Finance Bill

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Mr. Timms: Schedule 14 provides the new exemption, which we have been discussing, from corporation tax for dividends and other distributions from foreign companies. It amends the rules on taxation of distributions received from UK companies. The exemption will remove the need for groups to make complex double tax relief calculations and will allow profits to be repatriated, even in circumstances in which there would not have been enough double tax relief to eliminate a UK tax liability. Until now, when there was insufficient credit for foreign tax, overseas profits would typically stay offshore, with cash possibly being returned in the form of an upstream loan. Alternatively, groups might have adopted complicated, artificial ways of repatriating such profits other than through a dividend. Exemption will sweep all that away and allow for immediate repatriation of profits and the return of cash by dividend. That will enhance the attractiveness of the UK as a location for the headquarters of multinational businesses.
The rules will apply to distributions received by all companies in the UK, including small companies, which was not part of the original proposal. The rules for small companies are distinct from the rules for medium and large companies, but, in each case, the vast majority of all dividends and other distributions will benefit from the exemption. That protection, alongside that contained in clause 40 and schedule 19, which deal with personal dividend taxation, are a proportionate response to the risk of abuse of the exemption by small companies—the protection set out in the schedule. However, we will keep a close eye on the matter and take immediate action if any avoidance activity is identified.
The hon. Member for Fareham moved amendment 43 on capital distribution. Schedule 14 applies only to distributions of an income nature. The amendment would increase its scope so that it applied to most capital distributions as well. However, schedule 14 is concerned only with the taxation of distributions that represent income. Nothing in the schedule will cause any capital distribution that is currently exempt to become taxable, so there is no reason to extend the scope of the exemption as suggested. The legislation does nothing to alter the taxation of capital distributions that are excluded from the scope of proposed new part 9A of the Corporation Tax Act 2009. There is already an exemption for capital distributions, known as the substantial shareholdings exemption. It is not part of this Bill to change in any way the scope of that exemption, so I hope that he will accept that the amendment is not appropriate.
As the hon. Gentleman explained, amendment 48 would alter the definition of a small company. However, in doing so, it would change the standard definition used to determine whether exemption follows the small company rules or the rules applicable to larger companies. The legislation uses the standard European Commission definition of a small company, which includes a time lag whereby a company that changes from small to medium sized retains the status of “small” in the transition year but becomes a medium company the following year. A similar rule applies if a company moves down in size from medium to small. The amendment would delay the change of status by a further full year. That would be an additional complication and make it less likely that the appropriate legislation for that size of company was applied. I hope the hon. Gentleman will accept that that is an unhelpful additional complication.
Several Government amendments in this group are concerned with a rule that denies exemption if a foreign tax deduction is given for the distribution, on the basis that a distribution that is tax deductible represents a deduction from taxable profits rather than distribution of those profits. Therefore, it is closer to an interest receipt than a distribution and would be expected to give rise to a taxable receipt for the recipient. The rule denying exemption is extended to cases where amounts determined by reference to a distribution are tax deductible. That ensures that the rule cannot be side-stepped by the use of indirect tax deductions obtained through avoidance schemes. The change will also enable some simplification of the manufactured dividend rules, which no longer require a specific exception. I therefore recommend that Government amendments 92, 93, 99,101 and 102 to schedule 14 be accepted. I hope that the hon. Gentleman will not press amendments 43 and 48.
Mr. Hoban: I am grateful to the Minister for his comments, particularly on amendment 48 and the transitional year which dealt with the issue that I was seeking to tease out. I have a residual concern about amendment 43. My understanding is that certain distributions that would have been untaxed under the existing rules, because of the UK to UK rules, are taxable now. I will go back and think carefully about whether any issues ought to be drawn to the Minister’s attention and be the subject of further debate on Report. I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
Amendments made: 92, in schedule 14, page 134, line 1, leave out
‘any amount determined by reference to’.
93, in schedule 14, page 135, line 17, leave out
‘any amount determined by reference to’.—(Mr. Timms.)
Mr. Hoban: I beg to move amendment 44, in schedule 14, page 135, line 32, leave out ‘subsection 6(c) and (d)’ and insert
‘the words “is resident in the United Kingdom and” after “person who” in each of paragraphs (c) and (d) of subsection (6)’.
The Chairman: With this it will be convenient to discuss the following: amendment 45, in schedule 14, page 135, line 36, leave out from ‘of’ to end of line 38 and insert ‘an ordinary share.’.
Amendment 170, in schedule 14, page 136, line 19, after ‘dividend’, insert ‘or other distribution’.
Amendment 49, in schedule 14, page 141, leave out lines 29 to 34.
Mr. Hoban: The amendments cover several issues. Amendment 44 deals with the exemptions in proposed new section 930E—“Distributions from controlled companies”. I am concerned that in introducing this measure the Government have omitted some of the existing tests for controlled companies. It refers to holdings which, for a variety of reasons, may be split between various groups of companies but in aggregate mean that the company has control.
The existing tests read:
“(c) if the person is resident in the United Kingdom, rights and powers of any person who is resident in the United Kingdom and connected with the person; and
(d) if the person is resident in the United Kingdom, rights and powers which for the purposes of subsection (5) above would be attributed to a person who is resident in the United Kingdom and connected with the person (a ‘UK connected person’) if the UK connected person were himself the person.”
The situation here is that the ownership of subsidiaries may be split so that neither of the owners have control within the basic provisions of controlled foreign companies legislation, but taken together they would have control. If we do not replicate this in subsections 6(c) and (d), those dividends would fall outside the exemption and would therefore be taxable. It is not clear why the change has taken place. The explanatory notes suggest that the definitions replicate the CFC rules, but this exclusion for indirect ownerships suggests that that is not the case. The amendments try to address that by enabling shareholdings held through non-resident affiliates to be aggregated together.
Amendment 170 is a drafting amendment that seeks alignment: subsection (1) of proposed new section 930H refers to a dividend only, whereas subsection (1) of proposed new section 930G refers to a “dividend or other distribution”. Assuming that there is no reason for this difference, the amendment would simply correct a drafting error.
Dr. Pugh: I wish to speak against amendment 44. I understand that it replaces reference to Income and Corporation Taxes Act 1988 provisions with the words,
“is resident in the United Kingdom”
and “person who”. This is undesirable because the vagueness of UK residency requirements can lead to individuals exploiting distributions from controlled foreign companies and achieving tax advantages. The legislation is best left as it stands. I understand that there are difficulties at the moment in equating certain well-known Tory donors’ residency with their tax situation, and bringing residency into this is unsatisfactory.
Mr. Timms: Chapter 3 of the schedule introduces a set of exempt classes, and the amendments in this group, as we have heard, all act to increase the scope of the exempt classes in various ways. The idea of the exempt classes is to give exemption in circumstances where the risk of avoidance is low. The benefit is that the anti-avoidance rules can be targeted at narrow situations rather than being of general application. That is a significant benefit and I am cautious about extending exempt classes because of the risk of losing some of that benefit.
Amendment 44 would increase the scope of the exempt class for controlled companies in a way that would allow a distribution to fall within an exempt class even if the payer of the distribution was not within the scope of the CFC legislation. That exempt class gives exemption to more than 90 per cent. of dividends by value. It takes a simple and direct route to exemption for controlled companies, which is possible because the CFC rules protect against artificial diversion of profits. The protection reduces the risk that this exempt class might be abused by avoidance schemes and allows it to be free of any other conditions for exemption.
The effect of the amendment would be to allow the rights and powers of a connected foreign company to be taken into account in determining whether the payer of a distribution is a controlled company. Therefore, a distribution paid by a company controlled outside the UK—and therefore outside the scope of CFC defences—could be brought within this exempt class, so there is a potential danger of an unacceptable fiscal risk. The attribution was limited to UK companies, and that brought the risk of another EU legal challenge. The extension of that to all companies would have brought unacceptable risks and hence we removed it altogether.
12 noon
Mr. Hoban: Is the Minister certain that a significant risk is attached? I understand that the rules were in place under the existing regime. They allowed non-UK affiliates to be taken into account in determining whether the basic control rules were met. We seem to have shifted away from that. I am concerned that the Minister is taking a potential threat and using it in support of the changes, rather than recognising that the rules currently permit that aggregation to assess whether control has been in place. He has not justified as robustly as we would expect why we should move away from that position.
Mr. Timms: What I understand the hon. Gentleman to be asking is whether there is a real risk of EU challenge from the arrangement as it was. We have been very careful throughout the exercise to ensure that we are absolutely secure from any challenge under EU law, because such a challenge would create uncertainty which would be in nobody’s interest. I am not aware of anyone proposing to mount a challenge, but the way in which we have arranged this now means that we can be absolutely certain that there will not be a challenge. That is an important bolstering of the confidence with which people will be able to operate once the arrangements are in place, and is a worthwhile protection against challenge.
Amendments 45 and 49 would remove one of the two conditions required for exemption in the second class, which applies to distributions paid on non-redeemable ordinary shares. This class is relevant where the first class is unavailable because the CFC rules do not apply. An ordinary share is one that carries no preferential rights. The reason for the restriction is that in the absence of CFC defences, preferential rights attached to shares may be used to allow distribution exemption to be used to convert what would otherwise be taxable profits into exempt dividends. We need that when ordinary shares are not redeemable, since the right to redeem share capital might otherwise be used to provide an alternative form of preference for the shareholders, and we think that that would represent an unacceptable fiscal risk.
I should remind the Committee that a dividend that does not fall into the exempt class can still qualify for exemption. A dividend will always be exempt if it is not derived from transactions designed to reduce UK tax. That is the effect of the later part of chapter 3. The exempt class provides a simple route to exemption for many dividends, but it is not the only route—there is also a fall-back. I suggest that the amendments are not necessary and would create a significant avoidance risk.
Finally, turning to amendment 170, I should say again that there is a fall-back exempt class that ensures that dividends paid in wholly commercial circumstances are always exempt. The exempt class is based on a test of the profits out of which a dividend is paid. Exemption is given, provided that the profits do not derive from transactions designed to reduce UK tax. A dividend is necessarily paid out of profits, but the same cannot be said for other types of distribution. Since the class is a test of profits and not directly a test of the distribution, it is limited to dividends.
I am satisfied that amendment 170 is not necessary to enable all commercially derived profits to be repatriated in a tax-free form, which is our aim. The extension to non-dividend distribution would create risks because of the lack of a necessary link between the distribution and the profits. I hope that on that basis the hon. Gentleman feels able to withdraw the amendment.
Mr. Hoban: The areas that we are seeking to legislate on are obviously complex. The Financial Secretary has said that there are fall-backs that would allow distributions to be exempt in particular circumstances. It would have been helpful, where possible, to have drawn together on that. I do not understand why he objects to amendment 170; if a distribution is not designed to reduce tax, why is that not part of the clause? There is a danger that the dividing line that the Minister is seeking to draw between what should and should not be exempt will become quite complex.
The Financial Secretary is yet to give a robust explanation for why it is not appropriate, in relation to amendment 44 for example, to repeat the foreign affiliates rules in the existing CFC legislation, but we will not dwell on that. Part of the challenge with schedules 14 and 15 is that they have been heavily amended in the past few days, and I think that people need more time to think through some of the consequences. I am sure that that will be one of the themes that will emerge in later consideration. We are in danger of giving outside bodies insufficient time to think about the consequences of those changes and the knock-on effects. Having said that, I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
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