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Those members of the Committee who have been paying attention will remember that A, in proposed new paragraph 4A(1), and B, in proposed new paragraph 4A(2), are the subject companythe acquired UK company. The amendment's purpose is to limit the class of person who can be deemed, by virtue of that paragraph, to have controland who can thus be subject to the transfer pricing rulesto those who have a shareholding relationship or an interest in the borrower's shares. I say "the borrower" because we are talking about loan relationships, so A or B will be the borrower in the circumstances envisaged in the schedule.
Even if the Government were to accept the amendment, there would still be serious concerns about banks with private equity investments. Many banks these days either have an interest in a private equity house or have one of their own. Although they operate at arm's length from each other, the private equity division of a bank may find that its corporate debt financing division is lending money to an entity in which it is itself an investor, thus creating a relationship.
We are also concerned about banks that advance mezzanine debtironically, a form of debt that is designed to reduce the coupon payable and thus the interest that would be deductible in calculating the borrower's corporation tax charge, but that typically comes with an equity warrant attached for the benefit of the lender, so that the lender forgoes some of the coupon
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that he would normally have demanded for that class of lending in exchange for an equity kicker if the borrower performs and the equity price rises.
If the amendment were accepted, however, it would at least make it clear that third-party banks in a simple lending relationship could not be caught by the provisions. The Minister is well aware of the considerable concern among the financial community that, as it stands, the provision is not clear cut or plain for all to see. The Treasury says that banks in arm's-length third-party relationships will be caught by the schedule, but that it will be simple to demonstrate the arm's-length pricing. The Treasury's approach is to say that everyone is caught by this pretty much all-embracing provision, but that most of those embraced will be able to wriggle out of the clutches of the Revenue pretty easily. That, we would suggest, is going about it the wrong way and creating an additional compliance burden on businesses and on lenders, while introducing an element of further uncertainty.
It would be perfectly possible to exclude the third-party lenders who are lending at arm's length by writing in the words that are proposed in amendment No. 16, so that a person is made subject to the transfer pricing rules by virtue of new paragraph 4A only if he has an equity interest of some sort in the borrower. The problem is that sub-paragraphs 1(c)and 2(c) define P or Q respectively as a person who "acted together" with others in relation to the "financing arrangements" for the borrower, who is A or B respectively. That definition is bound to catch banks, even where they are involved only in arm's-length third-party lending.
Typically, in putting together a private equity deal the lending bank will have been involved with private equity investors and another department of that bank may or may not have been involved in another capacity, but all that is required for the bank to be caught within the scope of paragraph 4A is that it, together with other persons, acted in relation to the financing arrangements. That, I suggest to the Minister, will embrace all the banks that were involved in putting the finance package together.
The subsequent paragraphs go on to define P or Q as having effective control if his rights and powers over A or B, the target companies, together with the rights and powers of the other persons with whom he has acted, amount to control when they are taken together in aggregate. The problem with that is that P, the bank, may actually have no rights or powers. If control is defined in relation to a person P by the aggregate of the rights and powers that he and all the other persons involved have, and if all the other persons involved have rights and powers but P has no rights and powers at all, P would, bizarrely, under the paragraph 4A still be taken to have all the rights and powers that the other persons have and thus to have control.
If P is a bank and it acts together with private equity investors in arranging finance for a company, it will mean, at its simplest, that equity is coming from the private equity fund and debt from the bank P. In those circumstances, P, the bank, will be deemed to have control by virtue of the private equity investors' rights and powers as shareholders, even though P has none himself. Aggregating means ignoring entirely the stand alone rights and powers of each of the parties.
of the companies to which they are lending on account of the relationship that they had with the private equity house in arranging finance for that company. There will be an increase in compliance burdens because all bank debt will now be theoretically subject to the transfer pricing rules and the company must satisfy itself as to the eligibility of the payments that it is making to the bank for deduction against its corporation tax liabilities. I put it to the Financial Secretary that when this provision was first thought up, it cannot possibly have been the intention to bring into the scope of the transfer pricing provisions arm's-length lending by established third-party banks.
Amendment No. 16 would require a further qualifying characteristic before P or Q could be brought into the transfer pricing netthat there is a shareholding relationship or "an interest in shares". It would exclude all categorically arm's-length straightforward bank lending, exceptthere is still a flaw in the arrangementswhere the bank in question is also involved through another part of its parent company's operations in private equity financing. The Government have said that they do not intend to catch third-party bank debt and their expectations of revenue from these measures underpin the position that is set out, but the industry's concern is that the scope could be much wider.
Will the Financial Secretary address the need to exclude third-party bank debt in line with the amendment? In responding to the amendment, will he go further and deal with the practical problems that arise from the complexity of modern banks' business? They are often in many different businesses, including equity investment, senior debt lending, mezzanine financing and so forth. Will he also address concerns that go, frankly, beyond the scope of the amendmentabout the position of banks that are involved in mezzanine funding where equity warrants are attached to the debt instruments, and about banks involved in equity funding where they are providing a complex package of funding for a company, almost as an alternative to private equity funding?
Stephen Hammond: As a mere equity investor and equity analyst, I have followed the discussion with some difficulty, but it seems to me that private equity funds and venture capital funds are always typically structured by way of limited partnerships. The partners are effectively unrelated and the lending arrangements are traditionally third party.
If I understand my hon. Friend the Member for Runnymede and Weybridge (Mr. Hammond) correctly, amendment No. 16 is designed to deal with some particular concerns. The first is that there are a number of changes in the legislation being badged as anti-avoidance measures, although they seem to be based on a model that the private equity industry has traditionally agreed with the Revenue. Secondly, unless the amendment is accepted, it seems that there will be additional uncertainty for the industry, and the current wording will catch a wider range of transactions than initially envisaged.
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As has been said by others, the venture capital and private equity industry has been hugely beneficial, and if the tax framework is altered in the way suggested, it could become less attractive for inward investors.
The Revenue's concerns seem to be that in some cases borrowing and interest charged have been excessive, and could accrue relief beyond a reasonable commercial return. The new rules seem designed to catch a wider range of transactions than initially envisaged by the phrase "acting together". The rules seem to place a higher compliance burden on banking and finance operations. There are many relationships in which a private equity division of a bank has an arm's-length relationship with its corporate lending side, and there are many cases illustrating the fact that a lending bank can be involved with private equity investors, and another arm of the bank could also be involved.
If all bank debt is to be subject to transfer pricing rules, there will be an even greater growth of the compliance industry. As I understand it, the amendment is intended to limit the provision to situations in which the lender has an equity interest in the underlying business, so we should seek to address only a limited number of arrangementsthose in which the borrowing company obtains a benefit from the investor in paying a higher borrowing charge, by reducing the borrowing company's tax bill.
That practice does not happen widely, so it is important that we should not change or damage the tax treatment specifically created to assist the private equity and venture capital industry. The previous regime was created so that that industry would know what its limitations and rules were, and the change to the rules in the Bill would have an impact on that. The Government's aim seems to be to stop interest accruing on shareholder funds to owner-managed companies where interest is not paidmeaning that there would be an excessive benefit.
The amendment is designed to regularise and clarify the rules to ensure that properly structured private equity and venture capital arrangements long agreed with the Treasury would not be caught by measures branded as anti-avoidance. By tightening the legislation as my hon. Friend suggests, greater certainty would be granted to the industry. My hon. Friend the Member for Chipping Barnet (Mrs. Villiers) was concerned about the competitive threat to the industry and to Britain as an attractive location for inward investment, and as a basis for private equity and venture capital houses. I hope that the Government will accept the amendment.
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