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The Economic Secretary to the Treasury (Andrea Leadsom)
It is a pleasure to serve under your chairmanship, Mr Turner, and I wish you a happy new year. I congratulate my hon. Friend the Member for Amber Valley (Nigel Mills) on securing this debate on such an important subject. As a number of colleagues have pointed out, the new measure is designed to ensure that Britain is a very competitive place—in fact, our ambition is to be the best place in the world to start up and run a business. If a company comes to this country, we will charge it low tax rates, but it will be expected to pay. That is what lies behind the measure: to ensure that companies pay that fair rate of tax.
The Government are working to create the most competitive tax system in the G20—a simple, competitive and fair tax system that will support economic growth and investment. However, we then expect companies operating in the UK to pay these fair and competitive taxes, so we are taking action both domestically and internationally. It is not one or the other—one does not rule out the other, as the hon. Member for Birmingham, Ladywood (Shabana Mahmood) suggested it may. We are trying to address concerns about some businesses paying little or no tax on profits made in the UK.
When this Government came to power, Britain had one of the least competitive business tax regimes in Europe. Since 2010, the Government have introduced a series of tax reforms to boost competiveness, such as the patent box, increasing the generosity of research and development reliefs, modernising the UK’s controlled foreign companies regime, and cutting corporation tax from 28% to 21%—next year, it will fall to 20%, the lowest rate in the G20.
The corporation tax reforms were a central plank of our economic strategy, and that strategy is working: growth, jobs and investment are all moving in the right direction. An increasing number of multinational businesses are locating activities in the UK, including companies such as Brit Insurance and Hitachi Rail Europe. The UK is one of the most competitive and attractive countries when it comes to deciding where to base a business.
It is clear that the tax reforms we have made since 2010 are supporting the economic recovery, and that our plan to cut corporation tax again to 20% will lead to more jobs and investment in the UK. Nine out of 10 UK businesses say the corporation tax rate cuts delivered since 2010 have been good for UK competitiveness.
However, as all colleagues have pointed out, there are real public concerns about unfairness in the system, whereby some companies, particularly large multinationals, are seen to be aggressively avoiding tax in the UK. It is vital that the public have confidence in the tax system, and that the tax rules treat both companies and individuals fairly and consistently, without leaving them scope to avoid their obligations. As we seek to return the public finances to balance and reduce the deficit, it is also important to make sure that we collect all the tax that is due. For those reasons, we are taking action, both domestically and internationally, to reform the tax rules and tackle corporation tax avoidance.
The hon. Member for Birmingham, Ladywood asked whether we are therefore giving up on the international tax framework, and of course, as she will know, that is not the case. The current international tax rules were first developed in the 1920s and desperately need reforming, so that they continue to support free trade and ensure a level playing field for businesses, but also to make sure that they address weaknesses such as companies playing different regimes off against each other to avoid paying tax on their profits anywhere at all.
The UK has taken a lead on the international stage to reform these rules and is committed to multilateral action through the G20 and the OECD to tackle the issue of base erosion and profit shifting—known as BEPS. At their summit in St Petersburg last year, the G20 leaders fully endorsed the ambitious and comprehensive BEPS action plan set out over 2014 and 2015. The individual action points are being taken forward by various OECD working parties.
The OECD BEPS project is reviewing the international tax rules to find out where they are not fit for purpose in today’s modern globalised economy. Over 40 countries are collaborating to take forward the action plan: a comprehensive two-year strategy to tackle international tax avoidance.
Ian Swales
We constantly hear about the G20 and the OECD, but the Netherlands, for example, is not even a member of the G20. Is the Minister concerned that all this work is going to be focused on certain countries, but that will, in itself, just lead to even more activity in countries that are not party to this process?
Andrea Leadsom
The hon. Gentleman makes a good point; nevertheless, the UK is at the forefront of driving the international effort to tackle these problems—these weaknesses—in international tax laws that are very out of date. The UK is certainly doing its bit.
In line with the BEPS action plan, in September 2014 the OECD’s first set of outputs from the BEPS project were fully endorsed by the G20 Finance Ministers at their Cairns summit. In a global economy in which goods and services flow freely between countries, international co-operation, as the hon. Gentleman points out, is the only way to tackle the challenge of tax avoidance. Measures taken in Britain will not deal with the problem on their own; we must have global tax rules, too. That is why, under our Prime Minister, we have been pushing, through the G8, the G20 and the OECD, for global solutions.
David Mowat
Of course, that has to be the right answer, but does the Minister really believe that countries such as Luxembourg and the Republic of Ireland, which derive a considerable amount of GDP from a tax evasion strategy, will contribute to any such global effort when it is so important to their standard of living?
Andrea Leadsom
I am grateful to all hon. Members for the points they are making about other tax jurisdictions. What the UK can do is lead the international effort and focus on what we can do to ensure that the UK’s tax base is not eroded. Therefore, although these other points are extremely important, hon. Members will realise that I cannot influence directly the tax laws that Luxembourg undertakes for itself, other than through the contribution the Government make to the international effort to put pressure on different jurisdictions.
The Chancellor announced, in the autumn statement 2014, UK action on two of the internationally agreed 2014 outputs of the BEPS project. I know that the hon. Member for Redcar supports the UK’s introducing legislation to implement the G20-OECD agreed model for country-by-country reporting, which will require multinational companies to provide tax authorities with high-level information on profit, corporation tax paid and certain indicators of economic activity for risk assessment. Draft legislation for the Finance Bill 2015 was published on 10 December 2014, with a tax information and impact note and an explanatory note.
Furthermore, a consultation document on the UK plans for implementing the G20-OECD agreed rules for neutralising hybrid mismatch arrangements—another point raised by the hon. Gentleman—was published at the autumn statement. The new rules will tackle a tax avoidance technique used by multinationals to exploit differences between countries’ tax rules to avoid paying tax in either country, or to obtain more tax relief against profits than they are entitled to.
However, the Government have gone further still. The hon. Member for Birmingham, Ladywood asked whether that was instead of BEPS or because we feel that BEPS will not work, but no, not at all—this is in addition. The Government have gone further to tackle tax avoidance by multinational companies operating here in the UK and to strengthen our defences against the erosion of the UK tax base. That is entirely complementary to the BEPS process. Where companies in the UK are going to extraordinary lengths to avoid paying their fair share of tax, we will act to prevent that. That is why the Government have introduced the new diverted profits tax—to counter the use of aggressive tax planning by large multinationals to avoid paying tax in the UK on profits that have been generated from economic activity here in the UK.
The diverted profits tax will be applied using a rate of 25% from 1 April 2015. The measure is targeted at contrived arrangements used to shift profits away from the UK in a manner that ensures they go untaxed or largely untaxed. The measure is designed to counter the erosion of the UK tax base as a result of complex structures that circumvent the international tax rules on permanent establishment and transfer pricing.
For example, some multinationals have gone for aggressive tax planning that involves quite complicated arrangements, such as the so-called “double Irish”—a point raised by the hon. Member for Strangford (Jim Shannon) and my hon. Friend the Member for Amber Valley—using group companies in other countries as conduits to route expenditure to tax havens so that profits from UK activity goes untaxed.
Specifically, the diverted profits tax applies in two situations. The first is where a foreign company carries out activities in the UK in connection with the supply of goods or services to UK customers in such a way that it avoids creating a permanent establishment, and the main purpose of that arrangement is to avoid UK tax, or a tax mismatch is secured such that the total tax derived from UK activities is significantly reduced. The second situation is where a UK company, or a foreign company with a UK permanent establishment, creates a tax mismatch by using transactions or entities that lack economic substance.
If a multinational company is found to be using those contrived arrangements to avoid tax in the UK, HMRC will issue a notice that requires the diverted profits tax to be paid up front. The legislation provides for a review period of up to 12 months, within which the multinational company will have the opportunity, among other things, to demonstrate that it was not liable for the charge or to provide information to HMRC to show that the level of disallowance of intra-group expenditure in computing the charge is wrong on normal transfer pricing principles. The measure is designed to complement our transfer pricing arrangements.
Ian Swales
On the second case the Minister mentions, she can be interpreted as talking about artificial financing structures—for example, moving money to Luxembourg and then loaning it back to the UK—but the briefing note says that the legislation specifically excludes such arrangements. Can she confirm that?
Andrea Leadsom
I think I have been quite clear about the purpose of the legislation. I am not aware of the briefing note to which the hon. Gentleman refers. I will address the point again in responses to questions, so perhaps we can deal with it then.
After the 12-month review period, if the charge has not been withdrawn, the multinational company will have the right to appeal the charge at a tax tribunal on any appropriate grounds.
There are some specific exemptions from the tax. A number of hon. Members asked who was exempted. Those will include small and medium-sized enterprises, companies with limited UK sales and the situation where arrangements give rise only to loan relationships. I will come on to that in more detail at the end of my responses to questions. The draft legislation was published on 10 December and will come into effect from 1 April. Comments from industry are of course welcome as we finalise the rules to ensure that they are clear and targeted.
As I said, the UK is fully engaged in the work to reform the international tax framework through the OECD-G20 BEPS project. The introduction of the diverted profits tax is entirely consistent with those principles and complements the ongoing international efforts in the BEPS project, which is looking to align taxing rights with economic activity.
A number of hon. Members questioned the yield that is expected or forecast from the diverted profits tax. The Office for Budget Responsibility has certified the central estimate of tax yield to be £1.35 billion over the next five years to 2019-20. That will contribute to the £31 billion that HMRC has already secured from tackling tax avoidance and evasion by large businesses since April 2010.
Let me answer some specific questions. My hon. Friend the Member for Amber Valley asked whether this measure was in some way overriding UK tax treaties. I can reassure him that that is not the case. The scope of the UK’s tax treaties is limited under UK law to income tax, capital gains tax and corporation tax. The diverted profits tax is therefore not covered by those treaties, so, as a formal matter, there is no treaty override; and in fact the OECD, in the commentary on its model tax treaty, provides that states can deny the benefits of a tax treaty where arrangements have a main purpose of securing more favourable tax treatment in circumstances contrary to the object and purpose of that treaty.
My hon. Friend also asked whether the measure was compatible with EU law—he did so rather reluctantly, and I would be reluctant, too, on the matter of tax sovereignty. The diverted profits tax has been designed to comply fully with our obligations under EU law. It is aimed at structures that are clearly designed to erode the UK tax base. As such, it is an appropriate response to those who abuse EU law to divert profits from the UK. The safeguards built into the legislation provide taxpayers with a number of opportunities to demonstrate that they should not be subject to the diverted profits tax. Accordingly, we believe that this is a balanced and proportionate measure that tackles arrangements that are clearly designed for tax avoidance.
The hon. Members for Strangford, for South Antrim (Dr McCrea) and for Upper Bann (David Simpson) asked about the specific cut-off for the diverted profits tax. I can tell them that the rules do not apply to SMEs as defined by the EU. That includes companies with fewer than 250 employees, turnover of less than or equal to €50 million and a balance sheet size of €43 million. That is consistent with our transfer pricing legislation. There are also measures that restrict the diverted profits tax if there is not much UK business going on.
My hon. Friends the Members for Amber Valley and for Warrington South (David Mowat) asked about the Channel Islands and the Isle of Man. Of course, they will be aware that those territories are free to set their own rates. We in the UK will go through international forums in terms of influencing international tax jurisdictions, but the UK has a very clear and transparent tax policy-making process, as evidenced by this parliamentary debate. Tax is a national, sovereign matter, so individual tax jurisdictions are free to set their own tax policy. The diverted profits tax is designed to ensure that the UK’s tax base is not eroded by that.
My hon. Friend the Member for Amber Valley asked whether the assessment and collection processes will really work and whether they are fair. For example, if HMRC gets a notice from a big company saying that it might be within the scope, how can it issue an initial charge notice in 30 days? Where would the information come from and so on? I can tell him that the notification of potential liability to diverted profits tax must be made within three months of the end of the company’s accounting period. The Government are still consulting on the detail of the notification requirement and would welcome comments on the drafting. However, it is likely that not all notifications will result in the issue of a preliminary notice. The preliminary notice does not create a charge, but merely warns that a charging notice may be issued and sets out estimated figures that would be included. Following the issue of the preliminary notice, the company would have 30 days to correct any factual inaccuracies in it. That would include any errors in figures on which an assumption in the notice is based.
My hon. Friend the Member for Amber Valley and the hon. Member for Strangford asked whether the provisions were drawn too broadly, such that they might catch not only the abusive structures targeted but a whole load of other, unintended taxpayers. The Government are of course open to suggestions on how the drafting of the legislation could be clarified without undermining its effectiveness. However, the calculation of the charge follows well established transfer pricing principles. Those principles are widely understood and routinely applied by businesses in pricing intra-group transactions. The only difference is that where the contrived features set out in the legislation are present, the diverted profits tax will have to be paid earlier than in a normal transfer pricing dispute.
Ian Swales
I thank the Minister for giving way again; she is being very generous. She talked about the notification process and so on. Is she happy with our knowledge of legal entities and the fact that many of them will be outside the UK? Will HMRC be able to cope with that process?
Andrea Leadsom
The hon. Gentleman will be aware that this Government have significantly increased the resources available to HMRC for this purpose, so yes, we are confident we will be able to manage this process.
There were a number of other questions, which I fear I will not have time to deal with now, about interest payments being excluded. There is a limited exemption for certain arrangements that involve only loans, and separate work is going on to look at how to ensure fairness in the measures. That matter is not being excluded, but is being looked at separately.
Hon. Members raised the question of the wholesale diversion of profits to Luxembourg. The legislation targets profit diversion only where the profit has a clear link to the UK, as I think I made clear. It would not be appropriate for the legislation to go further than that and to bring into scope profits that originate from other territories. However, the Government are strongly supportive, as I said, of the BEPS process, which aims to prevent and address this international problem.
In conclusion, I reiterate that the whole purpose of the diverted profits tax is to create in the UK the most competitive environment in which to base and run a business, including low corporation taxes, but it is a requirement of this Government that companies wishing to do business in the UK should pay those taxes and should not seek to avoid paying them.