Mr. Bone: I do not know whether that was a slip of the tongue in the Ministers last sentence or so. She linked EU officials and MEPs, as though the clause applied to both. I thought that it applied only to MEPs. There are a couple of issues. How have the tax affairs of officials who are resident in the UK been treated? Have they been paying Community tax and British tax, or just Community tax? What was the loss of revenue to the UK Exchequer due to the double taxation relief mentioned in the clause?
Kitty Ussher: The clause applies only to MEPs. The tax applies to EU officials and MEPs. As I have tried to explainI apologise if I was not clearif there are such categories of people who are working in the UK, they will normally pay UK tax. However, I obviously cannot comment on every individual case.
Mr. Hands: The question remains as to which part of the EU does the tax-raising and where that money goes. I understand that payments will be made by the European Parliament. Presumably the European Parliament is not a taxing authority, so where do the moneys go?
Kitty Ussher: I presumeI shall correct myself if this is not the casethat under European Community treaties there is a small provision to do that, precisely in the circumstances mentioned.
As I promised, I shall also write to the Committee with the net position of the Exchequer as a result of the changes introduced by the new MEPs agreed statute, and shall add into that the effect of the clause. I am sure that I have answered more than eight questions, and I therefore now commend the clause to the Committee.
Question put and agreed to.
Clause 56 accordingly ordered to stand part of the Bill.
Tax underlying dividends
The Financial Secretary to the Treasury (Mr. Stephen Timms): I beg to move amendment 206, in clause 57, page 27, line 27, leave out subsection (2).
The Chairman: It might be convenient for the Committee to treat this as one debate on a technical matter, rather than to debate the amendment and then clause stand part.
After the giddy heights of political drama in our debate on clause 56, we reach a substantial set of clauses that aimed mainly at scams of various kinds
The clause changes how the amount of double taxation relief available to UK companies is calculated. Subject to certain criteria, UK companies in receipt of dividends paid from abroad are entitled to relief for tax charged on the original profits out of which the dividends have been paid; that is relieved against the UK corporation tax due on receipt of those profits. The recent reduction in the corporation tax rate caused a mismatch in how the relief is calculated. The clause corrects that by ensuring that the amount of relief available to UK companies is calculated by reference to the actual rate of corporation tax suffered on their UK profits.
An HMRC review of the clause found that subsection (2), which restricts the change to corporation tax cases, simply restates a restriction already contained in the Finance Act 2000, which first introduced the relevant legislation. The amendment removes the unnecessary duplication, which would otherwise have created some uncertainty and could have given rise to tax avoidance opportunities. I hope that the Committee is satisfied with the amendment.
The problem addressed by the clause was recognised last year, on Third Reading of the 2008 Finance Bill. My predecessor as Financial Secretary committed to rectifying the problem, after consulting with interested parties. HMRC has discussed the draft clause with business representatives, and the simple solution provided by the clause ensures that credit is given in line with my predecessors commitment.
The clause is retrospective and applies from 1 April 2008. The retrospective action is such that it can only apply to the benefit of companies by increasing the amount of foreign tax credit available. The clause is likely to have limited application after 1 July this year, because of the introduction of legislation that exempts from UK tax almost all foreign dividends, which we have already debated.
Mr. Hands: We agree with the Governments amendment. I will talk mainly about the general issues that arise from the clause.
The clause is a result of the changes enacted in the Finance Act 2008 that changed the corporation tax rate in the middle of a companys accounting year, and the unforeseen consequences of that. As the Financial Secretary has said, the clause deals with foreign source dividends, which are subject to corporation tax at the effective rate applicable for the accounting period in which they were received. Companies with accounting periods straddling 1 April 2008 have an effective corporation tax rate between 30 and 28 per cent.29.5 per cent., for exampledepending on how much of the tax year is in the relevant accounting year. However, the double tax relief mixer cap formula, which limits the amount of credit relief available for foreign dividends, operates by reference to the statutory rate of corporation tax in force on the payment dateeither 30 or 28 per cent. in that particular tax year, but not a combination of the two. That potentially results in an unintended restriction on the amount of double tax relief that might be available.
HMRC first acknowledged that mismatch in September 2007 and confirmed in July 2008 that the rules would be amended with retrospective effect from 1 April 2008, as
Foreign dividends are chargeable to UK corporation tax and in calculating the relevant income one has to show the dividend gross of all taxes suffered. Dividends received may have also suffered withholding tax. Withholding tax is always recoverable, subject to the limits for credit relief. However, in addition, as dividends are paid out of post-tax profits, the dividend will also have suffered what is called underlying tax. A credit for underlying tax can be claimed only when a company holds, directly or indirectly, 10 per cent. of the voting power of the company paying the dividend, or is a subsidiary of such a company.
The underlying tax, which is referred to as U in the legislation, is initially calculated by using the following formula: (dividend paid divided by relevant profits) multiplied by actual tax paid. The relevant profits are the profits of any period shown as available for distribution in the company accounts; they are not taxable profits. The underlying tax available for relief is found by using the formula: (D + U) x M, where D is the dividendthe amount received plus withholding tax; U is the underlying tax; and M is the relevant rate of UK corporation tax at that time, which is 28 per cent. The (D + U) x 28 per cent. formula is referred to as the mixer cap.
The clause has been welcomed by tax commentators, but I have one immediate question and one that is more fundamental. First, it is not entirely clear to me why subsection (5) is to take effect immediately, while all the other subsections are backdated to 1 April 2008. I thought the whole provision was supposed to be backdated to 1 April 2008. Perhaps I am just misreading the clause.
There is another important and technical question. The clause and everything that the Minister and I have mentioned so far refers to dividends, by which I assume that we mean dividends on all financial instruments, not just equities. If it were to refer to coupons or the interest rate payable on bonds or other fixed income instruments, an important consideration may arise on the precise day count used in those fixed rate instruments. For example, in this country the day count convention used is actual over 365 fixed, whereas in Japan it is actual over 365, and most eurobonds are denominated on a 30 over 360 basis.
When calculating the relevant corporation tax using the blended rate, what consideration will need to be given to the accounting method of the couponor, in this case, what the clause calls a dividend but is effectively a fixed income couponand the different day count conventions that may be involved in those coupons? What effect might that have on the blended mixer cap rate? As I said, we broadly welcome the clause and I await the Ministers response to those two questions.
Dr. Pugh: I rise to agree with the Minister that we have come to an important and surprisingly interesting set of clauses. A bit like the dull books of the Bible,
I seek clarification on a simple point. I understand that the clause is about the interaction of something called the mixer capa terms I had only associated with bathroom showersand corporation tax. Essentially it deals with the unintended consequences of lowering corporation tax in 2008. The clause is meant to have retrospective effect. The explanatory notes make it clear that a concerted effort has been made to limit any potential disadvantages, and I thought I heard the Minister say that the effect of the clause was wholly to the benefit of companiesthat nobody is disadvantaged by the original change in corporation tax. Can the right hon. Gentleman confirm that? If he cannot, can he tell us who was disadvantaged and who is still disadvantaged?
Mr. Timms: I welcome the support that has been expressed for the clause and the fact that it has commended itself to the Committee. The change to the rate of corporation tax took effect from 1 April 2008, so it is right that the change takes effect from that date as well. The hon. Member for Hammersmith and Fulham asked me why subsection (5) is not retrospective. In very rare situations subsection (5) can have a negative impact on business and that is why we are not applying it retrospectively. Nevertheless, I can confirm for the hon. Member for Southport my previous comments about the overall benefit for business from the change that we are making.
The circumstances where there could be an increased burden for companies are rare. There could be an increased burden for some companies, but only where dividends paid between foreign companies were paid before the change in the corporation tax rate. The subsequent case 5 dividend is paid after 5 April 2009 and is not exempt. Given the introduction of the dividend exemption with effect from 1 July 2009, that would occur only in very rare situations. Indeed, that aspect of the legislation is not retrospective so as to ensure that there is not an unfair negative retrospective impact on business.
Dr. Pugh: I understand the Ministers point that the provision is entirely for the benefit of business and will in no way disadvantage business. My question is simply this: as a result of the decision to alter corporation tax in 2008 and the difficulty that has occurred with the mixer cap, is it now the case that no one has lost out at all?
Mr. Timms: Yes, it is. There will, no doubt, need to be some adjustments in the light of the clause, but I can give the hon. Gentleman that reassurance.
The hon. Member for Hammersmith and Fulham asked about some detailed aspects of the profit calculations. There are two steps involved: calculation of profit and taxation of profit. The blended rate applies to all profits, however calculated, and there is no need to consider the precise details of the calculation when considering the relevant tax rate.
Mr. Hands: To press the Financial Secretary a little on that point, can he be absolutely clear that the clause also relates to bond coupons and payments on fixed income instruments? It is surely the case that, if the accounting basis of the bond and the day count convention is different, calculating the mixed rate, where one looks at the actual number of days over 365, times each of the relevant corporation tax rates, will in turn depend on whether the coupon rate, for example, has changed during that time. If there is a step-up bond, and if the coupon rate has changed during that time, surely the corporation tax calculation would have to be aligned in accordance with the way in which the bond is paid.
Mr. Timms: The clause is about correcting an unintended hit to double taxation relief and it is effective, whichever way the profit is achieved. The clause is not specific to one particular form of profit.
Amendment 206 agreed to.
Clause 57, as amended, ordered to stand part of the Bill.
Manufactured overseas dividends
Question proposed, That the clause stand part of the Bill.
Mr. Hands: Clauses 58 to 64 relate to anti-avoidance and we broadly support them. Since the Finance Act 2008, various attempts have been made to eliminate so-called MODs, which are manufactured overseas dividends, not the 1960s bikers seen in films such as Quadrophenia. Clause 58 and schedule 29 refer to repurchase agreements, or repos. The essence of the clause is that tax credit is being given for deemed payments on repos, rather than for actual payments, and the clause seeks to ensure that tax credit is only given for actual payments.
I might be the only member of the Committee who has ever carried out a repo, or repurchase transaction, so, seeing as that is the subject of schedule 29, it may be helpful if I explain what it is. An explanation will not necessarily help, however, because even though I might have an advantage in understanding the sorts of financial instrument behind clause 58 and schedule 29, that knowledge does not give much assistance in understanding the technical nature of the clause and schedule.
A repo allows a borrower to use a financial securityan equity, a bond or pretty much any financial instrumentas collateral for a cash loan at a fixed rate of interest. In a repo, the borrower agrees to sell immediately a security to a lender and also agrees to buy back the same security from the lender at a fixed rate at some later date. A repo is therefore equivalent to a cash transaction combined with a forward contract; it is a little bit like a foreign exchange, or forex, swap, where the price of the trade-back is a function of the relevant interest rate for that period. The cash transaction results in a transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between
A repo is therefore economically similar to a secured loan, with the buyer receiving securities, or a security, as collateral to protect against default. There is little that prevents any security from being employed in a repo: for example, probably one of the most frequently repod instruments would be a gilt, or a US treasury bond. Corporate bonds can be repod, as well as stocks and shares. The relevance to clause 58 is this: coupons or dividends, which are paid while the repo buyer owns the securities, are, in fact, usually passed directly onto the repo seller. It might seem counter-intuitive that the ownership of the collateral technically rests with the buyer during the repo agreement; however, that is whereI am guessing from the clausethat the problems arise in relation to the avoidance of tax, or more specifically, the creation of a manufactured overseas dividend.
As I understand it, HMRC has become aware of complicated schemes involving intra-group sale and repurchase agreements undertaken by bank groupsthat is, within two parts of the same banking familywhich are intended to produce a perceived tax advantage. As a result of the structure of the transaction and the prescriptive nature of the UK rules relating to manufactured overseas dividends, one party to the transaction is deemed for UK tax purposes to receive a MOD. In addition, that deemed MOD is treated as having been subject to deduction of foreign withholding tax and the recipient of the MOD is entitled to relief for that foreign tax. However, since the receipt is deemed an MOD rather than an actual payment, there is no actual deduction of foreign tax from any amount actually received by the recipient. Therefore, as I understand it, HMRCs viewI would be grateful if the Minister confirmed this explanationis that the recipient does not actually bear the economic cost of the foreign tax, despite the fact that it is entitled to relief for that tax.
That is the technical explanation I have been given, but it seems to me that certain foreign securities have been repod solely or mainly for the purpose of creating a credit or a debit against foreign tax paid or received, typically within the same banking group. The purpose of the clause, as I understand it, is to prevent that practice.
I am also puzzled by the fact that the clause, according to the explanatory notes, relates to repos that would normally relate in terms to fixed income instruments, or bonds. My understanding is that most of the MODs are actually created from equities, so I would be grateful for more explanation of what sort of underlying repo transaction we are considering that has been used in the pursuit of avoiding UK tax.
It would also seem sensible, if we are looking at repo agreements, to examine their stablemate, the buy-sell agreement, or the buy-sellback agreement. Those differ slightly from repos in that, with the sell-buyback agreement, any coupon payment on the underlying security during the life of the sell-buyback agreement will generally be passed back to the seller of the security by adjusting the cash paid at the termination of the sell-buyback agreement. In a repo, the coupon will be passed on immediately to the seller of the security. My guess, thereforeand I would be grateful in the Minister could confirm itis
The Bill counters that type of transaction by preventing relief for foreign tax, either by credit or deduction, when the recipient of a manufactured overseas dividend does not bear the economic cost of the foreign tax. In other words, relief for overseas tax in excess of the amount borne cannot be claimed. The legislation, as I read it, takes effect for dividends paid on or after 22 April 2009. We will have no problem supporting the clause if the Minister is able to confirm that my understanding of the situation is correct, that the clause covers equities as well as fixed income, and that sell-buybacks and buy-sellbacks are accounted for on the same basis and we do not need to be troubled by whether they might be used for the manufacture of overseas dividends in the future.
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