Finance (No. 2) Bill (Third sitting)

Anneliese Dodds Excerpts

Thursday 11th January 2018 Public Bill Committees

[The Financial Secretary to the Treasury (Mel Stride)]

A very good morning to you, Mr Owen. Once again, it is a pleasure to serve under your chairmanship. It is a great pleasure to be again in the company of the Opposition Front Benchers. On Monday we debated the customs Bill; on Tuesday we had the Finance (No. 2) Bill Committee here; on Wednesday we debated a statutory instrument, which was quite interesting; today we have the Bill again; and on Monday we will meet again to consider a statutory instrument. I am delighted that we are all here.

Before I address the Labour amendment, I will set out the general background and aims of the clause. Clause 18 and schedule 6 provide additional clarity about aspects of the taxation of partnerships. The changes and clarifications in the clause seek to address areas of uncertainty and complexity identified as problematic by stakeholders, and to reduce the scope for non-compliant taxpayers to avoid or delay paying their tax. The changes also facilitate the digital transformation of partner taxation using information in the partnership return.

Partnerships in the UK are required to file a partnership tax return in the UK once a year. This partnership return ensures that Her Majesty’s Revenue and Customs has the information it needs so partners are correctly taxed on the profits and losses allocated to them. The return should summarise the profits and losses allocated to each partner, and HMRC uses it to audit the tax returns made by the partners.

The clause changes the partnership return in the following ways. First, it clarifies the treatment of partners who are in bare trust arrangements—trusts in which the beneficiary has the absolute right to income and capital from the trust—by confirming that beneficiaries of such trusts are treated as partners for tax purposes. It also clarifies the tax treatment for partners who are themselves partnerships, by providing a statutory definition of an indirect partner and setting out the basis period rules—the basis period being the period for which a partner pays tax each year—and how they apply to indirect partners.

To ensure all partners can complete their returns accurately, and to facilitate HMRC’s assurance work, a partnership that has indirect partners will be required either to report details of all the indirect partners or to submit the four possible profit calculations for UK resident and non-UK resident companies and individuals. The clause simplifies the rules for investment partnerships in the UK that already provide the information that HMRC requires under the common reporting standard or the Foreign Account Tax Compliance Act; it reduces the reporting requirements for investment partnerships where the information has been reported under those other international obligations. Finally, it introduces a new process to allow disputes over the correct allocation of profit for tax purposes to be referred to the first-tier tax tribunal to be resolved. That will ensure that partners have a dedicated method for resolving disputes that does not rely on HMRC assurance processes.

On the amendment, I assure hon. Members that the Government have carefully considered the risk of non-compliance in drafting this legislation. In addition to the clarifications that the clause provides to address areas of uncertainty for partners, HMRC already has the power, subject to certain conditions, to require payment on account, in the form of an accelerated payment notice, from taxpayers who are involved in schemes disclosed under the disclosure of tax avoidance schemes rules or counteracted under the general anti-abuse rule.

HMRC has issued more than 79,000 accelerate payment notices since 2014, which have brought in more than £4 billion to the Exchequer. They have changed the economics of tax avoidance, and there is strong evidence that they have had significant impact on marketed avoidance, as the Office for Budget Responsibility noted in its September 2017 report. The Government do not consider it necessary or proportionate to extend such notices where there is no clear indication of avoidance and a partnership’s tax returns are simply the subject of an inquiry. It is therefore equally unnecessary to review the effect that such an extension would have.

I hope that reassures hon. Members that HMRC has sufficient powers to address non-compliance by partners, and that the amendment calling for a review on whether to extend those powers is neither necessary nor proportionate. The clause provides additional clarity about aspects of the taxation of partnerships; I therefore commend it to the Committee.

[Anneliese Dodds (Oxford East) (Lab/Co-op)]

It is a pleasure to serve under your chairmanship, Mr Owen. I am grateful to the Minister for his kind comments, and look forward to future iterations of our debates, on other matters.

I want to give some context on the use of partnerships in the UK economy. Obviously, in some sectors they have proliferated, especially in forms such as limited liability partnerships. There is a broad question about unintended consequences of the proliferation of limited liability partnerships, particularly in accountancy, but I am well aware that that form of governance was created in 2001, so that growth can hardly be viewed as the result of the Government’s activity.

There are ways in which we can and should seek to ensure that partnerships are put on to as equal as possible a footing with other corporate forms. I appreciate that the package of measures on partnerships in the Bill is intended to do just that, as well as to simplify tax law on partnerships. However, our amendment would revive a measure that was initially floated by the Government, but appeared to have been rejected later: the notion of introducing, where one partner is absent, a payment-on-account system in relation to partnerships whose income is derived from trading or property, as described by the Minister.

The proposal would be similar to the system used for the self-employed, in which half the previous year’s tax bill is due in advance, and payable in July, to protect HMRC’s revenue. The proposal was No. 4 in a consultation document set out by HMRC. It received some negative responses in the consultation, I admit; however, some respondents were positive about its potential. We agree with them. It is important properly to incentivise the reporting of partners.

The Government maintain that the existence of penalty provisions for incomplete and late submission of partnership returns would be sufficiently dissuasive to prevent the non-reporting of partners to HMRC. They maintained that in the response to the consultation, and the Minister has done so again now. Our concern is that the penalty or fine could be lower than the tax due, and that could potentially open a loophole that we would rather was closed.

Our amendment would require the Government to rethink their position. However, I took on board the Minister’s comments just now, particularly about the applicability of the general anti-avoidance rule in this context. Because of that, we are willing not to push the amendment to a vote, but I hope that in the light of our discussion, the Minister will keep the matter under informal review in the Treasury.

[Mel Stride]

I thank the hon. Lady for those comments and for not pressing the amendment to a vote. I shall certainly keep the matters under review, as she urged, and would be happy of course to take directly any representations that she may want to make on them in future.

Question put and agreed to.

Clause 18 accordingly ordered to stand part of the Bill.

Schedule 6 agreed to.

Clause 19

Research and development expenditure credit

Question proposed, That the clause stand part of the Bill.

--- Later in debate ---

[Anneliese Dodds]

The Opposition have not tabled any amendments to clauses 20 and 21, but I have a question for the Minister about a specific matter that I raised briefly on Second Reading. It was not satisfactorily resolved at the time, so with the Committee’s permission I will raise it again.

I am grateful to the Minister for his explanatory remarks, but a pertinent question remains. As I said on Second Reading, the clauses essentially grab at what in many cases may be the holy grail: the assigning of market value to certain kinds of intangible for tax purposes. In that regard, the clauses seem to contradict the direction of travel in the Finance (No. 2) Act 2017, in which the tax impact of intra-group transactions was limited rather than regulated—I refer specifically to the measures to restrict the tax deductibility of interest payments to intra-group companies. Hon. Members will remember that the Government decided on a limit of 30% of earnings before interest, taxes, depreciation and amortization, which was the upper bound of the OECD’s suggestion. We questioned that, but at least they adopted the OECD position of restricting such payments. However, rather than limiting the admissibility of intra-group payments as a means of reducing tax, the Bill attempts to regulate their calculation. I think such an attempt may be flawed.

The Minister has covered this to some extent, but let me provide some further background. Related parties, including subsidiaries, affiliates, joint ventures or associated companies, may transfer among themselves intangibles such as patents, know-how, trade secrets, trademarks, trade names, brands, rights under contracts or Government licences and other forms of intellectual property. The attempt to regulate market value may be flawed because it assumes a market value for such intangibles. For most people, the image underlying such a view is one of an active market with buyers and sellers in it, but there is often no such market for intangibles that are transferred—sometimes entirely legitimately, but sometimes as an attempt to pay less tax by shifting to a lower-taxed or differently taxed jurisdiction. For example, I have been looking at statistics on global biotech. As I understand it, about 10 corporations control two thirds of the industry, including the intellectual property in it, so there is no normal market and enormous mental gymnastics are necessary to determine the market value of intangibles.

Firms that wish to exploit the situation can make rather wild claims. I hope Committee members will remember as a particularly egregious example the facts revealed by the European Commission’s case against Starbucks, in which vastly inflated assessments were made of the value of intellectual property held by a firm that had no employees. However, the Starbucks case was unusual in the sense that such manipulations of the value of intangibles normally remain, sadly, unchallenged. In connection with that, I understand that HMRC had, as of 2016, just 81 transfer pricing specialists. Surely that is dwarfed by the number of advisers employed by the big four firms who, potentially, would advise large companies that might well seek to reduce their tax perfectly legally by manipulation of the location of intangible assets into lower-tax jurisdictions.

Clauses 20 and 21 do not define intangible fixed assets. In accounting terms, of course, an asset is something that generates future cash flows, revenues or benefits, but there are no other qualifying criteria. The woolliness of such a definition has been recognised in the courts as problematic. For that and many other reasons, the European Union is moving towards a unitary system of corporate taxation. I appreciate that that is a matter for another day, so I will not open a discussion on it now—probably no political party would want to state its position on it in a Finance Bill Committee. We should note it here, however, because it indicates how our country may be merely entrenching problems that the EU27 are moving towards resolution.

Will the Minister introduce legislation to provide clearer guidance about how an intangible asset should be defined for tax purposes? Will he give us any further information about how he will prevent the measures from being exploited and alleged market value from being manipulated to avoid tax?

[Mel Stride]

I thank the hon. Lady for her speech. She raised the interplay of the corporate interest restriction and various rules, including the 30% EBITDA rule in the Finance (No. 2) Act 2017. As I am sure she appreciates, there is a distinction between that legislation and what we want to do in the clauses before the Committee. In the case of the corporate interest restriction, we are thinking about making sure that groups of companies do not abuse the borrowing of money by moving it around the group, thereby artificially reducing their tax burden. The clauses that we are considering are about regulating inter-group transfers of intangible assets, and getting the right values imputed in the circumstances.

The hon. Lady is right to say that assessing and establishing true market value is extremely complicated. A market value rule is applied in the relevant circumstances. As to whether we shall return to the matter in future and address in legislation questions of guidance and of definition of the value of intangible assets, I am happy to ask officials to look at various no doubt deep and dark parts of the UK tax code, where such definitions and other useful information may lurk, and provide the hon. Lady with what I can.

Overall, despite the complexities of the clauses and their deeply technical nature, they are important and worthy anti-avoidance measures, which we need to add to those—more than 100 of them—that the Government have introduced since 2010, saving the taxpayer £160 billion and giving us one of the lowest tax gaps in the world, and in the history of our recording such gaps.

Question put and agreed to.

Clause 20 accordingly ordered to stand part of the Bill.

Clause 21 ordered to stand part of the Bill.

Clause 22

Oil activities: tariff receipts etc

Question proposed, That the clause stand part of the Bill.

--- Later in debate ---

[Mel Stride]

Clause 23 makes changes to ensure that the hybrid and other mismatch rules introduced in 2016 operate as intended. It does so by introducing a small number of technical amendments to those hybrid rules.

The hybrid and other mismatches regime was introduced in the Finance Act 2016 and deals with mismatches involving entities, permanent establishments and financial instruments. The regime is a set of anti-avoidance rules that tackle certain tax planning arrangements by multinationals. The regime addresses arrangements that give rise to hybrid mismatch outcomes and generate a tax mismatch. In doing so, it fully implements and, as a matter of policy, in some areas goes further than the OECD base erosion and profit shifting action 2 recommendations.

Mismatches can involve either double deductions for the same expense or deductions for an expense without any corresponding receipt being taxable. A consultation with stakeholders identified some practical and technical changes necessary to ensure that the UK regime fulfilled the policy intention. The clause amends the UK hybrid rules to clarify how they should be applied.

The changes made by the clause ensure that the hybrid and other mismatch rules operate as intended. Those changes and the hybrid regime in general will affect multinational groups with UK parent or subsidiary companies involved in cross-border or domestic transactions involving a mismatch in tax treatment within the UK or between the UK and another jurisdiction. The changes do not alter the overall effectiveness of the hybrid regime and will protect the expected yield from that regime. In some cases, as a matter of policy, the UK regime goes beyond OECD recommendations.

The detailed changes set out in schedule 7 to the Finance Bill make it clear that withholding taxes are to be ignored for the purposes of the regime, disregard taxes charged at a nil rate, ensure that capital taxes can be taken into account in appropriate circumstances, ensure that a counter-action in relation to partnerships will be proportional, clarify the scope of the rules in relation to companies with overseas branches, provide for certain intra-group transactions to be taken into account when quantifying mismatches, ensure that in appropriate circumstances income taxed in two jurisdictions can be taken into account in relation to imported mismatches, and provide for accounting adjustments that reverse or reduce mismatches to be taken into account.

Amendment 49 asks for a review into the hybrid and other mismatches legislation, focusing particularly on the rules that deal with hybrid transfer arrangements. Hybrid transfers are one of the several types of hybrid and other mismatch arrangements within the scope of the hybrid mismatch rules introduced by the Finance Act 2016. The rules that deal with hybrid and other tax mismatches, including hybrid transfer arrangements, have been implemented in line with the OECD BEPS recommendations. Likewise, the hybrid rules within the EU anti tax avoidance directive were designed to be consistent with, and no less effective than, the OECD BEPS recommendations on hybrid mismatches. The UK was instrumental in ensuring that the ATAD rules met that requirement, and the UK rules on hybrid transfers are consistent with the ATAD requirements.

In broader terms, the expected yield from the hybrid and other mismatches regime has been certified by the Office for Budget Responsibility, and those figures will be kept under review as part of the normal process for fiscal forecasting and monitoring of receipts. A review, in short, is unnecessary and will not strengthen our understanding of the legislation. As clause 23 demonstrates, the Government are already monitoring the operation and impact of the hybrid mismatch rules and making any changes necessary to ensure that they work as intended. I therefore commend the clause to the Committee.

[Anneliese Dodds]

I am grateful to the Minister for his explanation of the measures. As he explained, hybrid mismatch arrangements exploit differences in the tax treatment of instruments, entities or transfers between two or more countries. Sadly, those arrangements have proliferated in a number of countries, as sophisticated taxpayers and tax advisers have spotted opportunities to reduce the tax payable by what might otherwise be profitable companies.

The result has often been double non-taxation, whereby neither country involved in the arrangement can receive revenue, or the deferral of tax over many years, which is in practical economic terms similar to double non-taxation. That is just one part of the international dimension of tax avoidance that is, sadly, generally not picked up in statistics on the UK’s tax gap, but which experts maintain runs at a high level, denying our public services the revenue they need and placing small and medium-sized British businesses at a tax disadvantage.

Hybrid mismatch arrangements not only deny countries tax revenues but distort economic activity. They mean that investment decisions can be driven by tax-related criteria, not by effectiveness and efficiency. They can also lead to financial instability by encouraging tax-favoured borrowing and by reducing the transparency of company and taxation structures.

The Minister rightly referred to the groundswell of activity against these hybrid mismatch arrangements over recent years, from within the EU code of conduct group when it was chaired by the Labour MP Dawn Primarolo, and from 2013 onwards in the OECD and G20’s base erosion and profit shifting action plan. As colleagues will know, action 2 of the BEPS project, as referred to by the Minister, is focused on neutralising the effects of hybrid mismatch arrangements. The Minister referred to the fact that the most recent changes in this Bill build on those from last year. They were originally tweaks to the 2016 Bill, which amended the Taxation (International and Other Provisions) Act 2010, as I understand it.

I think we in the Opposition would agree that the general direction of travel appears to be the right one—considering the tax treatment in our own country and the corresponding jurisdiction, aligning our roles with the OECD’s approach and ensuring that measures have direct effect. As I understand it, in the past any measures had to be initially notified to the company before HMRC could take action. It is good that we now have a different approach. Above all, it is important that the new measures relate the tax treatment here to that in the corresponding jurisdiction. That means we need a more complex set of rules, but they are more appropriately targeted at dealing with the scourge of hybrid mismatch arrangements. It is precisely because of the need to continue to eliminate these arrangements that we believe a review is necessary.

I will quote here from an OECD report from 2012. It is, admittedly, from just before the BEPS process started, but I think it is still relevant. The report was specifically on hybrid mismatch arrangements, and it stated:

“Country experiences…show that the application of the rules needs to be constantly monitored. Revenue bodies have noticed that arrangements may become more elaborate after the introduction of specific rules denying benefits in the case of hybrid mismatch arrangements.”

The OECD report offers the example of Denmark, which in 2011 was required to amend its rules as sophisticated taxpayers and their advisers wised up to previous attempts to close loopholes.

I know that these specific rules are the result of successive rounds of finessing, from 2016 and through last year until now, but we would like a commitment to ensuring that the process continues through the mechanism of a review. I note that in discussions about the BEPS process, participating countries have expressed concern that without widespread acceptance and implementation of the new rules, the difficulties could be exacerbated by them. We really need more information about how they will operate in practice.

Of course, we must also bear in mind that the operation of these rules is affected by the foreign tax treatment of any companies concerned. In some ways, the Minister was absolutely right to say that such problems may have been reduced with the engagement of the OECD and EU in the adoption of consistent approaches to the treatment of hybrid mismatches. However, I note that there has been some suggestion that there is a different approach in the EU rules, as compared with the OECD rules, to the specific issue of which country is responsible for characterising the entity or instrument in the member state where the payment has its source. If that is still the case, our Government need to indicate to what extent our rules comply with the measures in the EU’s winter 2016 tax package relating to hybrid mismatches. The Minister stated that he felt that those measures were coherent, but we would like to see a more thorough assessment of that.

On a related note, I refer to my previous comments. It would be helpful for the Government to indicate the relative merits of their current approach to hybrid mismatches compared with formula-based approaches—or at least to reflect on that, given that the EU’s common consolidated corporate tax base programme is continuing at EU level. For all those reasons, I hope that the Minister and Government Members will agree to our sensible demand for a review of the effectiveness of these measures 12 months after their introduction.

[Mel Stride]

Once again, I thank the hon. Lady for a thoughtful contribution. I think we agree that hybrid mismatches are a form of avoidance and we need to clamp down on them as they operate between different tax jurisdictions. That is precisely why we are debating these measures today. She has reflected on the fact that they have come out of OECD and BEPS project activity, in which we have been absolutely at the forefront.

The hon. Lady said that she was satisfied with the general direction of travel. She made the important point that the work is, in effect, never done, because whenever we come up with new legislation to clamp down on loopholes, other, more ingenious, individuals out there come up with ways of working around it. By way of example, she raised the issue of identifying the effective country of origin for the hybrid mismatch and the different approaches that the OECD and the EU might have.

I reassure the hon. Lady that we agree with her on everything up to that point, and that we will continue to monitor the measures. There is no necessity to have some wide-ranging review that will go into things over time and report back while we wait for the outcome, because day in, day out we are monitoring exactly what is happening. The best evidence that I can provide for our approach and its efficacy is the fact that we have this clause at all. It is a perfect example of the way in which Government have put out some legislation to clamp down on tax avoidance—we are determined to do that—watched what has happened, identified some issues and come back to legislate quickly and in a timely way to ensure that we close new loopholes as they occur.

I ask the hon. Lady to withdraw her amendment and the Committee to accept the clause.

Question put and agreed to.

Clause 23 accordingly ordered to stand part of the Bill.

Amendment proposed: 49, in schedule 7, page 96, line 22, at end insert—

‘Review of operations

18A After section 259M, insert—

“259O Hybrid and other mismatches measures: review of operation

(1) Within 12 months after the passing of the Finance Act 2018, the Chancellor of the Exchequer must review the operation of the measures in this Part.

(2) The review under this section must consider—

(a) the impact of the measures on the use of hybrid transfer arrangements;

(b) the impact of the measures on the revenue effects of the use of hybrid transfer arrangements to reduce a person’s tax liability;

(c) possible alternative or additional measures to reduce the use of hybrid transfer arrangements to reduce a person’s tax liability;

(d) whether the measures constitute application of EU Directive 2016/1164 (‘The Anti Tax Avoidance Directive’), including in what ways the measures do not constitute an application of that directive.

(3) The Chancellor of the Exchequer must lay before the House of Commons the report of the review under this section as soon as practicable after its completion.”’—(Anneliese Dodds.)

This amendment provides for a review of the measures against hybrid transfer arrangements to reduce a taxpayer’s tax liability, and that this review consider whether alternative or additional measures would be more appropriate, and how these measures compare to the EU Anti Tax Avoidance Directive.

Question put, That the amendment be made.