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Clause 43

Implementation of the amended Parent/Subsidiary Directive

Question proposed, That the clause stand part of the Bill.

Mr. Spring: The clause amends the European Commission parent/subsidiary directive and is purely technical. It provides for profits distributed by an EU subsidiary to its parent to be exempt from withholding tax. The Verkooijen case at the European Court of Justice involved a Dutch taxpayer winning the argument that dividends from a Belgian company should be taxed in the same manner as dividends from Dutch companies. The current UK tax regime exempts UK dividends but taxes overseas dividends, and the ECJ
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would almost certainly view it as discriminatory. Will the Financial Secretary consider whether that change in the legislation is irrelevant, because the main legislation to which it relates will be struck out under ECJ principles?

10.15 pm

John Healey: Clause 43 makes a minor technical change to the rules on double taxation relief to ensure consistency between those rules and the recently amended EU parent-subsidiary directive. [Interruption.]

The Second Deputy Chairman: Order. Perhaps those hon. Members who are not going to take part in the debate will leave the Chamber to those who are.

John Healey: We announced our intention to make that minor change on 31 January, when we published the draft of what is now clause 43. Since that date, neither the Government nor HM Revenue and Customs have received a single representation or query on the provisions, which is unsurprising because the provisions will make little difference in practice. If the hon. Gentleman is concerned—nobody else appears to be—I will be happy to write to him. Any companies affected by the change can only benefit from it, and it will provide business with a degree of certainty to ensure that there is consistency between the UK's double taxation relief rules and the amended parent-subsidiary directive.

Mr. Spring: We must know more about the importance of the ECJ to the application of UK law, because examples now exist in case law. I accept that clause 43 makes a technical change, but I ask the Financial Secretary to examine the subject and to let me know his view.

Question put and agreed to.

Clause 43 ordered to stand part of the Bill.

Clause 44

Territories with a lower level of taxation: reduction of amount of local tax

Mr. Spring: I beg to move amendment No. 4, in page 35, line 37, at end insert—

'(1A)   In subsection (1), omit "outside the United Kingdom" and insert "outside the European Union".'.

The Second Deputy Chairman: With this it will be convenient to discuss amendment No. 5, in page 36, line 7, after 'account', insert 'in any accounting period'.

Mr. Spring: Amendment No. 1 focuses on the fact that certain cases in the ECJ mean that various provisions of UK tax law may be overridden. Up to £20 billion is estimated to be at stake for this country in relation to ECJ cases, and we want to know what provision the Government have made for that in their accounts.

Amendment No. 2 relates to the anti-avoidance measure in clause 44, which is part of the controlled foreign companies anti-tax haven rules.
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The Second Deputy Chairman: Order. The hon. Gentleman has referred to amendments Nos. 1 and 2 in his opening remarks, but we are dealing with amendments Nos. 4 and 5. Perhaps he will correct himself.

Mr. Spring: The measure is partially retrospective. [Hon. Members: "Which amendment?"] I am discussing amendment No. 5. The anti-avoidance measure in clause 44 applies to accounting periods beginning on or after 2 December 2004, and it catches income and profits arising after 1 January 2005 for most groups. The 2 December date has been included to prevent the implementation of certain avoidance structures, but clause 44 is widely drafted and may catch certain transactions because of general differences between tax regimes on when they tax specific items of income and expenditure. We want to tighten the definition because the controlled foreign company tests—the CFC tests—are applied annually. Proposed new subsection (1A) requires the adjustment to be made in respect of that particular accounting period, and it does not take into account the fact that the very same income or expenditure may fall into the charge to tax in a later period.

CFC rules apply where an overseas subsidiary of a UK company is subject to a 25 per cent. lower rate of tax than the UK charge and does not meet any of the exemptions from the CFC rules. A tax rate 25 per cent. lower than the UK tax rate is determined by computing the taxable profits of the CFC under UK tax law principles. At the heart of this issue is the fact that the clause prevents tax planning whereby income that is not taxed in the UK is taxed overseas to inflate artificially the rate of overseas tax to get above the limit. These structures normally work so that the post-tax profit stays the same, increases or reduces marginally, while the pre-tax profits and tax charge overseas are increased by roughly the same amount.

The amendment would limit the effect of the clause. Many items are taxed in the UK in a different accounting period from that in which they would be taxed in an overseas jurisdiction. For example, unrealised loss on a bond would not be tax deductible until it became a realised loss in territories such as Belgium, the Netherlands or the Channel Islands, but would be deductible in determining the comparable UK tax bill on those profits. These rules would impact on tax deductions for capital allowances and tax depreciation. It should be noted that that will cause a problem, as virtually all other major countries give tax relief for capital expenditure over a shorter period than does the United Kingdom.

There are other areas where the timing of tax treatment differs between countries. With certain exceptions, interest on bank loans in the UK is deductible when it accrues. Typically, in the UK interest income is taxed when accrued and elsewhere it is taxed when received, as in Ireland and Poland. Amounts due to be paid for genuine services to connected parties are often taxed or tax deductible when paid. For example, Estonia does not tax profits until they are distributed. For income taxable in the overseas calculation in the period, but in the UK in an earlier or later period, the Bill as drafted would mean that the overseas tax bill was deemed to be reduced by the local tax suffered on that
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income when seeking to determine whether the overseas tax charge was 25 per cent. lower than the corresponding UK charge. If the overseas tax charge was less, the quantum of UK tax that would then be levied on the direct UK parent would be increased, hence increasing the UK tax levied on that UK parent without there being a corresponding adjustment in the period when the position reversed.

Knitting that together, it is possible that the European Court of Justice may rule that the CFC rules cannot be used to impose a tax charge on UK companies based on the profits of subsidiaries located elsewhere in the European Union—[Interruption.]

The Second Deputy Chairman: Order. Conversations are breaking out throughout the House. The House must listen to the hon. Gentleman who is addressing us.

Mr. Spring: Cadbury Schweppes, for example, is taking the test case for the group litigation order on this point. I hope that the Minister will make some reference to that, as the implications for the Government and the Revenue seem on the face of it to be very serious indeed.

Under the current trend in corporation tax, companies paying tax at the standard rate in certain EU   countries—including Ireland, Poland, Slovakia, Estonia, Latvia and Lithuania—could, subject to the ECJ, be CFCs. I should also mention the general global trend in falling corporation tax rates. Denmark and the Netherlands recently made announcements that will cause their corporation tax rate to fall below the UK rate, which is now running at 30 per cent. That is hugely different from countries such as Latvia, Lithuania and others, where it is down to percentages in the middle teens. Virtually all the countries of the European Union are bringing down their overall corporation tax rates.

The implications for the Bill are serious. How much tax is at stake on the Cadbury Schweppes and ECJ cases? Given that, in most cases, the tax has been paid by the taxpayer to the Inland Revenue, what is the estimated refund of tax and accompanying interest? How do the Government propose to fund that additional black hole?

Those points are important because they relate to the competitiveness and sustainability of our businesses in the UK. Increasingly, our corporation tax rate and other tax burdens make us less and less competitive. They are now being subjected to challenges elsewhere. The implications make it necessary for the Committee to hear from the Financial Secretary, in view of our amendments, how the Government answer those points.

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