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John Healey: The hon. Member for Runnymede and Weybridge (Mr. Hammond) is right that amendment No. 18 would remove the restriction preventing compensating adjustments from being claimed in relation to guaranteed loans. It is our view that that would open up the scope for the compensating adjustment mechanism to be abused.
When compensating adjustments were introduced in the Finance Act 2004, their purpose was to ensure that if transactions between members of a group of companies were affected by transfer pricing rules, the position in the group could be balanced out. The compensating adjustments are intended for enterprises such as groups that must apply transfer pricing to different parts of the enterprise. We deliberately limited the scope of the adjustments in 2004 so that they could not be used by third-party lenders. If a company is denied a tax deduction for interest on a guaranteed third-party loan under existing transfer pricing rules, the third party is thus not allowed to claim a compensating adjustment.
The restriction on compensating adjustments in the schedule ensures that that policy is maintained under the new rules. If, for example, an independent lender was able to claim a compensating adjustment, the effect would be to enable the lender to receive interest tax free. A lender should expect to pay tax on the interest received on a loan, whatever the tax treatment of the borrower, so it would be wrong for a lender to receive such a tax benefit.
The hon. Gentleman asked about a loan guarantor's ineligibility to claim the compensating adjustment under the new rules. Our worry is that the adjustments could be abused if they were made available to loan guarantors under the new rules. In many cases, the loan
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guarantor will have a control relationship with the borrower and will thus be able to claim a compensating adjustment under existing rules.
The hon. Gentleman was also concerned that without compensating adjustments, there could be the risk of a double tax charge. Guarantees enable a third party, which is often, although not exclusively, a bank, to lend more than a borrower can borrow on an arm's-length basis. The tax treatment of the lender's income should not be affected by the tax treatment of the borrower in such circumstances. The purpose of compensating adjustments was to ensure that an enterprise did not suffer double taxation because it was structured as several entities, such as a group of companies. The rules of the compensating adjustments for which the Finance Act 2004 provided continue to achieve that.
The approach to compensating adjustments under the new rules is consistent with the policy that underlies the rules under the Finance Act 2004. Those rules did not extend compensating adjustments to a third-party lender, even if the borrower had to make a transfer pricing adjustment in respect of interest on the loan. The schedule is consistent with the 2004 rules, and we are in discussion with the British Bankers Association and others. We are worried that the amendment would narrow the scope of the provision and create the opportunity for precisely the abuse that we are trying to avoid, so, on that basis, I hope that the hon. Gentleman will withdraw it.
Mr. Philip Hammond: The key point in the Minister's response was his lastnamely, that discussions are ongoing. Until then, he had closed his mind to the problem as I presented it and had attempted to convince us that there was nothing to address other than that the entire financial world had suffered a bout of collective incapacity in being able to understand what the Government are about. The fact that he is in discussions gives us some cause to hope that the problem will be resolved to the satisfaction of all parties concerned.
We are not here to champion the cause of tax avoidersthat does no one any goodand we recognise that every Government have a duty and necessity to try to close down tax avoidance routes as they open up, as they surely always will. It is a constant battlea bit like painting the Forth bridge. However, we are concerned that they should get the balance right between protecting revenue on the one hand and using heavy-handed legislation and regulation that will have a negative impact on business on the other. The Minister will agree that no one among the body of official representatives of the financial sector or any other sector would defend tax avoidance. All such bodies agree with the principle of needing to close tax avoidance loopholes, but they want to ensure that it is done in a way that does not inflict collateral damage on other parts of the economy, industry or business.
Ideally, such measures should involve proper consultation with the affected parties and their official trade bodies to find a way forward that not only worksthe Government clearly think they have something that worksbut is well understood by business so that there is clarity and certainty. I understand that in relation to tax avoidance there is
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often a temptation to legislate first and consult afterwards. Perhaps discussions are ongoing as a result of the delay that has occurred this year in implementing those parts of the original Finance Bill that are now in this Bill.
I hope that the Minister is committed to finding an agreed solution to the perceived problem in the financial community so that his undoubtedly correct objective is achieved without creating negative fallout or, if he can resolve that problem, without creating the perception of the possibility of negative fallout, which would be equally damaging to business.
I hope that by the time we discuss the Bill on Report, the Minister will be able to tell us that his discussions have come to a fruitful conclusion. In view of what he said, I beg to ask leave to withdraw the amendment.
The Second Deputy Chairman of Ways and Means (Sir Michael Lord): With this it will be convenient to discuss the following amendments: No. 21, in page 127, line 5, leave out from 'time' to end of line 7.
Mr. Field: The amendments relate to definitional elements of small and medium-sized businesses. They deal with the proposed Government change to schedule 9 of the Finance Act 1996 which makes an exception if the debtor company is a small or medium-sized enterprise.
It is sensible to break up the amendments into three separate groups, starting with amendments Nos. 21, 22 and 23, which would disapply the
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exception. In schedule 8, the exclusion in paragraphs 2(3) and 3(6) of small and medium-sized enterprises from the latest interest rules in paragraph 2 of schedule 9 of the 1996 Act presumably acknowledges the fact that the private equity market provides valid support to start-up businesses as well as ailing companies that might otherwise fail. If that is the correct rationaleI am sure that the Minister will confirm that it isdo those rules produce satisfactory results? In our opinion, the definition of small and medium-sized enterprises derives from the annexe to the European Commission's recommendation in May 2003. The application of that definition to private equities is complex, but in determining which enterprises are being measured we must consider private equity funds and all the investee groups that they control or over which they have significant influence.
Those issues of control and significant influence are at the heart of our concern. The practical implication is that many private equity-backed groups are unlikely to fall within the definition of an SME, regardless of the size of the individual investment. We understand that that is not the Treasury's intention, but I should be grateful for the Minister's guidance. In addition, as the definition of a medium-sized company is relatively low, it will not assist the majority of ailing companies, which will be considered large for these purposes. Any unfavourable treatment of such companies would have a significant impact on the available funding and hence the prospects of those companies. I hope that the Minister can explain in detail why the Government have sought that criterion and whether, on balance, they accept that the size of the debtor company should not be a factor in their anti-avoidance proposals.
Amendment No. 26 seeks to allow businesses, whether SMEs or otherwise, to plan carefully. It would prevent their qualification under the provisions from hinging on the vagaries of the currency markets. As the Minister is aware, the definitional thresholds for small and medium sized enterprises are based on euros in the Finance Act 1996, as amended.
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