Finance Bill

Public Bill Committee, 25 May 2004.

Standing Committee A

(except clauses 4, 5, 20, 28, 57 to 77, 86, 111 and 282 to 289, and schedules 1, 3, 11, 12, 21 and 37 to 39) - Clause 112 - Private residence relief

Howard Flight (Conservative, Arundel and South Downs)

I welcome you to the Chair, Mr. McWilliam.

There have been significant professional criticisms of the clause and the measures in the schedule. The Chartered Institute of Taxation has argued that the changes—

John McWilliam (Labour, Blaydon)

Order. I would not want the hon. Gentleman inadvertently to mislead the Committee. The clause states:

''Schedule 22 (which makes provision about private residence relief) has effect.''

I cannot see any possible professional criticism of that; it is a fact.

Howard Flight (Conservative, Arundel and South Downs)

You are, as ever, correct, Mr. McWilliam. Perhaps it would be better to cover the issues under the schedule, but as there are amendments to be discussed under the schedule, I thought there was an argument for dealing with criticisms in principle of the arrangements under the clause.

John McWilliam (Labour, Blaydon)

It might help the Committee if I draw its attention to the selection list. The Committee will observe that I have selected schedule stand part together with new clause 11. That combination renders debate under clause 112 about the principle otiose.

Howard Flight (Conservative, Arundel and South Downs)

I stand corrected, and sit.

Question put and agreed to.

Clause 112 ordered to stand part of the Bill.

Schedule 22 - Chargeable gains: private residence relief

Howard Flight (Conservative, Arundel and South Downs)

I beg to move amendment No. 30, in

schedule 22, page 388, line 28, leave out from beginning to end of line 20 on page 389 and insert—

'( ) Where a claim for relief under section 260 has been made in relation to a disposal of a property, the trustees' relief under section 223 above on a disposal of that property shall be limited to that proportion of the chargeable gain which reflects the period during which the property has been occupied as an only or main residence under the terms of the trust as a fraction of the combined period of ownership of the trustees and the person who claimed the relief under section 260.

( ) In calculating the proportion mentioned in subsection (1) above, the Trustees shall only be entitled to relief for periods in which the property was in actual occupation by one or more beneficiaries and not for any period of deemed occupation.'.

John McWilliam (Labour, Blaydon)

With this it will be convenient to discuss amendment No. 1, in

schedule 22, page 390, line 35, leave out sub-paragraph (8) and insert—

'( ) In subsection (5) of section 223 of the Taxation of Chargeable Gains Act 1992 after ''and (2)(a) above'' insert ''and section 226A below''.'.

Howard Flight (Conservative, Arundel and South Downs)

The mischief that the schedule is designed to deal with is the technique of transferring a second home into a discretionary trust as a conduit to passing it on to, for example, one's children, and later realising the property free of capital gains tax. Where the value of the home was more than a quarter of a million there would of course be inheritance tax to pay. The schedule removes the availability of principal private residence relief from capital gains tax where there has been an earlier deferral of gain under section 260 of the Taxation of Chargeable Gains Act 1992. The rest of the schedule is concerned with consequential amendments and some rewrite language. The formal inclusion of a former concession giving private residence relief to the personal representative of the deceased in certain circumstances is a positive move.

I will return to the principles during the stand part debate. The problem is that if a person has, say, half a million in cash—lucky person—and settles it into a discretionary trust, the trustees could purchase a property and then claim PPR relief on a subsequent sale of the house, assuming it had been occupied by a beneficiary, but if the settlor provides not cash but an asset that becomes a beneficiary's PPR, there is no relief available. That may be the Government's intended policy position, but it seems unfair and disproportionate. Our point is that to avoid a double charge, there should be a credit against the capital gains tax of any inheritance tax paid in respect of the same gift. I recollect that in our debate on schedule 21, the Paymaster General said that the Government were not looking to bring in double taxation. I therefore ask her how she is addressing the issue in relation to clause 112 and schedule 22.

A possible alternative might be to address the perceived mischief directly. The objection is to short-term washing-out strategies, so might it not be possible to limit the PPR relief available to the trustees to that proportion of the gain that reflects the period for which the property was occupied as a PPR under the trust during the total ownership period of the trustees and the donor? That would address those situations where trusts are used as a short-term device to wash out, without unfairly treating innocent situations or catching changing circumstances.

It is not uncommon for young adult children to be provided with a home from a discretionary trust set up five or 10 years before. They are then given the use of the property, as one would not want to give large sums of money directly to young people for reasons of prudence. One might want to have the property used by a succession of beneficiaries. In both situations, there can be bona fides cases in practice, and tax is not a primary motivation for such arrangements.

Assuming the measures stand, there are some points of detail to address, with which amendments Nos. 30

and 1 are concerned. I am sure that the Paymaster General will argue that she simply wants to block a piece of tax avoidance, fairly or not. Our argument of principle is that the anti-avoidance measures are disproportionate and put trustees who receive cash and buy a house in a different position from trustees who receive a property. There are significant long-term record-keeping requirements and tracking of claims, and no response is allowed to changing circumstances.

Amendment No. 30 is a rewrite of paragraph 6, designed to persuade the Government that the mischief can be addressed in a fairer way. It proposes that trustees are no longer entitled to the last 36 months in any event, but only if the property is in actual occupation. Amendment No. 1 is a little less easy to get one's mind round, but where the existing legislation refers to 36 months the amendment would allow the Treasury to change that period to 24 months for all purposes. Would it not be easier to do that through a much simpler wording, as in the amendment? I would like the Paymaster General to justify the length of paragraph 8(8). I shall make slightly more fundamental criticisms in the stand part debate.

Dawn Primarolo (Labour, Bristol South)

I remind the Committee that clause 112 and schedule 22 are targeted at measures that are designed principally to avoid capital gains tax. That exploitation depends on there being no immediate capital gains tax charge. Subsequently, the effect of the interaction of gifts relief with private residence relief has been that capital gains tax is avoided entirely. The purpose of the measures is to ensure that the changes are appropriate in tackling that avoidance.

There are a number of reasons why I shall be asking the Committee to reject amendment No. 30, which would limit the restriction of private residence relief proposed in the schedule. The purpose of the schedule is to stop capital gains tax avoidance schemes that exploit the interaction between gifts relief and private residence relief. Such schemes aim to convert chargeable gains on disposal of residential property that would not normally qualify for private residence relief into tax-free gains by the use of the trusts. Clause 112 and schedule 22 deny private residence relief to people who dispose of a property, where the computation of the chargeable gain resulting from that disposal is affected by a claim to gifts relief relating to an earlier disposal.

In a simple case where a second home is sold and the owner wishes to avoid capital gains tax, he or she gifts the property to the trustees of a trust and claims gifts relief, so that no capital gains tax is payable at that point—it is deferred. Arrangements are then made for a beneficiary to live in the property for enough time—it can be a short period, possibly days or months—to establish an entitlement to private residence relief.

The trustees then sell the property and obtain the relief. The result is that the gain is wholly relieved by private residence relief and no tax is payable, not even in respect of the earlier hold-over gain that accrued

while the property was not the only or main residence of the person who owned it at the time. By denying private residence relief in circumstances where gifts relief is obtained, clause 112 and schedule 22 provide for the whole of the gain arising on the disposal of a second home to be taxed, irrespective of the interposition of a trust—a trust put there simply to avoid the tax on that gain.

As I understand it, amendment No. 30 would allow trustees private residence relief when they dispose of a property that has been the subject of a gifts relief claim, but would limit the amount of relief available by reference to the amount of time that the property was occupied as an only or main residence under the terms of the trust. That would render the legislation ineffectual in combating such avoidance, because it could easily be sidestepped. Committee members must ask themselves why those schemes are being used. They are being used to avoid paying the tax on the capital gain. The amendment would address only the most straightforward cases, where there is a single gifts relief claim and the trustees dispose of exactly what was gifted to them. That does not happen. There are many complex forms in that area.

The amendment would not, for example, deal with cases where successive gifts are made through a number of trusts, as frequently happens. Nor would it deal with cases where interests in a property are divided or combined and where there are a number of relevant gifts reliefs claims that have been made by different persons. Nor would it deal with cases where the final sale is made by an individual and not by those trustees of a trust who had gifted the property to that individual. It would leave open opportunities for people who dispose of second homes to be able to continue to avoid capital gains tax by exploiting the interaction of gifts relief and private residence relief.

On the other hand, clause 112 and schedule 22 deal with all such cases. I think that it would be naive to assume that those elements of the tax-planning industry that enthusiastically marketed those schemes would not be up to devising and selling variations, which could drive straight through the legislation if it were to be amended by amendment No. 30. It is not acceptable because it leaves open those possibilities.

Another reason why I will ask the Committee to reject the amendment is that even if it were effective it would impose a greater compliance burden on the taxpayers. The ultimate vendor of the property would need to know not only his acquisition costs following his gifts claim but the period or periods of ownership of the previous owner or owners. In anything but the simplest of cases, the burden might be considerable.

For those two reasons, I say to the hon. Gentleman that schedule 22 as drafted provides a more effective and equitable way of stopping this drain on the public purse than would the measures as amended by amendment No. 30.

I ask the Committee to reject amendment No. 1 as well. As drafted, it was very difficult to understand its objective, but in moving it the hon. Gentleman has clarified that. I have explained that the anti-avoidance

measure in the schedule is being introduced to prevent people from exploiting the interaction of gifts relief and private residence relief to make a tax-free disposal of a property that would not otherwise have attracted private residence relief.

We recognise that because the measure has effect from 10 December 2003 some people will have entered into arrangements before that date expecting a certain amount of relief. That is why we have included a transitional period preserving any entitlement to private residence relief, which is referable to the period before 10 December 2003. The transitional provisions also preserve entitlement to private residence relief if any proportion of the last 36 months of the ownership falls before 10 December 2003 and the relevant conditions are met. Frankly, that is as fair as we can be.

I am grateful to the hon. Member for Arundel and South Downs (Mr. Flight) for explaining that, by providing a neater way of catering for the effect of the consequential changes that would need to be made if the last-36-month rule were to be changed by Treasury order, amendment No. 1 is intended to be helpful. Although I thank him and I appreciate his sentiments, the amendment does not appear to achieve its objective, because it would have effect over the whole measure rather than just the relevant transitional rule. I am sure that that is not what he intended.

In any event, even if the amendment were to work, which it would not, its effect would be the same as that of the legislation as drafted. I appreciate the hon. Gentleman's motives, but the amendment does not deliver.

The hon. Gentleman made three specific points. The first was about cash being provided to a trust. If a person provides cash to a trust, they are not seeking to avoid capital gains tax by using gifts relief and private residence relief. The circumstances are different and therefore there is no unfairness.

Howard Flight (Conservative, Arundel and South Downs)

I understand the Minister's point, and we are agreed on the mischief that needs to be blocked, but the other side of that coin, as I set out, is that there are perfectly bona fides situations where a property is provided, to which these measures would unfairly apply.

Dawn Primarolo (Labour, Bristol South)

I was coming to that. This schedule has not changed the way in which capital gains tax and inheritance tax laws interact. There may be a charge to both inheritance tax and capital gains tax if within a seven-year period the person who has made the transfer of values that are immediately chargeable to IHT exceeds the IHT-exempt amount. CGT is due where the gain is chargeable within the rules. The effect of gifts relief is to transfer the CGT liability in respect of a chargeable gain from the transferor to the transferee, whose adjusted acquisition cost for CGT purposes reflects the fact that no CGT or a reduced amount thereof is paid in respect of the transfer. Any inheritance tax paid on the transfer is therefore allowed as a deduction in computing the transferee's gain, and none of these provisions has changed. The measure prevents people from exploiting

the interaction of the gifts relief and the private residence relief rules to realise a gain on residential property tax-free.

The hon. Gentleman also made the point that, for instance, people with a family home that came from a discretionary trust some years ago will either have to move to avoid the CGT on the sale of their home or face a tax bill like no-one else in the country. I am trying to make the point that the current rules are not disturbed. We are dealing specifically with the interaction of the gifts relief and the residential relief, at which point no tax is paid to the Exchequer. We are now seeing a considerable number of schemes exploiting this arrangement, and it is necessary that the Government move to defend that revenue.

I am sure the hon. Gentleman would agree that the tax rules are quite clear, and where a person puts in arrangements to avoid the tax charge that is clearly to be levied against the property, it is not unreasonable for the Government to move to ensure that the rules operate as they should, and to prevent that exploitation from occurring. That is precisely what we are doing in schedule 22. I hope, therefore, that he will not press his amendments to the vote, but if he does, I will ask my hon. Friends to oppose them.

Howard Flight (Conservative, Arundel and South Downs)

As I said a moment ago, we share a perception of what the perceived mischief is, and I felt I described it rather more simply and clearly. We are not opposed to measures to block up such mischief. Our concerns are that the measures being taken could fall unfairly on bona fides situations, although I was pleased to hear the Paymaster General's confirmation on the interaction between IHT and CGT.

I shall first ask the Paymaster General for a clarification that she will be aware has been generally sought. In paragraph 6 of schedule 22, new section 226A of the Taxation of Chargeable Gains Act 1992 allows private residence relief to continue if the hold-over claim under section 260 of that Act is revoked. In the previous paragraph, section 260 does not contain a specific right to revoke the election. Is there any time limit during which such a revocation can be made, or does the normal five years and 10 months apply? Does a revocation need to be entered into by both parties in the same way as a claim?

The Chartered Institute of Taxation has also argued that the route being employed by the Government to address the mischief is inappropriate and that it would have been better and simpler to have legislated so that main residence relief is not available on the hold-over gain. The institute is also concerned that there is an element of retrospection in the arrangements and believes that it should contain a more suitable set of commencement and transitional provisions and that taxpayers should, at least, be able to undo the effect of the earlier election and pay whatever tax would have been due if it had not been made. The institute also suggested that there should be a backstop date—for example, April 1997—with the new provisions applying only after that date.

The Paymaster General has, in general, not convinced me that bona fides situations will not be

unfairly disadvantaged. I broadly accept that amendment No. 1 may not work, but it is an attempt to simplify the drafting. She argues that amendment No. 30 would leave the door open to continuing exploitation, and I will take her word that neither amendment satisfactorily addresses the fundamental issues that we and others are concerned about. However, I would like to hear a clearer defence, if it exists, to show that bona fides situations are not disadvantaged by the proposed measures.

Dawn Primarolo (Labour, Bristol South)

The hon. Gentleman asked about time limits for revocation, whether both parties need to be involved, and how the gift hold-over claim can be revoked. If a claim was made within a tax return and the window for amending that return has closed, the person who made the gift cannot undo the position and is stuck with the consequences of the decision to make that arrangement in the first place to seek to avoid the tax. Likewise, if a claim was outside a return and the window for amending it has passed because it is more than 12 months from the date that the claim was made, the person cannot undo the position and is again stuck with the consequences of that decision.

We are back to a point that we have discussed before about those who undertake such tax planning in the full knowledge that it is designed to avoid paying tax even when legislation clearly says that tax is liable on the gain. They enter into those arrangements by choice, so they cannot say, ''I made that choice and I might have got away with it, but I am not going to now, so I want to revisit my choice with hindsight and make different arrangements.'' If we cater for that, we would be saying to those who seek, through tax planning, to avoid tax for which they are clearly liable, ''If you don't manage it on the first go, don't worry, we'll let you take another run at it by undoing the arrangements that you originally put in place and seeing if there's something else you can do to avoid it, or you can play by the rules.''

The hon. Gentleman has made this point in various ways during debates on the Bill, and I have responded in various ways. If people seek to avoid payment of tax that tax legislation says is clearly liable, they must take responsibility for their choices.

On revocation, it is clear that the tax legislation does not intend that people should seek gifts relief and then trigger residence relief as if the property was their prime property, the one that they occupy. I know that the hon. Gentleman understands that. It is right that we should make such changes, and frankly it is high time that people understood that consequences flow from their choices and that the tax system is not static but can change. I am reminded of the point that my hon. Friend the Member for Wolverhampton, South-West (Rob Marris) made on clause 162 of the 2003 Finance Bill about those who had entered into 25-year mortgages with mortgage relief. Mortgage relief was progressively reduced over time by the Conservative Government and this Government. No one argued that people should carry on receiving it or that they

should be able to revisit financial arrangements that they had made earlier. We all make choices.

I am very firm on this point and will continue to echo it through the stages of the Bill. The clear message to those who want to tax plan is that you can tax plan, but if we change the system, you are stuck with your choices. That is perfectly reasonable; that is life.

The hon. Member for Arundel and South Downs asked whether both parties would be subject to a revocation. That would be the case only if both parties were required to make the claim—it would not automatically have to be both parties. However, that will not be the case for gifts to trust. Trustees of settlements make gifts relief claims only if they are the party making the disposal.

The hon. Gentleman's final point was about claims being revoked. We have made no changes to the claims rules. Gifts relief is given if the transferor makes a claim, and the normal rules relating to withdrawal of that claim apply. That is still the case. Thus, a claim cannot be withdrawn or amended after it has become final, except in certain exceptional circumstances, which are provided for. Otherwise, it may be withdrawn at any time, and people can vary their claims as long as they are not final. Again, he well knows that that principle operates throughout the tax system for final claims, and that it is entirely reasonable.

The hon. Gentleman's arguments have not convinced me. The purpose of certain arrangements is to avoid tax. The purpose of schedule 22 is to block such opportunities. People take advice when they enter the schemes. They know full well what they are doing and that there will be consequences if any Government of the day move to ensure that the tax system operates properly. I believe that the hon. Gentleman, were he ever in the position of a Treasury Minister faced with such prospects, would make exactly the same decisions as I have, because it is the fair way to proceed.

John McWilliam (Labour, Blaydon)

Before I call the hon. Gentleman. I hope that the Committee does not think that I am feeling very lax this morning, but the Paymaster General's use of ''you'' in that context is entirely consistent with the fact that, unfortunately, Chairmen of Finance Bills are also covered by the legislation with which we are dealing.

Howard Flight (Conservative, Arundel and South Downs)

The Paymaster General thinks she is being very clever by finding a route to make measures retrospective that are technically only retroactive. I have a long letter from leading counsel and as a result I have written to the Joint Committee on Human Rights about clause 84 and schedule 15. It has been a long-established practice of this House not to enact retrospective legislation. There is a very subtle difference that the Paymaster General ignores between dealing with changing the rules on tax going forward and finding a method of retrospectively impacting on an individual.

If all the Paymaster General's moral preaching is correct, I very much hope that the Government will pass legislation as a result of which the £1 million saved by the Labour party on a clever bit of VAT

avoidance, to which I have referred twice, will be made retrospective. Oh no, we have not had that; we have not had a dickie bird about that. Of course, all bodies, including the Labour party and lots of its Members of Parliament perform the tax planning that is available to them within the law; it is only human nature. I strongly object to the tone of the Paymaster General's comments.

The Government's measures are contrary to British traditions, and we will see what the Joint Committee has to say about the presentation of what is retrospective as retroactive. It is a clever way round the established rules on the difference between retrospection and retroaction.

Government and Opposition Members agree on what the mischief is, we support prevention and accept that there has been an exploitation of the interaction of IHT and CGT. The disagreements are twofold: first, we disagree on the retrospective nature; and secondly, as I said earlier, we are concerned that bona fides situations will end up liable to tax charges.

Neither of our amendments is worth putting to the vote, but we cannot support the schedule for the reasons that I have outlined.

Rob Marris (Labour, Wolverhampton South West)

I put it to the hon. Gentleman that his analogies are misplaced, particularly in terms of Labour party purchasing, VAT and so on. Certain people have ordered their tax affairs in a certain way. It is like betting on a greyhound race: they put their money on Running Whip in a six-dog race, halfway through the race the dog gets disqualified, and with the hon. Gentleman's approach, they want to go back and place a bet on one of the other five dogs.

The hon. Gentleman made his cheap political shots about VAT and the Labour party headquarters, but the distinction is that the greyhound race is over. It is a done deal—it is not somebody trying to change things halfway through. The tax affairs are finished. It is in contradistinction to the situation that he seems to want, in which people order their tax affairs in a certain way hoping that the tax regime will remain unchanged and that—to use my analogy—their dog will come home and win. That is not the case, because the dog was disqualified. People cannot return to the beginning, status quo ante, and put a bet on another dog.

Similarly, when the Government lowered the rate of income tax—both the basic rate and the standard rate—that was a change in the tax regime. People in that situation under those Finance Acts had already earned money in that tax year, and I suspect that the hon. Gentleman did not stand up and say, ''That's a change in the tax regime; those individuals earned money when they thought they were going to pay 23 per cent. standard rate tax, now they are going to pay only 22 per cent. That is retrospective and a breach of their human rights. They should still be paying tax at 23 per cent.'' I did not hear him saying that.

Howard Flight (Conservative, Arundel and South Downs)

Without repeating what I have just said, the hon. Gentleman's analogy is not fair.

Mark Prisk (Conservative, Hertford and Stortford)

Not a runner.

Howard Flight (Conservative, Arundel and South Downs)

Perhaps so. To be as clear as possible, there is a subtle difference between when things have been viewed as retrospective from a legal perspective and when they are retroactive. Self-evidently there are all sorts of situations where Governments of all persuasions will change income tax rules and that is obviously an essential flexibility.

There are precedents for legal changes to block tax avoidance schemes going forward rather than taking measures that effectively cast back to when whatever was done was perfectly legal. The Government have deliberately—indeed, the Paymaster General has made a virtue of it and boasted about it—found routes, of which clause 84 and schedule 15 are the greatest example, but this is another, to introduce measures that technically look retroactive, not retrospective, but within the established body of legal thinking are deliberately retrospective in their impact by past or established standards. It is not a question of a dog not coming in; the law was as it was for better or worse and the measures change what the law would have been in the past. I concede that this is a grey and difficult area, even within the territory of what is retrospective and what is retroactive.

This is a dangerous path to walk. An eminent past Labour Member of Parliament phoned me this week to complain, and cited a well-known parliamentary proceeding when the previous Conservative Government were attacked by Labour Members for measures that they viewed as retrospective in their impact. There was a great parliamentary debate and changes were made. The Paymaster General is being dangerously glib and self-righteous. It is a territory that needs constitutional analysis, which is why I have referred to the Joint Committee on Human Rights to see what it has to say.

It is right to block up perceived abuses and mischiefs. The Inland Revenue should be on the ball and block them up as soon as possible, but broadly the established practice is to block them up going forward, and especially where the measures can result in bona fides situations being unfairly caught. That is not a fair way of proceeding. The basis of this country's tradition of taxation is about consent. It is bogus for Governments of either party to stand up and say that it is the will of Parliament, so be damned. Ultimately, taxation relies on the consent of those paying it.

Dawn Primarolo (Labour, Bristol South)

This is an important point about retrospection. The measure applies only to gains arising on or after 10 December 2003. Capital gains tax is an event-based tax. It is normal for capital gains tax changes, whether relieving or charging, to apply to disposals on or after the date when the change in question is announced. Any such changes will naturally affect existing arrangements because those are the ones being used for the avoidance and that would otherwise continue to be used. As the hon. Gentleman rightly identified, Governments of all persuasion seek to block avoidance when they see it.

The proposals also have transitional provisions that preserve any entitlement to private residence relief up to the date when the change came into effect. The use of that date featured in the procedure adopted by the previous Governments, and we are using it now. The conditions for entitlement and relief should take effect from 10 December 2003: the date when the change was announced. The relevant legislation and the explanatory notes were published at the same time as the announcement. Given that the hon. Gentleman has accepted that there is a mischief in this case, to allow avoidance to continue would mean an unnecessary loss to the Exchequer. Publishing the legislation and the explanatory notes makes it absolutely clear how the Government intend the legislation to operate from that date onwards.

That is not just a tried and tested route of this Government—I am not making a virtue of it, despite what the hon. Gentleman says—it is how the previous Conservative Government dealt with anti-avoidance measures, and it is perfectly proper to enact the provisions from the point when they are announced. I have said that we are not going back to undo, or returning to claims that are closed. We are simply saying that from 10 December 2003, the rules will operate and everybody has been told about that.

On that basis, I continue to argue that the measure is not retrospective, unless the hon. Gentleman is going to stand up and say that the previous Conservative Government got it all wrong when they introduced such legislation. He may disagree with the measure, but the Government rebut the accusation that it is retrospective. I am sure that it will continue to need proper scrutiny as we proceed, because it is important an important principle in taxation matters.

Howard Flight (Conservative, Arundel and South Downs)

I will not prolong the point more than I have to. We have no objection to the principle that the next Budget and Finance Bill will change the law effective from a specified date, such as last December, and as the Paymaster General rightly comments, previous Conservative Governments did that. That is not the basis of our objection. She said that the net effect was not to go back and undo. I shall oversimplify, because it is complex territory, but the point is that when past Governments took anti-avoidance measures the net effect was on a going forward basis. The scheme or arrangement was dead from the future. It was not always grandfathered in terms of what the situation had been before, but that was the general principle. As the Paymaster General has commented, in a number of ways this Government have introduced punitive measures, as if to say, ''You naughty people, you undertook this avoidance planning in the past. We are introducing proposals that make sure that you get hit because of measures that were perfectly legal at the time you took them.'' That is why we have concerns. The area is sufficiently grey that there are some aspects that, in an historical sense, have precedent, but some that do not.

I will send the Paymaster General a copy of the letter, because I was impressed by the arguments that

counsel made about why introducing a new basis of taxing things is, in substance, retrospective, even though in law it may be retroactive.

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That this schedule be the Twenty-second schedule to the Bill.

John McWilliam (Labour, Blaydon)

With this it will be convenient to consider new clause 11—Capital gains tax: foster carers and adult placement carers—

'In the Taxation of Chargeable Gains Act 1992, section 224, after subsection (1) insert—

''(1A) Subsection (1) above shall not apply to any part of a dwellinghouse that is used exclusively for the purposes of a trade or business which consists of the provision of:

(a) foster care within the meaning given by paragraph 4 of Schedule 36 to the Finance Act 2003;

(b) accommodation and care to people placed through an adult placement scheme operated by a local authority, an HSS trust or an independent body.'.

Howard Flight (Conservative, Arundel and South Downs)

We have had a sort of stand part debate. New clause 11 is related, but in a different territory. It—

John McWilliam (Labour, Blaydon)

Order. The hon. Gentleman is right, and under normal circumstances, I would have deemed that the stand part debate had taken place. However, new clause 11 is very specific and the points that it raises have not been covered.

Howard Flight (Conservative, Arundel and South Downs)

New clause 11 touches on the issue of where private personal capital gains tax relief should apply, part of which schedule 22 is about. Both the Low Incomes Tax Reform Group and various charitable groups have raised that issue. As we understand it, fosterers of a child or of an adult needing care—individuals who look after such people in their homes—are deemed to be operating a business and are therefore denied capital gains tax private residence relief. That seems to us to be wrong and to be a major deterrent to fostering.

The new clause would remove a capital gains tax liability on a principal private residence in such situations. I hope that the Paymaster General will tell me that that is not, for one reason or another, the case anyway, but as I understand it, it is the case. It seems to me to be morally wrong that people are penalised if they are doing good in the community by fostering children or adults.

Rob Marris (Labour, Wolverhampton South West)

I have considerable sympathy with the new clause, as I understand it. I urge my right hon. Friend the Paymaster General to consider the issue sympathetically, even if the wording is not quite right.

Dawn Primarolo (Labour, Bristol South)

I understand that the Low Incomes Tax Reform Group made representations on new clause 11, but it is incredibly difficult to find circumstances in which a charge would arise. I will explain to the Committee how the system operates and why new clause 11 is not necessary. The hon. Member for Arundel and South Downs and my hon. Friend the Member for Wolverhampton, South-West are, I think, echoing a point that all Committee members would want to make, which is that fostering children and

providing adult care are very important. We would all want to support people engaged in such activities.

The problem comes in the following respect, regardless of whether it is a theoretical point: if those activities amount to a trade or business, the person carrying on that trade or business sets aside part of their only or main residence exclusively for business purposes. If that occurs, the rules for private residence relief should be available in respect of the part of the gain that is their private residence. However, with fostering and adult care, the carer is taking the individual into their own home, and it is difficult to see where liability would arise—although I do not intend to speculate on circumstances, because that is always dangerous.

The hon. Gentleman will understand that I am a little nervous of a blanket clause that says that a residence set aside specifically and only for the purpose of trade or business should still qualify for residence relief. I do not see the problem in the first place—it is not occurring—and I am concerned about putting in a rule that just might provide greater opportunities for other things, let me put it no stronger.

As I have said, foster carers are using their own home and taking in children as if they were part of the family. That often happens with the provision of respite care for adults. In those circumstances, where there is either fostering or a placement of an adult in respite care, it is not the case that all such carers face a capital gains tax charge on the sale of their home, as if they had used it partly for the purpose of providing care and accommodation for the people placed under the scheme. I cannot see a reason for a new provision, and I am nervous of introducing one. It would be inappropriate for private residence relief to be available on the gain for part of a property that has been referred to as a business part of that property.

I am not aware that representations have been made to us that there is an issue here with regard to real cases. Of course, I am not aware of every single case that comes to the Inland Revenue. I am saying to the hon. Gentleman that where the care is being provided in people's own home, and they are therefore not carrying out a business or trade, the residence relief is available. I am struggling to see under which circumstances such care would come under the business or trade categorisation, because then the residence would have to be wholly put aside exclusively and only for that purpose, and it would not be foster care and respite care, which are driven by going into somebody else's home—if I am making myself clear.

The hon. Gentleman, who has made his point and spoken to the new clause, has certainly caused this subject to be scrutinised in preparation for the Committee.

Mark Prisk (Conservative, Hertford and Stortford)

I did not intend to intervene at this point, but I am reminded of a constituency case—it is one I suspect hon. Members will be familiar with—in which an extension was made to a home for the purpose of fostering a significantly disabled child. When that home went on sale, that extension was regarded as an improvement, and therefore there was a

question about tax. Will the Paymaster General clarify that situation?

Dawn Primarolo (Labour, Bristol South)

It is difficult for me to comment on particular cases without having the full details, but the example that the hon. Gentleman has given is similar to the theoretical example that I asked my officials about. A family is foster caring for a child with disabilities and adaptations are necessary, but the home is still a residence and is not exclusively put aside for the purpose of foster care. Would that come under the business or trading rules? The issue would be whether, under the rules, the people concerned were carrying out a trade.

It is difficult. We are venturing into how other tax rules impinge on this area. In those circumstances, I am advised that, where the residence still operates as the family home and the child or adult is taken into that home, residence relief would be available.

It is always dangerous to go down the route of saying, ''What if this happened? What if that happened?'' in a Finance Bill Committee. If the hon. Members for Hertford and Stortford (Mr. Prisk) and for Arundel and South Downs have specific examples of the rules not operating as expected, I will be happy for my officials to look into those individual cases. However, I am not keen to put a general blanket provision into the Bill when I do not think that it is necessary in the first place and am a little nervous that it might be used in ways that none of us intended.

Rob Marris (Labour, Wolverhampton South West)

Accountants used to advise—I think they still do—that a dentist, for example, who had a surgery in her own home should hold a party there at least once a year and invite the tax inspector. That would get round the word ''exclusively'' because it would mean that it could be shown that that room within the residence was not used exclusively for dental purposes. I am told by the Chartered Institute of Taxation that the problem with foster care is that it is difficult for people to say that, once a year, they share the bedroom where the foster child stays. I am grateful to the Paymaster General for saying that she will look into the matter. That is sufficient for me.

Howard Flight (Conservative, Arundel and South Downs)

I can understand why the Paymaster General does not want to change the law if that is not necessary. However, it strikes me that, to the extent that the issue could arise—she will be aware that not just the Chartered Institute of Taxation, but one of the key charities has raised the matter—it is unsatisfactory for the position to be at least potentially grey in an area such as this. Is not an alternative solution for the Revenue to make it clear in guidance that it does not regard fostering a child, or being an adult carer in one's house, as in any way constituting a trade for tax purposes? If that were made clear, it could resolve the problem.

Dawn Primarolo (Labour, Bristol South)

The hon. Gentleman is quite correct about the ways in which the matter could be resolved if there is a problem. However, unless he writes to me with examples, I am unable to ascertain whether somebody has looked at the Bill and said, ''We can see a theoretical possibility'', although no one has actually been caught in that situation, or whether

the matter is, as he said, a little grey for some people and therefore could be clarified in Inland Revenue guidance. As a rule, because Finance Bills are already rather large, I do not include provisions to deal with theoretical possibilities that may not arise—or I try not to.

I hope that the hon. Gentleman, recognising that guidance may be another way to deal with the matter, will send me the details, so that my officials can consider them. I would be happy to reply to him and all members of the Committee if such details should—that is a big should—make clarification and guidance necessary, in which case that simple step could be taken. On that basis, I hope that he will accept that this important subject has been adequately aired, will not press new clause 11 to a vote, but will agree to leave me to find out whether the incidents are theoretical or happening and, if they are happening, what I can do about them.

John McWilliam (Labour, Blaydon)

Order. If the hon. Gentleman presses new clause 11 to a vote, it will be not today but at the end of the Bill.

Howard Flight (Conservative, Arundel and South Downs)

I will be happy not to press new clause 11 to a vote later in our proceedings. I shall write to the Paymaster General, as she suggested. I simply end by saying that the issue is greyness, not whether such incidents are tax challenges. I cannot see any objection in principle to Revenue guidance that makes it clear that fostering and adult caring are not viewed as businesses for tax purposes. I do not believe that anyone ever thought that they should be, and I cannot imagine that any member of this Committee thinks that.

Dawn Primarolo (Labour, Bristol South)

The hon. Gentleman may be aware that the Government consulted on taxation and foster carers and that there were changes in the Finance Bill last year. To my recollection, his point was not made last year—it is completely new, and that is why I am struggling with it. It was not made when we specifically asked all the associations about these issues. That is why I wish to ensure that this is a grey area before we rewrite the guidance.

Question put and agreed to.

Schedule 22 agreed to.

Clause 113 - Authorised unit trusts: treatment of

Howard Flight (Conservative, Arundel and South Downs)

The clause arises because the current definition of an authorised unit trust may not work as intended in respect of umbrella schemes. It is a welcome technical improvement. I should also declare an interest, as the individual who invented the umbrella scheme structure 20 years ago. I am pleased to support the clause.

Question put and agreed to.

Clause 113 ordered to stand part of the Bill.

Clause 114 - Individuals benefited by film relief

Mark Prisk (Conservative, Hertford and Stortford)

I take this opportunity to welcome you to the Chair for our deliberations, Mr. McWilliam. Clause 114 begins chapter 9 of the Bill. Together with clauses 115 to 118, it seeks to tackle tax avoidance schemes whereby individuals try to convert what is, in essence, a tax deferral into a permanent tax gain. That can occur when someone in the film trade, whether alone or in partnership, calculates their taxable profits or losses in line with the sector's two principal tax relief schemes, known as section 42 and section 48.

The recent Culture, Media and Sport Committee report on the British film industry highlighted the fact that those two tax relief schemes have been vital to the UK film sector. After all, it is a business that in any average year is able to export films worth about £700 million. In the five years up to the end of 2003, the industry generated inward investment of about £1.7 billion. It is a very important industry. It is about not simply the quality of films, but the generation of crucial wealth and employment in this country by a British film sector with tremendous skills and talents that are the envy of the world.

The clause, supported by clauses 115 to 118, seeks to impose an income tax charge on an exiting partner. I would like to express the concerns of the industry and its advisers about whether it will achieve its stated purpose.

Rob Marris (Labour, Wolverhampton South West)

Does the hon. Gentleman agree that the tax breaks introduced by the Government in previous years for the film industry—some of them have been abused by the television industry—have resulted in £2 billion of foregone tax revenue, which is a considerable amount?

Mark Prisk (Conservative, Hertford and Stortford)

The hon. Gentleman refers to section 48 of the Finance (No. 2) Act 1997, and he is right to say that there has been significant abuse. Government and Opposition Members support the need for accurate and targeted measures that help. That will form part of the debate as we progress.

I do not deny that there has been persistent tax avoidance in the sector. Rather, I wish to ensure that the clause accurately affects abusive tax avoidance without unduly damaging commercial trade and legitimate business activity. Under clause 119, we will address the issue of film investment and film partnerships, where it seems that the balance is not being achieved.

I wish to raise a couple of concerns about how the changes for exiting partners and exiting individuals will work in practice. The clause seeks to impose a charge on the exiting partner at the point of exit. The Government seek no additional income tax charge in the event that the profits to which the exiting partner would have been entitled continue to be chargeable to UK income tax. Several representations, not least from the Chartered Institute of Taxation, have highlighted various situations in which an exit may be optimal to the individual but does not specifically

aim to remove future profits from a charge to UK income tax.

For example, there is the situation in which one partner dies. We understand that, in film and related industries, the revenue stream from royalties is important. They tend to last for a long period—10 or 15 years. Frequently, a partner involved in that sort of structure dies and, legally speaking, exits the partnership. Arrangements must then be made to handle future incomes from those royalties and the withdrawal of the capital investment. Those arrangements are bona fide and there is no wish or intention to abuse the tax system. Rather, someone is trying to settle an estate. In other circumstances, including those involving withholding tax, it is clear that the reasons for a partner exiting are entirely commercial and legitimate.

The concern with the clause is that there seems to be a genuine risk that the exiting partner could be liable for extra income tax even where their future profits face tax liabilities while in the hands of the remaining partners. Perhaps the Paymaster General can clarify the clause, but there is considerable concern that it could achieve for some people the opposite of its stated purpose.

Referring to the point made by the hon. Member for Wolverhampton, South-West, I have no doubt that unreasonable behaviour and abusive tax avoidance must be tackled. I hope that the Paymaster General recognises that the question is about not the intent of the legislation, but its efficacy.

A number of related issues concern the tax regime for the film industry and film partnerships, but the principal issues in that regard will arise later, particularly under clause 119, and I shall reserve my comments until then, if I catch your eye, Mr. McWilliam.

David Laws (Liberal Democrat, Yeovil)

Good morning, Mr. McWilliam. I have two questions on clause 114, which apply equally to clauses 115 to 118. The first question is straightforward and the second covers a wider issue that touches on the Government's intent.

First, can the Paymaster General clarify the individual revenue yield from clause 114? I am not sure whether that information has already been published. I may have missed it, but when I tried to find it in the Red Book and elsewhere I was unable to do so, so I should be grateful if the Paymaster General indicated what the expected revenue yield is from clause 114 and, if the figures are available, from clauses 115 to 118.

The second issue touches on the Government's intention in clauses 114 and 118, which is to tackle some of the tax avoidance associated with the film industry tax relief over the past five or six years. The hon. Member for Hertford and Stortford raised some concerns about that and the film industry has lobbied on the Government's measures and their impact on jobs and revenue in the industry.

I want to make a slightly different point. We are always lobbied effectively by the groups that are

directly affected by the measures in the Finance Bill each year and perhaps we do not always think of the general taxpayer and their interests in our debates. My concern is not so much about whether the Government's action in trying to deal with tax avoidance is going too far, but about whether it does not go far enough and whether it would not be better to replace clauses 114 to 118 with measures to abolish the reliefs. The hon. Gentleman touched on some of the tax-avoidance problems relating to film industry tax relief during the past few years. It may be helpful to remind ourselves of what has happened in relation to film industry reliefs and the avoidance issues that we are discussing and debating today.

After the Government introduced the latest film industry reliefs in the July 1997 Budget soon after the Labour party came to power, the estimated cost of the film industry reliefs was modest: £5 million in 1998–99 and £15 million in 1999–2000. There was a further upward revision of the figures in the 2001 Budget when film industry reliefs were extended and the cost estimate was increased by £50 million for 2003–04. That was pretty small beer—tens of millions of pounds—for the cost of those reliefs.

The figures now for the cost of film industry tax relief since 2001 are not £10 million, £20 million, £25 million or £50 million, as we were led to believe, but £440 million in 2001–02, £300 million in 2002–03 and £300 million in 2003–04 to 2005–06. If the Government have got their figures right—it remains to be seen whether they have got them right for the whole Parliament, because that has not been the experience so far—they will spend £1 billion on that tax relief during the current Parliament if it runs its full term, however unlikely that may be. That compares with around £1.25 billion for the whole of the child trust fund during a similar period. In other words, the Government have provided a £1 billion subsidy for the film industry compared with £1.25 billion for all the trust fund accounts for children during one Parliament.

We are entitled to ask the Paymaster General what returns we have had from that £1 billion, what estimates the Treasury have made of the increase in the activity and profitability of the British film industry over that period, and how many new jobs have been provided as a consequence of the expenditure of £1 billion of tax relief. We also ask whether clause 114 and—if you will allow me to mention them, Mr. McWilliam—clauses 115 to 118 go far enough, or whether we should consider a more draconian change. Instead of making the tax system even more complicated by bringing in anti-avoidance measures to deal with earlier problems, should we get rid of that tax relief altogether?

I have no doubt that the Paymaster General will say that, although I am making some legitimate points about the explosion in the cost of the tax relief in 2001–02 and 2002–03, that explosion was a consequence of avoidance issues that have been dealt with, not least, as the hon. Member for Hertford and Stortford mentioned, the classification of many well known television programmes as films, which allowed an explosion of tax relief in 2001–02 and 2002–03. The

Paymaster General will no doubt say that she dealt with those problems and that that abuse is not open.

The question remains, however, whether there has been any economic analysis of the benefits of the tax relief that is provided at great cost to the taxpayer and how many jobs are created as a consequence of that relief. The Treasury has been unable, to date, to answer that question. The question that I ask the Paymaster General to answer is: what would be the effect of not introducing clauses 114 to 118 but abolishing the film industry tax reliefs altogether and, as a consequence, saving the money for the general taxpayer? What is the Government's estimate of the effect that such a change would have on the film industry? What would be the reduction in jobs?

We are here to represent the interests and concerns of the people on whom the Finance Bill has a direct impact. Perhaps, as a consequence, we do not always take into account the interests of taxpayers in the wider public. I think that most taxpayers would be horrified to know that they spent £1 billion over the period of this Parliament in subsidising one industry in a way that may not have brought many additional jobs.

Dawn Primarolo (Labour, Bristol South)

I turn first to the general points about section 48 relief, as we are dealing with those issues. Section 48 was intended to pump prime the production of low-budget British films, leading to more success, to more recycled profits and, eventually, to structural change. It has produced about 50 films a year that otherwise would not have been made. I am sure that we are all great fans of the commercial successes, which include ''Billy Elliot'' and ''Bend It Like Beckham''.

In its investigation, the Select Committee on Culture, Media and Sport found that the tax reliefs have been vital in securing inward investment to the United Kingdom and maintaining a critical mass of indigenous film making. I will return to the period from 1997 but, in 2003 alone, the reliefs secured a record year for productions in the United Kingdom, with £1.17 billion of production expenditure and secure British involvement in 177 films. Section 48 relief has ensured the production of a number of low-budget British films. That is to be applauded and is precisely the issue that the Government wanted to tackle.

Even the industry accepts that the other aim, which was for the creation of the critical mass to lead to structural changes in the industry, particularly on the distribution side, has not been achieved. Some of the discussion about the new tax credit focuses on that principle. The industry accepts that section 48 has run its course and it is working with the Department for Culture, Media and Sport and with the Treasury to consider the replacement tax credit and the issues that need to be addressed. Since 1997, the British film industry has benefited from record investment. The latest estimates from the industry are that more than £6 billion has been invested under sections 42 and 48 reliefs. That level of investment continues. If the hon. Member for Yeovil (Mr. Laws) examines the detailed

study that the Select Committee has carried out on the industry as a whole, he will see that the reliefs are crucial in helping that pump-priming and ensuring that such investment continues to come into the UK.

Clauses 114 to 118—I have left out clause 119 because the hon. Member for Hertford and Stortford wants to discuss that specifically—counter an abuse of the reliefs. I want to explain why that is important. I know of the hon. Member for Yeovil's long-held opposition to the film reliefs, but the Government are committed to the success of the film industry. We are of the view that we should continue to invest in the prize of huge inward investment in the British film industry, assistance to indigenous film making and the creation of that critical mass.

David Laws (Liberal Democrat, Yeovil)

I am somewhat disturbed that, as evidence of the value of the tax relief, the Paymaster General seems to be relying on a Select Committee rather than work by the Treasury, with the accompanying scepticism that one would expect of the Treasury when it approaches such issues. Given that the taxpayer has spent £1 billion on the relief, will she undertake to have the Treasury conduct a proper study of the costs and benefits of the relief and publish the results of that study?

Dawn Primarolo (Labour, Bristol South)

It is not the habit of the Treasury to duplicate work undertaken by Select Committees, or to undermine or to question the excellent work that they undertake. If the hon. Gentleman has not read the Select Committee report, I commend it to him and its answers to the questions. I am sure that he is not suggesting that we should waste resources by conducting another investigation, only to reach the same conclusion. I have told him of the Government's conclusion. I know that he will disagree with that, but that is the view of the Government on investment in the British film industry.

Regrettably—I said this when we discussed the matter before—those who seek to tax plan and to gain advantage from the tax system go across the whole of the tax system. It is not just a matter of whether that occurs in the film industry. The hon. Gentleman will know from previous discussions on Finance Bills that I have sent the clear message, as I continue to do, to those who use the tax system in ways that are not intended that the Government will deal with that, should it be necessary.

The current relief works by giving individuals an upfront tax repayment in respect of trading losses claimed against their general income. As income arises from the films in later years, the individuals pay tax on the profits. The overall result is a form of tax deferral that gives an incentive to invest. We do that at different points in the tax system. That arrangement has been the traditional, accepted way of assessing the film tax relief.

The avoidance schemes, as is often the case, involve complex arrangements that enable individuals who have benefited from upfront relief to dispose of the income stream on which they would have had to pay tax. Such arrangements allow them to get back the capital that they invested. That leaves them with an

outright tax gain, which is not the purpose of the provisions and is not acceptable. The clause raises a tax charge where there has been such a disposal on the amount they got back, so as to ensure that the deferred tax liability is paid, and that a fair balance is struck and maintained between industry, investor and Exchequer.

The film industry agrees that the schemes concerned are unacceptable, and many representative bodies have welcomed the action we are taking. This clause, along with clauses 115 to 118, will ensure that the deferred tax, which is in excess of £2 billion, is recovered over the next 15 years.

I have heard arguments, so it is as well to put them on the record, that some of the schemes-, mainly the film schemes, are acceptable because the partnership might earn taxable income in year two onwards. That is highly questionable and the operators admit as much because, as an intrinsic part of the scheme, they value the future income as next to nothing at the end of year one. In any event, future taxable income does nothing to reverse the unfairness of the way the scheme is funded. The fact that a wealthy individual can make a significant return if a project is successful makes it even more objectionable that they should have the entire upfront gain.

I shall explain what is supposed to happen from the Exchequer's perspective. The Exchequer has given up tax relief upfront, which is the equivalent of 40 per cent. of the film's budget. If the film generates no income at all, that remains the position. Under the official reliefs under sale and leaseback structures, the tax on the rental income, which is what is cut out of the equation, ensures that four fifths of the initial relief is clawed back over the terms of the lease. That is what is cut out to protect the upfront gain, and the rest does not arise. To counter that, where individuals leave the scheme, we have put in place a charge that ensures the gain comes into the tax charge.

The hon. member for Hertford and Stortford raised the question of what happens if a person who has invested unfortunately dies. The charge will not arise after a person has died, unless that person has exited with a tax advantage before their death. The exit charge only applies to individuals who have claimed loss relief. If an individual dies, any capital withdrawn or contribution received after their death will be made or received by someone else, either their personal representatives or their beneficiaries, and they cannot therefore be subject to the exit charge.

The hon. Gentleman raised the question of an individual transferring future rights to profit to another individual. It is perfectly normal for some people to move to a different country and become a non-resident of the UK, and any person who does will be taxed as a non-resident on UK-sourced income, subject of course to the extensive network tax treaties. That can affect anyone who still carries on any business in the UK, and there is no reason to make a special exemption for people with a business interest in the film industry, because that would clearly be unfair and against the spirit of the obligations under the treaties. In circumstances where future rights to

profit are transferred to another partner or moved abroad, that is the current position.

The hon. Member for Yeovil asked what the yield was. He did not find it in the Red Book because it is protection of revenue of £85 million, we estimate, over the next three years—protection measures cannot be scored in the same way as the generation of income. It is part of the scheme that we are running to stop gains moving outside the tax net.

The hon. Gentleman asked whether film relief was just an invitation to avoid tax. That is a crude summary—he put it rather more tactfully in saying that he was not convinced by the reliefs. As I said to him, the Government's view is that the reliefs provide an incentive for people to invest in the film industry and there is a huge gain from that in terms of production of British films and the growth of an indigenous film industry to create the critical mass. It was always envisaged that film makers would access the main tax reliefs through sale and leaseback or similar tax deferral schemes.

In practice, those schemes allow investors to spread payment of part of their normal tax liability over a period of their exploitation of a film—the income coming in—in return for making an investment in that film, which goes to the film maker. The benefit to the investor is akin to an interest-free loan; it is an incentive to invest in British industry. Individuals who seek to exit tax free are effectively not playing the game, of which the rules are clear. It is reneging on the balance that has been struck. I am trying to put it delicately, having been chastised earlier today by the hon. Member for Arundel and South Downs.

The rules are there to operate in a particular way. If people seek to frustrate them, the Government will attempt to return to the legislation so that it is used in the way it should be used. Some people seek to use the investment incentive to create gain. The Government are interested in ensuring that people who are committed to the film industry and are prepared to invest in it over time are provided for within the tax system in the same way as in other parts of the tax system.

The hon. Gentleman referred to the new relief. The Inland Revenue and Treasury are discussing the details with the industry. We hope to publish full details in the summer. In brief, we are trying to ensure that the film maker will be able to claim a deduction for production expenditure that can either be offset against taxable income or surrendered to the Treasury, so it will be a tax credit. We are still looking in detail at the way in which the relief will work and its distribution through the film industry to try to direct it specifically at the area that the current relief is directed to and to take the opportunity to recheck, as the hon. Gentleman suggests we should, that the relief works as we intended. We will do everything that we can to ensure that it does.

However, it is impossible in these circumstances to ensure that all the policy points are met. The structure of the industry and distribution in particular are still of concern to the industry, DCMS and ourselves. We still

have not come to a conclusion over whether tax is appropriate there.

The Government remain committed to investment in the British film industry and to providing these reliefs. However, as with any other relief in the tax system, if they are used in ways that were not intended and people are making tax-free gains that were not intended, we will make arrangements to prevent that from happening. Clauses 114 to 119 and other clauses that we will discuss later deal with precisely that.

The film industry has welcomed the move. It recognises that, to have a sustainable and long-term future, it has to have reliefs that operate in the way that was intended and that do not make the industry a target of planning schemes that bring no extra money into films but result in a loss to the Exchequer, which is unacceptable to everyone.

Question put and agreed to.

Clause 114 ordered to stand part of the Bill.

Clause 115 - ''Disposal of a right of the individual to

Mark Prisk (Conservative, Hertford and Stortford)

Clause 115 defines how the previous clause operates in respect of disposals of the right of an individual to profits arising from the trade. Clause 114 considers the broader aspects of the provision, but I would like to focus on the specifics of disposal, particularly defaults. A default in the payment of income is included as a disposal, which is considered to be one of the three triggers for a tax charge. A default in the payment of income could occur for several reasons. For example, the payer could become insolvent, or a default may result after a genuine commercial dispute. It seems unreasonable that a tax charge might be triggered in such circumstances.

If a payer becomes insolvent, there are several instances in which their obligations are guaranteed or underwritten, as I mentioned earlier. In such circumstances, it would be helpful to know whether a disposal would be deemed to have occurred. I hope that the Paymaster General will at least be able to clarify the intent underlying the clause.

Dawn Primarolo (Labour, Bristol South)

Perhaps I could deal with the issues around default. To face an exit charge, a person must not only have lost their right to income but have obtained a tax advantage by receiving a non-taxable benefit. If there is a genuine commercial failure, a creditor will not receive non-taxable benefits that make them better off than they would have been without the failure. If we do not have that condition in place, it would be easy to avoid the exit charge. There are two points to consider: whether the payer artificially disposes of their assets and defaults on payments, and whether the film investor's loan liabilities are written off.

We are seeking to achieve a delicate balance, as was touched on by the hon. Gentleman and some of the

representations. The trigger is the two things together—the untaxable gain and the exit—but if there has been a genuine commercial failure, the other rules already operate, and we expect that to remain the case. However, we must be mindful that some may seek to create a failure in order to get out of the exit charge. We must prevent that. It is not without precedent in the tax system that insolvency has been a way of trying to escape tax charges.

Question put and agreed to.

Clause 115 ordered to stand part of the Bill.

Clauses 116 to 118 ordered to stand part of the Bill.

Clause 119 - Restriction of relief: non-active partners

Mark Prisk (Conservative, Hertford and Stortford)

I beg to move amendment No. 183, in

clause 119, page 99, line 30, leave out

'or a member of a limited liability partnership'.

John McWilliam (Labour, Blaydon)

With this it will be convenient to discuss amendment No. 182, in

clause 119, page 100, line 11, leave out subsections (7) and (8) and insert—

'(7) In subsection (1) ''a trade'' does not include—

(a) underwriting business within the meaning of section 184 of the Finance Act 1993 (Lloyd's underwriters), or

(b) a trade where the Board have, on the application of a partnership of which an individual is a general partner or member of a limited liability partnership, notified the partnership that the Board is satisfied that the trade will be effected for bona fide commercial reasons and will not form part of any scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability of tax.

(8) Any application under subsection (7)(b) above shall be in writing and shall contain particulars of the operations that are to be effected and the Board may, within 30 days of the receipt of the application or of any further particulars previously required under this subsection, by notice require the applicant to furnish further particulars for the purpose of enabling the Board to make their decision; and if any such notice is not complied with within 30 days or such longer period as the Board may allow, the Board need not proceed further on the application.

(9) The Board shall notify their decision to the applicant within 30 days of receiving the application or, if they give a notice under subsection (8) above, within 30 days of the notice being complied with.

(10) If the Board notify the applicant that they are not satisfied as mentioned in subsection (7)(b) above or do not notify their decision to the applicant within the time required by subsection (9) above, the applicant may within 30 days of the notification or of that time require the Board to transmit the application, together with any notice given and further particulars furnished under subsection (8) above, to the Special Commissioners; and in that event any notification by the Special Commissioners shall have effect for the purposes of subsection (7)(b) above as if it were a notification by the Board.

(11) If any particulars, furnished under this section do not fully and accurately disclose all facts and considerations material for the decision of the Board or the Special Commissioners, any resulting notification that the Board or Commissioners are satisfied as mentioned in subsection (7)(b) above shall be void.

(12) This section has effect subject to sections 118ZJ and 118ZK (transitional provision).

118ZEA Application to particular trades

(1) Section 118ZE(7)(b) shall not apply to any trade unless—

(a) It can be shown that in respect of any period where a loss was sustained, the trade was carried on throughout that period on a commercial basis and in such a way that profits in the trade could reasonably be expected to be realised in that period or within a reasonable time thereafter;

(b) The profits of the trade are taxed on the general partners or members of a limited liability partnership who claimed the reliefs referred to in subsection 118ZE(1) in the same proportions that the partnership's loss was claimed.

(c) The partnership's expenditure is not applied, directly or indirectly, to provide security for repayment of any borrowings of the partnership or of any of its general partners or members of a limited liability partnership, including without limitation, by means of a cash deposit;

(d) The receipts from the trade are entirely contingent on the performance of the products or services comprising the trade; and

(e) The trade is carried on for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability of tax.

(2) The Board may make regulations with respect to the application of section 118ZEA(1) above to particular trades.'.

Mark Prisk (Conservative, Hertford and Stortford)

Amendment No. 183 seeks to amend new section 118ZE of the Taxes Act 1988 in clause 119, so that it does not apply to members of limited liability partnerships. New section 118ZE introduces a new provision restricting interest relief on borrowings to fund a partnership and sideways loss relief for general partners and members of limited liability partnerships who carry on trade where the partners may devote only a small amount of their time to that trade.

There is provision for repeal in section 118ZB, which restricts that relief, but it is provided without any time requirement. New section 118ZE(3) creates a potential duplication, namely what I would describe as a parallel restriction for people in different circumstances. The purpose of amendment No. 183 is to probe the Government's reasoning, not least because new section 118ZE seems to lack any provision for repeal. I hope that the Paymaster General will address that particular point.

Amendment No. 182 makes a more substantial point. Clause 119 aims to restrict tax relief for non-active partners in limited liability partnerships. The purpose of the amendment is to allow commercial trade to continue subject to prior Inland Revenue approval. The Committee will recall the Paymaster General's decision on 10 February suddenly to change the rules on tax relief for partnership losses. There was quite a furore at the time. I think it is accurate to say that the action was precipitate and that it may well affect current projects. However, the most significant effect is the message that it sends.

The Paymaster General will say that her actions signal that the Government are no longer prepared to tolerate persistent and abusive tax avoidance. There is a strong element of truth in that and I fully understand it. However, there is an important balancing question to answer. Those investing from abroad, especially many of the major legitimate players, have been very concerned. They seek certainty and not sudden change. In previous debates on the clauses, she has rightly referred to the evidence and considerations of the matter by the Select Committee on Culture, Media

and Sport. What shines out from its report is that certainty is crucial in the tax regime treatment of the film industry, so there is a risk that 10 February has undermined that long-term confidence.

Amendment No. 182 seeks to provide certainty and to distinguish tax-avoidance-led trading and legitimate commercial trades. In addition, new section 118ZE already contains a carve-out for underwriting businesses. Therefore, it would seem legislatively logical for the amendment to provide a further carve-out by extending the scope of new section 118ZE(7).

The amendment would exempt commercial trades and make them subject to pre-approval by the Revenue based on a well established tax law test, namely, that the trade must be effected for bona fide commercial reasons. The benefit would be twofold: first, there would be considerable improvement in the certainty for the prospective investing partner; secondly, it would create an opportunity for the Government and the Revenue to protect tax revenues.

The amendment seeks to distinguish between commercial trades and tax-avoidance structures using several simple measures, including striving for profit, or the fact that tax on profit should be treated in the same way as tax on losses, or that profit should depend on performance.

The amendment seeks to enable the Revenue to make sector-specific regulations if it deems it necessary. That might allow the Government, if they feel that it is required, to change the definition of a British film in due course. There has been a recent change in that field and the amendment would allow the Government that flexibility.

I know that it is not the aim of the Paymaster General to hit genuine enterprises and investors. Indeed, that was made quite clear in the statement on 10 February. The Inland Revenue notice that was sent out to the press states:

''The new rules will apply to trades carried on in partnership, and will only affect partners who did not spend a significant amount of time working in the trade when the losses arose. The changes will not therefore affect genuine traders who actively run their own trade.''

Unfortunately, clause 119 may well restrain commercial trades. That is the view of several tax experts and a number of leading players in the field, such as Grosvenor Park and Ingenious Media plc, which has invested something like £120 million in the sector. The Paymaster General earlier referred to a number of films. One example is ''Girl with a Pearl Earring'', a film that has been much acclaimed—at least by the female population, given the presence of Mr. Colin Firth. That aside, it is nevertheless an important long-term investment.

Mr. Stephen Pound (Ealing, North) (Lab) rose—

Mark Prisk (Conservative, Hertford and Stortford)

I give way to the hon. Member for Ealing Comedy.

Steve Pound (Labour, Ealing North)

This has absolutely nothing to do with the subject under discussion, but in the interests of parity and equality we should mention Scarlett Johansson.

Mark Prisk (Conservative, Hertford and Stortford)

I am grateful to the hon. Gentleman, and I have no doubt that he will be making his usual erudite and unique contribution to the Committee's proceedings in due course.

I have mentioned a number of organisations. One example is, as I said, Ingenious Media, which operates a structure called Inside Track, which invests 33 per cent. of the film's budget and draws about 50 per cent. of the film's receipt by way of cash. It operates on a portfolio basis, or, as the industry describes it, a slate basis. That reflects the commercial reality, which the Paymaster General herself highlighted, that most UK domestic films do not make a profit, and that there therefore needs to be the ability to look at the portfolio as a whole. That form of investment is vital to the industry.

I am sorry that the hon. Member for Yeovil is not able to debate whether tax relief for the film industry is a good thing, but no doubt the Liberal Democrats will sort out their policy and decide whether they are in favour or not.

Steve Pound (Labour, Ealing North)

Possibly both.

Mark Prisk (Conservative, Hertford and Stortford)

Indeed, I suspect that they may be both simultaneously.

The crucial point is that, helpful as tax relief is, without the actual upfront investment, many films

would not even begin production. I am aware that the Paymaster General has received a number of representations from hon. Members from both sides of the House, be it from the chair of the all-party group on the film industry or senior members of the Culture, Media and Sport Committee. There is genuine concern across the House that the clause may be defective.

In short, ensuring that anti-tax avoidance measures do not ensnare legitimate operations is not only crucial to those affected but pretty important to the industry as a whole. That is at the heart of our concern. The aim of the amendment is clearly to distinguish between tax avoidance and genuine commercial trades. The amendment could well achieve that, while enabling the Revenue to take the reasonable steps it needs, in due course, to protect tax revenue. The approach is balanced and I hope that it will merit serious consideration by the Paymaster General. I fully accept that it is not a perfect amendment, but its purpose is certainly clear. On that basis, I look forward to listening to her response.

It being twenty-five minutes past Eleven o'clock, The Chairman adjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Two o'clock.

Standing Committee A

(except clauses 4, 5, 20, 28, 57 to 77, 86, 111 and 282 to 289, and schedules 1, 3, 11, 12, 21 and 37 to 39) - Clause 119 - Restriction of relief: non-active partners

John McWilliam (Labour, Blaydon)

I remind the Committee that with this we are taking amendment No. 182, in

clause 119, page 100, line 11, leave out subsections (7) and (8) and insert—

'(7) In subsection (1) ''a trade'' does not include—

(a) underwriting business within the meaning of section 184 of the Finance Act 1993 (Lloyd's underwriters), or

(b) a trade where the Board have, on the application of a partnership of which an individual is a general partner or member of a limited liability partnership, notified the partnership that the Board is satisfied that the trade will be effected for bona fide commercial reasons and will not form part of any scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability of tax.

(8) Any application under subsection (7)(b) above shall be in writing and shall contain particulars of the operations that are to be effected and the Board may, within 30 days of the receipt of the application or of any further particulars previously required under this subsection, by notice require the applicant to furnish further particulars for the purpose of enabling the Board to make their decision; and if any such notice is not complied with within 30 days or such longer period as the Board may allow, the Board need not proceed further on the application.

(9) The Board shall notify their decision to the applicant within 30 days of receiving the application or, if they give a notice under subsection (8) above, within 30 days of the notice being complied with.

(10) If the Board notify the applicant that they are not satisfied as mentioned in subsection (7)(b) above or do not notify their decision to the applicant within the time required by subsection (9) above, the applicant may within 30 days of the notification or of that time require the Board to transmit the application, together with any notice given and further particulars furnished under subsection (8) above, to the Special Commissioners; and in that event any notification by the Special Commissioners shall have effect for the purposes of subsection (7)(b) above as if it were a notification by the Board.

(11) If any particulars, furnished under this section do not fully and accurately disclose all facts and considerations material for the decision of the Board or the Special Commissioners, any resulting notification that the Board or Commissioners are satisfied as mentioned in subsection (7)(b) above shall be void.

(12) This section has effect subject to sections 118ZJ and 118ZK (transitional provision).

118ZEA Application to particular trades

(1) Section 118ZE(7)(b) shall not apply to any trade unless—

(a) It can be shown that in respect of any period where a loss was sustained, the trade was carried on throughout that period on a commercial basis and in such a way that profits in the trade

could reasonably be expected to be realised in that period or within a reasonable time thereafter;

(b) The profits of the trade are taxed on the general partners or members of a limited liability partnership who claimed the reliefs referred to in subsection 118ZE(1) in the same proportions that the partnership's loss was claimed.

(c) The partnership's expenditure is not applied, directly or indirectly, to provide security for repayment of any borrowings of the partnership or of any of its general partners or members of a limited liability partnership, including without limitation, by means of a cash deposit;

(d) The receipts from the trade are entirely contingent on the performance of the products or services comprising the trade; and

(e) The trade is carried on for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability of tax.

(2) The Board may make regulations with respect to the application of section 118ZEA(1) above to particular trades.'.

Ruth Kelly (Labour, Bolton West)

I am delighted to see you in the Chair again this afternoon, Mr. McWilliam, because I rise with a little trepidation, as the Treasury's resident tax expert, the Paymaster General, is undergoing an emergency dental procedure. Nevertheless, I am delighted to be able to address the subject of film tax relief, and in particular the amendments tabled by the hon. Member for Hertford and Stortford (Mr. Prisk). I believe that the amendments would seriously undermine the effect of the legislation and open the door to continued avoidance on a wide scale.

Clause 119 tackles tax avoidance and deals with schemes that offer a risk-free tax gain to wealthy individuals acting in partnership through misuse of loss relief intended to benefit people who risk their capital trying to make a living from a trade. The abuse consists of the misuse of sideways trading loss relief so that wealthy individuals receive tax relief that is greater than their financial contribution to the partnership. It follows that the partnership must be trading if there is to be a trading loss on which the scheme depends. I would argue that to exclude partnerships from the provision simply on the basis that they were trading would miss the abuse entirely. I want to make it absolutely clear that the clause does not enforce a specific commercial structure on partnerships. It simply restricts the way in which losses can be used for tax purposes.

The schemes that the clause targets effectively allow a business to transfer the benefit of its trading losses to a partnership of individuals by allocating more losses to the individuals than the amount they put into the partnership. The individuals can then cash in the loss by setting it against their general income and gains. Because they claim 100 per cent. of the losses, the wealthy individuals get back 40 per cent. as a tax rebate. That is more than the 25 to 35 per cent. that they typically put in, so they receive an immediate cash gain at the expense of the Exchequer.

The partners using the scheme have not, in effect, invested any of their own money: their investment was funded by the honest taxpaying public. In practice, the individuals are guaranteed to make a tax-free gain, even if the trade generates no income whatever, as the tax relief is greater than the amount they have put in,

and they have a chance of increasing their gain if the trade generates future income. They are on a one-way bet, underwritten by the Exchequer.

Mark Prisk (Conservative, Hertford and Stortford)

Does the Financial Secretary accept that, as was inferred from the Paymaster General during our previous debate, the clause as drafted casts the net wider than simply the illegal activity to which she has rightly referred, and which it is right to block in the clause? Does she accept that the danger is that, contrary to what was said previously, the provision will affect legitimate commercial trades, even if only a small number?

Ruth Kelly (Labour, Bolton West)

This turns on the point of certainty, which the hon. Gentleman talked about this morning. The new rules ensure that individuals cannot claim more loss relief against their general income than they have put into the partnership. To claim the rest of the loss, they must either stay in the trade and claim it against future profits or make a further contribution. The changes apply only to someone who is not active in running the trade and only to losses in the first four years that the trade carries on. They have no effect on someone who actively starts up and runs their own business.

I do not accept the hon. Gentleman's point. The legislation as drafted carries an objective test and people will know where they stand.

Mark Prisk (Conservative, Hertford and Stortford)

What future, then, would business angels have in this environment?

Ruth Kelly (Labour, Bolton West)

Well, business angels, just like any other investor through a partnership model, will know exactly where they stand. An objective test is applied, and they know under what circumstances they can claim options against future profits, and indeed they understand exactly how the contributions are treated, both in the initial year and in future years.

Mark Prisk (Conservative, Hertford and Stortford)

I am not entirely sure that that is clear, because many business angels do not take an ''active role'' as defined in this clause. Can the Financial Secretary clarify what that means, and what that will therefore mean to business angels, whether in film or, frankly, in any other partnership?

Ruth Kelly (Labour, Bolton West)

This is a narrowly drawn definition, for the reasons that I have set out already. Turning to business angels, one has to ask the question: why should they attain more relief than they have invested through a partnership in the film industry? It is a fairly common-sense proposition that relief should be constrained in the way that the new rules set out.

On amendment No. 182, an important part of the new rules is the change for limited liability partnerships. Under the current rules, as the hon. Gentleman pointed out this morning, a member of a limited liability partnership can base their claim to loss relief on the amount of their liability in a winding up. However, this liability can be no more than notional, and has been exploited aggressively to allow individuals to claim far more in loss relief than they have actually contributed. That is why we are changing the rules, so that only the actual amounts

contributed, either in the course of the trade or during a winding up, can rank as contributions for deciding the amount of loss relief against general income. However, we are making those changes only for people who are not actively engaged in the trade of a limited liability partnership, which draws a clear line between people who are actively running their own businesses and people who use these vehicles as schemes to claim large amounts of tax relief when they have no active role in the trade.

I can confirm that the existing provision under section 118ZC, which the hon. Gentleman raised this morning, has not been repealed, because this provision is still required to apply to partners who are not affected by the new rules—for example, active partners. If amendment No. 183 were accepted, it would mean that all members of limited liability partnerships could carry on as if nothing had changed, which would completely undermine the effect of this measure.

I also ask the Committee to reject the amendment No. 182, on two grounds. First, there is the question of certainty. I can confirm that it would create uncertainty over how and when the legislation will apply. The new rules that we have introduced are simple and objective, as I have already set out. If you are not an active trader, you can claim losses against general income only up to the amount of your contribution. It is easy to apply, and easy to understand. The amendment would introduce a whole layer of subjective tests that would make the position uncertain, as well as being a burdensome administrative procedure.

Secondly, the amendment is founded on a completely flawed view of profits and commerciality. These schemes involve creating a very large loss in year one by selling a film, say, with the right to future income, and estimating that future income at a fraction of the production cost.

Steve Pound (Labour, Ealing North)

Very briefly, those of us whose previous experience of these fiscal manoeuvres has been limited to watching ''The Producers'', the Mel Brooks film with Zero Mostel, which seems to have something in common with this situation, have been listening with great interest. I am becoming more inclined by the minute to support the Government on this. However, I have received a number of letters from constituents on the fashionable left bank area of Ealing, North—the left bank of the River Brent, of course—who are involved in film production and fear that the clause impacts on future plans and commitments that they have made over the next months. Will my hon. Friend give me an assurance that that will not be the case?

John McWilliam (Labour, Blaydon)

It will not be in order for members of the Committee to burst out singing ''Springtime for Hitler''.

Ruth Kelly (Labour, Bolton West)

I am delighted that my hon. Friend is inclined to support the Government's position. It is always reassuring to hear the value of an argument. I will continue to explain how contrived the actual schemes are, to illustrate the point that people who

entered into these artificial arrangements knew that they were in danger of being stopped.

The loss in year one is allocated to individuals in the partnership who use sideways tax relief so that they are guaranteed a return—gaining more from tax relief than their original capital contribution—even if the partnership earns no taxable income at all. That is not a genuinely commercial arrangement. It is an abuse of sideways tax relief, and the clause prevents that abuse fairly and objectively. In contrast, the authors of the amendment appear to believe that a scheme is commercial if it is set up with a prospect of the partnership receiving taxable profits from year two onwards, even if the profits are estimated to be a fraction of the loss in year one. That is not the Government's idea of a genuinely commercial arrangement. The amendment would mean that the prospect of even a few pounds of profit in later years would remove the restrictions on the initial loss claim.

We are determined to tackle tax avoidance. The Government have been extremely generous in supporting the film industry with tax relief. It was very disappointing to find that some people in the industry were intending to use an unintended tax subsidy that would have cost several hundred million pounds a year. I believe that any responsible Government would have acted quickly to stop such schemes with immediate effect.

Since the announcement on 10 February, most of the films have been refinanced and are in production. In April, 15 films were shooting in the UK: one more than in April 2003, and 2003 was a record year for film production. I therefore ask the Committee to reject the amendment, which would render the new rules ineffective and allow substantial tax losses through avoidance to continue unchecked.

Mark Prisk (Conservative, Hertford and Stortford)

I welcome the Financial Secretary, who is speaking at short notice for the Paymaster General. She is performing as what one might describe as a parliamentary stunt double.

We are discussing two amendments, and I am aware that amendment No. 183 has been proposed formally, but not amendment No. 182. Listening to the Financial Secretary run through the Government's arguments, I am not convinced that sufficient consideration has been given to the impact of the clause. If it is not the Government's intention to hit genuine trades, I have to say that the clause would undermine that aim.

The Minister has said that the clause has simple and objective rules, which may indeed be the case. However, one of the problems with the clause—this is a common theme in the Bill—is that it seems to have a catch-all approach, underwritten by very rigid rules, under which some innocent and legitimate trades will be caught up in the process, but there is an assumption that that can be amended in due course. Such a legislative approach is questionable and likely to lead to a significant number of further changes to tax law and, therefore, further complexities. Some might argue that the very reason why we are debating the clauses today is that the original scheme was not right in 1997.

It is also unclear whether the Government have made a proper and thorough assessment of the impact of the clause. The hon. Member for Yeovil (Mr. Laws) talked in previous debates about whether an objective assessment has been made of how a measure will impact on the industry. Members of the Committee will understand, as do members of the Culture, Media and Sport Committee, that certainty in the tax regime is crucial to the film industry. I shall briefly cite one of the leading witnesses to that Committee, Mr. David Elstein, the chairman of the British Screen Advisory Council. He said:

''What we actually need . . . if we were really going to try and solve this once and for all, is . . . a permanent fiscal regime which we know is there forever, that is how you treat a film from a tax point of view.''

That is very much the view of the industry as a whole. The danger is that the clause will compound the errors that were made in the beginning. The purpose of amendment No. 182, in particular, and No. 183 was to prevent that.

On amendment No. 182, I hope that the Financial Secretary will confirm that the Treasury, as well as the Department for Culture, Media and Sport, will watch and monitor the impact with care. There is concern across the House that, having established a stable fiscal regime, via both section 42 and section 48, for how film investment is treated, the events of 10 February—perhaps rightly plugging some activity that is not legitimate—sent out a signal that could undermine the long-term viability of many films in this country. I hope that she will forward those concerns to her colleague the Paymaster General.

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the clause stand part of the Bill.

Mark Prisk (Conservative, Hertford and Stortford)

May I ask for guidance, Mr. McWilliam? Amendment No. 182 was attached to No. 183. I am unclear whether I have formally withdrawn it.

John McWilliam (Labour, Blaydon)

No. It has not been moved.

Mark Prisk (Conservative, Hertford and Stortford)

So we have just debated No. 182?

John McWilliam (Labour, Blaydon)

We have debated both No. 182 and No. 183. We are now debating clause stand part.

Mark Prisk (Conservative, Hertford and Stortford)

Thank you, Mr. McWilliam. I wanted to make sure that we had not missed anything. I did not want to be cut off in my prime.

John McWilliam (Labour, Blaydon)

Order. The hon. Gentleman is wise. I have seen Opposition, and Government, spokesmen get it completely wrong and accidentally lose an opportunity for themselves.

Mark Prisk (Conservative, Hertford and Stortford)

Thank you, Mr. McWilliam. We do not want to tempt the hon. Member for Ealing, North (Mr. Pound) further.

Sitting suspended for a Division in the House.

On resuming—

Mark Prisk (Conservative, Hertford and Stortford)

Before the Kia-Ora oranges are put away after the intermission—I am showing my age.

Mark Todd (Labour, South Derbyshire)

He certainly did not get the choc ice.

Mark Prisk (Conservative, Hertford and Stortford)

I did not.

John McWilliam (Labour, Blaydon)

Order. Sedentary interventions are always to be deplored: they are rarely as funny as people think they are. The hon. Member for Hexham (Mr. Atkinson) had part of ''Robin Hood: Prince of Thieves'' filmed in his constituency, and the right hon. Member for Berwick-upon-Tweed (Mr. Beith) had ''Harry Potter'', but the only film made in my constituency was ''Get Carter''.

Mark Prisk (Conservative, Hertford and Stortford)

I shall not even try to compete with you, Mr. McWilliam. It would be dangerous to do so—certainly if I want to get called in any future debates.

So far, the clause has been considered in the context of the film industry, but it affects any partnership and reaches way beyond the film sector. What assessment has been made of its impact outside the film sector? Earlier, we touched on business angels. They are particularly important in, for example, the theatre sector. I would appreciate it if the Financial Secretary could clarify what thought the Treasury has put into the impact. Was casting the net this wide intentional, and if it was, has a regulatory impact assessment been commissioned to assess exactly how the provisions will work?

In new section 118ZH, a benchmark of 10 hours is set. That seems clear in one sense, but it is inevitably somewhat arbitrary, especially, for example, in the case of parallel partnerships. As many members of the Committee will realise, professional firms quite often create a side partnership to draw in a specialist in a particular niche in their profession. Creating such a partnership allows them to do that without the complication of restructuring an existing partnership. Members of the Committee will be familiar with that arrangement operating in the fields of accountancy, law, and in particular in the environmental trades and professions, such as surveying, architecture and planning. Would it not be logical to recognise that that takes place, instead of having a 10-hour fixed benchmark that is somewhat arbitrary? That benchmark will clearly cause significant problems in the tax affairs of the partnerships to which I referred.

There is a further danger with the rigid nature of the benchmark: it could discriminate against someone on maternity or paternity leave. In most circumstances, the end of the financial year is 30 April, so where a person goes on maternity leave on 1 July of a tax year through to the following May, and even if they were able to manage seven hours in a working day in the 40 days before they took leave in the July, they would still be treated as if they had done five and a half hours per week.

Rob Marris (Labour, Wolverhampton South West)

On a point of order, Mr. McWilliam. The hon. Gentleman seems to be citing examples from a brief from Grant Thornton, but he has not attributed them.

John McWilliam (Labour, Blaydon)

It is not necessary for anybody to attribute anything really. I have no idea what brief the hon. Gentleman is citing examples from, since with any briefs sent to me my staff have instructions to send a note back stating that I do not read them because I am chairing the Committee.

Mark Prisk (Conservative, Hertford and Stortford)

I am perfectly happy to say that I have read the brief, but I am also aware that the Financial Secretary has recently been on maternity leave. Many hon. Members know about that, including the hon. Member for Wolverhampton, South-West (Rob Marris).

In circumstances in which someone is judged to have worked five or six hours a week, if that partnership incurs a loss, the new parent could be at a disadvantage because of the inflexibility of the clause. I cannot believe that that was the Government's intention, so is the Financial Secretary prepared to account for it?

The clause highlights the general mistake of a tax avoidance strategy that is founded on trying to catch every possible activity in the knowledge that it will probably hurt a small number of legitimate activities but will inevitably have to operate in that way because it is trying to catch every last pound.

The Opposition do not reject the argument that abuse of the tax system should be dealt with. However, the danger of the catch-all approach in this clause and others is that a significant minority will be penalised.

Rob Marris (Labour, Wolverhampton South West)

The hon. Gentleman was citing the example provided by Grant Thornton. I did not hear him cite the concluding sentence of that paragraph dealing with the potential difficulties of the situation outlined in the example. It goes on:

''Otherwise the losses will be carried forward and treated as current-year trading losses.''

That suggests to me that someone on maternity leave could use the losses unless they gave up their role in the partnership or went on another maternity leave.

Mark Prisk (Conservative, Hertford and Stortford)

I am happy to return to that point, because the hon. Gentleman is right to say that there is a possible opportunity for avoidance. That is where the difficulty lies, however. How does one draw the line in a way that is not unfair? I am not sure that the clause does that, and that is why I want to hear from the Financial Secretary.

Ruth Kelly (Labour, Bolton West)

It is an interesting argument that somehow individuals should get more tax relief than the amount that they put into a partnership. It is quite a difficult argument to make. We are not removing the right to tax relief; we are just saying that one cannot use it to the extent that it is greater than the sum originally contributed to the partnership. As profits accumulate, losses can be set aside in future years.

The hon. Gentleman argues that legitimate trade could be affected, but we have received no representations whatever from anyone whom he thinks might be affected. No representation was made by the British venture capital industry or by individual business angels or people with the sorts of cases that he cites. We simply do not accept that

legitimate trade could be affected in the way that he suggests.

Mark Prisk (Conservative, Hertford and Stortford)

We all receive representations and we have to balance those that we receive with those that we do not. This year in particular, all the outside bodies have highlighted the fact that many people had significant difficulty responding to the clauses because the Bill was published on Maundy Thursday. We do not know whether the end result will be poor, but problems may well arise in due course and the rigidity of the drafting of some clauses is more likely to create problems than some flexibility would. I hope that the Financial Secretary can respond positively to that.

Ruth Kelly (Labour, Bolton West)

I do not accept that they are drafted in a rigid way. I will turn to the 10-hour test in a moment. Let me first consider some of the other points raised by the hon. Gentleman.

The hon. Gentleman asked whether we have done a regulatory impact assessment, but it is not Treasury practice to carry out an RIA for anti-avoidance measures, as I am sure he understands and realises. He also suggests that the industry desires certainty, and that it seeks a permanent new relief to provide that certainty. We think that the Budget announcement gives the industry the certainty that it is seeking to 2005 and beyond. As we have said, we are working in full co-operation with the industry to design a new permanent tax credit. That point has been widely welcomed by the industry and should provide the additional certainty that the hon. Gentleman desires.

Most of the detail of the measures before us was announced on 10 February, so organisations and individuals have had a fair amount of time to study them and make representations to us. It is an important point that no representations whatsoever have been made by people or organisations who think that this measure could affect legitimate trading activity.

Mark Prisk (Conservative, Hertford and Stortford)

I appreciate that the Financial Secretary is standing in for the Paymaster General, but she may find the Treasury has received at least one representation. The important point here, though, is not necessarily whether there have been one or two representations, but the concern that many people are not clear about the impact of the measure because of the length and nature of the legislation. We need an assurance from the hon. Lady that the Treasury—not just the other Departments—will monitor the impact and respond if it is clear that it is not having the desired effect. I hope that she will respond to that point.

Ruth Kelly (Labour, Bolton West)

We do, of course, keep all tax measures under review and monitor the impact of tax legislation in particular fields. We will continue both to do that and to listen to any representations about the impact. However, I put it to the hon. Gentleman that the intent of the legislation is very easy to understand. The concept is simple: it is not possible to have loss relief against one's general income for more than the amount that one has actually put into the business, and anyone who can understand that can work out whether they are affected. Clearly, to give effect to that, the legislation is more complex.

The hon. Gentleman asks about the 10-hour rule. Most people involved in the avoidance schemes have no active involvement whatsoever in the businesses, but we have had to guard against attempts to dress up very minor activity—a few hours a week, for example—as active involvement. We feel that 10 hours is fair, and it strikes the right balance between allowing genuine part-timers to carry on without any effect and making sure that we tighten the net around the tax-avoiders.

Michael Jack (Conservative, Fylde)

The Financial Secretary has said, with all the certainty that has required the rewriting of this clause, that she thinks 10 hours strikes the right balance. Will she, for my education and understanding, tell me what other options she looked at, and will she put on the record the reasons for rejecting them and fixing on 10 as, in her judgment, the right number?

Ruth Kelly (Labour, Bolton West)

We could debate endlessly whether the rule should have used nine or 11 hours, but 10 struck us as a relatively sensible compromise that people could work with, and one that would prevent people from dressing up a few hours as active involvement in a business when really there was no involvement whatsoever. That compromise recognises that some people may, for example, work part-time or take maternity leave during the year.

Michael Jack (Conservative, Fylde)

The reason I asked the question is that there are in statute law different definitions of part-time and full-time working. I was intrigued by this new definition, at 10 hours, of some-time working. Was there an effort to align the number with other delineations between part-time and full-time involvement, and if not, why not?

John McWilliam (Labour, Blaydon)

Order. The right hon. Gentleman is referring to a subsection that in fact limits the 10-hour test to section 118ZE and nothing else. Therefore, his question is beyond the scope of the matter under discussion.

Michael Jack (Conservative, Fylde)

On a point of order, Mr. McWilliam. I am sure that you will tell me if I am out of order, but is it not within the narrow confines of the matter under debate to ask a Minister why a particular number has been chosen and whether any attempt was made to import an existing concept from other statute law?

John McWilliam (Labour, Blaydon)

I am afraid that we are stuck within the confines of the matter under debate. If the right hon. Gentleman is trying to suggest that this measure could affect anything else or that anything else could affect it, it is not out of order to ask the question. It would be out of order for the Minister to answer it outside the context of what is in the Bill.

Ruth Kelly (Labour, Bolton West)

The fact is that the 10-hour test applies only to passive investors, who are not employees at all. We developed a definition that strikes a sensible and fair balance between those who are covered by it and others who may work in a different way.

The hon. Member for Hertford and Stortford says that the measure is unfair to those who work in more than one partnership and that there should be a rule to help such people. I do not think that that is a problem.

Mr. Prisk rose—

Ruth Kelly (Labour, Bolton West)

Perhaps the hon. Gentleman will listen to the explanation before I allow him to intervene.

Mark Prisk (Conservative, Hertford and Stortford)

I was not sure whether the Financial Secretary had finished with the question of the time limitation in the subsection to which you referred, Mr. McWilliam.

I am not entirely clear what consideration has been given to the special role of business angels, whose involvement is often passive. They make a capital investment and may occasionally contribute expertise at the beginning of a project, particularly in the creative sector, but then rightly step back. Their aim is not to run things; they do not have an executive or salaried role. I am genuinely worried that that group will be drawn in unintentionally. There may be a conflict with Department of Trade and Industry rules. What assessment was made of the impact on those people and that sector?

Ruth Kelly (Labour, Bolton West)

It is difficult to conceive circumstances in which legitimate business angel activity would be caught by the measure, because it is difficult to conceive a situation in which a business angel investor or anyone, other than those who are seeking a tax advantage, would want losses attributed to them that were greater than their contribution to the venture or partnership. I am sure that the hon. Gentleman agrees with the logic of that argument. The measure was specifically designed to counter tax avoidance.

To return to the 10-hour test, I can tell the Committee that it applies only to passive investors, and the new rule still allows someone to claim sideways loss relief up to the amount of their financial contribution. If people genuinely contribute their time, skills or money, they will not be affected. If they are affected, losses can be offset against later profits from the same trade. I believe that that directly relates to the hon. Gentleman's point. For those reasons, I urge members of the Committee to support the clause.

Michael Jack (Conservative, Fylde)

On a point of order, Mr. McWilliam. I have listened with interest to the debate on the clause. The Financial Secretary said on several occasions in her remarks on the amendments that the matter is one of tax avoidance. I was surprised that she did not in even a sentence or two explain some of the deficiencies in the drafting of the original legislation. What was wrong in the first place?

The hon. Lady has assured us of the correctness of the Government's position in rebutting the line of argument put forward by my hon. Friend the Member for Hertford and Stortford in favour of his amendments, on the grounds of her absolute certainty that everything in the clause is right, and therefore my hon. Friend's amendments are wrong. However, I am sure that that line was adopted when the original legislation was put to the House, so I am doubtful about how right it is. She has not told us what went wrong in the first place or why we now have several pages of legislation to fix it. My hon. Friend sought to improve the provisions through his amendments, yet the Financial Secretary tells us that

she is as certain now as she was when the original legislation was passed.

John McWilliam (Labour, Blaydon)

Order. The right hon. Gentleman was not present for the debate on amendments Nos. 183 and 182, so he did not have the benefit of listening to the Minister. We are dealing with the clause stand part, not the amendments, which have been disposed of.

Question put and agreed to.

Clause 119 ordered to stand part of the Bill.

Clause 120 ordered to stand part of the Bill.

Clause 121 - Charge to income tax

Mark Prisk (Conservative, Hertford and Stortford)

I do not intend to detain the Committee too long—[Interruption.] I hear sounds of disappointment.

The clause concerns the tax charge for individuals exiting a partnership. As the Financial Secretary is aware, the tax law rewrite project, which has support from across the House, has as one of its aims a reduction in the number of charges, so it is quite clear that that is Government policy. Would it therefore not make more sense if in this clause the charge to tax was under case I of schedule D and not under case VI? I have received a number of representations on this point and although I do not profess to be an expert on the tax law rewrite project, it seems to be a prima facie point to raise. What is the Government's view?

Ruth Kelly (Labour, Bolton West)

The clause is part of the same anti-avoidance measure as clause 120. It sets out when a charge to tax can arise under the measure and how to calculate the amount that is chargeable to tax. In calculating the amount to be charged, the clause makes clear the link between the losses relieved against income tax and the amount received, and ensures that tax is charged at the same rate as the rate of relief for the earlier trading losses. It is normal practice for anti-avoidance charges to be made under case VI so that the charge to tax is fully effective and not reduced by other losses or reliefs. If we changed the basis to case I, which is a charge for trading profits, it would, for example, allow the partnership to set up a new scheme, under which the losses might be restricted by clause 119, and then claim the balance of those losses against the exit charge. That would defeat the Bill's intention and allow yet more avoidance. For that reason, I hope that the hon. Gentleman will support the clause.

Question put and agreed to.

Clause 121 ordered to stand part of the Bill.

Clauses 122 to 124 ordered to stand part of the Bill.

Clause 125 - Companies in partnership

Mark Prisk (Conservative, Hertford and Stortford)

I beg to move amendment No. 190, in

clause 125, page 109, line 10, at beginning insert 'relevant'.

John McWilliam (Labour, Blaydon)

With this it will be convenient to discuss the following:

Amendment No. 191, in

clause 125, page 109, line 32, after 'include', insert 'any chargeable gains or'.

Government amendments Nos. 184 to 187.

Government new clause 12—Relationship with chargeable gains.

Mark Prisk (Conservative, Hertford and Stortford)

I am aware that there may be some overlap between the Government amendments and those in my name, not least because of the order in which they were tabled.

Amendments Nos. 190 and 191 seek to limit the clause to those circumstances in which arrangements have been put in place to divert income to non-taxable persons. I am particularly grateful to members of the Law Society, who have highlighted some of the issues. The new rules in the clause are intended to counteract the particular scheme under which a UK corporate taxpayer gets an excess in their capital withdrawals, which results from an arrangement under which they are not allocated a proportion of the income profits to a partnership which they would have otherwise have received. Where that occurs, a charged tax under schedule D6 is imposed on the UK taxpayer which cannot be mitigated by using capital losses. In addition, no credit is given for that charge against a tax that may arise because the increased capital has been allocated to that partner.

I appreciate that the Inland Revenue may not believe that that is double taxation. The worry for others is that the provisions written in the legislation are what they have to go by, and they are concerned that no distinction has been made on that basis. I hope that the Financial Secretary can assure us on the following point, which causes the worry: it is quite possible that a UK corporate taxpayer may be taxed under the provisions by reference to income, but they are also taxed while the income is with another UK resident partner. That is the essential problem, which causes the worry.

The purpose of the amendments is to narrow the clause. To avoid inadvertently catching bona fide arrangements, the provisions should be limited to circumstances in which income has been allocated—other than in accordance with partnership capital—to partners who are not liable to be taxed on that income. It is a complicated point, and I must confess that I am not sure I am any more expert on it than I was a few weeks ago. I confirm that the amendment's purpose is to probe the Government's intention.

Ruth Kelly (Labour, Bolton West)

I shall ask the Committee to reject the amendment, but it may help if I first explain the intention behind the clause. Clauses 125 and 126 tackle certain avoidance schemes used by companies. The schemes use a partnership structure to convert taxable profits into untaxed increases in a partnership capacity. They allocate partnership profit shares in different proportion to partnerships' capital shares; for example, a company may give up all rights to income in return for a greater share of capital, then withdraw its increased capital from the partnership with little or no tax to pay.

Clause 125 returns the position to what it would have been if profits had been allocated in proportion to partnership capital. When the company realises the increase in capital, it will pay corporation tax on the profits that it would have earned with reference to its partnership share. Those schemes threaten to cost the Exchequer a significant amount of corporation tax each year and the Government are determined to tackle them to protect the interests of genuine businesses and the majority of taxpayers who pay their fair share.

Michael Jack (Conservative, Fylde)

For the avoidance of doubt, will the Financial Secretary put on record how much tax is at risk, and how many partnerships were investigated to determine that number?

Ruth Kelly (Labour, Bolton West)

I shall deal with the precise figures later in my contribution. First, I turn to amendment No. 190, which would add the word ''relevant'' so that ''profit'' becomes ''relevant profit''. Our advice from parliamentary counsel is that the meaning is clear without the amendment. Relevant profit is clearly defined and the later reference to profit in the same sentence can only be a reference to the relevant profit mentioned earlier in the sentence. There is no need for further qualification.

Mark Prisk (Conservative, Hertford and Stortford)

Is the Financial Secretary saying that there are no circumstances in which the profit would be irrelevant?

Ruth Kelly (Labour, Bolton West)

I am saying that the definition is clear in that ''profit'' refers to the relevant profit mentioned earlier in the sentence. I hope that the hon. Gentleman will be reassured on that point and that he will withdraw his amendment.

Amendment No. 191 would have no practical effect. It seeks to exclude from the meaning of ''relevant profit'' any chargeable gains arising from partnership of assets. However, the term ''relevant profit'' involves considering the shares of partnership profits allocated between the members of a partnership and refers to the partnership's commercial profits, not to the profits for tax purposes. In contrast, chargeable gains are purely a taxation concept. Excluding them from the business profits of a partnership makes no sense, as they are not part of those profits in the first place. I therefore hope that the hon. Gentleman will not press his amendments. If he does, I will ask my hon. Friends to reject them.

The Government amendments and new clause correct technical points that were raised in representations on the Bill. Their purpose is to ensure that new world rules interact correctly with the rules for computing chargeable gains. They ensure that there is an appropriate link to the rules for chargeable gains. The majority of schemes do not involve assets that might give rise to a chargeable gain, but, where they do, the amendments and the new clause will ensure that there is no double charge to tax. I know that the hon. Gentleman is concerned about that. That is achieved, first, by ensuring that the amount charged under clause 125 reads through correctly to the chargeable gains rule and, secondly, by deducting any amount that is charged to

corporation tax by the clause. Those schemes cost at least £75 million annually, but we believe that more such schemes could be brought into play if the loophole were not closed. So the potential loss to the Exchequer is much greater than £75 million, and revenue would be put at risk.

Michael Jack (Conservative, Fylde)

I am grateful for that figure. Will the Financial Secretary tell the Committee whether any analysis was done as to why the loopholes were not spotted when the clause was drafted?

Ruth Kelly (Labour, Bolton West)

As I am sure you know, Mr. McWilliam, as do my hon. Friends, avoidance schemes are often updated and new schemes introduced, and the Revenue reacts accordingly. I am surprised that the right hon. Gentleman does not know that. A particular avoidance scheme has emerged and we have decided to close the loophole to secure revenue for the Exchequer in future years. That is perfectly reasonable, and I expect that my hon. Friends, at least, agree with our approach.

Rob Marris (Labour, Wolverhampton South West)

Like the hon. Member for Hertford and Stortford and many of my hon. Friends, I do not understand the precise technicalities of some of the clauses, and of the amendments in particular. The hon. Gentleman referred to the brief from the Law Society, of which I am a member. I am slightly surprised at amendment Nos. 190 and 191, which were tabled by the hon. Gentleman and by his friends. The Law Society proposed two amendments to the clause, neither of which are the amendments tabled by the hon. Gentleman.

John McWilliam (Labour, Blaydon)

If the hon. Gentleman is a member of the Law Society, he ought to declare that membership.

Mark Prisk (Conservative, Hertford and Stortford)

I do not want to intrude on the relationship between the hon. Gentleman and the Law Society, which is clearly complicated. It is important that, where amendments are tabled, it is because one feels that they have strong merit. I feel that all the amendments that have been tabled fall into that category.

Rob Marris (Labour, Wolverhampton South West)

Will the hon. Gentleman explain why he tabled his amendments and not the two suggested by the Law Society?

John McWilliam (Labour, Blaydon)

Order. The hon. Member for Hertford and Stortford does not have to do any such thing. It is his choice entirely.

Mark Prisk (Conservative, Hertford and Stortford)

Thank you, Mr. McWilliam. I happily declare that I am not a member of the Law Society.

I thank the Financial Secretary for explaining the background to some of the Government's thoughts. I am not entirely sure whether the relevant/irrelevant debate has clarified the matter for those outside who are affected, but it has been helpful.

There is one matter on which I am still not clear; the Financial Secretary may be able to clarify it. There are instances when the income and capital of a partnership are not related to the capital contributions originally

made. One of the worries with the new clause and the amendments is that organisations, whether capital funds or whatever, may give a general partner a priority share of income to cover expenses and so on, but there will not be the matching of income and capital. The worry is that in trying to deal with those two aspects, there will not be any effort or opportunity for the tax system to recognise the existing conventional or commercial arrangements. One of the dangers when a tax system is a catch-all approach to tax avoidance with rigid rules is that a number of legitimate activities may also be caught up in that process.

However, having said that and having made it clear that the purpose of amendments Nos. 190 and 191 was to probe the Government's intention, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Amendments made: No. 184, in

clause 125, page 109, line 49, leave out 'the lower of' and insert

'(subject to subsections (6) and (7)) so much of A as does not exceed B, where'.

No. 185, in

clause 125, page 110, line 1, at beginning insert 'A is'.

No. 186, in

clause 125, page 110, line 5, at beginning insert 'B is'.

No. 187, in

clause 125, page 110, line 9, leave out subsection (6) and insert—

'(6) Subsection (7) applies if this section applies on more than one occasion in relation to the same company and partnership (whether because of two or more receipts by the company of consideration relating to the same disposal or for any other reason).

(7) On each occasion after the first, the amount found under subsection (5) shall be reduced (but not below nil) by the total of the chargeable amounts found (under that subsection read with this) on the previous occasions.'.—[Ruth Kelly]

Clause 125, as amended, ordered to stand part of the Bill

Clause 126 ordered to stand part of the Bill.

Clause 127 - Finance leasebacks

Ruth Kelly (Labour, Bolton West)

I beg to move amendment No. 158, in

clause 127, page 112, leave out lines 20 to 23 and insert—

'(1) This section applies in relation to the calculation of the lessor's income or profits for a period of account for the purpose of income tax or corporation tax.

(1A) Where—

(a) an amount receivable in respect of the lessor's interest under the leaseback falls to be taken into account in that calculation, and

(b) that amount is reduced by an amount due to the lessee under the leaseback,

that reduction shall be disregarded when taking the amount receivable into account.

(1B) The amounts receivable in respect of the lessor's interest under the leaseback that fall to be taken into account in that calculation may be disregarded to the extent that they exceed the permitted threshold (whether or not subsection (1A) applies).'.

John McWilliam (Labour, Blaydon)

With this it will be convenient to discuss Government amendments Nos. 159 to 181.

Ruth Kelly (Labour, Bolton West)

This is a series of technical amendments to clause 127 and schedule 23, the purpose of which is to ensure that the Bill has the effect that was intended at the time of the Budget announcement. To help the Committee, I shall explain the purpose of the clause and schedule before moving on to explain the purpose of the amendments.

The purpose of clause 127 and schedule 23 is to bring an end to two tax avoidance schemes involving sale and leaseback or lease and leaseback of plant and machinery. Those schemes allowed businesses to obtain an unintended tax advantage by permitting them to claim relief twice for the cost of the plant and machinery. Giving relief twice for the same expenditure is clearly not justifiable. The measure removes the unintended tax advantages by restricting them to those rentals paid under the leasing arrangement. The result is that the cost of the plant or machinery is relieved once and once only.

Corresponding adjustments are made to ensure that lease rentals that are disallowed in tax computations or the business that pays them are not taxed in the hands of the recipient. The clause contains the basic rules for the new measure and the schedule contains transitional provisions to ensure that the new measure applies fairly to existing schemes. Stopping this avoidance will bring in an estimated Exchequer yield of £295 million over three years: £75 million this year and £110 million in each of the following two years.

I turn now to the amendments. The measure applies to complex business arrangements, and after the Bill was published discussions between officials and professional bodies identified some technical defects that should be put right to ensure that the rules will operate as we intended. We are grateful to all concerned for giving up their time to help us to get the measure right. The amendments also include anti-avoidance provisions to ensure that the new rules operate fairly and cannot be avoided. The amendments do not make any change to the policy underlying the measure, but if they were not made the measure would not be as effective or as fair as it should be. I therefore commend the amendments to the Committee.

Rob Marris (Labour, Wolverhampton South West)

On a point of order, Mr. McWilliam. Your selected amendments refer to Government amendment No. 181. Will you clarify whether that is intended to be No. 161, because No. 181 refers to schedule 23?

John McWilliam (Labour, Blaydon)

Because the schedule arises out of the clause and because of the principle that we have only one argument on anything, the debate takes part on the clause, even though some of the amendments are to the schedule. Those amendments will be formally moved when we get to the schedule.

Mark Prisk (Conservative, Hertford and Stortford)

I know that we are all grateful to you for steering our deliberations, Mr. McWilliam.

As the Financial Secretary said, the clause must be considered with schedule 23, which underscores the point that you have just made, Mr. McWilliam. The clause seeks to close down those structures that involve sale and leaseback or lease and leaseback of plant and machinery, which is an important aspect for many of

our more capital-intensive industries. The structures to which the Financial Secretary referred are those businesses that seek to obtain one deduction for the lease payment and one for the capital allowance. I accept that it was an unintended consequence of earlier legislation, and I therefore recognise that the measure's intent has some merit.

Once the Bill was published there were a series of hurried meetings between the Treasury and industry, and if my maths serves me well the results of those are the 20 Government amendments before us. It is a shame that the matter could not have been sorted out before the Bill was published, but I have examined the amendments—some are technical and some have a broader application—and it appears that most of the concerns of those affected by the clause and schedule have been satisfied. For example, one amendment that I considered tabling would have dealt with the question of the net book value and the current book value, and, wearing my chartered surveyor's hat momentarily, I am pleased to see that that has been included.

I do not want to detain the Committee, but we have some concerns about the application of the provisions and their potential impact on bona fide arrangements in a complex field, and especially for the lease and leaseback of plant and machinery. As long as we gain complete assurance that consultations will continue, we will not oppose the amendments in principle.

Howard Flight (Conservative, Arundel and South Downs)

There were concerns that the measures would be retrospective for people who had already entered into sale and leaseback arrangements, and I would be interested to know whether the amendments address that issue.

Ruth Kelly (Labour, Bolton West)

I thank the hon. Member for Hertford and Stortford for the way in which he accepted the amendments, and I apologise for the fact that so many were needed. Clearly, it is a complex area that quite recently came to our attention, and we needed to get it right. We have consulted and we will continue to do so to ensure that there are no more unintended consequences, but we do not believe that there are. As he said, representatives of organisations believe that we have tackled the problem fairly and reasonably, with the underlying policy intention being well served.

Will innocent transactions be caught? Commercially driven transactions will be within the legislation, but they will be tackled fairly and without the double benefit that could arise under existing rules. Hon. Members will accept that that was never the intention of the original legislation, and that it should stop. The provision will not affect the tax treatment of rental payments due for Budget day, to answer the point raised by the hon. Member for Arundel and South Downs (Mr. Flight). Nor will it affect the tax treatment of payments due after Budget day if they relate to periods before that day, so I do not believe there is any retrospective activity associated with this legislation. I therefore commend it to the Committee.

Amendment agreed to.

Amendments made: No. 159, in

clause 127, page 112, leave out lines 40 to 44.

No. 160, in

clause 127, page 113, line 35, leave out from 'machinery' to end of line 36.

No. 161, in

clause 127, page 113, line 39, at end insert—

'( ) Plant or machinery is not the subject of a lease and finance leaseback for the purposes of this section in any case where the condition in subsection (6)(c) is met only because of an election under section 199 made before 18 May 2004.'.

No. 162, in

clause 127, page 113, line 46, at end insert—

'228G Leaseback not accounted for as finance lease in accounts of lessee

(1) Sections 228B and 228C are subject to this section in their application in relation to a leaseback that is not accounted for as a finance lease in the accounts of the lessee.

(2) Subsection (3) applies where the leaseback is accounted for as a finance lease in the accounts of a person connected with the lessee; and in that subsection ''relevant calculation'' means the calculation of—

(a) the permitted maximum for the purposes of section 228B, or

(b) the amount by which the income or profits of the lessee are to be increased in accordance with section 228C.

(3) Where an amount that falls to be used for the purposes of a relevant calculation—

(a) cannot be ascertained by reference to the lessee's accounts because the leaseback is not accounted for as a finance lease in those accounts, but

(b) can be ascertained by reference to the connected person's accounts for one or more periods,

that amount as ascertained by reference to the connected person's accounts shall be used for the purposes of the relevant calculation.

(4) Subsections (5) and (6) apply in a case where the leaseback is not accounted for as a finance lease in the accounts of a person connected with the lessee.

(5) Sections 228B and 228C do not apply in relation to the leaseback.

(6) If the term of the leaseback begins on or after 18 May 2004 then, for the purposes of income tax or corporation tax, the income or profits of the lessee from the relevant qualifying activity for the period of account during which the term of the leaseback begins shall be increased by—

(a) the net consideration for the purposes of section 228C(3) (in the case of a sale and finance leaseback), or

(b) the consideration referred to in section 228F(6)(b) (in the case of a lease and finance leaseback).

(7) For the purposes of this section the leaseback is accounted for as a finance lease in a person's accounts if—

(a) the leaseback falls, under generally accepted accounting practice, to be treated in that person's accounts as a finance lease or loan, or

(b) in a case where the leaseback is comprised in other arrangements, those arrangements fall, under generally accepted accounting practice, to be so treated.'.

No. 163, in

clause 127, page 114, leave out line 1 and insert—

'228H Sections 228A to 228G: supplementary'.

No. 164, in

clause 127, page 114, line 2, leave out '228F' and insert '228G'.

No. 165, in

clause 127, page 114, line 3, leave out 'current' and insert 'net'.

No. 166, in

clause 127, page 114, line 25, leave out '228F' and insert '228G'.

No. 167, in

clause 127, page 114, line 33, leave out '228F' and insert '228G'.

No. 168, in

clause 127, page 114, line 37, at end insert—

'228J Plant or machinery subject to further operating lease

(1) This section applies where—

(a) plant or machinery is the subject of—

(i) a sale and finance leaseback, or

(ii) a lease and finance leaseback, and

(b) some or all of the plant or machinery becomes, while the subject of the leaseback, also the subject of a lease in relation to which the following conditions are met—

(i) the term of the lease begins on or after 18 May 2004;

(ii) S, or a person connected with S, is the lessee under the lease;

(iii) the lease is not accounted for as a finance lease in the accounts of the lessee.

(2) For the purpose of income tax or corporation tax, in calculating the lessee's income or profits for a period of account the amount deducted in respect of amounts payable under the operating lease shall not exceed the relevant amount.

(3) Subsections (4) and (5) apply in relation to the calculation of the lessor's income or profits for a period of account for the purpose of income tax or corporation tax.

(4) Where—

(a) an amount receivable in respect of the lessor's interest under the operating lease falls to be taken into account in that calculation, and

(b) that amount is reduced by an amount due to the lessee under the operating lease,

that reduction shall be disregarded when taking the amount receivable into account.

(5) The amounts receivable in respect of the lessor's interest under the operating lease that fall to be taken into account in that calculation may be disregarded to the extent that they exceed the relevant amount (whether or not subsection (4) applies).

(6) Where only some of the plant or machinery is the subject of the operating lease, subsections (2) to (5) shall apply subject to such apportionments as may be just and reasonable.

(7) For the purposes of this section a lease is accounted for as a finance lease in a person's accounts if—

(a) the lease falls, under generally accepted accounting practice, to be treated in that person's accounts as a finance lease or loan, or

(b) in a case where the lease is comprised in other arrangements, those arrangements fall, under generally accepted accounting practice, to be so treated.

(8) In this section—

''lease and finance leaseback'' has the meaning given in section 228F;

''lessee'' means the lessee under the operating lease;

''lessor'' means the lessor under the operating lease;

''operating lease'' means the lease referred to in subsection (1)(b);

''relevant amount'' means an amount equal to the permitted maximum under section 228B as it applies in relation to the leaseback.'''.

No. 169, in

clause 127, page 114, line 38, leave out '228G' and insert '228J'.—[Ruth Kelly.]

Clause 127, as amended, ordered to stand part of the Bill.

Schedule 23 - Finance leasebacks: transitional provision

Clause 128 - Manufactured dividends

Howard Flight (Conservative, Arundel and South Downs)

The clause and the accompanying schedule comprise various anti-avoidance measures that I would describe as an entirely fair cop. There is nothing in them that is retrospective, and I have not been able to identify laziness in transactions tort. Therefore, we have no comments to make.

Question put and agreed to.

Clause 128 ordered to stand part of the Bill.

Schedule 24 agreed to.

Clause 129 - Gilt strips

Andrew Tyrie (Conservative, Chichester)

My reaction to the clause is only a little less perfunctory than that of my hon. Friend the Member for Arundel and South Downs to the previous clause. It attempts to close what could reasonably be called a minor racket, which is the use of gilt strips for tax avoidance.

The anti-avoidance measures were originally announced in January 2004. The idea derives from the fact that the value of the bond is stripped into income and capital, the principal strip and the coupon strip. The opportunity for tax avoidance arises because non-corporate holders of the strips are deemed to have disposed of and reacquired the strip at the end of the tax year at market value, which gives an opportunity for loss relief.

I agree with the intended effect of the clause. My only questions relate to whether we get that effect. It is a very long anti-avoidance clause. Compared to clause 128, which is three and a half lines, we have here four and half pages, or 275 lines of anti-avoidance legislation. I have a couple of questions. I ask the easy one first. Do the Government know how much yield they are protecting with this anti-avoidance legislation? How prevalent are the schemes? Gilt strips are about 2 or 3 per cent. of the total bond market, which is about £180 billion. What proportion of the strips market is being used for anti-avoidance purposes? That would give us a rough answer.

The second question is slightly more complicated. In order to clamp down on the problem, the clause creates a definition of market value in subsection (8). The definition strikes me as a bit odd. For example, new paragraph 14E(2) in that subsection states:

''The market value on any day of a strip or security quoted in the Daily List shall be—

(a) the lower of the two figures shown in the Daily List for the strip or security for that day''.

There may be more than one price on any one day. Indeed, there may be wide variations in price, particularly if large transactions have gone through. Then there is the problem of computer-mapped market prices, under which the price may move around hugely during the day. The new paragraph refers to the list price. Other parts of the measure imply that there may not even be a list price, and the Government tacitly acknowledge that.

New sub-paragraphs (8) and (9) contain the sort of catch-all provisions that all too often act as a substitute for clarity of thought, and can give rise to a great deal of discontent later, in this case, about the definition of the market price. I would be grateful if the Financial Secretary commented on that and on whether she is sure that new sub-paragraphs (8) and (9) are needed if the definition of market price earlier in the new paragraph is right.

Those are technical points, and the Financial Secretary cannot be expected to know every detail of anti-avoidance legislation of this type. She is a very thorough Minister, but I do not expect her to have all the answers at her fingertips. She may have them, but I would not be in the least concerned if she did not. As a general point, I wonder whether this kind of scrutiny would not be better done in some Special Standing Committee, although I realise that saying that is considerably beyond the scope of this debate.

David Laws (Liberal Democrat, Yeovil)

We, too, support clause 129, which deals with a particularly serious form of tax avoidance. I wish to seek clarification from the Financial Secretary on a few points. First, can she provide the most up-to-date estimate of the cost of the tax avoidance? I am sure that she intended to deploy it in her speech in any case. Secondly, when was this form of avoidance identified by the Treasury and when were Ministers alerted to it? How long does she think it has been going on, and when were proposals first put to Ministers suggesting that the loophole be closed? How long ago was that suggestion first made?

Ruth Kelly (Labour, Bolton West)

Ah! I welcome you to the Chair, Mr. Todd, and look forward to your expert guidance.

I am delighted that members of the Committee recognise the serious form of tax avoidance that is at issue in the clause, which amends the law relating to the taxation of strips of Government bonds held by individuals and others liable to income tax and capital gains tax. The clause has two main purposes: to tackle aggressive tax-avoidance schemes and to prevent tax relief from being available for any loss of original capital invested in the strip.

The avoidance involves contrived deals to manipulate the cost or disposal proceeds of strips for tax purposes. The only purpose of such unwanted deals is to generate tax reductions at the expense of the Exchequer. The Government are committed to tackling such avoidance to ensure sure that everyone pays their fair share of tax. The changes will not affect genuine investors in any way.

Hon. Members have been interested in the yield at stake. We believe that the Exchequer has lost at least £200 million through that route. We believe that avoidance started around July 2003. My right hon. Friend the Chancellor was alerted in the first week of January this year and an announcement was made on 15 January—a quick reaction, I hope hon. Members will agree.

Clause 130 - Life policies etc.:

Andrew Tyrie (Conservative, Chichester)

I thought that this was going to be another clauses 128 and 129 job, and it nearly is, or at least it may well turn out to be. The clause is another anti-avoidance measure, and at first blush one might think it absolutely right to introduce the clause in

principle. I am not absolutely convinced and I would like some further help from the Financial Secretary.

The stated purpose of the clause is to restrict the use of corresponding deficiency relief. In fact, neither the clause nor the explanatory notes makes that clear. The main purpose of the clause could be much more simply stated. Unless I have misunderstood it, it is to prevent people trading losses in life insurance companies and annuity contracts. It is a little disingenuous not to make that clear in the explanatory notes, or perhaps it was a slip, but I am not entirely convinced of the case for the provision.

Why should people who have losses on such products, which may be damaging to them as they are of comparatively modest means, not sell them at a price that reflects the tax benefit for a seller lucky enough to be able use the tax loss to reduce his tax bill? All that would do is enable people who do not have the benefit of higher-rate tax liability to reap some of the tax benefit if they are unlucky enough to incur a loss, which will put them on the same footing as a wealthier taxpayer, or one whose experience with those products has been more fortunate.

The tax law rightly allows companies to trade losses. One can buy a company with an accumulated loss that it is carrying forward to consolidate it for tax purposes and to reduce the group's corporation tax liabilities. What is the logic of depriving individuals of that same benefit?

Ruth Kelly (Labour, Bolton West)

The clause is an anti-avoidance measure. It is aimed at contrived schemes designed to reduce an individual's liability to higher rate income tax. The schemes use life insurance policies to manufacture a tax rule called deficiency relief. They artificially create substantial amounts of tax relief through a series of transactions that have no genuine economic purpose. The transactions are designed solely to ensure that individuals who acquire the policies pick up the tax relief at no cost to them other than the fees they pay for the use of the scheme.

The schemes depend on a loophole that allows the taxpayer to claim deficiency relief in relation to earlier gains made by a previous owner of the policy, including gains that were not subject to tax at all. The clause closes that loophole. We have not had any representations stating that that would catch people unfairly. We are in the business of giving incentives to genuine economic relationships, but not the sort of transactions caught by the clause.

We estimate a yield to the Exchequer from the measure of £120 million over the next three years. If use of the schemes continued to grow, the loss of tax stemmed by the measure could be much higher. With such an amount at stake for no clear economic purpose, I am sure that the hon. Gentleman will understand that we need to close the loophole and will, therefore, choose to support the clause.

Andrew Tyrie (Conservative, Chichester)

The Minister may well be right. Sometimes the Inland Revenue can get it wrong—

Jim Fitzpatrick (Labour, Poplar and Canning Town)

But not the Minister.

Andrew Tyrie (Conservative, Chichester)

Of course not. One was trying to place the responsibility where it should lie. I wonder whether the Financial Secretary will reflect on what I have said about the mismatch between the treatment of the corporate sector and individuals with respect to accumulated losses on life policies and consider whether the matter merits further examination. Perhaps she would write to me with her view in due course.

Ruth Kelly (Labour, Bolton West)

I certainly will endeavour to consider that point. I can assure the Committee, however, that we have not received a single representation suggesting that the measure could operate unfairly. It is unlikely that it would disadvantage anyone not using a life insurance policy for avoidance. In the normal course of events, life policies are owned by the same individual throughout the life of the policy, and any gains in the policy go to that individual. If that is so, his or her entitlement to deficiency relief will be unaffected by the measure. I think that the hon. Gentleman is suggesting that it is somehow desirable that Government money, running into several hundreds of millions of pounds, should be used to a different end. If he is not, I am sure that he will support the clause.

Question put and agreed to.

Clause 130, as amended, ordered to stand part of the Bill.

Clause 131 - Relief for research and development: software and consumable items

Andrew Tyrie (Conservative, Chichester)

This is a big measure, and a change to a very big measure indeed, introduced four years ago. It follows consultation that was promised when the legislation was first introduced. The total value of the relief that was originally introduced is £600 million. The total value of the relief that we are discussing today is £35 million. The Financial Secretary will correct me if I have got those numbers wrong. The clause extends the relief to include computer software and so-called consumables such as water, fuel and power, and it simplifies the definition of materials, which has been a bugbear for a good number of people trying to claim R and D tax credits.

We are talking about large sums of money, and I shall return to that general point in a minute. First, I want to ask a few specific questions, some of which have been put in the public domain in various representations. One comes from Intellect, the computing services association. It is worried that tax inspectors are applying their interpretation of claims against definitions inconsistently, and it has written to express that concern. I would be grateful if the Economic Secretary would take a look at that. He may have discussed it with it or with the Inland Revenue. I do not need an answer now, but it is something that he ought to consider.

Secondly, will the Economic Secretary explain why sole traders and unincorporated businesses are still to be excluded from that area? It is often where most of

the innovation is to be found. Thirdly, does he have any evidence—I am sure that there must be some—to suggest that the relief is becoming part of the avoidance industry. It is complicated. Anecdotal evidence from the accounting firms is substantial—they are taking on staff and moving them into the area specifically to use R and D as a means of tax avoidance. Will it be long before a substantial cluster of people try to get hold of that relief?

I have many much more general points, which relate to the overall effectiveness of the scheme and whether the £35 million, or for that matter the £600 million, is being well spent. A recent survey of middle-market companies—carried out by KPMG, in conjunction with the Economist Intelligence Unit—reported that only 5 per cent. of executives felt that the R and D scheme had encouraged them to spend more on R and D. A quarter of executives had not even heard of the scheme and 80 per cent. said that it had no impact on their business. Is the extra £35 million—or whatever the final figure turns out to be—provided by the clause throwing good money after bad? I do not know whether the money will be, or is being, well used. I do not think that the Government know either, and I will return to that point.

In a nutshell, the Government have introduced and extended the relief, because they believe that the social rate of return is greater than the private rate of return—what firms earn. The Government say—and have said repeatedly in statements, including the Chancellor's Budget statement—that the good take-up of £600 million means that we are closing the gap between the social and the private return. However, the increase in the relief tells us nothing about whether the money is being well spent and whether the £35 million will be well spent.

The conclusion of a thorough short survey of the area—produced by the Institute for Fiscal Studies—came to a worrying conclusion. It said:

''Unfortunately, many unanswered questions remain about the extent to which and how we can subsidise R and D. This means that the Government should tread carefully in trying to design and implement any particular policy. While there is a strong rationale for subsidising R and D, there are many potential pitfalls and we could end up causing more problems than we solve.''

I agree that there is a rationale for the sort of subsidy seen in the clause, and I acknowledge that there are potential benefits in several sectors, particularly pharmaceuticals. However, I am not sure whether that rationale is as strong as some of the theoretical research suggests.

My main point is that the pitfalls to obtaining those benefits are large. I illustrate that by posing some questions to the Economic Secretary. First, there is the issue of deadweight costs, which was discussed when the measure was introduced. For example, how much of the money is going in extra pay? Since it is a handout to companies, they naturally enough increase the pay of their staff once they have got it. How much of the extra £35 million will find its way there?

In order to work that out, perhaps we should consider the £600 million, as that would give us some guidance. Judging by what has already happened to the relief, how much will go in deadweight as extra

pay? I do not believe that the Government will know the answer, but I can tell the Committee that best research suggests that around half goes in pay—in other words, it has a limited effect.

Rob Marris (Labour, Wolverhampton South West)

The hon. Gentleman talks about the deadweight of pay, but surely increased pay rates sometimes encourage people to stay in the United Kingdom or with a particular company and not go off to where they could earn more by managing a restaurant or similar, and society as a whole benefits. Pay increases are not all deadweight and are often desirable per se.

Andrew Tyrie (Conservative, Chichester)

As it happens, before I came to the Committee I scribbled on a piece of paper three possible reasons for the money going to pay not being completely disastrous. They were: it may encourage more people to go into such jobs, which the hon. Gentleman did not mention; it might make them work harder, although I am slightly more sceptical about that; and it might keep them in the United Kingdom, which is certainly possible, and he mentioned that. I think that he would also agree that if those are the objectives, they could all be accomplished much more cheaply and efficiently through a direct spending scheme or subsidy. All the theoretical and practical evidence suggests that a light rather than a blunderbuss tax break is preferable. The R and D tax relief is an inefficient way of achieving all the objectives on pay to which I alluded.

Rob Marris (Labour, Wolverhampton South West)

When the hon. Gentleman refers to an alternative model—you will direct me if I stray too far on this, Mr. McWilliam—is he suggesting a more direct state-sponsored model rather than one that comes through tax relief primarily to private companies? If he is, that surprises me, given the Benches on which he sits.

Mr. Tyrie rose—

John McWilliam (Labour, Blaydon)

Order. We are going a wee bit wide of the clause. I have gone with it until now, but that was just a shade over.

Andrew Tyrie (Conservative, Chichester)

Why do not I have a go at answering the question, and if you do not like it, Mr. McWilliam, you can shut me up.

One way of implementing the clause would be to create a spending line to have the same effect and to vote some money in a departmental budget and give a group of people the power to allocate it, as opposed to doing that through a tax subsidy. I am not going to try here to suggest an alternative model. I would be ruled out of order, and that is not a legitimate subject for discussion today. I want to make a general point that, inasmuch as those are the objectives, the clause and what it builds on are not the best way to go about attaining them.

My first question was about deadweight costs. Many other aspects of such costs might be triggered by the clause and the four-year-old legislation that it builds on, but I shall let that pass. I hope that I have made the point by illustration.

My second question concerns the administrative cost of running the scheme, to which we are adding with the clause. Do the Government know what the

full administrative cost and the full compliance burden of running the relief will be for both firms and the Government? The terms of the relief are extremely complex, which has been a bugbear and a moan of the industry. Although it will be billed as simplification when the Minister responds, on balance we will find that the clause introduces simplification on one hand and complication on the other. It also plays into the hands of big firms that can obtain the best advice on how to collect the R and D relief, and that worries me very much indeed. That is almost always the way with tax reliefs—they go to those who can obtain good advice, which is reflected in the KPMG survey to which I have just alluded.

Thirdly, there is the tax avoidance industry issue. A little while ago, I asked the Minister how much that had grown and whether he had any estimates. I doubt whether he has, but I shall be interested to hear anything that he has to say about that. There is quite a lot of anecdotal evidence to suggest that it is already quite a lively industry.

The fourth issue is the general pitfall of thinking that we need to engage in a tax competition with other countries. The argument goes like this: other countries may have a clause like clause 131, and they may already be giving subsidies for computer software, so we had better do the same. It is true that the UK is, in general, following a path that other G7 countries have already gone down in terms of increasing the scope for tax reliefs on R and D. In a debate in 2000, my hon. Friend the Member for Arundel and South Downs referred to Canada and the extremely generous scheme that is available there. Incidentally, I think that that scheme includes a relief on, among other things, computer software.

Rob Marris (Labour, Wolverhampton South West)

And Canada is booming.

Andrew Tyrie (Conservative, Chichester)

I realise that mentioning Canada in the same Room as the hon. Gentleman is extremely dangerous. I will move on very quickly.

Getting involved in an auction of R and D subsidies with other countries is a crazy idea. Just because some other countries already have subsidies, that should not be an argument for the implementation of the clause.

It is worth noting in passing that a good number of UK firms do much of their research abroad. Indeed, the UK virtually heads the global overseas research list. We need to think carefully about why that is so.

A fifth reason for being concerned about a further extension of the relief is that it will only add to an existing problem, which is that whenever relief is introduced on this scale, there will inevitably be a heavy distortion at the margin of what constitutes R and D. Indeed, in 2000, the Committee dealing with the Finance Bill dwelt heavily on the definition of R and D, and we will have exactly the same problems with the definition of R and D for software. When is software new? Is it new after six months? The tax advice industry will be having that debate.

John McWilliam (Labour, Blaydon)

Order. I had better declare an interest: not only did I engage in software R and D some 30 years ago, I have a couple of patents in it,

none of which is applicable today because they are written in languages that very few people understand these days.

Andrew Tyrie (Conservative, Chichester)

That is very good of you, Mr. McWilliam. Perhaps you will be able to get some financial advice from the Economic Secretary. I have no interest to declare. I am doing my best to offer my views, without any axe to grind except trying to increase overall economic performance in the country.

I have a sixth concern. Given that we are going to spend £35 million on the clause, what will be the overall yield? What will be our long-term benefit as a country from spending this money in the R and D field? Of course, the Government will not be able to answer that question because, by definition, R and D takes many years to show a benefit in most cases. Even when it does show a benefit, it is difficult to spot, because of spillover effects, as the economists call them, and therefore we have the constant problem of trying to create a shadow rate of return in order to justify any subsidies. That is a dangerous game to get involved in. I am not against the idea in principle, as a theoretical rationale, but it is dangerous and we must think where it leads. I worry that we may just be throwing some more money at another area of the R and D industry in this country, without any clarity about what we will get back.

Although I do not necessarily think that there is any connection between these facts, in the 1960s and 1970s Britain was a leading R and D performer—we were jolly nearly top of the league in spending money on R and D—but our economic performance was lousy. In the past 20 years we have slipped down the R and D league, but our economic performance is very near the top of the EU and much better in global terms.

Rob Marris rose—

John McWilliam (Labour, Blaydon)

Order. I can see some anxious faces wanting to come in and make general points about the economy, but such points do not arise from this clause.

Andrew Tyrie (Conservative, Chichester)

I am grateful for that protection from putative interventions. Incidentally, although I shall not labour the point, Japan is a mirror of the position that I have described for the UK. It was bottom of the R and D league and top of the growth league, and now it is top of the R and D league and bottom of the growth league. We are not talking about the odd year, but decade by decade. We need to be careful about thinking there is some inevitable logical connection, and that this £600 million—soon to be £1 billion, I should think, at the rate we are going—is going to have a dramatic impact.

John McWilliam (Labour, Blaydon)

Order. I have to tell the hon. Gentleman that non-endogenous economic growth theory does not arise from this clause either.

Andrew Tyrie (Conservative, Chichester)

On the contrary, if I may debate that point with you on a point of order, Mr. McWilliam, I think that that is exactly what this clause is all about. I will conclude with a few remarks about that in just a moment.

Rob Marris (Labour, Wolverhampton South West)

The hon. Gentleman is briefly questioning the 20 years that we have just had versus

the previous 20. Would he concede that in the 1960s in this country a higher proportion of R and D money was spent on defence research, which is arguably not very productive, and that that changed in the previous 20 years, which might explain the apparent contradiction in his figures?

Andrew Tyrie (Conservative, Chichester)

That was an interesting intervention, with which I have a lot of sympathy. It would be interesting to know how much of the £600 million is already going on defence. My guess is that it will probably be about a third—I have seen independent research suggesting that it is 37 per cent. We may have had our feet in the treacle, but we have not yet got them out.

Alongside aerospace, another major area is pharmaceuticals, where there is a stronger case. The lead time in pharmaceuticals is very long, and I have no doubt that the industry will benefit from the clause, among other parts of this relief. Even there, of course, it is worth bearing in mind the fact that the lion's share of R and D comes through the charitable sector, through Wellcome or, again, through direct spending subsidies through the NHS and off the NHS budget, rather than indirectly through the tax system. Again, we have to ask ourselves who is better at allocating this, and who is better at deciding whether software and consumable items are best handled through a tax system, or whether we should find some other way, if we want to at all, of giving a special subsidy.

What do I conclude from all this? Apart from the fact that the very reason that we have this relief is that the Chancellor, although he never talks about it any more, believes in neo-classical endogenous growth theory—or perhaps I should say, if it is not Brown, it is Balls. Certainly, Ed Balls wrote about this subject extensively in the mid-1990s. He did many excellent things, such as the Bank of England's independence, which I shall not mention any more because I can see that the Chairman is leaning forward. If—

John McWilliam (Labour, Blaydon)

Order. I am just pointing out to the hon. Gentleman that I was talking not about neo-classical endogenous growth theory but about non-endogenous economic growth theory.

Andrew Tyrie (Conservative, Chichester)

I think you need to have a conversation with Ed about that, Mr. McWilliam. Ed will be absolutely clear in his mind that he thinks endogenous growth theory is the key driver for this £600 million worth of relief.

Before we go any further down the road of spending money on such clauses, we need a serious, full and independent study of whether it is being well spent. The Inland Revenue is, for the first time, committed to producing core statistical information about the relief, which will presumably include the clause. That is important but, far more important, we need to take that and say, ''Now we're going to spend £0.66 billion or £1 billion.'' There will no doubt be further clauses to extend the provision, because people will be like bees around a honeypot, trying to increase the relief. We must decide whether the relief will be properly used.

The questions we need to ask are basic, but not necessarily easy to answer. Who is getting the money?

What is happening to it? Is it going in pay? Is it going towards the creation of genuinely new products? Is a large proportion of the money being absorbed in administration? What is the long-run return on such money and what alternatives are there to further extensions of the tax credit?

A while back, the Treasury Committee asked for just such a study in one of its reports. I would be grateful if the Minister committed himself to setting up such a study.

David Laws (Liberal Democrat, Yeovil)

I am encouraged by that speech and am stimulated to make a short speech in a similar vein. The hon. Gentleman pointed out that the Government are inviting us to approve additional expenditure of public funds on the R and D tax credit, and the extension of its reach. He said that those additional funds might total £35 million. The Red Book appears to indicate that the figure will total some £65 million over three years.

The hon. Gentleman raised exactly the right issue by asking whether the proposals amounted to throwing money at a problem without providing clarity about what the Government were seeking to get back. I shall not rewind to our earlier debate about the film industry tax relief, but the clause seems to deal with a similar example of the Government seeking to subsidise an activity—R and D expenditure. However, they are not always clear about the economic return through enhanced revenues to the industries concerned, or to the taxpayer.

In justifying the Government's film industry tax relief, the Paymaster General said that she was relying on a report prepared by the Select Committee on Culture, Media and Sport. I imagine that, if that Committee had condemned the Government's measure and said that the economics did not stack up, the Treasury would have relied on its own figures. It is odd that, when we table parliamentary questions on the cost-benefit analysis of such subsidies, it turns out that the Treasury has undertaken no such analysis, and has not assessed the economic benefits, or how much tax will come back through enhanced activity. That is surprising in light of the fact that the Treasury is the one Department that we would look to for rigour on and concern about the expenditure of public funds.

We cannot, therefore, escape the suspicion that the Chancellor, or some other member of the Government may have decided that it would be fantastic to be seen to be subsidising an activity such as R and D or the film industry, and to be urging officials and other Ministers to bring forward proposals in that area, without being aware of the costs and benefits.

The hon. Member for Chichester referred to a recommendation that the Treasury Committee made. That Committee should not judge whether the R and D tax credit is value for money. Rather, the Treasury should do so. It should produce estimates of the boost to R and D expenditure as a consequence of such tax reliefs and demonstrate how the enhanced revenues resulting from economic growth would benefit the taxpayer.

The hon. Gentleman mentioned that expenditure on the R and D tax credits is something of the order of £600 million and is growing considerably. I would have thought that, before we approved an additional £65 million of expenditure on them, we would want a Treasury assessment of how effective the relief has been to date, what the returns from it will be, and what the effect on taxpayer revenues will be through enhanced yields as a consequence of additional growth.

We would certainly want some estimate of how much additional R and D spend the Economic Secretary anticipates there will be as a consequence of clause 131. How much extra R and D expenditure are the Government anticipating we will get for the expenditure of £65 million of taxpayers' money? If we do not know those figures, how can we judge whether the tax relief has been a success and whether it offers value for money?

When we had the debate about film industry tax relief, the evidence that the Treasury cited came not only from a departmental Select Committee, whose degree of rigour on economic questions cannot be expected to be as great as that of the Treasury, but from industry bodies, which are not objective or independent in such matters. It also cited anecdotal evidence that there was additional expenditure as a consequence of those subsidies. However, the question is not whether there is some additional expenditure. After all, if we are spending £1 billion on film industry tax relief or close to £1 billion on R and D tax credits, we would expect there to be some economic consequence. The question is how much economic consequence flows from that. How much impact is there?

I hoped that we would be looking at the possibility not of amending or extending the R and D tax credit, but of abolishing it. If we were talking not about abolishing it but about extending it, I hoped that the Economic Secretary could have come forward with a serious study showing how the R and D tax credit has worked to date in economic terms. He should certainly be giving us today an indication of how much more R and D expenditure will result from the additional £65 million of taxpayers' money that will go into this Government policy.

John Healey (Labour, Wentworth)

I was interested in the general critique of the R and D tax system offered by the hon. Member for Chichester. He described it at one point as rather inefficient, and many of his comments were echoed by the hon. Member for Yeovil. I am not sure whether that means that either of their parties would axe that tax credit, if they were ever in a position to make such a decision.

Mr. Laws indicated assent.

John Healey (Labour, Wentworth)

The hon. Gentleman is nodding. I am sure that that will be of interest to business organisations that have urged us to introduce and to develop that tax credit.

In contrast to those general comments, clause 131 is relatively narrow in scope. Last year, we said that we would introduce a change to include the expenditure

on software used in R and D as a cost that qualifies for R and D tax credit. We also invited views on whether the definition of materials used in R and D could be improved. Clause 131 implements those changes, and includes a further change to widen the range of qualifying costs, so that expenditure on power, water and fuel is included, as the hon. Member for Chichester pointed out.

Both hon. Members cast doubts on the nature and purpose of the tax credits. We believe that we need those tax credits. It is a belief that is shared by business organisations and many of the businesses that are now benefiting from them. We need them to encourage new products, services and technologies. The economy needs such innovation to grow in the long term.

It is vital that companies invest in R and D, and to be able to do so it is vital that finance is available to support what are sometimes long-term and risky investments. The UK has trailed competitor countries in investment for some time. Giving an incentive to invest in R and D is one way to help to reverse that trend. More investment in R and D should lead to greater innovation and, ultimately, to higher productivity.

The credits work by giving companies extra tax relief for their spending on R and D. Before the credits, companies could set 100 per cent. of their R and D spending against profits. For small and medium-sized companies, the credits raise that to 150 per cent., and for a larger company to 125 per cent.

Since the inception of our schemes in 2000, more than 9,000 claims from SMEs have been received, providing support to innovative companies of around £530 million. As the hon. Member for Chichester said, this is a big measure. It is also, although he did not concede this, welcomed by businesses and has been of benefit to them. I am not sure whether those 9,000-plus companies would agree with him that it is not making a difference.

Andrew Tyrie (Conservative, Chichester)

Can the Minister name a tax relief that has not been welcomed by the recipients?

Rob Marris (Labour, Wolverhampton South West)

Widow's relief.

John Healey (Labour, Wentworth)

I thank my hon. Friend for his intervention. I am not sure what the position of widow's relief is in Canada, but I do not want to encourage the hon. Member for Chichester, as we should be discussing clause 131.

John McWilliam (Labour, Blaydon)

Unless the lady was widowed as a result of research and development expenditure, it is out of order to talk about that in this clause stand part debate.

John Healey (Labour, Wentworth)

We have had no reports at the Inland Revenue of large-scale avoidance as part of this relief. I am also happy to say that we have had no reports of deaths as a direct result of the tax credit.

I turn to the serious issue of evaluation. At present, with tax credits relatively recently introduced and still bedding down, and because they are designed to stimulate long-term investment with long-term impact,

it is too soon to say precisely what effect they are having. The Inland Revenue is starting a full evaluation, which, as hon. Members would expect, will include an analysis of value for money. It will cover precisely the issues that the hon. Members for Yeovil and for Chichester have raised. It will provide information and analysis on the effects of the policy over a number of years.

All the academic evidence suggests that tax credits are a measure for the longer term. The impact of R and D on the prospects and productivity of individual companies, and on the economy more generally, will become clearer only in the longer term. Without doubt, the Government are making an investment in the long-term prospects, the long-term growth and the long-term stability and prosperity of the British economy.

David Laws (Liberal Democrat, Yeovil)

I am pleased to hear that a study is being conducted by the Treasury. Can the Minister tell us when that will be published?

John Healey (Labour, Wentworth)

I do not think that the hon. Gentleman listened carefully enough. The evaluation is being undertaken by the Inland Revenue, which is appropriate as it is responsible for this area of taxation. The work is starting now, and at the moment I do not know when the results will be published. As soon as Ministers can confirm such detail, no doubt we will.

The hon. Member for Chichester referred to the Institute for Fiscal Studies. It has raised some important questions, which he and the hon. Member for Yeovil have echoed. We will bear them in mind as we carefully design and carry out the evaluation. However, I remind the hon. Gentlemen that the IFS also argued for a system of tax benefits to boost investment.

I turn to one or two other specific points that I took from the hon. Member for Chichester. He cited intellect and claimed that there had been an inconsistent application of the definition for the purposes of the relief. He has heard that message from professionals and some representative bodies; we heard the same message. He may remember that, during the 2004 Budget, we announced that the Inland Revenue would be looking hard at the practical delivery of tax credits. I can confirm that, as part of that, the Revenue will be considering, both internally and by holding discussions with outside interests, whether the schemes can be improved. That will include careful consideration and examination of whether there are grounds for the claims that he has heard.

The hon. Gentleman asked why unincorporated bodies and sole traders should be excluded from the R and D tax credit. The short answer is that all the evidence, including our discussions with business, suggests that almost all the R and D over £10,000 is conducted by limited companies. Where a company sub-contracts R and D to an individual, which is perhaps the most likely scenario that he is considering, it can claim the R and D tax credit. He might accept that, in the long term, that may mean a benefit to the

individual, as the company may be able to conduct more R and D than individual concerns.

Andrew Tyrie (Conservative, Chichester)

A moment ago, the Minister prayed in aid the IFS report, the concluding section of which I have in front of me. It says:

''Tax incentives seem a natural policy tool for a market-oriented government wanting to increased R and D expenditures.''

It goes on to say:

''Economists, however, been traditionally been sceptical over the efficacy of fiscal provisions.''

The last line of the report concludes:

''While there is a strong rationale for subsidising R and D''—

we agree that that is a reference to the theoretical rationale, which nobody is disputing—

''there are many potential pitfalls and we could end up causing more problems than we solve.''

John Healey (Labour, Wentworth)

I think that the hon. Gentleman simply amplifies the point that he made earlier, which I dealt with.

The hon. Gentleman also said that R and D tax credits are becoming a part of the avoidance industry. The Revenue does not yet have evidence of any large-scale avoidance emerging in the R and D tax credit regime. I say to him, quite directly, that if, as he was suggesting, accounting firms know of tax avoidance of that nature, I hope that they will help us to stamp it out, rather than taking on extra staff and turning it into a business activity for their own ends.

Finally, the hon. Gentleman said that the definitions are complicated, and suggested that they may somehow play into the hands of big companies. The Committee will recognise, and I accept, that the definition of research and development is not straightforward. It simply reflects in legislation the fact that the definition and practice of R and D are constantly changing and quite difficult to pin down. It is an area of innovation, new activity and new techniques, and it is never going to be straightforward to reflect such activity in tax legislation. Nevertheless, I was not sure that I heard him do so, but I hope that he will welcome our attempt to improve the definition.

The feedback that we have received from business and the industry has been very welcoming. For example, Deloitte said:

''The new guidelines are generally acknowledged as a significant improvement on the original'',

and PricewaterhouseCoopers said that the new definition that we proposed in the Budget is ''clearer and simpler''. In passing, I make it clear to the Committee that it also welcomed the extension of tax credits to apply not just to software but to power, fuel and water.

The changes in the clause will widen the range of costs that qualify for the relief, representing, as the hon. Gentleman said, a further Government investment in R and D of £35 million per year. We have listened, in addition, to calls to simplify the definition of materials used in R and D, which this clause implements, in the terms recommended by many companies and professionals. To be clear, the same changes are being made to all the R and D tax

credit schemes: first, the small and medium-sized company scheme; secondly, the large company scheme; and thirdly, the vaccines research scheme.

I do not know what the hon. Gentleman will choose to do, but I hope to see very strong support on the Labour Benches for an innovation that the Government introduced in 2002 and for clause 131.

Question put and agreed to.

Clause 131 ordered to stand part of the Bill.

Clause 132 - Temporary increase in amount of first-year allowances for small enterprises

Howard Flight (Conservative, Arundel and South Downs)

I beg to move amendment No. 104, in

clause 132, page 123, line 3, after 'small', insert 'or medium-sized'.

John McWilliam (Labour, Blaydon)

With this it will be convenient to discuss the following amendments:

No. 99, in

clause 132, page 123, line 5, after 'small', insert 'or medium-sized.'.

No. 100, in

clause 132, page 123, line 7, after 'small', insert 'or medium-sized.'.

No. 101, in

clause 132, page 123, line 12, after 'small,' insert 'or medium-sized.'.

I remind the Committee that this is a very narrow group of amendments, which deals only with changing ''small'' to ''small or medium-sized''. The meat of the clause is in the clause itself.

Howard Flight (Conservative, Arundel and South Downs)

I have much sympathy with the comments made by my hon. Friend the Member for Chichester (Mr. Tyrie) and the hon. Member for Yeovil (Mr. Laws), which have some relevance to this clause and these amendments.

The four amendments are all concerned with the proposed widening of the increase in first-year allowances, which will go up from 40 per cent. to 50 per cent., to include medium-sized as well as small businesses. As I understand it, the definitional territory is that a small business has a turnover of up to £5.6 million, a balance sheet of up to £2.8 million and up to 50 employees, and a medium-sized business has a turnover of up to £22.8 million, a balance sheet of up to £11.4 million and up to 250 employees.

The amendments reflect one of the suggestions in the CBI response to the clause. There are others, which I will come to later, in the stand part debate. It is fair to say that, in a sense, medium-sized businesses have become the poor relation. There are a great many tax and other incentives in the venture capital area. Large businesses have better access to markets. If anything, while a business is medium-sized, wherever the lines are drawn, it really does not have many advantages.

It is questionable whether such measures really work—as the previous comments made clear—but if they are to be introduced there does not seem to be much logic in restricting them to small companies, when if anything the medium-sized sector needs more assistance.

John Healey (Labour, Wentworth)

I was interested to note that the hon. Gentleman started by saying that he had a great deal of sympathy with the comments made on the previous clause. Those comments argued that we should not be extending the R and D tax relief scheme.

Howard Flight (Conservative, Arundel and South Downs)

I was duly obeying our Chairman's instructions. The other comments will come later. The amendments are to the clause as it will stand if we are to have such incentives.

John Healey (Labour, Wentworth)

I am in no doubt about the effect of the amendments. My point was simply that the hon. Gentleman expressed sympathy with the argument that was made about the previous clause, in which it was claimed that we should not be committing extra Government expenditure to the R and D tax relief scheme, when his amendments would do just that—to the tune of £180 million a year. The hon. Member for Chichester anticipated what he described as bees round the honeypot of claims for extending the relief in the future. Amendment No. 104 is clearly looking to the honeypot.

The purpose of the amendments is to extend to medium-sized businesses the increase in first-year capital allowances that we are introducing for small businesses. We are talking about something that is of a similar nature to what we have just discussed under clause 131. I want to ensure that the Committee is clear about the treatment of medium-sized companies, which is the concern behind the amendments. Earlier this year, we increased the thresholds for small and medium-sized businesses to the maximum allowed under European Union regulations. It is anticipated that that will cost the Exchequer £100 million this year, £170 million next year and £125 million in 2006–07. From January 2004, a business with a turnover of up to £5.6 million may be classified as small. In fact, about 99 per cent. of UK businesses are classified as small and so will be able to benefit from the increased allowances in the Bill.

Medium-sized businesses, which include businesses with a turnover of up to £22.8 million, will continue to benefit from the generous 40 per cent. first-year allowances for small and medium-sized enterprises that we made permanent in 2000. Increasing the rate of the first-year allowances for medium-sized enterprises from 40 per cent. to 50 per cent. would carry the high Exchequer cost that I mentioned, of £180 million for one year. That additional cost could not be justified. I am surprised that the hon. Gentleman is in favour of that. He has made it clear that it is the result of a representation made to him by the CBI.

Rob Marris (Labour, Wolverhampton South West)

Is my hon. Friend aware that the Institute of Directors, which has made submissions to me—and, I suspect, to other Committee members—has not suggested an extension of the allowance to medium-sized companies. The IOD has historically had a greater tendency to represent small and medium-sized enterprises than the CBI, which has a greater tendency to represent the big boys, although it does not do that exclusively, so it seems that the big boys want the extension and the little boys do not.

John Healey (Labour, Wentworth)

My hon. Friend makes an interesting point. I suspect that it will help him make up his

mind—as I hope it will all my hon. Friends—that the Committee should reject the amendments if they are pressed to a vote.

Howard Flight (Conservative, Arundel and South Downs)

I have not heard any rationale for why the allowance should be increased from 40 per cent. to 50 per cent. for small companies and not for larger ones, other than money. I take issue with the figure. I want to hear the Government's logic in doing this for small companies but not for medium-sized enterprises, which if anything are the poor relations.

John Healey (Labour, Wentworth)

The hon. Gentleman suggested that, if you were to allow a stand part debate, Mr. McWilliam, he would make some general points. I therefore thought it appropriate to consider such general questions if you do allow a short stand part debate.

Howard Flight (Conservative, Arundel and South Downs)

I look forward to hearing the Economic Secretary's response on stand part. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the clause stand part of the Bill.

Howard Flight (Conservative, Arundel and South Downs)

I will use the stand part debate to mention the two other issues raised by the CBI. The first concerns whether the Government are considering extending the benefit to businesses that do not buy plant but lease it. A later new clause—new clause 4—deals with that issue. Secondly, the CBI raised the issue of whether relief might be given for making physical alterations to premises to meet the requirements of the Disability Discrimination Act 1995, where I understand that the capital investment that is required to be in place by 1 October 2004 does not count as capital investment for first-year allowances.

More widely, and echoing the previous points, my concern is that the reason for the Government giving what it is giving to small businesses is, in fact, a sop or fig leaf to hide the removal of the 100 per cent. allowance on information and communications technology equipment and the introduction of the 19 per cent. non-corporate distribution rate tax. There seems little logic in a period of just two years. Small businesses do not have armies of accountants and finance directors to know about all these things. It does not seem logical to turn the tap on and turn the tap off. If anything, the economy is already at full capacity this year, so I look forward to hearing the Minister's justification for the measures.

John Healey (Labour, Wentworth)

This clause increases the rate of first-year capital allowances for small businesses from 40 to 50 per cent. for one year from April 2004. In our view, the increased allowances will assist small businesses' cash flow, and will provide enhanced funding for new investment. They are, of course, a vital part of the UK's economy, currently investing over £3 billion in plant and machinery. The increase in the first-year allowances at this time is designed further to support small businesses, encouraging them to innovate, invest and grow in the long term, ensuring that the UK economy more generally remains one of the fastest-growing in Europe.

The hon. Gentleman asked why now. If we accept the proposition that it is essential that our small businesses invest for the future, the upturn in the economy means now is the right time to provide the additional support to new, and in particular small, growing businesses. That is the reason for this targeted temporary increase.

On the CBI's representations over leased plant, the hon. Gentleman knows well that at present we have a radical review of the reform of corporation tax, and we have already announced that we will consider further whether the taxation of leased plant and machinery can be modernised. It makes sense to consider the CBI's representations and the points that he makes in the wider context, rather than in the narrower context of this clause.

On that basis, I commend the clause to the Committee.

Rob Marris (Labour, Wolverhampton South West)

On a point of order, Mr. McWilliam. I would like some clarity from you, perhaps via a Minister, as to whether Members should be declaring interests on this in terms of capital allowances to Members' expenses, and so on.

John McWilliam (Labour, Blaydon)

Anybody who has an interest should declare it.

Howard Flight (Conservative, Arundel and South Downs)

I certainly did not imagine that there was something other that Members of Parliament could claim here. If it is the case, it is yet another example of the lack of wisdom of such measures.

John McWilliam (Labour, Blaydon)

I can imagine one: if Members of Parliament wanted to buy an old steam typewriter out of their allowances, it would be covered.

Howard Flight (Conservative, Arundel and South Downs)

I just raised the question of incorporation versus non-incorporation, but if an interest is to be declared, let us declare it on behalf of all of us.

I suggest that the real reasons for this measure are that there is likely to be a general election in the next year, and it is a sop to the 19 per cent. non-corporate distribution rate. As I pointed out, there is no economic logic for benefiting small rather than medium. This is an example of a less than properly thought through economic justification for legislation.

Question put and agreed to.

Clause 132 ordered to stand part of the Bill.

Clause 133 ordered to stand part of the Bill.

Clause 134 - Lloyd's names:

Howard Flight (Conservative, Arundel and South Downs)

I rise just to acknowledge that I understand there has been very useful co-operation between the Inland Revenue and Lloyd's to sort out these arrangements, which arise from individual Lloyd's members converting to underwriting through limited liability vehicles, and we support the measures.

Question put and agreed to.

Clause 134 ordered to stand part of the Bill.

Schedule 25 agreed to.

Clause 135 - Offshore funds

Howard Flight (Conservative, Arundel and South Downs)

I beg to move amendment No. 192, in

clause 135, page 126, line 7, leave out

'the day on which this Act is passed'

and insert '17th March 2004'.

[R] Relevant registered interest declared.

John McWilliam (Labour, Blaydon)

With this it will be convenient to discuss the following amendments:

No. 193, in

schedule 26, page 408, line 29, leave out from beginning to 'this' in line 30.

No. 196, in

schedule 26, page 408, line 29, leave out

'the day on which this Act is passed'

and insert '31st December 2005'.

No. 194, in

schedule 26, page 409, line 20, leave out from beginning to 'this' in line 21.

No. 197, in

schedule 26, page 409, line 20, leave out

'the day on which this Act is passed'

and insert '31st December 2005'.

Again, this is quite a narrow group of amendments.

Howard Flight (Conservative, Arundel and South Downs)

May I crave indulgence by saying up front that the investment management industry—and I personally declare an interest for the register—was greatly concerned that the measures under this part of the Bill would be damaging for the industry, and especially potentially damaging for hedge funds, and there is great relief that the reverse is the case. The clause contains some important relaxations, and it will enable umbrella funds to include distributing and non-distributing funds, which saves quite a lot of time, administration and costs for individual investors. The measures are essentially welcome.

There are two starred amendments in the group, but to a large extent they are a different way of achieving the aims of two of the other amendments, which deal with accounting date issues and including as large a number as possible of funds within the new arrangements. The start date in the clause is likely to exclude those funds with a 30 June 2004 year end. Amendment No. 192 suggests that the date should be brought forward. An eventuality that appears not to be covered is the position relating to a sub-fund or a share class that ceases prior to the effective date, and the implications of that in relation to whether the sub-fund falls under the new or old rules.

Amendments Nos. 193 and 194 are alternative versions, in a sense, of Nos. 196 and 197. They are a response to the fact that the change in calculation of UK equivalent profits from an income tax basis to a corporation tax basis in connection with creditor relationships and derivative contracts, as the clause stands, raises some problems that might be better dealt

with within the Bill. Following a pragmatic approach, the amendments would do away with the complication and uncertainty in calculating UK equivalent profits for bonds and derivatives as the accounting measure will tend to be followed. However, an important assumption is that the accounts of the funds are compliant with the authorised unit trust statement of recommended practice.

More guidance is required on what will be accepted by the Inland Revenue in relation to what the offshore fund managers need to do to prove the fund accounts are SORP-compliant. There have been some discussions with the Revenue on the amendments, and I repeat that there are two versions: amendments No. 193 and 194 and amendments Nos. 196 and 197. We seek to standardise accounting arrangements in the future.

Ruth Kelly (Labour, Bolton West)

I will ask the Committee to reject the amendment. Before I address the specific points raised, it may help if I explain the purpose of the changes that we are proposing. Their aim is to provide more flexibility for fund managers to tailor their products to the marketplace and to enable more UK investors to use the tax rules that they would have used if they had invested in an equivalent UK fund.

The changes focus on the rules for an offshore fund to obtain distributor status. That in turn determines the tax treatment of the UK investor. There are three main changes. First, offshore funds will be able to use the same corporation tax rules as a UK unit trust in measuring their distributions against their profits instead of income tax rules. Secondly, some of the investment restrictions are abolished. Thirdly, separate sub-funds and classes of interest can qualify for distributor status individually in their own right without affecting or being affected by other parts of the fund.

The Bill provides a regulatory power to deal with some mainly administrative issues arising from applying the rules to sub-funds and classes of interest. Consultation with industry representatives is in train to identify what regulations will be needed, but at this stage I can assure the Committee that I have seen nothing to suggest that the regulations will cover anything other than minor points of detail and/or transitional issues that would overburden the primary legislation with changes with a short lifespan.

The changes follow a productive period of consultation with the funds industry. I am confident that they will be welcomed by fund managers and investors alike. Indeed, I note the support of the hon. Member for Arundel and South Downs for the overall thrust of the changes.

Amendment No. 192 seeks to bring forward the commencement date so that the changes apply to account periods ending on or after Budget day—17 March 2004—instead of on or after the date of Royal Assent. However, I draw to the Committee's attention the fact that the changes have already been announced. They have been welcomed by fund managers, who have already started planning in

response to them. They will have taken decisions based on the expected start date. If we change that to 17 March, some fund managers may have to unpick commitments that they have given, and that may not even be possible.

Moreover, if the new rules were to apply to account periods ending on or after 17 March 2004, they would affect the last but one tax year. It would be wrong to expect some investors to check back to that year to determine whether they were affected. If the start date is left as it is, it will affect only the tax year that has just ended.

The hon. Gentleman asked about a sub-fund or share class that ceases before the effective date. The new rules allow the sub-fund or class of interest to take the same account period as its umbrella fund in order to qualify under the new rules, provided that the umbrella fund account date falls after the commencement date. I imagine that that deals with the hon. Gentleman's concern.

The remaining amendments appear to address the same point, so I shall take them together. The changes respond to a long-held concern of the industry: namely, that to test for distributor status, accounts had to be recast on an income tax basis for interest income and income from derivative contracts such as futures and options. The industry pressed us to allow it to move to the full corporation tax basis, and we have changed the rules in response to its concerns. We also took note of its concerns that existing funds might need time to change their systems and deal with any transitional problems before moving fully to the new basis. The new rules allow for that to happen.

The amendments would allow wholly new funds to use the old income tax-based method to test their distributor status. That would run counter to the aim of the changes and counter to what the industry clearly wants. Both the industry and the Government wish to phase out the old rules, but we will not achieve that if yet more funds start up under them.

I note that amendments Nos. 193 and 194, which would allow new funds indefinitely to use the old rules, have been tempered by the later proposals to allow that only for new funds established on or after 31 December 2005. However, that would still allow new funds to work on the old basis long into the future; for example, a new fund established in December 2005 would draw up its first accounts in December 2006. Fund managers argued that the corporation tax basis was the way forward and, having agreed to that, we wish to press ahead without undue delay.

The hon. Gentleman asked about SORP. The Revenue is discussing with the industry how to take that forward in guidance. I will respond to him if he writes to me with particular concerns.

In summary, we have gone a long way towards achieving the reforms for which the industry has been looking. The changes will boost funds' ability to compete in the market. This is a changing environment. I welcome the positive dialogue with the industry that led to the changes, and I assure the

Committee that that dialogue will continue. I urge the hon. Gentleman to withdraw his amendments.

Howard Flight (Conservative, Arundel and South Downs)

Amendment No. 192 is intended simply to allow more funds to take advantage of the new flexibility earlier. It is a minor, constructive point, and I take the point that the main concern has been addressed.

The two other sets of amendments are supported by the industry and the Institute of Management Accountants, which I understand are in continuing discussions with the Inland Revenue. The issue is that the Bill prescribes one regime for accounting standards for funds established before Royal Assent, and another for funds established afterwards. Funds subject to other jurisdictions' accounting requirements have to perform additional computations of UK equivalent profits, and that has given rise to a lot of operational hassle. The Bill proposes that funds established on or before Royal Assent can elect to compute UKEPs arising from creditor relationships and/or derivative contracts by reference to chapter 2 of part 4 of the Finance Act 1996 and schedule 26 of the Finance Act 2002 as if they were an authorised unit trust. However, the same flexibility is not provided for funds established post-Royal Assent.

The amendments would provide that flexibility for funds established post-Royal Assent but before international accounting standards were adopted in January 2006, and from January 2006 the Government would use the new regulatory power to update the reference to international accounting standards. In its discussions with the Revenue on that point, the IMA had been seeking to implement a common implementation date, and it hoped that that would have support.

Ruth Kelly (Labour, Bolton West)

I thought that I had dealt with the hon. Gentleman's amendments during my response to his concerns. The issue of international accounting standards applies to listed companies and consolidated accounts for the accounting period starting on or after 1 January 2005. In the United Kingdom, individual companies may use them from that date too, but other jurisdictions may have other rules or requirements and are unlikely to be driven by when the offshore funds themselves will be required to adopt international accounting standards. We are in continuing discussions with the industry about how the issue will be dealt with, and I am sure that we will be able to respond to the point to the satisfaction of both parties. On that basis, I hope that the hon. Gentleman will seek leave to withdraw the amendment.

Howard Flight (Conservative, Arundel and South Downs)

In respect of amendments Nos. 196 and 197, I understood that there was some agreement between the Revenue and the IMA on the arrangements. On the basis of what the Minister has said, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 135 ordered to stand part of the Bill.

Schedule 26 - Offshore funds

Howard Flight (Conservative, Arundel and South Downs)

I beg to move amendment No. 195, in

schedule 26, page 414, line 30, at end insert—

'(1A) In subsection (3), paragraph (a) replace ''5 per cent'' with ''15 per cent''.'.

The investment conditions to be met by funds seeking distributor status are essentially being removed, but the 5 per cent. limit on investment in other funds has been retained, which poses problems for funds of funds. The amendment would allow an offshore fund to hold a greater interest in a non-qualifying offshore fund and it would allow greater flexibility in the fund-of-funds market; 15 per cent. is a common threshold used in other investment funds. It may be arguable that 15 per cent. is too great, but the 5 per cent. limit still causes significant problems to the development of funds of funds.

Ruth Kelly (Labour, Bolton West)

The amendment would triple the amount that an offshore fund can invest in other offshore funds without losing its status as a distributing fund. As I explained earlier, the clause and the schedule introduce changes to the offshore fund regime. They are the result of consultation with the industry and have generally been welcomed as providing more flexibility for fund managers to tailor their products to the marketplace. They also enable more UK investors to have the same tax rules as if they had invested in an equivalent UK fund. The changes do not alter the investment restriction, which limits to 5 per cent. the amount an offshore fund can invest in other offshore funds without losing its distributor status.

The purpose of the 5 per cent. rule is to stop funds accumulating income in lower-level funds and taking only a small distribution from those funds, which they then distribute to their own unit-holders. The level of 5 per cent. is a form of de minimis to allow relatively small investments in other funds to be disregarded.

A change to 15 per cent., as proposed by the hon. Gentleman, represents a major shift, and it would give funds wider scope to structure their investments to minimise the amount that they are required to distribute. It could radically alter the competitive balance between offshore and UK funds. Moreover, a level of 15 per cent. can hardly be regarded as de minimis, as it is even higher than the 10 per cent. regulatory limit on investing in other funds imposed by the EU directive for collective investment funds.

The new offshore fund rules offer a considerable gain in flexibility to the funds industry, but we must retain the basic integrity of the offshore funds tax system to ensure a level playing field. I therefore urge the hon. Gentleman to withdraw his amendment.

Howard Flight (Conservative, Arundel and South Downs)

I am inclined to accept the argument that 15 per cent. is too high. It is not a matter simply of the difference between onshore and offshore funds, because an onshore fund may wish to develop along a founder funds route and the regulatory level is 10 per cent. I hope that the Government will further consider that as a matter of principle, but I accept that the

industry should be pleased with the measures. On that basis, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 26 agreed to.

Clause 136 - Meaning of ''offshore installation''

Howard Flight (Conservative, Arundel and South Downs)

There have not been any major objections to the clarification offered by the clause, but some questions have been raised. The explanatory note states:

''The same types of vessel will continue to be categorised as an offshore installations as now'',

and it gives the examples of offshore installations, jack-up drilling rigs—

John McWilliam (Labour, Blaydon)

Order. We are speaking to the schedule again and not the clause. It is the usual problem with schedules; I do not know why we are not allowed to debate schedules with clauses. That would seem eminently sensible to me. Perhaps I should write to the Chairman of the Procedure Committee about that.

Howard Flight (Conservative, Arundel and South Downs)

I thank you, Mr. McWilliam; I have nearly finished. The courts have held that those vessels are currently not offshore installations. Confirmation is sought that vessels that the courts have said attract relief will continue to do so. However, as you pointed out, Mr. McWilliam, that is the schedule and not the clause.

Question put and agreed to.

Clause 136 ordered to stand part of the Bill.

Schedule 27 agreed to.

Clause 137 ordered to stand part of the Bill.

Clause 138 - Corporation tax: health service bodies

Andrew Tyrie (Conservative, Chichester)

You will be pleased to hear, Mr. McWilliam, that I will not delay the Committee for long. I want clarification about what the clause means because the background notes are somewhat confusing. As I understand it, the Treasury is saying that, by order, it can remove a foundation trust exemption for a specified activity or class of activity that appears to be of a commercial nature where the exemption is likely to favour the foundation trust over a commercial body which might want to undertake or is already undertaking the activity. In that case, the foundation trust can choose to form a non-charitable company to conduct such activities and be taxed in the normal way; otherwise, I presume, it is possible for the foundation trust to form charitable companies so that the foundation can benefit from gift aid. In other words, it can get the relief on tax that it would

otherwise have to pay back to the foundation through gift aid. If that is what the measure is about, I want to raise two issues.

First, what is the purport, if any, of paragraph 16 of the background notes? It states that

''there is no requirement for NHS foundation trusts to conduct such activities within a limited company. So''

in the absence of

''any requirement to do so, it is entirely possible for such activities to be carried on by and within NHS foundation trusts themselves and any profits would be exempt from tax.''

That is confusing.

Secondly, I presume that there are some general provisions to prevent round-tripping of the gift aid so that, if the money goes back to the foundation trust, it cannot then go back to that commercial entity to which I referred and thereby give the company that has been created by the foundation trust a commercial advantage.

Provided that I have clarification of those two points, I am happy with the clause.

Ruth Kelly (Labour, Bolton West)

The purpose of the clause is straightforward: to put NHS foundation trusts on the same tax footing as NHS trusts. The companies set up by NHS foundation trusts are not charities, so the issues that the hon. Gentleman raises do not apply. They would be run as commercial companies and taxed on the same basis as NHS trusts are currently taxed. This is purely a competitive issue so that NHS foundation trusts do not have an unfair competitive advantage over other companies that are attempting to run the same business. [Interruption.]

Does the hon. Gentleman want to intervene?

Andrew Tyrie (Conservative, Chichester)

I am sorry, but I have not made myself clear. We are completely at one on the intention. I just wanted clarification on the blocking of round-tripping, which I am sure is there somewhere, on the gift aid side. Perhaps the explanatory notes could have been better drafted. When the Financial Secretary looks at them later, she will see how much scope for confusion they contain.

The rest of the debate is in Hansard.