Mr. Hoban: As the Financial Secretary said, the Government have undertaken quite a thorough consultation process on this issue in the past couple of years. As a consequence of that consultation process, there have been a number of changes of tack by the Government on the taxation of foreign profits. I just wanted to explore that issue a little further.
When the Government published their consultation in 2007, they produced a fair summary of the issue that we face when they said:
The current system of taxing foreign dividends and relieving double taxation through crediting foreign tax produces only a modest amount of direct tax yield, but together with the Controlled Foreign Companies (CFC) regime, provides safeguards to ensure that profits from economic activity are properly taxed in the UK.
It is a question of getting that balance right, which provides a link to some of the later thoughts that the Government had. The document went on to say:
The case for change rests largely on supporting large and medium business operating in rapidly growing global markets by simplifying and modernising the current regime.
The challenge that the Government had to face was that a number of multinationals were taking the view that the UK was not a good place for them to be based and they were exploring whether or not they could move to other jurisdictions where there was a better regime for the treatment of foreign dividends.
The consultation process also hit upon the issue of ensuring that profits from economic activity were properly taxed in the UK. That led the Government to consider the issue of a proposed controlled companies regime to avoid the potential mischief of companies seeking to shift income streams offshore, particularly what were described as mobile income streams, which are financing income and royalties. When the Government floated that idea, however, there was a significant outcry from industry about the consequences, certainly about the administrative cost, and it triggered a further wave of concern from companies that look to redomicile overseas. The further concern was about whether the rules that the clause seeks to change led to a sub-optimal allocation of capital in an international groupthat when it was not necessary for an overseas subsidiary to pay a dividend to its UK parent for the purpose of making a dividend, those dividends and that capital would be trapped in an offshore location. There was concern that the Governments rules got in the way of the efficient use of capital in businesses because businesses felt that it would be better to keep profits in a low-tax jurisdiction rather than repatriate them to the UK.
One of the issues that has most exercised the Government, and on which I would be grateful for further clarification from the Minister, is cost. Cost was a feature of the technical note published in July last year by the Ministers predecessor, the right hon. Member for Liverpool, Wavertree (Jane Kennedy), who expressed concern that the potential cost of the dividend exemption would act as a barrier to taking it forward. That technical note, published at the conclusion of our deliberations on the Finance Bill 2008, set out that in 2005-06 £200 million was collected in corporation tax paid on foreign dividends, £100 million was paid on portfolio dividends and £100 million was paid on direct dividends. The assessment was that by 2012 the yield on foreign dividends would be about £300 million. However, the technical note suggested that the tax loss to the Exchequer that could arise from introducing the dividend exemption had a central estimate of about £600 million, within a range of £200 million to £1.1 billion, depending on the behavioural responses. There was a suggestion that the tax take could increase because of the repatriation of cash to the UK, which would then be used to reduce indebtedness. The Government were sceptical that that was an issue, and felt that there were ways in which companies could repatriate those profits without incurring a corporation tax charge.
Cost was clearly a barrier at that point, but it no longer appears to be a barrier to the Governments changes. The impact assessment published after last years pre-Budget report suggested that the package of
As I mentioned earlier, the proposals set out in 2007 looked at a move to an income-based regime, to ensure that businesses did not use the opportunity of the dividend exemption to restructure their operations and move various sources of income overseas for tax purposes, rather than as a consequence of how their businesses operated. That led to a significant outcry from businesses. Deloitte stated that
in our view, this could significantly detract from the UKs competitiveness, both from a financial and an administrative point of view, and could dissuade companies from locating holding companies here.
Ernst and Young commented on the potential compliance burden that would arise from that, stating that the proposals would
neither improve clarity and transparency, nor make the rules more certain and straightforward in applicationthey are in fact a significant move in the opposite direction.
The outcry prompted the Government to move, as there was a big concern that moving from an entity-based stream to an income-based stream would require businesses to rework the basis on which they submit information to the Treasury. Companies currently account on an entity basis and so would have to revisit how they structure their reporting to deal with it on an income basis. Clearly, the concern that businesses will seek to move certain income streams offshore to lower-tax jurisdictions still exists, as there might be a particular incentive in relation, for example, to intellectual property rights or to finance income. Is the Minister content that the anti-avoidance measures in schedule 14 are sufficient to tackle those issues relating to mobile income streams, or is that still a potential gap that will need to be addressed later?
Another point I want to raise relates to the structure of the exemption and the way in which it is given. Schedule 14 starts with the premise, as set out in proposed new section 930A, that all distributions received will be subject to tax. The existing legislation is framed differently: the assumption is that all distributions received in relation to UK shares are not taxed, but those in relation to overseas shares are taxed. We have now moved to a basis on which all dividends and distributions are taxed unless there is an exemption. Could the Minister explain why that change has been made? It has been suggested to me that, given the increased importance of the European Union in matters of direct taxation, because of issues relating to the freedom to establish and freedom of movement, that means it is difficult to distinguish the dividends and distributions of UK companies from those of non-UK companies.
Therefore, we have made the regime more challenging for UK companies than it was before, and I shall be grateful if the Minister can provide some clarification on that. Will that change, which we will debate in greater detail when we come to schedule 14, increase the compliance cost to UK business as a consequence? There is a concern about how the legislation has been structured, so it would be helpful if the Minister would explain why that move from a distinction between UK and non-UK distributions has been changed, because I think that that will have a knock-on effect, as we will debate later.
We are broadly content with the concept to which the Government have moved: that there should be a dividend exemption for foreign dividends. I think that that will help to address the issues of competitiveness that the UK faces as a location for holding companies. It has taken a long time to get thattwo yearsand at one stage last year I thought we might never see it. It is good that the exemption will make it on to the statute book, but an understanding of how the Governments objections on the grounds of cost have been overcome would be helpful.
Mr. Timms: I am grateful to both Opposition spokesmen for their support for the principle of what we are doing and the approach we have taken. Consultation has been broad, and as the hon. Member for Fareham pointed out, the proposals have been substantially modified in the light of our discussions. As we go through this part of the Bill there will be several technical discussions on the details, which will be important, but I am glad that the principle has been so strongly supported. The hon. Member for Southport was right to highlight the importance of our ability to continue to bear down on avoidance, and we will debate the issue later.
The hon. Member for Fareham asked about the costs involved. He is right to say that our initial intention was to make the change in a fiscally neutral way. As he indicated, there is a degree of uncertainty about precisely how companies will react to the changed framework introduced by the clause, so one cannot be too definitive about exactly what the fiscal impacts will be. However, as discussions have developed and as we have listened to the concerns that have been raised, we have relaxed the requirement that the change should be fiscally neutral. Consequently, while the initial intention was for the package to be revenue-neutral, it now has a cost.
On next years expectation, dividend exemption will lead to a tax reduction of £500 million and we expect that to be offset by £200 million from the impact of the debt cap, which we will discuss in relation to the changes to the controlled foreign companies rules in clause 36. We also expect a loss of revenue of £50 million as a result of the abolition of the Treasury consents rule. All of those changes mean that we expect an overall loss of revenue of £150 million, which will grow as time goes by and companies increasingly reorganise their activities in the light of the changes.
The big difference is that, whereas we initially envisaged the debt cap as centring on a companys net debt, it now centres on gross debt. That is the big change both in the structure of our proposals and in the fiscal impact.
Mr. Hoban: The right hon. Gentleman says he expects the cost of the package to increase over time. I assume that there will be a tax loss as companies restructure
Mr. Timms: I am not sure whether the hon. Gentleman is thinking about a particular kind of change, but I am certain that, with a substantial change of this kind, companies will want to look at potential opportunities for them to change the way in which they organise themselves in order to take advantage of the provision. That is perfectly appropriate. He was right to raise concerns about potential avoidance opportunities and we will debate a general anti-avoidance rule later in relation to a Government amendment. We certainly need to keep a close eye on avoidance activity, but in response to an earlier question of his, I believe that the measures under consideration will do the job.
The hon. Gentleman asked why some UK to UK dividends will be taxed for the first time. We need to provide equality of treatment for UK and non-UK dividends, as the previous inequality was not appropriate. In fact, the impact of the proposals on UK dividends will be pretty minor. We need to be certain that there is no risk of a challenge under EU law, because challenges of that kind lead to damaging uncertainty that is in nobodys interest. The legislations structure gives us a helpful guarantee on that front.
Question put and agreed to.
Clause 34 accordingly ordered to stand part of the Bill.
Corporation tax treatment of company distributions
other than in the case of a distribution within the meaning of section 209(2) of ICTA..
The Chairman: With this it will be convenient to discuss the following: Government amendments 92, 93 and 99.
Amendment 48, in schedule 14, page 140, line 36, leave out is in and insert
was in the accounting period ending immediately before.
Government amendments 101 and 102.
Mr. Hoban: I shall speak to amendment 43 first. This touches on a point I raised in the clause stand part debate about the treatment of UK to UK dividends. Under existing rules all distributions from UK companies are non-taxable, but new section 930A presumes that they are taxable unless they are exempt. The Minister acknowledged that it was the threat of challenge under EU rules that gave rise to that equality of treatment between UK and non-UK distributions. That is a topic that I will come back to under the next clause as well.
Having established that all distributions are taxable, there is then a series of exemptions from that tax. If an exemption is met, no tax is payable on those dividends.
The issue stems from the exclusion, in new section 930A(2), of a distribution of a capital nature. The feedback I have received is that the principles for that exclusion are relatively untested. To determine whether a distribution is of a capital nature, they would have to be tested against some very unclear case law. There are certainly some cases where distributions that were previously exempt will no longer be so under the new provisions and that will increase uncertainty in some fairly common transactions. Amendment 43 says that all distributions currently falling under section 209 of the Income and Corporation Taxes Act 1988 should continue to be exempt, so that there is a continuity of treatment between the old regime and the current regime.
Amendment 48, which I have also tabled in this group, deals with a small companies exemption. Schedule 14 provides for two regimes: one for small companies and one for medium and large companies. Schedule 14 provides a definition of a small company in new section 930R. However, it creates a degree of uncertainty as to whether a small company is a small company in the year of the dividend accounting period. My amendment seeks to create some certainty by referring back to the accounts of the previous accounting period to determine whether a small company is a small company. Rather than the uncertainty of new section 930R inserted by the schedule, which looks at the current accounting period, amendment 48 refers to the previous accounting period to give the taxpayer greater certainty.
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