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Dr. Pugh: I thank the hon. Gentleman for that useful lesson. I shall now test my understanding of this fairly complex schedule and clause.
As I understand it, it is intended that manufactured overseas dividends will qualify for exemptions from double taxation, as real dividends do. Manufactured overseas dividends are characteristics, as the hon. Gentleman has said, of repo deals. I believe that the scam to be targeted involves one might call an illusory repo deal between two companies in the same group—phantom dividends, an allowance for foreign tax liability but no actual foreign tax liability. If I am correct that that is what the Minister wishes to target, my only question is: how prevalent is the scam and what are the savings to the Exchequer in closing that loophole?
Mr. Timms: I am grateful to both the Opposition spokesmen for their support.
The clause and schedule 29 counter a complex tax avoidance scheme whereby the recipient of a manufactured overseas dividend claims relief for overseas tax that he has not paid, as the hon. Member for Southport described. The description of what is going on given by the hon. Member for Hammersmith and Fulham is broadly correct. The manufactured payments arise under repo or stock-lending transactions. They are payments that are representative of interest or dividends paid on securities such as gilts or shares, and are intended to compensate the transferor of the securities for not receiving the real interest or dividends.
Nearly all manufactured payments are made by companies under routine transactions involving banks, securities houses and insurance companies. Earlier this year, we became aware of a complex tax-driven scheme involving the sale and repurchase of a foreign shareholding between two group companies. Part of the repo agreement involves what is, in substance, an obligation to pay a manufactured overseas dividend, which does not bear any overseas tax and is equal in amount to the gross overseas dividend. Despite that, the recipient claims relief as if overseas tax had been deducted. That is the heart of the scam.
The hon. Member for Southport asked about the potential losses from the scheme. Our assessment is that more than £150 million per year would be at risk if the measure was not put in place. Tax avoidance is unfair to the majority of taxpayers. It can undermine the funding of public services, and we are determined to take appropriate and prompt action to counter it. The set of clauses before us contain a number of instances of such action being taken.
The hon. Member for Hammersmith and Fulham asked about the extent to which the measure is applicable in slightly wider circumstances. Other non-avoidance legislation deals with transactions other than repos, but repos cover sale and buyback transactions, and the legislation will apply to those. Only dividend repo transactions are affected by the avoidance legislation in the clause and schedule, because only dividends can give rise to double taxation relief. I therefore commend the clause and the schedule to the Committee.
Question put and agreed to.
Clause 58 accordingly ordered to stand part of the Bill.
Schedule 29 agreed to.

Clause 59

Payments by reference to foreign tax etc
Question proposed, That the clause stand part of the Bill.
Mr. Timms: The clause contains a provision to counter an avoidance scheme that abuses the double taxation relief rules. The provision will not bring in substantive additional corporation tax, but it is estimated that it will prevent losses to the Exchequer that would be up to £100 million a year if the abuse continued unchecked. The double taxation relief rules are designed to give relief in the UK for foreign tax paid on the same income or profits charged to UK tax. If any of that foreign tax is reduced, UK tax should be reduced by the same amount.
HMRC has become aware that in some circumstances it is possible for a UK parent company to obtain a payment by reference to the foreign tax paid by a subsidiary company. The payment is made when the subsidiary pays a dividend, so the parent company receives the profits with little or no foreign tax suffered. That has been exploited by groups in an avoidance scheme that seeks to obtain relief for foreign tax where the group has not borne the economic cost of that tax.
It is a long-standing principle that if foreign tax is repaid, credit for foreign tax should be reduced by the amount of the repayment. The clause ensures that the same reduction in credit occurs if the payment, by reference to the foreign tax, is made not only to the company that originally paid the tax, but to a different person connected with that company. Typically, that will be the parent company. However, it has been brought to our attention following the publication of the Bill that the clause may affect the operation of commercial cross-border loan arrangements arising from the London loan market.
The Government amendments would have provided that the clause applied only to payments made under the laws of a territory outside the UK. Opposition amendment 217 addresses the same point differently and perfectly appropriately, although not, technically, in the correct way. The Government amendments reflected agreement that HMRC reached with industry legal advisers and had the advantage of following existing legal precedent that applies for the purposes of controlled foreign company legislation. The Government amendments would have covered the overwhelming majority of cases where refund of foreign tax might arise from commercial contracts. However, since formulating the Government amendments, we have received further representations—I am grateful to the Chartered Institute of Taxation for those—which show that there may remain situations where the amendments do not go far enough to ensure that the clause does not hit any unintended targets. Although these are unusual circumstances, it is right that we should take account of them.
The Opposition amendment would restrict the operation of the clause across a wider range of circumstances than the Government amendments because it limits the clause to those cases where the repayment is made by the foreign tax authority only. By contrast, the Government amendments would have left the clause in operation whenever the repayment arose out of the application of foreign law. In view of the further representations that we have received, I accept that the Government amendments would not have gone far enough in restricting the scope of the clause. Therefore, I have not moved the Government amendments. I will reconsider the position and return to the matter with further Government amendments on Report.
The Opposition amendment is broader in scope but has some technical difficulties. The reference to a taxing authority would be novel in tax law and its effect is not altogether clear. Although I am grateful to hon. Members for tabling it, there needs to be further reflection in order to get this right on Report.
Mr. Hands: I reiterate that we broadly support clause 59. As the Minister said, it targets a specific avoidance scheme. In essence, as I understand it, this relates to where the UK gives credit for tax paid elsewhere but where separate relief has already been granted to a connected party. The Minister used the term “group” and I would be interested to hear from him what sort of groups he means. Would they typically be financial institutions, as with the last clause, or would another type of corporate structure be involved in this sort of scheme?
Currently, a UK company which has claimed double tax relief in respect of foreign tax paid must notify HMRC and amend its claim if there is a subsequent change in the amount of foreign tax, for example, as a result of a repayment. However, if the tax is repaid to a person other than the claimant, it is arguable that there is no obligation to amend the double tax relief claim. This can arise, for example, because in some foreign territories when a resident company pays a dividend, a refund of tax paid by that company is made to the recipient of the dividend rather than to the company. Clause 59 ensures that a double tax relief claim will have to be withdrawn or amended where there is a repayment of a foreign tax to a person other than the company that made the claim—that is, to a connected party, as the Minister described another party within that same group. Relief will then be given only for the net amount of foreign tax paid, less the payment to the connected person. As we know, the clause is effective for payments made on or after Budget day, 22 April 2009. We very much agree with that point.
I am going to explain our amendment and consider where we would go from here in relation to the three amendments. In our view—and I think the Minister is saying the same thing—the clause does not specify that the payment must come from a taxation authority. There are situations between private companies where one company may pay another in respect of foreign tax. For example, on the simple sale of a company, the selling company will normally indemnify the purchaser against any outstanding tax liabilities, which would include foreign tax. Under the current drafting of subsection (2) —the proposed new section 804G of the Income and Corporation Taxes Act 1988—the person making the payment is not specified. Therefore, in our view it has great potential to catch unintended matters that are entirely commercial and at which the legislation is not aimed.
The Minister said that our amendment does not deal with these matters in technically the same way. I am slightly at a loss. I think he is probably right and I am going to take his word for it in this circumstance. I am slightly disturbed that we are now going to have to come back to this on Report. We have had two Government amendments, two attempts to get this right, since the Finance Bill was published. I must minute our disappointment that we are going to have to bring back this measure on Report, even after today’s reasonably full debate. However, we will not oppose either the clause or the Government’s intention to return to it.
Question put and agreed to.
Clause 59 accordingly ordered to stand part of the Bill.

Clause 60

Mr. Hands: I beg to move amendment 218, in clause 60, page 29, line 34, after ‘costs’, insert ‘, and
‘(c) the taxpayer has entered into a scheme or arrangement a main purpose of which is to secure that the included funding costs are less than the national funding costs’.’.
The Chairman: With this it will be convenient to discuss Government amendments 209 to 212.
Mr. Hands: The clause deals with anti-fragmentation, a term I had not heard of until I started working on the Bill. However, I have been trying to get my head around the term and I will give it the best that I can.
The clause is another anti-avoidance measure that has our support. In essence, it is about banks, and in particular how they might find ways to book income and expenses in different accounting units to avoid tax. Following the decision in a 2005 court case, Legal and General Assurance Ltd v. Thomas, in front of the special commissioners, the Finance Act 2005 introduced legislation restricting the availability of double taxation relief for foreign taxes paid on schedule D case 1 income, which now of course are treated just as “trading income” under the Corporation Tax Act 2009, or income computed on a similar basis for UK tax purposes. The rules aim to ensure that the double taxation relief claimed cannot exceed the equivalent corporation tax on the net profits attributable to that source of income, after deducting an appropriate allocation of expenses, and are often referred to as a “mini-D1 computation”.
HMRC believes that certain banks have sought to avoid the impact of this legislation, either by routing loans through subsidiaries, which are taxed differently, or by financing in such a way that funding costs are not directly attributable to the income and therefore are not deducted in calculating the double taxation relief restriction. Although HMRC considers that the existing legislation should already have the desired effect, clause 60 is intended to put the matter beyond doubt.
The current rules provide that, where income that would otherwise have formed part of the trade receipts of a bank but instead is received by an affiliate that is differently taxed and can claim double tax relief without the restrictions affecting the bank, the income is treated as trade income of the subsidiary. With effect from Budget day, the new measures will extend the existing wording, with the intention that its scope mirrors HMRC’s interpretation of the current rules. Furthermore, when allocating bank funding costs in calculating the relief due, this must now be done on the basis of a proportion of average funding costs, even when specific funds are used to finance an investment.
My understanding is that, if one has a pool of investments and a pool of different vehicles funding those investments, one would have to allocate things on a proportion of the average funding cost for the whole portfolio rather than specific funds underlying a specific asset and how that asset in particular has been funded. That is my understanding of the situation; I would be grateful if the Minister could confirm whether that is correct. These changes have effect from 22 April 2009.
Amendment 218 was suggested to me by the Law Society, which believes that both sets of amendments, as they are aimed at artificial manipulation of double tax relief, should be subject to a tax avoidance motive test. The basic rules, as they stand, already contain provisions relating to the allocation of expenses and these rules should apply over and above those rules only in exceptional cases where there has been deliberate manipulation for tax reasons.
That is what our amendment seeks to do. My understanding is that the language used is entirely normal for these tax avoidance motive tests and I would be grateful for the Minister’s view on whether he will accept the amendment and on the importance of attaching motive to tax avoidance in this case.
Dr. Pugh: I rise to test my understanding of the term “anti-fragmentation” in the clause. It seems to me that the term restricts the banks in two ways. First, it restricts them in how they proportion the cost of overseas transactions under the Finance Act 2005. Secondly, it curtails their ability to dodge that regime by arranging income to be received by a non-banking company under their control. The explanatory notes say that clause 60
“will clarify the existing legislation that prevents banks avoiding the intention of the DTR legislation by artificially arranging for income to be received by a non-banking company”.
That rather creates the perception of the banks as a slightly slippery customer, if one considers what might be behind it. It certainly makes the case for HMRC vigilance and Treasury intelligence. It also endorses the strong public suspicion over banking behaviour in general. Can I tempt the Minister to indicate which bank’s behaviour is being targeted and how many banks are in receipt of taxpayer funds?
12.30 pm
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