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Mr. Dunne : I support the amendment moved by my hon. Friend the Member for Runnymede and Weybridge (Mr. Hammond), and echo some of the comments that have already been made by my hon. Friends about the importance of the private equity industry to the economy. I shouldprobably to the amusement of the Ministerdeclare another interest, in that I am the director of a venture capital trust that is quoted on the stock exchange. It is a very domestic businessin contrast to the issues that the Bill is trying to reach, which involve primarily offshore relationships.
In this country we have the most effective and substantial private equity industry outside the United States, and each of the funds that raise capital in this
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country does so on a global basis, with which I am familiar, ranging from the United States to Japan, and including Canada and most of continental Europe. Most of those investments are structured through vehicles not designed primarily to evade tax at the underlying corporate investment level. They are efficient structures, designed to allow funds from around the world to come together and support investments made by the fund managers. We should not therefore try to introduce a level of complexity that would drive such transactions into more tortuous structures.
Secondly, increasingly sophisticated measures are being introduced to support companies that have been taken private. I refer not only to mezzanine finance, as referred to by my hon. Friend the Member for Runnymede and Weybridge, but to high-technology companies, some of which are offered distribution agreements by other companies. Some of the insurance companies are involved in providing insurance products, so other financial arrangements may become involved within the transactions, and they might inadvertently get caught by the legislation.
Many of the lenders may not necessarily be banks. In the case of mezzanine finance, for example, they are often banks provided with an equity kicker, which would be caught by the suggested arrangements, but some mezzanine finance is now provided by insurance companies without an equity kicker, through a loan-note structure with a high interest rate, which would not be caught by our amendment because there is not an equity relationship.
The whole picture of private equity in this country is increasingly sophisticated, and by drawing the provisions as the Government have, I fear that they may impose unnecessary and undue burdens on our very successful investment management industry. For that reason, I support the amendment.
John Healey: I hesitated a little before speaking, because I noticed the activity of the Opposition Whip among the Back Benchers earlier, so I wondered whether there were any more Back Benchers with a sudden interest in the particularly narrow provision that we are considering under the schedule. The hon. Member for Wimbledon (Stephen Hammond) and the hon. Member for Ludlow (Mr. Dunne) made a series of points wider than the narrow provisions covered by Amendment No. 16, which might have been more suited to a stand part debate. They paid tribute to the successful venture capital industry in this country, so no doubt they will welcome many of the policies that we have put in place since 1997 to help thatregional venture capital funds, booster venture capital trusts, the enterprise investment scheme, and the 10 per cent. cut in capital gains tax on business assets held for more than two years.
As I have said, amendment No. 16 is narrowly drawn, to narrow the scope of the parties affected by the new transfer pricing rules. As the hon. Member for Runnymede and Weybridge said, to limit the class of persons within the scope of the new rules, the amendment would restrict the extension of the new rules to parties with an interest in the shares of the company involved. However, the chance for interests to act
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together to set up abusive financing transactions is not limited to such parties, so narrowing the scope of the new rules in that way would risk opening new loopholes. The new rules have no tax consequences for transactions made on an arm's length basis, so there is no reason why their scope should cause any real problems for ordinary commercial transactions.
The hon. Gentleman was particularly concerned about banks and third-party bank lending. Let me confirm clearly for him that where banks act together in relation to the financing of a business with other persons who control a company, the new rules apply. However, if the bank lends on an arm's-length basis, the tax position will not change. Indeed, businesses should not expect to obtain deductions for costs of debt finance over and above the arm's length amount.
The position with regard to the hon. Gentleman's concern about mezzanine finance with equity warrants is similar. That can be provided, and often is, on an arm's-length basis. There is no reason, as far as I can see, why that should give rise to particular difficulties in applying the new rules, so long as it is provided on an arm's-length basis. A couple of hon. Gentlemen, including the hon. Member for Runnymede and Weybridge, talked about the complex nature of banks' activity and the imposition of these rules. Where banks are just providing an ordinary loan on an arm's-length basis, the work undertaken in the normal course of that lending should be sufficient to demonstrate that. Therefore, the provisions of the schedule are not an additional compliance burden with significant costs for banks, about which the hon. Member for Wimbledon was concerned.
Mr. Philip Hammond: Will the Financial Secretary talk about the situation in which a bank's corporate lending department is lending and its private equity division is investing? As my hon. Friend the Member for Wimbledon (Stephen Hammond) pointed out, that is not uncommon these days. As the Financial Secretary will know, such matters are dealt with at arm's length in the large banks. What would be the position then?
John Healey: The principle is clear and well established. When lending is done on an at arm's-length basis, the rules do not apply. We are extending the rules in the schedule because some professional advisers are now promoting ways for companies to work around the existing rules and we need to ensure that that will not happen again. I hope that the hon. Gentleman will withdraw the amendments.
The Financial Secretary just said that when lending was on an at arm's-length basis, the rules will not apply, but I think that he meant to say that they would apply but would not have any tax effect, which has been the thrust of his argument. I have listened with interest to my hon. Friends the Members for Wimbledon and for Ludlow (Mr. Dunne) and I am sorry that the Financial Secretary found it necessary to make a churlish remark about the interventions from Opposition Back Benchers. I note for the record that we have not been entertained by any such interventions from Labour Members or, indeed, from the Liberal Democrats who some weeks ago were asking
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incredulous electors to consider them a potential real opposition. They have not managed to muster their forces to demonstrate that tonight.
The Financial Secretary understands our concerns. We all accept that no tax consequences will arise for arm's-length transactions that are caught within the scope of the rules, but we find it bizarre to introduce a new regime that will catch hundreds, perhaps thousands, of innocent transactions, placing the burden on the taxpayer to demonstrate that he should not suffer a tax disadvantage. A compliance burden will be placed on business. Why do we find that extraordinary? Because it would be very simple to exclude that group of arm's-length corporate bank lenders from the scope of the rules. The amendment that we have tabled may not be perfect, but I have not heard the Financial Secretary criticise it from a technical point of view. It would remove a significant compliance burden from a large number of transactions and businesses, and he has not demonstrated, to my satisfaction, why it would not be a good idea to introduce such a provision. Therefore, I ask my hon. Friends to support the amendment in the Lobby.
Schedule 28 AA of the Income and Corporation Taxes Act 1988 provides that where an interest payment is disallowed or reduced under the transfer pricing rules, thus increasing the tax payable by one party to the transaction, a corresponding adjustment is available to the other party. That is a sensible measure, which avoids double taxation occurring where part of a transaction has been disallowed under the transfer pricing rules.
Sub-paragraph (5) of paragraph 1 inserts a new sub-paragraph (4A) in paragraph 6not to be confused with the paragraph 4A that we were debating earlier; for some reason everything in schedule 8 relates to a paragraph 4A. The new sub-paragraph (4A) excludes the entitlement to a corresponding adjustment where two conditions are met: first, that the provision subject to the transfer pricing rules is subject to them only as a result of the paragraph 4A introduced by sub-paragraph (3) in paragraph 1; and, secondly, that a guarantee is provided in relation to the security issued by the debtor
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by a person who has a participatory relationship with the debtor. That participatory relationship is defined so as to include the subsidiaries of the debtor.
If A is one of the private equity investor group defined by sub-paragraph (4A) of schedule 28AA as participating in the management, control or capital of Bthe acquisition vehicleand B is both the acquisition vehicle and the debt issuer, it would be perfectly normal in those circumstances for B's obligations as a debt issuer to be guaranteed by its operating subsidiary. To put that in practical terms, the companies generating the cash flow will, typically, guarantee the debt obligations being taken on by the holding company in the form of a raft of cross-guarantees between companies in the group.
The transaction is subject to transfer pricing rules because of the sub-paragraph (4A) to be inserted in schedule 28AA. So, B's interest charge may be reduced or disallowed for corporation tax purposes but, because of sub-paragraph (5), the lender is not entitled to reciprocal treatment, thus reducing its interest receivable for corporation tax purposes.
Why is that? The question does not arise because we are being a little slow on the uptake. No one, including the body of expert opinion in the City, which considers these matters very closely, is sure of the answer. What is the relevance of the guarantee? Why does the existence of the guarantee relationship between a subsidiary and its holding company invalidate the right to claim a corresponding adjustment in the corporation tax return of the lender where a corporation tax deduction has been disallowed or reduced in the hands of the borrower? What is the abuse that the Government imagine they are addressing by the inclusion of sub-paragraph (5)?
In many cases in which straightforward bank debt is involved, there will be no disallowable interest because the transaction will clearly be at arm's length. However, to rehearse the argument that we had on the last group of amendments, what about banks with an equity participation in the target company? What about banks that have a private equity division or those that have provided an integrated financing package for the company, including equity and debt as an alternative to a conventional private equity investment? On the face of it, those banks will not be able to secure a corresponding adjustment.
For example, when the lending that takes place is not senior debt lending but mezzanine lendinghigh coupon lending that takes a subordinate security to the senior debtthe correct pricing of that arrangement may not be so clear-cut for it to qualify as an arm's length transaction. I am not talking about a situation in which an equity kicker is attached to the mezzanine funding, but about one in which there is relatively high coupon debt with a subordinate security interest.
It is not clear to us what the mischief is and what the relevance of the guarantee is, but it is clear that the provision must be wrong in principle. The existing provision that allows for an offsetting adjustment on the other side of the transaction when any adjustment is made is a neat and simple double-entry type solution to what could otherwise be a serious injustice. It is clear that, in the absence of an entitlement to an offsetting
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adjustment, these arrangements could give rise to a double tax charge where a partial or total disallowance of interest is made and both parties are within the charge to UK corporation tax.The provision potentially puts UK taxpayers at a disadvantage compared with non-UK taxpayers who will often be able to achieve a corresponding adjustment through a double tax treaty adjustment.
The amendment probes the Government on their attitude to the problem by seeking to delete sub-paragraph (5) in its entirety. I have to say to the Financial Secretary that I have seldom been in receipt of such unanimously perplexed sets of briefing notes from different qualified external advisers. I am sure that he will have seen some of the briefings and noted the genuine perplexity of specialist practitioners in this sector about what the Government are seeking to address, the perceived mischief and the relevance of granting an intra-group cross-guarantee.
I hope that the Financial Secretary will be able to explain all these things, and we will listen carefully to what he says. I assure him that the expert bodies that have expressed mystification will also look closely at what he says to see just how the provisions are intended to work. Are they really intended to apply to group cross-guarantees? Why are they intended to apply to them; what do they seek to address; and how will they work in practice? We will listen carefully to his reply before deciding how we should proceed.
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