Finance Bill

House of Commons, 14 May 2003.

Clause 130 — Charge and Rates for 2003–04

Howard Flight (Conservative, Arundel and South Downs)

As hon. Members know, the clause simply sets the basic rates of income tax for this year at 10 per cent., 22 per cent. and 40 per cent. We have already pointed out that the Government appear to be confused by their tax system. They misquoted the basic rate at 20 per cent. in the explanatory notes, when automatic indexation increases in the tax bands of 2 per cent. accompany the rates. However, we wish to speak about the clause because of the failure to deal with personal allowances and inflation: yet another stealth tax especially hits lower and middle-income earners.

When compared with our competitor countries, Britain has the lowest levels at which people start to pay tax. They will be even lower in real terms as a result of the fall in the real value of personal allowances, which have decreased from 60 per cent. of average income in 1950 to 24 per cent. today. Someone who earns only £15,000 a year—25 per cent. below average earnings—will pay tax of 22.5 per cent. of income as a result of combined income and national insurance tax liabilities of £3,388. If such an individual has, for example, two children, depending on the income of the spouse, whether they can complete the form and whether the Government can handle the administration, they may get back all or more in child tax credit and qualify for working tax credit.

Why tax people on such modest incomes in the first place? Why do a Labour Government make the rate at which taxation starts even lower in real terms? It is difficult not to conclude that the Government's concealed objective is to make people feel dependent on them for their tax credits to offset the ridiculously low rates at which taxation starts.

John Redwood (Conservative, Wokingham)

Has my hon. Friend also noticed that in the Bill the rate for those earning a slightly higher income and above is 40 per cent.? However, we know that the Government want to levy tax at 41 per cent., which they are doing by a backdoor means of changing the rules on national insurance. Would not it be more honest to set the rate at 41 per cent. and thus accept that the Government have broken their promise to the British people not to raise income tax rates?

Howard Flight (Conservative, Arundel and South Downs)

I thank my right hon. Friend for his comments. The Government have already learned from the local election results that the British electorate are not stupid and that they know perfectly well that they now pay income tax at a rate of 41 per cent. if they qualify for higher rate taxes.

The immediate effect of the stealth tax of freezing personal allowances will yield about £500 million per annum directly, but the knock-on effect will push more people into the higher tax rate. Data received in response to questions put by my hon. Friend the Member for Eddisbury (Mr. O'Brien) show that, according to the Government's own figures, there will be a 23 per cent. increase between 2002–03 and 2004–05 in the number of people with incomes over £34,515, rising from 3.9 million to 4.8 million. Not all those people will pay higher rate tax, because some will be pensioners, but that is nevertheless a good rough and ready measure of the extent to which the Government's income tax policies are pushing policemen, teachers, soldiers and nurses into higher rate tax brackets, as well as starting to tax them at a lower real income.

We regard this stealth tax as particularly devious and wrong. The Conservatives wish to reform and simplify the tax system when we are elected at the next election, and to take large numbers of people out of paying tax on such ridiculously low incomes.

Norman Lamb (Liberal Democrat, North Norfolk)

I entirely endorse the comments of the Conservative spokesman on the impact of freezing personal allowances. It is a stealth tax that will have a significant impact on low-paid people. We wish to debate this clause because it is clearly central to the Government's Budget strategy and to the choices that the Government make about taxation. I understand that, under the procedures of the House, we cannot table amendments to the rates, so I shall make our points by speaking on the clause.

I want to start by reasserting the Liberal Democrats' belief in the principle of progressive taxation. After six years of a Labour Government, it seems extraordinary that the poorest 20 per cent. pay a higher proportion—41.7 per cent.—of their income in taxes, compared with the richest 20 per cent., who pay just 34.2 per cent. That is a regressive tax system, and we would like to see it adjusted.

George Osborne (Conservative, Tatton)

Will the hon. Gentleman help me to understand his remarks by telling me what the rates and bands of the Liberal Democrats' local income tax would be?

Norman Lamb (Liberal Democrat, North Norfolk)

We simply want to propose an entirely revenue-neutral system that would replace council tax—which I shall come to later—with a local income tax. If the hon. Gentleman wishes to support the council tax, which is having a dramatic effect on low-paid people and pensioners on fixed incomes, I would like to see him do so.

One of the reasons that the rates in clause 130 remain the same as last year's rates is that the Government have orchestrated a £2 billion tax hike through the council tax. They have failed adequately to fund nationally agreed pay rises, pension increases, national insurance increases and new requirements on services imposed on local authorities. We support those requirements, but they have not been adequately funded. The result has been an average increase in council tax that is four times the rate of inflation. The impact of that on pensioners on fixed incomes is severe and cannot be supported. I would have thought that many Labour Members would see that such a regressive system needs to be reformed. The regressive nature of local taxation is even worse than that of national taxation. The poorest fifth of households pay 7.1 per cent. of their income in local taxes, compared with the richest fifth, who pay just 1.8 per cent.

Income tax is self-evidently based on the ability to pay. The Liberal Democrats' preference for a 50p rate for income over £100,000, which is in line with much of Europe and the state of New York—there is hardly evidence there that it leads to a brain drain—and which I suspect is supported privately by many Labour Members, could initially provide funding to cut council tax by £100 per household this year and get rid of the iniquities of tuition fees and top-up fees, which act as such a disincentive to students on poor incomes.

Howard Flight (Conservative, Arundel and South Downs)

I thoroughly endorse the hon. Gentleman's comments on council tax. However, the US tax system has substantial allowances against income, including interest payments, so it is not entirely accurate to say that there is an effective 50 per cent. rate of income tax. The net effect on higher earners generally comes out at about 40 per cent.

Norman Lamb (Liberal Democrat, North Norfolk)

I thank the hon. Gentleman for those comments; he may well be right. I am sure that he knows more about it than I do, so I am happy to accept his comments. None the less, the fact remains that the overall tax system in Britain is highly regressive and, with the impact of the increases in council tax, it is having a severe effect.

John Burnett (Liberal Democrat, Torridge and West Devon)

In years past, I have had opportunities to gauge the disparities or otherwise between the taxation levied by different states, so will my hon. Friend take it from me that the precedent in the United States, whether it be federal, state or city tax, is according to the ability to pay—an important principle that we should not forget?

Norman Lamb (Liberal Democrat, North Norfolk)

Absolutely. That is in great distinction to the system that we have in Britain with a system of local taxes, which, self-evidently, is not based on ability to pay.

John Redwood (Conservative, Wokingham)

How does the hon. Gentleman work out that someone on a higher income paying 40 per cent. income tax on practically all his income and then paying lots of other taxes out of net income, is on an effective tax rate of 31 per cent? That sounds like Liberal Democrat arithmetic.

Norman Lamb (Liberal Democrat, North Norfolk)

As I understand it, the figures have all been properly assessed and are based on parliamentary answers, so they have been accepted as factual.

John Bercow (Conservative, Buckingham)

The hon. Gentleman's attempted response to my right hon. Friend the Member for Wokingham (Mr. Redwood) will not suffice. Simply to say that the facts have been checked but that he cannot trouble us with them now is not good enough. What assessment has the hon. Gentleman made of the probable impact of the level of income tax at the higher rate and the increase in national insurance charges on the prospects of recruitment and retention in the police force, the teaching profession and the NHS?

Norman Lamb (Liberal Democrat, North Norfolk)

I personally have not made any assessment. [Hon. Members: "Ah!"] Hon. Members express great surprise. I would say only that these higher rates of tax apply in many other countries and do not cause massive problems in terms of a brain drain or recruitment to public services. At the end of the day, we all have to decide how best and most equitably to raise our taxes, and the Liberal Democrats believe that the current system is not adequately progressive and we would prefer to move to a more progressive system.

To return to the funding of students in further and higher education, about which the Conservative party has also raised concerns, although I am not sure about the funding of its proposals—

Roger Gale (Conservative, North Thanet)

Order. The Chair has been extremely tolerant of the debate so far, but we are now moving far away from income tax.

Norman Lamb (Liberal Democrat, North Norfolk)

I am grateful for that. I was simply making the point that with the rate that we are proposing of 50 per cent., the Government could get rid of the iniquitous proposed system of funding of top-up fees and tuition fees for students.

As I have said, many Labour Members would share our view that the tax system should be more progressive than it is. I suspect that the Minister, in her quieter, private moments may well agree. The Government are caught on the horns of a political commitment not to raise income tax, so tax is still raised but in ways that are more unfair than if it was raised by way of income tax, and which this year is hitting people on low pay and pensioners on fixed incomes very hard indeed by way of the council tax.

Richard Younger-Ross (Liberal Democrat, Teignbridge)

Can my hon. Friend explain the impact that the present unjust system has on areas such as Devon where we have a large number of people on fixed incomes and a large number of pensioners and low-paid people who have been penalised by the council tax? Is he aware that all parties on joint administrations in Devon have agreed that the council tax system is wrong and that they want to see a fair taxation system, and that includes the Conservative leader of Devon county council, Christine Channon?

Roger Gale (Conservative, North Thanet)

Order. I remind hon. Members again that this is a debate about income tax levels, not council tax.

Norman Lamb (Liberal Democrat, North Norfolk)

I am in some difficulty in responding to the intervention given your comment, Mr. Gale. I simply endorse what my hon. Friend says and say that in North Norfolk, with a low-wage economy, the position is much the same.

John Redwood (Conservative, Wokingham)

I declare my interests as they appear in the Register of Members' Interests.

The clause sets out income tax rates, but it does not tell us the whole story about how incomes will be taxed. As my hon. Friend the Member for Arundel and South Downs (Mr. Flight) pointed out, we must take clause 130 in conjunction with the meanness over the bands and the 1 per cent. surcharge on national insurance payable over the whole income range for the first time, which means an increase in the 40 per cent. tax rate in the Bill.

I rise to speak against the clause because I represent a constituency where an income of £35,000 a year is not huge but necessary to meet the ordinary living expenses in such an area, given high house prices, high costs of services, high council and other local taxes and the general cost of living.

The Government are making a great mistake in drawing so many hundreds of thousands of additional people into the tax net to pay the 41 per cent. tax—the combined income tax rate in the clause and the 1 per cent. national insurance surcharge. That will leave many people quite short of cash to meet their family bills over the year. People in Britain under the Conservative Government, and more recently under the Labour Government, have become used to experiencing rising take-home pay and rising spending power if they are in a reasonable job and keep that job. That is something that Members on both sides of the House usually welcome. The question that we have to ask today is whether the Government are now damaging that in a dangerous way. I believe that they are. They are reaching the point where higher taxes of a stealthy kind on people's incomes are now doing considerable damage.

What should the Government do about it? They should be more honest about the fact that they are effectively increasing income tax and review again their public expenditures to see whether they can do a better job in controlling and containing waste and unnecessary expenditure so that they do not need to put through such large increases in the tax burden. I am sure that that advice will fall on deaf ears with the Minister, but it is heartfelt and well meant, and the Labour party will discover to its dismay in the ballot box during the months ahead that this is an extremely unpopular imposition, and that the combination of the rates, bands and the national insurance surcharge is correctly perceived outside as a substantial increase in the income tax burden. When the Government use their majority to push this through today, they will do something that they will live to regret.

George Osborne (Conservative, Tatton)

I welcome you to the Chair, Mr. Gale.

I congratulate my hon. Friend the Member for Arundel and South Downs (Mr. Flight) on ensuring that the clause is debated in the Chamber because this is a classic stealth tax that should be brought to the attention of the public. My hon. Friend has done that exceptionally well, as has my right hon. Friend the Member for Wokingham (Mr. Redwood). The charge that it is a stealth tax is not just a Conservative charge. If one reads the commentary after the Budget from the various accountancy firms, one is struck by the fact that almost every firm pointed to this stealth tax. Tax partners at accountancy firms, including Mr. Warburton, a senior tax partner at Grant Thornton, have said:

"Because the increase on tax bands has been very modest, there has been a stealth rise . . . The rate bands are only going up by about 1.7 per cent, while earnings have gone up by about 3 or 4 per cent."

Of course, that will have a serious effect on people and their incomes. Because the tax-free allowance for people under 65, which is normally increased in line with inflation, is staying at £4,615, KPMG, another accountancy firm, has estimated that it will cost the average taxpayer £95. Those are serious increases at a time when people are already facing increases in council tax, national insurance and so on.

Grant Thornton has also said:

"This is a classic case of fiscal drag. More people are drawn into the higher tax bracket and pay the top rate on a rising proportion of their income."

We need to ask ourselves: what is the point of a higher tax rate if more and more people are drawn into it? The higher tax rate was originally designed for the people with the highest incomes in society but now, as my hon. Friend the Member for Arundel and South Downs pointed out, people in the education system, the health service and police service are paid far beyond that.

I discovered from the "Today" programme this morning not only that my constituency has the highest income of any in the country—the highest in terms of purchasing power, that is—but that the average income in my constituency is around £30,000. A huge number of people will be paying the higher tax rate in that constituency—and there were many others on the list. Each year, the number increases. This year, as a result of the clause, it will increase by 150,000 people.

It is incumbent on the Committee to ask the Minister to be honest about this matter. If the Government want to increase income tax, why do they not put it in their manifesto, come to the House with a Budget and do it? Instead, each year, we get this salami-slicing stealth tax, which is eroding people's disposable income.

Jonathan Djanogly (Conservative, Huntingdon)

Having heard my right hon. and hon. Friends speak in the debate, it seems to me that income tax rates are becoming increasingly irrelevant to the concept of take-home pay. The Government have thrown the majority of people into the dependency culture. The use of tax credits has in effect rubbished the concept of tax rates in relation to take-home pay.

I had an example of that only a few weeks ago. One of my constituents, a local employer, explained to me how he had two members of staff both earning roughly the same amount of money. However, one of them was getting a lot more through the use of tax credits. He said that that destabilised the wage environment in his company because people compared take-home pay. He resented the fact that he was being used to monitor income tax and in effect to act as a benefits agency on behalf of the Government. That is why I say that overall rates are becoming increasingly irrelevant.

The same argument applies to national insurance, which now has little to do with the old stamp concept. It has simply become another way to raise income tax, with the added benefit of squeezing a bit more out of companies. Some have called it a stealth tax but I see nothing stealthy in the way most people's pay packets were hit last month. There will not be much stealth there. However, the stealthy part is the way in which comparative take-home pay is being hit in a secret way. People cannot tell what is going on.

This Government said that they would not increase income tax and I believe that they are still saying it. In practice, they are deceiving the British people as to what is going on.

Howard Flight (Conservative, Arundel and South Downs)

My hon. Friend makes an extremely important point. Does he not think that, if we have a society where people do not know what their tax rates are, and where what they receive in their pay packet bears no relationship to the job that they are doing, it is a huge demotivation to increase their skills and productivity and to take the whole economy forward?

Jonathan Djanogly (Conservative, Huntingdon)

I thank my hon. Friend for making that important point. This area needs a lot more study, because there are many implications from mixing the dependency culture with income tax and with corporation tax. Companies are viewing the three together. There is a new mind-set coming into play that, whichever way I look at it, works to the negative. I agree with my hon. Friend's point.

John Bercow (Conservative, Buckingham)

My anxiety is that the Government are plundering the pockets of the people but, to put it mildly, it is not at all clear to the people that they are getting a fair return for that which is levied upon them. I say in all candour to the Paymaster General that she has a responsibility to abandon the insider mentality that is increasingly characterising both the decision making and defensive pronouncements of Ministers.

It is natural that Ministers will think, "Let us just increase tax a bit. It will not cause appreciable harm. People may not notice. We seem to have been able effectively to con them thus far and it may boost our finances somewhat." My warning to the hon. Lady is that the legendary patience and stoicism of the British people when confronted with additional imposts could soon be wearing thin, if it has not already done so. I invite her to reflect on a number of considerations.

George Osborne (Conservative, Tatton)

My hon. Friend talks of the legendary patience of the British people. However, I have noticed that they are growing very impatient with the council tax increases. Of course, with the fuel tax increases, their patience broke and there was a tax strike.

John Bercow (Conservative, Buckingham)

One of my hon. Friend's great qualities is his prescience and it has not failed him on this occasion, for he has precisely anticipated my thought process. The reaction to the incidence of exorbitant council taxes could soon be mirrored in a public reaction to the incidence of exorbitant direct taxation flowing from the Treasury and the Inland Revenue.

The hon. Lady has a responsibility to reflect on a number of considerations. First, at what point does the incidence of higher taxation both on individuals and on the corporate sector threaten to undermine individual incentive and competitive industrial performance? If we have not reached that point, we must be very near to it. In the light of the Chancellor's downgraded forecasts for the performance of the economy in the years to come, it would be sensible for her and her colleagues to take stock of the consequences of that burdensome taxation. That is the more powerful a consideration in the light of the fact—which no amount of Treasury casuistry can gainsay—that over the past six years we have sacrificed two thirds of the competitive tax advantage that we have enjoyed relative to other member states of the European Union.

The second consideration on which the hon. Lady should reflect seriously and which she should discuss with her colleagues is the likely incidence, to which I referred in my intervention on the hon. Member for North Norfolk (Norman Lamb), of higher tax rates, fiscal drag and national insurance contributions on people working in key posts in the public sector. One cannot continually clobber those upon whom we critically depend for the effective discharge of public services without there being an impact on recruitment and retention. In the words of the late Enoch Powell, that point is so blindingly obvious that only an extraordinarily clever person could fail to see it.

Jonathan Djanogly (Conservative, Huntingdon)

Take-home pay has fallen for the first time in over a decade this year and that is not to be forgotten, but in relation to the public sector my hon. Friend will be aware that this is the first time in the history of this country that benefits-included average take-home pay in the public sector is higher than in the private sector. That says little for our productivity.

John Bercow (Conservative, Buckingham)

That is indeed a bad sign, and a worrying portent of the likely development of the two economies of the private and public sectors in the months and years to come.

George Osborne (Conservative, Tatton)

Will my hon. Friend give way?

John Bercow (Conservative, Buckingham)

I will give way once more, but as you will readily discern, Mr. Gale, I am itching to make my third point. Whether the Committee is itching to hear it is of course another matter.

George Osborne (Conservative, Tatton)

Has my hon. Friend made any calculation of the amount of churning that will result from the clause? The state will be paying those who work in the public sector, who will then pay it back with tax. My hon. Friend may not be able to answer my question, but perhaps the Paymaster General will.

John Bercow (Conservative, Buckingham)

I am grateful to my hon. Friend for the deft shoe-shuffle with which he ended his intervention. He is absolutely right. If I were a Minister, I would feel it incumbent on me to provide the answer. I am not, so it is not; but it is the Paymaster General's responsibility to give a satisfactory reply. What merit is there in an arrangement whereby the middle man takes the money and gives it back again, with all the bureaucracy that such a process entails? It would have been sensible to take account of those considerations in policy formulation at the outset.

My third point is very simple. It is easy for Governments to think—as my party did when in office—in terms of sums raised and inputs made, while focusing far too little on outputs. I have noticed, not just in the Paymaster General's words but in those of her right hon. and hon. Friends, an increasing tendency to stick to the brief and to assume that the House and, more important, the country can be fobbed off with a continuing regurgitation of statistics relating to what is being raised and spent.

That is understandable, but misguided. Let me say in all sincerity that, ultimately, the public are not much interested in hearing from any of us about inputs. They are interested in outputs, and if the words that they hear from Ministers about the level of inputs do not resonate with them because they are not reflected in local service delivery, they will come to regard Ministers' pronouncements first with cynicism and then with contempt.

The fact that the Government are spending £50 million an hour makes it incumbent on Ministers to demonstrate that improved services on a substantial scale are resulting from that level of expenditure of the public's money. The effect of the higher taxes is very real and painful for those—often on modest incomes—who must pay them, while the effect of the Government's increased expenditure, often poorly distributed and untargeted, is much less beneficial. The pain is clear, but the gain is frequently either insubstantial or non-existent.

John Redwood (Conservative, Wokingham)

Will my hon. Friend give way?

John Bercow (Conservative, Buckingham)

How can I resist my right hon. Friend's entreaties?

John Redwood (Conservative, Wokingham)

Does my hon. Friend think that the ministerial reluctance to speak from the heart rather than sticking to the brief is connected with the fact that Ministers are benefiting greatly from the increased taxes? We see that in the ministerial travel bill, the ministerial drinks bill, the ministerial entertainments bill, the ministerial aides bill and the ministerial press support bill. I think that that is where a lot of the money is going, which may explain why Ministers are not prepared to say much here. They know that they are robbing the British people for no good reason.

John Bercow (Conservative, Buckingham)

My right hon. Friend is usually right, and he is right on this occasion. I believe that money raised from the taxpayer should be used for the taxpayer's benefit. I bear the Paymaster General—who trounced me in Bristol, South in 1992, but with whom I have enjoyed cordial relations ever since—no personal ill will, as she knows; but I do not want her, or her colleagues, to benefit at the centre from increased imposts on the public. I want the British people to benefit, and above all I want my Buckingham constituents to benefit. They are not currently doing so. They are getting restless; they are increasingly angry; they are about to vent their spleen on the Government, and their reaction will be mirrored nationwide. 1.15 pm

Dawn Primarolo (Labour, Bristol South)

I am grateful to the right hon. Member for Wokingham (Mr. Redwood) and the hon. Member for Buckingham (Mr. Bercow) for giving me the benefit of their views and advice. Both made it clear that it was for political parties and individual Members of Parliament to decide on the policies that they advance, and to take responsibility for them.

I was greatly encouraged by the reference of the hon. Member for Buckingham to the 1992 general election campaign in Bristol, South, when he was my very able Conservative opponent. On that occasion he put to the people of Bristol, South the views that he and the right hon. Member for Wokingham have advanced today. He is right: the voice of the people of Bristol, South was pretty substantial. There was an 8.5 per cent. swing to Labour. While I greatly enjoyed the campaign, I am sure that the hon. Gentleman is more safely tucked up in Buckingham now than he would ever have been in Bristol, South.

George Osborne (Conservative, Tatton)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

I am happy to, but I am sure that you would like me to speak about clause 130, Mr. Gale. I was being polite to Members.

George Osborne (Conservative, Tatton)

Will the Paymaster General reflect on the fact that the difference between the 1992 election and subsequent general elections is that in 1992 the Labour party told the public in advance that it would increase taxes and they rejected it, whereas in 1997 and 2001 it did not tell them and then proceeded to increase taxes?

Dawn Primarolo (Labour, Bristol South)

The huge difference between the election in 1992 in Bristol, South, as in the country—

Roger Gale (Conservative, North Thanet)

Order. This is an interesting exchange, but it is totally irrelevant to the clause.

Dawn Primarolo (Labour, Bristol South)

I was enjoying myself, Mr. Gale, as no doubt were Opposition Members, but you are right to return me to clause 130.

The clause imposes income tax for 2003–04. The starting rate of 10p that we introduced in 1999 means that around 3 million lower earners continue to pay about half the marginal tax rates that they would otherwise pay. We have kept our promise not to increase the basic or top rates of tax, which remain at 22p and 40p.

Norman Lamb (Liberal Democrat, North Norfolk)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

Will the hon. Gentleman allow me to make a little more progress? I want to reply to a couple of points that he made. The right hon. Member for Wokingham was right—the figures do not add up—and I should like, in a spirit of friendship and generosity, to explain why that is. I shall be happy to give way to the hon. Gentleman later.

At 22p, the basic rate is at its lowest for 70 years. As Opposition Members said, the tax rates are complemented by measures designed to make work pay and to eliminate poverty. With effect from April, the Government have introduced child tax credit and working tax credit. Those new credits represent the biggest-ever investment in families, with some £13 billion to be spent on child tax credit alone. Child tax credit is paid not through the wage packet, but directly to the main carer, normally the mother.

As the hon. Member for Buckingham said, the income tax rates are also part of our commitment not just to macro-economic stability but to sound public finances. That applies particularly to policies enabling us to make a sustained investment in public services. Prudent management of the economy has allowed us to increase public services without raising income tax rates.

We have already outlined our ambitious plans to increase investment in the national health service, matched by reform, by 7.2 per cent. a year after inflation for the next five years. That will be financed by the increased national insurance contributions to which the hon. Gentleman referred, which is entirely in line with the Beveridge tradition.

John Bercow (Conservative, Buckingham)

Will the right hon. Lady give way?

Dawn Primarolo (Labour, Bristol South)

Before the hon. Gentleman asks me to give an example, I shall give it now and then give way to him. Compared with 1997, by 2008 there will be 66,500 more nurses, 20,000 more doctors, 44,000 new therapists and about 100 new hospitals. To return to the example of Bristol, South, the difference between 1992 and now is that unemployment is down from some 15 to 17 per cent. to under 3 per cent.; people can also see real improvements in a health service that was so badly starved of money for such a long time.

Howard Flight (Conservative, Arundel and South Downs)

rose—

Dawn Primarolo (Labour, Bristol South)

I did say that I would give way to the hon. Member for Buckingham.

John Bercow (Conservative, Buckingham)

I am extraordinarily grateful to the Paymaster General. I shall be candid: I had hoped to tip her into the proverbial pit, but for her to do that herself before I had the chance to do so is generosity on a truly grand scale. Does she not realise that what she has done is to commit precisely the sin—regurgitating statistics about inputs—of which I was accusing her a few moments ago? Why does she not answer the very straightforward and practical question that the Chief Secretary has twice refused to answer in the past four weeks: why does the increase in clinical activity in the national health service represent only a tiny fraction of the increase in expenditure on it?

Dawn Primarolo (Labour, Bristol South)

Without wishing to try your patience, Mr. Gale, by entering into a discussion on the national health service, I should point out that the hon. Gentleman well knows that given the resources put into the NHS to date, there has been a significant increase in activity. I will not try your patience by listing them all now—

John Bercow (Conservative, Buckingham)

Oh go on.

Dawn Primarolo (Labour, Bristol South)

No, I shall stay in order despite the hon. Gentleman's invitation. Through the increase in national insurance over the next five years, there will be substantial continuing investment in the NHS.

John Baron (Conservative, Billericay)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

I am happy to give way to the hon. Gentleman, but I should point out that clause 130 is only about the actual rates of tax. I shall let him make his point, and then I shall return to being in order.

John Baron (Conservative, Billericay)

I thank the Paymaster General for giving way—I shall be brief. How can she square her comments about the NHS with Government statistics that clearly show that during the past three years, expenditure on it has risen by £9 billion—an increase of approximately 24 per cent.—yet hospital treatments have risen by only 1.5 per cent. and hospital admissions have actually fallen by 0.5 per cent.?

Roger Gale (Conservative, North Thanet)

Order. I will allow the right hon. Lady to respond, but I should be grateful if the Committee would return fairly swiftly to tax rates.

Dawn Primarolo (Labour, Bristol South)

I will do exactly as you ask, Mr. Gale. Of course, as the hon. Gentleman knows, when the national health service has been starved of resources and does not have enough beds, doctors, nurses, therapists and other support workers, it takes time to put those people in place to provide treatment. We are now reaching a critical point, whereby such staff are in place and the NHS is going from strength to strength.

I turn to the specific issues raised by hon. Members. The hon. Member for Arundel and South Downs (Mr. Flight) referred to the indexation of personal allowances. The freezing of them came into effect in April 2003, and cost the basic rate taxpayer 36p a week. As I said, that will help to fund annual real growth in national health service spending—something that the electorate desperately wanted and supported when this Government announced it; and of course, most pensioners over 65 are protected. Those aged 65 to 74 benefit from above-inflation increases in personal allowances, as do the over-75s. The Conservatives repeatedly froze income tax allowances when in power, but they did not use the money to invest in public services; they used it to pay for their economic failure.

Norman Lamb (Liberal Democrat, North Norfolk)

None the less, the freezing of personal allowances is a tax increase on low-paid workers. Will the Paymaster General give a commitment that it will not be repeated during this Parliament?

Dawn Primarolo (Labour, Bristol South)

If the hon. Gentleman will allow me, I shall first respond to a few more of the points that I need to deal with. I will deal later with his completely incorrect assertion about the position of the lowest 20 per cent. of earners vis-à-vis tax, as he is indeed very wrong.

The hon. Member for Arundel and South Downs and other Conservative Members referred to the increased number of higher rate taxpayers. To use again the example of Bristol, South, one excellent thing for the constituents whom I represent is that they now have jobs and can contribute to public services through national insurance and the tax system—something that the very high level of unemployment under the previous Administration denied them. We have increased the basic rate limit by inflation to maintain its value. As I said, that is in contrast with the previous Government, who froze the basic rate limit.

I would have expected Conservative Members to applaud the increase in the number of taxpayers, because it is a sign of a healthy economy—of more people getting into work and getting paid more. For the period 1997–98 to 2002–03, mean male average earnings increased by 25 per cent., and average full-time earnings for men and women increased by 26 per cent. Full-time earnings for the top 10 per cent. of men and women increased by 27 per cent., but prices went up by 13 per cent. Employment has increased by nearly 1.5 million since the spring of 1997. The number of people in work is at record levels—something that the previous Administration never achieved.

The right hon. Member for Wokingham and some of his colleagues referred to the use of national insurance. The reason why they keep on referring to the increase as a stealth tax escapes me. We announced that we would increase national insurance by 1 per cent., and we said that all the money would be spent on the national health service, which it is. If Conservative Members are saying that they would cancel that rise as well making, according to the hon. Member for Arundel and South Downs, a 20 per cent. cut across the whole public expenditure sector, they need to concentrate not on what this Government are doing but on how to explain to the electorate that there would be fewer teachers, fewer nurses and fewer doctors.

Howard Flight (Conservative, Arundel and South Downs)

rose—

John Baron (Conservative, Billericay)

Will the right hon. Lady give way?

Dawn Primarolo (Labour, Bristol South)

As I have just referred to the hon. Member for Arundel and South Downs, I should give way to him; that would be the polite thing to do.

Howard Flight (Conservative, Arundel and South Downs)

I thank the Paymaster General for giving way. She said that all of the 1 per cent. national insurance charge is being devoted to health service expenditure, but I distinctly recollect that approximately half is for the health service, with half going towards tax credits. Would she care to comment on that? Secondly, I repeat that she should not indulge in what she knows to be Labour party misrepresentations. She should instead be concerned by, and take note of, factors such as the 50 per cent. increase in the cost of the central civil service, whose numbers are rising from 450,000 to 529,000. She should also consider ways in which Government expenditure on unnecessary bureaucratic costs might be reduced. That is what I was talking about, rather than Government spending overall.

Dawn Primarolo (Labour, Bristol South)

All of the 1 per cent. national insurance rise is devoted to the national health service. If the hon. Gentleman refers to last year's national insurance legislation, which provided for that, he will discover that I said that repeatedly and that it is on the record. Indeed, the figures demonstrate that fact; the rise is not being used for anything else.

John Bercow (Conservative, Buckingham)

Will the right hon. Lady give way?

Dawn Primarolo (Labour, Bristol South)

If I may, I shall deal with the second point made by the hon. Member for Arundel and South Downs. I can only go on the newspaper reports about, and the direct quotes from, the hon. Gentleman himself and the right hon. Gentleman the Leader of the Opposition. If I were to engage in propaganda devised by the Labour party, I would opt for something more spectacular—but I do not need to, as I can merely report the words that have come from the hon. Gentleman's mouth.

I shall now deal with the points raised by the hon. Member for North Norfolk (Norman Lamb). He asserted—[Interruption.] I shall answer the hon. Member for North Norfolk, who has waited patiently; I may give way to the hon. Member for Buckingham later.

The hon. Member for North Norfolk asserted that the poorest 20 per cent. of households pay 40 per cent. of their annual income in tax. He bases that assertion on a publication from the Office for National Statistics, "Effects of Tax and Benefits on Household Income". However, the hon. Gentleman wants to forget—conveniently—some crucial and substantial facts that did not appear in that publication. The first is that the latest figures for 2001–02—the figures used by the hon. Gentleman—do not include any measures that the Government have introduced to help low-income households, which came into effect from April 2002.

Some of the excluded measures are the working tax credit, the child tax credit and the baby tax credit, the above-inflation increases in the basic state pension in April 2002 and 2003, and the increase in the minimum income guarantee for pensioners to match the increase in earnings. The article does not take into account the working families tax credit, which, following OECD guidelines, would reduce income tax payments for those in receipt of the benefit. Taking all the measures announced between 1997–98 and 2001–02, independent research by the Institute for Fiscal Studies shows that households in the bottom two quintiles have experienced the greatest proportion of real income gains over the five-year period.

What of the assertions of the hon. Member for North Norfolk about council tax and the proposal that a 50 per cent. rate for those earning £100,000 or more will somehow pay for a £100 reduction of council tax—and just about everything else that the Liberal Democrats want to fund? It is interesting to recall that the Liberal Democrats wanted to increase public spending last year, but this year they want to cut council taxes. It seems that they want to fund whatever is fashionable. However, the hon. Gentleman's figures are wrong. The 50 per cent. rate on £100,000 would raise—the Treasury confirmed, when asked—an income of about £4.5 billion. That is the net take when the whole United Kingdom—England, Wales, Scotland and Northern Ireland—is costed. However, when the £100 deduction on council tax is calculated, the Liberal Democrat figure applies only to England.

As the hon. Member for Buckingham said, it is difficult to take people seriously when their figures do not add up. It is also difficult to take them seriously when it is clear that they read the papers every day to find out what might be in vogue and then shape their policies around it. As confirmed by the hon. Member for Truro and St. Austell (Matthew Taylor), who speaks as the Liberal Democrat shadow Chancellor, the Liberal Democrats now believe that the Government are making the correct and necessary investment in public services. The direct tax burden on a single-earner family on average earnings and with two children will be 20.1 per cent., which is lower than in 1998 or any previous year since 1997, so it is irritating to hear the hon. Member for North Norfolk and his party asserting that such people are paying more tax. That does not sit well with the facts.

Norman Lamb (Liberal Democrat, North Norfolk)

Does the Paymaster General have any concerns about the impact of this year's council tax increases—four times the rate of inflation—on low paid and pensioner households this year?

Dawn Primarolo (Labour, Bristol South)

Of course I have concerns about impacts on lower income households. I shall not try your patience by listing the figures, Mr. Gale, but the Government were generous with the local government settlement on council tax this year. However, many Liberal Democrat authorities chose to increase local taxes on a large scale, so for the hon. Gentleman to stand in his place and claim that his party is concerned—when his councillors are not—is simply not a coherent position. I know that the Liberal Democrats like to be all things to all men and women—even depending on which ward, let alone which city, people live in—but when they are in the House, they should be more consistent in their suggestions. For the party that massively raised council taxes to suggest that it is now someone else's fault is not fair, correct, or accurate. I hope that the hon. Gentleman will not persist.

Clause 130 is a modest clause and I have explained the effect on tax rates in detail. I have answered the many and varied questions put to me at the Dispatch Box. Before I sit down, may I say that for the rest of the proceedings I shall confine myself to the clauses—and not with questions unconnected with them—if that is how you would like me to proceed, Mr. Gale? I commend the clause to the House.

Question put and agreed to.

Clause 130 ordered to stand part of the Bill.

Clause 131 — Indexed Rate Bands for 2003–04: PAYE Deductions Etc

Howard Flight (Conservative, Arundel and South Downs)

The clause extends by one month the date on which statutory inflation-linked changes to income tax bands must be made to PAYE deductions. It changes from May to the first pay day after 14 June. Essentially, it short-changes taxpayers by £10 as a result of the Chancellor introducing the Budget later than usual. People have received no apology. They will get the money back: in a sense, it is a £20 million interest-free loan from taxpayers to the Government.

Such disregard of ordinary people is objectionable. Why cannot the Government get their act together? They were able to charge increased national insurance contributions with effect from May, but here they are messing about with ordinary people, who were expecting to see income tax band adjustments in their May salary. It may be a small matter, but it represents the arrogance of the Government, who could not care less about short-changing people a pound or two here or there.

John Redwood (Conservative, Wokingham)

I support my hon. Friend, who has summed up the main point extremely well. The Government's action is arrogant, thoughtless and unhelpful to employers, who are under pressure to explain it to their employees. There is no need for an interest-free loan from taxpayers to the Government, given that they are proposing to raise vast amounts of taxation through the Bill and from existing legislation. I hope that the Paymaster General will apologise to the British people for the incompetence of her boss, the Chancellor of the Exchequer. He may well have been preoccupied with his rows with the Prime Minister about the euro, but he has not even offered a statement to the House on that matter. As a result, we have had a delayed and bodged Budget, and we now have a forced loan from the British people to the Treasury. We deserve an apology.

Norman Lamb (Liberal Democrat, North Norfolk)

I endorse the views of the Conservative spokesman on the matter. Is it not possible, as the Treasury Select Committee recommended in its report on the pre-Budget report last autumn, for much more notice to be given of the date of the Budget? It should take place in time to ensure that proper arrangements can be made for the new tax year. The problem that we are seeing here should never be allowed to happen.

Dawn Primarolo (Labour, Bristol South)

The first day after 17 May has been the day on which employers and pension providers are asked to implement any codes and tax changes resulting from changes in the Budget. As last year, this clause changes the date, for this year only, from the first pay day after 17 May to the first pay day after 14 June. That allows time for the Inland Revenue to send out the necessary employer packs, and for employers to implement them, given that the Budget was in April this year.

As PAYE works on a cumulative basis, no one will lose out as a result of the delay. The system automatically gives people the benefit of any tax reduction that they are due on the first pay day after 14 June. The clause makes no difference to the way in which the Inland Revenue and employers administer PAYE. It is essentially a technical amendment, to bring matters into line. As the hon. Member for Arundel and South Downs well knows, the same clause was brought forward last year in a straightforward and reasonable way and he saw no problems with it.

Question put and agreed to.

Clause 131 ordered to stand part of the Bill.

Clauses 132 to 134 ordered to stand part of the Bill.

Clause 135 — Provision of Services Through Intermediary

Stephen O'Brien (Conservative, Eddisbury)

I beg to move amendment No. 8.

I welcome you to the Chair, Mr. Gale, on what is the first occasion on which I have served under your chairmanship on the Floor of the House.

Clause 135 extends the scope of the much reviled and criticised IR35 legislation, which continues to cause distress. It applies to people who provide personal services through an intermediary to those who are engaged in a domestic capacity. The proposals are to take effect retrospectively, from 10 April this year.

The clause means that affected people will have to submit two self-assessment tax returns. The amendment is very simple and offers an easy solution. I am surprised that the Government did not adopt a similar approach in the first place. I hope that, for once, they will accept the amendment with the result that we get a better Bill. The amendment would simply delay the effective date for the income tax change, so that changes to national insurance and income tax happen on the same date.

The Government's anti-avoidance legislation is drafted in such a way that the people concerned, to reflect their tax affairs properly, must make two self-assessment tax returns this year. Those individuals were encouraged to incorporate by the Government, but they will be left with the increased burden of corporate regulation, no tax incentives, and considerable complexity when it comes to self-assessing their tax affairs.

It would be sensible to remind the House that the IR35 rules were originally written specifically to exclude domestic staff, presumably because the amounts at stake in tax and national insurance charges were not high. Has that changed dramatically over the past year? Is that why the Government are so monumentally concerned about the matter that they have to capture the domestic staff involved? Given that the clause is expected to raise only £15 million a year, that would be very surprising.

Furthermore, although a huge—for them—additional regulatory burden is being placed on the people concerned, no regulatory impact assessment is available. Has one been undertaken? The Government claimed always to be able to put in place such an assessment. When the matter has been raised in various Committee discussions, the Government have responded by saying that they would sort out such an assessment—they never volunteer to provide one. Frankly, it is not good enough for the Government not to provide such an assessment, given that some people are patently being given an additional regulatory burden. The people involved are those least in a position to be able to bear such a burden. I call on the Government to issue a regulatory impact assessment in relation to this provision. I think that they would find it pretty poor reading, and that it would be sensible for them to accept the amendment.

To make matters worse, the Government last year encouraged sole traders to incorporate, with the introduction of lower corporation taxes for smaller companies. A number of people acted on that, and incorporated—well done them—but now, only a year later, this Bill proposes to tax certain of those individuals as though they had not incorporated at all.

The provision is not targeted at wealthy tax planners. It will affect workers on relatively low incomes, who pay tax at the basic rate. They relied on last year's legislation in good faith. The Chancellor's proposed IR35 changes will be a major headache for tens of thousands of people who provide domestic services, such as gardeners, cleaners and cooks. They will be dragged into the Government's bureaucratic tax trap. The people affected will lose money, and be forced to submit extra tax returns.

The Chancellor is taking almost £50 million over the next three years out of the pockets of nannies, gardeners and cooks, and transferring it to the Government's coffers. The Federation of Small Businesses has noted that the provision will affect some of the lowest earners in Britain.

Only last year, many of the people involved were encouraged by the Government to incorporate. Twelve months on, they are to be hit by this regulation. None of the expected tax incentives can continue to apply and, for the people involved, assessing their tax position will be a considerably complex task. The problem has arisen solely because of the Government's incompetence, and their inability to draft effective legislation. Many people who thought that they were doing the right thing by following the Government's advice last year will now be seriously inconvenienced and financially penalised for their diligence.

No doubt, the Government will try to justify this clause only 12 months after they incorporated the very encouragement that has led to what they regard as the mischief of anti-avoidance. The Government say that they must stop anti-avoidance, and the Opposition have said repeatedly—as we must, to prevent the Government from falling into the temptation of mounting a false argument—that we support that. I have demonstrated the scale of the matter, but the theme of this Finance Bill, as was shown yesterday, is that the Government are determined to wrestle as many of the measures as possible through the House under the cloak of anti-avoidance. That is a blatant attempt to stifle scrutiny and criticism.

The Government and the Treasury have adopted an arrogant approach. They are not aiming to target anti-avoidance so much as making a futile attempt to be anti-accountability. Britain's honest and hard-working citizens will not be fooled.

I have read the official record of last year's Finance Bill Committee debates. The Government were fully aware that the interaction of lower corporation tax rates and dividend planning would provide tax advantages for an incorporated business. Even so, they implemented the measures without amendment.

It is proper and right to remind the Committee and the Paymaster General—I also hope that the Chancellor may deign occasionally to listen to arguments that do not accord entirely with his own—about a Federation of Small Businesses report published on 3 February this year. The report said that, at the time that the Government proposed the measures last year, a self-employed person with profits of £15,000 could pay up to 32 times more in tax than an incorporated counterpart.

The report, entitled "The Self Employed versus Incorporated Businesses", is well worth a read. It quotes figures from the Institute of Fiscal Studies, so it is not merely self-serving special pleading on the part of small businesses, although there is no more worthy cause in the business arena. The report states that, on profits of £15,000, the self-employed person would pay a combined income tax and national insurance bill of £2,884, which is 32 times more than the £91 paid in corporation tax by a limited company. On profits of £30,000, a self-employed person pays a combined income tax and NIC bill of £7,234, compared to £3,654 in corporation tax for a limited company. Is that not an obvious disparity between self-employment and incorporation?

As a background to the amendment and to the Government's purpose in extending the measure to low-income earners, such disparity in tax treatment shows that, even after all the strong encouragement and the legislative power devoted to persuading those on low incomes to incorporate, the minute that, in good faith, they do so, they are slapped with a further regulatory burden. Their affairs become complex and they may suffer financial penalties.

The remarks of Neil Hamper, the head of the Federation of Small Businesses taxation unit, are striking. He said:

"Clause 135 is evidence of the hole which the Chancellor has dug for himself. It comes as little surprise that many self-employed people, some of the lowest-paid people in the UK, will choose to incorporate when the tax system so obviously discriminates against them."

It is right that our scrutiny of the measure should be carried out by a Committee of the whole House. Our amendment would at least ensure synchronisation so that the regulatory burden was eliminated. The Treasury could easily accept our proposals, but one fears that, due to the Government's characteristic arrogance and their resistance to admit that they might have got something even slightly wrong, they are so stubborn that they will even resist something as sensible as our amendment, although I hope that the opposite will be the case.

Through the Government's mistakes, the original legislation was not drafted properly, so they have a responsibility to those who relied on it. The least that they can do is to implement the measure in such a way that individuals can unwind their affairs or carry out self-assessment with the least complication.

If the Government are characteristically blind to our arguments, I and my party, on behalf of the relatively low-earning nannies, gardeners, cooks and all the others who are affected by the measure will wish to press the amendment to a vote.

Roger Gale (Conservative, North Thanet)

Order. The hon. Member for Eddisbury (Mr. O'Brien) took a fairly wide-ranging approach in introducing his amendment. It may be helpful if I indicate now that I shall be unlikely to accept a stand part debate as well.

Norman Lamb (Liberal Democrat, North Norfolk)

We very much support the amendment. We, too, share concern about the absence of a regulatory impact assessment. Often, such assessments do not comply with the Government's guidelines as to what they should include, but the fact that there is to be no assessment at all is of serious concern. The measure will add to the regulatory burden of people who are trying to operate small businesses, so there should be an assessment and I should be grateful if the Paymaster General would respond to that concern.

I also share the concerns expressed by the Conservative spokesman, the hon. Member for Eddisbury (Mr. O'Brien), about the disparity in the tax treatment of sole traders and of limited companies. I shall not go into that in detail, in acknowledgement of your comments, Mr. Gale, but serious concerns have been raised with me and many others by the Federation of Small Businesses. People have been encouraged to incorporate and now this change has happened.

Last year, when IR35 came in, the Liberal Democrats opposed the measure. We fully accepted the importance of tackling abuse and tax avoidance, but we thought that the Government were taking a sledgehammer to crack a nut and that the implications of the measure could be extremely serious. We are now discussing an extension of IR35, and I have some questions for the Paymaster General.

What evidence can the Government show that the scale of abuse makes the measure necessary, given the relatively small amount of extra revenue that it will bring in? Why was it thought necessary to extend IR35? Why was the matter not dealt with last year when the first measure was introduced? I was going to ask what assessment had been made of the amount of extra income that would result, but a figure was mentioned by the Conservative spokesman. What is the overall purpose of the reform?

John Redwood (Conservative, Wokingham)

The clause is disappointing. I welcomed the Government's proposals last year to favour incorporated businesses and to introduce a better tax regime for the smallest companies. It was a sensible measure in favour of enterprise, so it is particularly disappointing that, after only a year, when, as one could have forecast, the policy has enjoyed modest success, the Government want to clobber those who took advantage of it and to reverse the position. I urge the Paymaster General to think again. Her thoughts last year were rather better than her thoughts this year.

In support of my case, the Paymaster General has evidence that IR35 is not only a widely hated tax but also that it is extremely damaging to the United Kingdom. It pushed people out of self-employment. It sent some of them abroad, where they had successful, high-earning businesses; but others simply left that employment altogether, because the tax was an imposition too far. It did considerable damage at a time when the high-tech industries, which were especially targeted by the measure, were extremely fragile.

My hon. Friend the Member for Eddisbury (Mr. O'Brien), in moving his amendment, pointed out the big imbalance between the taxation on earnings for a self-employed person and the taxation on profits for a small, incorporated business. He is right about that. However, a fair comparison for the Paymaster General to make, when she assesses the potential damage, as she sees it, to the Revenue, would be not between profits held within an incorporated business and the earnings of a self-employed person but between distributed profits in a small business and earnings. In such a case, the comparison is not as stark as my hon. Friend said, because there would be taxation on the money being drawn out as wages by the person concerned, or even as share dividend. If the person was the shareholder and decided to take money out, there would be a tax payment, which would narrow the gap, so the threat to the Revenue would not be as great as the Paymaster General will undoubtedly want us to believe when she replies to the debate. In normal circumstances, the gap for low-earning, self-employed people would not be nearly as great in terms of tax, as they would want to take all or most of the money out of the incorporated business in one form or another because they would want it to live on. As my hon. Friend pointed out, those people often do not earn much.

Having listened carefully to my hon. Friend, I think that he was very gentle towards the Government, given the magnitude of their U-turn, in their decision to bash the very people whom they encouraged a year ago. His suggested remedy is mild. If he wishes to push the amendment to a vote, I shall have no worries about supporting it because it is better than the current provision.

However, it would be better still if the Government dropped the clause altogether. The clause is nasty and brutish; it is part of rip-off, insensitive government. It will not bring in much revenue—the Treasury figures probably exaggerate the amount—but it will do damage and put many small entrepreneurs, people who are trying to provide a service, under a lot of pressure that they do not deserve. Such people are not experts on the tax system; they do not want to go through these enormously expensive and difficult changes. The measure will worry them, when they want only to provide a livelihood for their families and a service for someone else. I hope that the Paymaster General will realise that, in the main, they are decent people, trying to make a modest living while paying sensible amounts of tax. Her decision to target them will not be welcome in any constituency.

John Baron (Conservative, Billericay)

May I welcome you to the Chair, Mr. Gale?

I support the amendment. There is little doubt that clause 135 creates a gross injustice, a point that has been raised by several of my constituents. Last year, the Government encouraged sole traders and the self-employed to incorporate by introducing lower corporation tax rates for small companies. Subsequently, a large number of people did just that. Only a year later, on the grounds of reducing tax avoidance, the Government propose legislation that will tax individuals as though they had not been incorporated at all. Those measures are not targeted at wealthy tax planners; they affect many low-paid workers, who were fooled by the Government into incorporating and, having done so, they are now being ambushed by the Government under the Bill. The victims are normal taxpayers who rely on the Government's legislation in good faith, and they have been badly let down.

In addition, the anti-avoidance legislation has been drafted so that the individuals concerned will now have to submit two self-assessment returns for this tax year properly to reflect their tax affairs. So those individuals whom the Government encouraged to incorporate now face not only an increased burden of corporate regulation, but no tax incentive whatsoever and considerable complexity in self-assessing their tax affairs.

I can only add to the request made in support of my hon. Friend the Member for Eddisbury (Mr. O'Brien) by asking the Government to undertake a regulatory impact assessment to ensure that the measure has been properly thought through. As has been mentioned previously, IR35 rules were originally written specifically to exclude domestic staff, presumably because the amount of tax and national insurance contributions at stake was not very high—the figure of £15 million has been suggested. I should like to understand better whether that has changed dramatically, which would be surprising given the figures suggested.

The Government are obsessed by tax avoidance, and that is obviously not necessarily a bad obsession, but their approach in this case has hit legitimate businesses that have set up companies to help the organisations that they serve. They are not avoiding tax and, moreover, they provide the very flexibility in the labour market that the Government say that they are trying to encourage and that is an asset to this country.

The Government criticise other EU countries for their lack of labour market flexibility, but they appear to be piling on more and more regulation domestically and introducing more taxes and tax measures that undermine the asset about which they boast. That cannot continue.

I support amendment No. 8, as the Government's proposed changes to the law will put an unnecessary burden on individuals who do not deserve to be persecuted in this way. I ask the Government to recognise that they should have listened to the warnings from my Front-Bench colleagues during consideration of last year's Finance Bill. They should seriously consider accepting the amendment, which will at least attempt to salvage something from this shameful sequence of events.

John Burnett (Liberal Democrat, Torridge and West Devon)

May I too welcome you, Mr. Gale, to the chairmanship of our proceedings this afternoon?

Opposition Members are absolutely right to say that the Government have actively encouraged people to incorporate. However, in this case, the commissioning contractor—for want of a better expression—often insists on dealing with an incorporated person and they do so for reasons of saving tax themselves. We debated that at length when IR35 was introduced, and I consider the changes made then and these changes to be outrageously unfair. Obviously, when the changes are made, additional national insurance contributions will be payable by the subcontractor; nevertheless, no additional employee benefits will accrue or be available to those subcontractors. In other words, they will pay and they will get nothing, and they will also be subjected to an additional burden of bureaucracy.

Finally, I should like to ask the Paymaster General whether she could let the Committee know whether the Government yet have any proposal to make the fiscal penalties for disincorporation more fair and less punitive.

Jonathan Djanogly (Conservative, Huntingdon)

My hon. Friend the Member for Eddisbury (Mr. O'Brien) described in detail and extremely well how the provision could affect some of the poorest workers in our country. While totally concurring with him, I should like to examine the other side of the coin and explain how the clause will attack middle-class, middle-earning, aspirational and hard-working parents, particularly women. I shall do so in relation to the implications of applying IR35 and how it will affect nannies. That will cost parents who take advantage of the existing regime hundreds of pounds a year. We are talking about extra charges of at least £6 a week and probably £10 or more in London.

Outside London, the average nanny's wage is about £235 a week net of tax, and it is likely that parents will lose about £312 a year. I note that that is some £60 more than the new child trust fund that is being introduced. One tax partner at Grant Thornton said:

"If you employ a nanny or housekeeper, the chances are you will pay around 25 per cent. more for the service now this tax break has been removed."

Parents will therefore have to start paying a triple whammy—their own national insurance, presuming that they work; the employer's national insurance contribution for their nanny and, of course, any other domestic staff; and their nanny's own national insurance bill, because parents traditionally take care of their nanny's tax and insurance liabilities.

For example, a working mother would have to earn a gross salary of £30,345 simply to pay her nanny a gross salary of £20,400, netting some £300 a week. That shows how middle-class parents are being hammered at the moment. The mother's own annual net pay after tax and national insurance deductions would be about £22,350, while the cost of employing her nanny—including employers' national insurance contributions, which are additional to the nanny's gross wage—would be £22,360. Of course as nanny's wage grows, the triple-whammy effect gets worse.

The Government provide help with child care through the working tax credit, but although that payment is worth up to £200 a week for people with approved child minders, it is important to note that, despite ongoing lobbying on that point, the Government refuse to apply registration to nannies. Child minders are mostly registered through Ofsted and regulated by national standards for day care and child minding, but nannies are not approved in that way. In addition, parents with a joint income of £58,000 or more will not be eligible for child tax credits.

We have increasingly seen a move towards nannies and parents going underground in relation to employment, and that will increase under the clause. One of the worst-kept secrets in the capital is that probably as many nannies work outside the tax system as inside it. People do not want to do things that way; they are being forced to do so by a system that does not take notice of the needs of middle-class parents in this country.

Of course this tax affects women in particular because their salary normally pays for the nanny. Most women will have a very difficult decision to take when they have children: should they stay at home, or should they go back to work? They will want to go back to work to keep their minds ticking over and to keep their trade experience up to date, but in effect they will do so to pay for the nanny, as the figures that I have given show, rather than to provide themselves with any additional salary, so we are talking about an additional tax on women. I thought that the Government were in favour of getting women back to work, but they are clearly in favour of getting people whom they see as being lazy and sitting at home back to work but not doing so for aspirational, hard-working middle-class women who want to get out and do something for this country, and we desperately need to get more women back into the labour force.

John Redwood (Conservative, Wokingham)

Although I see my hon. Friend's point that some might be tempted down the path of illegality into the black economy, does he not agree that many of the professional women about whom he is talking, who wish to return to work and have every right to do so, would never dream of going down that path, as it would be against their principles and would prejudice their important employments, in which they are expected to be decent, honest and upright? Will not this therefore be a tax that stops women having the freedom of choice that they should have? It will be very bad news for them and will put them off returning to the labour market, which may result in their losing their confidence in future years.

Jonathan Djanogly (Conservative, Huntingdon)

I agree absolutely. This Government are not considering aspirational women who want to get out there and improve themselves. My constituency currently has virtually no unemployment, and is one of the fastest-growing areas of the country—a fact of which I am very proud. When I visit local businesses, I am told consistently that there are serious problems with recruitment: they cannot find the people to fill the jobs, and they cannot find people with the necessary skills. Thousands of women in this country are highly skilled and want to work, but they cannot do so because of the current tax system. I hope that that provides some spur, while going in the opposite direction, for the Government to rethink this issue.

Dawn Primarolo (Labour, Bristol South)

It may help if I explain to the Committee how the mechanism works in relation to service companies, why domestic employees were exempt last year, and why the Government acted this year. That will lead me directly on to some of the hon. Gentleman's points.

Although I appreciate and understand the important points that Opposition Members have been making about a company being incorporated or unincorporated, they are sorely mistaken on the focus of this specific measure. I want to explain to them why that is. In relation to the decision last year to exempt domestic employees, what has happened subsequently confirms the point that the Government repeatedly make: if a loophole is left, unfortunately, somebody will try to exploit it.

The existing service company legislation ensures that workers who would have been taxed as an employee if they had been working under a contract with the client cannot avoid paying tax and national insurance on the same basis as any other employees by using a limited company or other intermediaries to sell their services. As I have said, the current legislation does not, however, apply to engagement in a domestic capacity. Regrettably—again, this point has been made repeatedly since 1997—the Government have to have mind to how taxpayers will behave towards the tax system. Our duty is to ensure that the right amount of tax is collected and that it is collected fairly: by that, we mean that those who should be paying tax do not find artificial ways of not paying it, as that is patently not fair to all other taxpayers. In advocating a higher rate of tax, the hon. Member for North Norfolk (Norman Lamb) fails consistently to understand that it is important to ensure that people pay the tax that they are supposed to be paying.

Generally, schemes operate by setting up the domestic worker as a director and shareholder of a personal service company. The individual employee therefore starts off as an employee of the client. Subsequently—not because it improves the employer-employee relationship or because the employer is interested in helping self-employment grow—the positioning of an intermediary is used simply to reduce tax. I shall explain how that works.

The domestic company is set up for the domestic worker so that the domestic worker is a director and shareholder of the personal service company. The service company offers the services of the director to the former employer. The domestic worker takes a salary from the company at around the personal threshold of £4,615, and the remainder in dividends. Therefore, if the company net profits are below the threshold for the starting rate of £10,000, the domestic worker can extract up to £14,615 free of tax and national insurance contributions.

Let me remind the Committee: somebody who was an employee is then encouraged to use an intermediary to reduce the cost to their previous employer or to increase the payment to them by setting up the service company.

John Burnett (Liberal Democrat, Torridge and West Devon)

rose—

John Baron (Conservative, Billericay)

rose—

Dawn Primarolo (Labour, Bristol South)

The hon. Gentlemen should let me finish, as they need to know what was being marketed. I will then challenge them to say what they would have done were they in government. We did not act out of some fickle desire: there was proof of what was going on, and I shall give that proof to the Committee.

John Burnett (Liberal Democrat, Torridge and West Devon)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

I will not. If the hon. Gentleman will let me explain this complex point, there will no doubt be plenty of time for interventions.

The scheme providers usually charge a monthly fee for operating the scheme. Effectively, the domestic worker still receives a weekly or monthly payment, albeit that it might be a larger amount because of the savings that the scheme produces through avoidance—the savings might be split between the former employer and the domestic worker, or the former employer might take all the benefit.

It was right to ask the question—we did not think that leaving domestic workers outside the system would not raise issues, and as with all points of the tax system, we give careful consideration and follow developments. We had been approached by several parties, however, of which I will give one example, about the number of schemes that were about to be marketed to exploit the loophole. The schemes were able to offer significant savings in tax and national insurance contributions to any domestic employee with net weekly earnings above £111 a week. In terms of the attitude to the Government action, let met quote Leonie Kerswill of PricewaterhouseCoopers:

"IR35 previously exempted domestic staff, but the cost savings of the arrangement for parents employing nannies has led to an explosion in the use of service companies".

John Baron (Conservative, Billericay)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

No. I will finish making this point and then I will give way to the hon. Gentleman. I am trying to explain this complex point, giving the proof for why the Government acted in this way. I will give way at the relevant point.

Bearing in mind the tax and national insurance savings, the Government were faced with a significant problem. For example, a letter was circulated to every client of a particular agency that runs the arrangements for nannies. The letter states:

"As you will see, we do not believe that the use of a personal service company represents best practice in nanny employment because they involve the use of a tax-saving vehicle which obscures the real employer/employee nature of the relationship between parents and their nannies, with some attendant loss of employment rights for the nannies",

most of whom are women. The hon. Member for Huntingdon (Mr. Djanogly) was concerned about women's rights.

When the measure was announced and comments were made about the Budget, on Saturday 12 April The Daily Telegraph reported the managing director of Nannytax as saying:

"We cover all types of domestic workers—housekeepers, gardeners, butlers, as well as nannies. The decision to close the tax-break loophole was appropriate. We think the relationship between, for example a family and a nanny, should be one of employer and employee. Nannies who were employed as a private company were losing employment benefits such as maternity leave and some pension rights."

The fact that the exemption was about to be exploited on a massive scale was flagged up to the Government in the run-up to the Budget, along with the attendant loss of income to the Government and the difficulties that would be created for employees.

Nursery World is concerned with issues that relate to child care and nannies. In a poll, it asked:

"Is it a good idea for nannies to become limited companies?"

Some 36 per cent. said yes and 62 per cent. said no. The clause is not about self-employment. It relates to employees and the problems created by a mechanism that is driving them into a relationship that leads to a diminution of their rights and a loss of tax revenue. The Government have acted now to avoid extensive use of the mechanism before it creates the many problems that the hon. Member for Huntingdon flagged up about families making those arrangements only to find the loophole closed.

John Baron (Conservative, Billericay)

Does the Paymaster General accept that there is a gross injustice? Those problems should have been thought through before the mechanism was introduced last year. The Government have in effect encouraged many self-employed unincorporated people to incorporate, and in the following year have ambushed them with the tax measures in the Bill. That appears to many outside the Chamber as grossly unfair. Will the Paymaster General address that central issue?

Dawn Primarolo (Labour, Bristol South)

The hon. Gentleman is entirely wrong. The Government have done no such thing. We made our position on IR35 clear when we debated last year's legislation. The clause is not about the rights of people to be self-employed or employed; nor is it about the right of people to have their own companies; it is about the use of a mechanism that is designed only to reduce the amount of tax paid.

George Osborne (Conservative, Tatton)

rose—

John Baron (Conservative, Billericay)

rose—

Dawn Primarolo (Labour, Bristol South)

No, I shall not give way.

I am describing a tax distortion that has been driven by a particular arrangement in the tax system by which people choose to be employees and are in danger of being required not to be.

Howard Flight (Conservative, Arundel and South Downs)

When we debated the new zero rate of corporation tax for small companies in the last Finance Bill, we welcomed the general principle but stressed that to introduce it without a parallel or averaged rate for sole traders made it an obvious tax incentive for people to incorporate and exploit. Indeed, I made the same point when I wrote to the Paymaster General some eight months ago. I said that it was wrong in principle to have rules in our tax system that act as a massive incentive to incorporation and to the exploitation of the advantages that it brings. The Federation of Small Businesses made the same point. The issue is specific, but it is part of the wider territory. If there is such a big distortion in our fiscal arrangements, it is inevitable that people will try to exploit it at all levels.

Dawn Primarolo (Labour, Bristol South)

The clause is not about individuals who choose to be self-employed or to incorporate. It deals with a specific aspect of the tax system. The exploitation of a loophole was driving people into a particular tax position simply to save tax for their previous employer or themselves, or to share it equally. The hon. Gentleman will know that from our discussions on IR35.

The wider debate, which the hon. Gentleman verges on, relates to changes to incorporated and unincorporated companies, and whether that balance is correctly struck. I believe that it is, but that should not be debated in the context of this clause. I accept that many hon. Members, and people and companies outside the House, want the issue to be explored further. We must always find a basis on which to strike a balance, but that is not what we are dealing with now.

Hon. Members asked why we are making the change now, and I have set out our reasons. They asked how the mechanism was being exploited and why, and I have made that clear. The debate is not about incorporation or unincorporation; it is about whether we should leave a mechanism in the tax system that leads not only to a loss of tax revenue but to a diminution of employment rights, and all because of a loophole.

John Burnett (Liberal Democrat, Torridge and West Devon)

The Paymaster General is invariably fair, and I think she would agree that it is right to put it on the record that there are tax consequences in making distributions out of companies to individuals. However, I sincerely hope that she will deal with the point that I raised. If incorporated sub-contractors pay full employee national insurance contributions, surely they should qualify for full employee benefits.

Dawn Primarolo (Labour, Bristol South)

The hon. Gentleman teases me back to the debate that is at the heart of the changes known as IR35: does the individual operate as a shareholder or an employee of his or her own company? If they operate as an employee of their own service company, they get all the rights that all employees get.

As for opinions within the relevant employment sector, it is interesting to note what is said in an article in Professional Nanny. The article asks whether nannies are being urged to become directors of their own companies and says that

"if all nannies saw themselves as young Richard Bransons, eager to make their first million, then maybe running their own service company might be an irresistible prospect. But in reality, many nannies are in their first or second job, dedicated to the children they are responsible for, and looking to the parents to protect their interests both as an employee and as a new member of the family."

It is incumbent on the Government to protect nannies' best interests. The temptation provided by the loophole has been removed precisely to protect those nannies.

George Osborne (Conservative, Tatton)

The right hon. Lady would accept that the driving force behind the provision is the high cost of child care. I received a copy of the letter that she read out, but resisted the temptation to take up the offer, because a friend of mine who is a tax barrister told me that the Treasury would close that particular avenue. However, does she accept that dealing with what she calls tax avoidance is likely to cause an increase in tax evasion? Has the Treasury analysed whether there will be an increase in the already large number of working nannies who will be outwith the tax system altogether?

Dawn Primarolo (Labour, Bristol South)

I am glad, but not surprised, that the hon. Gentleman decided to resist that temptation on the sound advice of his friend—that clearly supports the case that I have put to the Committee this afternoon. The position of nannies as people who are employed by a family or supplied by agencies remains unchanged, but we have removed any driver that might change that relationship. He will remember that, in the letter to which he referred, the company made it clear that it expected the Government to close the loophole because it was neither reasonable nor fair. For those reasons, it is inappropriate, to put it mildly, to accept an amendment that leaves in place, even for a specific period, the arrangements that gave rise to that loophole. I urge the Committee to reject it and support the clause.

Stephen O'Brien (Conservative, Eddisbury)

Much of the Paymaster General's riposte concerned nannies, but let us not lose sight of the fact that the provision will affect cooks, gardeners and many others in domestic service, not all of whom are subject to the arrangements that she sought to pray in aid. As we predicted, she sought to defend the provision as an anti-avoidance measure. The Treasury, having found out from its scouts in the City that somebody, somewhere had come up with a clever wheeze and was beginning to market a new product, decided to put a stop to it.

The Paymaster General has missed the point. We oppose the provision not because it is an anti-avoidance measure but because it lets down people on relatively low incomes who, encouraged by last year's Budget, acted in good faith. They are now being slapped down and face a regulatory burden of two self-assessed tax returns in the current tax year. The amendment would reduce that regulatory burden. Furthermore, the Paymaster General never bothered to answer my serious question about why there is no requirement for a regulatory impact assessment because, I dare say, she would not like the answer that she would have to give.

Dawn Primarolo (Labour, Bristol South)

I apologise to the hon. Gentleman. I did not mean to avoid his question, I just forgot to answer it. A regulatory impact assessment is not included because, as he knows, the Government are not required to carry out such assessments of anti-avoidance measures, although he is challenging that. The costs are in the Red Book, but it is impossible to say how much the problem would continue to grow. The experience of the last Conservative Government of profit-related pay shows that initially payments are small but they end up being very large.

Stephen O'Brien (Conservative, Eddisbury)

The Paymaster General is quite right—there is no obligation to produce a regulatory impact assessment. We have had many discussions about that when debating secondary legislation. Even though it is not required, in some cases it is offered, and we receive letters about that. The provision under consideration would have been a worthy candidate for such an assessment.

John Gummer (Conservative, Suffolk Coastal)

Has my hon. Friend noticed that if the Government decide that any measure is an anti-avoidance measure, they are able to tell the Committee, "We do not need to give you the information that we ought to have"? We should point out to the Committee that that is a dangerous argument that leads to self-assessment and self-regulation.

Stephen O'Brien (Conservative, Eddisbury)

I thank my right hon. Friend, not least because he speaks with experience of government. I am grateful for the opportunity to point out to the Committee, particularly to those who were detained elsewhere at the outset of our debate, the fact that I said that a theme of the Bill is to arm-wrestle as much of its content as possible into the cloak of anti-avoidance in a blatant attempt to stifle scrutiny and criticism. That arrogant approach, I said, was less about anti-avoidance than about a futile attempt by the Government and the Treasury at anti-accountability, which will not fool the hard-working citizens of this country. That answers precisely the point made by my right hon. Friend, with whom I could not agree more: anti-accountability is the inherent culture of this Government. There could have been recognition of unintended consequences in the clause, and the Government could have used it to close a loophole. However, they have blatantly disregarded our arguments, and the clause is now a slap in the face for domestic workers who have incorporated.

John Bercow (Conservative, Buckingham)

Given that the Government have consistently spun the policy as a response to abuse by fat cat entrepreneurs, and given that my hon. Friend made the seminal point that its main victims will be some of the most vulnerable people in our society, would it not be helpful to know how many cooks, cleaners and gardeners may be affected by the provision? The Opposition have a responsibility to communicate to those people the scale of the damage that the Government are inflicting on them.

Stephen O'Brien (Conservative, Eddisbury)

It is impossible to give those numbers without a census, but it certainly is our duty to speak up for those people. It is interesting that Mr. Neil Hamper from the Federation of Small Businesses said that people running their own businesses should be able to choose which business model suits them best. They should not have to contend with the hoops and hurdles of incorporation to secure generous tax breaks. That is the problem: people incorporated to take advantage of a tax break touted by the Government. My right hon. Friend the Member for Wokingham (Mr. Redwood) properly pointed out that the extent of that incentive depends on the way in which the differential is measured, but there is a differential none the less, so the incentive remains. Seeking to end an abuse that has not been proven is, in fact, an abuse by the Government.

George Osborne (Conservative, Tatton)

My hon. Friend has spoken about consultation and its impact. Has he had the opportunity to discuss the matter with the hon. Member for St. Helens, South (Mr. Woodward), an expert on these matters, who may have been able to help him draft amendments?

Stephen O'Brien (Conservative, Eddisbury)

I am grateful to my hon. Friend for that colourful example. I gave a speech in St. Helens only the other day, but did not spot the hon. Gentleman or his alleged butler.

We have a duty to point out the unintended consequences of the clause. However, the Government have made plain that its intended consequence is a slap in the face for certain people. They have slammed the door shut on people who took advantage of a tax break in good faith. We should speak up for the people whom my hon. Friend the Member for Buckingham (Mr. Bercow) mentioned, and I urge my right hon. and hon. Friends and everyone else who accepts the power of these arguments to join me in the Lobby.

Clause 138 — Approved Share Plans and Schemes

Howard Flight (Conservative, Arundel and South Downs)

There is a broad measure of agreement between hon. Members on both sides about the merits of employee share ownership. The changes introduced by the clause are intended to provide relief and make more flexible the share incentive plan or SIP arrangements, save-as-you-earn option schemes and the company share option plan or CSOP.

I believe passionately that as many people as possible should own shares in the businesses for which they work. All the evidence shows that companies with widespread employee share ownership perform better and have much better human relations. Such ownership clearly engenders an owner-employer mentality rather than a them-and-us mentality. Businesses such as the John Lewis Partnership, which has succeeded so well on the back of employee share ownership, are legendary.

The arrangements generally give greater flexibility in the administration of share plans. That includes, for example, the removal of the former requirement that, in order to be tax-free, a CSOP option must be exercised more than three years after a previous tax-free exercise. Furthermore, an individual will be able to participate in more than one connected SIP in a tax year—that is, he can participate in one or more approved SIPs established by his company or a connected one. However, three aspects of the arrangements are unsatisfactory, and the industry and associated advisers, including ProShare and many of those concerned with encouraging employee share ownership, have made criticisms and contacted the Treasury to seek changes.

Of particular concern is the change to rules about pay-as-you-earn and the national insurance contribution in relation to CSOPs exercised within three years of grant. The change is clearly unfair and will cause some problems. It should logically apply to options granted on or after 9 April this year, rather than options exercised after that date. The change to options exercised on or after 9 April has two implications for companies that are retrospective in nature.

The employer will now be responsible for withholding PAYE and NICs from employees, although he can under law deduct those payments from an employee's cash pay. There are strict rules in that regard. If the employee has already been paid for the month or his net pay is insufficient for deduction of the new PAYE and NIC liability, the employer will not have sufficient funds to pay the required sums to the Revenue. It is extremely rare for approved plans, unlike unapproved ones, to contain a provision to prevent exercise of the option if satisfactory arrangements to deal with PAYE and NICs cannot be made. The reason for that is that such provision has not been necessary in the past, as there has been no obligation to apply NICs or PAYE.

The new rule will therefore mean that employers will often have to pay PAYE and NICs without having any practical method of recovering the costs from employees. The employer will also have their own NIC liability on the exercise of the options. Typically, it will be set at 12.8 per cent. of the employee's option gain. As the new rules apply to options exercised on or after 9 April this year, the employer will have a new liability for which they could not previously have provided. When the NIC rules were amended to allow employers to transfer to employees the NIC liability on unapproved share schemes, many companies attempted to include such provisions in their approved share option plans as insurance against NICs being charged to them, but the Inland Revenue refused to approve share option plans that contained such provision.

A point of principle is at stake. The Government's argument for applying NIC on unapproved plans was that gains from such plans were liable to income tax, so the contributions went together. Approved plans remain under the capital gains tax regime, however, so there is an issue of principle about whether it is appropriate to charge NICs at all.

Jonathan Djanogly (Conservative, Huntingdon)

My hon. Friend makes a good point in saying that, when people try to amend approved schemes, the Inland Revenue throw them out of the door. We are talking not only about a tax implication, but significant cost implications, because many professionals will have to be paid to redo schemes.

Howard Flight (Conservative, Arundel and South Downs)

I thank my hon. Friend for that accurate point.

I apologise, Mr. McWilliam, for not having welcomed you to the chairmanship of our proceedings. It has always been a great pleasure to have you as Chairman in Finance Bill Committees.

The proposed arrangements will require trustees to maintain records of those who have participated in one or more approved share incentive plans. That presents a problem in that, to maintain records of such participants, the trustees will need the full requisite information. It should not be a breach of the plan conditions if the trustees fail to maintain such records as a result of not receiving the necessary information from the company or the participants concerned.

The retrospective nature of the application of NIC charges to company share option plans will particularly hit companies that allow employees to take options with them when they leave. Such a company would find itself paying the PAYE tax and employees' NICs, as well as the employer's NICs, and would be lucky to make the payments to the accounts office in time, assuming that it knows that the exercise has taken place. Indeed, despite the statement in the Budget notes that the motivation behind the provisions is to close a loophole, there is a broad belief in the share scheme world that CSOPs have not been promoted as an NIC mitigation tool, especially given the continued low limit of only £30,000 of participation.

Companies sometimes seek to maintain approved status during a takeover as part of their general tax and NIC arrangements. In that context, some small firms may have tried to sell the CSOP to private companies that are looking for an exit on the full understanding that the options would be exercised within three years without the NIC liability being payable. Many of those companies can now benefit from the EMI—executive management incentive—plan arrangements and can exercise them when they wish without paying any tax or NICs, but those that cannot benefit from EMI will now be in a less advantageous position whereby they use the CSOP instead. The chief concern is that the provision applies to all existing options. Although the provisions that allow employers to transfer their NIC charges to the employee can apply to CSOP options, it is extremely difficult to make that happen. This is a fundamental issue. The Government may ultimately decide that the measure will not yield much tax, but if the legislation has to change, it should apply only to future, not existing, option grants.

Another aspect of the proposals is intended to be helpful, but looks to be unworkable—that is, the changes to ease the complexity of the dividend share provisions. Those are contained in paragraphs 9 to 15 of the schedule, which we will debate Upstairs. I understand that the Government recognise the weakness of the proposals and intend to withdraw them for reconsideration. I should be grateful if the Paymaster General could confirm that.

Another important issue is the threat to employee share ownership in the shape of the proposed requirement by the International Accounting Standards Board that all forms of subsidy towards employee share ownership are charged to the profit and loss account. It is clearly understood that the background to that is abuse in the US, but if it becomes the accounting rule here, it will lead to a major contraction in employee share schemes and do much more to undermine the positive aspects of clause 138 and the accompanying schedule. It is, of course, not for politicians or Governments to tell the professional accounting bodies what to do, but it is important that they realise the extent of the threat to employee share ownership. The theoretical accounting arguments are very much balanced on both sides.

Conservative Members want to ensure maximum employee share ownership for the good of businesses, the good of individuals and the overall good of our economy.

John Burnett (Liberal Democrat, Torridge and West Devon)

I, too, welcome you to the chairmanship of the Committee, Mr. McWilliam.

The notes to the Bill state that clause 138 deals with

"tax relieved, employee share and share option schemes designed to encourage employees to identify with the success and growth of the companies for which they work."

Of course, we support that aim.

An increasing amount of legislation, certainly in Finance Bills, is increasingly complicated, and Opposition Members rely heavily on briefings from outside bodies. The hon. Member for Arundel and South Downs (Mr. Flight) highlighted the problems with the clause, which is designed to simplify procedures. Will the Paymaster General tell us what consultations the Government have had with professional bodies such as the Law Society, the Institute of Chartered Accountants, other accountancy bodies, the Bar Council and the Chartered Institute of Taxation? I hope that the Government will listen not only to the submissions of the hon. Member for Arundel and South Downs, but to those of the professional bodies. It is in all our interests to have a satisfactory, tax-efficient, un-bureaucratic system that encourages employee share ownership and acts as a first-class incentive to employees. It is important that employees feel part of the ownership of an organisation. Organisations that have such schemes are shown time and again to thrive and grow.

Jonathan Djanogly (Conservative, Huntingdon)

At a time when many, if not most, option holders have been saying that their options are going underwater and that their participation in the equity of their company is being wrecked, why do the Government feel that now is the time to start cracking down even further on such schemes? With 600,000 jobs lost, tough times and low productivity in the manufacturing sector, is not this the time to encourage share participation and involvement by employees? To that end, why does not the clause, rather than punishing people through tax, increase the use of approved schemes by, for instance, raising the limit of £30,000 to £100,000?

Dawn Primarolo (Labour, Bristol South)

First, I want to remind hon. Members of the huge amount of taxpayers' money that we commit to supporting share ownership. Combined tax and national insurance means that the figure is rising to just under £1 billion a year, involving approximately 2.5 million employees. That figure is also rising.

The hon. Member for Arundel and South Downs (Mr. Flight) is right to extol the virtues of approved employee share ownership schemes in their varying guises in not only rewarding employees but giving them a stake in their company. That leads to the associated benefits in productivity and staff commitment. He will also know that many views exist about the administration of such schemes. As David Cohen, head of employee incentives at Norton Rose, explained recently in an article on the proposals for employee share schemes:

"This is an area of Tax Law which"—

he phrases it delicately—

"has always been an active battleground between the Revenue and Tax Payers."

That has happened not recently, but over time. He continues:

"The Revenue's abiding concern is that share schemes will be used to remunerate employees"

in a way that is proper. He points out that often, taxpayers are motivated to do exactly what the Inland Revenue is trying to minimise.

It has always been a Government objective and, I presume, a goal of the previous Government, to try to ensure that the patchwork of rules and regulations that have built up over the years should be as clear and simple as possible, given that the subject is already complex.

Let me deal briefly with consultation. Over several years, the Inland Revenue has been in extensive dialogue with the representative bodies, especially those that are most concerned with employee share ownership schemes. Many comments have been made over that period about desired changes to legislation. The Inland Revenue drew on those dialogues and representations in drafting the changes that are incorporated in the Bill. I recommend the article by David Cohen in this week's "Tax Journal", which clearly sets out the main principles that needed to be tackled and would be helpful to the scheme. I am eternally grateful that they bear a startling, almost identical resemblance to the Government's actions. Dialogue and consultation have therefore been going on for some time.

Consultation does not always guarantee that there will no subsequent changes. The hon. Member for Arundel and South Downs referred to that. Sometimes representative bodies recommend actions about which they might not have consulted extensively in their organisations. They might subsequently find that they do not quite fit. I will deal with that and the changes that the Government might make later.

The clause introduces several changes to employee share schemes to make them simpler and more flexible, with the caveat that they are not necessarily straightforward in the first place.

The provision is focused on the tax and national insurance advantage of approved share schemes. The Government remain committed to employee share schemes as an important means of increasing productivity. We acknowledge the positive effects of staff motivation. For example, a large proportion of the FTSE 100 companies have some sort of approved scheme. More than 850 companies granted more than 4,500 options under the enterprise management initiative in 2001–02. Executive management incentive—EMI—was introduced for the smallest and newest companies to help them to recruit and reward the high-calibre staff that they need in order to grow.

Even during the current low in the stock market, companies have continued to introduce and develop their employee share schemes because they are a long-term investment. They are intended not to provide short-term gain but to give employees a long-term interest in the success of the company for which they work.

The changes that clause 138 introduces are only the latest in a series of improvements that we have continued to make to employee share schemes. Other provisions introduce the statutory corporation tax deduction for companies that offer employee share schemes. Last year, we worked closely with my hon. Friend the Member for Edinburgh, North and Leith (Mr. Lazarowicz) on the Employee Share Schemes Bill to introduce some positive changes, which would encourage share incentive plans.

The changes in this Bill will affect all the improved employee share schemes. We are proposing a key change to share incentive plans—SIPs. The SIPs scheme is one of the two newest schemes, which the Finance Act 2000 introduced. It was designed after extensive consultation and it is intended to fulfil the needs of all companies. It offers them flexible methods of achieving employee share ownership, with tax advantages for employees and the companies that employ them. As the hon. Member for Arundel and South Downs acknowledged, SIPs have been widely welcomed. To date, some 750 companies have applied for Inland Revenue approval of their plans and more than 500 have been implemented or are ready for implementation. We have listened over time to the share scheme industry's ideas on ways to improve the administration of the schemes.

The changes in the Bill to ease administration for employers respond to industry requests. They have been generally welcomed but the industry has expressed anxiety about the proposed change to the rules for dividend shares. Although the change achieves the simplification for which the industry asked, it appears that those who requested it did not establish its full impact with scheme administrators. Feedback from the industry suggests that it would prefer to retain the existing rules. So, since the Government listen to business—

George Osborne (Conservative, Tatton)

That was said with feeling.

Dawn Primarolo (Labour, Bristol South)

Perhaps we should not have listened in the first place. I shall table amendments in Standing Committee to withdraw the new proposals, in line with the industry's request.

The package also includes changes to modernise the older approved schemes—save-as-you-earn and the company share option plan—that were developed in a more regulated climate. The provisions align the company share option plans and the save-as-you-earn rules with those of a SIP when possible and appropriate, to help reduce administration of the schemes.

Clause 138 also introduces changes to extend the application of pay-as-you-earn to any income tax due after early exercise of a company share option plan. That is not a new tax charge. Early exercise in three years of grant of a company share option plan option currently attracts a tax liability but it is collected through self-assessment and does not attract national insurance. Unfortunately, we have become aware of evidence that company share option plans are being granted and exercised within three years solely to avoid national insurance, and not for any sound commercial reasons. That is not fair on the majority of employees who pay their national insurance contributions, nor is it in line with the objective of encouraging employees to take a long-term stake in the success of their company.

John Burnett (Liberal Democrat, Torridge and West Devon)

Will the Paymaster General address a more hazardous aspect of this issue—namely, the possible penalty on the declining value of the shares?

Dawn Primarolo (Labour, Bristol South)

An initial problem that we need to address with regard to avoidance is when options are given for shares for 100 years' time, for instance, and the value is rather difficult to quantify. The tax charge is then levied and the benefit year is reassigned—and, lo and behold, it is within three years. There were some difficulties in regard to that, and I appreciate the point that the hon. Gentleman raises, but this is always a challenge. How can I put this delicately? If a set of rules is to operate fairly for everybody, everybody has to use those rules fairly. When some do not, they can spoil it for others.

John Bercow (Conservative, Buckingham)

Will the right hon. Lady give way?

Dawn Primarolo (Labour, Bristol South)

I would like to make some progress, but I will be happy to give way to the hon. Gentleman later.

The change in the Bill will treat company share option plans exercised early in the same way as any other unapproved option. That will not only help to encourage employees to hold their options for three years to qualify for tax and national insurance relief but make collecting tax through the PAYE system simpler for the employee. We recognise that there are some difficult circumstances in which people have no choice but to exercise their options early. Other company share option plan changes that are being introduced as part of this package will ensure that employees who exercise options within three years of grant because of injury, disability, redundancy or retirement, for example, will be able to do so tax and national insurance-free. That recognises the hard choices that people sometimes face in their employment. We are trying specifically to deal with that issue here.

John Bercow (Conservative, Buckingham)

Will the right hon. Lady give way?

Dawn Primarolo (Labour, Bristol South)

Not at the moment.

John Bercow (Conservative, Buckingham)

I was going to be helpful.

Dawn Primarolo (Labour, Bristol South)

I thank the hon. Gentleman but I can manage under my own steam at the moment. Should I need his help, I shall certainly call on him.

The further changes proposed will modernise company share option plans and ensure that they continue to be attractive vehicles for employers wanting to encourage employees to take a stake in their company. That package of improvements is further evidence of the Government's continuing support for companies that offer employee share schemes. The changes result from listening to and working with practitioners. Indeed, ProShare, the organisation that exists to promote share ownership, has already signalled its appreciation of most of the changes.

The hon. Member for Arundel and South Downs raised a number of questions about the national insurance charge. The Government believe that employers should pay their fair share of national insurance on all forms of employment-related remuneration. While the majority of employees and employers undertake their tax responsibilities diligently, there remains a small but, unfortunately, significant group that seeks to avoid paying tax and national insurance contributions on employment remuneration. The change means that companies that seek to avoid paying national insurance can no longer do so. Employers face an employer's national insurance charge only if the options that they have awarded are capable of being exercised within three years of grant. Employees exercising their company share options within the three years of grant will be able to do so tax and national insurance-free. That means that employers who have been using company share option plans as intended—that is, to encourage employees to take a long-term stake in the company that they work for—will not be affected by the changes.

We have also been careful to protect employers from the employer's national insurance charge when employees have to exercise their option within three years. That relates to the point that I made earlier about employees being forced to exercise their options. It is a matter for companies and employees to make provisions and arrangements for the recovery of any PAYE and national insurance contributions from employees who exercise early and have a tax liability.

The hon. Member for Arundel and South Downs also raised some issues about PAYE and asked whether the measure was retrospective. The charge arises if employees exercise their option after 9 April 2003 and within three years of grant. If employees exercise their option in those circumstances, they do so in the full knowledge of the tax and national insurance charge that will arise—that is, on the basis of the law as it applies on exercise. That change will not prevent employees from exercising early for commercial reasons. They will simply make the decision taking into account the tax and national insurance to be paid. A company share option plan is designed so that employees can take a long-term stake in the company that they work for. If employees keep their options for at least three years after grant, they can be exercised tax and national insurance-free.

John Bercow (Conservative, Buckingham)

Will the right hon. Lady give way?

Dawn Primarolo (Labour, Bristol South)

No.

The hon. Member for Arundel and South Downs also raised the issue of tackling avoidance using company share option plans, and the question of leavers. Failure to tackle avoidance would continue to undermine the share schemes that aim to incentivise employees, and he well knows that. As I made clear in my speech on Second Reading, measures to counter tax and national insurance avoidance would not damage business or investment in the City. On the contrary, this is about creating a level playing field by ensuring that a small number of businesses can no longer gain an unfair advantage over their competitors by avoiding their national insurance and tax contributions. We estimate that the tax and national insurance that will be protected by these changes will be in the region of £55 million in 2003–04, and between £30 million and £35 million in subsequent years. Employees who have to exercise their options within three years of grant because they have lost their job or for other reasons will be protected. In that way, we protect the innocent and stop the avoiders.

John Bercow (Conservative, Buckingham)

The Paymaster General began by appearing to lament the phenomenon of early exercise, but was then gracious enough to concede that there were circumstances in which employees would have no reasonable alternative but to exercise that option. Now that she has, with prescience, anticipated precisely the redundancy scenario that I was intending to depict for her, will she tell the Committee whether the loss of job to which she has just referred would also apply to circumstances such as the termination of employment unrelated to redundancy?

Dawn Primarolo (Labour, Bristol South)

To be perfectly honest, I do not think that I understand the hon. Gentleman's question.

John Burnett (Liberal Democrat, Torridge and West Devon)

May I help?

John Bercow (Conservative, Buckingham)

Will the right hon. Lady give way?

Dawn Primarolo (Labour, Bristol South)

I am spoilt for choice. Who will help me first? I shall ask the hon. Gentleman to repeat his question.

John Bercow (Conservative, Buckingham)

I am genuinely grateful to the right hon. Lady. She was being slightly churlish a few moments ago, because I had intended to compliment her on the intellectual osmosis that seemed to exist between us when she anticipated what I was proposing to say. I am not trying to be clever or unhelpful—that would be difficult for me—but simply asking whether the concession applies when someone is sacked, as opposed to being made redundant.

Dawn Primarolo (Labour, Bristol South)

I clearly was not hanging on the hon. Gentleman's every word and listening as carefully as I usually do. The answer is no.

The final point, to which the hon. Member for Arundel and South Downs and others have referred, not just in today's debate, and which is of concern elsewhere, relates to the International Accounting Standards Board's proposals. He will appreciate that its proposals for share schemes are not a Government initiative, and while the accountancy proposals are being developed, it would be inappropriate for the Government to become directly involved in the debate. However, I think that I have made it clear, as the hon. Gentleman certainly has, that we are committed to employee share schemes and continue to pursue a course that enables them to develop and benefit not only employees but the companies as well, and I hope that nothing will be done in future that would undermine that.

I commend the clause to the Committee and look forward to the debate on the schedule.

Clause 139 — Employee Securities and Options

Howard Flight (Conservative, Arundel and South Downs)

I beg to move amendment No. 12.

Clause 139, which gives effect to new schedule 22, takes up some 80 pages of the Bill—

John McWilliam (Labour, Blaydon)

Order. I think it would be unfair if I did not let the Committee know my thinking. It strikes me that debate on the amendment encompasses a clause stand part debate. I ask Members who intend to speak to bear that in mind. I have not finally made up my own mind, but I think it is probably the case.

Howard Flight (Conservative, Arundel and South Downs)

I thank you for that, Mr. McWilliam. Indeed, I was going to crave your indulgence that I might discuss the amendment in a wider, "stand part" context.

As I said, the proposals in clause 139 take up some 80 pages of the Bill. It strikes me that they have been introduced in response to a court judgment that has proved a problem to the Revenue and needs to be corrected. There has, however, been no consultation on the provisions. Dare I say that it has been drafted extremely poorly? It contains a raft of potential new charges and burdens, some of which could be retrospective. To be candid, the proposals as they stand have received widespread criticism from the relevant professional bodies.

The amendment calls for new schedule 22 to be suspended pending further consultation. The schedule's drafting constitutes a complete rewriting of the Income Tax (Earnings and Pensions) Act 2003, which came into force on 6 April. Indeed, it is a complete contradiction of that legislation; as the Bill stands, we will revert to an incomprehensible drafting.

The scope and breadth of the proposals were not evident from the Budget speech and press releases—a point that is particularly true of the proposed changes to pay-as-you-earn and national insurance. A statute is being amended that had already been rewritten in plain language; however, the opposite effect is now being achieved. Formulae are used as in the rewritten legislation, but the acronyms used are not explained, save in the explanatory notes. For example, according to the explanatory notes the expression "UMV"—it is used in a particular clause—means "unrestricted market value"; however, it would be a great deal more user-friendly for such expressions to be included in the body of the legislation itself.

John Bercow (Conservative, Buckingham)

Can my hon. Friend advise me, in so far as he can interpret the thinking of the Paymaster General, as to how schedule 22 is consistent with the right hon. Lady's support for the tax law rewrite project, given the implication that that project is intended to simplify taxation?

Howard Flight (Conservative, Arundel and South Downs)

I thank my hon. Friend for making, in his splendid way, the point that I was making in a rather low-key fashion. This provision is a complete contradiction of any commitment to clearly drafted legislation. As I have pointed out before, eminent lawyers have described schedule 22 as

"massively complicated and almost impossible to explain, even to . . . sophisticated people."

The schedule, in

"its Technicolor complexity, was introduced without any . . . consultation".

As it stands, it is difficult even for the lawyer-experts to understand all the proposals.

The Bill expands the definition of a "readily convertible asset". In particular, shares in a company under the control of another are to be treated as readily convertible assets. That gives rise to additional PAYE and national insurance liabilities for the employer when charges arise under the new legislation. Several of the changes apply to securities issued before 16 April this year. Before the Budget, shares could have been issued to employees on the basis of legislation then in place—only for those employees and their advisers to discover that the shares are subject to provisions that they could not have been aware of when the transactions were entered into. That, combined with changes to PAYE and national insurance, means that employers are likely to face tax charges for which they have not provided. In respect of national insurance, they will not be able to recover it from employees. The changes should not apply to securities issued before 16 April, where such unforeseen liabilities could arise.

A new chapter 2 of part 7 applies to restricted securities. The provisions stop the avoidance of the income tax charge when securities are acquired by an employee subject to conditions or otherwise reduced in value. It is a tax-avoidance issue, which the Government understandably sought to address. The conditions were subsequently removed. Without the provisions, the growth in value of the securities would have been subject to capital gains tax. The schedule modernises the existing provisions and makes them more sophisticated. I welcome the fact that the powers provide for a number of elections, which will allow employees to pay income tax by reference to the value of the securities acquired at the date of acquisition on the assumption that some of the restrictions are not there.

We are particularly concerned that the new raft of proposed legislation is highly complex and has not had adequate consultation. We appreciate the Government's desire to reverse the impact of the recent court ruling and to deal with the PAYE avoidance schemes to which I referred. However, the current drafting will leave many genuine share schemes in a serious mess and will overlay an already over-complicated regime, which could come to represent a material barrier to wider share ownership for unlisted companies.

The catch-all drafting could result in a raft of unexpected income tax charges arising at various points during the period of ownership of the shares. The new PAYE and national insurance contribution rules will mean that charges arise when shares have not been disposed of. Venture capitalists with investee companies in which restrictions on shares are included in the articles could face particularly serious problems. There is a plethora of purpose tests, valuation tests and requirements to look back for seven years, which will mean that unlisted companies and owner-managed businesses will need to navigate most carefully through extremely difficult legal waters.

We wonder whether the Revenue intends to issue any guidance on such matters as the meaning of market value—for example, when restrictions are in the articles of association of the company as opposed to when they are outside the articles. The effects of new capital gains tax, market value definition, the position regarding management buy-outs and what constitutes commercial purposes are all important issues.

Many of the changes apply with immediate effect, and we are concerned that the new measures impose charges that people did not conceive of when the relevant share schemes were set up, and will leave people having to comply with legislation with which they are unfamiliar. Very little of the principles of the tax law rewrite has been included, as I explained.

Another concern is the harshness of some of the provisions that could be mitigated by an election, which has to be made in a Revenue-approved form within 14 days of a transaction. I am led to understand that the Revenue has stated that it will not allow taxpayers to make an election before Royal Assent and will positively prevent them from doing so by declining to issue a prescribed form of election. The Revenue has stated that no provision or concession will be granted to allow elections for events that take place between 16 April and Royal Assent to be made within 14 days after Royal Assent. If that is the case, it strikes me as unethical, unfair and without precedent. It could cause real problems for clients who need to get things done before mid to late July.

I end by echoing the comments of my hon. Friend the Member for Buckingham (Mr. Bercow). So much for the Government's commitment to clarity, transparency and fairness: the provisions in schedule 22 are an absolute nightmare. We have tabled many amendments, and I hope that the Paymaster General will respond by saying that she, too, recognises the need for very considerable clarification and better drafting, and for unintended problems to be addressed.

John Burnett (Liberal Democrat, Torridge and West Devon)

I endorse entirely what has been said by the hon. Member for Arundel and South Downs (Mr. Flight). All the information that I have received from the professional bodies leads me to conclude that the clause and schedule are exceptionally complex, and that there has been insufficient consultation.

If City experts do not understand the clause, what hope is there for anyone else? Do the Inland Revenue and parliamentary counsel understand the clause and the schedule, and the repercussions and tax consequences that they will have?

It is empty for Ministers to trumpet tax reliefs when they are so complex that they cannot be accessed. It is worthless for them to exclaim that they are seeking to simplify the tax system, when provisions such as the clause and the schedule only make the legislation more complex.

The scope and breadth of the proposals were not evident in the Budget press release. That is especially true in respect of the consequences for PAYE and national insurance. I hope that the Paymaster General will concede that the amendment is entirely reasonable in the circumstances, and that there should be proper consultation. People need to understand the law, which should be readily accessible. It is in the interests not only of tax practitioners but of their clients and of businesses that they should be able readily to understand the law and its consequences. They must be able to access the law without undue risk or expenditure.

John Gummer (Conservative, Suffolk Coastal)

Does the hon. Gentleman agree that not only businesses or tax advisers need to understand the measure, but that it should be readily accessible to the people whom it affects? Is not one of the problems with the tax system that, if it is not accessible or comprehensible, people will feel that it is not fair? The Government must understand that this complication does not merely make matters difficult for the professionals—it makes them difficult for many people who are pretty ordinary as far as tax is concerned but who will be affected by the schedule.

John Burnett (Liberal Democrat, Torridge and West Devon)

I am grateful to the right hon. Member for Suffolk, Coastal (Mr. Gummer) for making an excellent point. For taxation to achieve public acquiescence, it must be fair and intelligible. I draw the right hon. Gentleman's attention to the excellent memorandum, dated May 2003, issued by the revenue law committee of the Law Society, which gives pages of suggested amendments. I hope that we shall have an opportunity to probe those amendments so that we can try to make some sense of a complete mess.

John Bercow (Conservative, Buckingham)

Notwithstanding the pertinent point made by my right hon. Friend the Member for Suffolk, Coastal (Mr. Gummer), does the hon. Gentleman not think it a pity that the Chancellor cannot be with us in Committee this afternoon, in order to explain how he squares schedule 22 with his foreword to Labour's business manifesto, entitled "Equipping Britain for the Future", published in April 1997, in which the right hon. Gentleman said—ho, ho!—

"We will not impose burdensome regulations upon business because we understand that successful businesses must keep costs down"?

John Burnett (Liberal Democrat, Torridge and West Devon)

I am grateful to the hon. Gentleman for that intervention; he makes an excellent point. However, I hope that the Chancellor is busy squaring the Prime Minister on his view on the euro—

John Burnett (Liberal Democrat, Torridge and West Devon)

I shall not go down the euro road—

George Osborne (Conservative, Tatton)

Oh, go on.

John Burnett (Liberal Democrat, Torridge and West Devon)

I know that would be welcomed by many—[Interruption.]

John Burnett (Liberal Democrat, Torridge and West Devon)

I do not need much encouragement, Mr. McWilliam; that is the trouble.

We shall be going into these matters in detail in the Standing Committee. Will the Paymaster General assure us that, having heard the arguments, she will acquiesce in this amendment, which is, in the circumstances, entirely reasonable?

Jonathan Djanogly (Conservative, Huntingdon)

To date, my policy on the Bill has been to go for brevity, but I am not able to do so on this clause, not least because we are considering about 90 pages of extremely complex new measures. The provisions are problematic in many respects and we are not helped by the fact that there has been a massive lack of consultation, as my hon. Friend the Member for Arundel and South Downs (Mr. Flight) explained.

The new rules are generally thought to be a sledgehammer to crack a nut and a compliance nightmare. One specialist noted that generalist advisers, let alone their taxpayer clients, will not know when to make their elections under paragraph 431. They will not know how to operate the regime or how to comply with it on every possible occasion that a chargeable event arises. How they were to do that was, he said, beyond him. Even if they managed to comply with the regime, the shares valuation division would be inundated with applications to agree hypothetical values of securities, with and without their restrictions, in order to calculate the amount of schedule E tax charged on each chargeable event.

The new regime imposes income tax on the acquisition of securities and/or on their value at the time of defined chargeable events, where such securities are made available by reason of any person's employment. That applies irrespective of who acquires and provides the securities.

I have a few basic points to make about the regime. First, income tax charges can arise for an employee at various stages in the life cycle of a security, on what is, of course, purely a paper value. Secondly, there will not always be a corresponding corporation tax deduction for the employer company because there are many mismatches with the corporation tax regime under schedule 23. I am sure that we shall look into that point in greater detail in the Standing Committee. I understand from representatives of the venture capital industry that the measure will be extremely hard on private equity investee companies, as they are often under the control of their investing limited partnership funds and thus cannot enjoy the tax advantages of things such as EMI—executive management incentive—options, nor will they be able to receive corporation tax deductions.

Thirdly, the regime will render the employer company liable to account for the income tax under PAYE, which was originally done under a withholding system. Finally, it will require the employer to account for employer national insurance. All those cases apply even where a person other than an employer provides securities to a person other than the employee. All that makes this proposal extremely draconian.

Proposed new section 421B(3) says that anything provided by a person's employer or by a person connected with the employer will be deemed to be made available by reason of employment, unless the provider of the security is an individual—for example, another shareholder. It also says that the right or opportunity arises

"in the normal course of domestic, family or personal relationships of that person."

That wording is very strange; it appears to suggest that an opposite presumption exists where the provider of the security is not the employer or a person connected to the employer, or where the security is to be treated as not acquired by reason of employment. That is not clear, and an indication of where the Government are coming from would be helpful before we have to gather our thoughts later in Committee.

The new regime will catch gifts of securities—those securities provided at a price less than their market value; those provided with future payment obligations attached; those provided whether or not at market value or acquisition price; those that attach restrictions on transfer or retention; those that are subject to forfeiture or are convertible; those with artificially depressed or enhanced value; or those that are disposable for more than market value. It will also catch securities options acquired by reason of employment. Some options seem to be caught twice, because the definition of security includes subscription warrants, so a subscription option is both a security and a securities option. Is the regime therefore trying to draw a distinction between subscription and purchase options? That is not clear, and it is absolutely vital that we have an idea from the Minister about that before we go into the details later in Committee.

Most importantly, can the employer and employee elect under the main part of the new regime—chapter 2, which relates to the restriction of forfeitable shares—to be taxed on the initial acquisition of the securities, valued for tax purposes on a basis that ignores the restrictions on those securities? If so, the subsequent chargeable events tax charges will not arise. However, if people do not elect, income tax charges will be made at various stages in the life cycle of the security, depending on what happens to it. Why not instead say that the profits on the ultimate disposal of the security will be taxed as income under schedule E, unless people elect for upfront income tax treatment to be the cost of entry to the capital gains tax regime, instead of trying to tax the security at lots of different stages in its life cycle? Of course there is no corresponding relief for a fall in value following a chargeable event.

As my hon. Friend the Member for Arundel and South Downs said earlier, 14 days is much too short a period in which to have to elect for the reasons that he gave, which I will not repeat. Significantly for the private equity industry, which seems to be extremely concerned by these proposals, it would appear that the receipt of a carried interest in a venture capital or limited partnership would fall within the new rules. However, that needs clarification, as it is not clear whether the security interest that the employer acquires is the limited partnership interest itself, as with a unit in a collective scheme, because there is no definition of unit in the legislation, or whether the shares and securities that the partnership acquires in its investee companies count as the employee's securities, and whether, if the latter is the case, they acquire that interest qua partner or qua employee, deriving from their initial acquisition of a carried interest qua employee.

By making an election, it may be possible to opt for income tax treatment at the outset, so that capital gains treatment for the future is secured, but if the electing needs to be done every time the fund makes an investment, that will be an administrative nightmare, and it will be impossible because, with a fund of funds, carry holders in the top fund will not even know what acquisition funds the lower funds are making. It is illogical that the employer and employee can agree that the employee will bear the employer's national insurance costs in the case of securities options, but not in that of other security interests.

Those regimes, when enacted, will generally apply to securities acquired on and after 16 April 2003. Again, in the context of partnerships, it is not clear what is the date of acquisition of the security interest, as that depends on whether it is the partnership interest or the underlying shares or securities in investee companies that count. The definition of collective investment scheme is much too nebulous and unclear. The extension to the definition of readily convertible asset in paragraph 15, which in turn triggers national insurance and PAYE liabilities, is also of concern to the private equity industry, because the widened definition catches shares in a company that is under the control of another company, and limited partnership funds, investee companies, are often caught by that control test. That, of course, gives the employer company a national insurance liability. It also denies it a corporation tax deduction under the schedule 23 regime, and denies it the ability to adopt an enterprise management incentive option scheme, as I mentioned previously. That, of course, is a triple whammy to an industry sector that the Government have said previously they are keen to support, although they may not have intended it to have that effect, in which case I would be interested to hear the Paymaster General's views.

All the people to whom I have spoken about this clause have said that more time is needed for consultation to get it right and to strike the right balance between anti-avoidance measures—which, of course, the Government wish to implement—and the serious impact that those measures will have on the mid-market private sector and the private equity industry too.

Dawn Primarolo (Labour, Bristol South)

This has been a short but none the less important introductory debate to clause 139 and the associated schedule, which we will consider in the Standing Committee. In responding to the amendment and explaining the clause, I will address the issues raised, notwithstanding the fact that, clearly, there will be an interesting and detailed debate when the Bill moves upstairs to a Standing Committee.

For the sake of absolute clarity, I urge the Committee to resist the amendment, and I commend clause 139, which introduces the reforms to the taxation of share-based remuneration. As the debate proceeded on clause 138, I stressed, and the Committee accepted, that the majority of employers and employees undertake their responsibilities in this area diligently. Unfortunately, however, a small though significant group persists in seeking out ways of avoiding those responsibilities. We have evidence that, in the most recent year for which data are available, at least £1.4 billion has been put through avoidance schemes using shares and securities to take advantage of the fact that the existing rules do not operate consistently and coherently in every situation.

The anti-avoidance measures relating to employee benefit trusts announced in the Chancellor's pre-Budget report address much of that, but they cannot tackle every scheme: for instance, schemes in which the tax and national insurance saving is worth more than the associated corporation tax deduction for the employer.

John Burnett (Liberal Democrat, Torridge and West Devon)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

If the hon. Gentleman would let me make my opening remarks and respond to the questions that have already been put to me, I will be happy to take an intervention. This is a complex set of issues, on which I must concentrate as I respond to the Committee.

The scale of the avoidance that uses share schemes in one form or another, which the measures in schedules 21 and 22 tackle, costs the Government—the taxpayer—in excess of £110 million a year. That is not insignificant. Although I recognise what hon. Members say about the representations that they have received from various bodies, I counter that—perhaps this demonstrates the complexity and importance of the subject—by referring them to the article, which I quoted earlier, in this week's "Tax Journal" by David Cohen of Norton Rose who is an expert in such matters. He details each substantive change that we are making and explains why they are better in some instances and clearer in others.

Obviously the Government do not want to send out the message to the majority of employees and employers who are paying their fair share of tax that we are allowing highly paid executives to avoid their tax liability with complete disdain, which would be the result of the amendment. I make no apologies—I am sure hon. Members would not expect me to—for focusing on the changes that the clause introduces to tackle avoidance and to close loopholes; nor do I apologise for the comprehensive redesign of the rules, which will produce a system that is consistent, coherent and fair. A system that meets those criteria will be less open to abuse by a minority of predominantly highly paid employees who are intent on paying less than their fair share of tax and national insurance.

The main focus of clause 139 is on tackling avoidance. As hon. Members know, that means that consultation is not appropriate. That is the practice not just of this Government but of the previous Government when trying to deal with such issues. However, in redesigning the rules we have drawn heavily on the feedback from consultation processes that have accompanied a number of discussions with the industry. We have also taken into account the industry's concerns, expressed to us over a long period of time, about the inequities in the current system and its proposals for making the rules fairer so that we design a new system that taxes to income only the value received from the employment at the time when that value becomes accessible and not the capital growth in the value of the share following acquisition, which is the current arrangement.

I assure hon. Members that those anti-avoidance provisions are targeted at non-commercial transactions that place such benefits in the hands of employees without them paying their fair share of tax and national insurance on the value. They will not adversely affect those who offer their employees genuine share schemes that provide a real stake in the businesses for which they work. However, I accept that hon. Members will want to explore that in more detail upstairs in the Standing Committee.

If we delay implementing the clause we will not only give a green light to such people to continue to exploit the loopholes in the legislation, but provide a sign-posted road map for everyone else as well. It would be an utter disaster. Hon. Members should be in no doubt that a large coach and horses would be driven along the roads identified in the attempts to change and stop the anti-avoidance, to the detriment of the Exchequer—the taxpayer—for the benefit of a few.

Our concerns are real. In the space of just last week, Inland Revenue officials received interesting telephone calls from accountants. It seems that the saying for accountants is similar to that for lawyers: the number of opinions required dictates how many different accountants one needs to speak to. One accountant admitted that the existing avoidance schemes would be stopped by the proposals. Another admitted that a new scheme under development would be similarly frustrated, and yet another admitted that if only he had known about the loopholes, he would have had a field day making sure that his clients had access to tax and national insurance relief. To demonstrate our determination not to disadvantage people operating genuine share schemes, I have listened to representations on schedule 22, and I intend to introduce amendments in Standing Committee to correct an error in proposed section 446F(2)(b) of the Income Tax (Earnings and Pensions) Act 2003 and replace "16 April 2002" with "16 April 2003". That is a simple printing error which uncorrected would have resulted in unintended retrospection. In that respect, I agree with the hon. Member for Arundel and South Downs (Mr. Flight). Unfortunately, typographical errors sometimes occur.

We wish to correct two drafting errors and ensure that appropriate relief is given when arriving at the taxable amount in relation to restricted securities, a point made by the hon. Member for Huntingdon (Mr. Djanogly). We also wish to extend the facility to allow people all the tax upfront on restricted securities awarded in the period between 16 April 2003 and an appointed date. I give hon. Members warning that I shall also table amendments to close the remaining avoidance opportunities that have been drawn to our attention. We will tighten the definition of convertible securities following representations that certain avoidance opportunities may remain if that is not done, putting beyond doubt the fact that PAYE must be operated on all charges to tax arising from the operation of these new provisions.

At a time when we are asking everyone to make a greater contribution to the UK's need for investment in the public service through national insurance contributions it is important that everyone, including businesses, should pay their fair share of tax and national insurance. As I have already said, people operating genuine share schemes have nothing to fear from the changes.

I shall now respond to points that I have not covered in my explanation of the amendments that I shall table in Committee. I believe that the question from the hon. Member for Arundel and South Downs about retrospection referred specifically to 16 April 2002, so I hope that he accepts that the correction to 2003 deals with that. Several hon. Members suggested that the provision was a sledgehammer to crack a nut, but I have demonstrated to the Committee that a large amount of money is being taken by a small number of people.

John Burnett (Liberal Democrat, Torridge and West Devon)

rose—

Dawn Primarolo (Labour, Bristol South)

Perhaps I should explain why the provision is not a sledgehammer to crack a nut before the hon. Gentleman intervenes.

Share-based remuneration takes many forms, and is used in many different ways. That reflects commercial reality, and the tax rules try to reflect that. However, the cost of avoidance is substantial. A significant sum is involved, and we have no reason to believe that it would reduce over time. The avoidance rules are carefully targeted on those carrying out non-commercial transactions designed to manipulate the value of shares with a view to avoiding tax and national insurance. Companies across a wide spectrum of business are using those schemes—the larger ones to shelter annual cash bonuses, the smaller ones to shelter the owner-director's remuneration. The chairman of the share scheme lawyers group, writing in The Tax Journal on Monday, had no difficulty grasping and explaining succinctly in just two pages what we were attempting to do. As always, I have listened carefully to the points that Members have made in debate, and shall reflect on them, but I must remind them that we will not be deflected from dealing with anti-avoidance.

John Burnett (Liberal Democrat, Torridge and West Devon)

I think the Paymaster General told the Committee that about £1.4 billion was the tax lost.

Dawn Primarolo (Labour, Bristol South)

No—the value through the scheme.

John Burnett (Liberal Democrat, Torridge and West Devon)

The right hon. Lady said that about £110 million a year was lost. How long has that been going on, and how have the Government quantified the loss?

Dawn Primarolo (Labour, Bristol South)

I am not sure that I can answer the question as to how long. The issue is when tax avoidance schemes become apparent to tax inspectors, as opposed to when they start operating. That is not always immediately clear. I shall check, and if there is a more suitable answer, I shall make sure that it is passed to the hon. Gentleman. With reference to the £110 million loss, I said that in the past year or so we have seen a growth in this area, but we have been aware of the inconsistencies for some time and we have been moving to correct them. As the hon. Gentleman well knows from his substantial experience, it is a complex area and one should not legislate in haste. We have tried not to do that.

Norman Lamb (Liberal Democrat, North Norfolk)

Will the Paymaster General respond specifically to the concerns about the complexity of the provisions, so soon after the tax rewrite Bill was considered in this place? It seems extraordinary that the language used is not consistent and that, after a good initiative from the Government, we are now moving in the wrong direction.

Dawn Primarolo (Labour, Bristol South)

The Bill is in the tax law rewrite style. That is why the measure has been taken out in its entirety and put back in. The total number of pages incorporating the necessary changes to deal with avoidance has increased the Bill by 10 pages—if that figure is wrong, I shall correct it in writing to the hon. Gentleman: that is, 10 pages to protect £110 million and produce fairness.

The hon. Gentleman is right: I am utterly committed to the tax law rewrite project and as a Minister I have given it a great deal of support. Its job is to rewrite existing provisions, not to take decisions about the policy or make improvements. Imperfect as that is, I considered it inappropriate to hold up the tax law rewrite project in order to get the provision in place. This area and another area of the Bill closely follow the tax law rewrite style. We can all agree that that is the way forward.

On changes to the taxation of convertible shares, the existing rules do not operate fairly to ensure that the right amount of value is taxed when the employee unlocks access to it. We have received representations about this unfairness. The new rules are fairer, taking into account the security acquired and the right to convert at a later date, and treating each of those separately to calculate the tax charged. There are examples where that is of considerable importance.

There was a question—I do not remember who from—about interaction with enterprise SMEs. We are not attacking genuine share schemes that give employees a real stake. It is the Government's policy to make sure that we do not do that. We are attacking the exploitation of rules by those who do not use the rules properly. Small companies that want to improve their productivity through employee initiatives can benefit from tax and national insurance advantages by using Inland Revenue tax-advantaged arrangements, particularly the enterprise management scheme. The hon. Member for Huntingdon raised that with regard to its interaction with other areas of the tax system, and stressed that we should ensure that there were no adverse effects that would damage provisions elsewhere in the system. I agree. We will discuss the impact of the new rules, particularly in the context of venture capital, with the British Venture Capital Association. We will be mindful across the piece to ensure that there is no inadvertent knock-on effect.

The hon. Member for Huntingdon also asked whether there would be guidance. The answer is yes. We want to ensure that the current guidance is updated. In particular, we want to work with the industry to ensure that it is appropriate. It is one thing to write guidance, but another to ensure that it is acceptable and usable by the industry.

We are studying carefully the representations made by such august bodies as the Law Society. So far, none of them suggests that the fundamental concept and approach of the changes is flawed. Many proposals appear—I am sure that this is unintentional—to weaken the anti-avoidance effects and not deal with the structures involved.

I realise that I may have spoken for longer than I should, but I hope I have made it clear why the Government consider absolutely inappropriate an amendment that seeks to delay implementation. That is why I ask my hon. Friends to oppose it, as it is foolish to give, in such a spectacular way, a road map on how not to pay tax. I hope that I have dealt with many of the points that have been made, although I appreciate that I have not mentioned all of them.

In recommending the clause to the Committee, I look forward to the discussions in the Standing Committee, which I am sure will be interesting and detailed and will enable us to deal with many more issues so as to put people's minds at rest.

Howard Flight (Conservative, Arundel and South Downs)

I thank the Paymaster General for her response. In particular, I thank her for some of the corrections that she mentioned, including those about the date and the question of representation and retrospection. I am also glad to note that the Government are now studying the submissions of the Law Society. I trust that they are also considering representations made by the Institute of Chartered Accountants and other professional bodies.

The clause, as it is currently drafted, smacks of legislation made in haste. As it stands, there is potential for a number of unintended consequences. In particular, as my hon. Friend the Member for Huntingdon (Mr. Djanogly) pointed out, the issue of private equity and venture capital is crucial. Unfortunately, development in that area is already stalling pretty seriously in this country.

I do not accept that there has been no scope for consultation on such a major issue. Indeed, the Paymaster General is effectively accepting a degree of consultation with the Law Society. The Government have been seeking to close down avoidance and that seems a clear and straightforward objective. The concern is that, because they have not consulted professionals about where they want to go and the unintended consequences that they want to avoid, we have ended up with legislation that is exceedingly complicated for lawyers, let alone those who have to obey it.

We therefore feel that our amendment is appropriate. As the Paymaster General said, there will be a full debate in Standing Committee and many of the issues will be discussed. However, we are not yet in a society that is so totalitarian that it is right suddenly to introduce such massive and complex legislation with very modest flagging up in the Budget or previously. Furthermore, the new rules are not only about anti-avoidance. We therefore intend to press the amendment to a Division.

Clause 148 — Non-Resident Companies: Basis of Charge to Corporation Tax

Howard Flight (Conservative, Arundel and South Downs)

I beg to move amendment No. 66.

Alan Haselhurst (Deputy Speaker, Saffron Walden)

With this it will be convenient to discuss amendment No. 67.

Howard Flight (Conservative, Arundel and South Downs)

The two amendments to which I am about to speak should be viewed in the context of some of the wider issues associated with clause 148, and I hope that the House will grant me indulgence if, rather than making certain points twice, I speak more widely around the amendments at this stage of our discussions.

Clause 148 was foreshadowed in last year's Budget and the Government's proposals were summarised in a subsequent press release that stated that the new proposals were

"aimed at modernising the UK tax regime by eliminating a weakness in the existing rules, and so bringing the UK more into line with other major industrialised countries, such as France, Germany and the USA".

That was essentially because

"recent work by the OECD . . . highlighted the fact that the UK was out of step with other major countries, and the changes here . . . make the UK approach similar to that seen elsewhere".

The press release stated that the changes would apply to accounting periods commencing on or after 1 January this year. Clause 148 gives effect to those proposals, although, curiously, clause 147, which defines the term "permanent establishment", contains no commencement provision and so will take effect from Royal Assent. I am not clear whether clause 148 can take effect from 1 January as the crucial definition will not have been enacted at that point.

Amendment No. 66 deals with the issue of the permanent establishment having the same credit rating as a non-resident company. Ratings are given to companies, to corporate debt and sometimes to specific transactions, and it is not clear what is being referred to here. Only a few companies that carry on business in the UK through a permanent establishment will have a credit rating. It is surely not appropriate to treat a UK permanent establishment, which might carry on only one or a limited range of the activities carried on by the company itself, as having the same credit rating as the company as a whole.

Both the OECD model and the draft legislation attribute to the permanent establishment the profits that would have been realised by a separate enterprise carrying on the same or similar activities. If any rating were to be assumed, it should be that which the assumed separate enterprise would have to have had, having regard to the activities that it carries on. It is illogical to assume a credit rating equivalent to that of the company itself.

The term "shareholders' loan" is also an issue. Given that "loan" has a meaning that does not include unpaid purchase money, a definition would be required if, contrary to what we feel is appropriate, the provision is to be retained. Failing that, debt securities issued as a consideration for an acquisition would not be included.

The explanatory notes to the Bill refer to equity capital and loan capital. That would probably be acceptable for financial institutions where there is a substantial amount of guidance, but for other companies it would be difficult to work out what is meant by the term.

Subsection (5) also permits the Revenue to make regulations for the application of subsection (2) to insurance companies, including the attribution of capital to a UK permanent establishment. That confers an unacceptable degree of power on the Revenue.

We are also concerned that the terms of the accompanying schedule 25 are discriminatory. The effect of paragraph 5 is that a permanent establishment would be in a worse position than a subsidiary that borrowed from its parent company. That could make organisations think more carefully about whether to set up in the UK as a branch or subsidiary. To be able to deduct interest would require the permanent establishment to have its own credit rating and deal at arm's length with other parts of the organisation. It could be discriminatory if the branch were not treated in the same way as a subsidiary.

The commentary in the OECD model is a flexible document and there is an ongoing debate about whether a branch should be treated as independent. There is a risk that, if the commentary is changed, the UK provision will then be out of line. If provisions are included in the Bill based on the current version of the commentary, there is a risk that that will restrict the Revenue's flexibility.

The clause is not specifically about European issues, but it is based on the long-standing principle of the UK's "territorial" basis of taxation for overseas companies, so it indirectly allows European issues to be raised; it focuses on European issues. Indeed, some of the commentary on the proposals from professionals has suggested that it contravenes EC treaties.

The premise from which the clause proceeds is that British companies should be taxed on all their profits, wherever they arise, and that non-UK companies should be taxed on their UK profits. In both cases, the tax yield is protected by a number of rules that prevent assets or profits from being siphoned out of the UK through transfer pricing, tax-free transfers of assets or excessive interest payment. The UK tax base is also protected by allowing offset of losses only where those have arisen in the UK.

The Paymaster General will be aware that a number of recent decisions have challenged some fundamental aspects of the corporate tax system of EU countries and our own corporate tax system. Indeed, they could challenge clause 148 and its accompanying schedule. The challenges seek to argue that the application of different tax rules to transactions with foreign companies from the rules that apply domestically is unlawful discrimination, but from a domestic perspective such discrimination is necessary and has been practised to ensure that companies do not simply siphon off profits to low-tax countries.

Those challenges are a significant threat to the UK's ability both to control its tax borders and to exercise its own corporate tax policies. For example, it may be unlawful to restrict interest deductions to EU companies where those payments represent excessive deductions designed to shift profits overseas. That is raised in the German Lankhorst case and the awaited Dutch Bosal case. It may be illegal to apply transfer pricing rules to transactions within EU companies, an issue that has not yet been litigated but which follows in principle from other European Court of Justice decisions. The UK may need to allow tax-free transfers of assets to EU companies because they are permitted between UK companies. The controlled foreign companies rules that prevent British companies from accumulating tax-free cash outside the UK may be unlawful. Again, that issue has not yet been litigated but there are relevant French cases. The well known Marks and Spencer case currently being litigated would require Britain to allow losses of foreign subsidiaries against UK profits. The recent decision in the Lankhorst case may well undermine the usefulness and effectiveness of the clause as interest payments to other EU members of a group would still be deductible.

The Government have to date refused to discuss—indeed, the Revenue appears to have buried its head in the sand—the impact of European Court of Justice decisions on the UK tax system. We welcome the announcement in the Red Book that that issue will be looked into, but it is the first acknowledgment that a major problem exists.

I would like in that context to make the following key points to the Paymaster General. The first is about whether the Government are confident of the forecast yield from clause 148, particularly in light of the slowdown in the financial services industry in the City as well as the EU issues. Secondly, the European Court's decisions have made provisions that are designed to prevent abuse of domestic tax rules unlawful. That challenges the UK's ability to protect its corporate revenues. What are the Government doing to defend the UK's tax rights over UK and non-UK companies operating in the UK?

The Government's failure to face up to the problem so far leaves them with only two—potentially unattractive—options. They can extend the rules that are designed to apply only to international transactions to cover all domestic businesses, which would be highly regulatory and would impose unnecessary compliance costs on UK businesses. Alternatively, they can abandon the rules that prevent international tax avoidance, which would mean the loss of significant tax revenues.

How do the Government propose to balance the need to raise revenue with the competitiveness of our tax system? The Red Book suggests that they are more concerned with protecting the tax yield than with the all-important issue of competitiveness. They have, at least overtly, ignored all the warning signs that sovereignty is being undermined in this crucial tax area, and are now acting in a way that will have an adverse effect on British business interests and the vital attractiveness of Britain as an international business location.

Will the Government consider tabling an amendment to the European treaty as part of the 2004 intergovernmental conference, to ensure that specified tax rules designed to prevent international tax avoidance are agreed not to be unlawful, so that we can retain national sovereignty in these areas and, indeed, ensure that what is proposed in clause 148 is effective?

John Baron (Conservative, Billericay)

Clause 148 could, I think, cause serious problems for the City of London and therefore for the country as a whole, as the City is a major contributor to our economic well-being. The clause alters the tax treatment of UK branches of non-UK companies, which will have a particularly adverse effect on overseas banks operating in the City. It could seriously jeopardise the City's position as the world's leading international financial and business centre, as foreign banks downsize their operations in London.

Let me say a little about the importance of the City to the kingdom as a whole. It is no exaggeration to say that it is a global powerhouse at the heart of the UK's financial services, a sector whose net contribution to the UK's current account has been over £13 billion, a significant amount of which has been generated within the square mile. There is a daily foreign exchange turnover of over $500 billion in London, and 56 per cent. of the global foreign equity market and 70 per cent. of eurobonds are traded there. London is the world's leading market for international insurers: the worldwide premium income reached £157 billion in 2001 alone.

I must declare an interest. I was a fund manager before entering the House, which enables me to testify to the importance of foreign banks to the City's prosperity and wealth generation. About 500 foreign banks currently operate in London, employing some 60,000 people. They contribute enormously to the City's pre-eminent financial position. I believe that this tax change will threaten that position, because it has been built on a false premise by a Government who misunderstand the way in which the City works—and, I suggest, misunderstand the economic facts of life. The Chancellor tries to justify this move by claiming that such changes in the tax treatment of foreign companies simply bring us into line with the US and with other European countries. However, he misses the point that this country's existing favourable tax treatment helps to compensate foreign companies for other factors that make doing business in London, in particular, less attractive when compared with other cities.

One example is the capital's transport infrastructure, which is a mess. Average journey times have increased by about 16 per cent. since 1998, and motorway congestion is up by 250 per cent. since 1997. Meanwhile, congestion charging has added a further marginal cost to businesses operating in London. At the same time, train punctuality has worsened each year under this Government. By withdrawing the advantage of a low-tax regime, they have made the decision whether to locate to London or elsewhere a more finely balanced one for foreign companies. This Government fail to understand that when it comes to the City, increasing mobility of labour and modern technology mean that business undertaken in the London branches of foreign banks can easily be done elsewhere.

Ian Mullen, chief executive of the British Bankers Association, said of the tax change last year, when it was first mooted:

"This will massively increase the costs of foreign banks operating in the UK and have an adverse impact on jobs and the competitiveness of the City".

In a letter to the Financial Times last year, Angus MacLennan, chairman of the Foreign Banks and Securities Houses Association, said that he guarantees that this tax change will result in business going abroad—in the first instance, by way of assets being moved to reduce additional tax, and afterwards as income follows the assets. He said:

"the reduced revenue base and increasing costs of being in London (compare these with the US, France or Germany . . .) will lead many to conclude that, economically, they should not be here at all".

He concluded his letter by saying:

"This is the reality. Short-term gain and long-term destruction of the best industry in the UK. Our competitor countries must be laughing with anticipation".

John Bercow (Conservative, Buckingham)

Does my hon. Friend agree that Ministers are especially short-sighted in this matter, given that they know, as we do, that this country has already sacrificed two thirds of its competitive tax advantage since 1997, relative to other members of the European Union?

John Baron (Conservative, Billericay)

I readily agree with those figures and that sentiment. What worries Conservative Members is that this country's competitiveness appears to be being continually eroded by these tax increases and regulations. Independent statistics suggest that we are slipping down the competitiveness league tables, which is causing a loss in productivity that will eventually result in the loss of our pre-eminent economic place.

It is true that these measures will generate income for the Treasury over the short term. Estimates vary, but it is suggested that some £350 million will be generated in the first year, with perhaps another £650 million being generated in 2004–05. However, as my hon. Friend the Member for Buckingham (Mr. Bercow) has just suggested, they will prove to be among the many tax measures that raise money in the short term but lead to a loss of revenue to the Treasury in the longer term—a loss that will far exceed any short-term gain, as foreign banks and employees quietly move out of London.

This issue is important to the country as a whole. By attacking the jewel in the UK industry's crown, the Chancellor is eating away at our competitiveness and longer-term prosperity. I urge the Government to reconsider their position, because, as sure as night follows day, the tax increase will result in a loss of prosperity and revenue in the longer term to the detriment of us all.

Dawn Primarolo (Labour, Bristol South)

The central issue at stake in clause 148 and its supporting schedule—the amendments are designed to attack and eradicate it—is whether it is fair that foreign banks operating in the City of London, which are competing with UK banks, should, on account of their structure, pay little or no corporation tax. Is it fair for UK banks to compete for business against foreign branches that pay no tax? That is the central issue.

John Baron (Conservative, Billericay)

rose—

Dawn Primarolo (Labour, Bristol South)

I am not posing a question for the hon. Gentleman to answer, but opening my case on the clause and the amendments. I shall urge the Committee to reject the amendments, comment on the key aspects of the clause and respond briefly to the hon. Member for Arundel and South Downs (Mr. Flight), who posed wider issues about the European Court of Justice, though I realise that that is strictly outside the remit of the amendments and I shall try to remain in order.

The amendments would remove the main charge introduced by clauses 147 to 155 and by schedules 25 to 27. The charge remedies what I would politely call a weakness in UK domestic law and ensures that UK branches of foreign companies will pay a fair share of UK corporation tax, reflecting the profits that they make from their UK activities. The bulk of clause 148 and schedule 25 set out in UK law the rules that the UK applies in taxing foreign companies. They also modernise the terminology used in UK law.

The one truly new element of clause 148 is set out in new section 11AA(3), which changes the way in which the taxable profits of branches are measured. For the first time, consideration will have to be given, for tax purposes, to the amount of equity and loan capital that a branch would have at arm's length. That is, consideration will need to be given to the capital that the branch would have if it were a separate entity carrying on the same or similar activities under the same or similar conditions.

Amendment No. 66 would remove that change. If it were accepted, the winners would be UK branches of foreign banks—it is primarily banks that operate through branches—which would continue to pay little or no corporation tax in the UK. The losers would be the UK Exchequer and UK incorporated banks that compete with foreign banks for their business.

It might be helpful briefly to explain the deficiency in the old legislation. Previously, there was no requirement for a UK branch to have regard to the amount of capital that it would require commercially in order to support its business. That meant that a UK branch of an overseas bank could, for tax purposes, borrow every pound that it lent to customers, and the interest cost of that borrowing would significantly reduce the UK profit. In contrast, a UK bank would need to have equity capital and would not borrow every pound that it lent, so it would have a smaller deduction for interest expense. The result was that nine out of 10 of the top foreign bank branches in the UK were paying no corporation tax on their UK profits, despite their large and long-standing UK operations. 5.15 pm

John Baron (Conservative, Billericay)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

No.

Amendment No. 67 would remove the new provision in new section 11AA(5). That provision would give the Board of Inland Revenue the power to make regulations specifying how the new capital requirements are to apply to insurance companies. That will enable the new rules to be adapted for insurance companies, because their capital requirements are organised differently from those of banks and other companies.

The hon. Member for Arundel and South Downs raised several issues, the first of which was the question of guarantee fees paid to head offices. The new legislation specifies that when computing the profits of a permanent establishment, it should be treated for tax purposes both as if it were a distinct and separate enterprise and as if it were trading in the same or similar activities under the same or similar conditions. That is based on the wording used in article 7 of the OECD model tax convention. There is an inevitable tension here, which arises from the fact that a branch is clearly not the same as a subsidiary, and different economic and legal consequences arise from adopting one structure over another. If the permanent establishment is assumed to be acting under the same or similar conditions, that must logically apply to the actual cost at which it can raise funds. The cost at which it can raise funds will be dependent on the company's credit rating. While it is our view that the assumption of the same or similar conditions means that the permanent establishment must have the same credit rating as the rest of the company, that matter was specified in the legislation to provide clarity and put the matter beyond doubt.

John Burnett (Liberal Democrat, Torridge and West Devon)

Is the Paymaster General talking about the profits of the branch operating in the UK?

Dawn Primarolo (Labour, Bristol South)

I am talking now about the ability of the branch in the UK to raise loan moneys at cheaper cost, because it has the credit rating of its parent company. The whole clause refers to the profits of branches raised specifically from their UK operation.

John Burnett (Liberal Democrat, Torridge and West Devon)

Is that described as "the rating" in the legislation?

Dawn Primarolo (Labour, Bristol South)

Yes. We are seeking to ensure that the profits accumulated in the UK are correctly taxed within the UK net.

The question of guarantee fees is complex and it should be noted that the assumption of the same credit rating is also in line with the current OECD view. If the UK were to take a different view on credit rating, it would be out of line with international consensus, which could lead to double taxation for the foreign branches of UK banks.

Various representations have suggested that a permanent establishment should not be regarded as having the same credit rating as the company of which it is part and that guarantee fees should be allowed, but it is difficult to justify that both logically and legally. All parts of the same company will have the same credit rating. The permanent establishment will therefore have a certain actual cost of funding. It would be inconsistent with the arm's-length principle to treat the permanent establishment as funded at anything other than the actual rate at which it could borrow funds from third parties. Guarantee fees paid by one part of the same company to another will have no legal effect, and as the permanent establishment can access funds at a certain cost, it is difficult to see why it would pay such a fee.

The hon. Member for Arundel and South Downs also raised the question of whether the proposals are incompatible with European law.

John Baron (Conservative, Billericay)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

No.

The aim of the legislation is not to treat branches and subsidiaries as though they were exactly the same. There are clear economic and legal consequences to adopting one or the other structure. Branches and subsidiaries are not the same, and we cannot pretend that they are. For instance, a branch is able to access the capital of the company as a whole to support its business, and that is why banks often choose to trade through branches. If a bank chose instead to trade as a bank in another country through a separate company, it would need to raise further capital to support the activities of that subsidiary, rather than being able to benefit from the capital and credit rating that it already held. The Bill will create a more level playing field between branches and subsidiaries, so that the way in which the profits of branches are computed reflects the commercial reality: that they have access to company capital to support their business. The Bill will mean that UK branches of foreign banks will now pay a fairer share of corporation tax. That does not mean that branches are being treated more harshly than subsidiaries.

The new provisions require consideration of the amount of equity and loan capital that the branch would have at arm's length. The Bill adopts a capitalisation approach, which produces a more level playing field between the branches and subsidiaries of foreign banks, and so removes discrimination. That is entirely in line with current practice.

John Baron (Conservative, Billericay)

Will the Minister give way?

Dawn Primarolo (Labour, Bristol South)

No, I will not.

The hon. Member for Arundel and South Downs asked why the terms "equity capital" and "loan capital" were not defined. The Inland Revenue saw no need for those terms to be defined in the Bill. Although some have commented that the terms should have been defined, other respondents have agreed that there was no need. The hon. Gentleman recognised that the terms are well established among the banks that form the main group of foreign companies affected by the changes made by the clause.

I turn now to the issue of decisions with regard to European law, and to the points raised on that matter by the hon. Member for Arundel and South Downs.

John Baron (Conservative, Billericay)

Will the Minister give way?

Dawn Primarolo (Labour, Bristol South)

No. I want to continue to make my points.

The Committee will no doubt be aware that there have been recent judgments in the European Court of Justice, and there are ongoing challenges under European law. The particular case to which the hon. Member for Arundel and South Downs referred was in fact a ruling against the German tax system, not the UK's. As a result, the Government are of course aware that some uncertainty may have developed.

We accept that there is a need to restore certainty as quickly as possible. That point is reflected in the Red Book, in the proposals on corporation tax reforms and the next stage of consultation. The hon. Member for Arundel and South Downs will be well aware of the excellent relationships that have existed between this Government and interests in the City of London, especially in connection, for example, with matters arising from discussion of the draft directive on the taxation of savings. At every point, the Government have discussed—with business in general and with those sectors that have a specific interest in the matter—the developments that we want to secure. We want to ensure that we continue to have a corporation tax system and a general tax system that enhance the Government's objectives of establishing fair tax competition, increasing productivity and ensuring that the UK is the most competitive place to do business.

John Baron (Conservative, Billericay)

Will the Minister give way?

Dawn Primarolo (Labour, Bristol South)

No, I will not give way. The hon. Gentleman has stood up repeatedly, but I will not be giving way to him.

This summer's forthcoming consultation on corporation tax reform will provide an opportunity for the Government to consult business on the legislative options to achieve our objectives of continuing to modernise and develop our tax system with regard to the objectives that I set out. We look forward to receiving input from the companies involved. It would be foolish in the extreme to speculate on what might be in the consultation document, and I am sure that the hon. Member for Arundel and South Downs does not seriously expect me to address those points, or to prejudge consultations with the very businesses with which we have worked so closely and in such detailed partnership.

The final points related to whether the measure would damage the City of London. The Government's credentials for acting in the best interests of the City and for defending its competitive advantage cannot be challenged either in Parliament or in the City itself. Indeed, our credentials are not challenged: we continue to receive accolades from all concerned on our exemplary conduct of the debates.

John Baron (Conservative, Billericay)

Will the right hon. Lady give way?

Dawn Primarolo (Labour, Bristol South)

No, I will not give way.

It is clearly not the case that the measure will drive foreign banks from the City of London. Those banks are there for good business reasons. The City is one of the world's premier locations for conducting business of that type. The banks are there because of the crucial networks and support systems. There is nothing to rival the City in the rest of the European Union, and foreign banks will continue to do business there, but they will do so on the same competitive basis as UK banks, which is entirely fair and correct.

I ask the Committee to reject the amendments, and urge hon. Members to support the clause when we reach that point in today's business.

Howard Flight (Conservative, Arundel and South Downs)

There are two key points on which I want to put further questions to the Paymaster General. I also want to respond to her comments about the ingredients for the continuing prosperity of the City of London.

I went into the first point at some length when I asked the Paymaster General whether the judgments of the European Court of Justice to date, and the principles on which they were based, pose an inherent threat to what clause 148 and schedule 25 seek to achieve. As I pointed out, the recent Lankhorst decision could undermine the clause, as interest payments to other EU members of a group would still be deemed to be deductible. If any EU banks or a significant number of foreign banks in the City of London are based in other EU countries, the whole issue of not allowing the charging of wider interest, which the clause is substantially about, could be undermined by the ECJ's principles and rulings.

Secondly, although I acknowledge the fact that the Government have consulted widely, and in the main effectively, with the City on a number of issues and that, in fighting our patch with the EU, there has by and large been effective collaboration between the Government and enterprise, I passionately believe that it is a mistake to think that the continuing prosperity of the City relies purely on geography, networks and established talent. Having lived through 30 years of history, I have to point out to the Paymaster General that that prosperity always related fundamentally to tax.

In 1970, the City of London was a dead duck. It was too large for the UK economy, and it came to life only when the then Labour Government agreed with the Governor of the Bank of England on what amounted to tax-free Euro-banking, which thus took off in London rather than in Zurich or any other location. There is a mixture: the City has to be competitive tax-wise and regulatory-wise, and it has to be attractive tax-wise and regulatory-wise, as well as using its inherent advantage of a pool of talented people. If the City becomes uncompetitive regulatory-wise or tax-wise, business will go to New York, Zurich and other places, as sure as eggs are eggs. We must thus consider how we tax overseas businesses in London in comparison with how they are taxed in New York, Zurich and so forth. As I said earlier, I am well aware that the provisions have been consulted on and that they appear broadly comparable to the arrangements in New York and other locations and therefore are not immediately a threat.

Amendments Nos. 66 and 67 would not undermine those provisions; they would address the two little, specific issues to which I referred. We will not want to press the amendments to a vote, because they are not of fundamental importance, but I wish to tell the Paymaster General that, although the provision itself was done and dusted last year, certain things have changed, and in particular the way in which the ECJ has responded, which may render it inoperative. However, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 148 ordered to stand part of the Bill.

Schedule 5 agreed to.

Clause 184 — Rate of Landfill Tax

Howard Flight (Conservative, Arundel and South Downs)

The Chancellor announced in his 1999 Budget that

"To reduce the amount of waste going to landfill, the landfill tax, £10 per tonne in 1999, will in future rise by £1 per tonne per year."—[Official Report, 9 March 1999; Vol. 327, c. 182.]

The increases made this year are the last under the £1 a tonne annual duty escalator. From 2005, the annual duty escalator will increase to £3 a tonne, with a view to reaching a rate of £35 a tonne in the medium to long term.

The United Kingdom has one of the lowest levels of recycling in Europe, with only 11 per cent. of waste recycled—well below that of many European countries, some of which recycle as much as 40 per cent. of household waste. The Government have failed to provide a coherent strategy for sustainable waste management, and we have seen an ad hoc approach, with a tax increase here, a complicated and failing tax credit scheme there and, meanwhile, landfill usage is increasing.

The Government have little hope of complying with the 1999 European landfill directive, under which the amount of biodegradable municipal waste going into landfill sites would be reduced to 75 per cent. of 1995 levels by 2006. The amount of municipal waste sent to landfill sites has increased from 21.9 million tonnes in 1999, to 22.1 million tonnes in 2000–01.

The Environmental Audit Committee recently criticised the Government's strategy, saying:

"The Waste Strategy 2000 is not so much a waste strategy but a strategy for complying with some of the requirement developed in the EU. Even with that interpretation, it has still not proved effective in delivery".

I am afraid that the phrase, "not proven effective in delivery" is rather familiar in virtually all areas of this Government's activity.

The last Conservative Government introduced the landfill tax in 1996—the first tax with an environmental purpose. We understand the need to encourage a comprehensive sustainable waste management system by promoting more recycling and less landfill. The long-term use of landfill is clearly unsustainable, and we believe that the Government should be more effective in promoting the alternatives.

The response to this measure has been mixed. The Engineering Employers Federation commented:

"The current rises in landfill tax are only acceptable if the funds raised are hypothecated directly into improving the waste management infrastructure".

The CBI said that businesses "remain to be convinced" of the need to raise the tax by £3 per tonne per year. Can the Economic Secretary confirm that the £140 million increase in landfill tax revenue scheduled for 2005–06 will go towards promoting sustainable waste management and recycling programmes? Given that the rationale behind increasing landfill tax is to ensure that the UK complies with EU legislation, surely it is vital that that money goes towards increasing recycling and improving markets for recycled materials.

The arguments against the landfill tax increase are that the increasing rate of tax could act as an incentive to move over to other forms of waste disposal, which end up being more damaging to the environment and in some cases illegal. The Environment, Transport and Regional Affairs Committee cited

"two very good arguments for the landfill tax not being increased to a much higher level without other changes taking place".

First, there is a danger that the use of incinerators may increase as landfill becomes a more expensive option, together with the problem of illegal fly tipping. How do the Government plan to avoid simply shifting the problem elsewhere and making things worse? Secondly, the increase in the tax will hit local authorities hardest. The Government's 2002 strategy unit publication, "Waste Not, Want Not" says:

"Of the total revenue sourced from active waste, approximately 46 per cent. is paid by business and the remaining 54 per cent. by local authorities . . . Like business, a rise in landfill tax will provide local authorities with an incentive to fund alternative ways of managing waste disposal".

My concern is that local authorities that cannot claim under the landfill tax credit scheme are struggling hard enough as it is. If the landfill tax trebles over the next eight years, matters will be made worse and the council tax driven still higher.

Finally, the landfill tax credit scheme, which was introduced along with the tax in 1996 and enabled landfill sites to direct part of their landfill tax liability towards funding local environment projects in return for a tax credit, has encountered high administrative costs. Overall, the scheme was deemed to be a success, but the Public Accounts Committee report identified the following problems:

"a lack of overall accountability . . . and a lack of transparency",

as well as high overhead costs. Following that, the Government announced reforms in the November pre-Budget report, with the new scheme starting on 1 April, but many waste management groups have expressed concern about the new scheme. Two thirds of the money from the scheme—some £100 million—will go towards public spending to encourage sustainable waste management, but the remaining third will continue to go to local projects. I understand that local waste reduction and recycling campaigns have expressed concerns that they may lose out on funding under the new scheme.

Do the Government remember the pledges that they made in "Waste Strategy 2000", proposing to use the landfill tax credit scheme to help deliver an increase in recycling, particularly of household waste? Are WasteAware and other such schemes not recycling projects? We would contend that "Waste Strategy 2000" is in a shambles. It has failed in its piecemeal approach to sustainable waste management. According to the European Environment Agency, to meet the requirements of the landfill directive alone, the UK must divert 27 million tonnes of biodegradable municipal waste away from landfill sites. The UK will therefore need to deliver the equivalent of one new management facility, capable of processing 40,000 tonnes of waste, per week, for the next 14 years.

We have a huge problem, and the EU targets are unrealistic. Instead of working together towards the short-term goal of meeting those EU targets, the Government should embrace a long-term programme to promote recycling, the use of biodegradable materials and sustainable management systems. We would not rule out the use of economic instruments, but we remain unconvinced that increases in the landfill tax will create a sustainable waste policy and promote recycling programmes.

Like most of the Government's environment policies, the tax stems from a panic to meet the targets laid down by Europe and from the primary motivation of raising revenue. I remind the Economic Secretary of the fridge mountains, the problem of abandoned cars and the disastrous climate change levy, all of which are a result of rushed and ill-thought-out legislation. They fail to take account of the bigger picture or to address the long-term environment issues and deliver the objectives that were claimed.

We urge the Government to reconsider their policy. They should not base the tax increases on fiscal and short-term considerations, but consider them in the light of an effective long-term waste policy.

Simon Thomas (Plaid Cymru, Ceredigion)

I support the clause. Despite pertinent points made by the hon. Member for Arundel and South Downs (Mr. Flight), I am not sure what Conservative policy is on waste minimisation, waste reduction and recycling. However, he was right that the landfill tax is one of the longest running pieces of environmental taxation in the UK. Its relevance to the waste mountain is important, so it is vital to spend a couple of minutes examining why we need a landfill tax, the rate at which it should be set and whether it will help us to meet the Government's aims and the wider European aims to which we have all subscribed.

The landfill tax is one of the few taxes that businesses recently asked the Government to raise, and at a greater rate than proposed in the Bill. Although the hon. Member for Arundel and South Downs prayed in aid the CBI, the Economic Secretary will be aware that the waste companies wanted an accelerated increase in the economic drivers towards waste minimisation and a reduction in landfill in favour of recycling. In fact, they were a little disappointed that the Bill did not impose a greater level to reach the Government's eventual target of £35 per tonne for the landfill tax.

Those companies see clearly that we will not meet our recycling obligations and our more important European obligations to reduce the amount of waste that we send to landfill without a much stronger driver in the economic market. I would have expected the Conservatives at least to be in favour of strong economic drivers, because that is how markets work. Sometimes it is necessary to regulate markets so that they take the right direction for the greater aims of the public good.

I want the Economic Secretary to address some of the concerns of the Environmental Audit Committee, on which I serve and which recently produced a report on waste. As the hon. Member for Arundel and South Downs rightly reminded the House, that report makes it clear that the Committee thinks that the Government's approach is a knee-jerk reaction to the demands of the European Union. We did not think that their approach was anti-European. The reality is that the Government reacted to demands for which they had not properly prepared. They had not properly engaged with the EU legislation and had not thought through how it would work domestically. As a result, they have been forced to rely on a landfill tax and very little else to achieve their waste minimisation and recycling aims.

In that context, we have the unhappy news from MEPs who have served on the European Parliament's environment committee that the Government are already missing their EU targets and will fail miserably in implementing EU legislation. I hope that the Economic Secretary can give us assurances tonight that that will not happen and that the landfill tax, increasing at a set rate of progression, will achieve the aims of the 2000 waste strategy throughout the United Kingdom, not just England. The obligation to represent the UK in negotiations on EU targets involves not just Westminster but the devolved Administrations.

Finally, to emphasise the point made by the hon. Member for Arundel and South Downs, the landfill tax may encourage less sustainable methods of waste disposal, and I am particularly concerned that there may be an increase in incineration. That is no reason to argue against the landfill tax. Indeed, it is a reason to argue for an incineration tax or the correct regulation of incineration to ensure that such an increase does not happen. However, I am concerned that we may rely on a single economic instrument that is not designed to encourage recycling or waste minimisation but to stop waste going into landfill. Are we sure that the market and people responsible for the disposal of waste will make the necessary jump?

We cannot dispose of things in landfill and cannot go ahead with the co-disposal of hazardous waste in landfill, but have we ensured that local authorities and waste disposal companies will take the opportunity to achieve waste reduction, minimisation and recycling? Have we ensured that the landfill tax will prevent the use of other methods of disposal such as incineration? That is not yet clear in the Government's approach to the issue. An economic driver such as the landfill tax is undoubtedly the correct approach, but the Government have not yet thought through its impact on the market—it is a suck-it-and-see approach. I am concerned that many local authorities are already missing their recycling targets, as has been admitted in evidence to the Environmental Audit Committee. We would be in an even worse position if we missed the target set by the European Union. I hope that the Economic Secretary can give guarantees that the Bill will bring about what other areas of government aim to achieve—greater use of recycling, less waste going to landfill and a reduction in the waste produced in the first place.

George Osborne (Conservative, Tatton)

As my hon. Friend the Member for Arundel and South Downs (Mr. Flight) pointed out, clause 184 points the way to substantial increases in the landfill tax. The clause proposes that it should increase by £1 this year, £1 next year and, from 2005–06, by £3 a year so that, according to the Government, it will be levied at £35 a tonne. That is a substantial increase on the original tax introduced by the Conservative Government in 1996, which was just £3 a tonne. Before the clause passes into law, we should reflect on the original assumptions behind the decisions made by the then Chancellor, my right hon. and learned Friend the Member for Rushcliffe (Mr. Clarke), when introducing the tax.

The first assumption was that the landfill tax would be offset by a compensatory reduction in employers' national insurance. Indeed, in his 1994 Budget, my right hon. and learned Friend said:

"I am determined not to impose additional costs on businesses overall . . . I want to raise tax on polluters to make further cuts in the tax on jobs."—[Official Report, 29 November 1994; Vol. 250, c. 1098.]

There is a striking contrast with this year's Budget. Instead of a compensatory reduction in employers' national insurance, there are substantial increases. The hon. Member for Ceredigion (Mr. Thomas) did not give the landfill tax the credit that it is due. It is not just one of the oldest environmental taxes, it was the first tax with an explicit environmental purpose. The assumption—pretty radical at the time—was that a landfill operator could offset any contributions that it made to an environmental charity or voluntary group against its liability for landfill tax up to a specified limit. Indeed, it could claim tax credits for 90 per cent. of its contributions to charities and voluntary groups up to a total of 20 per cent. of its overall landfill tax bill in any one year. The nature of those environmental bodies was spelt out—they were non-profit-making bodies, they were not controlled by central or local government and they were often local schemes. They were administered by Entrust, a central Government regulator.

Since landfill tax was introduced and the landfill tax credit scheme came into operation, more than £400 million has been contributed to environmental bodies, including, in 2000–01, the most recent figures that I have seen, £109 million to those charities. Substantial sums have been given to very small local groups, which has been a huge boon to such groups and charities. It has enabled them to be set up and has done an enormous amount of good locally in, I would guess, every constituency.

There is a philosophical point here. This is about strengthening civil society. It is about Burke's "little platoons", and about supporting voluntary groups, local charities and so on. As a member of the Public Accounts Committee, I am the first to accept that there have been problems with the scheme. The Committee looked into the matter, and I have its report. There were problems with the lack of oversight, accountability, transparency and so on. It is all spelt out in the Committee's report. However, the problems lay with the Government, the regulator and the way in which the scheme operated, not with the principle of the scheme. That is why I am sad that, instead of trying to fix the problems and stick with the principle, the Government have largely decided to abandon the principle altogether. That is a tragedy, not least because the Government recognised in their pre-Budget report what a good thing the scheme has been. The report stated:

"The Government recognises that the Landfill Tax Credit Scheme (LTCS) has supported many worthwhile community and environment projects that have improved the quality of the environment at the local level . . . The scheme has also been successful in generating local community involvement in such projects."

If we are not here to support such schemes, what are we here for? As I said, it is sad that the Government are largely abandoning the scheme.

That has caused enormous concern in groups in my constituency and in constituencies across the country. The Economic Secretary is proposing, in effect, to remove two thirds of the funding of the scheme—funding raised directly by clause 184—and to put that money into general public expenditure, although he says that it will be hypothecated to environmental management and so on within centrally managed expenditure. Nevertheless, £60 million or more, which is currently given to the charitable and voluntary groups, will go straight into the Treasury coffers.

When I wrote to the Minister about the matter, as no doubt did other right hon. and hon. Members, he replied on 22 January and, I think, gave the game away. He wrote:

"This change reflects the Government's conclusion that public spending will be a more effective way of providing strategic direction to sustainable waste management."

That tells us all we need to know about the Government. They think that Whitehall knows best. They think that their public spending is a more effective way of delivering change on the ground.

The charities and environmental groups that have written to me do not accept that, nor do the groups that will lose out most—those involved in activities such as research, development, education and information, all of which are vital, as the hon. Member for Ceredigion said, to a change in attitude in our country towards these issues.

I shall briefly further detain the House, although I know that the nationalists are keen to get on to their whisky clauses. Waste Watch has written to me and probably to many hon. Members. It runs the Cheshire Schools Waste Action club, which, it points out

"is a successful education project, which increases awareness of waste issues and supports schools in taking action to reduce their waste outputs. Projects have achieved between a 30–80 per cent. reduction of waste within schools."

Schoolchildren will take that learning with them for the rest of their life. Waste Watch comments:

"We will lose the opportunity to enable staff and children in Cheshire schools to reduce their waste."

The Cheshire Landscape Trust has brought to my attention a number of serious concerns, and I should be interested to hear the Minister's response. The trust points out that

"by moving some £100 million from the private to the public sector, to fund waste management projects, the public sector could lose the substantial amount of matched funding, which is currently running between £400 and £700 million."

Again, that should be the sort of thing that we want to encourage. Surely, we want to encourage local groups to work with local businesses and to bring in money through match funding. According to the Cheshire Landscape Trust, that will be lost. It asks,

"how will local communities, universities and other research establishments who are currently undertaking Research and Development projects access funding for sustainable waste management projects in the future?"

It goes on to express another very serious concern, noting:

"One estimate puts the number of job losses due to this transfer of funds away from Environmental Bodies to be 5000. This includes jobs created on and through projects as well as employees working for Distributive Environmental Bodies. For this trust, the proposed changes would put us in a very difficult position with possible job losses."

Finally, I wish to refer to an organisation that no right-thinking Member of Parliament could ignore—the Cheshire Federation of Women's Institutes. The Prime Minister learned to his cost what happens when one puts the women's institutes' backs up. The federation makes the point:

"The transfer of funds away from Environmental Bodies, many of which bring local knowledge to the allocation of the funds, means that local involvement and community participation will be lost."

It asked me to bring those concerns to the attention of the Government and the House.

These are very serious matters. We are talking about good-minded people who give their time voluntarily in our constituencies to work for local environmental groups and improve our local environment for everyone. Those groups will lose out to the tune of tens of millions of pounds.

Alan Whitehead (Labour, Southampton, Test)

The hon. Gentleman speaks as though the entire amount that is currently gained in tax forgone will suddenly disappear. Does he accept that, even under the proposals, most of the money that currently goes into the scheme will remain? The money to which he refers relates to the increase and is not taken away from the present amount. Does that not mitigate his case that the money is disappearing from the groups that he is talking about?

George Osborne (Conservative, Tatton)

I accept that a proportion of the money will remain, but it is quite small; indeed, it will be less than half. According to the letter that I received from the Economic Secretary, approximately £47 million will remain in the scheme annually, but £100 million will be taken out. Only a third of the money will remain. Given the environmental credentials of the hon. Member for Southampton, Test (Dr. Whitehead), I wonder whether he supports the change. Does he think that the Government would be better at spending the money centrally than local charities and environmental groups on the ground? I would be surprised if he took that view, as it is certainly not my view or that of the groups involved.

I ask the Economic Secretary to reflect on what I have said and deal with my points, some of which he will no doubt have heard about from environmental groups. In particular, will he address the loss of match funding and the question of where the groups will get their money? I know that he is phasing in some of the changes, but in a year or two those involved will be hit with a big shortfall. Will he also comment on the serious job losses that at least one organisation that has written to me predicts?

John Healey (Labour, Wentworth)

The clause is relatively narrow in the context of this rather wide debate. In line with the escalator that we announced in 1999, it increases the standard rate of landfill tax by £1 a tonne to £14 a tonne, with effect from 1 April this year, and by a further £1 a tonne to £15 a tonne, with effect from 1 April next year.

The Government are committed to a sustainable approach to waste management. The increases will encourage waste producers to seek more environmentally friendly alternatives to landfill, as they will encourage producers and the waste management industry to switch from landfill to minimising waste and increasing re-use and recycling rates—the very purposes that the hon. Member for Arundel and South Downs (Mr. Flight) urged us to adopt.

The increases are part of a principled national policy to reduce the volumes of waste going to landfill, and they are complemented by additional public spending on sustainable waste management that was announced in the House on 6 May by my right hon. Friend the Secretary of State for Environment, Food and Rural Affairs.

The hon. Member for Arundel and South Downs asked about revenue from increasing the landfill tax by £3 per tonne in 2005–06—not in 2003–04 or 2004–05, which are covered by the clause. Although that will make a significant contribution to the increased investment, it is not directly hypothecated. However, the Government made a commitment in the pre-Budget report and the Budget that additional revenue from the increases in the standard rate would be recycled to business.

Discussions with business and other stakeholder groups have already shown that there is broad support for a package of measures, including some tailored to those sectors facing the greatest waste management challenges. We will continue to pursue that package of measures through developing the options and consulting further, and we plan to make decisions to the time scale in the pre-Budget report and the Budget.

The hon. Gentleman raised the spectre of fly tipping connected with increases in the landfill tax. There is no evidence to justify that. A Tidy Britain Group survey in 1999 showed that the majority of fly tipped waste is household waste. As householders do not directly pay the landfill tax, it is unlikely to be the cause of the increase in fly tipping. That said, we take illegal waste disposal by fly tipping very seriously. The penalties are now severe: they include unlimited fines and up to two years in prison.

The hon. Gentleman and the hon. Member for Ceredigion (Mr. Thomas) asked about incineration. As announced in Budget 2003, the Government have commissioned a review of the environmental and health effects of all waste management and disposal methods, and we aim to report on its findings later this year. The case for using economic instruments in relation to incineration will be considered in the light of that work and in consultation with those with an interest in the field.

The hon. Member for Ceredigion urged the Government to increase the rate of landfill tax more quickly in order sooner to reach what we set as the medium to long-term level of £35 per tonne. Our research and the recommendations of several reports suggest that that level will result in alternatives to landfill being more widely available and becoming more economically viable. As the hon. Gentleman will know from his work on the Select Committee on Environmental Audit, that view is widely shared. Given the lead times for investment, however, the most important factor in stimulating a shift in behaviour away from landfill is not the current rate of the tax, but the confidence, knowledge and certainty that it will reach the medium to long-term level of £35 per tonne. That gives the lie to the accusation by the hon. Member for Arundel and South Downs that we have a short-term set of policies.

I have been fortunate enough to give evidence to the Environmental Audit Committee a couple of times. I say to the hon. Member for Ceredigion that I am confident that the landfill tax increases, alongside the other policy measures that we have introduced or plan to introduce, will deliver a waste policy that is better suited to Britain, and which increases recyling and re-use, minimises waste production and helps us to make the reductions in volume that we need to meet our European Union targets.

The landfill tax is not our only measure. We recently passed legislation to introduce a scheme of tradeable landfill permits, which will help. We have substantially increased public spending through the EPCS—environmental, protective and cultural services—block grant to local authorities and the transfer of the landfill tax credit scheme to public spending. That will help. We have also announced plans for a performance fund for waste management for local authorities, and that, too, will help. All those measures will play an important part in helping the United Kingdom meet our targets.

The hon. Member for Tatton (Mr. Osborne) asked about the national insurance contributions increase, which was introduced in last year's Budget and took effect last month. It will help fund the 7.5 per cent. real-terms increase each year in spending on the national health service from 2002–03 to 2007–08. It has nothing to do with the landfill tax. However, the hon. Gentleman is right that when the previous Government introduced the landfill tax, it was accompanied by a 0.2 per cent. cut in employers' national insurance contributions.

The Government estimate that in 2003–04, the cut that was originally introduced with the landfill tax will be worth approximately £780 million, compared with about £670 million raised by the landfill tax. Next year—2004–05—the NIC cut will be worth approximately £820 million, compared with £745 million raised by the landfill tax. The revenue from the landfill tax has yet to recoup the original cut to employers' national insurance contributions.

The hon. Member for Tatton is a member of the Public Accounts Committee and knows the flaws in the design of the landfill tax credit scheme better than many other hon. Members. He knows that flaws in its design caused the problem, because the Committee examined the matter, as did the then Select Committee on Environment, Transport and Regional Affairs. The problem arises from the design rather than the principle of the scheme. The Government strongly support the principle; that is why we have retained it for non-waste projects. We shall not abandon it, but we will transfer the funding for category C and CC projects to public spending because that will deliver a more strategic, sustainable waste management policy and programme in this country. The hon. Member for Arundel and South Downs urged us to do that.

The hon. Member for Tatton also knows that one of the flaws in the design and operation of the landfill tax credit scheme since its inception has been a chronic lack of information on what the money is being spent. He asked about match funding, but we face a lack of information and evidence on which to assess some of the individual claims and stories that we hear about projects. Glasgow Caledonian university has conducted the only systematic research on that. It suggests that the rate of match funding for waste projects as well as those in other categories of the landfill tax credit scheme is significantly below the levels that the hon. Gentleman cited.

Although it is not directly covered by the clause, Committee members may find it helpful if I say a little about our plans for the standard rate of landfill tax after the two years to which clause 184 applies.

George Osborne (Conservative, Tatton)

Before the Economic Secretary moves on, will he deal with the specific point about the loss of match funding and jobs that many groups and voluntary organisations will experience? I presume that people have written to him about that.

John Healey (Labour, Wentworth)

I do not know whether the hon. Gentleman missed it, but I have dealt with match funding. I believe that he refers to category C and CC schemes, although he was not explicit. They deal with waste, and their funding has been transferred to public spending. I have written to him and other hon. Members and made a statement in the House and he therefore knows that we have put in place for this financial year a transition scheme to help such projects continue and reach a point where they can sensibly plan for a continuing operation after this financial year if they choose to do that. That will play an important part in providing security, certainty and the ability to plan in the long term for the projects about which the hon. Gentleman is concerned.

As we have already announced, the standard rate of landfill tax will increase by £3 per tonne to £18 per tonne in 2005–06, and by at least £3 per tonne in the years thereafter, on the way to the medium to long-term target of £35 per tonne. These higher rates send a clear market signal, and announcing them in advance maximises the effect. The Government have discussed with business and others how to make the increases revenue neutral to business as a whole. I have explained that the preferred options will now be developed, and decisions on the package of measures will be announced in the 2003 pre-Budget report. On that basis, I commend the clause to the Committee.

Question put and agreed to.

Clause 184 ordered to stand part of the Bill.

New Clause 1 — Rate of Duty on Spirits

Angus Robertson (Scottish National Party, Moray)

I beg to move, That the clause be read a Second time.

I am delighted to be able to move new clause 1, which is aimed at reducing the duty on spirits by 3 per cent. This measure is primarily aimed at helping to boost the Scotch whisky industry, but it would of course have a positive effect on the Irish whiskey industry, affecting colleagues from Northern Ireland, and on the constituency in Wales that produces the sole Welsh whisky, Penderyn. It would also help spirit producers elsewhere in the UK who do not produce whisky.

The new clause has been tabled after discussions with the Treasury, and I am pleased to see the Economic Secretary to the Treasury in his place this evening. A delegation from the all-party Scotch whisky group, on which I serve as vice-chairman, along with other Members from all parties in the House, lobbied the Treasury on this matter earlier this year. Members from all parties also pressed the Government to accept a 4 per cent. cut in duty. That move was supported by Labour, Conservative and Liberal Democrat Members, and, of course, by the Scottish National party. In that spirit, I hope that there will be cross-party support for this measure, as it is more modest than the proposal supported by the all-party group.

The Economic Secretary to the Treasury does not need reminding that Scotch whisky is one of the UK's top five export earners, generating more than £2 billion a year from sales in 200 markets. The industry uses around 25 per cent. of Scotland's barley, and 70 per cent. of all Scottish grain is used in grain distilleries, many of which are in my constituency in Speyside, which contains more than 50 per cent. of Scotland's malt whisky distilleries. The industry accounts for 5 per cent. of manufacturing jobs in Scotland and there is a £1 billion a year spend on the purchase of goods and services from local suppliers. Forty thousand jobs depend on the industry, including 7,000 in rural areas, many of which have fragile economies. Indeed, my constituency has the lowest weekly wage of anywhere in Scotland, although that is not something of which people are proud. Any measure that helps to boost an industry of such significant importance must, therefore, be welcomed.

Pete Wishart (Scottish National Party, North Tayside)

I am sure that my hon. Friend will join me in welcoming the decision to reopen the Glencadam distillery in Brechin. Does he not agree that, for new businesses such as that to develop and thrive, we need a fiscal regime that encourages rather than penalises?

Angus Robertson (Scottish National Party, Moray)

I agree with my hon. Friend. That point is being made across the industry, no matter where the distilleries are located. All the key indicators that I have outlined underline the importance of the industry throughout Scotland, and illustrate the need for the Government to provide the optimal conditions for it to flourish.

Over the years, commentators have established that the taxation regime at home and abroad is one of the most significant factors in determining whether whisky sells as well as possible. In recent decades, Scotch whisky has made great strides in markets such as Spain, Italy, the United States and the far east—all areas with generally more benign tax regimes. Sadly, some of the worst taxation excesses are to be found in the UK, the state that benefits from massive revenue from the industry.

As most whisky drinkers will be aware, two thirds of the price of a bottle of whisky is tax. Since 1973, the price of a bottle, including the excise duty, has been subject to VAT, which is levied on the duty price paid. That means that the price of a bottle of Scotch whisky is increased by and subject to a tax upon a tax. On 10 occasions in 18 years of Conservative government, sadly, the Tories took the opportunity to raise the burden on the whisky industry. That discrimination has continued under the Labour Government, and the duty on whisky is one and a half times higher than on other competing beverages.

The rest of the debate is in Hansard.