DOUBLE TAXATION RELIEF (Hansard, 21 July 1967)

§ The Financial Secretary to the Treasury (Mr. Niall MacDermot)
I beg to move, That an humble Address be presented to Her Majesty, praying that, on the ratification by the Grand Duchy of Luxembourg of the Convention set out in the Schedule to the Order entitled the Double Taxation Relief (Taxes on Income) (Luxembourg) Order 1967, a draft of which was laid before this House on 22nd June, an Order may be made in the form of that draft.

§ Mr. Speaker
It has been suggested to me that we should take the three Income Tax Orders together.

§ Mr. Patrick Jenkin (Wanstead and Woodford)
That would be convenient to this side of the House, Mr. Speaker.

§ Mr. Speaker
Thank you very much. If so, that is what we will do. The first Order will be moved and we will discuss the other two with it.

§ Mr. MacDermot
This Order relates to the new comprehensive Double Taxation Convention with Luxembourg which was signed in London on 24th May last and laid before the House on 22nd June. This is the first convention to be made between the two countries, and for those who are familiar with these conventions it will be at once apparent that it is based on the draft model convention 2701 drawn up by the Fiscal Committee of the O.E.C.D., and therefore follows closely the general pattern of other conventions recently concluded by this country and which the House has had the opportunity of debating. Perhaps for that reason it is not necessary for me to outline the provisions, which now follow familiar lines. But I should refer specifically to the provisions relating to the taxation of, and relief for, dividends, because they tend to vary in different agreements.
The rate of withholding tax which may be imposed in the source country on dividends paid to residents of the other country is not normally to exceed 15 per cent. for portfolio investment and 5 per cent. for direct investment. There is a similar 5 per cent. provision in relation to royalties. The agreement provides for a credit for underlying tax to be given in cases where the recipient of the dividend is a United Kingdom company which controls not less than 25 per cent. of the voting power of the paying company. In other words, there is a 25 per cent. test of control for that provision. Perhaps that is all I need say at this stage about the Luxembourg Order.
The South Africa Order relates to a Protocol which amends the Double Taxation Convention between the United Kingdom and the Republic of South Africa, which was signed in 1962. The Protocol was signed on 14th June last and laid before the House on 7th July. The Order concerning South-West Africa relates to an exchange of letters on 14th June in Cape Town, immediately after the signing of the Protocol. The substance of the letters is included in the Schedule to the draft Order, the effect of which is to extend the Portocol to South-West Africa.
The Orders deal only with double taxation relief in respect of dividends received from a South African or South-West African company by a United Kingdom resident. Our double taxation conventions generally need amendment to take account of the 1965 changes in our tax system, in particular, in relation to underlying tax, to withdraw the relief in the case portfolio investment and to define the circumstances in which relief is to be given for direct investment. It is with those matters that the Orders deal.
2702 Portfolio investors' relief is withdrawn, and on direct investment we have made clear from the outset that, subject to reciprocity, we are prepared to give relief where there is a 10 per cent. control by the recipient company. In the case of both South Africa and South-West Africa this reciprocity exists. It is provided because in both cases the general rule under their domestic laws is that dividends received by a company are not within the charge to the normal tax which is levied there.
Accordingly, the Protocol provides for credit for South African underlying tax where the recipient is a United Kingdom company which controls at least 10 per cent. of the voting power in the South Africa company paying the dividend. It is proposed that that shall similarly be extended to South-West African companies.
Article II ensures that the provision will not operate retrospectively. It will apply only to dividends payable after the date of entry into force and dividends payable on or before the date of entry into force which are chargeable to tax for a future tax year.

§ Mr. Patrick Jenkin (Wanstead and Woodford)
I am coming to the conclusion that the double tax Orders, are perhaps not among the most exciting matters which we debate here. We are reaching the 10th, 11th and 12th—or thereabouts—in the series, and the prospect of facing another 50 or 60 before this round of re-negotiations is completed fills me with the deepest gloom. But they must be dealt with, and we shall do so as briefly as we can.
However, I have a few points to raise. The hon. and learned Gentleman pointed out that the Luxembourg Order is based on the O.E.C.D. model Convention, and, indeed, it has followed it very closely, probably as closely as any we have yet had the pleasure of dealing with. This clearly demonstrates the value of the work of the O.E.C.D. in bringing common rules to a pattern of treaty negotiation which otherwise, because it is of necessity conducted on a bilateral basis, could give rise to enormous variations and complications.
The hon. and learned Gentleman mentioned Article X of the Luxembourg 2703 Order, dealing with dividends. It exactly follows the O.E.C.D. model, with its discrimination in the withholding tax between direct and portfolio investment, with the maximum of 5 per cent. for direct investment and 15 per cent. in the case of portfolio.
In Article XXV we see one of the lacunas of the O.E.C.D. Convention. The problem of a common pattern for giving relief for underlying tax was clearly one of the matters on which the members of the O.E.C.D. were unable to reach agreement. The commentary on Article 23 of the model convention, which deals with the special credit in respect of dividends, says in paragraph 52: Certain States wishing to apply the credit method allow in their Conventions, in respect of dividends received from companies in other States, credit, not only for the amount of tax directly levied on the dividends in those other States, but also for that part of the companies' tax which is appropriate to the dividends. Member States applying this method are left free to do so. The hon. and learned Gentleman has explained that as a result of a change to the Corporation Tax the Government have found it necessary to withdraw the relief for underlying tax from portfolio investment, though they still allow some relief for such tax on direct investment. We have been over this matter a number of times, but one question arises. The usual pattern which appears to be developing in the Conventions in which this country is concerned is that there is no relief for underlying tax on portfolio investments.
Where there is a direct investment in the Commonwealth, whether or not there is a treaty the test of direct investment is a 10 per cent. holding. Where there is a treaty, it has almost always been possible to negotiate that for the direct investment the test should be a 10 per cent. holding. It is only where there is a non-treaty relief for a non-Commonwealth country that the fall-back position, as it were, the least favourable test, is applied—the test of a 25 per cent. holding in the company in the other country.
But here we have a Luxembourg Treaty that the Government have been able to negotiate only for a 25 per cent. holding. I should be grateful if the Financial Secretary could explain why it is thus necessary to treat a United Kingdom direct 2704 investor in Luxembourg less favourably than he appears to be treated in other European countries where the 10 per cent. rule applies. That is to say, there will be a number of investments in Luxembourg which would have been regarded as direct if made in France or Germany but because they are made in Luxembourg they will be treated as portfolio investment because the holdings will be less than 25 per cent.
The Orders in respect of South Africa and South-West Africa are very much more limited and deal only with what the Financial Secretary said in earlier debates is the limited alteration necessary to bring the Conventions into harmony with our new tax system. Here we deal with disallowance of credit for underlying tax in portfolio investment. I imagine they here apply the mirror image provisions of Section 31 of the Finance Act, 1966, in that deductions shall be allowed from a dividend paid abroad only to the extent that the foreign company would be allowed to deduct on a dividend paid from that territory to this one.
In the case of South Africa this is an unusual provision. The distinction between direct investment and portfolio investment is that the test of withholding tax credit is not a 10 per cent. or a 25 per cent. but a 50 per cent. holding. Under the South African law investment is regarded as direct investment in connection with the rate of withholding tax if it is a 50 per cent. holding or more. This seems to give rise to very much complication which will apply in reverse to British investment in South Africa. So where a company has a holding of less than 10 per cent. of the share capital of the South African company, there will be no relief from underlying taxes and the rate of withholding will be 50 per cent. Where the share is 10 per cent. or up to 50 per cent. there will be relief from underlying taxes, but the 15 per cent. rate of withholding of tax will apply. It is only if the share is more than 50 per cent. that one gets the full rates.
This appears to add an unnecessary complication and an unnecessary additional consideration which British investors in South Africa will have to consider before they decide what share of the investment to take. This seems to be unduly complicated. I hope that this will not be a permanent arrangement 2705 and that we shall not have to find ourselves dealing permanently with two different tests of direct investment, one for deciding the rate of withholding tax and the other for deciding whether the underlying tax will or will not be levied.
Apart from those remarks, we welcome the Orders. If the Financial Secretary can answer our points I think that we can let them go unopposed.

§ Mr. MacDermot
If I may, with permission, speak again, I agree with the hon. Member for Wanstead and Woodford (Mr. Patrick Jenkin) that these are not among the most exciting matters that we debate in Parliament. If the prospect of a substantial number more of the Orders to come daunts him somewhat, I can only promise him that we will see that they do not come as single spies.
I agree with the hon. Gentleman's remarks about the value of the O.E.C.D. model convention, which is fully demonstrated in the case of the Luxembourg Agreement. There is no doubt that it has greatly facilitated negotiations in this field.
With regard to the question about the test of 25 per cent. control in connection with the Luxembourg agreement, the hon. Gentleman stated the position correctly, which is that we are prepared in the case of non-Commonwealth countries to accept a 10 per cent. control where reciprocity is offered. But I am afraid that the answer is that it was not offered in this case. That is the reason why there is the 25 per cent. test.
With regard to the South African agreement and the question of the test of 50 per cent. control in relation to withholding tax, the hon. Gentleman is right in saying that this is the reflection that we received in applying the mirror image provisions. What he specifically asked was whether he could hope that this would 2706 not be a permanent provision. This is a matter for negotiation. This is only an interim agreement dealing with the immediate interim situation. I can assure the hon. Gentleman that when the time comes to re-negotiate fully the agreement, as I think must happen before too long, we shall bear in mind the points that he has made and seek to negotiate provisions which would be more in conformity with some of the other agreements that we have.
I am grateful to the hon. Gentleman for the welcome that he has offered in general to the Orders.