Orders of the Day — Finance (No. 2) Bill

House of Commons, 3 May 2006.

[Sir Alan Haselhurst in the Chair]

Schedule 14 — Investment reliefs: venture capital schemes

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 6, in page 74 [Vol II], leave out lines 5 to 26.

Alan Haselhurst (Deputy Speaker, Saffron Walden)

With this, it will be convenient to discuss the following amendments: No. 7, in page 74 [Vol II], leave out from beginning of line 27 to end of line 4 on page 75.

No. 8, in page 75 [Vol II], leave out lines 5 to 18.

No. 9, in page 75, line 18 [Vol II], at end insert—

PART 1A

definition of gross assets

Mark Hoban (Conservative, Fareham)

The first four amendments in this group deal with issues to do with the gross assets of investee companies. Those matters come into sharp focus as a consequence of the proposed reduction in the gross assets limit for venture capital trust investments. The final amendment in the group deals with changes announced in the Budget to the treatment of the VCT's own assets.

One of the most significant changes to the rules applicable to VCTs and enterprise investment schemes is the Bill's proposed reduction in gross asset limits, and amendments Nos. 6, 7 and 8 would reinstate the limits that apply under the current legislation. The current rules state that gross assets should be equal to, or less than, £15 million prior to fundraising and £16 million after fundraising. That allows the very largest qualifying companies to raise £1 million.

The proposed changes will reduce the gross assets limit so that a company will have no more than £7 million in gross assets prior to fundraising and no more than £8 million afterwards. The effect will be to reduce the amount that certain companies are able to raise. At present, a company with gross assets of £6 million is able to raise an additional £10 million through fundraising, but in future it will be able to raise only about £2 million. I am concerned about the effect on the operation of VCTs, and about the nature of the companies in which they can invest.

If a VCT invests now in a company whose gross assets before investment comply with the new rules proposed in the Bill, its ability to make a follow-on investment will be restricted. Under the current rules, however, the VCT can make further investment in the company until the £15 million asset limit is reached.

My experience before I came to the House was that early investors can find that their holdings and interest are diluted by people who come in later. It is often in their interest to make follow-on investments to maintain the size of their interest in the company. Reducing the gross assets limit from £15 million will restrict VCTs' ability to do that if the company hits the proposed new £7 million limit.

Secondly, the proposed reduction in the gross assets limit is that it could change the asset base that VCTs and the Enterprise Investment Scheme can invest in. The focus will be on smaller, and therefore arguably more risky, companies.

The lower gross asset limit proposed by the Government will focus more finance on the companies in the funding gap identified in the Treasury publication entitled "Bridging the Gap", but there is a feeling that some slightly larger companies will still find it difficult to attract investment. The proposed reduction in the gross assets limit will exclude them from this source of investment, with the possible unintended consequence that the funding gap is moved further up—that is, that the needs of smaller companies will be met, but that slightly larger companies will lose out.

The reduction in the gross assets limit could also change the type of businesses that VCTs invest in. Simon Rogerson of Octopus Asset Management has said:

"Managers will steer clear of asset rich UK manufacturing companies, focusing on asset poor service companies."

When manufacturing is suffering from overseas competition and business investment is at a record low in real terms, is it right to exclude those businesses from the opportunities that VCTs present?

It is not just manufacturing businesses that are asset rich. Last week, I visited a firm in my constituency that acts as a data centre for businesses, housing the servers that they need to power and maintain their websites. It is a relatively small business with about 30 employees but the cost of its data centre, including plant, cooling and some security measures, is extremely high relative to its turnover and its employee numbers.

We must recognise that even a relatively small service business can be asset intensive and fall outside the limits set out in the Bill. Is it right that asset-intensive businesses are squeezed out of such funding? The Minister will argue that the problem would exist at whatever level the gross assets limit is set, and that is true. In a way, it is a crude proxy for company size, but the reduction in the gross assets limit from £15 million to £7 million makes the problem all the more evident. As asset levels fall, it is likely that more businesses will find funding through VCTs difficult to access.

I should be grateful if the Minister would explain the basis on which the new lower gross assets figures were determined and say what steps he will take to monitor the flow of funds into VCTs and the EIS and the nature of the companies in which those funds are invested to ensure that the reduction does not adversely affect companies seeking funds. Will he also ensure that the measure does not simply lead to the funding gap moving up from companies with assets of less than £15 million to companies that previously would have benefited from funding through VCT schemes?

Brooks Newmark (Conservative, Braintree)

Does my hon. Friend recognise that moving to lower asset values and smaller companies will mean a much greater inherent risk to those investing in such companies?

Mark Hoban (Conservative, Fareham)

My hon. Friend is absolutely right. When companies have lower asset values there is an increase in the level of risk, which will prompt investors to consider the risk-return ratio and think about whether their likely returns from VCTs in the future are sufficient to warrant that investment being made. The Government need to monitor that carefully to ensure that having turned the tap on in VCT funding by increasing the tax relief, a matter to which I will return in later amendments, the consequential changes in the Bill of reducing that relief, increasing the holding period and reducing the gross assets limit, will make VCTs less attractive to investors, thus depriving smaller businesses of the funds that they need to expand and grow. My hon. Friend was quite right to highlight the importance of risk and its role in assessing these investments, and the relationship between small businesses and risk.

Amendment No. 9 relates to the definition of gross assets that is set out in the Income and Corporation Taxes Act 1988. The amendment revisits that definition, taking into account changes in accounting practice that might have an adverse effect on companies' ability to access funds from VCTs in the future. It is, I regret, a highly technical amendment relating to the definition of gross assets of an investee company. Under UK generally accepted accounting practice, companies were given a choice with regard to the capitalisation of development expenditure: they could capitalise it or expense it. The rules setting out the basis on which that could take place were set out in the standard statement of accounting practice—SSAP 13—"Accounting for Research and Development".

The permissive nature of SSAP 13 in giving companies that choice, together with the wide application of the prudence concept, generally resulted in businesses writing off development expenditure in their profit-and-loss account. For companies seeking investment from VCTs, and through the EIS, that was good news, because there was no addition to their gross asset figures.

However, although UK accounting standards remain in place for unlisted companies, listed companies are adopting international financial reporting standards and one of the differences between UK and international standards is the treatment of development costs. Under international standards, development costs can be capitalised if they meet one of the following six criteria: the technical feasibility of the project; the intention to complete the intangible asset for use or sale; the ability to use or sell the intangible asset; how the intangible asset will generate probable future economic benefits; the adequacy of the resources for completion; and the ability to measure reliably the development expenditure.

The criteria are broadly similar to those used under SSAP 13 and are designed to ensure that only costs clearly identifiable as relating to a project that will be completed, which the company can afford to complete and which will yield financial benefits will be capitalised. In essence, they ensure that only costs that can lead to a realisable asset will be capitalised. If international financial standards matched SSAP 13 in their entirety, there would be no issue, as a company would be unlikely to capitalise those costs. However, there is a vital difference from SSAP 13: the relevant international standard states that where the six criteria are met, the costs should—I emphasise the word "should"—be capitalised.

So where is the issue for VCTs and investee companies? Capitalised development costs will count towards the gross assets test. That is increasingly important for two reasons: first, the lower gross assets test will bite, and secondly, although the Treasury might argue that IFRS apply only to listed companies and are thus unlikely to become an issue for unlisted companies, in reality I suspect that companies will increasingly adopt IFRS as a basis for reporting. That will be of particular interest to companies who may want an exit route through a listing in the future and may want to implement IFRS from the outset rather than restate their accounts at a later date. Having worked on such exercises in the past, I should prefer to start off with the basis on which I intend to report my results, rather than changing it partway through. If nothing else, it would save on the fees businesses pay to organisations such as my former firm.

In practice, the adoption of IFRS is likely to mean that more development expenditure will be capitalised than under UK GAAP. Coupled with the reduction in gross asset rules, that could lead to fewer companies in need of capital qualifying for investment under VCT rules. As my hon. Friend the Member for Braintree (Mr. Newmark) suggested, there could be a double effect: first, there will be a change in accounting standards and, secondly, the lower gross asset figure will bite at much smaller companies. The changes will have an impact, in particular, on the software and pharmaceutical industries, many of which seek VCT investment.

We believe that the decision to transfer to accounting under IFRS should not be hampered by the need to consider that potentially extremely significant adverse impact. I would be grateful for the Financial Secretary's thoughts on what is very much a probing amendment at this stage.

Amendment No. 13 covers the way in which VCTs manage their assets. Again, it is a technical amendment, which highlights the concerns of a number of VCT managers and their advisers. One of the challenges that faces a VCT is how to manage its investments and any cash balances, while ensuring that once the initial investment period is over it complies with the rule that 70 per cent. of its investments are in qualifying investments—that is, investments in unlisted companies. Changes under the Finance Bill have an impact on the way that VCT managers can manage the affairs of their trusts. Historically, a VCT could place cash in non-interest-bearing accounts as a short-term measure to try to meet the 70 per cent. rule.

Let me give an example to explain more clearly. A venture capital trust with investments of £10 million fully invested in unlisted companies would meet the criteria as 100 per cent. of its investments are in qualifying companies. A VCT could, for commercial reasons, decide to realise an investment of £4 million. If it put the cash in an interest-bearing account, it would have investments of £10 million but qualifying investments of only £6 million. Therefore, it would fail the 70 per cent. test. Under current rules, the VCT would be able to place the £4 million in a non-interest-bearing account and achieve the 70 per cent. rule by having £6 million in investments and £6 million in qualifying investments. It could then act to return that cash to its shareholders or make a further investment in another company without losing its qualifying status, because it would not be in breach of the 70 per cent. rule.

There are strong reasons why VCTs would seek to use the cash as soon as possible. Investors focus on returns and if one invests the realised proceeds in a non-interest-bearing account, that is not very good for the overall return of the VCT. There is an opportunity under the existing rules to manage the VCT more smoothly, but there is also commercial pressure to ensure that the assets are used as quickly as possible and in a way that does not disturb the orderly management of the VCT.

Under the rules in the Bill, that opportunity would no longer be available to VCTs and the concerns of managers have fallen into two categories. Those in the first group say that they would rather the rules were not changed at all. They would make it easier for all VCTs to handle non-interest-bearing deposits and to put cash into them to ensure that the 70 per cent. rule applies. Those in the other group suggest that the rule should not apply to VCTs that have already been set up. Managers might have taken different decisions if they had known that the relief was to be removed from the VCT. Under amendment No. 13, when a VCT has raised money before 6 April 2006, the money could still be placed in non-interest-bearing deposits and fall outside the definition of investments to ensure that it would be easier for VCTs to meet the 70 per cent. rule while bearing in mind that there will still be the commercial pressure to ensure that the money is returned to shareholders or reinvested as soon as possible.

In conclusion, amendments No. 6, 7 and 8 seek to elicit from the Government their reasoning for reducing the gross asset test and to establish whether they have fully thought through the impact of that on the potential investments of VCTs. Amendment No. 9 seeks to change the definition of gross assets to reflect changing accounting treatment and to find a way in which the reduction of gross asset test could be mitigated to the benefit of certain companies that invest in, and spend a great deal of money on, development. Amendment No. 13 seeks to make it easier for VCTs to manage their own assets in an ordered way rather than having to act precipitately when a realisation is made.

Brooks Newmark (Conservative, Braintree)

I begin by drawing attention to my entry in the Register of Members' Interests. Although I have never invested in a venture capital trust, I have, over the past 15 years, been both a venture capitalist and an angel investor. I hope that I can bring some of my practical experience to bear on this debate, especially in the context of amendments Nos. 6, 7 and 8. I will not address amendments Nos. 9 and 13, because my hon. Friend the Member for Fareham (Mr. Hoban) thoroughly covered those issues.

Yesterday, we established that one of the themes of this year's Finance Bill is the Government's ongoing attempt to fix things that are not broken and to fudge those that are. The Bill's treatment of venture capital trusts is no exception to that trend. VCTs have clearly demonstrated that they are performing well in the market and seem to vindicate the Government's attempt to address the "equity gap" through targeted market intervention.

We need look only as far as the figures given on the website of Her Majesty's Revenue and Customs for the total investment in VCTs. After a peak in 2000–01 of £450 million, investment plummeted to only £70 million in each of the years 2002–03 and 2003–04. That was the situation facing VCTs at the time that the Finance Act 2004 implemented the new income tax relief scheme. In the following year, investment reached £520 million and has surpassed £700 million in the last financial year.

When the Treasury Committee conducted its inquiry into the success of the incentives it heard that

"there is very clear evidence"

that the incentives had reversed "a dramatic decline" in VCT investment, and had led to a

"significant uplift in the amount of capital that VCTs have been able to raise."

The Government should be congratulated on that; it is beyond dispute. However, I do dispute that the reduction in the gross asset value of companies eligible for VCT investment is the appropriate way to refocus tax incentives on the equity gap.

Not only are the Government moving in the wrong direction on this issue, but they are moving in two directions at once. Part 1 of schedule 14 will alter the level of risk that VCT investors are exposed to by targeting VCT investment in smaller companies. That is the Government's stated aim. However, part 2 of schedule 14 cuts the incentives that investors will receive. The two parts must be considered together because if any of part 1 remains in the Bill, it will have a knock-on effect on the need for the incentives offered in part 2 of the schedule.

As one industry analyst has said, the Government's proposal

"has changed the risk and reward profile of VCTs significantly".

Another comments that the change

"appreciably alters the risk-reward profile of private-equity investment by personal taxpayers."

Since bad news comes in threes, let me offer one further comment:

"The reduction to company size greatly increases the level of investment risk. Smaller companies are normally, by their nature, more risky."

That is the point that I made to my hon. Friend the Member for Fareham. That problem has long been foreseen.

In 2003, the Treasury conducted its own analysis of the likely consequences of tinkering with the balance between risks and return. It concluded:

"If there were clear evidence that this would reduce the attractiveness of investment in VCTs, there might be a case for enhancing tax reliefs at the same time as tightening the scheme's focus."

Reducing the gross asset value of eligible companies was always considered to be an alternative to altering the structure of incentives.

Three years later, the Treasury is determined to pursue contradictory objectives by increasing risks and cutting incentives at the same time. The position is simply not sustainable. Instead of fundamentally altering the balance between risk and return, the Government should be ensuring greater investor protection. Bearing in mind that there are already a healthy number of business angels available to provide seed capital for high-risk start-ups, I question whether it is appropriate to encourage individual investors into higher beta investments in companies with a gross asset value under the proposed new limit.

This concern is growing in currency. In November, the chief executive of the Financial Services Authority told the Treasury Committee that, despite having issued warnings to investors and VCT providers, the FSA

"need to be perhaps a little smarter on how we convert the data we put on our website into the information that goes into the hands of the population."

The Government have a responsibility to keep a grip on the balance between the risks and rewards offered by VCTs. Changing both sides of that equation at the same time is imprudent.

Nevertheless, I recognise that there has been some justified concern that VCTs are not operating in the way that was intended when they were set up 10 years ago. Foremost among those concerns is the one about the practice of parallel investment, in which two or more VCTs under the same management act together to invest beyond the £1 million investment limit imposed on each separate VCT. As Lucius Cary, the founder of Oxford Technology VCTs, has said, although that behaviour

"may be technically legal, it is pushing the boundaries and undermining the original objectives of the legislation."

Clearly, VCTs clubbing together to take part in larger management buy-outs is a problem, but it is a problem that was foreseen. The Treasury's report into the equity gap, which dated from before the changes included in the Finance Act 2004, examined the issue of regulating concert parties in order to assist early-stage investment. The report suggested that

"the scheme rules could place restrictions on VCTs forming part of an investment syndicate that collectively invests beyond the £1 million upper investment limit."

If the Government remain concerned by parallel investment, Ministers should confront the issue head-on and not seek to address it by the roundabout route of restricting the gross asset value of eligible companies.

I want to return to my substantive objections to the changes proposed in part 1 of schedule 14 and to my reasons for arguing that they should not stand part of the Bill. Based on my experience as a practitioner, I believe that restricting the gross asset value of eligible companies to £7 million before investment and £8 million immediately afterwards does not focus on the real equity gap. If anything, the limits have been moved in the wrong direction and the probing amendments tabled by my hon. Friend the Member for Fareham are modest in seeking to preserve them at the current level.

There are an abundance of business angels who are capable of providing seed capital—that is generally provided for companies with gross asset values of £1 million to £3 million—to kick-start small businesses. The real difficulty that businesses continue to face is in accessing second-round financing. That is the issue. Many individuals who came to me when I was in the business before I came into the House would complain that there was a lack of access to capital once companies got above roughly £5 million. We should address that gap between £5 million and £25 million.

Further restriction of the gross asset value of eligible companies would be retrograde. I appreciate that this is not part of the amendment, but we should be looking to raise the limit to £25 million instead of slashing it. Recently, in another place, Lord MacGregor of Pulham Market said of the existing gross asset value limit:

"There is clear evidence that it is companies above that level which need the venture capital investment. The limit has not . . . been indexed, and it needs to be looked at again."—[Official Report, House of Lords, 16 March 2006; Vol. 679, c. 1410–11.]

The Government have indeed looked at the matter again, and drawn the wrong conclusions again. That is a judgment based on my experience in the industry. The change in gross asset value in schedule 14 is too sudden and significant to be undertaken without greater industry consultation and I urge the Government to reconsider their decision.

Colin Breed (Liberal Democrat, South East Cornwall)

The Liberal Democrats and the House as a whole have to recognise that the private equity market in the City has been one of the great successes in recent years. It now provides more than 50 per cent. of all private equity in Europe; perhaps it is second only to the US in the provision of that capital. The Government have played a part in that by providing the legislative and taxation framework and a business-friendly environment in which that could happen.

It therefore seems rather strange that we should be restraining that very success with the proposals in the schedule. I suspect that tax breaks have been the driving force. The hon. Member for Braintree (Mr. Newmark) successfully pointed out that, only a few years ago when things were going into a decline, the change was made and more money was put in. Perhaps it is the very success—now building up to more than £700 million or £800 million—that is causing the Treasury to become rather frightened at the prospect of the amount of tax relief that it is going to allow.

Rob Marris (Labour, Wolverhampton South West)

According to my understanding of the matter, the hon. Member for South-East Cornwall (Mr. Breed) is making exactly the same mistake as the hon. Member for Braintree (Mr. Newmark). The hon. Member for South-East Cornwall is talking about the capital limit, which is of course the subject of the amendments. But when he is talking about the restriction of relief, he seem to be overlooking that the relief for enterprise investment schemes will increase from £200,000 to £400,000 and that the reference by the hon. Member for Braintree to a rate of 30 per cent. involved a misunderstanding. The rate is currently 40 per cent. for a two-year period, which is expiring. If it expired and no provision were made in the Bill, the rate would go down to 20 per cent. In fact, under the Bill, the rate will go to 30 per cent., so tax reliefs are being increased.

Colin Breed (Liberal Democrat, South East Cornwall)

I entirely accept that. We can look at those compensations and the way in which the provisions tinker about with the actual amount of tax relief and the allowable assets. That tinkering has been brought about to try to engineer a more focused approach to smaller companies and to try to address some of the issues in respect of the risks and rewards. The incentives in that respect have been drastically reduced and there will be a significant reduction in the amount of private equity that will be going into small businesses in relation either to start-up or to development capital.

That echoes what we were talking about yesterday afternoon in relation to small businesses. We are looking to try to provide a regime that gives businesses that have been started up the opportunity to move on, so that they become more successful, provide more opportunities in relation to the economy and employment and indeed provide corporation tax. We seem to have situations and regimes that are not connected to each other. The hon. Member for Braintree was talking about the gap between £5 million and £25 million, which may be termed development capital, rather than venture capital. There is certainly a gap there.

Brooks Newmark (Conservative, Braintree)

One of the problems that we face is that the private equity industry, which was alluded to, is, in effect, moving further up the food chain and the elements involved are getting bigger and bigger. The funding gap is indeed at the lower level, which is where business angels are needed and are playing a role. The point made by the hon. Member for Wolverhampton, South-West (Rob Marris) was irrelevant to the amendments; it had to do with taxation. We are concerned with gross asset values. By shrinking where we give the incentives for investors to go in—by lowering that limit—we are going to make it far more risky and far less attractive for individuals to go into that part of the market.

Colin Breed (Liberal Democrat, South East Cornwall)

I entirely agree with that. We will see that reduction in the figures next year if these proposals go through. The Government are trying to engineer a reduction because they are looking to try to save some money in relation to this scheme. That will be a false economy. Opportunities will be largely missed because private equity funds are not going to be as prevalent as they have been in the past few years. There is no suggestion that there is a shortage of businesses looking for such capital. Indeed, there is probably more demand than there is current supply. If it were the other way round, there could be an opportunity to say, "Well, we do not need so many incentives." However, significant numbers of businesses—even at that lower level; let alone the development level—are looking for the sort of private equity that they require to expand.

I also entirely agree that the 70 per cent. investment rule needs to be looked at, particularly in relation to those funds that regularly liquidate some of their investments and then hold them in some sort of interest-bearing account. It would make no sense whatsoever to force them into non-interest bearing ones. I am sure that there is an easier—or perhaps more elegant—way of dealing with that than is currently the case.

The alternative investment market has been a great success, but less money will go into it because the sort of companies that will qualify will not attract—

John Butterfill (Conservative, Bournemouth West)

Order. The hon. Gentleman will be aware that this particular issue arises on a later group of amendments. I would be grateful if he confined his remarks to the present group of amendments.

Colin Breed (Liberal Democrat, South East Cornwall)

I am grateful, Sir John, and sorry that I transgressed.

I have tried to find out what the savings resulting from the measure will be, but the estimates are rather wide. When the Minister gives us the benefit of his information, will he tell us what sort of savings there will be? I have seen figures ranging from between £15 million and £400 million, so I do not know what the exact savings are likely to be. However, if the savings are anywhere between those figures, such tinkering seems to be unnecessary. The measure addresses a success, rather than a problem, and that success needs reinforcing, not restraining. The opportunities that are available to private companies will necessarily be reduced and investment will become less attractive. Overall, the measure is unnecessary, given the sort of savings that it will make.

If a reduction is absolutely necessary, the methods that the Government are choosing represent using a sledgehammer to crack a not especially difficult nut. A more sensible approach might be to focus on certain sectors, rather than going across the board. If the Government want to define the scheme so that it is less expensive to the Treasury, I am sure that there would be ways in which they could focus on the sectors for which they want to produce more help. As the hon. Member for Fareham (Mr. Hoban) said, the proposals will probably lead to gravitation towards technology-based businesses with intangible assets, rather than businesses with tangible assets.

Stephen Hesford (Labour, Wirral West)

The hon. Gentleman says that the Government could approach the matter differently by focusing on sectors. If there was limitation in the way in which he suggests, how would he guide us? Which sector would he focus on and how would he do that?

Colin Breed (Liberal Democrat, South East Cornwall)

First, I would prefer to leave the scheme as it is. However, if we were to examine certain sectors, we would have to look at those that find capital especially difficult to obtain. The situation is not difficult for a management buy-out that will be going to the market in two or three years' time because most people would be scrabbling to try to invest in something that would produce a great return in a short time. However, there are businesses that require a longer gestation period—they are perhaps smaller and need to retain for a longer time—and they might be above the limit on eligible assets. Putting an arbitrary restriction on eligible assets, rather than considering each sector, is an across-the-board approach. A more elegant approach would be to introduce more targeted and focused support for the specific sectors and companies that we would like to support.

Rob Marris (Labour, Wolverhampton South West)

I understood the hon. Gentleman to be saying that his preference would be to leave things the way that they are, which I assume to mean that he supports amendments Nos. 6 to 8. I understand that he has had difficulty getting the figures. However, in his methodology for approaching the question of encouraging investment, especially in some of the riskier areas, he is looking at only half the equation, as I suggested earlier. If he was to leave things as they are, the enterprise investment scheme tax relief would be capped at £200,000, not £400,000, and furthermore the tax relief would revert from the current rate of 40 per cent. to 20 per cent. If we could get the figures for the whole equation—the changes to both tax relief and the capital limits—he might find that he supported the Government.

Colin Breed (Liberal Democrat, South East Cornwall)

I understand the hon. Gentleman's argument. He is right that a judgment can really be made only in retrospect. It is difficult to prejudge the exact outcomes. However, it is my judgment that for relatively little benefit, we are changing a successful scheme. Leaving aside the figures involved, the change sends the unhappy message to the industry as a whole that even when a scheme is successful and producing real benefits, the Government are prepared to tinker with it. For the sake of what I suspect will be a relatively modest saving, we could undermine some of the confidence that has been built up in recent years that the Government are behind the scheme. However, having seen the scheme's great success, they now seem to want to chop that away and retreat to the pre-2004 position, which would be a retrograde step.

Philip Dunne (Conservative, Ludlow)

I remind the Committee of my entry in the Register of Members' Interests. I am an investor in a venture capital trust: Baronsmead VCT 4. I am also honoured to chair its non-executive board.

I welcome the measures to improve access to capital, especially the increase in the EIS limits to which the hon. Member for Wolverhampton, South-West (Rob Marris) referred. Of course, investments in that category are not for the faint-hearted because they do not provide the portfolio risk diversification that is the attraction of a VCT. I also welcome the retention of tax relief for VCTs, albeit at a lower level, which we will discuss under a later group of amendments.

The reduction in the gross assets of a company in which VCTs may invest from £15 million to £7 million immediately before an investment and from £16 million to £8 million immediately after an investment will significantly reduce the scope of eligible companies. As my hon. Friend the Member for Braintree (Mr. Newmark), who is an expert on these matters, rightly said, that will raise the risk profile of investors in VCTs. The risk profile will be raised by definition because the portfolio effect of a mix of business sizes in a VCT helps both the underlying investors and the managers of the trust to have greater confidence because investment performance tends to be better when there is a greater spread of both risk and the size of investment in individual companies. The reason why the limits have been selected is unclear, so I urge the Minister to give an explanation to Opposition Members who are perplexed.

When VCTs were first introduced under the previous Government in 1995, the limit on the gross assets of eligible companies was £10 million. Over the following 10 years, that would, of course, have inflated to a much higher figure, but even £10 million is significantly more than the amount proposed. Many VCTs take advantage each year of the period prior to and immediately after the end of the tax year to undertake fundraising. Several VCTs pulled their fundraising following the Budget. I have read several of their websites and many have cited the halving of the maximum size of investee companies as the reason. I will name a couple of funds—not my own—because they are peer funds that perform well: Northern VCT 2 and First State AIM VCT, which was the best performing AIM VCT that was launched last year.

Those who are involved in marketing such funds have a good sense of investor appetite for VCTs. I refer especially to Henry Chaplin, the chief executive of Noble Fund Managers, the website of which points out that he anticipates that the VCT market, having raised £800 million in the last tax year, will decline to only £300 million by 2007–08. That gives some idea of the impact of the changes that the industry is expecting.

That takes us to why are the Government so keen to introduce this change. As was said earlier, this may be purely a revenue limiting exercise. It may be to do with the gaping deficits in the public accounts. It appears that it has little to do with seeking to professionalise and encourage a stable VCT industry. One issue that it will give rise to for small companies has been touched on already. Those companies with gross assets of, for example, £6 million—just under the limit—can now raise only £2 million compared with a £10 million subscription that they could have raised under the previous regime. That will have a significant impact on small and medium-sized companies that have a requirement for significant amounts of capital, and this avenue of raising that capital is likely to be shut to them. That could have an effect on higher risk and potentially higher return or high risk and nil-return companies in the pharmaceutical sector and other areas that are great consumers of capital.

John Bercow (Conservative, Buckingham)

The prognosis that my hon. Friend cited of a prospective reduction from £800 million to £300 million is both gloomy and alarming. For the avoidance of doubt, can he confirm that the person whom he has quoted, Mr. Chaplin, is suggesting that the reduction will be exclusively the consequence of the Budget and not in any way attributable to other unrelated factors? If that is so, it is a source of alarm.

Philip Dunne (Conservative, Ludlow)

I have been quoting from Mr. Chaplin's website. I have not had a direct conversation with him. The implication is that venture capital trusts that were in the process of fundraising and have cancelled are doing so as a result of the specific Budget amendment that we are considering.

Brooks Newmark (Conservative, Braintree)

It might be helpful to explain a little more the cause behind the statement to which my hon. Friend referred. It has to do with the fact that smaller investments are far more risky. Therefore, people are far less likely to invest in such companies. At the same time—this is the point that the hon. Member for Wolverhampton, South-West (Rob Marris) was making—if there are not the tax incentives that follow these investments, that will be another reason why people will not invest in the industry. There is a double whammy, which is what I was talking about earlier.

Philip Dunne (Conservative, Ludlow)

I am grateful to my hon. Friend for supporting my contention that that will be a direct consequence of the Budget. Access to follow-on capital will therefore be severely restricted as a result of the proposed measure. It will be interesting to know whether that is part of the Government's intent.

The second issue that I want to raise is perhaps a slightly more detailed point, but it is a direct consequence of the proposals that are subject to the amendments. A number of VCTs, including the one that I chair, have a dividend reinvestment scheme under which investors are given the option to receive their dividends not in cash tax-free, but by reinvesting in new shares issued by the VCT. That has attractions for investors as they can increase their investment in a VCT with the accordant tax advantages. It is also attractive to managers of VCTs because they can raise modest capital on regularly without having to go through the costly exercise of marketing and producing a prospectus, for example.

The problem is that as a result of the proposed changes from 6 April any new shares raised by a VCT will have to be invested in companies that meet the new criteria. That means that an existing VCT, which has an established portfolio of investments in companies that exceed the current criteria, will have to start managing an entirely separate portfolio. I believe that that is the case. I think that the Minister is nodding.

John Healey (Labour, Wentworth)

indicated dissent.

Philip Dunne (Conservative, Ludlow)

That applies to every new investment that a VCT seeks to make using new capital raised by issuing shares in respect of dividends under a reinvestment scheme. This will increase the complexity to a point where this sort of dividend reinvestment is highly unlikely to be worth while for the manager, notwithstanding the tax benefits that it provides to investors. If the Minister can say whether that is something that he intends to catch by the proposed measures, I shall be most grateful.

John Healey (Labour, Wentworth)

We have had a broad-ranging debate on this set of amendments. In a sense, it sets the scene for a wider range of issues connected with the package of reforms that we propose in clause 91 and schedule 14, which go beyond the five amendments in the group. I shall seek to deal specifically with the five amendments and the points that have been raised during the debate.

I turn first to amendments Nos. 6, 7 and 8, which deal essentially with the growth of assets test, as the hon. Member for Fareham (Mr. Hoban) made clear. The amendments seek to remove from the Bill the provisions that are designed to refocus venture capital schemes on those small firms that are most in need of improved access to finance. After all, this is the principal purpose of the policy framework and the principal justification of investing a significant amount of public money in terms of the tax forgone.

It may help the Committee if I explain why we have brought forward these proposals that bear on the gross assets test. The amendments, if they are pressed, should be rejected. Venture capital schemes are an important range of interventions contributing to the Government's wider policy to improve access to finance for small companies with growth ambitions. It is important that we build on the success of the schemes so far. It is important also that we ensure that the support that the schemes provide is effectively targeted to where it is needed most. That is what the provisions in the Bill are designed to do. Refocusing the growth assets test in this way will ensure that investment under these schemes is directed to those companies that most need it and to where there is most clearly a market failure. It is interesting that this purpose is recognised clearly by the industry.

Comments after the proposals were published included those from Paul Mumford of Cavendish Fund managers. He said:

"the changes bring things back to the true spirit of venture capital, which means investing in young companies and sticking with them as an investor until they have grown enough to merit further investment from institutional investors."

Julian Hickman, a partner of Longbow Capital, said:

"the Chancellor seems to be trying to guide venture capital schemes back to their original intended role; the support of small businesses in search of venture capital funding."

That is precisely the point and the purpose of the package set out in clause 91.

The change will ensure that money raised under the schemes does not drift towards lower-risk investment, where it would be less focused on driving growth and more devoted to simply maintaining value—the sort of investments that firms could and should be more capable of sourcing from other places.

Brooks Newmark (Conservative, Braintree)

What analysis the Minister has undertaken to justify that comment and to show what size the market will become after the Bill is enacted? What analysis has he undertaken to show that there is not a funding gap above £7 million or £8 million? Why has he chosen £7 million or £8 million as opposed to £10 million? I am curious as to what analysis the Government have made to make the decision that they are about to make.

John Healey (Labour, Wentworth)

The hon. Gentleman again poses the questions that he posed earlier. I have not yet come to the points that he and others made. I was about to turn to the specific points raised by the hon. Member for Fareham, then to those of the hon. Member for Braintree (Mr. Newmark) and then on to those of the hon. Member for Ludlow (Mr. Dunne).

The hon. Member for Fareham asked the same question, namely, what is the basis of the new gross assets test and the level at which we have set it. He, too, expressed concern that it will somehow lead to neglect of manufacturing industry, particularly relatively small business services companies. I will share with him some of the analysis that underpins the decision to set the new gross assets test at £8 million and £7 million. Analysis of the investments made in the VCT scheme and the enterprise investment scheme shows that investments in companies with total assets of less than £8 million are proportionately higher in technology, business services and manufacturing. All such companies are higher-risk sectors, which the Government therefore want to target. By way of contrast, VCT and EIS investment in companies with total assets of more than £8 million is proportionately higher in sectors that tend to be asset-backed and therefore less risky forms of investment, such as the hotel sector, bars and catering, wholesale and retail. Having assets clearly increases their ability to put up collateral against loans, so they are less likely to face the same problems that small firms in some other sectors face in accessing finance. The hon. Member for Fareham may be interested to know that the average size of a company invested in under a VCT is £3.8 million.

The hon. Gentleman also asked whether we will monitor the impact of these changes, and the short answer is that of course we will. We have done so since we took responsibility for the scheme and we will measure and monitor the impact on the funds raised, on the investments made, and on small and growing firms. We will also monitor evidence of change in terms of a finance gap.

The hon. Members for Braintree and for Ludlow spoke from their own personal experience. I was interested to hear about that, but it has led them to draw conclusions rather different from our own and from many experts and specialists in the field. I point out to the hon. Member for Braintree in particular that riskier investments that have difficulty raising other forms of growth capital are precisely where the market failures lie and where the case for Government intervention and support is strongest. Our proposed change in the gross assets test is designed to ensure that significant Government support is well justified and well targeted.

The package in schedule 14 to which the hon. Member for Braintree referred will increase, rather than reduce, the incentives to invest, as my hon. Friend the Member for Wolverhampton, South-West (Rob Marris) said. I suspect that we will discuss this issue in more detail when we consider amendments Nos. 10 and 11, so I shall not stray there, except to point out to the hon. Member for Braintree—who mentioned the risk-reward balance—that the package includes setting the rate of income tax relief for investments in VCTs at a new and increased level of 30 per cent.

I appreciate the tribute that the hon. Member for South-East Cornwall (Mr. Breed) paid to—

Brooks Newmark (Conservative, Braintree)

Will the Financial Secretary give way?

John Healey (Labour, Wentworth)

I suspect that the point that the hon. Gentleman is about to raise is one that he will have ample opportunity to discuss when we consider the next group of amendments; however, I give way.

Brooks Newmark (Conservative, Braintree)

I am curious as to the Financial Secretary's logic. How can reducing the tax incentive from 40 per cent. to 30 per cent. and lowering the gross assets reduce risk? By definition, doing so tends to lead to riskier investments.

John Butterfill (Conservative, Bournemouth West)

Order. The hon. Gentleman knows very well that that point will be dealt with in the next group of amendments; it is not particularly relevant to this one.

John Healey (Labour, Wentworth)

My suspicions, Sir John, were precisely confirmed by the hon. Gentleman's intervention.

Perhaps I may turn, as I had started to do, to the contribution of the hon. Member for South-East Cornwall, whose tribute to the success of the economy under this Government—and particularly the ongoing success of the venture capital schemes—I appreciate. He was right to say that the UK is one of the leading economies; in fact, a recent US report described the UK as the best business environment for small firms to access investment finance in. On the particular set of arguments that he laboured, I should point out that the package of changes in clause 91 is not about reducing cost or reducing support for this form of business investment. It is about focusing such support first, where it is most needed; secondly, where the greatest value to the taxpayer lies; and thirdly, where it is likely to make the greatest contribution to the growth and productivity of the UK economy.

I stress that this package of reforms is not about looking for savings. If the hon. Gentleman consults the Red Book, he will see that the scorecard cost of these proposals, which were announced in the Budget, for the next financial year is minus £15 million. In other words, for that and the following year, the additional cost of the proposals to the Exchequer is £15 million. He may also be interested to know that the cost of such schemes this year is £220 million.

Colin Breed (Liberal Democrat, South East Cornwall)

I am grateful to the Financial Secretary for that information, which reinforces my view. Given that there will to be no visible change in the cost to the Treasury in forgone tax—if anything, the cost might even increase slightly—is the proposed across-the-board test on eligible assets the most elegant way of ensuring that the limited sums available are focused on the right area? As the Financial Secretary knows, certain sectors of the small business world are perhaps more demanding than others, and some are more deserving. Applying seemingly arbitrary figures across the board—he has yet to explain how he arrived at the figures of £8 million and £7 million, rather than, say, £10 million—will not enable us to focus on the companies and sectors that need support.

John Healey (Labour, Wentworth)

We are looking for effectiveness, not elegance. The package of measures, including the reduction in the gross assets test, will help us to build on the success of the scheme and ensure that it is properly targeted and good value, therefore, for the substantial sums of taxpayers' money that such support entails. The hon. Gentleman expressed concern at our setting the gross assets test at £8 million and £7 million respectively, but I should point out that the average size of a company invested in under a VCT is £3.8 million. The test should not be a concern to him if he is genuinely interested, as we are, in achieving greater levels of investment and easier access to finance for firms that are riskier investments. Such firms tend to be smaller firms, and they always find it more difficult to access the investment and growth capital that they need from other sources.

John Bercow (Conservative, Buckingham)

Precisely in the light of what the hon. Gentleman just said about the net cost to public funds of his overall package, and of the widespread uncertainty about whether the effects of his scheme will be exactly as he envisages, does he think this a very good test case of the appropriateness of the Government's introducing a sunset clause? The provision would therefore automatically expire after a given period, whereupon we could judge who was right and what action did or did not need to be taken.

John Healey (Labour, Wentworth)

I know that the hon. Gentleman is keen on sunset clauses, but in this instance the short answer to his question is no. I think that he was on the Finance Bill Committee, and he almost certainly participated in proceedings on the Finance Bill 2004, when we introduced the temporary two-year uplift of the rate of income tax relief available on VCTs from 20 per cent.—the ongoing rate—to 40 per cent. Although I did not refer to the concept of a sunset clause in moving that provision, it was time-limited, so I am sure that it meets with his approval at least in retrospect, even if he did not support it at the time.

Amendment No. 9 seeks to exclude any capitalised research and development expenditure from the calculation of a company's gross assets for the purposes of the qualifying test. The hon. Member for Fareham said that it is a probing amendment, and I hope that he will be convinced of my view that it is neither necessary nor desirable. Let me try and explain why.

The gross assets test, as I said, is designed to target smaller high-risk companies for investment under the schemes by focusing on the level of assets on the balance sheet. The legislation deliberately does not define the assets to be taken into account, but as is our approach in general, it follows accountancy practice. If the tests were to diverge from accepted commercial accounting rules, more complex legislation would be required, which neither the hon. Gentleman nor I generally advocate. It could lead to additional burdens on the conduct of VCT businesses. However, the international accounting standards, IAS 38, have introduced a requirement to capitalise research and development expenditure in certain circumstances, whereas the UK standard to which the hon. Gentleman referred, SSAP 13, states that that treatment is optional. In either case, the range of circumstances in which R and D must or can be capitalised remains limited to certain development costs, not research costs.

Expenditure, therefore, will be capitalised only where it is already established that the outcome will be a marketable product—in other words, cases where the company has a genuine asset that can be valued on the balance sheet. The effect of the amendment would be to open up the scheme to companies that have already developed valuable assets with a balance sheet value above the threshold of the scheme.

We have already introduced the research and development tax relief, which is widely recognised as an effective, generous and appropriate policy measure. We announced in the Budget that it would be extended to provide additional support for mid-sized companies with up to 500 employees. The Opposition are effectively asking us for another form of indirect support for research and development. The right mechanism for that support, I suggest, is the R and D tax credit. It targets R and D expenditure directly, and does so in a way that is widely accepted to be an effective form of incentive for research and development.

Finally, amendment No. 13 seeks to exempt money raised from venture capital trusts prior to the current tax year from the requirement that it is invested in line with the objectives of the scheme. The 70 per cent. rule for venture capital trust investments, as the hon. Gentleman explained, already allows flexibility on up to 30 per cent. of the value of a VCT's fund. That is generous enough to allow VCTs the flexibility that they need to operate, and the Government's proposed change simply closes a loophole that makes it possible to get round the test.

Let me dwell on the rule change and the accusation of retrospection, which I do not accept. What we are proposing will help to ensure that the scheme meets the policy purposes for which it was introduced, and makes a contribution to the growth and productivity of this country and our small firms, as intended. The 70 per cent. rule about the funds from the VCT being invested in qualifying investments was the original intention of the scheme. Rules were drawn up to achieve that, and it is the basis on which approvals have been sought by VCTs and given by the Government.

It cannot be right that funds raised with a significant tax relief are not used for the purpose for which the tax support was intended. It cannot be right that fund managers have a get-out if they fail to make the level of qualifying investments that are often in their prospectus. It cannot be right also that investors' expectations that their money will be invested in small companies with high growth potential are thwarted by the funds instead being kept in cash or non-interest-bearing accounts.

I urge the hon. Gentleman to bear it in mind that the measure will not apply to funds raised before 6 April this year. It is not designed to catch inadvertent breaches. If there are inadvertent breaches of the 70 per cent. rule, they should be reported, together with a plan to correct them, to HMRC, which will not take the enforcement action that would otherwise be required. The measure is not a device that the majority of VCTs use or need to use in order to maintain their adherence to the 70 per cent. qualifying rule.

When those considerations are added to the fact that we are not removing the essential generous flexibility of the 30 per cent., it is clear that the amendment is not appropriate. The hon. Gentleman, the hon. Member for Braintree or the hon. Member for Ludlow may know that one of the leading VCT advisers advises all its clients that they should aim not for 70 per cent., but for 80 per cent., so that they have sufficient flexibility to deal with the peaks and troughs of the cycle.

Clause 91 ensures that the legislation operates effectively in requiring that the funds raised by VCTs are directed towards qualifying companies. I say to the hon. Member for Ludlow that we see no reason why the VCTs should have difficulty adapting to the change by next year, when it comes into force. The provisions of schedule 14 are designed to increase the effectiveness of the venture capital schemes—

Philip Dunne (Conservative, Ludlow)

rose—

John Healey (Labour, Wentworth)

I was just winding up, but I will give way to the hon. Gentleman. He has assiduously attended the debates of the Committee of the whole House, and I welcome that.

Philip Dunne (Conservative, Ludlow)

I am grateful to the Financial Secretary. The HMRC guidance on inadvertent breaches is welcome, as it may deal with the issue mentioned by my hon. Friend the Member for Fareham (Mr. Hoban) concerning a realisation generating a substantial amount of cash at an inopportune point in the year, when a test might be about to be met, for example. It would be helpful to the Committee if the Minister would confirm whether that would be addressed by the guidance from HMRC. If it would not, ought there not be provision in the Bill?

John Healey (Labour, Wentworth)

To put the matter in perspective, the cases of inadvertent breaches of the rule that have come to our attention number fewer than a dozen. It is a small-scale problem in a minority of VCTs. HMRC will shortly issue guidance that will help cover important aspects of inadvertent breaches. I shall make sure that the hon. Gentleman receives a copy directly.

The amendments would prevent us from improving the scheme as we intend. I hope the Opposition will see fit to withdraw them, having had this useful and extended debate. If not, I shall have to ask my hon. Friends to vote them down.

Mark Hoban (Conservative, Fareham)

I thank the Minister for the effectiveness of his reply. I shall comment first on amendments Nos. 6, 7 and 8. He makes a persuasive case for the reduction in the asset limits. I am grateful, as I am sure is the VCT industry, for his reassurances that the situation will be kept under review and action taken where necessary. The House would welcome regular updates on the monitoring of the nature of the investments undertaken by VCTs working under the new asset limits.

On amendment No. 9 on accounting practices and the differential treatment that there can be under UK and international standards for the capitalisation of development—the right hon. Gentleman was right to distinguish between research and development—the issue is not so much that one group of businesses would get a double benefit for R and D, as that a business that applied international financial reporting standards could go over the gross asset test, whereas the same business using generally accepted UK accounting practice could fall below the gross asset test.

Given the difference in accounting practice for the treatment of capitalised development costs under the UK and international financial reporting standards, a company could benefit from VCT investment while another does not. I hope that the Financial Secretary will reflect on that as we consider unlisted companies' take-up of international financial reporting standards, and whether that causes some businesses to lose out on VCT relief because they adopt one method of accounting rather than another.

On amendment No. 13, I also welcome the Financial Secretary's reassurance on inadvertent breaches of the 70 per cent. rule and his comments on the associated guidance that HMRC will issue. Although his remarks are absolutely right about the importance of such money being invested—that is what investors in VCTs would seek—it is important that the guidance on inadvertent breaches should consider situations where investments might well be realised and the trust might breach the 70 per cent. rule, pending a further investment or the return of cash to its shareholders.

John Bercow (Conservative, Buckingham)

The Financial Secretary referred to the issue of guidance by the Inland Revenue. Although we are not discussing regulations that will be the subject of a statutory instrument, and therefore subject to either the negative or the affirmative procedure, does my hon. Friend agree nevertheless that it would be helpful to the House if we could have sight of that guidance, if only in draft form, before the final passage of the Bill? It would aid and support our deliberations to get that before rather after the event.

Mark Hoban (Conservative, Fareham)

As ever, my hon. Friend makes an important point about the parliamentary scrutiny of such issues and the way in which we can address them before consideration of the Bill has been completed, and I am sure that the Financial Secretary will take that point on board. I hope that the industry and its advisers are fully consulted on the guidance, to ensure that it tackles inadvertent breaches. With that, and the Financial Secretary's assurances, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 10, in page 75, line 25 [Vol II], leave out '30' and insert '40'.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss amendment No. 11, in page 75, line 30 [Vol II], leave out '30' and insert '40'.

These amendments have already been referred to en passant.

Mark Hoban (Conservative, Fareham)

I am sure, Sir John, that we will have a fuller airing in this debate of some of the issues that were raised in the debate on the previous group of amendments. Under the amendments now before us, we seek to make permanent the temporary increase in income tax relief that applies to VCTs and enterprise investment schemes. The Financial Secretary and I have different views of what a move to 30 per cent. means. He seems to think that it is an increase; I might suggest that it is a decrease—but I am sure that we will return to that topic in a minute.

It is worth remembering why the 40 per cent. rate was introduced in 2002. It was intended to stimulate the VCT market, and in the words of the British Venture Capital Association's pre-Budget submission,

"meet the Government's objective of creating funds for investment in entrepreneurial companies that stimulate growth and create employment and tax revenue."

Indeed, it has had the benefit of stimulating the VCT market and raising more funds for investment in unlisted companies. In 2004–05, VCTs raised more than £500 million in funds; press comment around the end of the financial year suggests that they had raised about £730 million. Of course it is worth bearing in mind the fact that in the year before the relief was increased from 20 to 40 per cent., the sales of VCTs were worth less than £100 million.

Stephen Hesford (Labour, Wirral West)

In simple terms, as I understand the matter, before the change took place in 2004 the rate was 20 per cent. That rate was introduced as a temporary two-year measure to increase VCTs, which it has done. I understand that the hon. Gentleman is making that point. The Government are now regularising the situation consonant with that prior to 2004, to a higher rate—30 per cent. What is wrong with that?

Mark Hoban (Conservative, Fareham)

I will address the hon. Gentleman's question about why that might be wrong, but the point, which was touched on in the last debate, is that both the Financial Secretary and the hon. Gentleman talk about the rate increasing from 20 to 30 per cent. Some people would argue that there is really a decrease, from 40 to 30 per cent. It depends on one's starting point, in judging what the measure is trying to change. With amendments Nos. 10 and 11, I seek to retain the 40 per cent. tax relief rate, rather than to reduce it to 30 per cent.

Before the changes took place in 2004, VCTs were running out of steam—their sales were low—and the temporary increase in tax relief to 40 per cent. stimulated that market. There is concern in the VCT market about the impact that the reduction in tax relief to 30 per cent. might have on the sales of VCT funds, and I shall quote some of the press comment around the time of the Budget. Bestinvest suggested that sales of VCTs in 2006–07 might be about £100 million to £150 million—quite a significant decrease on the amount achieved in 2005–06. Martin Churchill of Tax Efficient Review forecast sales of £250 million to £300 million. My hon. Friend the Member for Ludlow (Mr. Dunne) quoted the views of Henry Chaplin, suggesting that sales would be about £300 million. Clearly, we will not know the outcome until the end of the financial year, and there is uncertainty about the funds that VCTs will raise, and therefore the money that will be available to trusts to invest in small and growing businesses.

Stephen Hesford (Labour, Wirral West)

The hon. Gentleman would not have intended to conflate two arguments, but I understand that when the hon. Member for Ludlow (Mr. Dunne) gave us figures about the differential sales of VCTs, he was talking about the previous set of amendments, and the sales differential that resulted from what the Government were doing with those amendments. We are now talking about a different set of regimes, and the hon. Gentleman is conflating the previous figures with these. Which sales drop does he think results from these changes—or is he quoting another set of drops that was put before the House on a different set of amendments?

Mark Hoban (Conservative, Fareham)

The hon. Gentleman needs to remember that there is a series of three changes in schedule 14 that impact on the sales of VCTs, and it is very difficult to pull apart the impact that each one will have on sales. My hon. Friend the Member for Ludlow referred to Henry Chaplin in the context of the impact of the reduction in gross asset values. Some people will point to a later amendment on the holding period as being the driver behind this; others will look at the change in tax relief. The complexity arises in part because of the way in which the amendments have been selected for debate, but also because of the complex interaction between holding periods, gross asset tests and tax relief.

Stephen Hesford (Labour, Wirral West)

Does the hon. Gentleman accept that there is an element of double counting? The House needs to be sure which figures we are relying on—those for the specific amendments that we have under review, not those for the other amendments.

Mark Hoban (Conservative, Fareham)

The hon. Gentleman is about to make a mountain out of a molehill. There are differing effects, and it is difficult to unpick the precise effect that each one has. The point that I am making is that in 2004–05 and 2005–06 sales of VCTs were strong, and had increased significantly during 2003–04, during which time the income tax relief was 40 per cent. If the Government say that the 40 per cent. rate led to that increase in sales, the hon. Gentleman must conclude from that that the reduction in income tax relief could, as has been suggested by some in the industry, lead to a reduction in sales in 2006–07 and subsequent years.

The concern in the sector about the change in the rate of relief boils down to a relatively simple but fundamental point that my hon. Friend the Member for Braintree (Mr. Newmark) referred to in his intervention on me during our debate on the previous group of amendments. There is a relationship between the level of risk that an investor will take on board and the return. The concern is that the overall effect of reducing the rate of relief, and allied to that the increase in the rate of investment that we dealt with in the previous group of amendments, will be a reduction in the return from VCTs, making them less attractive to investors. Will investors be prepared to accept the greater risk attached to smaller companies with fewer assets given the reduction in tax relief on their investments in VCT and EIS schemes?

Martin Churchill, to whom I referred earlier, from Tax Efficient Review, suggests that there might be a flight from higher-risk investments within VCTs to lower-risk investments. Robert Drummond, a former chairman of the British Venture Capital Association, has said:

"With the 30 per cent. income-tax relief rate the Chancellor has found a compromise between maintaining the current level and returning to 20 per cent., but this change, together with the increase in the minimum holding period from three to five years"—

we will deal with that in the next group of amendments—

"appreciably alters the risk-reward profile of private-equity investment by personal taxpayers."

I appreciate that many in the VCT sector were relieved when the Chancellor announced that the rate of relief was to be 30 per cent. A number were concerned that it would be reduced further to 20 per cent. But I think that even the hon. Member for Wirral, West (Stephen Hesford) will agree that it is clear that VCT investment levels are sensitive to changes in tax relief, as the sales figures over the course of the past three years show. It is difficult to build a viable VCT sector and facilitate investment in smaller companies if flows are volatile.

I want to pick up on a commitment made by the Chief Secretary to the Treasury on Second Reading last week in relation to the change in the rate of tax relief. He said:

"To ensure that the industry has a solid foundation for stable fundraising and continued growth, the Bill guarantees the rate of income tax relief for investments in venture capital trusts at 30 per cent. for the rest of this Parliament."—[Official Report, 24 April 2006; Vol. 445, c. 365–66.]

I should be grateful if the Financial Secretary would elaborate on that commitment. It is rare for a Treasury Minister to commit to fixing rates so long in advance. In election campaigns, despite the efforts of interviewers, the Chancellor and the Prime Minister have always been evasive about giving any long-term commitment to rates. Will the Financial Secretary explain why that commitment has been give to VCTs in this Budget?

When the Financial Secretary replies, will he answer three questions? Can he confirm that the Chief Secretary's statement to the House last Monday will hold? What steps can he take to ensure that that will be enshrined in legislation so that investors can plan with confidence for the rest of this Parliament? Is this a symmetrical commitment? That is, will the relief remain unchanged, either up or down, regardless of events? Those are important clarifications that the Financial Secretary should give today to provide the industry with some comfort about the Chief Secretary's commitment. Regardless of whether 30 per cent. is the right or the wrong rate, stability and consistency are vital to the sector if it is to build.

I end on this note of caution. As I said earlier, the rate of sales of VCTs has been sensitive to changes in the tax rate, and, following the Financial Secretary's reassurances on a previous group of amendments, I would not like to see the small businesses that are meant to be helped by such schemes lose out because investors turn off the flow of funds into VCTs.

Brooks Newmark (Conservative, Braintree)

The Government's desire to refocus VCT investment is a simple excuse for dealing with the unforeseen cost to the Exchequer of the tax relief currently offered to investors. The cost to the Exchequer of 40 per cent. income tax relief has risen from £220 million to £315 million, nothwithstanding the caveat that those figures are

"particularly tentative and subject to a wide margin for error."

Treasury Ministers have perhaps got into the habit of not expecting their market interventions to be successful, and when they are, they are caught short. That is the real justification for part 2 of schedule 14.

The Treasury Committee had the benefit of a simple warning in March 2004 when it heard:

"I think that the Chancellor has to be careful that the history of an awful lot of tax reliefs is that they are set up with very tight restrictions, they have little effect, progressively Chancellors relax the effect, increase the benefits, and then the thing takes off in a completely unexpected direction and has to be stopped."

The Chancellor lectures that there should be no return to boom and bust—it is his favourite stick with which to beat the Opposition—but what is the result of all these changes if not boom and bust for the venture capital trusts and their investors?

The Chief Secretary has committed the Government to maintaining the 30 per cent. income tax relief for the life of this Parliament.

Stephen Hesford (Labour, Wirral West)

Which part of "temporary" does the hon. Gentleman think that the industry did not understand in 2004?

Brooks Newmark (Conservative, Braintree)

The hon. Gentleman is absolutely right; the point was made that the relief was temporary. But, as we saw, the industry was flat on its back, at a size of £50 million or £70 million, and it is now successful and has grown. But that has been primarily because of the stimulus that the Government gave by increasing the tax relief from 20 per cent. to 40 per cent., and that is my argument here.

The fact remains that repetitive changes in the tax relief scheme and, concurrently, the risk profile of VCTs, will undermine investor confidence and prevent legitimate tax planning. Is that really the solid foundation to investment that the Chief Secretary would have us all believe it to be? The justification for the 40 per cent. income tax relief was always couched, as the hon. Gentleman said, in terms of a temporary stimulus that would be the subject of continued review. But it is questionable whether that approach is helpful to investors who are looking to plan their long-term financial affairs. It has denied them the reasonable level of certainty that should be their right.

My concern as a past practitioner is that there is a high probability that the market will begin to shrink back—the point made by my hon. Friend the Member for Ludlow (Mr. Dunne)—notwithstanding the preservation now of a proposed 30 per cent. income tax relief.

I also question the assumptions that underpin the figure of 30 per cent. Was it chosen simply because it is a midway point between the old 20 per cent. relief and the two-year period of uprating to 40 per cent., or is there a more substantial justification for the compromise? Venture capital trusts are working, and working well, because there is sufficient incentive to stimulate uptake by investors operating in an inherently risky market. We should not arbitrarily change incentives, even for the lifetime of the Parliament, without subjecting them to regular review.

Philip Dunne (Conservative, Ludlow)

I should like to make a couple of brief observations. The industry has been almost silent on the issue since the Budget. The explanation is that it has breathed an enormous collective sigh of relief that the relief rate has gone from 20 per cent. up to 40 per cent., and now down to 30 per cent. rather than 20 per cent., which was the anticipated level after the announcement in the Budget two years ago to which the hon. Member for Wirral, West (Stephen Hesford) referred. As a result, it seems that the Treasury has listened to the industry's explanation that reverting back to the 20 per cent. level would risk cutting off the flow of capital to help bridge the vital equity gap.

As I said earlier, I am pleased that the Treasury team has not sought to restrict the rate to its original 20 per cent. level. I remain perplexed, however, why it has not kept it at 40 per cent., particularly if the policy objective, to which the Financial Secretary referred earlier, is to help companies gain access to capital that will allow them to grow, to compete to become larger businesses and to compete internationally in the increasingly global marketplace, on which the Chancellor is constantly lecturing us. It is well understood on these Benches that we are competing on a global scale. Why on earth introduce a measure with relatively little financial cost, as was made clear in the response to the hon. Member for South-East Cornwall (Mr. Breed), in this manner? It will have the undoubted consequence of reducing the capital available to such companies. Why not leave it alone at 40 per cent., where it is working so effectively?

Colin Breed (Liberal Democrat, South East Cornwall)

I would like to reinforce what has already been said from the Opposition Benches. I am sure that the Minister is right in saying that the average investment to date has been £3.8 million, based on the 40 per cent. tax allowance. I suspect that it is more likely to have been the 40 per cent. rate than the eligible assets test that encouraged the greater investment. There is general agreement that the investments eligible under the new rules are likely to be—although they will not always be—more risky in profile than they were, so there may be more justification for maintaining the 40 per cent. rate. At least if it were temporary, it could be extended for one more year and we could see how much more effective the eligible assets test will be. I am concerned that we may face a stop-go problem, irrespective of how much money is invested in the market. Obviously, 30 per cent. is better than 20 per cent., but it seems rather arbitrary. I believe that we could have retained the 40 per cent. rate for one further year while we assessed the effect of the eligible assets test, which would have provided a stronger basis of information on which to judge the success of the scheme.

I therefore broadly support retention of the 40 per cent. rate, but I accept that the Government have made a judgment—that is what it is, a judgment—about whether changes to the rules will focus down on the particular companies that are investing. I accept what the Minister said about going back to the original aims of helping younger and growing companies, but because of the reduction in the incentive, it remains to be seen whether there will be enough money to do so. That remains to be proved.

John Healey (Labour, Wentworth)

Amendments Nos. 10 and 11 would renew and make permanent the temporary rate of 40 per cent. income tax relief for investments in venture capital trusts. When the Government announced in the 2004 Budget a two-year temporary rate set at 40 per cent. to boost investments in venture capital trusts, it could not have been made clearer that it would expire on 5 April 2006. I made those points very clear in our Committee debates on the Finance Bill that year. It was intended as a stimulus to VCT investments and I am glad that the hon. Member for Fareham (Mr. Hoban) recognised how successful it has been over the past couple of years.

We have seen record investment in these two years with fundraising of £520 million in 2004–05 and more than £700 million in 2005–06. That record fundraising investment led to substantial growth in the VCT industry, in the number of venture capital trusts and in the number of fund managers. I am sure that the hon. Member for Fareham would accept that it is unreasonable to expect the industry to continue this exponential growth and record fundraising increases every year. What it requires now is stability and our proposals are intended to provide just that.

Brooks Newmark (Conservative, Braintree)

I am sure that the Financial Secretary will go on to deal with some of the points that I made earlier, but I am concerned about his perverse logic. The Government should rightly be congratulated on providing a stimulus for the venture capital trust industry by increasing the tax relief from 20 to 40 per cent. That resulted in clear success, with growth in the sector increasing from £500 million to £700 million. I do not understand why changing the rules will mean the continuance of success, particularly when it was the tax stimulus that helped the industry become a success in the first place.

John Healey (Labour, Wentworth)

It was just that. It was set at 40 per cent. for two years; it was due to revert at the beginning of April to 20 per cent.; and our judgment now, backed up with a proposal, is that a 30 per cent. rate of income tax relief for VCT investments is appropriate. It represents an increase of 10 percentage points on the original relief rate. As the hon. Member for South-East Cornwall (Mr. Breed) said, that is our judgment in the circumstances. We believe that it will help to ensure a sufficient and stable level of fundraising in the years to come and that it will therefore help to support a sustainable VCT sector in the years to come. It is designed, in response to the issues raised by the hon. Member for Fareham, to be a settled rate. As we discussed in the last group of amendments, it is also important carefully to monitor the application of the VCT schemes and the impact of the package of changes that we are introducing. It is right to keep under review, as we do with all taxes, the operation and impact of the scheme.

Mark Hoban (Conservative, Fareham)

I hope that I am not about to pre-empt the Minister's next comment, but will he reiterate the Chief Secretary's commitment last week on Second Reading that the rate is designed to last the life of this Parliament?

John Healey (Labour, Wentworth)

I am explaining that it is designed to be a new, settled and more generous rate than existed in the scheme previously when it was set at 20 per cent. The hon. Member for Braintree (Mr. Newmark) believes that that is not generous enough, but let me put it to him again that this package of reforms related to clause 91 is costing the Exchequer more, not less, in respect of the support it gives to venture capital schemes. It is an additional annual cost of £15 million, amounting to a total annual cost from this year of £220 million of support for venture capital schemes.

John Thurso (Liberal Democrat, Caithness, Sutherland and Easter Ross)

Hon. Members of all parties agree on the importance and desirability of investment in venture companies. Clearly, the ultimate measure of success will be the return that the Exchequer gets on its own investment when the companies come to maturity and are able to pay back to the Treasury in tax. Has any estimate been made—I understand that it is early days—along those lines about what sort of return can be expected from the Government's investment when these companies mature?

John Healey (Labour, Wentworth)

The hon. Gentleman would not expect the Treasury to micro-monitor the performance of investments by VCTs at that level, but we assess the overall impact of such schemes. That is an important feature of Government accountability, to which I expect hon. Members to hold us.

The amendments would introduce a permanent 40 per cent. rate of income tax relief, which does not offer a sustainable position for VCTs or a cost-effective position for UK taxpayers. On that basis, I hope that the hon. Gentleman will withdraw the amendment. If not, I must ask my hon. Friends to vote against it.

Mark Hoban (Conservative, Fareham)

I thank the Financial Secretary for his response to the debate. I am concerned whether the move from a 40 to a 30 per cent. rate will create a stop-go environment within the VCT sector. Other hon. Members have already referred to boom and bust, because the sector has gone from bust to boom, and we cannot know what will happen next until the end of this financial year.

I have taken on board the Financial Secretary's comments about keeping the matter under review. However, I do not think that his reassurances about the 30 per cent. rate were as copper-bottomed as those provided by the Chief Secretary on Second Reading, and it is important that reassurance is provided. I do not know whether there will be an opportunity on Report for the Financial Secretary to introduce amendments to make it clear in the Bill that the 30 per cent. rate will see us through until the end of this Parliament, because the sector expects the 30 per cent. rate to hold throughout this Parliament. However, given the Financial Secretary's comments, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 12, in schedule 14, page 76 [Vol II], leave out lines 1 to 13.

The amendment probes the third element of the change to VCTs. Until the Finance Bill was introduced, investors in VCTs benefited from the full income tax relief, if they held their investments for at least three years. The Finance Bill lengthens that holding period to five years, which is one of three measures that could impact on the attractiveness of that form of investment in the VCT market and consequently the flow of funds into VCTs and therefore into small and growing businesses.

Again, I shall quote Mr. Robert Drummond, who is a former chairman of the British Venture Capital Association:

"With the 30 per cent. income tax relief rate the Chancellor has found a compromise between maintaining the current level and returning to 20 per cent., but this change together with the increase in the minimum holding period from three to five years, appreciably alters the risk-reward profile of private equity investment by personal taxpayers."

In the context of the interlocking web of proposals, Mr. Drummond is arguing that the holding period may have the impact of discouraging investment in VCTs.

I can see the benefit for VCTs and companies that receive investment of increasing the holding period from three years to five years, which will give both the VCTs and the companies reassurance, stability and the ability to plan for the long term. However, it is difficult to strike a balance, because one might end up with a scheme that is perfect for the interests of the companies and VCTs but that is not sufficiently attractive to investors.

I seek an explanation from the Financial Secretary on why the five-year period was chosen—the next amendment proposes lengthening the holding period—before a VCT investor can gain the full benefit from the reduced tax relief.

Philip Dunne (Conservative, Ludlow)

I want to support amendment No. 12 and make a couple of observations from my experience about the investor base in VCTs. Increasing the holding period for an investor from three years to five years will unquestionably reduce the attractiveness of the investment to private investors. Investors in VCTs are, by definition, individuals who have reached a certain stage of maturity in their investment life. I hesitate to say that the majority of those individuals are pensioners, but judging by those who turn up at the annual general meeting of my VCT, the majority who take an active interest are pensioners, although that may be because they have readily available leisure time in which to attend AGMs.

The manager of the VCT group with which I am involved has analysed the average age, investment expectation and holding period of investors in VCTs. People invest in VCTs for a number of different reasons: some are interested in capital appreciation in a tax-free environment; some are interested in income in a tax-free environment; and some are interested in a combination of the two. However, the notion that they would put at risk the tax relief available on their initial subscription if they were to seek to sell their holding within five years will undoubtedly lead a number of investors to move away from VCTs. Those investors will not necessarily include larger investors, who have further opportunities for portfolio diversification and may invest primarily for the tax reliefs, but a lot of small investors want exposure to smaller companies and feel that they are doing what the Government want by helping to finance young, energetic companies run by entrepreneurial people, which contributes to the growth and revival of the British economy. Indeed, some people choose to invest in VCTs for altruistic reasons. Increasing the holding period is the most significant measure among those proposed by the Government to change the VCTs regime, and it will restrict the attractions to investors and therefore limit the Government's policy objectives.

John Healey (Labour, Wentworth)

We propose to lengthen the shareholding period for investments in VCTs following formal and informal representations from the VCT industry, which is the direct answer to the hon. Gentleman's question about the five-year period.

Mr. Andrew Holmes, chairman of Quester Capital Management Ltd, is not untypical. He wrote to the Chancellor in January, suggesting that we reinstate the original five-year holding period, which he described as one method of

"making the whole scheme more clearly matched to the realities of building young companies over the longer term".

I point out to the hon. Member for Ludlow (Mr. Dunne) that that is the principal purpose of those schemes. There was an interesting reaction from the industry on the holding period. Ben Yearsley of Hargreaves Lansdown said:

"It means there will be fewer short-term investors hoping to making a quick return—that is not a bad thing."

The announcement was widely welcomed. The Sunday Times reported:

"The increased holding time had been welcomed by advisers, many of whom believed that the three-year rule encouraged investors to think of VCTs as short-term investments when they really should be held for a longer time".

Unlike the application of the 70 per cent. rule, which, after April 2007, will apply to all funds, including funds raised before this financial year, the change to the holding period will apply to new funds, not to funds raised before 6 April 2006. There is broad consensus in the investment community that the change is positive: equity investments in small firms need to be longer term to provide stability for the firms in receipt of investment, and sufficient time is required to generate genuine gains for the investor. I hope that the House accepts those arguments and the fact that we are making the right changes in clause 91. I therefore hope that the hon. Member for Fareham will withdraw his amendment.

Mark Hoban (Conservative, Fareham)

In response to my hon. Friend the Member for Ludlow (Mr. Dunne), it is a relief to discover that there are similarities in the audiences who attend the AGMs of all sorts of organisations, whether they are VCTs or otherwise. It is reassuring to learn from the Financial Secretary that managers of VCTs have responded to the proposal, and have encouraged the extension of the holding period. As I explained, I understand why they sought that extension. As was said earlier, it is important that we ensure the stability of the VCT industry. On that note, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 5, in schedule 14, page 77, line 3 [Vol II], at end add—

PART 6

Inheritance tax