OIL EXTRACTION ACTIVITIES ETC.: CHARGES ON INCOME (Hansard, 19 March 1975)

§ Mr. Robert Sheldon
I beg to move Amendment No. 227, in page 20, line 25, leave out from 'shall' to 'have' in line 26.

§ Mr. Speaker
With this it will be convenient to take Government Amendments Nos. 229 and 228 and the following amendments:

§ Mr. Sheldon
The amendments are concerned with the allowance of interest, and they effect a major change. They introduce an important relaxation in the ring fence rules concerning the allowance of interest for corporation tax.
I said in Committee that there were two aspects with which I was concerned. One is the rule that interest paid shall not be allowable against North Sea income unless it is secured on North Sea assets. That rule is dropped. Secondly, the requirement that the borrowed money shall have been borrowed for the specific purpose of North Sea expenditure becomes a requirement that the borrowed money shall have been used, or appropriated to use, for North Sea purposes.
Then there is the interest paid to an associate, which will be allowable, whether or not matched by an external borrowing by the group, provided that it meets the test in the second requirement, and so far as it is not in excess of a reasonable commercial rate. Those are the important elements. I shall not go into detail, although I shall be happy to do so if required.
I shall comment on the final position as it will be if the amendment is accepted. The situation on payments of interest to associates is as follows. Without the Clause 13 rule for such payments, or some effective alternative, groups could, in effect, obtain relief for extraneous losses against an interest slice of their North Sea profits.
1795 Those who are interested in these matters will know that this has been one of the main points that concern us. We have not accepted the argument that this is right in principle. Without the Clause 13 rule, interest paid to overseas associates would normally escape the United Kingdom tax net under double taxation agreements. Although those amounts are large, it is a matter for argument whether this should be treated as a breach of the ring fence. This matter was not referred to by the Public Accounts Committee.
The existing rule in the clause for associates does not fit in with the changes which the Government are committed to make in the basic rule. An alternative to the present rule would cover group relief, though on somewhat broad-brush lines, but would let out the payments to overseas associates and therefore could be attacked as discriminatory.
In all the circumstances, we have decided that the only practicable course is to accept that interest paid by a North Sea company to an associate should be treated under the ring fence, as regards both payer and recipient, in the same way as interest paid to a non-associate, so far as it is paid at a reasonably commercial rate. I am sure the Opposition will welcome this move because it ties in with a number of points strongly made by the oil companies.
There are one or two other matters about which there is some concern and which I should seek to make clear. First, there is nothing to prevent a parent company—this is particularly important for overseas parents—putting minimum share capital and maximum loan capital into a subsidiary, so that virtually all its income from the subsidiary is taken in the form of interest payments. In view of the large amounts of money involved, we are reviewing the question to see whether it is appropriate to give companies the unfettered right to continue in this way. Although the basic rate income tax, deducted at source, will normally be charged on such interest, this does not fully compensate the Exchequer, with income tax at 33 per cent., for the corporation tax relief to the paying company at 52 per cent.
1796 Again, I wish to reserve the Government's right to review this matter.
The third point concerns arm's length lenders. This would normally require a North Sea company to repay the loans over a short period, often by reference to the rate of production of oil. An associated company, however, could leave the money on loan indefinitely to enable the group to keep a large slice of North Sea income outside the ring fence over an indefinite period. I should like to consider a rule which would deem such loans to be repaid over a normal commercial period. There is the risk that certain devices would be used to write up the loans from an associate to amounts far in excess of the actual North Sea expenditure, so that even with a "commercial" test for the rate of interest, the actual interest withdrawn from the ring fence could be inflated. Again. I wish to consider whether special measures are needed to prevent this happening.
Finally, I wish to deal with the detailed effect of this operation. Amendments No. 227 and 228 provide for the clause, as modified, to have effect only as regards such part of an accounting period as falls after 11 th July 1974, or a period falling wholly after that date. As the clause stands, it applies to the whole of any period straddling 11th July. We believe this to be appropriate as regards the starting date of the clause. We reject the view that it is retrospective to apply the clause, from the date of the White Paper, to payments made under existing agreements. We have made substantial relaxations in the clause and hope that the Opposition will not press their proposals.
I think I have given a fair indication of the way in which the clause operates as reconstructed, and I shall be happy to deal with any further points.

§ Mr. Patrick McNair-Wilson
This is a tremendous improvement in the situation. We made clear in Committee that Clause 13 should never have been included in the Bill as drafted. Therefore, it was refreshing to hear the Minister justifying the changes which we suggested should be made. He has met the points which we pressed in Committee. My only concern is that he has not been able to go the whole way.
1797 Subsection (4) sticks out like a sore thumb. If a company pays to an associated company a charge on income which does not consist of payment of interest, the charge will not be allowable. The Minister has tried to explain to us why that will be the case. If he is prepared to take the risk of changing the purpose for which the money is borrowed, why cannot he go the whole distance and tidy up subsection (4) as well?
Amendment No. 88 is substantial and important. The Minister should search his heart and decide whether he is not being over-suspicious. I recognise the difficulties which the Government have experienced throughout the debates on the Bill, and their terror of creating loopholes through which oil companies can climb. Since the Minister is prepared to go this far with Clause 13, I do not think he should worry about subsection (4). I think that Amendment No. 88 tidies up this clause finally and completely. Since the Minister has introduced an amendment to allow the deduction of interest paid to an associated company, why cannot he extend it to other charges?

§ Mr. Robert Sheldon
From time to time Finance Bills are brought before the House. If it were possible to extend the concession in the way proposed by the hon. Gentleman, we should be in a position to do so, but without any commitment.

§ Mr. McNair-Wilson
That is a step forward. I take it in the spirit in which it is meant. In view of the fact that all legislation has to be reviewed from time to time, we leave on record our determination that our amendment is the right one but do not press it to a Division.

§ Mr. Patrick Jenkin
I beg to move Amendment No. 89, in page 21, line 12, at end insert: ' (4) Nothing in this section shall have the effect of disallowing any charge on income under the said section 248 paid under an arrangement made before 19th November 1974. (5) Where any charge on income has been disallowed by virtue of the provisions of this section and the payment concerned would, but for this subsection, be treated as income subject to corporation tax in the hands of the recipient, then the payment shall not be treated as so subject'.

§ Mr. Robert Sheldon
I do not think that I have anything more to say about this matter, which I dealt with under the previous amendment, when I pointed out the nature of the concessions which had been made regarding the interest charge and the problem of accounting periods straddling that date.
1799 I pointed out that these were very valuable concessions, and I had hoped that the right hon. Gentleman would accept that they went a long way to meeting his points.