Diverted Profits Tax

David Mowat Excerpts

Wednesday 7th January 2015 Westminster Hall

[David Mowat (Warrington South) (Con)]

My hon. Friend said that this unilateral action should not affect a global agreement that may be reached in the future. What concerns me, however, is that some countries—Luxembourg, the Republic of Ireland and, possibly, Holland—are acting as de facto tax havens. They regard helping big companies avoid tax in our country as a method of increasing their GDP. Given that, it is unlikely there will ever be a global agreement of the type my hon. Friend is talking about.

[Nigel Mills]

I have always been cynical about the OECD process, for exactly the reason my hon. Friend gives: the risk is that some countries will block it or undermine it out of self-interest. If the main countries are serious about tackling multinational tax avoidance, one country that really needs to change its rules is the US. The US could stop a lot of this by changing some of its rather strange entity classification rules and other things. That would stop US corporates getting the real tax saving they are after. I sense that until the US is willing to do that, we will never see these things stop completely.

[David Mowat]

I should have added that our hands are not clean. We appear quite sanguine about the status of the Isle of Man, Jersey and Guernsey. I am always a bit surprised that neither Front Bench has ever regarded that as an issue on which more action is needed. People in Luxembourg would raise that issue with us, just as I am accusing them of acting as de facto assisters of tax evasion.

[Nigel Mills]

My hon. Friend makes a fair point about the UK doing some sponsoring of the Channel Islands and the Isle of Man, but I will leave the Minister to answer for the Government’s policies on tackling that. My hon. Friend says our hands are not entirely clean; it is interesting that we have introduced the Patent Box to try to have a lower tax rate for intellectual property in the UK—presumably on royalties charged in countries around the world. We have also been trying to get our tax rate down to a low level to encourage international investment. Someone sitting somewhere with a tax rate much higher than 20% might think that we are trying to encourage profits to be taxed here that perhaps should not be, but I am sure that is not the Government’s intention.

To wrap up on the BEPS process, the Association of Revenue and Customs—the trade union for professionals at HMRC—raised the concern that the Government’s proposals were unilateral and stood outside the BEPS proposals. The ARC suggested an alternative approach, whereby the Government remain in the BEPS process and timetable, but use their current initiative to show they will have legislation in place in case the process falters or is impeded. I presume the Government will confirm that they do not intend to slow down on the rules and wait for the BEPS process and that we will see them on the statute book later in the year.

The second area I would like to look at briefly is how likely the rules are to be effective. We all want the tax to be collected in the UK. We do not want to see these corporates able to artificially avoid paying the tax that is due here, but there is a question on whether the rules will survive a challenge under the UK’s many double tax treaties or under EU law. People suspect that the Government have chosen to do a whole new tax, rather than just tweak the existing corporation tax rules, to try to ensure that the rules are not struck down by our international treaties or by EU law. Can the Minister confirm that the Government have looked into that and are satisfied that the treaty analysis is correct? Paragraph 4 of article 2 of the OECD’s model tax convention states:

“The Convention shall apply also to any identical or substantially similar taxes that are imposed after the date of signature of the Convention in addition to, or in place of, the existing taxes.”

At first glance, it looks as though the direct profits tax will be a tax on corporate income, which sounds similar to a corporate income tax and our corporation tax. The definition in the convention suggests that the tax might be caught by the treaties. Article 7 of the convention, which is on business profits, states:

“Profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein.”

The problem we are trying to fix with the avoided permanent establishment part of the rules is that if a company does not have a PE, we cannot tax them. We think they are diverting profits out of the UK and we want to tax those profits, but if we are dropped back into the treaty, we might end up in the same position as we started. It would be useful to understand how the Government have satisfied themselves that the tax will not be caught. Is it because they are trying to tax the UK establishment that already exists, or do they believe that it is a new tax that falls outside the treaty?

On the EU law point, I am no big fan of the EU interfering in our tax system. Tax is meant to be for nation states and not the EU. I have never been keen on the view that the European Court of Justice should interfere in sensible tax avoidance rules, so I will not advocate that here, but there must be a risk for the many companies that choose to site themselves in Luxembourg, as my hon. Friend the Member for Warrington South (David Mowat) said. We have all seen the tax rulings that have been published, and we know how many companies are doing that. A company based in Luxembourg might say, “Wait a minute: if I am established in the UK and pay tax there, I pay it at 20%. Why, because I am in Luxembourg, do I pay a slightly different tax at 25%? Is that not fundamentally contrary to some kind of freedom of establishment principle?” There is a risk of a legal challenge to the rules on that basis. It would be useful to understand how the Government have satisfied themselves that the European courts would not strike down what many of us see as a sensible anti-avoidance measure that we would not want to lose.

The flipside to that is whether the provisions have been drawn up in the right way, so that they catch those we are aiming at, but do not create onerous burdens for loads of “innocent” corporations or place a ridiculous burden on HMRC. We want targeted rules that attack the corporations engaging in what they must know to be pretty aggressive artificial structuring. The guidance is clear on some of the structures that HMRC and the Treasury are targeting. We would all probably agree that it looks artificial if a sales force gets 95% of the way through a sale and cannot sign the final contract, but has to refer it to Luxembourg, Switzerland or somewhere else. If the rules are drafted too broadly, there is a risk of thousands of companies that the Government had not intended to be caught fearing that they will be caught. That creates a burden on them, and they will have to go through the whole compliance process to satisfy themselves that they are not caught.

The flipside to that is the risk that HMRC gets thousands of notices that it cannot possibly deal with, and then misses the notices that have all the tax at stake. By drawing the rules too widely, people could sneak through the middle who should not. The adviser community is expressing sensible concerns and asking, “Have the rules been drawn too broadly? Is there any way that they can be focused, perhaps through filters, such as those in the controlled foreign company rules?” Through that, we could be clear to taxpayers on who is intended to be caught, and what the hallmarks are that let them know that they are caught. That can give those who are not trying to avoid UK tax artificially some kind of comfort that they are not in the rules and do not need to do the self-assessment.

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[Ian Swales (Redcar) (LD)]

It is a pleasure to serve under your chairmanship, Mr Turner. I, too, congratulate the hon. Member for Amber Valley (Nigel Mills) on securing the debate. His initiative is excellent, given the enormity of what is proposed.

There is something of a crisis in corporation tax: globalisation, the European Union and the internet have all given many more opportunities to move tax or profits around. In the days since I was a global finance director in 1996, we have seen a lot more predatory activity by advisers and companies. They seem to be far more shameless about carrying out transactions without a commercial basis. With my training, I would have said that that was already a problem, even without any new legislation, but companies seem quite happy to do such transactions, to the extent that a year or so ago the chief executive of WPP could describe the amount of tax paid as “a question of judgment”, which tells us a lot about the amount of flexibility that he could see in the system.

Moreover, the chief executive of Google famously boasted about avoiding £2 billion in tax in a single year. He seemed to have no concept that that meant £2 billion in cuts to public services in the all countries in which his company operates, or the same amount more in tax that other companies and individuals in those countries would have to pay. The climate seems to be changing, although the Prime Minister’s business advisory group still includes that chief executive. I wonder whether he had any input into the new policy and what he thinks of it.

After the measure was announced, Newsweek commented on 26 December:

“The British government, after a search, says it knows how to tax profits Google earns in the United Kingdom. Its solution is simple and elegant, and it probably won’t change a damn thing.”

That view is perhaps overly cynical, but it backs up a point made by several Members: the expectation is that companies will take other measures rather than lie down and pay the tax. That is a huge issue.

The hon. Member for Amber Valley was right to mention the question of how on earth the tax will be calculated. City experts are already saying that the calculations will lead to a “legal quagmire”—that is one expression I have seen used. In other words, when HMRC comes up with an assessment the lawyers will probably start work. I wonder whether HMRC has budgeted sufficiently for the resources that it will need to make the tax stick. It could be involved in lengthy legal cases with expensive lawyers paid by large companies.

That leads us to the main question concerning this tax. When I was trained as an accountant, we were told that the one principle a tax system needs is certainty. In other words, it should be clear what a company is doing and what the tax on that will be; the company can then pay that tax. Certainty is one of the functions of a good tax system, but with the diverted profits tax we are straying into an area of high uncertainty about how the tax will be assessed and paid. The hon. Gentleman made an excellent point about our ability to collect the money: by definition, it could be all over the place and not in the UK. That leads us to the question of the confidence the Minister has in our ability to collect the money—I am interested to hear her comments on that.

[David Mowat]

The hon. Gentleman has made an interesting point about certainty and also about the difficulties that globalisation and the internet have caused for gathering corporation tax. Is there a case for the international community to give up on corporation tax and instead have higher taxes on sales and, if necessary, dividends, so that the tax is still raised in the end but we do not have a continual process of chasing money across international boundaries, which, for the reasons he has given, is time consuming and perhaps counter-productive?

[Ian Swales]

I take the hon. Gentleman’s point on board. I know that some commentators believe the right way to go is to scrap the incredibly complex system that we have. Although that might be where we end up, I would like to see country-by-country reporting introduced first, so that we know what activity companies are carrying out in each country, and where they are trading and are declaring their profits will be transparent to the world at large. That would help tax authorities; also, the problems companies would then have with reputation management would cause quite a shift. I would like to see that country-by-country reporting first, but perhaps we will end up in the position that he has suggested.

The estimate is that the tax will raise £1 billion over five years. That is a very small amount given the scale of the issue. One commentator has suggested that Google alone could be assessed as owing around half that figure. The Financial Times has found that in 2012 seven US technology companies paid only £54 million in tax on UK sales of $15 billion. I am aware that corporation tax is levied not on sales but on profits, but the companies we are talking about typically make 20% profit or more on sales, so we could quickly come up with a large number there. Will the Minister tell us how the assessment of the amount the tax will collect was made? What assumptions sit behind it? The figure seems small given all the relevant issues, which we are well aware of.

The hon. Member for Amber Valley rightly mentioned EU law. I will not repeat what he said but there is clearly the potential to challenge the tax through the EU. When one talks to global finance directors, there is no doubt that financing structures and interest payments are the tax avoidance measure of choice—they are how the largest diversion of profits occurs. Will the Minister explain why offshore finance centres and excessive foreign interest payments have been specifically excluded from the diverted profits tax? I welcome the moves that have been made, but a large area has not been addressed by the tax.

I will mention a few other aspects of profit diversion. The Minister may tell us that they are included, but my guess is that most are not. There are well documented loopholes used by banks for tax arbitrage between countries, particularly between the UK and the US, because different instruments are taxed differently in the two countries and by shuffling money backwards and forwards it is possible to create beneficial tax arrangements. Will the legislation address those loopholes? Does the legislation deal with hybrid entities, for which there are similar opportunities because of the different taxation of legal structures between different countries? They are another method that the financial services sector in particular uses to shift profits.

Some of the issues connected to Luxembourg have been mentioned already, but will the Minister address the issue of the wholesale tax avoidance and profit diversion that, for example, sees Vodafone holding five times as much capital in Luxembourg as the GDP of Luxembourg, although it does no trading there? That kind of thing enrages the public, and it is high time it was addressed. When will she get the EU to deal with the preposterous activity going on in Luxembourg behind its so-called headline corporation tax rate of 29%?

The Channel Islands have already been mentioned. The particular point I want to raise is that the majority of contracts for UK private finance initiatives are now financed from those islands. That makes a mockery of the Green Book assumptions about PFI tax recovery; it is assumed that a very high figure—I think it is 6%—will come back to the Treasury in tax receipts, but that assumption completely ignores the fact that PFI deals are routinely moved to the Channel Islands, including those for 50% of the schools in my constituency, which are apparently owned in Jersey.

Those are just a few of the arrangements that may or not be covered by the diverted profit tax legislation. I suspect most are not, but they illustrate the fact that there is a lot more yet to do.

Diverted profit arrangements do not simply cost tax or allow profit diversion; they incentivise offshore acquisition and ownership of UK businesses. These days, highly profitable UK businesses have to create some offshore financing or else somebody else will do it for them, as predatory takeover activity in the UK is often predicated on offshore finance structures designed to move taxable profits out of the country. A good example would be Betfair. Last year, a company was looking to take it over in an aggressive takeover. I wondered what the company was going to add in terms of betting technology or new IT, but the clue was the name: “So-and-so Partners, London and Luxembourg”. The factor the takeover was going to add was the shifting of Betfair’s profits away from the hands of the Treasury. In the end, that takeover did not go through, but the diversion of profits affects business ownership and competition in the UK.

I mentioned the amount that the tax is expected to raise. I think the figure is low because of what are traditionally called behavioural effects—in other words, what companies may do as a result of the tax—and so I am interested to hear more from the Minister on what the Treasury thinks will happen, as opposed to the idea that companies will simply sit there and pay the tax. What kind of measures does the Treasury consider companies might take?

How will the success of the tax ultimately be measured? As the hon. Member for Amber Valley rightly said, it could well be that the real success of the legislation will appear not in diverted profit tax receipts but as higher corporation tax receipts. Does the Treasury have any way of judging how the measures have played out?

I welcome what is happening and hope that the Government will do more. I have mentioned country by country reporting, and that has begun to happen in the financial services sector. It is driven partly by other countries’ legislation. I hope it will expand through the work of the OECD and pressure from our Government, and in the operation of companies around the world will become more transparent. We should push for that.

John Cridland, the head of the CBI, said about a year ago that he was confused and did not know what the Government wanted on tax. I do not think that it is confusing at all. We want companies to account for their UK activities in the UK and pay tax on the profits that they earn in the UK. It could not be any simpler. I addressed the CBI tax forum two or three months ago and made that point. I said bluntly that if its companies were doing otherwise, we would steadily be coming after them.

The Government have a record of at least moving in the right direction. I was a member of the Public Accounts Committee for more than four years and took part in scrutiny of large companies and tax advisors; judging by the culture and attitudes out there, we still have a long way to go. I vividly remember asking a tax advisor how many of the schemes that he had advised individuals and companies to adopt in the previous few years had been made illegal; he cheerfully said it was all of them. It is good news that HMRC keeps pinning those things down, but the fact is that there is an industry out there constantly looking for new ways to avoid the taxes that we try to levy. I hope that the Treasury will make its proposals work, and will continue to recognise that there is still much more to do.

[Shabana Mahmood (Birmingham, Ladywood) (Lab)]

It is a pleasure to serve under your chairmanship, Mr Turner. I congratulate the hon. Member for Amber Valley (Nigel Mills) on securing the debate, and on his speech. He raised many points on which I, too, want to press the Minister. He was right to say that the issue has not received a huge amount of attention, and that there will not be a great deal of parliamentary time for detailed scrutiny of the Government’s proposals, given where we are in the parliamentary cycle.

The announcement of the proposals was of course rather trumped by the changes in stamp duty, which led the media coverage and debate. However, there has been a lot of coverage in the specialist taxation media, and that has helped to bring out some of the issues raised by the proposed diverted profits tax. I am grateful for this opportunity to press the Government further on their proposals. I will seek answers about technical detail— bearing in mind that there is currently a technical consultation, which will report on 4 February—as well as about practical elements and the Government’s emerging thinking about the impact on the OECD BEPS process. All three hon. Members who spoke mentioned that.

Our general approach is not dissimilar to the Government’s, and we recognise that there is a significant issue. All those who have spoken have referred to the public examples of large companies, with significant businesses that are doing very well, effectively gaming international tax rules to minimise their tax liabilities in this country. That significantly undermines public trust and confidence in the taxation system, particularly at a time of economic difficulty and stress. It is a real issue, and it is legitimate for all political parties to look for practical answers to alleviate such concerns.

As a general principle, economic activity should be taxed where it takes place. The question for all politicians to grapple with is finding an effective way to get to that point. For the Opposition—and for the Government, going by what they have said throughout this Parliament—the starting point is to try to work with international partners, notwithstanding the concerns raised by the hon. Member for Amber Valley about whether the US and other jurisdictions would be willing to play ball on co-ordinated international action to deal with gaming of the international tax rules. It is the right place to start, and that is why we have supported the OECD’s BEPS process. It is the right forum for seeking an international agreement on tax rules.

The Government have of course been much closer than the Opposition to that process, and we rely on publicly available information about its progress, and expert commentary from, and conversations with, some of the participants. From what the Government were saying up to the time of the autumn statement, we anticipated that their preferred way of proceeding on all the issues that form BEPS action points would be to await the final reporting in September before thinking how to go further. They have of course moved a little more quickly with the diverted profits tax, and I, like other hon. Members, would like to hear more about how that affects our role in the BEPS process.

We agree that a solution is needed and are keen for the issue to be dealt with, so we broadly welcome the Government’s proposed action. We will approach the diverted profits tax proposal in the Finance Bill in a supportive and constructive spirit, because we want a workable solution to reach the statute book; but I want to press the Minister further, particularly about the BEPS process. It would be helpful if she could tell us how those in the process have reacted to the DPT proposals, and why the Government felt it necessary to take unilateral action at this point, notwithstanding what many commentators have said about the looming general election. Was there a feeling that BEPS would not produce much of a result in relation to the relevant element of the international tax rules? Does the decision mean that BEPS will effectively be a failure? Is that the kind of world that we are looking at?

Some commentators have, as I am sure the Minister is aware, expressed cynicism about the motive for a unilateral move by the UK, and some have even suggested that it will torpedo the whole BEPS process, so that we get nowhere. I am interested to understand the conversations that the Government have had with people in the OECD and in the tax specialist community about where BEPS now stands.

[David Mowat]

I have been listening carefully to the hon. Lady’s points about international co-ordination. In the event of a Labour victory in the May election, what would its position be on UK tax havens such as Jersey, Guernsey and the Isle of Man? I thought that the hon. Member for Redcar (Ian Swales) made a powerful point about the 50% of schools in his constituency that are financed from Jersey. I would expect the Opposition to have developed some policy on that.

[Shabana Mahmood]

I am grateful to the hon. Gentleman for giving me the opportunity to highlight Labour policy in this debate. A few months ago, we published a paper on corporate taxation that included a section on the Crown dependencies and overseas territories. We have made the commitment that, if we win the general election, we will require the Crown dependencies and overseas territories to publish a public register of beneficial ownership. That is the key demand of all in the wider tax justice and fairness community, and it would shine a light on the true owners of businesses based in the Crown dependencies and overseas territories. The Government have spoken a great deal about doing something similar, but I think it is fair to say, without being party political, that progress has stalled. We have gone further by saying that we will ensure that that process happens. I have already taken the conversation forward with Ministers and other officials from the Crown dependencies and overseas territories.

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[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.