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Schedule 6

Avoidance involving financial arrangements

Ed Balls: I beg to move amendment No. 99, page 181, line 2, at end insert—

‘Repeal of rent factoring provisions

A1 (1) Sections 43A to 43G of ICTA (rent factoring) shall cease to have effect.

(2) The amendment made by this paragraph has effect in relation to transactions entered into on or after 6th June 2006.’.

Mr. Deputy Speaker: With this it will be convenient to discuss Government amendments Nos. 16, 100, 17 and 101 to 106.

Ed Balls: These amendments cover two similar areas. They deal with changes to the legislation on “repos”—the name for agreements for the sale and repurchase of securities—and introduce legislation on the factoring of income generally, replacing existing legislation on the factoring of rents from land. Both these areas involve anti-avoidance rules.

Amendments Nos. 99 to 101 deal with factoring of income generally and are more substantial, so I will describe them first. The ideas behind the rules for structured finance arrangements are not new; they build on, extend and replace legislation introduced in 2000 called rent factoring. However, the structures that Her Majesty’s Revenue and Customs has seen recently are new: they take rent factoring ideas and extend them to types of receipts other than rents.

Before turning to the detail, it may be helpful to start by outlining why the amendments are being introduced at this stage of the Finance Bill cycle, rather than on Budget day. The context is that, earlier this year, HMRC became aware that a major corporation had entered into the new type of factoring scheme to avoid paying tax on significant amounts of income. At that stage, HMRC was not aware of the detailed mechanics of the scheme, so the Government were not in a position at Budget time to introduce properly targeted legislation. Work continued to ensure that the scheme was properly understood and then on developing a legislative solution.

3.45 pm

On 6 June, my right hon. Friend the Paymaster General announced to Parliament that the Government would introduce amendments to the Finance Bill on Report to ensure that the new type of factoring arrangement would be properly taxed, and that the legislation would have effect from 6 June. On that day, HMRC published draft legislation and a detailed explanatory statement on its website identifying the types of scheme that the legislation would affect. It also invited interested parties to attend a longer open day later in June, with HMRC
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and Treasury officials, with the object of clarifying the new rules and identifying any areas where they might need to be amended. As I said, this is, in essence, anti-avoidance legislation. The Government do not usually consult about anti-avoidance legislation.

Mr. Hoban: Will the Minister explain to the House the principal differences between the draft legislation that was published on 6 June and the provisions in front of us today? What types of transactions were taken out?

Ed Balls: I was just coming on to explain how the consultation had affected the initial proposals and how consultation had helped us to make better tax policy.

I was saying that, normally, one would not consult on this kind of anti-avoidance legislation, but because we are talking about a difficult area, we thought that it would be helpful for there to be a period of consultation and discussion about the detail—as long as it was always clear that the legislation would have effect from the date that it was announced, 6 June, and provided that the House was content for these amendments to be introduced on Report. As I said, we held an open day discussion on 20 June, which was attended by about 30 representatives of business and the advisory professions, to go through the legislation and, in particular, to consider whether the exclusions that had originally been built in were sufficient. Those exclusions were to make sure that we did not inadvertently capture appropriate behaviour as we tried to deal with the particular form of tax avoidance relating to this complex way of providing loan finance.

The consultation process has been constructive and beneficial in identifying areas where changes to the original proposals were needed in order to exclude cases that could be inadvertently caught. The process has been welcomed by business as a way of striking the right balance between protecting tax revenues and making sure that we get legislation right. The main exclusions are for transactions that are already taxed in the way that the amendments propose. That includes finance leases and other similar arrangements such as repos, stock lending and some types of Islamic finance. To put the point beyond doubt, ordinary loans are also excluded. In essence, the new legislation for structured finance arrangements will bring other types of financing arrangements into line with the new finance leasing rules, and so remove what would otherwise have been an anomaly from the tax system.

I want to confirm in particular that, following discussions, the finance leasing industry is content with the exclusions in the amendments. In response to the hon. Member for Fareham (Mr. Hoban), I should say that it was around those issues of finance leasing that most of the detailed changes to the original 6 June announcement were made. Following those consultations with the industry, we understand that it is content that the exclusions in the amendments provide the right outcome, particularly in relation to any overlap between the leasing rules and the structured finance rules. We think that these measures are a proportionate response to complex arrangements. Had we not acted, several hundreds of millions of pounds of tax would have been at risk. The provisions do not penalise, but put all finance arrangements on a level
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playing field so that a company’s decision on how to finance itself is not driven by tax considerations, but by commercial ones.

Amendments Nos. 16 and 17 are changes to the tax treatment of sale and repurchase—or, as they are commonly known, repo—transactions. These amendments are the Government’s prompt reaction to a recent adverse decision of the special commissioners—the first instance tax tribunal—in a case where there was what is known as a three-legged repo. Clearly, in this case, there was no question of consultation because we were responding to that decision.

Repos are used widely in the financial markets as a form of a secured loan. They typically involve one party agreeing to sell securities to another, with a related agreement to buy back the securities at an agreed future date at a price agreed at the outset. Ordinary repos involve only two parties: the original holder and the interim holder. The special commissioners held that the legislation for taxing repos did not work properly in a three-legged repo situation and upheld a company’s claim to a deduction when, overall, there was no net loss to the group of companies involved. It is very likely that HMRC will appeal that decision, but it opens up the possibility of companies trying to enter into similar schemes in the hope that the special commissioners’ decision will be upheld. The possible cost of that could run into hundreds of millions of pounds.

The amendments on repos will ensure that such a scheme will not succeed in future, whatever the outcome of the appeal. The changes will not have any wider effect on genuine commercial repo transactions. This is another example of us acting quickly and fairly, but properly, to deal with tax avoidance without damaging legitimate transactions. I hope that I have assured the hon. Member for Fareham that the consultation has been well handled, and I commend the amendments to the House.

Mr. Hoban: I thank the Minister for his explanation of these complex and technical changes. He was right to suggest that the consultation process has been thorough and effective. Given that many of the issues on which we have had conflict during the passage of the Bill have been areas on which there has not been proper consultation, that is something on which we can agree. The Minister has taken on board fully the remarks made by tax advisers. On that point, may I put on record my thanks to the advisers who have helped us throughout the passage of the Bill? PricewaterhouseCoopers has helped us to tackle some of the complexities of the Bill, but it was not alone in providing us with guidance, support, suggestions and help.

The Minister is right to clamp down on the problem. I understand that taxpayers are trying to obtain tax relief on both the interest and the principal. The example given in the explanatory notes demonstrates the extent to which people will structure such transactions simply to acquire tax relief on them. The amendments are thus valid. My discussions have shown that the industry is broadly content with them. Things such as finance leases were in the original scope of the draft legislation and the fact that they have been taken out is welcome. There is provision in the legislation that when other genuine commercial transactions could be caught by the changes, there is a mechanism for ensuring that they will fall outside the scope of the anti-avoidance provisions.

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May I ask several questions about repos? The Minister was right to point out that such transactions are ordinarily straightforward. However, the transactions that came to the Government’s attention through the case considered by the special commissioners involved three parties. The original owner sold securities to an interim purchaser, who sold them to someone else, who then sold them back to the original owner—that is quite a complex loop. When considering such transactions, did the Treasury or HMRC do any research to determine whether any valid commercial transactions involved three parties in a tri-party repo arrangement?

I understand that there are frequently occasions on which a third party will act as an agent between the two parties to a repo. Will the Minister confirm whether the use of agents will lead to transactions being classified as tri-party repos and thus fall under the terms of the amendments? Clarification on that would be useful because agents are widely used when such transactions are carried out.

The third issue is assignment and novation of the arrangements. There may be occasions when, for entirely commercial reasons, existing repos are assigned and novated to another party—for example, as part of a corporate reorganisation or a transfer or takeover of business. In those circumstances, since the assignee would not be the party to whom the securities were originally sold, one would not expect that they would be eligible for tax relief in respect of any deemed manufactured dividend or interest. There is some concern that the new rules might capture those transactions inadvertently.

I should be grateful if the Minister responded to those three concerns: has there been any research into the valid commercial use of tri-party repos; will it capture deals where an agent has facilitated the repo; and what will happen where there are assignments and novations as part of an ordinary commercial transaction or corporate reorganisation? Will the Minister clarify those three matters?

Ed Balls: I am happy to clarify those three issues. Having spent some time reflecting on these matters in recent weeks, it is clear that it is a highly complex area and that changes to legislation in respect of market developments over a number of years have led to very considerable complexity. In future, we will look to finding ways to make the legislation more user friendly, without at the same time losing any of the important protections that have been introduced in recent years and in the amendments today.

On the first point, I can confirm that protection of revenue is being put in place without affecting normal transactions in any way. We have been careful to ensure that standard repo contracts will not be affected. We are talking about a particularly contrived form of three-party repo—not the sort of transactions that one stumbles into inadvertently. They exist only where taxpayers are attempting to avoid paying tax by using artificial or contrived arrangements. Standard commercial or two-party repos will not be inadvertently affected by the changes.

The second question was about agency cases. I can confirm that they will not be caught by the changes, as we looked into that particular problem.

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On the third question about novations, I can confirm that our understanding is that they will not be caught in that way. Following the special commissioner’s decision, we decided to act quickly. We do not want to open up a wider problem. As a result of the commissioners decision, the right thing to do was to act in a speedy manner and hopefully in a well thought out manner. I can assure the hon. Gentleman on all of his three points. More generally, because this is a complex area, we will keep it under review and if we can take further action in future Finance Bills to bring greater simplicity while at the same time keeping proper revenue protections in place, we shall certainly do so. For now, I urge hon. Members to support the amendments, which are necessary to protect the taxpayer from the potential loss of hundreds of millions of pounds. They will also help to ensure that the vast majority of people who go about their proper business in the financial markets will not be affected by the problem.

Amendment agreed to.

Amendments made: No. 16, page 185, line 8, at end insert—

‘Multiple holders of securities subject to sale and repurchase agreement: no relief for deemed manufactured payments

3A (1) Section 737A of ICTA (sale and repurchase of securities: deemed manufactured payments) is amended as follows.

(2) In subsection (5) (application of Schedule 23A and dividend manufacturing regulations), after “apply” insert “, subject to subsection (5A) below,”.

(3) After that subsection insert—

“(5A) If the relevant person is not the person to whom the transferor agreed to sell the securities, the relevant person is not entitled, by virtue of anything in Schedule 23A or any provision of dividend manufacturing regulations, or otherwise—

(a) to any deduction in computing profits or gains for the purposes of income tax or corporation tax, or

(b) to any deduction against total income or total profits,

by virtue of subsection (5) above.

Where the relevant person is a company, an amount may not be surrendered by way of group relief if a deduction in respect of it is prohibited by this subsection.”.

(4) In subsection (6) (interpretation), for—

(a) “subsection (5) above”, and

(b) “that subsection”,

substitute “this section”.

(5) The amendments made by this paragraph have effect in relation to securities if—

(a) the agreement to sell them was made on or after 27th June 2006, or

(b) a person other than the person to whom the transferor agreed to sell them became the relevant person in consequence of any other agreement made on or after that date.’.

No. 100, page 185, line, at end insert—

‘Structured finance arrangements: factoring of income receipts etc

3B (1) After section 774 of ICTA (transactions between dealing company and associated company) insert—

774A Meaning of “structured finance arrangement” for purposes of s.774B

(1) For the purposes of section 774B an arrangement is a structured finance arrangement in relation to a person (“the borrower”) if the following condition is met in relation to the borrower.

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(2) The condition is that—

(a) under the arrangement the borrower receives from another person (“the lender”) any money or other asset (“the advance”) in any period,

(b) in accordance with generally accepted accounting practice the accounts of the borrower for that period record a financial liability in respect of the advance,

(c) the borrower, or a person connected with the borrower, makes a disposal of an asset (“the security”) under the arrangement to or for the benefit of the lender or a person connected with the lender,

(d) the lender, or a person connected with the lender, is entitled under the arrangement to payments in respect of the security, and

(e) in accordance with generally accepted accounting practice those payments reduce the amount of the financial liability in respect of the advance recorded in the accounts of the borrower.

(3) For the purposes of this section, in any case where the borrower is a partnership, references to the accounts of the borrower include the accounts of any member of the partnership.

(4) For the purposes of this section and section 774B—

(a) references to a person connected with the borrower do not include the lender, and

(b) references to a person connected with the lender do not include the borrower.

774B Disregard of intended effects of arrangement involving disposals of assets

(1) If—

(a) an arrangement is a structured finance arrangement in relation to a person (“the borrower”), and

(b) the arrangement would (disregarding this section) have had the relevant effect (see subsections (2) and (3)),

the arrangement is not to have that effect.

(2) If the borrower is a person other than a partnership, the relevant effect is that—

(a) an amount of income on which the borrower, or a person connected with the borrower, would otherwise have been charged to tax is not so charged,

(b) an amount which would otherwise have been brought into account in calculating for tax purposes any income of the borrower, or of a person connected with the borrower, is not so brought into account, or

(c) the borrower, or a person connected with the borrower, becomes entitled to an income deduction.

(3) If the borrower is a partnership, the relevant effect is that—

(a) an amount of income on which a member of the partnership would otherwise have been charged to tax is not so charged,

(b) an amount which would otherwise have been brought into account in calculating for tax purposes any income of a member of the partnership is not so brought into account, or

(c) a member of the partnership becomes entitled to an income deduction.

(4) If—

(a) a person in relation to whom the structured finance arrangement would otherwise have had the relevant effect is a person within the charge to income tax, and

(b) in accordance with generally accepted accounting practice the accounts of the person record an amount as a finance charge in respect of the advance,

that person may treat the amount for income tax purposes as interest payable on a loan.

(5) If a person in relation to whom the structured finance arrangement would otherwise have had the relevant effect is a company within the charge to corporation tax—

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