Government's assessment and the industry's assessment of the revenue raised by these measures—I think that the Minister has already made this point—is that the Government intend that the measures be used in a limited and sensible way to target flagrant abuses, and not to nitpick the fine detail of every arrangement in order to see whether it complies at the margin with the most rigorous test of arm's-length pricing.

7.45 pm

If my understanding of the Treasury's explanation is correct, the concern that a formula would be too inflexible is not well founded, because one would expect it to be set a little on the generous side so that arrangements that approximately constitute an objectively assessed arm's-length pricing arrangement could be deemed okay. Only
 
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when participants had moved beyond what could be reasonably argued as that position would the formula kick in and cut them off. That seems a fairly sensible way to proceed.

It cannot be in the interest of the taxpayer that every single arrangement be scrutinised in detail to see whether it is entirely compliant. It certainly cannot be in the Revenue's interest to have to examine thousands of transactions in detail to see whether they are entirely compliant with what might be deemed an arm's-length arrangement. Nor can it be in the interest of the economy as a whole to have such uncertainty and the introduction of such a compliance burden. I am little surprised that the Minister is not more favourably inclined toward some form of fixed parameters, particularly given that they exist, operate quite successfully, and are appreciated by taxpayers in other jurisdictions. In fact, they operate elsewhere in the Revenue's guidance, as the Minister has already mentioned.

However, the intention was simply to raise these issues and I am grateful to the Minister for the way in which he has responded to them, although I would be even more grateful if he could respond more fully in due course, perhaps in writing. I do not intend to detain the Committee by pressing the amendment to a vote. I beg to ask leave to withdraw the amendment.


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