HC Deb 09 July 1985 vol 82 cc1015-35

5.—(1) In this Schedule and section [Withdrawal of right of certain non-resident companies to payment of tax credits] of this Act—

(2) For the purposes of this Schedule and section [Withdrawal of right of certain non-resident companies to payment of tax credits] of this Act—

  1. (a) section 533 of the Taxes Act (connected persons) applies; and
  2. (b) section 302 of the Taxes Act (meaning of "associated company" and "control") applies with the substitution of the words "six years" for "one year" in subsection (1) of that section.'.

Mr. Grylls

The clause stands in my name and those of 100 hon. Members in all parts of the House.

No doubt to some observers it will appear ironic that an early-day motion calling for action to change the corporate tax system in California, Alaska, Idaho, Montana, New Hampshire and north Dakota has attracted the support of 250 hon. Members on both sides of the House over the past few months. Such is not normally the stuff of politics here in Westminster. Although it may appear ironic, the reality is—I think that the House will agree with this — that the universally deplored, worldwide reporting system applied in those states to foreign multinationals is a potential time bomb ticking away under international trade and investment.

I hope that the new clause, which I commend to the House, will succeed in persuading United States companies to press and lobby hard their state governments and federal Government to remove that time bomb once and for all and clear up the issue of unitary tax. It has been a tremendous encouragement to me, in the preparation that I and many others have done for the new clause, to have the support of all parties in the matter, particularly because it affects trade and investment. With the high unemployment throughout the world it is a crazy time to have taxation that threatens jobs and investment.

It is important for the House to realise that worldwide the United Kingdom is second only to the United States in the amount of its overseas investments. Within the United States, British companies invest more than any other foreign multinational. Therefore, many British companies with the United States operations are at risk from the state corporate tax system. This is the important point that the House will want to grasp. The system reaches out beyond the shores of the United States to include the worldwide financial operations of a United Kingdom multinational group, although that has no conceivable relevance to the group's activities in the United States, and in that state in the United States.

That reporting system makes a nightmare of business planning and investment by multinationals, by creating uncertainty as to the tax due in a state such as California. I ask the House to consider the situation in a London headquarters company with a subsidiary in California, which is therefore subject to Californian unitary tax. That subsidiary in California cannot kno its tax liability without supplying the state authorities with such details as payroll, property and equipment in every other country throughout the world in which that British multinational operates.

The House may be interested to have an example, which brings the matter home. It is the case, which has been well written up, of the subsidiary of the EMI group, Capitol Records. It is in California, and now part of the Thorn EMI group. The Capitol Records subsidiary was asked to provide information on a worldwide reporting basis. It sent that request from the Californian state authorities to its headquarters in London, which wrote to the Californian state authorities saying, "We would love to give you this information, and would normally be happy to do so, but we happen to be a defence contractor for Her Majesty's Government, and we have signed the Official Secrets Act. If we give you this information, we shall be put in prison, so we shall not do it, even for the Californian tax authorities." The company then suffered a 25 per cent. penalty clause for non-disclosure of information from London and other parts of the world. That illustrates the unpredictability and irrationality of such taxation.

The sheer unpredictability and illogicality of such a method of tax assessment threatens investment and trade. Above all, it strikes a blow at the internationally accepted principles of taxation by creating tax liabilities in a state which bear no direct relation to profits earned in that state. For the purposes of state taxation, the method can turn a company's loss in a state into a profit by bringing in the worldwide figures. Perhaps more seriously, it burdens companies with the unproductive work of creating and producing information and translating it into dollars from the foreign currencies in which those subsidiary companies operate. That is not sensible. An example of this is that the worldwide accounts of companies must be recomputed in dollar terms and must conform to American accounting standards. That is especially offensive when a state—a political subdivision of a nation—attempts to carry out what is, in effect, foreign policy. I am sure that those who created the constitution of the United States did not intend that the individual states should carry out foreign policy by asking for information in that way.

To draw an analogy closer to home, it is as though Lambeth borough council asked for worldwide information from an American company whose United Kingdom subsidiary was based in Lambeth. That would be an impertinence and an abuse of the powers of Lambeth borough council. I am sure that it would do no such thing. That is comparable with what is happening in some American states. It runs counter to all the work that has been done. Through double taxation treaties, the United States and Britain have worked for many years to eliminate barriers to trade and investment, which were created, understandably, by the variety of tax systems in the world. The arms-length system of taxation embodied in our treaty network and that of the United States is the international standard and the custom of nations. It is recognised by the OECD and by the United Nations. The use of the worldwide reporting system violates that standard.

I should run through what has happened since the United Kingdom-United States treaty was being negotiated in 1975, because the history of what happened is the basis of new clause 27. When the current treaty was being negotiated in 1975, it contained a clause—clause 9(4)—which would effectively have barred unitary tax. That would have been fine. Unfortunately, although clause 9(4) was passed by a majority in the Senate, it was not passed by the necessary two thirds majority, and it failed. By this American action, Britain was placed in the position of either rejecting the entire treaty — some would describe that as throwing out the baby with the bathwater — or of accepting it without clause 9(4). The House, rightly, accepted the treaty, subject to assurances from Ministers that they would press for an early resolution of the issue, backed by assurances from the United States that it would use its best endeavours to secure an early solution.

On 18 February 1980, the then Minister of State—my right hon. and learned Friend the present Chief Secretary—said: To those who remain concerned about the unitary question, I say that there is no disposition on the pan of the Government to let the issue die. If the House approves the convention and if it is ratified thereafter, we shall be prepared to place on record, for all to see, our reservations on the unitary system. The Administration of the United States were left in no doubt by what I told them … We do not propose to bury the issue if the House gives its approval to the convention and the three protocols."—[Official Report, 18 February 1980; Vol. 979, c. 179–99.] When ratification took place on 25 March 1980 — entering into force on 25 April 1980 — the British Government expressed to the United States Administration strong disapproval of the worldwide combined reporting system. In a note to the United States Administration, the Government said: It must be emphasised however that the acceptance of the Senate reservation"— taking out clause 9(4)— in no way implies approval of the unitary basis and that it is the urgent request of Her Majesty's Government for the reasons given above that the Government of the United States should use its best endeavours to eliminate the international application of the unitary basis of taxation". United States' companies received substantial tax concessions as a result of the treaty in return for the inclusion of clause 9(4) prohibiting the use of unitary tax. Clause 9(4) was to be, in the words of the then Senator Morgan, who participated in that debate in the Senate, a concession for a concession". I believe that in 1980 the House would not have ratified the treaty without United States' assurances that the unitary tax problem would be solved.

Since 1980 there have been various attempts in the United States Congress, as my colleagues who visit the United States regularly will know, to put through a Bill outlawing unitary tax. It is odd that, despite general antipathy in Washington towards this unfair system, so far none of these Bills has succeeded in being passed. It seems that, whenever a Bill has approached the winning post, another general election has been called, and the whole process has had to start again. I suppose that we hale the same problem here. During this period the United Kingdom Government and many other Governments have pressed vigorously for an end to this perverse system.

I should like to pay a warm tribute to the staff of the British embassy in Washington who, over these five or seven years, have worked hard to resolve this issue. I pay particular tribute to the Economic Secretary in the embassy, Mr. Harry Walsh, who has just returned to London. He had become one of the great experts there. He slaved away on this issue and worked tirelessly to produce a solution. I should like to thank the British consulates at the state level which have negotiated and done what they can. I pay tribute also to Treasury Ministers and their officials in the United Kingdom, in the Foreign and Commonwealth Office and especially in the Inland Revenue, who have borne the burden of this continuing problem.

Two years ago, on 12 July 1983, my right hon. Friend the Chancellor in a letter to the then Treasury Secretary, Donald Regan, said that he was keen for the matter to be resolved … before harm is done between our two countries. I emphasise that quotation, because hon. Members and all the British people do not want in any way to damage our relations with our strongest and, perhaps, favourite ally. I think that my right hon. Friend the Chancellor had that point very much in mind. However, the problem has not been resolved.

In September 1983 President Reagan set up a working group to look into the problem. The Prime Minister, who was visiting Washington at that time, chivvied the President to resolve the issue and, with commendable farsightedness, warned the Administration: We might be under very severe pressure to take retaliatory action. Two years later we find ourselves having to do just that.

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I pay tribute also to the efforts of my right hon. Friend the Secretary of State for Trade and Industry. He lobbied for industry during his recent visit to California and I know that that was helpful.

By the autumn of 1983, despite all the efforts that had been made, three years had passed and the promises of 1980, which I have quoted, to resolve the issue had not been met. Frustration and impatience were being expressed in Westminster and British firms were becoming increasingly caught up in a tax nightmare. I hope that the House will feel strongly that it is our duty and that of the Government to protect the interests of individuals travelling abroad and those of companies that operate abroad.

In April 1984, seven months later, there were no signs of progress from the United States working group. I went to Washington to announce details of a retaliatory clause that we had tabled last year. The clause had the support of many of my hon. Friends. Unfortunately, and I believe mistakenly, the Government refused to back the clause and to have a debate last summer, almost precisely at this time of year. They claimed that it was premature to retaliate.

There is no doubt that the tabling of the clause in 1984 alerted United States opinion to the real possibility of legislation being enacted in Westminster to retaliate against them. As a result of publishing the clause last year, there was evidence of fresh activity in the United States against the continuation of unitary tax. There were clear signs of United States companies working hard to get rid of it.

When the clause was not inserted in the Finance Bill 1984, it seemed that United States corporations saw that the threat of retaliatory action had receded. Later in 1984, the working group reported. It recommended what it described as a "water's edge" solution. At that time the United States Treasury Secretary wrote to the President as follows: If there are not sufficient signs of appreciable progress by the States in this area by 31st July next year whether by legislation of administrative action, I will recommend to you that the Administration propose federal legislation that would give effect to a water's edge limitation patterned after that in the Chairman's Report. That was the result of the working group's activity.

I pay tribute to the states that have repealed their unitary tax provisions since then — including Oregon, Florida and Colorado—but it is important that during the debate the United States Administration is left in no doubt that the House does not regard the action by those states as being enough to constitute "appreciable progress" in removing unitary tax and that it does not constitute a real solution to the problem. It is not our job to pick off states one by one.

The problem will not be met until California and the other five unitary states have passed satisfactory legislation, or until the federal Administration has produced a solution that will stand for the whole United States. In many ways a federal solution would be the best one.

Over the past year, attempts — unfortunately all in vain so far — have been made in Sacramento, the state capital of California — to progress legislation on unitary tax. I am grateful to the governor of California for the personal efforts that he has made to seek a solution to the unitary tax problem. Only two weeks ago I went to California to see what progress was being made and, perhaps more importantly, to express the continuing anger and frustration of many in the House and in British industry that so little progress had been made.

United States business men whom I met, and Japanese business men, all told me that they wanted a solution to the problem. That view is shared by our European Community partners, especially the Netherlands, France and Germany, and by Japan, Canada and Switzerland. However, satisfactory legislation in one form or another still eludes us seven years after the treaty was signed and after assurances were given to the House of Commons. This House, which has been patient almost to a fault during that period, can no longer wring its hands and hope that something will be done. The time for action has come. We must apply leverage on the United States to secure a complete, satisfactory and final solution to this irritating problem. That is the reason for new clause 27.

Since the first retaliatory clause was tabled in 1984, extensive consultations have taken place with business and lawyers to try to provide in this new retaliatory clause a greater element of flexibility for the Government when deciding how widespread the United Kingdom countermeasures should be. When it is triggered by statutory instrument, the clause would withdraw payments of tax credits to United States companies with a substantial business presence in unitary tax states — for example, California.

There are three options. Depending upon which of the three options the Government choose, the trigger will affect United States companies in the United Kingdom which have 7.5 per cent. or more of their property, payroll or sales in a unitary tax state, or which are subject to tax on income in a unitary tax state, or which have their principal place of business in a unitary tax state. Those are the three triggers that the Government will have at their disposal if the House decides to accept the new clause. My hon. Friend the Member for Tatton (Mr. Hamilton), who is a very experienced lawyer, has been working with me on this new clause. He will expand a little further, if he catches your eye, Mr. Deputy Speaker, on the details.

The House will want to know what advice those hon. Members who have sponsored the new clause will be giving to the Government about when they should activate one of the three triggers. Such a decision will not be easy for my right hon. Friend the Chancellor of the Exchequer and his colleagues in Government. I pay tribute to them for having expressed considerable sympathy for the clause and for enabling this debate to take place. Rather like marriage, retaliation against a friend and ally is not something to be entered into lightly.

We must all hope that if this new clause is passed it will succeed in inspiring action in California and the other sunitary tax states during the remaining few weeks of the 1985 legislative session. We must also hope that it will inspire action in Washington and that they will lobby the federal Government to use their influence to solve this problem. If they do not, I hope that my right hon. Friend the Chancellor of the Exchequer will not flinch from pulling a trigger which will hit United States companies where it hurts: on their bottom line. That would produce a response.

If the new clause is successful in motivating the United States Administration, the states and business to secure a solution to this problem, the trigger could be released just as quickly as it had been pressed.

I pay tribute to the determination of the 50 companies which some years ago formed themselves into the unitary tax campaign which has worked very hard to solve this problem. A number of the companies benefit from the application of unitary tax. Despite that, they believe that the principle is wrong and they vigorously oppose it. I pay tribute to them for their stand. I pay tribute also to the chairman of the unitary tax campaign, Mr. Peter Welch, and to Professor Peter Whiteman, QC, a highly skilled lawyer who has helped us to draft the new clause. If the new clause is accepted, the House will owe him a great debt. The CBI, too, should be praised for its action in sending a mission earlier this year to California.

Although I have criticised the Government for resisting the pressure for retaliation in 1984, I am the first to say that the Government, including the Chancellor, the Foreign Secretary and the Financial Secretary, have shown admirable resolution and determination in pressing for a solution to the problem. I hope that the House will approve the new clause and that the Financial Secretary will agree that the time has come to put these powers on to the statute book.

Dr. Marek

I was interested in the remarks of the hon. Member fo Surrey, North-West (Mr. Grylls) and to hear the long roll call of people who have been involved in the campaign and the various actions that they had taken to arrive at the position which we are discussing tonight.

However, missing from the hon. Gentleman's comments was any justification from the point of view of, say, California as to why that state felt that it had no option other than to institute unitary taxation. The hon. Gentleman said that such taxation could, in a particular example, change a loss into a profit. That may be so from an examination of the company's books, but it may not be so from a careful examination of whether transfer pricing between different parts of the company — remembering that we are talking about multinationals — has taken place between one country and another. That is the problem facing us as we consider the new clause.

Companies do not have a code of morality and say, "We honestly believe that we made 20 per cent. of our profits as a multinational in the United Kingdom, so we will pay 20 per cent. of the tax to the UK, and the respective rates of tax in all the countries in which we operate." Multinationals will, by and large, try to minimise the tax that they pay worldwide, and rightly so. If, say, in California wage rates, land taxes or whatever are high, multinationals will minimise the tax that they pay in California and maximise the tax that they pay in, say, Taiwan and Korea. The same is true of multinationals based and registered in this country.

For a company that is based in this country and has much of its business in America, it gets caught by way of unitary taxation, and there is a real problem for such companies. There is an inherent unfairness in a system by which some states apply the normal code of taxation and others apply unitary taxation because, in effect, that creates double taxation, and that hits particularly hard those companies whcih are registered in, say, the UK but have a substantial trading interest in a country which applies unitary taxation, such as California. It is clear, therefore, that the system is not fair. For that reason I hope that the new clause will be accepted.

However, price fixing and transfer pricing by multinational companies operates not to the benefit of this country. It is not to the benefit of this country. Having said that, I do not think that affects the issue of unitary taxation. It ought to be looked at but not now.

I wish the new clause well. We cannot have two systems working side by side. We will either have to have one or the other. We do not have unitary taxation, there is no prospect of it coming, therefore it is sensible to see if we can get rid of it.

12.30 am
Sir Eldon Griffiths (Bury St. Edmunds)

I very rarely speak in finance debates. I am quite sure that the rule of the road should be brevity, but I have perhaps some small credentials to speak in this matter because I have spent virtually the whole of my political and personal life as a devotee of the United States. I went to college there. I earned my living there for some 17 years. I bought my first house there. I was married there. I have a son there who is a banker. I am a director of two American companies. I visit the United States many times each year and I have the honour of representing, indirectly no doubt, some 23,000 American airmen who have the good fortune to be stationed in my constituency. So I make no bones about it. The United States is my second home, and my dearest wish in politics is that the Anglo-American alliance shall continue to be the bulwark of freedom and prosperity in the western world.

But there is one thing that I have never been able to stand when it comes from the United States and that is the attempt occasionally to export American policies beyond the water's edge and to impose them on other people. They tried that at the federal level in respect of the Soviet population and certain states, those named by my hon. Friend the Member for Surrey, North-West (Mr. Grylls) in particular, California, have been seeking to do so for a number of years in respect of unitary taxation. It is a subject that my hon. Friend dealt with copiously and clearly. There is not much more I need to say about it. But I have discussed this matter with American bankers, businessmen and politicians these 10 years and there is general agreement among those who care for the maximising of trade between the two sides of the Atlantic and indeed between the two sides of the Pacific that unitary tax is bad for business, bad for trade and bad for our relations and the United States ought to get rid of it.

As my hon. Friend has said, over the years we have tried virtually every which way, if I can use an Americanism. We have tried the legal route and got nowhere. We have tried the congressional route and got nowhere. We have tried the lobbying route through American businesses, banks and exporters and again we have failed. Consequently we are driven, reluctantly, to the retaliatory route. I, for one, always hoped that it would not be necessary that we should ever come to a point where it would be the duty, as I see it, of Parliament to put into the hands of Government the means of retaliating against the United States in this particular area, but as a friend of America I believe we now have no choice left.

I would simply, if I may, in supporting this clause, make these few simple points. There is nothing to be said in favour of unitary tax. It flies in the face of the broad movement towards the liberalisation of world trade. It is contrary to the declared policy of successive American Administrations, Democrat as well as Republican. It is damaging to the best interests of United States business abroad and it is worth saying that the third industrial power in the world, after the United States and Japan, is not the Soviet Union. It is not the Federal Republic of Germany. It is American industry abroad and it is contrary to the best interests of that industry that this tax should continue.

I hope that the federal Government will screw up their courage and find the time and the persistence to get rid of it at the federal level. I suggest to my hon. Friend the Financial Secretary, whose diligence in this matter I admire, that he should not only accept this clause when the House comes to consider it but that he should go further. He must bring this point home to the United States. He can do it in four ways.

First, there are now some 5,000 American lawyers in London. They will shortly be in Westminster Hall. It is important that not one of those lawyers should leave London without knowing how the British Government feel about unitary taxation. Secondly, he should ask representatives of all substantial Anerican multinationals headquartered in London to come to the Treasury and to hear, from Ministers if possible, but if not from senior officials, that we mean business in this matter. The more of those representatives that are told precisely what the feelings of the House are, the better it will be.

Thirdly, it is enormously important to strengthen British representation in California. I have many times said in the House that the Foreign Office's judgment of America is faulty. I have lived there long enough to know that that is so. There should be a strengthening of our representation on the west coast of America, even if it means some reduction of our representation on the east coast. The consulate in Los Angeles is inadequately staffed, and it is important to increase that staff, if only to get this point across.

Finally, I suggest to my hon. Friend the Financial Secretary that he seriously considers putting full page advertisements in the New York Times, the Washington Post, the Wall Street Journal Europe and, above all, the Los Angeles Times, explaining very carefully that the best allies of America and some of the closest friends of California have said in the House of Commons that we cannot tolerate any longer the discrimination that this unitary tax imposes on us, and we expect them to get rid of it. The more that that can be put in the major national newspapers—television would follow — the more that it will be brought home. The matter can be resolved if the Government will follow what the House has started tonight.

Mr. Blair

The hon. Member for Surrey, North-West (Mr. Grylls) has been admirably clear and thorough in his presentation of the new clause, and I can therefore be brief.

The major employer in my constituency is Thorn EMI and, therefore, I am aware of the problems of unitary taxation. There is no doubt that it adversely affects United Kingdom companies. I agree with the general aims of the unitary tax campaign, and the Labour party will support the new clause.

However, we should appreciate the seriousness of what we are contemplating, and examine the drafting and timing of the new clause. We should also reflect on the frustration that has given rise to it, because we are taking a serious step.

It is essential to remember that the new clause is not proposing to cure unitary taxation, because we cannot do that, but is a retaliation against it. It is important that that point is made, because it emphasises that we are not taking this step lightly, but after a due consideration of the difficulties.

One can understand how unitary taxation came about. It began in California before the second world war, mainly as a result of the activities of certain movie companies sending earnings abroad. In California, the spirit behind the tax was, quite properly, to prevent creative international accounting. Unfortunately, California introduced unitary taxation, whereas most other countries attempted to have transfer pricing arrangements, as we do. They are particularly difficult. When considering these factors, one is considering activities within a particular state as well as worldwide.

California remains the main state of difficulty, and I understand from an article in the Financial Times that getting on for two-thirds of the revenue raised from unitary taxation is raised in that state. The main problem for United Kingdom companies is the enormous compliance costs involved in the unitary taxation system. These result not just in the specific problems that the hon. Member for Surrey, North-West referred to, because another difficulty is the sheer scale of the information that has to be given in order for the unitary taxation rules to be applied. He quite rightly went through the problems that have arisen since the 1975 double taxation agreement.

There are difficulties in connection with the United States Federal Government. One understands in particular the sensitivity of states over Federal Government interference in state activities and state prerogatives. The Federal Government have shown a certain sensitivity over this, or at least that has been the stated reason for slow progress, but the Federal Government must make far greater use of the opportunity they have to bring pressure to bear on the states to change.

Two events which occurred in 1983 are worth mentioning. First of all, there was the decision in the Container Corporation case, where the Supreme Court of the United States determined that unitary taxation was not outlawed by the constitution. But that was a majority decision with a strong dissent, and the United States Justice Department was not briefed to appear in that case but attempted to appear after it ended. The commission set up by Secretary Regan, which reported in July 1984, looked at the matter in a certain way. In particular, it recommended that unitary taxation should be restricted to the water's edge; in other words, confined to taxing as a unit a company's activities within the United States.

According to the Unitary Taxation Campaign, there are still nine states with unitary taxation, which means that they go across the water's edge. There seems to be some disagreement as to the precise number of states. Some Treasury Ministers put the figure at six and the Library told me it was seven. Perhaps the Financial Secretary could elucidate on that. When the Regan commission reported, it set a deadline of 31 July 1985 for the states to take action on unitary taxation. That deadline is fairly close now, and I hope that this new clause, if it is passed, will give the Government a negotiating weapon. It will be a sign of our seriousness of intent to allow the federal and state governments to recognise exactly what we are contemplating.

The new clause meets the injustice of unitary taxation with the fairly rough justice of retaliation. Were a state to be designated by an Order of the House, any company with a qualifying presence within that state would not be able to claim back the refund of ACT under the double taxation treaty. That is a fairly heavy penalty for those companies with a qualifying presence in that state to bear. One hopes that that will encourage them to put pressure on their own state Governments to change their attitude towards unitary taxation.

It is right that the House will have to approve an order before the new clause can come into operation. We are expressing the seriousness of our concern, but we are saying, "We do not want to go all the way until they have had another chance to put their house in order." The new clause will force the pace towards abolition of unitary taxation.

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The British Insurance Association and a number of insurance companies are worried about the difficulties that could arise for them if the new clause is implemented. I should like an assurance from the Financial Secretary that their representations would be taken into account before it was decided to put an order before the House.

It is important that the new clause has all-party support and that the House is united in identifying the problem and in its desire to ensure that discrimination against British companies is prevented. If it is felt that an order should be put before us—we hope that the need for that will not arise — it would he wise for the Opposition to be kept fully informed of the state of play, so that the all-party support can be retained. It is important that we should act as one.

The issue is important to British firms. We hope that the United States Government and the state governments will note the strong feeling of both sides of the House and will act voluntarily, rather than wait for the threat of retaliation to become actuality.

Sir William Clark

I support my hon. Friend the Member for Surrey, North-West (Mr. Grylls). Like him, I have been battling for years against unitary taxation.

I wholeheartedly agree with the hon. Member for Sedgefield (Mr. Blair) that it is a great boost to our battle that the new clause has all-party support. The Financial Secretary would be wise to note the comments of the hon. Member and to stress to the United States Government that we are not making party points.

I am sorry that the hon. Member for Wrexham (Dr. Marek) brought in multinational companies. We do not want to complicate the issue. We are talking about unitary tax and that has nothing to do with multinational companies.

The hon. Member for Sedgefield mentioned the worries of the British Insurance Association. It fears that if we take action against the United States the fourth convention will be cancelled. I cannot envisage that happening. The fears of the BIA are unfounded.

We are talking about an iniquitous tax which is anti-investment in the United States. We have well over $30 billion of investment abroad. As my hon. Friend the Member for Surrey, North-West said in a speech which everyone has commended for its clarity and lucidity, British companies own well over 20 per cent. of all foreign investment in the United States.

When I was in Washington before the presidential election I met Mr. McClure, the chairman of the working party set up by the President, and I told him in no uncertain terms what Back Benchers on both sides of the House thought of unitary tax. I warned him — and I am glad that the Prime Minister said much the same thing to the President — that pressure from both sets of Back Benches would be such that our Government would have to give way eventually, whether on the next Budget or the one after that.

Here we are at the next Budget. The United States has not taken on board what unitary tax could lead to. There is a great deal of British and American investment in Third-world countries. If any country thinks it legitimate and good business to have unitary tax, it would be disastrous for overseas investment for both the United Kingdom and the United States. I accept that this is retaliatory action. We can control only what we control, and we control only advanced corporation tax. That means on a £100 gross dividend that instead of an American investor receiving £85, in future he will receive only £70 because he will not get the 50 per cent. reduction in ACT. That should be pressed home because the latest figures show that the ACT concession for the United States is well above £300 million. If American companies, which invest in the United Kingdom and receive British dividends, realise that their income is at risk, the Federal Government may come under more domestic pressure.

I recognise that the Federal Government have difficulties in that the states are autonomous. On the other hand, if we had inserted the clause about outlawing unitary tax in 1975, it would have been mandatory on all the states because the sovereignty of the Federal Government in Washington means that they can sign an international agreement which binds all the states.

We must bring pressure to bear on the Washington Government to end this iniquity. We are approaching 31 July and we cannot allow the present position to continue. I earnestly hope that my hon. Friend the Financial Secretary will accept the clause, and that he and the Chancellor of the Exchequer will trigger off the three points made by my hon. Friend the Member for Surrey, North-West. That is the only way to bring home to the Americans that we mean business and that unitary tax must cease.

Mr. Pike

I shall speak only briefly, because the hon. Member for Surrey, North-West (Mr. Grylls) argued the case well, and my hon. Friend the Member for Sedgefield (Mr. Blair) made the points that I intended to make. I support the new clause because it takes the right line. It is unfortunate that the line that the Government have pursued for many years has been unsuccessful in achieving the result for which we have wished. If the Government accept the amendment and it is carried, I hope that it will not be necessary to trigger the lines of action proposed in the clause, and that the Government will not find it necessary to return to the House for an order to take retaliatory action. I hope that California and the Federal Government realise that we mean business and that we intend to ensure free trade.

My hon. Friend the Member for Wrexham (Dr. Marek) referred to multinational companies, but the hon. Member for Croydon, South (Sir W. Clark) took his comments out of context. The new clause has all-party support, as has the early-day motion, in spite of doubts among my right hon. and hon. Friends about multinationals.

I have some doubts and fears about multinationals, but I recognise the importance of the taxation rather than the trade issue. It is significant that, despite fears and worries, Opposition Members are prepared to support the early-day motion and the new clause. I hope that the new clause is accepted and that it is not necessary to trigger the orders. I hope that the California authorities in particular will wake up and realise that we mean business. The House as a whole is saying that if they do not, we shall, unfortunately, have to retaliate. We hope that we do not have to take that action.

Mr. Neil Hamilton

I have a small qualification to take part in the debate because, when the double tax treaty was about to be ratified back in 1979, I wrote a book on the topic — one of the few ways in which members of the Bar can draw their presence to the attention of solicitors. A few hundred copies of the book survive and can be obtained at discount rates. I never quite made the Jeffrey Archer class, so I never needed to take advantage of the provisions of the double tax treaty in relation to the international earnings which I received from that book.

The topic has concerned British industry for a long time, so it is important to examine the way in which the clause is drafted and to discover why particular words are used rather than the alternatives which might have been used. It is important to recognise that this is merely enabling legislation which might never be used if the appropriate remedial action is taken.

As my hon. Friend the Member for Croydon, South (Sir W. Clark) said, the financial consequences of the new clause would be severe for many companies if we had to activate its provisions. It would deny tax credit equivalent to £15 on a £100 dividend to the parent company in the United States which would otherwise benefit from the repatriation of profits from United Kingdom subsidiaries.

The companies affected are those which have a substantial presence in the unitary tax state which operates the worldwide combined reporting system. The qualifying presence is defined as applying to a United Kingdom subsidiary which is a member of a group which has 7.5 per cent. or more of its property payroll or sales in a unitary tax state. That formula is used deliberately, because it is that which is used in the unitary tax states themselves and will therefore be familiar to companies operating there.

It is important to know that the terms property payroll or sales are disjunctive and not conjunctive and therefore that, if any one of them gives rise to the 7.5 per cent. trigger, the clause will affect all the companies which operate in that state. This is important to United States corporations because they already have to compile the information for state taxes. It is therefore available and will not involve any extra administrative costs to provide it to the Inland Revenue.

The 7.5 per cent. test could have been applied to income and we could have given ourselves extra test, but we decided to reject that because conceptual problems might otherwise have arisen — such as whether we should choose gross or net income and whether it should be income for United States tax purposes or for the tax purposes of some other jurisdiction. It seemed much simpler to restrict ourselves to the tried and tested formula of the unitary tax states.

Why have we chosen 7.5 per cent.? Many right hon. and hon. Members have said that the main problem is California. I am convinced that, if California takes the lead in getting rid of unitary tax, the other states will follow. California accounts for about 12.5 per cent. of American gross domestic product. That means that most American companies might come into the net if we have to activate new clause 27. Although, on that basis, the average company would have 12.5 per cent. of its assets in California, the figure pitched that high would have left many companies out of the net. We considered that the same was true for 10 per cent., so the next logical step seemed 7.5 per cent.

Why did we not go lower? In this respect, the other states that apply income tax come into play. The other states are small and there are few companies in the United States that would have more than 7.5 per cent. of their profit, payroll or sales in a state such as North Dakota. It seems that 7.5 per cent. is adequate to catch enough companies in California so that pressure can be put on the state legislature to remove the unitary tax provisions. If California repeals, the effect of the new clause is spent. Some states are not as legislatively busy as the rest of us. North Dakota, for example, has a lively system — its state legislature does not meet at all next year so, without a special session, it will be unable to conform to the new clause.

The onus of proof of entitlement to the tax credit for a company that would otherwise be caught by the new clause lies on the company, not the Inland Revenue. That means that the company must prove that it is not in the unitary tax net. It is not for the Revenue to dispute with the company its coming within the ambit of the clause, but for the company to prove that it can take advantage of the double tax treaty.

The Treasury should act early or, once again, people in California will assume that we are not serious and that this is just so much huffing and puffing. I do not think that the consequences that have been feared would necessarily follow from early action. Under subsection (7)(a), the orders that the Treasury would have to lay can be backdated to 1 April 1985. That blocks any avoidance possibilities by which United States corporations could attempt to avoid the clause by repatriating massive dividends now and draining their subsidiaries in Britian of funds. As that is a possibility, but as we do not want to create too much uncertainty in international trade, there should be as little retrospection as possible. We should therefore have action as quickly as possible.

There are two alternative triggers to the 7.5 per cent. test to which I have already referred. One is a wide alternative trigger and the other is a narrow one. On the basis of the wide alternative the Revenue would be able to trigger the proposals in the new clause in relation to any company which has a qualifying presence in, for example, California by virtue of having any of its income subject to state taxes. The narrower definition would mean that the principal place of business of the company should be in the unitary tax state. This gives enormous flexibility to the Revenue but also creates uncertainty. The states which operate unitary tax systems should realise that there is a wide battery of possibilities open to us and that we are determined that the new clause will be effective if it ever needs to be activated. That should encourage states to take early action to remove the cause of difficulty.

If by some mischance a company tries to evade or avoid the ambit of the new clause, a variety of penalties are provided in the new schedule. A fine could be levied equal to twice the tax credit. This type of fine is important as it entails the company not just repaying the tax credit that it has already received but suffering a fine equivalent to the tax credit plus an equivalent amount on top. That is important because, under the internal revenue code of the United States, fines are not deductible from corporate profits for tax purposes, so it would increase the cost to US corporations attempting to avoid or evade the new clause.

Interest is set at the rate of 9 per cent. under paragraph 1(3) of the new schedule, effective from the time when the tax credit is paid. The loss of the right to set-off is covered in paragraph 1(4)(b), which provides for a loss of the right to set-off advance corporation tax on the dividend which cannot then be set against mainstream corporation tax liability. The right to set-off is not only lost for the accounting period in which the tax credit is paid to the company but can be carried forward indefinitely if there is any excess or surplus available for that purpose.

Various avoidance techniques might be used to try to get around the working of the clause, but I believe that we have effectively prevented them from succeeding. For example, what would happen if the United States parent company refused to pay the fine? Paragrpah 1(4)(a) of the new schedule provides that the fine can be recovered from the United Kingdom subsidiary or from any connected company. What if the United Kingdom subsidiary pays the dividend and the parent company then liquidates the subsidiary to try to circumvent the clause? The liquidated company is deemed to exist for a further six years and if a new subsidiary is formed in its place within six years that company will be liable for the accumulated fines in relation to the original infraction. Thus, both simple liquidation and liquidation followed by reincorporation will be ineffective.

If a United Kingdom subsidiary or connected company pays the interest or the fine on behalf of the United States corporation, that will not be deductible for corporation tax purposes in this country. The purpose of that provision is to recapitulate for our own tax regime the effect of a fine not being deductible for tax purposes under the American internal revenue code.

The United States parent company subjected to fines and interest will have to pay the interest gross whereas normally the withholding of tax is deducted first and the interest is paid to the recipient net. That, too, will reduce the benefit of attempting to avoid the purposes of the clause.

The hon. Member for Wrexham (Dr. Marek) and others have referred to the use of creative accounting techniques, but I believe that we have prevented the use of such techniques by paragraph 3(1) of the new schedule. For example, if a United States parent company lends a United Kingdom subsidiary, say $1 billion and then charges 10 per cent. interest on the loan as a notional transaction intended to convert what would otherwise have been paid by way of dividend to a payment by way of interest, that too will be covered because the new schedule provides that interest paid where it is reasonable to suppose that a qualifying distribution would otherwise have been made will not avoid the provisions of the new clause.

The draconian powers of inspection and requirement of information in paragraph 4 are based on the controlled foreign companies provisions rushed through the House last year without debate and with the connivance of the Opposition, so I hope that both Front Benches will approve of the insertion of those provisions.

The measure that we propose is draconian, but desperate diseases require desperate remedies and that is the situation in which we now find ourselves. I repeat, however, that the effect of the new clause can be avoided by timely action by the states concerned. If repealing legislation is passed by 31 December 1986, even if the new clause is put into effect in the meantime, the United States corporations affected will get their 15 per cent. tax credit and will be no worse off than they now are even if the repealing legislation was not in force when the distribution payment was made. I believe that that will be a great incentive to action by California and I hope that the authorities there will take the hint.

It may be argued that we are setting a precedent, but I believe that the United States has already set the precedents. For example, the United States double tax treaty with France came into being as a result of a threat of retaliatory action of the kind that we propose today, Section 891 of the American internal revenue code sets that out, so in a sense we are simply following the action of the United States and not setting a precedent of our own.

It may be argued that our proposal overrides the double tax treaty and that that itself is a precedent. If the proposals were triggered off, they would certainly override the provisions of that treaty, but there are precedents for that in the United States. For example, the Foreign Investment in Real Property Tax Act 1980, which became effective on 1 January this year, specifically overrides all the double tax treaties entered into by the United States with all countries around the world. The Americans have thus introduced domestic legislation of their own which overrides international obligations entered into freely by treaty; and that was a unilateral move on their part.

In relation to our own double tax treaty, too, the United States has overridden one of the articles. There is therefore a precedent for action in that context, too, in so far as the American Internal Revenue Service has made a ruling which overrides the provisions of the treaty in relation to insurance premiums received by United Kingdom insurance companies.

I believe, therefore, that this measure is timely and necessary. I do not believe that it will lead to retaiiation by the United States. I believe that the Federal Goverment are determined to see an end to this problem in the interests of their own international trade and that the cost to United States companies of inaction by the Californian authorities will be very great indeed. If the Government support the new clause today they will do a great service not just to the cause of business in this country but to the whole international trading and business community.

I commend the new clause to my hon. Friend the Financial Secretary and I hope that what he has to say today will be trumpeted across the Atlantic as a meaningful and determined attempt to declare war upon a system of taxation which is as unjust and damaging to the insterests of the United States as it is to the interests of this country and of all other countries affected by it.

1.15 am
Mr. Wrigglesworth

I support the motion, and urge others to support it. It is timely, as the hon. Member for Tatton (Mr. Hamilton) said. Some would say that it is long overdue. When the tax treaty came before the House, we had the opportunity to exert considerable pressure on the Administration, and, through the Administration, upon the states in the United States, to rectify the situation that had arisen. Although assurances were given, action did not result to the extent that we had hoped.

I have come firmly to the conclusion that only this sort of retaliation will pay the dividends that we want. In the mid-1970s I remember discussing the matter with Governor Brown in California and trying to get him to see the sense of the argument that was being put to him. It was clear that he was not going to budge an inch, and that no other state government would, unless there was a clear reason for them to do so, in responding to their own electorate and their interests. The only way in which we can bring that about is by putting on the pressure proposed in the new clause.

Therefore, I hope that the House will give its full support to the new clause and that the Government will enthusiastically welcome it as a means to put pressure upon the Federal Government and through them on the state legislature, so that this ridiculous situation can be resolved.

Mr. Moore

I shall try to be brief, but the House will understand that it is essential that I express with great care and clarity the Government's attitude to the clause.

This has been a major debate on an issue of great importance to the United Kingdom, the United States and all our trading partners. If I may say so, the speech of my hon. Friend the Member for Surrey, North-West (Mr. Grylls) was fully in keeping with the importance of the issue. The House is indebted to him and his colleagues — I specifically mention my right hon. Friend the Member for Taunton (Sir E. du Cann), who is not with us tonight but who has been long active in the campaign, and my hon. Friends the Member for Croydon, Souvh (Sir W. Clark), for Bury St. Edmunds (Sir E. Griffiths), and for Tatton (Mr. Hamilton). It is important that on the issue we have had consistent all-party support. I particularly welcomed the speech by the hon. Member for Sedgefield (Mr. Blair), representing the official Opposition, that of the hon. Member for Stockton, South (Mr. Wrigglesworth), and the continued presence throughout the debate of the hon. Member for Roxburgh and Berwickshire (Mr. Kirkwood). It is crucial that we have a clear signal on whatever we do in the area. The consistent all-party support has been a key feature of the debates on the issue.

It is clear that my hon. Friend the Member for Surrey, North-West spoke for the whole House when he referred to the widely felt frustration that a solution to the problem has been so long delayed. It is equally clear that he spoke for the House when he said that the time had come for Parliament to take legislative action to register the United Kingdom's determination to see that a solution of the problem is achieved in the United States. That was borne out by contributions to the debate from all parts of the House. It is reinforced by the number of hon Members — again from all parts of the House — who have put their names to the new clause on the amendment paper.

I should like to make it clear that the Government strongly endorse everything that has been said in the debate about the imposition of unitary taxation on United Kingdom-controlled companies and other non-American corporations.

The basic objection to unitary tax is that it is contrary to the internationally accepted principle of allocating profits where a company or group operates internationally. That is that tax authorities charge tax on foreign-owned companies only on the profits arising in the country or state for which they are responsible. The arm's-length method is recognised by both the Organisation for Economic Co-operation and Development and United Nations, and is enshrined in a worldwide network of bilateral double taxation treaties including the treaties to which the United States is party. It provides a coherent and consistent tax framework for international trade and investment.

As applied by states such as California, the unitary tax method applies a formula apportionment to the worldwide profits of a multinational group to establish the tax due in California. In doing so, a unitary state is reaching beyond the borders of its own jurisdiction and taxing profits earned outside it, and thus breaching the internationally accepted principles.

For individual companies, as many hon. Members have said, that means unfair tax bills and excessive compliance costs. It can also produce double taxation. Income earned by the foreign parent of a United States subsidiary is taken into account in the unitary tax bill, and taxed without any relief for overseas tax. Multinational groups can be taxed on more than 100 per cent. of their income in a particular state, and a loss can be turned into a taxable profit. Another serious objection is the excessive compliance burden imposed by worldwide unitary tax. The method inevitably involves financial information on the worldwide activities of the group, which can be extremely burdensome in practice. It is objectionable that a state tax authority should demand information about the financial records of United Kingdom companies, and their subsidiaries, which are outside the United States and unrelated to activities within the United States.

If unitary tax continues, it will distort investment decisions. The immediate effect is to damage inward investment in the states that impose it. There is increasing recognition in the United States that it is, therefore, in the economic interest of such states to remove it.

The damage goes wider than that. If unitary tax continues, it will disrupt the internationally accepted taxation framework, and have a damaging effect on the development of world trade. The importance of a solution is, therefore, self-evident.

A speedy resolution of the problem is especially important to the United Kingdom, because the cumulative total of United Kingdom investment in the United States is now more than $32 billion. This is more than any other country and represents nearly a quarter of all foreign direct investment in the United States. In 1983 alone, the United Kingdom invested more than $3.7 billion in the United States, which accounted for 32 per cent. of the total of foreign direct investment in the United States in that year.

The American Administration recognised this as long ago as 1977, when the United Kingdom and America negotiated a provision in the tax treaty to prevent individual states from applying the unitary method to United Kingdom companies. The proposed treaty was ratified by the House of Commons in 1977. However, article 9(4) was rejected by the United States Senate in 1978. The United Kingdom Government were then assured that the United States Administration would use their best endeavours to secure a solution.

Since then, there has been some progress, but not enough. There was a major setback, as the hon. Member for Sedgefield (Mr. Blair) said, when the United States Supreme Court ruled in the Container case that the California worldwide unitary method was not unconstitutional, at least so far as it was applied to a United States parent corporation and its foreign subsidiaries.

However, a working group was set up under the then Treasury Secretary Regan to seek to resolve the issue. The group reached a consensus on the general principle that unitary taxation should be limited to the United States water's edge. But it left important issues on the application of that general principle unresolved. In his report to the President in July 1984, Secretary Regan said that these issues should be left for resolution at state level. However, he also said that if there were not, sufficient signs of appreciable progress by the states, by 31 July 1985, he would recommend to the President that the Administration propose federal legislation to give effect to a water's edge limitation.

It is right to recognise the importance that the United States Administration attaches to securing a solution, which will — as Secretary Regan put it — enable the United States, to speak with one voice in dealing with its foreign trading partners", so that, this irritant to international commercial relations will have been eliminated". It is clear that there is a common objective. Some progress has been made at state level since the working group reported. Six states have now repealed or modified the worldwide application of unitary tax. But in some cases, the state legislation does not provide a comprehensive limitation on the application of unitary tax to United Kingdom groups. In five states, legislative initiatives have failed to succeed. In California, the key state fo the United Kingdom, a legislative initiative last year was unsuccessful. Despite the Governor's efforts to achieve a solution and intense activity by key legislators, the chances of satisfactory legislation passing this year are in serious doubt.

It is against this disappointing background that the House must consider the legislation proposed in the clause and schedule. Before we contemplate the passage of this legislation, we should ask whether we in the United Kingdom have done enough to impress on our friends in the United States the importance we attach to the issue. I think the answer must be yes. This has been confirmed by all we have heard in the debate. The Government have lost no opportunity to urge a speedy solution on the United States Administration, and have done so at the highest levels. The Administration have been well aware of the strong parliamentary pressure for legislative action if such a solution was not forthcoming. In the past year, when the focus has been on action at states level, there has been vigorous and concerted activity by the United Kingdom Government and industry. Government and industry teams have gone to Florida, Colorado, Utah and North Dakota in the past 12 months. Since last July, United Kingdom teams have visited California on four separate occasions. These included a major delegation led by Sir Terence Beckett of the CBI in February this year. I would like to pay tribute to the energy and resource displayed by the CBI, the Unitary Taxation Campaign — especially its chairman, Peter Welch — and other representatives of British business in trying to secure a resolution of the problem. As my hon. friend said, a similar tribute should be paid to our officials in the Embassy in Washington and in the other American consulates and, if I may say so, especially to our officials in the Inland Revenue.

Despite all this activity from the Government and industry, and from other countries, a resolution of the problem still remains in doubt. The Government have therefore concluded that it is right that the enabling powers proposed in the clause should be passed into legislation, and we so recommend to the House.

The hon. Member for Sedgefield asked for two assurances. I happily give an assurance that the Government will take account of representations on behalf of the insurance industry, to which the hon. Gentleman particularly referred. Of course, that would extend to the rest of British industry. I recognise the absolute importance of obtaining all-party support. I cannot give an absolute undertaking in this matter, as clearly we cannot anticipate events and circumstances. However, I take the hon. Gentleman's comments very much into account. It is clearly far better to retain a united parliamentary front. As the hon. Gentleman said, the House will have time to reflect and vote under the affirmative order procedure.

The powers in the clause and schedule, if invoked, would deprive United States parent companies of tax credit on dividends paid by their subsidiaries in the United Kingdom. They could have a major impact on the finances of such companies. At the extreme, they could cost these companies as much as £500 million a year.

The Government will not, of course, recommend to the House that these enabling powers should be invoked without the most careful consideration and consultation with all those concerned. It is important that if it becomes necessary to invoke the reserve powers there should be a degree of flexibility in specifying the companies and states that will be affected. My hon. Friend the Member for Surrey, North-West made a convincing case for this when he explained the changes that he has introduced into his clause to provide the maximum flexibility for the Government if a resolution were laid to bring the powers into effect.

I conclude, however, by expressing the earnest hope that it will prove unnecessary for the United Kingdom to invoke the reserve powers in the clause. I very much hope that our friends in the United States — in the Administration, the states and business — will soon be able to secure a satisfactory solution to the problem of their own volition. There is a common interest in solving the issue. The basis of that solution is common ground between the United States Administration, states and business. We trust that the United States will now be able to overcome the remaining obstacles to achieving a complete and enduring solution to this problem, by action in the states or by federal action.

In this spirit, I commend my hon. Friend's clause and schedule to the House.

Mr. Grylls

With permission, I should like to respond to the debate. I reiterate the all-party support for this measure. It is important that a signal should go to the United States that the House is determined in this matter and that the threat of retaliatory action will not go away until the problem is solved. In that spirit, I hope that the House will accept the new clause.

Question put and agreed to.

Clause read a Second time, and added to the Bill.

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