Finance (No. 2) Bill

Public Bill Committee, 16 May 2006.

Standing Committee A

Clause 23

John Healey (Labour, Wentworth)

May I begin by welcoming you to the Chair, Mr. Benton? I have had the pleasure of serving previously under your chairmanship and that of your co-Chair, Mr. O’Hara. I look forward to doing so again.

It may not feel like it to members of the Committee, but we have now reached part 3, chapter 1 of the Bill. Clause 23 imposes income tax for the year 2006-07. The starting rate of 10p, that we first introduced in 1999, means that more than 3 million low earners continue to see their marginal rate of tax halved. We have kept our election promises not to raise the basic or the top rate of tax, which remain at 22p and 40p respectively, and the 22p basic rate is the lowest basic rate in the UK for more than 70 years. The income tax rates set out in the clause are part of the Government’s commitment to maintaining macro-economic stability and sound public finances. I commend the clause to the Committee.

Mark Hoban (Conservative, Fareham)

I, too, welcome you to the Chair, Mr. Benton. The stand part debate presents an opportunity to mention the issue of the proposed shortening of filing deadlines for income tax self-assessment returns, as outlined in the Carter review that was published at the time of the Budget. The review’s recommendations were accepted by the Government. For those submitting their tax returns for the 2007-08 tax year online, the filing date will be 30 November 2008, whereas for those submitting their income tax returns on paper, as all Members of the House currently have to do, the deadline will be 30 September 2008, instead of the existing filing date of 31 January in the year following the end of the tax year.

The consternation that the proposal has caused among tax advisers can be imagined—they are concerned about the impact that it will have on them and on their clients. The news section of TaxationWeb has an item that says:

“FILING DATE PROPOSAL HAS TAX ADVISERS ‘UP IN ARMS—A campaign against a proposed 30 November deadline...has signed up 2,500 supporters in less than four weeks.

The specialist magazine Taxation launched its ‘No to November’ campaign on 13 April. Editor Mike Truman told TaxationWeb that completed forms were still arriving at the rate of about 100 a day. Only one correspondent so far has said he agrees with the proposal.

Frank Askew, of the ICAEW”—

I should declare that I am a non-practising member of the Institute of Chartered Accountants in England and Wales—

“said ‘It is very disappointing that this recommendation has been accepted by the Government with no debate and consultation.’

Ann Redston”—

the chair of personal taxes at the Chartered Institute of Taxation—

says ‘There has been no consultation with taxpayers or agents on this measure. HMRC should first find out if this idea is practicable before they announce such a radical change. Consultation should precede decisions, not follow them.’

She continued:

“This is putting the ‘Carter’ before the horse.”

Helen Goodman (Labour, Bishop Auckland)

Is the hon. Gentleman not aware of the National Audit Office report on tax collection, which was produced at the end of last year? The NAO, and indeed the Public Accounts Committee, found that the long deadlines are one of the reasons why people make mistakes and do not submit their tax returns at all. That is one of the main reasons for changing the administration.

Mark Hoban (Conservative, Fareham)

The hon. Lady makes an interesting comment and I shall return later to the report of the Public Accounts Committee. However, shortening deadlines could also lead to more mistakes and problems with tax return submission.

Tax advisers have good reason to be concerned about the lack of public consultation. It is certainly not in line with the HMRC’s guidelines on consultation, and the lack of consultation has been remedied not by publishing and circulating a consultation document but by asking professional advisers to comment on the partial regulatory impact assessment. That is not a very satisfactory way to gain tax advisers’ and their clients’ consent and agreement to the change.

The other aspect that concerns me is the impact that the proposals will have on three key groups: taxpayers, their agents and the HMRC itself. Taxpayers must produce information to enable them to complete their returns on time. Hon. Members will know from completing their own tax returns that, depending on how simple or complex they are, a great deal of information can be needed. Some of that information is supplied in line with statutory deadlines. For example, Members should receive a P60 by 31 May and, where applicable, a P11D by July of each year.

For other providers, however, no such statutory requirements exist. Often, information is provided only on an annual basis—for instance, on the anniversary of a particular policy or investment—and there is no consensus on when that information should be received. Taxpayers will have to wait for information before they complete their tax returns, and will have a shorter period in which to complete them.

Taxpayers in seasonal occupations are also an issue. We mentioned that topic in debate last week. Many people who complete self-assessment forms are self-employed in small owner-managed businesses. They will face challenges when trying to achieve those deadlines. Businesses will have to use the time between the end of March and September to finalise their returns. By bringing forward the filing dates for assessment, the Government will compress the time that small businesses have to complete their returns for tax and other purposes, placing an additional burden on them.

We know that certain sectors have seasonal peaks in their work load. A large amount of the tourism and hospitality sector’s business is done during the time when the new filing deadlines will require businesses to complete and finalise their returns. The farming sector spends the time between July and September bringing in the harvest. Farmers will want to use those hours to harvest their crops, not to complete income tax self-assessment forms.

As we heard on Thursday, auctioneers and people who work in the art market find their own seasonal peak in the summer. They too will find it difficult to produce their returns. According to research undertaken by the Association of Chartered Certified Accountants, 54 per cent. of its members feel that the revised dates will have a negative impact on businesses engaged in seasonal trade. The pressure of assembling the information required for self-assessment during that period and completing the form will place additional burdens on individuals at their busiest time of the year.

A number of people will employ agents to complete their tax returns. Such agents will have issues managing their work load. In April, they will need to complete year-end returns for the HMRC; in May, they will deal with P60s on their clients’ behalf; in June, they will deal with P11Ds; and they then normally experience a lull in their work load until September when some paper returns are finalised and again in January when returns are finalised.

That is not to say that outside those peaks, agents are twiddling their thumbs. Often, they do audit and accountancy work on their clients’ behalf and offer high-quality business advice. Such agents will find their work load and their ability to manage it challenged. Some 91 per cent. of respondents to research on the impact believe that the Carter review will have a significant impact on tax agents’ working practices.

Agents want to ensure an even flow of work throughout the year. They have an interest, as does the HMRC, in doing so. It is easy to forget the scale of operations undertaken by some tax agents. A medium-sized practice with 13 individuals in its tax department might process as many as 3,500 returns. It normally starts to receive information from the majority of its clients in early August. By the end of November, a practice of that size has received back the information required for about 80 per cent. of its clients, submitted draft returns for approval to about 65 per cent. and filed about half of those returns with the HMRC already. That is by November, the latest date under these recommendations for filing online returns. If the deadlines were brought forward, that would bring forward the timetable for clients and their agents.

It is not just advisers and their clients who will have a problem; the HMRC needs to deal with the issue as well. It has two work load peaks, one near the self-assessment filing date in January and the other at the annual return deadline in May. The concern is that the arrangements will not smooth that workload but will bring forward the peaks. The industry would hope to see taxpayers and agents receiving greater encouragement to file their returns earlier, so as to spread the work load. Tax advisers welcome a great deal of Lord Carter’s report, and they support his proposal to align the inquiry window with the actual, rather than the statutory, filing date, as they believe that that would encourage the smoothing of the work load.

The hon. Member for Bishop Auckland (Helen Goodman) referred to mistakes and errors in relation to the later filing deadlines. If the deadline were earlier, advisers, agents and businesses might submit provisional or estimated figures in order to meet the September deadline for paper returns or the November one for online returns.

Andrew Selous (Conservative, South West Bedfordshire)

An accountant in my constituency has informed me that the Revenue website cannot cope with partnership returns, capital gains or foreign income. Is my hon. Friend aware that people who receive such income will not be able to benefit from the two-month extension?

Mark Hoban (Conservative, Fareham)

Indeed, and those are not the only types of income or clients that the Revenue’s website has a problem with. Members of Parliament cannot submit returns online at the moment. There is a great deal of work to be done to ensure that agents and their clients can submit online a range of returns reflecting the complexity of our tax system.

There is a risk that, with the shortening of the deadline, people will submit estimates or provisional figures. In addition, there is no electronic system for amending a tax return, so the HMRC will receive manual amendments that correct, update and revise data submitted online in accordance with the suggested deadline. As my hon. Friend the Member for South-West Bedfordshire (Andrew Selous) said, the current system for submitting tax returns online has limitations. As well as being unable to deal with the forms of income that he mentioned, the HMRC cannot accept additional documentation online so that, too, has to be submitted in paper format. It is clear that the implementation of the recommendations of the Carter review will create problems not just for advisers and their clients but for the HMRC.

The Public Accounts Committee report on theissue contains interesting evidence from the HMRC. On page 18 of the evidence section of the report,David Varney, the chairman of the HMRC, says of moving the paper filing deadline to September:

“Whilst this would provide a single combined date that already has currency for SA taxpayers, it would create an un-manageable paper filing peak in September as well as clashing with the tax credits renewal peak.”

Even the chairman of the HMRC recognises the problems that will be created by the Carter recommendation to bring forward that filing deadline. The report contains a graphic illustration of the peaks. The graph on page 16 demonstrates that there are peaks in both September and January for returns that are filed by post. If we move the deadline for filing paper returns from January to September, we will create a huge spike in the HMRC’s work load, dwarfing the number of returns submitted online at the moment. Even the HMRC recognised that problem, as did the Public Accounts Committee’s report, which acknowledged the major peaks in work load at the time of the September and January filing deadlines and highlighted issues around smoothing those peaks and improving the accuracy and efficiency of the tax system.

In conclusion, issues need to be resolved that affect taxpayers, their agents and the HMRC to ensure that their work loads are dealt with sensibly. It would be no answer to the PAC’s recommendations for smoothing the work loads if those of the HMRC, businesses and their advisers are simply compressed into short spaces of time creating an increase in the number of errors, estimates and re-statements that would require a long tail of remedial action.

It is a pity that those changes have not been introduced in line with the HMRC’s code of practice on consultation. That has caused a great deal of unhappiness and disappointment among tax advisers. In recent weeks, we have heard about the importance of consultation and agreement before major changes from the Treasury, yet it seems keen on pre-emptive announcements and deadlines for changes. It would have been far better to have discussed the matter with interested parties, rather than to have sprung the decision on them without warning.

Joe Benton (Labour, Bootle)

Before I call the next speaker, may I take this opportunity to remind the Committee that the clause is about rates and that although it is not unreasonable to allow those on the Front Bench a little latitude, we cannot have repetitive debate? I insist on that.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

I shall attempt to return to the substance of the clause, which is actually very straightforward because it leaves income tax rates as they have been for some time.

There is an issue of fairness. In a fair taxation system, those with higher incomes should pay a higher proportion of tax than those in the lower income brackets. In our taxation system, however, the bottom 20 per cent. of households pay 39.5 per cent. of their gross income in tax, whereas the top 20 per cent. of earners pay only 34.2 per cent. That might not be because of the income tax levels themselves, but because of other increases in, for example, national insurance and council tax, which year on year have risen above the rate of inflation. That has led to inequality in the system. What plans does the Financial Secretary have to make taxation fairer given those inequalities that still exist despite the existing rates of income tax?

George Young (Conservative, North West Hampshire)

I welcome you, Mr. Benton, to the Chair. I wish to add a brief footnote to the excellent speech that my hon. Friend the Member for Fareham (Mr. Hoban) made from the Front Bench. Much of the Finance Bill has little impact on the average taxpayer, but the change that he mentioned will by its nature impact on everybody who submits a tax return. They, and indeed the Committee, are entitled to a better explanation than the one that we have had so far for bringing forward the dates.

First, if we make those changes, there will be a penalty on those who, for whatever reason, cannot submit their tax returns electronically. They will have an earlier filing date. It would be helpful if the Financial Secretary explained why, 10 years after self-assessment was introduced—I was the Financial Secretary who introduced it—it is still not possible for Members or civil servants to submit their tax returns electronically.

Secondly, it would be helpful also if we could have up-to-date figures for the numbers of tax returns—electronic and paper—submitted between September and January so that we can see the impact of the proposed reforms. My hon. Friend referred to such figures from a PAC report. Those reforms would compress dramatically from July to January—the current time frame—to July to September or November, the effective working time in which tax returns are produced. Inevitably, that will concentrate them more in the holidays. It would have been better if there could have been slightly more effective consultation with those involved before those reforms were introduced.

According to a survey produced by the Society of Professional Accountants, 84 per cent. stated that the earlier filing dates were not readily attainable. I am sure that the Government do not want to introduce a reform that those who will have to deliver it believe to be unattainable. If the Government want to move the dates forward, perhaps they could stage the process and bring them forward one month at a time rather than all at once. That would allow the accountancy profession and taxpayers more time to adjust to the demanding schedule that the Government wish to impose.

John Healey (Labour, Wentworth)

Clause 23 sets income tax rates only for the current financial year, but I have some sympathy with the hon. Member for Fareham, who tabled amendments to the clause that were judged to be outside the scope of the Bill. I say to him that the measures following Carter’s review are not in the Bill. We intend them to be in next year’s Finance Bill.

I shall pick up the point about consultation made by the right hon. Member for North-West Hampshire(Sir George Young) and the hon. Member for Fareham. In July 2005, we asked Lord Carter to advise us on increasing the usage of the HMRC’s online services. I do not accept that there has been no consultation. Many representations were made to Carter’s review team, which contained several tax agents from different fields. We published Lord Carter’s report at the Budget, and we issued alongside it a partial regulatory impact assessment. We specifically invited views and evidence on Carter’s recommendations from those in the fields involved and from anyone else, and we have set a deadline of 30 June for those consultations. There has been plenty of time to contribute and to influenceLord Carter’s thinking in the preparation of his report and our thinking on how we may implement his recommendations in next year’s Finance Bill.

Mark Hoban (Conservative, Fareham)

I recognise that certain changes need primary legislation and will be introduced in the 2007 Finance Bill. It is interesting to note that evidence to the PAC suggested that the changes would have to be introduced in this year’s Finance Bill to be effective, in line with the recommendations of the Carter report.

For a change of such magnitude, tax advisers would have expected a discussion paper to be published and debated in the industry, rather than the Carter review being published and the Government saying that they would accept its recommendations. They expected a more formal process of consultation, rather than simply having to comment on the effectiveness of recommendations that the Government have already committed to accept and implement.

John Healey (Labour, Wentworth)

I had not yet finished dealing with the process that we are going through to get in place eventually the measures that we feel are appropriate following the review that we asked Lord Carter to make. It is out for consultation and we have invited, and welcome, views and evidence. I shall take the hon. Gentleman’s comments in Committee as part of that process.

My hon. Friend the Member for Bishop Auckland was right to refer us to the National Audit Office report published in February. I say to the hon. Member for Fareham that the PAC takes a tougher line thanLord Carter on the mandatory filing of electronic returns. The purpose of the Carter review and of implementing its recommendations is quite clear: it is to have the most efficient tax service and system possible for taxpayers and to continue to support the necessary and proper efforts of the HMRC to ensure compliance. I do not want to get into the detail of Carter’s recommendations; we will have a full opportunity to do so when next year’s Finance Bill is published. I simply say that nobody will be required to file a self-assessment return online. We are looking to simplify the self-assessment to take as many as possible of those whose tax affairs are relatively simple out of the self-assessment system altogether.

Having rightly pointed out that the clause is straightforward, the hon. Member for Falmouth and Camborne (Julia Goldsworthy) asked a much more general question about fairness in the tax system. I remind her that, as a result of the personal tax and benefit reforms that the Labour Government have put in place since 1997, in real terms this year, households will, on average, be £950 better off. Families with children will, on average, be £1,500 better off and families with children in the poorest fifth about whom she is worried will, on average, be £3,400 better off.

When we consider the income tax rates under the clause alongside the operation of the tax credit system, about four in 10 families now pay no net tax. A two-child family earning up to £21,000 as a result of the combination of the tax and tax credit system pay no net tax. I say to the hon. Lady that, in my book, that is a fair tax system and it is one that we are keen to protect and develop.

I welcome the contribution of the right hon. Member for North-West Hampshire who was a much more distinguished Financial Secretary. It is still not possible for Members of Parliament to file their tax affairs online. He will know that there remain long-standing concerns about the additional safeguards that are judged appropriate for the tax affairs and personal data of MPs. There have been lengthy debates on the subject that, in some cases, pre-date the current Government. That is why the HMRC still handles those tax returns separately from the system that is set up for other taxpayers.

I hope that with my explanation and my final reassertion of the fact that we expect to bring forward a packet of measures to implement specific proposals following Carter in next year’s Finance Bill, when there will be a full opportunity for the sort of the debate that the hon. Member for Fareham wants in Committee this morning, the Committee will allow the clause to stand part of the Bill.

Clause 24

John Healey (Labour, Wentworth)

I will attempt to be brief on this clause, too. The Labour Government are committed to maintaining a modern, fair and competitive corporation tax system. That is becoming more important in what is increasingly a more flexible and competitive global trading environment. Since 1997, we have therefore attempted in part to promote enterprise by reducing the headline rate of corporation tax from 33 per cent. to 30 per cent., the lowest United Kingdom corporation tax rate since its introduction. Alongside that, we have introduced several more targeted measures, including relief for research and development costs, which we shall debate under future clauses.

The clause will enable corporation tax to be charged for the financial year 2007-08. It sets the main rate for that year at 30 per cent., which is no change from the current rate. I commend the clause to the Committee.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

The Financial Secretary talked about competitiveness. Although corporation tax rates have fallen in recent years and have remained unchanged since 1999, they have been falling in other developed countries. I should therefore be interested to know what investigation his Department has carried out into whether the United Kingdom looks set to remain an attractive place for investment compared with other countries. I want also want to know his future projections for revenues from the tax since, in 2004-05, the UK revenues from corporation tax, excluding North sea oil, represented 2.6 per cent. of the total tax take. Including North sea oil revenues, the figure is 3.3 per cent., which is very high for countries in the Organisation for Economic Co-operation and Development. I shall be interested to know what future implications he thinks that that will have for competitiveness. Are the taxes are being relied on more heavily because of the commitment not to increase income taxes?

John Healey (Labour, Wentworth)

The hon. Lady is right to say that maintaining a competitive economy and tax system is a continuing challenge. She asked me about corporation tax projections, which are set out as normal in the pre-Budget report and the Budget. It makes no sense to strip out the corporation tax returns and projections from a particular sector of the economy as she tried to do. I remind her that the World Economic Forum’s most recent global competitiveness report ranked the UK as the most competitive of all the major European countries.

Clause 25

John Healey (Labour, Wentworth)

The clause sets the small companies’ rate of corporation tax for the financial year 2006-07 at 19 per cent. for companies with under £300,000 profit; it is unchanged from previous years. The clause also sets the fraction used for calculating marginal relief on the main rate at 11/400ths, which ensures that companies with profits between £300,000 and £1.5 million face a smoothly rising average tax rate. That is also unchanged from the previous year. I commend the clause to the Committee.

Clause 27

Joe Benton (Labour, Bootle)

With this it will be convenient to discuss new clause 7—Interpretation of Chapter IV of ICTA—

‘In section 413 of ICTA, after subsection (10) add—

“(11) This Chapter shall apply notwithstanding the terms of the European Communities Act 1972.”.'.

John Healey (Labour, Wentworth)

The clause introduces schedule 1 and together, they provide for a small extension to the group loss relief rules for companies, which will allow UK groups to claim corporation tax relief for foreign losses in some very limited circumstances. I put it on the record so that it is clear that existing group relief rules for UK losses, which business is understandably keen to retain, are unaffected by the proposal.

The Government are introducing this small extension to group relief following the decision last December by the European Court of Justice in the case of Marks & Spencer v. Halsey. In that case, the court ruled that the UK’s group loss relief rules are in principle compatible with European law, but they go too far in denying relief for foreign losses in some narrowly defined circumstances: where a UK parent company can show that a foreign subsidiary has exhausted all possibilities of relief in its state of residence.

With effect from 1 April this year, our domestic tax legislation will be changed by the clause to reflect the decision taken by the European Court of Justice, making it clear that relief will be available in some limited circumstances to a UK parent company and its UK subsidiaries for the tax loss of a foreign subsidiary. That foreign subsidiary must either be resident in the European economic area or have made the loss in a permanent establishment based in the European economic area.

Schedule 1 sets out new conditions and rules. To ensure that they are observed the UK claimant company will be responsible for showing that all the conditions for the new relief are met. That is necessary because losses surrendered under the new rules will be from foreign companies that are not generally subject to UK law. Although the relief will be available only in the narrow circumstances set out in the schedule, the Government became aware that some people were planning arrangements with the aim of obtaining relief in the UK where it would not otherwise have been available. My right hon. Friend the Paymaster General announced on 20 February that relief in the UK would be denied where such arrangements are made. The schedule contains provisions that will give effect to the announcement from that date.

Mr. Benton, you are encouraging us to debate new clause 7 at the same time as clause and schedule stand part, so perhaps I may take briefly the opportunity to deal with it. It is interesting that it was tabled by the hon. Member for South-West Hertfordshire (Mr. Gauke), rather than his party’s Front Bench spokesmen, and it will be interesting to see what they do if he presses it to a vote.

This is an extraordinary new clause; it could have been drafted by the European People’s party in the European Parliament—perhaps it was. Its intention is clearly to pretend that the European Union does not exist and, therefore, has no impact on the UK tax system. I explained earlier why, in our view, clause 27 and schedule 1 are necessary and reasonable. Just as importantly, we cannot renege on our treaty commitments in the way that the new clause encourages and suggests that we do; it is impossible for us to do that. Simply seeking to say that existing legislation applies notwithstanding the European Communities Act 1972, does not set aside those commitments, even though the hon. Gentleman may wish to do that.

On the important central point, it is right—it is the Government’s clear policy—that member states should have the power to determine the shape of their own tax systems. Other treaty provisions make it clear that that competence is preserved. We are not endangering that power to determine our own tax policy by introducing the clause and the schedule; we are simply aligning our law with the latest developments in European Union jurisprudence in an area specifically related to the internal market.

In conclusion, clause 27 and schedule 1 make provision for a small extension to the group relief legislation, to make it clear how relief from foreign losses will be available in certain narrow circumstances, and enable us to preserve existing group relief for UK losses. I commend the clause to the Committee.

David Gauke (Conservative, South West Hertfordshire)

I am grateful for the opportunity to speak on the clause and on new clause 7. As the Financial Secretary said, the purpose of clause 27 and schedule 1 is to ensure that our group relief laws comply with the European Court of Justice judgment in the Marks & Spencer case. This is not the first occasion—nor will it be the last—on which it is necessary for us to amend our taxation laws to comply with ECJ judgments. I raised the significance of the impact of the ECJ on our corporation tax law during Second Reading and I have no intention of running through the complete history of this matter again.

It is also worth noting that there is a widespread consensus in the UK in opposition to tax harmonisation, particularly relating to direct taxation. I welcome the Financial Secretary’s saying that it is right that we determine our own tax policy. The Chancellor of the Exchequer has stated that

“we must explicitly reject old flawed assumptions that a single market should lead inexorably to tax harmonisation”.

It is sometimes tempting to think that tax harmonisation is simply about rates, but it is not. It is broader than that; it is also about exemptions, reliefs and thresholds. Although the Financial Secretary states that it is right that we determine our own tax policy and this measure is only to align group relief with regard to the latest developments in EU jurisprudence, it cannot be considered in isolation. Since 1996, a series of judgments by the ECJ has determined that our tax laws have not been in compliance with European law in respect of provisions relating to freedom of establishment under the single market.

When this matter was debated on Second Reading, the Paymaster General was understandably quick to point out that this is Conservative legislation and that the various ECJ judgments are a consequence of that. However, it is also worth pointing out that at the time of the Single European Act there was no expectation that the various freedoms of establishment and other freedoms set out in that Act would apply to direct taxation. There was no explicit mention of direct taxation. All attempts at giving EU institutions jurisdiction over direct taxation had been rejected by member states. There was also an argument, widely accepted until relatively recently, about the need for fiscal cohesion, and therefore that single market provisions should not be used to strike down national laws.

The Marks & Spencer case determined that it was in breach of European law to allow profits and losses made by UK residents to be offset against each other but not to allow losses made by a subsidiary resident outside the UK, but in the EU, to be offset against the UK group company. As a consequence, the Finance Bill amends our law with the intention of complying with this judgment and subsequent judgments made in the UK courts. But as I said, this is not the first case and it will not be the last where we are required to do this.

Consortium relief, advance corporation tax and thin capitalisation rules have all had to be reformed as a consequence of ECJ judgments. In addition to the reforms of group relief being discussed today, we can expect the ECJ to determine against the UK in respect of franked investment income, and even since Second Reading, the Advocate-General has determined that our rules in respect of controlled foreign companies are illegal. The cost of these judgments to the UK Exchequer is considerable. Vast amounts of tax have to be repaid and the estimates that I have seen suggest that the cost to the Treasury of the Marks & Spencer case will be in the region of £3 billion to £4 billion. I would be interested to know what the Treasury estimates the ongoing annual cost of implementing the provisions contained in clause 27 and schedule 1 will be, as compared with being able to maintain the previous position, as my new clause 7 proposes.

There are those who argue that the change to the law in these circumstances, specifically in relation to group relief, is a good thing and that UK companies will ultimately benefit from the reform of group relief. That may well be the case. However, taken as a whole, I take the view that even with this Government—I am clearly not a supporter—the best interests of the country will be served if decisions about our tax system are taken by the democratically elected legislature of this country and not by a group of Luxembourg-based judges.

That brings me to the purposes behind my newclause 7. As the Financial Secretary has pointed out, new clause 7 amends section 413 of the Income and Corporation Taxes Act 1988 to state that the existing group relief rules shall continue in effect, notwithstanding the terms of the European Communities Act 1972. It reinstates the legal position as existed prior to the Marks & Spencer case. It sets out the law which this Parliament determined and says that that law shall continue to apply. It sets out the law which the Government wished to maintain throughout the Marks & Spencer case. It will also save the Treasury several billion pounds.

Will it be treated as valid by the UK courts? At this point, and at the risk of sounding like my hon. Friend the Member for Stone (Mr. Cash), I need to turn to the Factortame case—not that there is anything wrong in sounding like my hon. Friend. The Factortame case will be familiar at least to the lawyers among us.

Rob Marris (Labour, Wolverhampton South West)

Three of them.

David Gauke (Conservative, South West Hertfordshire)

Not nearly enough, but we will make a start there. In brief and to simplify, the Factortame cases related to the Merchant Shipping Act 1988, which determined that in respect of shipping quotas, the UK quotas would be available only for UK persons. The ECJ determined that this was in breach of EU law. The House of Lords determined that the terms of the European Communities Act 1972 meant that the terms of EU treaties were to be incorporated into UK law and existing and future Acts of Parliament are subject to EU law.

Consequently, the Income and Corporation Taxes Act 1988, which contains the corporation group relief provisions, is subject to the provisions of EU law, as determined by the ECJ. The Act, in its present form, cannot stand because it is inconsistent with EU law, as the Financial Secretary rightly says. Consequently, the Government have considered it necessary to modify the law in order to comply with the views of the ECJ. However, the will of the current democratically elected legislature is not necessary for the case law of the ECJ to override the 1998 Act. Our role is to plug the gap in the least damaging way possible.

I want to explore the alternative approach that is set out in new clause 7. It is to state explicitly that UK law in its existing, enacted form continues to apply, notwithstanding any contrary principle of EC law. Returning to the Factortame cases, the essence of the judgment was the European Communities Act 1972. It entrenched EC law by giving it the capacity to override a later statute. The statute in question, the Merchant Shipping Act 1988, did not purport to repeal or exclude the effect of the European Communities Act. That gives rise to the essential question whether a later statute may, by express words, repeal or exclude the effect of the European Communities Act in giving effect to EC law.

The suggestion that the 1972 Act cannot be repealed or overridden is surprising, even if that is Parliament’s express intention. If that is not the case, the whole concept of parliamentary sovereignty is thrown out of the window. Some constitutional experts have suggested that that is the natural consequence of the Factortame decision and that the ECJ case law is for the supremacy of EC law. Reassuringly, the English Court of Appeal has refused to accept the argument. In Thorburn v. Sunderland City Council, the weights and measures or metric martyr case, Lord Justice Law stated:

“Whatever may be the position elsewhere, the law of England disallows any such assumption. Parliament cannot bind its successors by stipulating against repeal, wholly or partly, of the 1972 Act. It cannot stipulate as to the manner and form of any subsequent legislation. It cannot stipulate against implied repeal any more than it can stipulate against express repeal. Thus there is nothing in the 1972 Act which allows the Court of Justice, or any other institutions of the EU, to touch or qualify the conditions of Parliament’s legislative supremacy in the United Kingdom. Not because the legislature chose not to allow it; because by our law it could not allow it. That being so, the legislative and judicial institutions of the EU cannot intrude upon those conditions. The British Parliament has not the authority to authorise any such thing. Being sovereign, it cannot abandon its sovereignty. Accordingly there are no circumstances in which the jurisprudence of the Court of Justice can elevate Community Law to a status within the corpus of English domestic law to which it could not aspire by any route of English law itself.”

Joe Benton (Labour, Bootle)

Order. The hon. Gentleman’s remarks are becoming more generalised. Will he come back specifically to new clause 7?

David Gauke (Conservative, South West Hertfordshire)

I am grateful, Mr. Benton. I will not proceed with the quotation, but the direction in which it is going is clear. The purpose behind new clause 7 is to state that the law made by this legislature stands. An argument that may be used against it is that European Union law stands above it. There is nothing that we can do. It would be ineffective. There is an argument that new clause 7 would be entirely ineffective and that the British courts would not recognise it.

My view and that of numerous judicial authorities is that, where Parliament determines, as I propose it does in new clause 7, that an element of European Community law will not stand, Parliament’s will prevails. I should be grateful to know later in the debate whether the Financial Secretary agrees with that interpretation and whether we have that power. That still leaves the issue of our EU treaty obligations. I fully accept that were new clause 7 to be accepted and to become law, there are enormous issues with regard to our treaty obligations. I have no doubt that enforcement action would be taken by the European institutions against the UK. I should be grateful to know what assessment, if any, the Government have made of the likelihood of such action, and what the sanctions or fines are likely to be. I raise the matter because the fiscal costs of the various changes to EU law are considerable—I am talking about billions. We need, at least, to be able to evaluate all the options that are available to us.

My purpose in raising the issue, both on Second Reading and today by speaking to new clause 7, has been to highlight the increasing interference in our tax law by the EU. Secondly, I am trying to obtain a clear statement of Government policy on the matter, both in respect of the M & S case and more generally. Thirdly, I hope to clarify the constitutional position: has Parliament the right to insert an explicit override of EU law within legislation, and do the Government expect UK courts to recognise the validity of such an override?

The ECJ has played a prominent role in our deliberations during the last few sittings of this Committee. We have seen how it has damaged our competitiveness in the art market, and how the Government’s strategy to tackle missing trader intra-Community fraud has been scuppered by an ECJ judgment. Now we see that our corporation tax laws are being fundamentally amended because of the ECJ. We have to ask who should decide our tax laws—the democratically elected UK Parliament, accountable to the British people, or the judges of the ECJ? Is our purpose merely to implement our instructions from European institutions, and do we really think that that would be to the long-term benefit of our tax system and our economy? This might not be the time or place to determine such matters, but we have a responsibility to ask those questions.

Mark Hoban (Conservative, Fareham)

I congratulate my hon. Friend on the way in which he made his case for new clause 7. He was right to highlight the way in which the ECJ is shaping the direct tax system in the UK. Of course, he refers particularly to the Marks & Spencer case, which underpins this clause and the schedule. When we discuss amendments to the schedule, I shall come to some of the issues arising from that case and the way in which the Government have responded to that judgment.

We should reflect on the fact that the case brought by Marks & Spencer used two articles—articles 43 and 48, relating to the freedom of establishment and the equality of treatment of member states—to argue the point that group relief should be available in the UK for losses incurred by overseas subsidiaries. Those articles have been used by businesses in other countries to amend or to force through changes to their own tax legislation. My hon. Friend mentioned the changes in capitalisation rules—I think that they were in the Finance Act 2005—that stemmed from a case that sought to unpick the rules on capitalisation in Germany that favour German businesses to the detriment of other businesses located there. In a way, that action helped the UK heads of corporate businesses to try to dismantle barriers in Germany.

David Gauke (Conservative, South West Hertfordshire)

It is also worth pointing out that, as a consequence of that case, we have had to amend laws that imposed a considerable bureaucratic burden on UK companies in order to show that transactions within a group took place on an arm’s length basis.

Mark Hoban (Conservative, Fareham)

Indeed. As happens in such cases, if the determination of a matter of European law affects one member state, it might well have to be applied to other member states. A tax adviser has told me that the ECJ is interested not in tax avoidance in a particular member state but in tax avoidance that takes place across the European Union as a whole. There will inevitably be situations in which changes in one jurisdiction will lead to changes in other jurisdictions.

My hon. Friend made an eloquent case for effectively carving out direct taxes from the implications of the Single European Act, as that Act has been used to bring the case before us. However, we need to think carefully about the implications of doing so. He made a powerful argument in the context of tax, but I am sure that other legislatures could make equally powerful arguments about other matters covered by the Single European Act. Those seeking to withstand market liberalisation measures introduced by the Act might see a UK carve-out as an argument for a carve-out to protect their own services. Those Governments that seem inclined to protect their own businesses and withstand cross-border flows of transactions might see the carve-out as a reason to seek their own carve-outs from the Single European Act.

If we carve out direct taxes, what will other member states seek to carve out? We must be careful how we tackle the issue, because of what the consequences might be. Although we all subscribe to what the Chancellor said—

“we must explicitly reject old flawed assumptions that a single market should lead inexorably to tax harmonisation”—

the legislative bite required to put it into effect might have a knock-on effect on aspects of our relationships with other member states.

I come to another issue concerning the judgment and its application through the clause and schedule—the Government’s consideration of the ECJ judgment and its elaboration by Mr. Justice Park in the High Court. I shall deal in more detail later with the point that the Government’s interpretation of the ECJ’s judgment is far narrower than Mr. Justice Park’s. He said in his judgment that he did not feel he needed to return to the ECJ to clarify certain points left ambiguous as a consequence of its judgment; he felt that he could do that himself.

The Government’s interpretation and implementation of changes to group relief that are narrower thanMr. Justice Park’s judgment creates a risk that businesses will challenge schedule 1’s interpretation of the ECJ’s judgment, that they will push the Government on issues of timing, arrangements and other aspects and that the Government will incur great costs defending its narrow interpretation of the ECJ, to taxpayers’ detriment.

I shall make one specific point on the Government’s consideration of the application of ECJ judgments to tax policy. Some would argue that although the judgment in the Marks & Spencer case dealt specifically with group relief, which is available only when a parent owns 75 per cent. or more of the subsidiary, it should also apply to consortium relief and the rules for claiming group relief should be reflected in the rules for claiming consortium relief. It is argued in the light of the ECJ judgment that businesses will seek to take the Government to court in the ECJ, saying that if the Government are going to apply the ECJ’s judgment on group relief in a particular way, they should also make the same applications and changes to rules for consortium relief.

John Healey (Labour, Wentworth)

The hon. Gentleman gives a reasoned exposition of his views, but he has not been clear about where he stands on new clause 7. Does he support it or not?

Mark Hoban (Conservative, Fareham)

I think that I have given that explanation clearly already by highlighting some of the issues and the thought required before such a clause is put to a vote. I hope that, in the light of my remarks and given the thought that needs to go into how such a change might be implemented, my hon. Friend the Member for South-West Hertfordshire will seek the Committee’s leave to withdraw the new clause.

Joe Benton (Labour, Bootle)

Order. New clause 7 has not been moved, so there will be no necessity to withdraw it.

Mark Hoban (Conservative, Fareham)

I am grateful. That will give my hon. Friend even more time to think about the matter before it is dealt with towards the end of our proceedings.

I conclude by saying that this stand part debate has raised important issues about the application of European law to tax. We cannot see it in isolation from the wider issues of reducing barriers to business across Europe, which we must examine carefully. We must remember that much of our economic success at home and abroad is due to the free movement of capital, both human and financial. We should be wary of making changes that, while satisfying us on one issue, damage us on a broader range of issues.

Rob Marris (Labour, Wolverhampton South West)

I am grateful to the hon. Member for Fareham for rebuking the hon. Member for South-West Hertfordshire on new clause 7, perhaps better than I could have done. The new clause would be a first step towards taking us back to 1971, before the Heath Government rightly negotiated our accession to the European Union—the Common Market, as it was then called. It is a wrecking amendment and would wreck the UK’s position within the European Union. The hon. Member for South-West Hertfordshire was quite clear about that. He cited various cases, but as his colleague the hon. Member for Fareham pointed out, European Union law is a two-way process.

The hon. Member for South-West Hertfordshire mentioned the Factortame case; I assume that he meant Factortame No. 1 rather than No. 2 or No. 3. He did not talk about the debate within the EU, which is perhaps too wide for us to discuss today, on the horizontal applicability of directives in contra-distinction to their political applicability, or about cases such as Foster v. British Gas and the Francovich case in Italy on the applicability of EU directives. The EU is now a club of 25 members, all of which, including the United Kingdom, are at least in theory bound by the same laws. If new clause 7 were accepted, we would be seeking to opt out of that arrangement and see ourselves as distinct from the EU. The huge risk is that other member states would do the same, and we would end up with a fragmented EU. That would not be in the interests of the UK. In particular, it could adversely affect the position of the UK in financial markets, as the hon. Member for Fareham said.

London is the financial centre of the EU; most people would accept that, although perhaps the hon. Member for South-West Hertfordshire would not. One of the ways in which we have built on that position is by taking advantage of the financial rules of the European Union, which are binding on all 25 member states at least in theory and often in practice. If we were to start to resile from those rules, it would weaken the position of London and the UK within the EU, to our detriment. It might satisfy the hon. Gentleman’s view of where the UK should be going as a sovereign state, but it would be something of a little Englander approach and an own goal in financial matters. We have the leading centre within the European Union, a position that has been built upon in large part, though not solely, due to our membership of the EU. New clause 7 would seek to wreck that, and I urge my hon. Friends to vote against it if it is pressed to a Division.

John Healey (Labour, Wentworth)

I appreciate the reasonable way in which the hon. Member for South-West Hertfordshire put forward his entirely unreasonable proposal. He has many colleagues who take an equally hostile view of the European Union but have generally framed their arguments in a less temperate tone.

The hon. Member for Fareham was interesting. He encouraged the hon. Member for South-West Hertfordshire to a point and then urged him to be cautious, particularly on the concept of carve-outs, for which he was arguing. My hon. Friend the Member for Wolverhampton, South-West was much clearer and more direct about the risks that such an approach might pose to our national economic interest.

On a number of points, the hon. Member for South-West Hertfordshire touches on the high principles of domestic and European Union jurisprudence. The simple legal fact at the heart of the matter is that the relevant Community laws are those concerning fundamental freedoms prescribed by European Community treaties and relating to cross-border movement between member states.

The hon. Gentleman also asked about costs. It is true that following judgment in the Marks & Spencer plc case, several reports suggested that the cost to the Exchequer would be high. However, they reported the outcome of the case in a way that was misleading;the judgment of the European Court of Justice was much narrower than was implied in those reports. The Government estimate that the cost to the Exchequer of the small extension of group relief proposed in this clause and schedule 1 as a result of the Marks and Spencer judgment, will be about £50 million a year. That estimate was set out and reflected in the Budget documentation. The Government are prepared to accept that cost in order to maintain the existing group relief that we believe is important and beneficial to UK business.

The hon. Member for Fareham made a number of points which, as he said, we will come on to in more detail later, but it is appropriate that I return to two of his points now. He took the Government to task by saying that the provisions in the clause and schedule are in fact narrower than Mr. Justice Park’s judgment. We have studied the ECJ’s judgment carefully and consider that the proposed extension to the group relief legislation is in line with the requirements in the EC treaty. The ECJ’s decision was very narrow—a view that has been reinforced by Advocate General Geelhoed. [Interruption.] I should spell that out for the Committee. The Advocate said that the judgment should be applied restrictively.

The hon. Member for South-West Hertfordshire asked about consortium relief. I am not sure if he is aware, but consortium relief is minute in comparison with group relief and typically accounts for less than a quarter of 1 per cent. of the volume and value of group relief. So we have concentrated our efforts on the effects of group relief because that has the greatest impact and effect on business. To be direct, the implications for consortium relief of the Marks & Spencer judgment are unclear, and we are still considering what—if any—consequences there might be. If we judge that it is appropriate to take action, we will do so, but only if we feel that it is necessary. I commend the clause to the Committee and if the hon. Gentleman wishes to press his new clause, I shall ask my hon. Friends to oppose it.

David Gauke (Conservative, South West Hertfordshire)

I am grateful to the Financial Secretary for his kind and generous words. I fear that I will have the worst of both worlds due to the manner in which I addressed the Committee earlier; I presented something that might be unpopular with some colleagues, but in such a way that I shall lose all credibility with some of my Eurosceptic colleagues.

When we evaluate our relationship with the European Union, it is important to take into account both the credit and debit sides. The purpose of new clause 7 is to highlight one of the disadvantages of our relationship with the European Union. Our tax system is being changed to our disadvantage, which is making it more difficult for the Government to raise revenue through corporation tax in the way that they would like. There is also a constitutional point about how there has been no consent from this House that direct taxation, in particular, should be a matter for the European Union. However, one has to accept that there is a wider picture. There are undoubted advantages to our membership of the European Union: anything that means that Peter Mandelson spends most of his time abroad has got to be a good thing.

Joe Benton (Labour, Bootle)

Order. We are not debating the merits or demerits of, or anything else about, the European Common Market. We are now discussing new clause 7, and I must ask the hon. Gentleman to return to that.

David Gauke (Conservative, South West Hertfordshire)

I merely say that new clause 7 highlights a particular aspect. My hon. Friend the Member for Fareham fairly makes the point that there is a larger debate, but it is not the purpose of this Committee to debate that now. I therefore have no intention of pressing new clause 7.

Schedule 1

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 25, in page 150, line 7 [Vol 1], leave out from ‘arrangements' to end of line 9.

Joe Benton (Labour, Bootle)

With this it will be convenient to discuss amendment No. 28, in page 150, line 11 [Vol 1], leave out from ‘secure' to end of line 12 and insert

‘that the amount in question was not eligible for qualifying relief within the meaning of Schedule 18A paragraphs 6, 7, or 8.'.

Mark Hoban (Conservative, Fareham)

The amendments concern the specific way in which the Government have chosen to implement the ECJ judgment, and I want to talk about something that the Financial Secretary highlighted in the clause stand part debate. He referred to a statement made by his right hon. Friend the Paymaster General in February, about the Government trying to close down any attempts made by UK companies to use the Marks & Spencer judgment to claim group relief and to enter into what was described as relevant arrangements to enable group relief to be claimed.

I should like to probe the arguments of the Financial Secretary about the clauses that concern those arrangements. It is fair to say that if someone were setting up a UK-based group of companies, they would seek to ensure that the shareholdings were such that they were able to claim group relief if losses were incurred in trading operations. They would check that they could offset the losses in one company against the profits in another for tax purposes. I would argue that that is a legitimate form of tax planning from the outset. Following the Marks & Spencer case, my belief would be that a UK parent company setting up subsidiaries overseas would, when starting up a new operation or new business, seek to structure the shareholdings so that they qualified for group relief. It may be that rather than encouraging an overseas investor to buy 30 per cent. of a subsidiary, they might ask that investor to buy just 24 per cent., so that they could qualify for group relief, and set up such arrangements from the outset. That is a perfectly reasonable form of tax planning.

However, there may be circumstances in which other arrangements are put in place, which would enable businesses to claim group relief on losses incurred by overseas subsidiaries. I should like to run through a few examples, to try to tease out from the Minister where he thinks the boundary lies between what he thinks is a sensible arrangement as part of the normal structure of a group and arrangements that might, in his view and that of the Treasury, be deemed to be tax avoidance. When companies are looking at structuring their businesses overseas, they need some certainties and some clarity.

Stephen Hesford (Labour, Wirral West)

With respect to the hon. Gentleman, it seems that he wants to have his cake and eat it. If he accepts that the Marks & Spencer judgment has to be made clear in the Bill, how can he argue on one hand that we have to implement it—that is, in favour of Marks & Spencer and the wider regime for tax relief for groups of companies throughout the European Union, which I understand is the essence of the judgment—and also argue that it is wrong of the UK Government to narrow the proposal as far as possible so that Marks & Spencer does not take over-advantage of that situation? Is the hon. Gentleman in favour of Marks & Spencer getting away with it or is he in favour of narrowing down to the bare minimum? Which is it?

Mark Hoban (Conservative, Fareham)

I am in favour of proper implementation of the ECJ judgment in the Marks & Spencer case. I will come to two issues that are connected with that matter in the next group of amendments. The schedule refers to relevant arrangements to enable companies to claim group relief. Anyone setting up a group structure from scratch and determining its structure would think about how to ensure that if losses do arise—no company sets out to make losses—they can flow through to UK tax computation and be offset against UK tax and profits. That is legitimate planning.

However, I am concerned about where the line is drawn between legitimate planning and the actions that people might take in order to make losses eligible for UK tax relief at a later date. There might be some tax structuring at the start of a new business opportunity, but people may find that the arrangements they make further on in the process, especially their choices about changes to group structures, for example, could make some losses eligible for relief in the UK, depending on their actions.

To help the hon. Gentleman, I give the example of a minority shareholder in an overseas company in which the UK parent owns 60 per cent. and a minority shareholder owns 40 per cent. If the minority shareholder exercises a put option, and requires the UK parent to buy those shares, which puts it over the 75 per cent. threshold for claiming group relief, the arrangements have not actually been made at the behest of the UK parent. If that happened as a consequence of actions by the minority shareholder, those actions will act as a trigger and enable the UK parent to claim group relief on the losses, assuming that there is no other way of obtaining relief in the country where the overseas subsidiary is located. However, because it is not their action or at the parent’s direction, they have not entered into the relevant arrangements for the purposes of securing group relief.

We have heard of cases in which the parent company may deliberately buy out the minority shareholding and decide to close down the operation, and in doing so goes over the 75 per cent. threshold, which in principle would render those overseas losses eligible for group relief in the UK. If that is the case and the parent actively seeks to acquire that minority interest, does that fall within the remit of the anti-avoidance provisions in the schedule?

We are trying to understand what actions a company can legitimately take that will trigger group relief which will not be picked up by the anti-avoidance claims. Is structuring from the outset okay? Will transactions later on fall inside or outside the anti-avoidance regulations? That is not clear, as the wording in the schedule is quite broad. People have a legitimate interest in understanding where the Government and HMRC will draw the line when considering what is permissible and what is not in relation to the structures of group companies.

John Healey (Labour, Wentworth)

It is intended that the amendments should, as the hon. Member for Fareham said, alter certain detailed rules which would otherwise—as the clause and schedule are drafted—prohibit relief under the schedule in some circumstances. They would remove some of the protections in the legislation that prevent groups of companies from entering arrangements with a view to obtaining tax relief in the UK for foreign losses.

I should like to deal with some of the hon. Gentleman’s questions about the scope of our proposals. The European Court of Justice only expects cross-border loss relief in narrow circumstances, therefore it is important that we ensure in legislation that that is given effect and cannot be manipulated. The judgment in the Marks & Spencer case also makes it clear that Governments can adopt measures to prevent companies from seeking to achieve a tax benefit in one jurisdiction rather than another—in other words, choosing in which jurisdiction they will obtain relief for the losses. Just to be clear, the legislation does not prevent the movement of business activities. Section 403G only prevents loss relief from being obtained in the UK where a main purpose of the arrangements is to obtain group relief in the UK. That is the central provision, which, in some senses, answers the hon. Gentleman’s specific questions. I cannot give him a judgment on hypothetical or individual taxpayers’ cases. The purpose is to consider the motive in each particular case and instances would have to be examined on a case-by-case basis. HMRC has established procedures, with advisers and business, for doing just that.

In summary, I am concerned because the amendments would remove some of the important protections in the legislation. I am surprised that the Opposition have tabled such amendments. I should be interested to hear the hon. Gentleman say whether these are probing amendments, because he is trying to be much more generous with UK tax. It is not possible to be precise about the costs of the amendments, but without the protection that they seek to remove, the potential for abuse, which is our main concern, runs into hundreds of millions of pounds a year.

I hope that the hon. Gentleman will not press the amendment to a Division, but if he does, I shall ask my hon. Friends to oppose it.

Mark Hoban (Conservative, Fareham)

I am slightly disappointed with the Financial Secretary’s response to the amendments, because people are looking for a greater degree of clarity about what the fairly broad paragraphs in the schedule are seeking to achieve. He referred to assessing the motive in each case and the procedures that the Revenue and Customs have to assess the purpose of transactions. I can see a range of corporate transactions that people could enter into.

Stephen Hesford (Labour, Wirral West)

Will the hon. Gentleman give way?

Mark Hoban (Conservative, Fareham)

I shall just finish this point.

Some of those transactions are currently regarded as legitimate and acceptable and others would unlock the losses for relief in the UK after a loss had arisen and some group structuring had taken place. The Financial Secretary is trying to capture such transactions in this anti-avoidance provision in respect of groups that undertake restructuring to unlock those losses for use in the UK, perhaps where there is an overseas subsidiary with an external shareholder with more than 25 per cent. of the shares in the company and some transactions have been entered into that change the direction or benefit of the taxpayers. We ought really to have some greater clarity on that.

Stephen Hesford (Labour, Wirral West)

Is it not simply this? We have a judgment which we did not want and we are seeking to narrow that judgment down to protect the Rvenue in this country. Does he not agree?

Mark Hoban (Conservative, Fareham)

I referred to that point in my earlier remarks. We want to see the judgment properly implemented. In doing so, we also need to give some clarity to taxpayers on the implication of that, particularly where actions are taken to minimise the scope for abuse and where we are looking for greater direction and clarity from the Government. I regret to say that I do not think that the Financial Secretary offered that clarity in this matter.

As I said at the outset, these are probing amendments. I will not push them to a vote but I hope that the Financial Secretary will reflect on ways in which further guidance can be given to taxpayers on the breadth of these anti-avoidance techniques. Would they inhibit or catch groups that were set up as perfectly legal and sensible business arrangements, but to which the Revenue might impute the motive of being set up to enable group losses to be relieved at some time in the future if a business is loss-making? Unless the Financial Secretary has further clarification to offer, I beg to ask leave to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 5, inpage 153, line 35 [Vol 1], leave out from ‘liability' to end of line 36.

Joe Benton (Labour, Bootle)

With this it will be convenient to discuss the following amendments: No. 6, in page 153, line 38 [Vol 1], after ‘every' insert ‘reasonable'.

No. 7, in page 154, line 19 [Vol 1], leave out from ‘liability' to end of line 20.

No. 8, in page 154, line 23 [Vol 1], leave out

‘immediately after the end of the current period'

and insert

‘when the claim for group relief was made'.

No. 9, in page 155, line 5 [Vol 1], leave out from ‘liability' to end of line 6.

Mark Hoban (Conservative, Fareham)

These amendments deal with two different areas within the judgment of the European Court and particularly refer back to the judgment of Mr. Justice Park on 10 April 2006, where he tackled a couple of the issues that were perhaps ambiguous in the ECJ’s original judgment. I should like to deal first with amendments Nos. 5, 6, 7 and 9. One of the issues that was left outstanding in the minds of Marks & Spencer and their advisers, and on which they sought clarification from Mr. Justice Park, was the use in the ECJ judgment of the word “possibility”.

Mr. Justice Park’s judgment states at paragraph 33 that in his view when the ECJ refers to possibilities available, it means recognised possibilities, legally available, given the objective facts of the company’s situation at the relevant time. Some of the sub-paragraphs of the schedule refer to every possibility, rather than trying to be more specific about the nature of those possibilities.

Two issues emerge from Mr. Justice Park’s ruling. First, there are the legally recognised possibilities and whether those are available, given the objective facts at relevant times. Mr. Justice Park states that while there may be legal possibilities for group relief, the fact that they are available does not necessarily preclude losses in other EEA countries offsetting UK tax or profits. He goes on to discuss what is meant by objective facts at the relevant time and uses two examples to illustrate that. The first is where the overseas business is loss-making and still trading. He said that although the parent company might argue that the overseas subsidiary will not return to profit, the fact that it could—thereby offsetting its losses against future profits—would mean that those losses could not be used to offset UK taxes.

His other example was of a loss-making overseas company that had been closed. The losses had been fully utilised in that country, and a balance of unrelieved losses remained that could be offset against UK taxable profits. He said that the objective facts in that case proved that the losses could be relieved in no other way than against UK taxable profits.

Paragraph 6(4) of schedule 1 refers to “every step”, but what does that mean? Will HMRC examine what a UK parent company has done to turn around a subsidiary prior to closing it, in order to ensure that every step has been taken? What is the objective measure of any step? In the case of Marks & Spencer, the French subsidiary was sold to Galeries Lafayette, which then used the losses. If M&S had not tried to sell the business to Galeries Lafayette, would it still have satisfied the “every step” criterion? If it had not been able or had not tried to sell the business, would Revenue and Customs have said that the UK parent had not tried every step?

With the idea of every step, the Government are asking UK parent companies to know what purchasers have done with their losses. In the M&S case, it was known that Galeries Lafayette had used those losses to reduce its taxable profits, but most groups retain a degree of confidentiality about their tax affairs. There is no legal basis on which a parent that disposes of companies can find out what the acquirer has done with the losses.

My concern is that phrases such as “every step” and “by any other means” are poorly defined. In the effort to give better guidance to taxpayers, perhaps they should be either changed or qualified. That is why amendment No. 6 would insert the word “reasonable”. Amendments Nos. 5, 6, 7 and 9 seek to clarify what actions a claimant might take to meet the conditions for losses to qualify for offset against UK tax by defining more tightly the issue of possibility left hanging by the ECJ judgment.

The second issue that I shall tackle is that of timing, which is dealt with by amendment No. 8. The Government say in paragraph 7 of schedule 1 that a group relief claim should be made at the end of the current period. It is important for the Committee to know that UK companies claiming UK tax losses are allowed two years after the end of the current period to make a group relief claim. In defining so clearly the timing of the group relief payment for overseas losses, the Government are opening up a mismatch between the treatment of UK losses and the treatment of losses arising elsewhere in the European economic area.

In his judgment, Mr. Justice Park sought to elaborate on the ECJ judgment, which I understand was silent on the issue of when the group reliefclaim should be made. He identified three points at which the claim could be made. The first, in line with the Government’s new clause, is at the end of the accounting period when the loss was made. The second is at the time or times when the group relief claim is made by the parent—effectively a later date. The third is when the matter is dealt with by the special commissioners. I shall deal with the first two options.

Schedule 1 as it is drafted reflects the first option, yet it and the third option were ruled out by the High Court. In paragraph 44 of his judgment, Mr. Justice Park said that

“option 1 is too soon, and would be likely to rule out virtually every case.”

He went on to say:

“At the end of an accounting period in which M&SG and M&SB made a loss, and therefore was still likely to be carrying on its trade it is hard to imagine any case in which German or Belgian law would not provide for any possibility of relief for losses.”

So there could be a situation in which a business continues to trade at the end of a period. Say the financial year ends at 31 December and the business is still trading in Germany or Belgium, under schedule 1 any claim for group relief on those losses should be made. Given that the business is still trading at that point, and is likely to trade on into the next year, there is still the possibility in German or Belgian law—assuming that they allow for such possibilities—for those losses to be relieved against future profits. The only way in which a claim for group relief could be made in those circumstances would be if the business had closed during the current accounting period, so that it was known that there would be no future trade against which the losses could be offset, if they were unable to be offset in that year or in previous accounting periods.

The ECJ judgment is that, where possible, losses should be relieved in that country first, before being made available to offset in the UK company. If the decision had to be made at the end of the financial year, the company would know that there had been losses, but not whether there would be profit in future years against which that year’s losses could be offset. Because the possibility still existed to offset those losses against future trading profits, they could not be offset against UK taxable profits. In a way, the timing in schedule 1 makes it virtually impossible for a business to make a valid claim, because unless it is closed down in the course of the year, it will still be trading, so there will still be the possibility at the end of that financial year to make a claim.

Mr. Justice Park decided that the decision to make a claim for the use of losses should be made at the time at which the group submitted its claim for group relief. Such claims can be made up to two years after the end of the accounting period in which the losses were made. In those circumstances, a UK parent company could have much greater certainty about the possibility that the losses could not be relieved in the country in which the subsidiary was resident. For example, it could have closed a loss-making subsidiary, so it would know that there would be no tax on profits against which the tax losses could be offset.

If the Committee were to accept amendment No. 7, schedule 1 would reflect Mr. Justice Park’s judgment on the matter. My concern is not merely to achieve certainty for businesses and clarity on the timing, but—having seen Mr. Justice Park’s ruling, and the fact that he chose option 2—

“the time or times when the group relief claim was made by the parent”,

that some UK companies might seek to take the Government to court again to get them to comply with Mr. Justice Park’s original judgment.

The Government might say, “That is fine. We must go through that process and take it through the House of Lords and to the European Court.” However, asMr. Justice Park said in paragraph 41 of his judgment,

“A principle that runs through the whole of community law and has been enunciated by the ECJ in numerous cases is the principle of effectiveness: procedures in Member States must not render practically impossible or excessively difficult the exercise of rights conferred by Community Law”.

It appears to me that the drafting of schedule 1 ignores Mr. Justice Park’s judgment and the principle of effectiveness. It will leave the Government and taxpayers open to further challenge in the courts.

Stephen Hesford (Labour, Wirral West)

Is it the hon. Gentleman’s view that all that Mr. Justice Park said was necessary in that case, or was much of it not necessarily directly relevant to what we are now considering? It is an opinion, but it is not necessarily one that the Government need to take as black-letter law at this time.

Mark Hoban (Conservative, Fareham)

The hon. Gentleman opens up a can of worms in questioning the legal status of Mr. Justice Park’s judgment. To an extent, that goes back to the stand part debate, and the remarks of my hon. Friend the Member for South-West Hertfordshire about the primacy of Community law. If Mr. Justice Park’s judgment were seen as fleshing out the ECJ’s original judgment, should it be part of Community law? If it is part of Community law, will it have primacy over this legislation? I suspect that some people will go back to the ECJ about that. There is an important legal issue here about the status of Mr. Justice Park’s judgment in elaborating on the ECJ judgment. If we go down his route, we are saying that the Finance Bill overrides that judgment. However, as my hon. Friend has said, we know that parliamentary sovereignty is subservient to Community law. If Mr. Justice Park’s judgment is seen as elaborating on Community law, that may well prove ultimately to have primacy over the Bill.

Stephen Hesford (Labour, Wirral West)

It was potentially an interesting, wider question that the hon. Member for South-West Hertfordshire asked. However, I am asking a very narrow question. Did Mr. Justice Park need to say, when he made the judgment in that case, what he said, or did he just go on, because he felt like going on to elaborate on areas that he did not need to elaborate on for the purposes of the case? If the latter, his comments were obiter, and therefore unnecessary as part of the letter of the law.

Mark Hoban (Conservative, Fareham)

The hon. Gentleman, who was a barrister, would find it valuable to look at the judgment.

Stephen Hesford (Labour, Wirral West)

You have got it.

Joe Benton (Labour, Bootle)

Order. Remarks must be made through the Chair.

Mark Hoban (Conservative, Fareham)

My understanding is that Marks & Spencer went back to Mr. Justice Park for a ruling on the issues, and that he was specifically asked to clarify those points. In the detail of the judgment, he refers to representations made on the issues by counsel for both Marks & Spencer and HMRC. What he was saying on the matter was therefore relevant, and not simply some asides that we should not take into account in dealing with this schedule.

John Healey (Labour, Wentworth)

Like you, Mr. Benton, I wanted to ensure that all members of the Committee had a chance to contribute if they so wished. These amendments would remove some protections in the legislation that ensure that relief is consistent with Government policy and the relevant European law, as expressed in the Marks & Spencer judgment. It is clear that the ECJ, in the Marks & Spencer case, intended relief to be given for foreign losses only in very limited circumstances, where all possibilities of relief had been exhausted elsewhere. The Court went out of its way to note that Governments are free to adopt measures to prevent artificial arrangements seeking to obtain a tax benefit.

I shall deal, as the hon. Member for Fareham did, with amendments Nos. 5, 7 and 9 together. They would undermine the purpose of the new schedule, which is to ensure that if losses have to be, or could be, relieved in future in another state, the UK is not obliged to give relief for them.

We still want to ensure that if a foreign company gets relief elsewhere, it cannot do so here. That is why a general description of other possibilities of obtaining relief is necessary in the legislation. The alternative would be an attempt to describe all the possible ways in which other countries provide relief for losses. Such a description would have to be updated each year. It would be burdensome for us to do and burdensome for business to follow, and it would carry the obvious risk that not all the possibilities of obtaining relief in the other EU member states had been identified.

As for the second issue raised by the hon. Gentleman, amendment No. 8 would change the date at which a determination must be made on whether a loss is potentially relievable for a future period in another state. He proposed an alternative approach and, in so doing, made reference to Justice Park’s recent High Court decision on Marks & Spencer. There is indeed a difference between the approach in Justice Park’s decision—members of the Committee might wish to know that that might not be the final word on the subject—and that in the Finance Bill as to the relevant time at which tests of unrelievability of foreign losses are to be applied.

The difference in position comes about because there are two different and distinguishable scenarios. The judgment of Justice Park applies only to the circumstances of Marks & Spencer. It applies in the context when the United Kingdom legislation does not contain provisions to allow relief on the losses of foreign subsidiaries. We are dealing under the schedule with legislation that, first, reflects the European Court’s decision in December last year and, secondly, translates that decision into UK legislation. In doing so, the Government have decided that the relevant time should be immediately after the end of the period in which the losses were incurred by the foreign subsidiary.

In setting out the legislation in such a way, we are relying on paragraph 55 of the European Court’s decision in the Marks & Spencer case. That paragraph sets out the conditions where, exceptionally, group relief should be extended to foreign losses. Our view is that those conditions are restrictive; that view was supported by the Advocate-General in another European case. When giving his opinion on class IV of the ACT group litigation case, he said:

“The court held that, in exceptional circumstances...a home State must extend domestic group relief”,

but that that extension

“should be applied extremely restrictively”.

The amendment would make the relief not restrictive, but more generous. However, it would not make it more equitable. In short, these amendments would remove important protections under the Bill, so I hope that, having said that they are probing, the hon. Gentleman will not press them.

Mark Hoban (Conservative, Fareham)

I am grateful to the Financial Secretary for his response. I shall begin by dealing with the first aspect of the amendments. I understand his point about the requirement to specify in great detail the particular circumstances that would preclude losses being utilised, and indeed being offset. He made a valid and important point about that, which I accept.

On amendment No. 8, the Financial Secretary distinguished between the specific circumstances in the Marks & Spencer case and the decision of Mr. Justice Park, and the general position that is reflected in the schedule. I understand the Financial Secretary’s argument about restricting the availability of the losses and setting out a theme that runs through the proposals to which we have just referred.

I wonder whether, in practice, the Financial Secretary has taken restriction to a point at which it renders the possibility of claiming group relief almost impossible. He is asking businesses, at the end of the financial year, to make a decision about submitting a group relief claim for overseas losses. Before a business has had chance to work through the accounts, think about what the scale of the losses might be, implement some judgments made in drawing up a set of accounts and determine the loss, he is expecting it to decide whether it should submit a claim for group relief for overseas losses. He is asking businesses to do something impractical.

A business might be continuing to trade, but it could be thinking about closing down. The Financial Secretary is asking such a business to make decisions at the end of the financial year—without proper reflection, without the opportunity to draw up proper financial statements and without knowing the quantum of losses—and before it is able to determine whether the losses it has incurred in that year can be relieved against past profits or profits that have emerged during that year. For example, if a series of overseas subsidiaries are operating the same territory, how will the UK parent business know that their profits are greater than the loss incurred by that business that year? The losses can be offset against the profits of overseas subsidiaries in the same accounting period.

The Financial Secretary is asking businesses to know far more than they are capable of knowing and is applying the provision in such a restrictive fashion that it is impossible for those businesses to make a claim for group losses. This is an area on which the Government should reflect further. He is being restrictive in asking businesses to make decisions that they are not in a position to make at the end of a financial year. While I do not wish to press the amendment nor amendments Nos. 5, 6, 7 and 9 to a Division, I shall reflect on the issue. I beg to ask leave to withdraw the amendment.

Joe Benton (Labour, Bootle)

With this it will be convenient to discuss Government amendment No. 23.

Mark Hoban (Conservative, Fareham)

I would be grateful if the Minister discussed the amendments. I have his letter to the shadow Chief Secretary about them, and while I appreciate the need for the Committee to move on at pace, it would be appropriate to explain their purpose. What does the Financial Secretary want to achieve by changing the definition of losses to be relieved and the comparison between UK measures of the EEA losses and other measures?

John Healey (Labour, Wentworth)

The amendments will make minor technical changes to ensure that the amount of EEA losses that can be surrendered as group relief to UK companies is in line with the policy objective of preventing double relief for those losses. The previous version could have been read in two ways. That was not drawn to our attention by external sources, but it was something we spotted and decided to clarify with the amendments. I could go into detail, but I hope that the hon. Gentleman accepts that that is the reason for tabling amendments and how they have arisen. They will simply clarify technical changes. I hope that they are acceptable to the Committee.

Mark Hoban (Conservative, Fareham)

I do not want to appear to be an anorak or pedantic about the changes, but the Government have sought to amend the Bill here. Is the Financial Secretary confident that, when EEA losses are restated using UK accounting rules and if those losses exceed original EEA losses, the higher value will not be offset against UK taxable profits?

John Healey (Labour, Wentworth)

Yes.

Clause 28

John Healey (Labour, Wentworth)

I rise to speak to the first of the two clauses dealing with research and development tax credits simply to emphasise the point, of which Labour Members are well aware, that the tax credits are a key part of the Government’s strategy to increase business research and development. In so doing, we will boost the levels of science and innovation in the economy to help to secure long-term prosperity.

Since the scheme was introduced in 2000 for small and medium-sized enterprises, the support claimed amounts to just under £1 billion for such enterprises and almost £1.8 billion overall. Early evaluation of the scheme suggests that companies claiming R and D tax credits generally find the process quite easy and find that it is having a positive impact on their R and D spending. However, we have constantly looked at ways to improve the package and to make it easier to apply for and more effective in its application. The amendments and changes announced in the pre-Budget report should improve the experience of companies claiming the credits. The announcement was widely welcomed, as was the fact that HMRC will set up dedicated units to specialise inR and D tax credit claims.

We also announced that the range of qualifying costs for the scheme will be expanded to include payments made to clinical trial volunteers. The clause will enact that announcement. It follows the suggestion put to us by the Association of the British Pharmaceutical Industry, which argued that the cost of paying volunteers for clinical trials is a legitimate R and D cost incurred by pharmaceutical and biotech companies and others undertaking medical research.

The clause also makes equivalent changes to vaccine research relief, which was introduced in 2002 to provide extra incentive for R and D on drugs and vaccines to treat or prevent diseases.

Brooks Newmark (Conservative, Braintree)

At the end of last year, the then Minister for Competitiveness, the hon. Member for Brent, North (Barry Gardiner), said of the R and D tax credit:

“The truth is that it hasn't been a success. A lot of it has to do with a misunderstanding of what the R&D baselines were. We are trying to iron that out.”

While I appreciate that clause 28 will take out a wrinkle by including payments to clinical trial volunteers, does the Financial Secretary agree that the Government have some more ironing to do? I ask that question in the context of a comment by John Cridland, deputy director general of the CBI, who said:

“Companies are experiencing too much uncertainty and inconsistency in its application. That has to change if the Government is to achieve its target of R&D spending at 2.5 per cent of GDP by 2014.”

I would be interested to hear the Financial Secretary’s comments on that.

Jeremy Wright (Conservative, Rugby and Kenilworth)

I welcome you to the Chair, Mr. Benton.

Will the Financial Secretary engage in some joined-up government? I welcome what he said about the extension of relief for clinical trials, which is clearly a necessary and important move, but he will know that there are other reasons why it is difficult for companies, particularly smaller ones, to conduct such trials. Many of those are related to the European clinical trials directive. To see that the measure is enacted as effectively as he and I want it to be, it is necessary for him to speak to his colleagues in the Department of Health and to remove any administrative obstacles to the conduct of clinical trials so that advantage can be taken of the tax relief.

John Healey (Labour, Wentworth)

Obviously, it is the Treasury’s role to set fiscal policy; the role of HMRC is to manage and administer that tax policy. We do so within the broader regulatory framework, for which other parts of the Government are responsible, but I shall draw the comments of the hon. Member for Rugby and Kenilworth (Jeremy Wright) to the attention of my hon. Friends in the Department of Health.

I say to the hon. Member for Braintree (Mr. Newmark) that, as I think I indicated in my short opening remarks, at each stage of the introduction of the R and D tax credit system—first for small firms, then larger companies—we have made it clear that we want to build on the emerging success. At each stage we have said that we shall look at possible improvements, including in the administration, and have welcomed the views of businesses, including that of the CBI, and their suggestions for improving the administration of the credit and payable allowance.

That was the intention behind the package of announcements in the pre-Budget report and the setting up of specialist units in HMRC, and that is why both were welcomed. The hon. Gentleman referred to the ironing out of some of the wrinkles in the system—I am keen on ironing; clause 29 does a bit of ironing too. I hope thereforethat he will support clause 28, and clause 29 when we get to it.

Schedule 3

Joe Benton (Labour, Bootle)

With this it will be convenient to discuss new clause 5—Cost of claims for R & D—

‘The Chancellor of the Exchequer will publish a review in relation to the cost of making claims for relief for research and development before 1st March 2007 and will consult with organisations which have a special interest in claims for relief for research and development.'.

Mark Hoban (Conservative, Fareham)

I should like to pick up on some of the Financial Secretary’s comments and those of some of my hon. Friends. Schedule 3 refers to the harmonisation of the timing of claims rules for R and D tax credits. In other contexts, harmonisation might not be welcomed, but it is in this one.

I shall talk about the claiming of tax credits. New clause 5 calls upon the Chancellor to

“publish a review in relation to the cost of making claims...before 1st March 2007”

and to

“consult with organisations which have a special interest”

in that particular area.

The Government and the Financial Secretary are proud of the introduction of tax relief for R and D expenditure, but the fact that it is available does not necessarily mean that it is accessible to all businesses. The Treasury needs to think about the cost of claiming those credits and how it might be made easier, and about who is currently excluded by the complexity of the system.

The Institute of Chartered Accountants commissioned independent research into the R and D tax credit, and the claiming of it. In the context of the debate on the schedule and the new clause, it is worth reflecting on that research. The report highlighted some of the challenges faced by businesses without the resources to make claims, and the impact on those businesses.

A large business with a well-funded R and D programme will find it relatively straightforward to make a claim, because it will have the systems and procedures in place, and the technical expertise to claim efficiently and effectively. The institute’s research indicated, however, that that did not necessarily lead to an increase in R and D expenditure, because the business had already maximised its programme. That is, the business would already have made the decision on how much to spend, and the decision would not be particularly affected by the nature of the offered incentives.

Medium-sized businesses, on the other hand, did actually benefit from the tax credits. They tend to be have better resources and to be better able to go through the process of making claims. The view was that the tax credit has been very helpful for them and has enabled businesses to grow without having to seek further venture capital funding. Businesses that have taken advantage of the tax credit have commented to me that it has aided their cash flow, and that they have not had to raise funding from outside sources.

The area of greater concern is that of smaller companies, and the Government need to think about that. The report quoted the example of a small business run by two scientists, which did not have adequate human resources to complete the returns, and so did not submit a claim. It therefore missed out on the incentives brought by the R and D tax credit.

As to the cost of preparing the returns, the indications were that it could cost approximately £12,000 to employ a chartered accountant to fill out the returns fully and to provide all the necessary support and administrative back-up. That is quite a significant sum. The taxpayer would need to consider the cash-flow benefit that it would receive from submitting the return and obtaining the tax relief, and whether it would be worth spending £12,000 of the small resources available to most small companies in order to make the claim.

Alternatively, the company could decide that it needed only to be briefed by a chartered accountant, in which case it could submit a claim itself. It was estimated that such a briefing would cost approximately £3,000, but the HMRC would come back and question the claim. I am not disputing the need for HMRC to ensure that claims are valid, but there is a cost in time and resources, including financial resources.

In preparing for the debate I looked at the guidance that is available to small businesses on the HMRC website, because one might ask why one should spend £3,000 on a chartered accountant if one can go to the HMRC website to find the information. In saying that I am probably doing a great disservice to fellow accountants who are still practising, but on looking at the website I was struck by why it would be difficult to complete a return without professional assistance. There is a series of user steps that companies need to take to determine whether they qualify, and there is a web page entitled “Is it worth reading any further?” which has a flow chart with more than a dozen boxes. If I were hard pressed for time I think I might question whether it was worth reading further.

Nevertheless, I continued, and I came across theR and D tax credit claim template for SMEs, which has a number of different lines for completion relating to, for instance, consumable items, consumable stores, computer software, staffing costs, externally provided workers, payments to staff providers, issues about connected persons, underlying relevant expenditure, subcontracted activities and payments to subcontractors. That is a lot for a small business to consider and I can understand their having difficulty with it. However, there are pages of helpful guidance to underpin it. I have one here headed “CIRD82400—R&D tax relief: categories of qualified expenditure: consumable items: meaning of consumed or transformed.” That sounds fairly hopeful. The first sentence begins:

“It is not possible to offer a simple definition”—

that supports my case that we need more chartered accountants to help by providing us with advice. However, it continues—

“because of the variety of possible circumstances.”

It goes on to say that it is specified in statute that

“the term ‘consumable or transformable materials’ includes water, fuel and power...Apart from these specific items, we then have to deal with the generality of the wording.”

I am reminded of the comments of the Financial Secretary during the last debate in which we discussed the importance of using general wording so that we do not need specific items. However, specific items might be helpful for somebody completing an R and D tax relief claim. The form says that

“A good example of a consumable item would be a laboratory chemical used in the R&D process which is used up...or converted to an unusable product.”

I am sure that scientists will be able to work their way through that. I quote this not for cheap laughs but to demonstrate the complexity that businesses face in trying to deal with some of the issues. Another page of guidance, “CIRD82500—R&D tax relief: categories of qualifying expenditure: software”, sounds as though it could be fairly straightforward. It rightly mentions that software, directly employed, can be used. However, it goes on to talk about the apportionment of software that a business might already have:

“Where software is only partly employed in direct R&D an appropriate apportionment of the expenditure should be made.”

So I suppose that if a business bought a licence to use Microsoft Office, and used Excel spreadsheets for the purpose of tracking the expenditure for R and D tax credits but also for some of the calculations that are required for research, it could apportion the cost of that software to the R and D tax credit. It rightly says that a pragmatic approach should be adopted. I make these comments to illustrate the scale of the challenge that is faced by businesses trying to claim these reliefs.

The other aspect is not the complexity and the record keeping that is required, but the degree of uncertainty about the likelihood of success of a claim. Companies with a stable and recurring path of expenditure find it relatively easy to claim tax credits. However, evidence collected for the ICA report suggests that that is not a universal experience; there can be issues about what constitutes R and D expenditure according to HMRC. Often, people’s decisions to invest in R and D are irreversible. Once the die is cast, that is it: they are going forward. Particularly in the case of a smaller business, the extent to which the likelihood of success of a claim is under question might have an impact on its willingness to make that irreversible decision.

In that context, the Financial Secretary was right to highlight the importance of setting up dedicated teams to tackle R and D tax credits. A concern that was highlighted by a number of respondents to the survey was that although some tax offices are very experienced—I should imagine that the one that serves Silicon Fen in Cambridgeshire would be very adept at dealing with such claims—there could be problems for somebody whose tax office did not have that experience. The dedicated teams that the Minister mentioned will help to tackle that.

I hope that in ironing out the wrinkles, to use the metaphor introduced earlier by my hon. Friend the Member for Braintree, the Financial Secretary will reconsider the cost of making claims, and think about what further steps can be taken to simplify claims, to provide better guidance to taxpayers who might want to take advantage of the relief, and to ensure that tax relief is not just available but accessible to smaller businesses.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

In their own terms, the new clause and schedule are rational and attempt to simplify the process by aligning the claims processes and time limits for R and D tax reliefs with those of enhanced deductions. However, I should like to follow the points made by the hon. Member for Fareham by considering the impact of the changes in tax credits on small businesses and the knock-on impact that they may have on them again. If all claims need to be made in company tax returns within 12 months of the filing date, what will be the impact of these changes on small businesses? Given that that is already a difficult administrative burden for them, reducing the time scale will be an additional difficulty.

There is still an issue with small businesses having to pay up front and claiming back tax credits. I should like to quote one conclusion from the report by the Manchester and Nottingham business schools, commissioned by the Institute of Chartered Accountants in England and Wales, which says:

“R&D tax credits on offer in the UK are similar to some of the best schemes offered around the world. The incentives are relatively more generous to smaller firms. The application process, however, diminishes the effectiveness of the policy and this is especially so for smaller firms and firms with small R & D programmes. In some cases the costs of preparing and administering claims prevents firms from taking advantage of the incentives.”

Given those conclusions, I wonder whether the Government really consider this to be an efficient mechanism for supporting small businesses in particular.

Rob Marris (Labour, Wolverhampton South West)

It is a pleasure to follow an entertaining speech by the hon. Member for Fareham. I say to my hon. Friend the Financial Secretary that I have some sympathy with new clause 5. [Interruption.] Before the hon. Gentleman gets too excited, I should say that the new clause is perhaps a little premature for the reasons to which he and my hon. Friend adverted in a previous debate.

The Red Book says, on page 62, paragraph 3.80:

“In ‘Supporting growth in innovation: next steps for the R&D tax credit’, published in...2005, government announced that HMRC would set up dedicated R&D units to handle all SME claims for tax credits. It is envisaged that these units will be fully operational across the country before the end of the year. At the same time, a statement of practice will be published presenting the standard of service and support that SMEs can expect from the new units.”

I understand that, at the end of the calendar year 2006, the dedicated SME claims units for R and D tax credits and statements of practice will be in place.

New clause 5 suggests a date of 1 March 2007 for the research to be done on the costs of claiming R and D tax credits. Understandably, we have a particular concern for SMEs. I am delighted that the Budget extended the number of employees from 250 to 500 in respect of the beneficial arrangements. However,1 March 2007 is a little bit early for a procedure or new way of doing things—including new support and so on—in respect of provisions that will be in place by the end of 2006. However, if the Government have not already included such provision in the Finance Bill next year, the hon. Gentleman might consider tabling a new clause similar to new clause 5.

I have sympathy with the hon. Gentleman’s approach. To echo the comments that have already been made, I say to my hon. Friend the Financial Secretary that we have to be careful that we do not have a wonderful tax regime that is too difficult for people to claim under and therefore does not boost R and D in the United Kingdom in the way that all hon. Members wish.

Stewart Hosie (Scottish National Party, Dundee East)

I am intrigued by new clause 5, and I hope that the hon. Member for Fareham can offer some enlightenment. It suggests publishing a review, having first consulted organisations with a special interest in claiming the tax relief forR and D. Would he envisage that the organisations consulted may not offer feedback in the published review that would make the R and D tax credit system more effective and efficient, but might suggest alternatives to it, at least in some small way?

I have said previously to the Financial Secretarythat in 2004-05, the last year for which I have figures for R and D tax credits and other R and D funding for Scotland and England, £670 million was budgeted to be made available for the tax credits, but only £290 million was actually taken up. In the same year—the figures are useful and interesting in this regard—in addition to the tax credit, a total of £710 million of Government funds were available, of which some £37 million came through collaborative research and development, knowledge transfer networks, knowledge transfer partnerships, grants for research and development, and the grant for investigating an innovative idea. The latter two apply only to England. In the same year in Scotland, some £16 millionwere available through Smart Scotland, SPUR, SPURplus, Score, SEEKIT, R & D Plus, and the small company innovation support scheme, which also includes a certain element from the Highlands and Islands Enterprise area.

Given that £670 million of tax credits were budgeted for, of which only £290 million were taken up, these small, more targeted schemes seemed to be quite successful, and the take-up seemed quite high. Does the Financial Secretary envisage that in the published review of the consultation, he will look for feedback from companies to have the Government’s research and development funding provided through such other mechanisms, not merely through the R and D tax credit system, of which, in certain years, only 50 per cent. of the budget has been taken up?

John Healey (Labour, Wentworth)

There appears to be something of myth around that, somehow, the R and D tax credit is costly to operate from a company’s point of view, and too difficult to operate in order for companies to claim. Frankly, if that were the case, I do not think that£1.8 billion-worth would have been claimed so far by companies, including £1 billion by small firms. Alongside that, I do not think that I could have been clearer. Since the system’s introduction—first for small firms; then for large companies—we have been ready, and have proved that we shall continue to look at its costs for business. We have been willing to improve, and have improved, the process for applications and administration where we can. We have also been ready and willing, and continue to be so, to improve the guidance that is available to firms if suggestions that seem sensible to us are made.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

Does that mean that the Financial Secretary rejects the conclusions of thework commissioned by the Institute of Chartered Accountants for England and Wales that found that there were significant difficulties for smaller businesses in accessing these credits?

John Healey (Labour, Wentworth)

Is the hon. Lady aware of how many companies constituted the study to which she refers? The answer is 10. I shall come to that shortly.

The schedule before us is not a big move; it is a modest move, and should help companies in the process of claiming tax credit. Harmonising the rules for claiming across the two elements of the R and D tax credit system ought to make it easier for companies to understand the claims process, and improve the incentive effect of the schemes.

New clause 5 urges us to publish a review and a report by 2007. However, we have gone further than that. We have already commissioned an independent survey of almost 1,000 R and D performing companies, looking at their experiences in claiming tax credits, the results of which we published last year, In contrast, the Manchester business school study was based on interviews with just 10 R and D performing companies. Members of the Committee could reasonably conclude that that was not the strongest piece of evidence. Interestingly, the results from that very small study contrast strongly with the results of the much wider first-stage evaluation that the Government undertook. The results of the latter, in contrast to the points made earlier, were very positive. It found that three quarters of the companies that had claimed R and D tax credit found the claims process fairly or very easy. That does not suggest that the costs of claiming are prohibitive, and experts generally agree with that view.

Finally, a recent article in Tax Journal surveying the R and D fiscal incentives in the UK compared with the US, Canada, Japan, Austria and the Netherlands, stated:

“For SMEs, the UK system is widely regarded as the most generous and the simplest to administer”.

Mark Hoban (Conservative, Fareham)

I am grateful for the Minister’s response. He is right to highlight the nature of the survey by the Institute of Chartered Accountants, which acted almost as a focus group in the way it carried out its work. Hon. Members on both sides of the Committee are aware of focus groups and the role that they play in modern politics. Perhaps the ICA should not be criticised for adopting the techniques with which so many of us are familiar.

So that the Committee is clear about the structure of the survey, 10 businesses were involved in R and D and five people who were interviewed were involved in manufacturing. Any manufacturing business today that does not invest in R and D is likely to suffer from the competitive challenge posed by India, China and eastern Europe. It is entirely reasonable to discuss with businesses their experience of R and D. I do not necessarily concur with the Financial Secretary that it is a myth that it is costly to claim, as there are issues that affect the cost of claims that the Government should think about and it is helpful to keep the system under regular review.

I say to the hon. Member for Wolverhampton, South-West that I wish the Standing Orders had allowed us to discuss new clause 5 to capture his mood of co-operation and harmony. I am pleased that he expressed support for a simpler tax system and I am sure he will warmly welcome the outcome of the Tax Reform Commission’s report on simplification later this year, which will contain much for him to comment on positively.

The hon. Gentleman is perhaps right to say that the date of the review should be moved backwards. I hope that the system of dedicated units will be evaluated as they are rolled out, rather than waiting until the full roll-out is completed across the country. I will not be setting the terms of the review as I do not expect to become Chancellor of the Exchequer shortly, but I am sure that the Chancellor will take note of the hon. Gentleman’s comments.

The hon. Member for Dundee, East (Stewart Hosie) made a valid point about the complexity of the support on offer to businesses investing in R and D and taking up new developments. A theme taken up by businesses in my constituency and expressed to me is that there are several different means of support as well as R and D tax credit and that it can be difficult to navigate their way around them.

Clause 30

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

I beg to move amendmentNo. 60, in page 28, line 20 [Vol 1], leave out ‘12' and insert ‘24'.

Joe Benton (Labour, Bootle)

With this it will be convenient to discuss amendment No. 61, in page 28, line 31 [Vol 1], leave out from ‘in' to end of line 32 and insert

‘2006-08 or financial year 2006 and 2007.”.'.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

These are probing amendments that consider the rationale behind the proposed changes to the time scale that apply to the increased amount of allowances for small enterprises. The clause proposes a temporary change to the first-year allowance of one year, which the amendment would extend to two years in order to try to understand the rationale for increasing the allowance to one year. Could the Financial Secretary explain how small businesses will be capable of responding to these relatively small and rapid changes? If the change proposed is introduced, the allowance will have changed from year to year in four consecutive years. I have received many representations from people who feel that the changes add to the regulatory uncertainty and the—

Standing Committee A

Clause 30

John Butterfill (Conservative, Bournemouth West)

I remind the Committee that with this we are discussing amendment No. 61, in page 28, line 31 [Vol 1], leave out from ‘in' to end of line 32 and insert

‘2006-08 or financial year 2006 and 2007.”.'.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

Amendments Nos. 60 and 61 are probing amendments dealing with the proposed changes to the time scale to which the increase in the amount of allowance for small enterprise applies. Clause 30 proposes to increase for one year the first-year capital allowance for spending by small businesses from 40 per cent. to 50 per cent. The amendments propose to increase that time to two years.

I seek the rationale behind the Government’s decision to propose the increase for only one year. I should be interested to know the Minister’s opinion on how capable small businesses are of responding to relatively small and rapid changes. If the changes proceed as proposed by the clause, that will represent year-on-year change in the capital allowance for four years. I have received many representations expressing concern that that uncertainty will undermine business confidence about how the allowances can be used. Has the Department assessed how such a small temporary change will affect small businesses’ behaviour?

Brooks Newmark (Conservative, Braintree)

Does the hon. Lady share my earlier concern that the Government are dealing with the issue wrinkle by wrinkle? What the Government really need is a major facelift in dealing with the issue of R and D tax credits. They should use a big bang, rather than doing things slowly and one by one.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

The issue is whether the Treasury decided that it wanted creases down the front or not. It seems to keep changing every year.

I know that the Minister does not particularly approve of the report referred to earlier, which was undertaken for the Institute of Chartered Accountants in England and Wales by the Manchester and Nottingham business schools. The report examined the role of tax incentives in capital investment and expenditure. Looking specifically at the capital allowance issue, the report found that

“if it is intended that the capital allowances regime should provide positive incentives to increase or accelerate the level of investment in capital, this is not being achieved. Capital allowances, with the exception of some generous investment incentives such as those for environmentally friendly investment, are too small to influence the expected payoffs from the investment.”

The Minister has already expressed his concerns about the small scale of the study, and other hon. Members have referred to it as a focus group. Does the Treasury know whether the businesses claiming such capital allowances are aware of the fact that the capital allowance has increased and select it, or do its figures showing take-up of the scheme actually reflect small businesses that have already made a business investment decision and then look to see what allowances are available?

It is doubtful that capital allowances accelerate investment. Any further uncertainty would undermine it.

Mark Hoban (Conservative, Fareham)

I welcome you to the Chair for our proceedings this afternoon,Sir John. Those of us on the Conservative Benches look forward to serving under your chairmanship. I am sure that you will ensure that the business of the day proceeds as smoothly as it did this morning.

Rob Marris (Labour, Wolverhampton South West)

Without wrinkles.

Mark Hoban (Conservative, Fareham)

The hon. Gentleman tempts me down a route of metaphor that I do not wish to exploit further. We had too many ironing metaphors this morning for me to risk continuing with that train of thought. [Interruption.] I know that the Economic Secretary to the Treasury is getting excited because he is on the next chapter of the Bill, but it might be better for him if he can just control himself for a moment and hold his firepower for that stage—I should like to give him that advice from the Opposition side.

I want to comment briefly on clause 30 and pick up on the point that the hon. Member for Falmouth and Camborne (Julia Goldsworthy) made about the fluctuating fortunes of the rate of first-year allowances. It is worth remembering what has happened since 1998. From 1998 to the fiscal year 2003-04, first-year allowances were 40 per cent., and there was a nice period of stability, but in 2004-05 they went up to 50 per cent., in 2005-06 they went down to 40 per cent., in 2006-07 they will be at 50 per cent., and in 2007-08 they will go down to 40 per cent.

The hon. Lady suggested that the 50 per cent. rate should continue for two years. However, if small businesses are to expand, invest capital and take on some of the challenges that have been discussed in the debate, they need some stability and predictability in the first-year allowance rate. How can a business plan confidently for the future, taking into account the incentives offered by the Government, if it is difficult to predict the level of first-year allowances from year to year? Will the Minister therefore give some indication of the Government’s thoughts on how long the 50 per cent. rate will continue and when there will be stability on first-year allowances?

John Healey (Labour, Wentworth)

I welcome you to the chair, Sir John, and I look forward to serving under your chairmanship again. The clause increases the rate of first-year capital allowances for small businesses from 40 to 50 per cent., for one year from April 2006. It is designed to assist the cash flow of small businesses and to provide enhanced funding for new investment.

The hon. Member for Falmouth and Camborne addressed the amendments that she has tabled as probing amendments and she cited again the Manchester business school survey that was commissioned by the institute. However, although the study sample was larger than the one that we discussed this morning, it was still based on interviews with only 20 respondents, which is not a terribly strong basis on which to determine important policy. Its findings do not contradict the fact that first-year allowances provide a valuable cash-flow boost to small businesses.

The purpose of the hon. Lady’s amendments is to extend to the 2007 financial year the increase in the allowances that the Government are introducing inthe Bill. I remind the Committee that it was in the pre-Budget report that we announced the package of changes of which the proposal in the Bill is a part, and there was a considerable discussion on other elements of the package in a Committee of the whole House. The package includes the one-year increase in first-year allowances for small businesses—an element that was introduced in response to submissions from a number of bodies that represent the interests of small firms. It was warmly welcomed at the time.

The hon. Lady and the hon. Member for Fareham (Mr. Hoban) asked for an explanation of the thinking behind the decision. Although we recognise the value of certainty and stability in the tax system, we have to ensure that the system is responsive to increasingly flexible and global business pressures. That was manifest in the package of announcements of which this proposal is a part and which was set out in the pre-Budget report. The Government are committed to supporting small firms, and we shall keep the options that may be appropriate for the future under close review. In doing so, we shall try to ensure that small business support is provided in the most effective way, but in a manner that is consistent with a set of principles that could be summarised as simplicity for businesses that comply with their tax and legal obligations, support for small businesses that have aspirations to grow and determination to maintain the attractiveness of the United Kingdom as a business location. The amendments would tie our hands rather than enable us to continue to work with business interests on these factors.

I emphasise that the changes in clause 30 were not only requested by business organisations; they were also welcomed when we announced them. On 5 December, the Federation of Small Businesses said:

“We welcome the small business measures and the simplification they will offer, especially the corresponding increase in the level of capital allowances that can be claimed by small businesses.”

On the same day, the Institute of Directors said:

“The replacement of the zero rate corporation tax by increased capital allowances for small businesses was welcome.”

Mark Hoban (Conservative, Fareham)

The Minister spoke of turning capital allowances on and off as part of a package. We need to remember that the abolition of the zero rate corporation tax is not just for this year, yet one of the measures that he offers in compensation is for one year only.

John Healey (Labour, Wentworth)

The hon. Gentleman is right. The matter was debated in Committee of the whole House. I quoted the responses of business representative organisations, such as the Institute of Directors, to the package that was announced, including the moves on zero rates. The Institute of Directors supported that move, or gave the response that it did on 5 December, because it will reduce the differences in taxation for small businesses, depending on how they are organised. He will remember that that was the principal rationale for the moves that we have made on the zero rate.

Finally, the response and the welcome from those organisations is significant not only in policy terms, but because it may help to deal with the concern of the hon. Member for Falmouth and Camborne about how small firms will become aware of the changes. In addition to the sources of Government-sponsored advice and information, we would expect their tax agents and advisers to play a large part in ensuring that they are aware of changes that may benefit them.

However, organisations such as the Institute of Directors with its large membership and the Federation of Small Businesses with its federated network also have an important role to play in helping to ensure that their members and small businesses in general are fully aware of the tax support and benefits. On that basis, I hope that the hon. Lady will feel comfortable about withdrawing the amendment.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

I must apologise, Sir John, for not yet welcoming you to the Committee. That was perhaps due to my eagerness to debate the amendments.

I listened carefully to the Financial Secretary’s response. I am keen to press upon him that the issue is not simply awareness of the allowances, but whether there is an incentive to take up the first-year allowances or whether it is something that small businesses come to after they have made the decision to invest. The support for the proposals, which have been welcomed by many parts of the industry, has not been entirely unqualified. Although it refers to the changes as beneficial changes, the Chartered Institute of Taxation said that

“this constant change and uncertainty undermines the effectiveness of any particular beneficial change and generally increases the complexity of the system unnecessarily”.

On the basis that the Financial Secretary has spoken of his commitment to small businesses and has left the door open to greater stability and consistency in future, I beg to ask leave to withdraw the amendment.

Clause 31

Theresa Villiers (Conservative, Chipping Barnet)

I beg to move amendment No. 30, in page 29 [Vol I], leave out lines 3 and 4.

I join the rest of the Committee in warmly welcoming you to the Chair, Sir John. I also congratulate the Economic Secretary to the Treasury on his recent appointment. I look forward to a constructive and positive debate on film tax this afternoon.

Before turning to the substance of amendmentNo. 30, I should like to start with some general remarks about part 3 and the Government’s new film tax-break regime and its history. Strictly speaking, the latter might be more suited to the debate on clauses 46 and 47, but as it is important that we learn from our mistakes, it would be useful to take this matter at this stage in order to set the scene and background for the new framework proposed and the Opposition’s amendments to it. I am conscious of the need to make progress, so as I have indicated informally, I should be happy for the debate on the amendment to cover the clause stand part debate without the need for any separate discussion of the clause.

I start by declaring that my sister-in-law is a film producer. I do not think that it counts as a declarable interest, but I thought I would mention it just in case. Like the Government, the Opposition believe that it is important to work to ensure that the UK provides a competitive and attractive environment for the film industry for commercial and cultural reasons. However, although we understand the Government’s motivation in their film tax-break regime and we, too, want a successful and sustainable film industry in the UK, we have serious concerns about their effectiveness in that area to date.

The Chancellor’s film tax regime has a chequered history. The costs of film tax relief spiralled from£10 million when it was initially introduced in 1997-98 to £520 million in 2004-05 and to a staggering£560 million in 2005-06. They are huge sums when one takes into account the fact that the UK’s entire cinema sales were only £770 million last year. It seems clear that many used the tax breaks in a way that the Treasury did not intend, and that a significant proportion of the revenue lost to the Exchequer did not directly benefit film producers and production.

Many of the funding arrangements developed under the section 42 and section 48 reliefs that we are proposing to abolish had much more to do with reducing the tax bill of a limited number of high net worth individuals than any desire to make films. The outgoing regime depended on investors to provide funds through complicated sale and leaseback arrangements, which gave rise to a veritable industry of tax avoidance schemes. As Revenue and Customs set out in its recent consultation paper, that led to considerable problems. It said:

“Whilst the current film tax relief has ensured the production of many valuable British films, the financing structures that have been used to access them have affected their value for money for the taxpaying public, calling into question their fairness and effectiveness. The repeated use of tax avoidance schemes around the current film tax relief has also involved significant Exchequer cost and there remains a clear Exchequer risk in the current reliefs. This has resulted in fluctuating and, at times, untenable levels of Exchequer costs over the years the reliefs have been in operation.”

Some of the aggressive structures allowed investors to make high rates of return that were almost risk-free, and some schemes apparently allowed investors to claim more in tax relief than they invested. Loopholes included so-called double dipping, which enabled film producers to claim tax relief twice on the same production—on production costs and the sale and leaseback of the final film.

In September 2003, the Culture, Media and Sport Committee stated:

“The historical cycle of change in the tax regime was presented to us by the majority of witnesses as a huge disadvantage to the industry.”

Although acknowledging the problems flowing from aggressive avoidance schemes, the Chartered Institute of Taxation said recently:

“We think there has been too much tinkering with the tax system. As with other relieving provisions, the government introduces a relief and then expresses surprise when taxpayers obtain the benefit of it.

Then the relief was withdrawn or redrafted.

More careful thought and consultation would have resulted in better legislation.”

Since the Chancellor first introduced his tax break, the rules have been amended in the Finance Acts in 2000, 2002, 2004, 2005 and now again in 2006. The continual change has caused uncertainty, damagingthe competitive position of the UK as a destination for the film industry.

The announcement of a further review last year unsettled the industry yet again. Harry Hicks, a film tax consultant with Grant Thornton, commented:

“The quicker we see the new legislation in full, together with HMRC’s proposed interpretation of its practical application, the better. In the meantime, I fear that many projects will be prevented from going ahead whilst financiers and bankers simply sit on the fence and wait and see how the new tax breaks will operate in practice”.

His firm predicted a downturn in the film business in 2006. It would be useful if the Minister gave us an insight into recent levels of investment in the film industry. Pinewood’s profits fell from £6.5 million to £571,000, which it attributed in part to the uncertainty caused by the pending new regime.

Problems were also reported with several other films: “Lassie” was due to be filmed at the book’s original British locations but was moved to Ireland, “The Libertine”, starring Johnny Depp, moved to the Isle of Man, and, most controversially, James Bond’s 21st film outing in the remake of “Casino Royale” will be the first of that long-running series to be shot predominantly overseas. Pinewood, Bond’s traditional home since “Dr. No”, lost out to Barrandov studios in the Czech Republic. Tim Adler of Screen Finance commented:

“For the Government to allow its most high profile civil servant to go abroad is extraordinary”.

Certainty is of key importance, and it will be the theme of a number of the amendments that I table. If there is significant uncertainty about how our rules operate and will operate in future, that will deter the large US studios from investing in the UK and making films here. Uncertainty probably has an even bigger impact on indigenous, independent film producers, because it impacts so significantly on their ability to raise finance for their film projects. They are unlikelyto have the ready cash available, so they must borrow to finance their projects. If this regime is to be successful, we must ensure that film producers can borrow against the tax credit. If the rules are uncertain, the risks will be higher and the banks will be reluctant to lend; where they do lend, it will be at significantly higher rates. Currently, few if any banks are willing to lend pending resolution of the new structure.

While we regret that it has proved necessary to introduce yet another revision of the rules, we agree with the Government that changes are necessary to deal with the problems I have outlined and the significant loopholes in the existing framework. There is no doubt that the proposed new framework is an improvement on the current rules and that it has received some positive comment from many of those who are affected by it. In particular, the Opposition agree that it makes sense to amend the framework to try to ensure that the benefits can be claimed only by the companies who are making the films.

We still have several reservations about the proposals. I have tabled a series of amendments that seek to elicit clarity from the Government about a number of points that have been raised with me by the film industry and by those who are affected by the new framework. As I said, the amendments were tabled in a constructive spirit to try to ensure that we end up with a framework that achieves the goals that the Government have set.

Turning to clause 31 and amendment No. 30, the clause defines the meaning of the word “film” forthe purposes of the tax regime. Anyone who produces a film as defined by the clause will automatically fall within the new framework, although they will qualify for the tax break—the enhanced deduction or tax credit—only if they also comply with the conditions set out in clauses 32 to 41.

I want the Committee to consider clause 31(2), on films produced as a series. Amendment No. 30, which I moved, seeks to delete paragraphs (a) and (b) from the clause and deal with the fact that the Bill currently provides that unless a series complies with all of the criteria set out in subsection (2) each film will be treated as a separate film for the purposes of taxation. Paragraphs (a) to (c) require that the series has no more than 26 episodes, that the total length is no more than 26 hours and that it

“constitutes a self-contained work or is a series of documentaries with a common theme”.

The cumulative conditions of subsection (2), particularly paragraphs (a) and (b), could cause considerable practical problems if the legislation goes ahead as it is. For example, a TV series that has a significant number of short episodes would fall outside the cumulative conditions of those paragraphs. There seems no sensible reason to treat such a series as separate films for the purposes of taxation, nor is there any obvious reason why a series of more than 26 hours should not be treated as a single unit for film tax purposes.

As the Chartered Institute of Taxation pointed out in its briefing on the Bill, the cumulative conditions would give rise to a considerably increased compliance burden because of the requirement to treat each episode of a series as a separate trade. Schedule 4 treats each film as a separate schedule D case 1 trade. For example, TV companies producing long-running soaps will be required to keep separate tax records, monitor costs and estimate the total future income for each individual programme. They will have to track the loss position for each separate episode, and that will involve considerable extra cost.

Rob Marris (Labour, Wolverhampton South West)

Does the hon. Lady think that the British taxpayer should subsidise through tax breaks the production of soap operas?

Theresa Villiers (Conservative, Chipping Barnet)

No. I was just coming to that. TV companies cannot qualify for the tax break as their programmes are not intended for theatrical release, but, because of the way the legislation is structured, they come within the taxation framework that is being introduced. They are concerned about getting an additional compliance burden without any chance of getting a tax credit. That is why I am discussing the clause with particular reference to TV companies. I am not suggesting that we should extend the tax credit to cover them—that would be inappropriate—but we must mitigate the compliance burden that clause 31 would impose.

I have also tabled an amendment that we shall discuss later which would take TV companies that do not qualify for the tax break out of the overall taxation framework in the Bill. That would also deal with the problem.

I hope that the Economic Secretary will explain why he thinks it inappropriate to consider a series of short episodes to be a single film and a single trade for the purposes of taxation.

To conclude, clause 31(2)(c) deals with the connection that there needs to be between films in a series. Perhaps the Minister would like to expand on that. It seems that it could involve subjective judgments as to whether a series of films is sufficiently connected to qualify under paragraph (c). One example that springs to mind is the series of Harry Potter films. Would they be considered sufficiently connected to come within the paragraph? If we leave uncertainty and subjective judgments in the framework, they could lead to disputes about the level of the tax credit, which of course will drive up the cost of borrowing against it. That was one of the general points in my introduction. I look forward to the comments of members of the Committee and the Minister.

Edward Balls (Labour, Normanton)

May I start by echoing the words of the hon. Member for Chipping Barnet (Mrs. Villiers) and say that it is a great pleasure and privilege to serve for the first time on the Front Bench in a Committee under your chairmanship, Sir John? I thank you for your indulgence in allowing us to debate the amendments and discuss clauses 31 and 32 at the same time. In discussing those two clauses, I shall deal with several issues that were referred to by the hon. Lady and that are pertinent to the Bill.

I thank Opposition Members for their kind, warm words of welcome last week to those on the Front Bench and particularly the hon. Member for Fareham for his comments a moment ago. I served for 20 hours last year during the proceedings on the Committee dealing with the Finance (No. 2) Act 2005 and, until today, I would not have recognised the concept of becoming over-excited in Committee. After the fine speeches of the hon. Member for Fareham and my hon. Friend the Member for Wolverhampton, South-West (Rob Marris), I would not say that I was over-excited, but there have certainly been moments of interest.

I shall start by following the lead of the hon. Member for Chipping Barnet in making some introductory remarks about chapter 3 in general and clause 31 in particular. I will then turn to the points that she made about the amendment. I have some comments to add to hers about the context of the new tax credit for British films. She made many points about that context with which my hon. Friends and I could agree. At times, it was almost as if she had seen some of my speaking notes, so I shall make sure that I do not repeat any of her words.

The importance of British cinema to our cultural heritage was obvious from the hon. Lady’s comments in welcoming the importance of the clauses. It plays an important role in Britain and around the world in building a sense of national identity and propagating it beyond our borders. Our aim in the clause is to continue to provide and enhance the support necessary to encourage a sustainable British film industry in what is an increasingly competitive environment. That can be done in a range of ways. For example, the Department for Culture, Media and Sport supports the film industry in a number of ways directly through grant support. However, the tax system also plays an important role. The UK is not alone in this: many countries around the world do the same. All large countries use their tax system to some extent to provide incentives to support film production.

As the hon. Lady said, the previous tax reliefs for British films have been in place since the beginning of 1992 and, in 1997, they were enhanced and tailored to meet the needs of small films. In that time, as she explained, expenditure on British film production has risen from around £98 million in 1992, when the reliefs were first introduced, to £569 million in 2005. Over that period, attendance at cinemas in the UK hasrisen from 98 million at the beginning of the 1990s to 264.7 million last year. It has clearly been the case that as the strength of the British film industry has grown—along with its use of tax relief—cinema audiences have grown as well.

The hon. Lady mentioned “Harry Potter and the Goblet of Fire”, and many other British films have been produced in recent years. In the last year and a half, “Charlie and the Chocolate Factory”, “Nanny McPhee”, “Pride and Prejudice” and “Bridget Jones: The Edge of Reason” were released. I have seen some of these films, but I must admit I have never seen other British films such as “Layer Cake”, “Kinky Boots” or “Ladies in Lavender”. I am told, however, that the production of these films was based in Britain.

In response to the hon. Lady’s point about the danger of the number of UK films dropping off, I point out that, in 2004, the number of British productions was 133. In 2005, during which the debate about these reforms was ongoing, the number fell, but only marginally—from 133 to 124. Numbers for this year will show the continuing engagement of the British film industry in the production of films.

Unfortunately, as the hon. Lady said, there is another side to this story. Throughout the lifetime of the old reliefs that the Bill will deal with, there have been examples of abuse and of people using those reliefs not as an aid to film production but as a convenient way of avoiding tax. That is why anti-avoidance legislation aimed at protecting the Exchequer from abuses of film tax reliefs has been enacted regularly. Such reliefs have featured in a number of Finance Bills.

The hon. Lady referred earlier to the consultation document produced last summer, which contains a full explanation of how the previous reliefs, which were inherited in 1997 and continued since then, have been subject to abuse, particularly from sale and leaseback schemes and, more generally, because people who are not really film makers or producers used such reliefs for tax purposes. There is a very long list on page 13 of the consultation document of all the different times in Finance Bills from 2000 onwards that action has had to be taken to try to tackle that abuse and those problems.

We announced in last year’s Budget that there would be a formal consultation on a new approach to reliefs for the film industry to remedy the defects of the predecessor regime. As that consultation document exemplifies, there has been an intensive, constructive consultation over last summer, leading up to the details of the new relief being announced in the pre-Budget report in 2005 and a complete change in the conceptual basis on which film taxation support will be provided.

The change will mean that the targeting of the relief will now shift directly to the film production companies, rather than indirectly through the financiers, investors or other intermediaries. That means that not only will film makers no longer have to share the benefit of the reliefs with others, but it will also bring an end to the tax-driven sale and leaseback structures used extensively by film financiers to access relief, which has been the source of so much tax avoidance in the past.

A further significant way in which the new relief differs from its predecessors is that, for the first time, its value to film makers is directly related to the amount of work actually done in the UK. Previously, eligibility for tax relief was determined by the certification of the film as British under schedule 1 of the Films Act 1985, and the way in which the certification rules worked meant that it was possible to claim the relief on the total production budget, even where little, if any, filming took place within the UK. Instead, the new relief provides a direct incentive to make full use of film making skills, facilities and infrastructure in the UK.

Another important feature, which we will debate later when we get to the loss provisions and the details of schedules 4 and 5, is the way in which this relief is now designed to encourage genuine sustainability in the British film industry. The value of the reliefs will be greatest where film is profitable and where its income is retained within the UK, rather than sent offshore, and there are also incentives for film makers to reinvest profits from films in the UK, particularly in the production of further British films.

Together, the various elements of the new relief constitute a package designed to give genuine reassurance of the Government’s continuing support to the film industry. We have already announced the rates at which the relief is set, which will mean that small budget films will be able to claim a guaranteed minimum benefit worth 20 per cent. of qualifying production costs, while large budget films will be able to claim a benefit typically worth 16 per cent. of qualifying production costs. By targeting the new relief at film producers, the provision will be much better focused and more effective in fulfilling the Government’s objectives for the film industry. As John Woodward, chief executive officer of the UK Film Council, has said, the new relief marks a new era for the future growth of our industry, which operates in a highly competitive global marketplace.

We take seriously the comments of the hon. Member for Chipping Barnet about the importance of moving forward expeditiously to ensure that we have no unnecessary uncertainty. It is important that we move expeditiously through the debate on the clauses and amendments, because there is a danger that, if we take too long over the details, we will add to the uncertainty rather than resolve it. Margaret Matheson, a producer, from Bard Entertainments, has said:

“Yes, there will inevitably be delays involved in the changeover. That is unfortunate, but this time next year we will have forgotten about it.”

I am not so sanguine as to believe that people will have forgotten, but once the film industry sees the scale and benefits available under this new support, we will be able, as John Woodward said, to move into a new era with substantial benefits to the British film industry for making films in Britain, with British employees and British ideas.

Amendment No. 30 would relax the test under which a series of films is treated as a single film by removing the requirement that it must not have more than26 separate parts or a playing time of more than26 hours. A series that has fewer than 26 parts can be considered to be one film, whereas a long-running series such as “EastEnders” or “Friends”, if produced in Britain, would have to be accounted for under tax purposes on a case-by-case and episode-by-episode basis. The 26-part, 26-hours test is a purely administration decision. It does not make any difference to the favourability of the tax treatment; it is only to do with the way in which the tax is accounted for.

A 10-hour episode TV drama would be treated as a single film, but a long-running series such as “Friends” or “Blue Peter”, if they were being made as a TV series, would not be treated as single films. They would instead be treated for the purposes of the tax regime as separate trades. That is not new; it simply reproduces a requirement under the Films Act 1985 that has been in force since 1999 and is based on our consultation with not only the film industry, but the TV industry.

In our view, the requirement will not involve any significant concerns. It is quite in line with practice in the industry. A series such as “Parkinson”, the “Jonathan Dimbleby Programme” or “Davina” does not begin with the assumption that it will be made in perpetuity. People will want to be sure that they are making a return case by case, that the audience figures match it, and that the costs are being covered episode by episode. On the basis of the consultations, our understanding is that that is in line with how the industry chooses to organise itself and therefore should not cause a problem. On that basis, we urge the Committee to reject the amendment.

The hon. Lady referred to the broader issue of whether we are right to try to have a single regime for the treatment of films, and TV and DVD production, whether or not they qualify for the enhanced tax relief that comes from their being made in Britain as a British film for cinema showing. For the benefit of members of the Committee, I must say that a key requirement is that at least 25 per cent. of the film has to be made in Britain, an important matter that we shall be discussing later.

The existing treatment of film production is based on the principle that film makers exploit the films to generate income from their use rather than by selling them. It is also tied to the completion of the film at which point a trade of exploitation can start. At that point, the cost of creating a film is deemed to be a normal trading expense. However, on the evidence of our consultations so far, that fits pretty badly with the way in which the industry works, how it accounts for itself and how the accounting model was put to us during those consultations.

The industry regularly makes films for immediate sale or in a way that pre-sells almost all the exploitation rights to generate income to fund the film. Rather than the tax treatment occurring at the end of the process when the film is completed, it makes more sense to calculate taxable income on a cost basis through the lifetime of the production of the film. That is why we are structuring the tax reliefs under schedules 4 and 5 to follow the principles that are used to account for income and expenditure on long-term contracts. Although the treatment is essential for the new film tax relief, it also provides a firm foundation for other film production companies, such as those making films for TV or for transfer to DVD. Nothing that we have been told by the industry suggests that the working of those industries will find difficulty with that.

Helen Goodman (Labour, Bishop Auckland)

Before my hon. Friend sits down, I have a question following on from the points made by the hon. Member for Chipping Barnet. Subsection (2)(b) says:

“the combined playing time is not more than 26 hours”.

In the consultations, did officials or Ministers consider more avant garde installation events shown in museums and art galleries that may last for more than 26 hours, with a film playing on a continuous basis, or where a film is on a loop?

Edward Balls (Labour, Normanton)

I am grateful to my hon. Friend for that intervention. We consulted widely with the film and TV industry. I am sure that many people whom we consulted have had their avant garde moments, but I am not sure whether we consulted any specialist avant garde producers. My feeling is that if one is making an avant garde film of more than 26 hours, it would still be one episode—one film—and would therefore count as one film for tax purposes. There may be examples of avant garde film companies that have attempted to make films of more than 26 hours in length running to a series of more than 26 episodes, but it strikes me that the idea of 26 or more episodes of a 26-hour-plus film would not necessarily be a profitable enterprise. I do not think that that particular example was put to us during the consultation.

Philip Dunne (Conservative, Ludlow)

I add my congratulations to the Economic Secretary on his promotion to the Front Bench. May I also say that is a pleasure to serve under you, Sir John?

While we are on the holistic nature of the Government’s proposals, and the fact that they are trying to bring television and film production under the same regime, I am a little confused by what the Economic Secretary is saying; it seems to fly in the face of the proposals in clause 39, under which, in order to be eligible for film tax relief, productions have to be intended for theatrical release. Several examples that he cited were clearly made for television, rather than theatrical, release.

Edward Balls (Labour, Normanton)

The hon. Gentleman is absolutely right. We are putting in place a way of accounting for films, television and DVD productions for tax purposes, under which enhanced relief is available only for films intended for showing in a cinema. The point that I was just concluding, in response to my hon. Friend the Member for Bishop Auckland (Helen Goodman), is that when one commences the production process, it is not always clear whether the film will be for cinematic or TV purposes. It would not make sense to do as someone proposed and have one method of accounting for tax for films that will qualify for enhanced relief, and a completely separate and different basis for TV and DVD films that will not qualify for enhanced relief.

We do not think that the proposal will be a problem for the industry; in fact, in the main, it is in line with industry accounts, and in line with the direction in which international accounting standards are moving, in terms of their reform. It is much more sensible to move to the single system proposed in the Bill for tax accounting purposes for all films, including TV and DVD films. Included in those are films intended for cinematic showing, which will also qualify, beyond the normal setting of cost against income for tax purposes, for the enhanced relief that is set out in the schedules to come.

Some have suggested that we run two completely parallel systems—a new one for cinema films, and the old one for TV films. Our view is that that is out of line with best international practice and current TV practice, and would be complex, burdensome and over-regulatory. It is much better to move over to a single system for all TV, film and DVD production, within which the enhanced relief is available only for British films produced in Britain that are for cinematic release. Having said all that and having made a reasoned case, I urge the Committee to reject the amendment in the name of Opposition Members, and to support clause 31, allowing us to commence debate on the rest of the Bill.

Theresa Villiers (Conservative, Chipping Barnet)

I was slightly unnerved by the spooky similarity between the first part of the Economic Secretary’s speech and mine. That outbreak of consensus is welcome, although I suspect that he and I will not always find ourselves of such like mind.

The Economic Secretary also emphasised the importance of not delaying this afternoon’s debate so that we did not add unnecessary uncertainty to Bill business. I suspect that the film industry will not mind whether we take an hour or two hours to deal with the issue, particularly as most of its members are yacht-hopping at Cannes this week. I do not think that they are looking at what we are up to with great closeness. [Interruption.] My sister-in-law is not there; her film was not selected. It is important that we take time to get this issue right. We do not want to rewrite the film tax regime for the seventh time—or whatever time it would be—next year.

In a sense, it is a little difficult to respond to a number of the Economic Secretary’s points, because they tend to bleed into the debates that we will have on the coming amendments. I shall confine myself to picking up on one or two things that he said. He emphasised that the issues relating to the amendment of paragraphs (a) and (b) were administrative and did not affect the amount of tax payable. My response is to ask why we are imposing that complicated and difficult framework if it is not going to yield revenue benefits for the Government. It seems to me that we are imposing a burden unnecessarily.

For reasons that I shall go into when we explore the next set of amendments, it is impractical and not sensible to have separate regimes for TV and film companies. It is entirely possible to retain a framework for TV companies that runs along ordinary company law accounting lines, and I have tabled amendments to that effect to which I shall speak in a moment.

I remain concerned about the issue of treating each particular episode as a separate trade and have tabled amendments on schedule 4 in respect of that. I shall not press my amendment to a Division and I beg to ask leave to withdraw it, but I retain concerns about the issue and hope that the Government will take them on board.

Clause 32

Theresa Villiers (Conservative, Chipping Barnet)

I beg to move amendment No. 47, in page 29, line 14 [Vol I], at end insert

‘; but notwithstanding the provisions of this section, a company is only a “film production company” if it meets the conditions for film tax relief as set out in section 38 of this Act.'.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss the following: Amendment No. 64, in page 29, line 17 [Vol I], leave out lines 17 to 20 and insert—

‘(a) undertakes (whether on its own account or whether it is responsible to a third party)—

(i) principal photography and post production of the film, and

(ii) delivery of the completed film,'.

Amendment No. 31, in page 29, line 18 [Vol I], leave out ‘pre-production'.

Amendment No. 65, in page 29, line 22 [Vol I], leave out ‘pre-production,'.

Amendment No. 32, in page 29 [Vol I], leave outlines 24 and 25.

Amendment No. 33, in page 29, line 26 [Vol I], at end insert—

‘(3A) The Treasury may, by regulations—

(a) amend subsection (3); and

(b) provide that specified activities are or are not to be regarded for the purposes of this Chapter as film making activities;

and in this subsection “specified” means specified in the regulations.'.

Amendment No. 46, in page 29, line 27 [Vol I], after ‘company', insert

‘resident in the United Kingdom (and not resident in another place in accordance with the law of that place relating to taxation)'.

Amendment No. 34, in clause 34, page 30, line 19 [Vol I], after ‘on', insert ‘development,'.

Government amendment No. 26.

No. 35, in clause 35, page 30, line 37 [Vol I], at end insert—

‘But for the purposes of this subsection—

(a) services provided in relation to rented equipment shall be considered to have been performed in the United Kingdom where the equipment is used in the United Kingdom; and

(b) where goods are initially supplied in the United Kingdom, their subsequent transport and use outside the United Kingdom shall not prevent the relevant expenditure from being treated as UK expenditure.'.

Theresa Villiers (Conservative, Chipping Barnet)

I do not propose to press amendment No. 46. Having reflected on it, I do not believe that it would be a positive change to the Bill.

Clause 32 is one of the most important and controversial parts of the new film tax structure. It defines the meaning of “film production company” for the purposes of the Bill. The clause represents one of the most significant changes to the old rules, focusing the tax advantages solely on film production companies to ensure that what the Chancellor called grey middlemen cannot get the tax advantage. As we have heard, the clause focuses the scheme on the people making the films, not on the groups of high net worth investors.

The new framework proposes that only companies falling within the definitions set out in clause 32 can be capable of qualifying for the new film tax breaks. A number of film industry sources have expressed anxieties about the definitions; many are worried that legitimate productions will miss out because of how clause 32 is drafted. In its helpful briefing, the British Screen Council stated that

“the provisions of clause 32 are very proscriptive and make it extremely difficult for genuine film production companies to qualify”.

It felt that a simpler and clearer definition should be considered.

In amendment No. 33, I proposed to allow the Treasury to refine and update the definition through regulations. The use of secondary legislation in the tax context is always problematic, and I am also conscious that it would give rise to a degree of further unpredictability and instability. However, it could be useful for the Committee to consider the idea, given the definition’s drawbacks, which I shall outline.

First, I turn to the issue that we have already started to address: that of TV companies. As we have heard, any company falling within the scope of the Bill’s definition of a film production company is covered even when it cannot qualify for the tax break. Hence, a number of companies will not be able to benefit from the advantages of the film tax regime, but will be subject to the disadvantages. As we have heard, that will concern a lot of TV companies, although not only TV companies could be involved.

Those making training videos or safety or promotional films, or airlines that produce films with guidance on safety measures could also be affected. My amendment No. 47 would remove companies from the scope of the legislation unless they were making a film that would qualify for the tax relief set out in clause 38—that is, the enhanced deduction or film tax credit.

That would leave TV producers governed by the ordinary rules on company taxation and the existing rules set out in the Finance (No. 2) Act 1992. I have tabled consequential amendments on clauses 46 and 47 to make that possible. They would deal with the problem that we have discussed because TV companies would no longer be at risk of having to draw up separate accounts for every episode of a single series.

However, there is another pressing reason to take such companies out of the framework. In general terms, the framework set up by the Bill requires that a relevant proportion of income from the making or exploiting of films is brought into account for tax purposes on an estimated basis, before it is earned. That includes income from merchandising and the use of characters and music, as well as directly attributable income.

The effect is that tax liability will be accelerated and tax will be due on income that has not yet been earned. I do not wish to anticipate our debate on schedule 4, but although applying the provisions to film companies that can qualify for the tax break is controversial, it seems even more harsh to apply what I think is a problematic regime to companies not eligible for the tax break at all. That would mean subjecting such companies for no reason to a regime harsher than that applicable to companies in other industries.

It would be useful if the Economic Secretary explained the motivation behind that new regime in schedule 4. If it is to do with a tax break and seeks to deal with some kind of tax loophole, there is no justification for applying it to companies that are not capable of qualifying for the tax break in the first place.

Rob Marris (Labour, Wolverhampton South West)

Just to be clear, is the hon. Lady saying that, for example, each episode of “Coronation Street”, which would not meet the 26-parts rule that we discussed, would have to be treated as a separate film? Is that how she understands the legislation?

Theresa Villiers (Conservative, Chipping Barnet)

Yes, my understanding is that that is how it works. I urge the Committee and the Economic Secretary to consider the problems in respect of TV companies.

The Committee should consider a second point about clause 32.

Theresa Villiers (Conservative, Chipping Barnet)

Another key problem with the definition of film production company in clause 32 is that subsection (3) requires a company to be involved in and responsible for multiple activities before it can qualify as a film production company and potentially obtain the tax break.

Paragraph (a) seems to require that a film production company should be responsible for all activities that are listed. They include,

“pre-production, principal photography and post production...and...delivery of the completed film”.

Paragraph (b) requires the film production company also to be involved in the planning and decision making in relation to those activities, and paragraph (c) introduces a further requirement that the company

“directly negotiates, contracts and pays for”

those rights, goods and services.

An initial problem arises because there is no statutory definition of terms such as “pre-production”, “principal photography” and post production. It could be cured by regulation if amendment No. 33 were agreed to. Alternatively, the early publication of guidance notes would I am sure be welcome. However, even if that problem were dealt with, the definition would still be at odds with the way in which the industry works. It seems unrealistic to expect a single company to be directly responsible for all the listed activities in subsection (3).

The Committee knows that all industries break down their activities into specialist areas, and the division and specialisation in the film business is more marked than in any. Some of the specialist production companies in Britain are world leaders in their field, and if a single company must undertake all those activities to qualify as a film production company, many in the industry are concerned that it would mean depriving many genuine film production companies of the support of a tax break. For example, when a company films overseas, it is standard practice to hire a local production company to organise much of the work and carry out many tasks in relation to the film. In some countries, there may even be a legal obligation to hire a local firm for such activities.

Rob Marris (Labour, Wolverhampton South West)

In paragraph (a) the second word is “responsible”, as the hon. Lady will be aware. As I read it, it does not say that in order to be a film production company, the company concerned has to carry out the activities itself; it says that it has to be responsible for them. I have a joint mortgage with my partner. I am responsible for it. If she makes the mortgage payment, it is made. I remain responsible for it, but it is not I who has made that mortgage payment.

Theresa Villiers (Conservative, Chipping Barnet)

If the Government adopt that same interpretation and do not require direct involvement when they construe “responsible”, it will be a positive move and it will make the framework much more workable. There is a particular problem in paragraph (c) where it refers to “directly”. It says,

“directly negotiates, contracts and pays for rights”.

However, the hon. Gentleman is right. I hope that a sensible interpretation might modify any practical problems.

Brooks Newmark (Conservative, Braintree)

But is there not the concept that companies must also be—I believe this is the expression—actively engaged in each of those activities? The concept of actively engaged goes beyond what the hon. Member for Wolverhampton, South-West implied.

Theresa Villiers (Conservative, Chipping Barnet)

Both interventions indicate that it would be useful to obtain more clarity about that point. If one were to take a flexible interpretation, as the hon. Member for Wolverhampton, South-West proposed, it would mitigate the problems. However, if one were to take a more conservative interpretation—[Hon. Members: “Hear, hear.”]—I am not sure that that is the right word. Perhaps I should say a more restrictive interpretation.

I hope that the Minister will make it clear that a film production company is permitted to subcontract parts of the film-making process. That is the point. Without the ability to subcontract the listed activities, many companies will fail to qualify for the relief that I am sure the Government intend they should benefit from. If the terms of the clause do not include the flexibility to subcontract, the tax relief will either be very narrow or lead to a wholesale restructuring of the film industry. I do not think that the Government intend either of those results.

Jeremy Wright (Conservative, Rugby and Kenilworth)

Does my hon. Friend agree that if one looks ahead toclause 41, which I appreciate we will come to later, it is clear that the Government anticipate that a great deal of work will be done by qualifying film production companies abroad? The provisions require that 25 per cent. of spending be done within the country’s UK spending. It is clear that the Government accept that a great deal of work on some productions must or could be done outside the UK, so it makes sense to accept in clause 32 that a good deal of work must be done by other companies also.

Theresa Villiers (Conservative, Chipping Barnet)

Yes, we must take a realistic view of how the film industry works if the tax break is to be effective and workable. We must ensure that film companies can subcontract and still claim relief, particularly in relation to filming overseas, as the hon. Gentleman said. I tabled amendment No. 64 to deal with that problem and to make it explicit that FPCs can subcontract without losing the tax break. I hope that the Minister can give us some assurances on interpretation.

There is a particular problem with pre-production. Paragraph (a) states that one of the activities for which the company must be responsible is pre-production. The effect is that any company not involved in pre-production will not be able to qualify for the film tax credit. Generally, pre-production tends to cover rehearsals with actors, deciding on a film location, building a dressing set and sorting out the finance for the project—activities that occur in the run-up to the roll of the cameras.

Amendment No. 31 would delete “pre-production” from paragraph (a) and amendment No. 65 would delete it from paragraph (b), which refers to involvement in the planning process. If the amendments were adopted, FPCs could still qualify for the tax break even if they were not involved in pre-production work. That is important because many companies are set up as special purpose vehicles specifically to produce a particular film. A film’s development and pre-production are often done before that special purpose vehicle is set up. Hence, it is common practice for the company making the film not even to exist during pre-production. Even if we took a flexible approach to being “responsible for” and even if it were possible to subcontract, we would still run into a significant problem if pre-production remained one of the compulsory activities for a film production company to be involved with or responsible for, because of the overall structure of the film industry.

From what I have read of the Revenue’s publications and consultation document, I understand that it knows that SPVs are commonly used in the film industry and recognises that they are useful vehicles. I understand that the Government are not seeking to change that, so I ask them to look again at pre-production. Unless that term is deleted from the section, it will become much more difficult to make a film using an SPV. SPVs often do not come into existence until film production and principal photography start because until that stage, the studio or entrepreneur might not know whether the project will actually go ahead. Once all the preparation work is done, a vehicle is set up to make the film.

Stephen Hesford (Labour, Wirral West)

Would not the problem be solved—I think this is what the Minister may be getting at in the proposed clauses—if there were a clear link between those who bring the matter to pre-production and those who then go into production, whereby they would be one body, rather than entirely separate vehicles? They would then all be responsible, even though technically and legally they may be separate companies.

Theresa Villiers (Conservative, Chipping Barnet)

That would not work within the framework of the Bill as it is drafted, because the Bill deals specifically with individual companies, so if the same company that makes the film does not undertake the pre-production, it cannot qualify for the tax break. That is the problem that the Opposition are getting at.

Stewart Hosie (Scottish National Party, Dundee East)

Is the problem not compounded by paragraph (c)? It may well be the studio that negotiates contracts, perhaps pre-production and afterwards, and pays for rights, perhaps for a book or a play, and which negotiates merchandising rights and enters into contracts concerning them. However, the real production company that undertakes the filming would have nothing to do with it. The clause—especially the combination of paragraphs (b) and (c)—makes it almost impossible for the real production company to gain the benefits, because that company almost certainly would not undertake all the activities that are referred to.

Theresa Villiers (Conservative, Chipping Barnet)

Yes. I shall address those points in a moment, but I agree with the hon. Gentleman.

To conclude my remarks on pre-production, my understanding is that the proposal made in the clause was not a requirement of the initial framework set out in the pre-Budget report. The PBR dealt with principal photography and post-production, but it did not require the film production company to be involved in pre-production. It is interesting that the Department for Culture, Media and Sport guidelines on the area, which were published only a few weeks ago, after the Finance Bill, did not mention pre-production either. There seems to be a difference of opinion, and it would certainly be useful if the Economic Secretary outlined why the Government have changed their mind between issuing the PBR and publishing the Finance Bill.

Rob Marris (Labour, Wolverhampton South West)

I think I understand the hon. Lady’s point. However, when I look at her proposed amendments it seems to me that it would have been logical to include an amendment to delete subsection (2), which says:

“There cannot be more than one film production company in relation to a film.”

Why did she not do that? Is she suggesting that the companies that undertake pre-production before an SPV is even formed should not be counted as film production companies at all, or should not get tax breaks, or both?

Theresa Villiers (Conservative, Chipping Barnet)

That might be one way to tackle it, but I do not think one need go that far to tackle the problem. I suspect that deleting subsection (2) might have problematic knock-on effects—I certainly believe that the Economic Secretary would be concerned if the Committee proposed deleting it. I agree that such a deletion might mitigate the problem, but it could have unintended consequences.

On the point raised by the hon. Member for Dundee, East (Stewart Hosie), there are problems with subsection (3)(c) which I have sought to address through amendment No. 32. The amendment proposes deleting paragraph (c), which requires the FPC to be directly involved in negotiations, to contract directly, and to pay directly for rights, goods and services in relation to a film. As the hon. Gentleman said, the structure of the industry can make compliance with paragraph (c) difficult. The British Screen Advisory Council has said that requiring a single company to be directly involved in all negotiations makes matters difficult, for similar reasons to those that I have outlined in relation to the earlier part of the clause.

There is a particular practical problem with the requirement to contract directly for goods, rights and services. As with pre-production, the rights may have been contracted for and bought before the SPV was brought into existence in order to make the film. There are additional problems, however, in that some key directors and actors may not wish to contract with the SPV. Some writers and directors, together with certain artists—American actors in particular—may insist on contracting with a signatory to the relevant actors’ guilds agreements. For example, many US actors will contract only with a company that has been approved by a screen actors’ guild.

Many film producers in Britain whom the Government, I am sure, would want to benefit from the tax break will not fall into that category. Currently, the usual practice is for the actor to contract with a US-based company that has the relevant SAG approval. That American company then invoices the British company for the cost of the arrangement. That indirect relationship is not contemplated in paragraph (c), so the measure could again make it difficult for several sensible and genuine film productions to fall within the scope of the tax break.

Rob Marris (Labour, Wolverhampton South West)

I bow to the hon. Lady’s superior knowledge of common arrangements with certain American film stars, but would such arrangements not come under the rubric of “services” in paragraph (c)? The services would be provided by the American intermediary, as it were, to provide a named actor for a particular British production.

Theresa Villiers (Conservative, Chipping Barnet)

That could be a way to approach the matter. We might be stretching things if we tried to persuade a court to interpret the measure in that way. If there were a requirement to contract directly for something, the court’s interpretation is likely to be that it would expect a company to contract directly with the actor. A very flexible interpretation might solve the problem, but I would be worried if we relied on that kind of tenuous interpretation. The Economic Secretary might be able to reassure us on the point, because I do not believe that he would want to exclude film production companies that enter such arrangements. If he were to provide such reassurance, that would give us comfort. A significant degree of uncertainty needs to be dealt with.

A third problematic issue about the clause is a horizontal one, which stretches across a number of the subsections and relates to co-productions. In this instance, I should like to quote a copy of a letter from a firm of accountants, Malde and Co., who got in touch with me about this issue. It stated:

“The Revenue’s emphasis in clause 32(3) that an FPC should be responsible for ALL the activities set out in subclauses (a), (b) and (c) of clause 32(3) virtually rules out any possibility of an FPC embarking on film production activity as a co-producer with another genuine film production company”.

Subsections (3) and (4) both specifically exclude companies working in partnership and specifically refer to activities “otherwise than in partnership”. I would be grateful if the Economic Secretary would explain why companies working in partnership will be excluded. Some in the industry are concerned that that blanket exclusion may adversely impact on the film industry. Virtually all co-productions seem to involve companies working in partnership. Depending on how one views the law, the mere fact of two companies working together could be sufficient to qualify as a partnership. The exclusion of all partnerships from the film tax credit scheme could therefore limit its scope considerably.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

On the point about co-productions, subsection (5) states:

“If there is more than one company meeting the description in subsection (3) or (4), the company that is most directly engaged in the activities referred to...is the film production company in relation to the film.”

Does the hon. Lady share my concerns that the British film industry is well known for its post-production skills? In those cases, there may be significant British involvement, but because the company might not be “most directly” involved, it might not qualify under the clause.

Theresa Villiers (Conservative, Chipping Barnet)

That certainly is a concern. It is important to realise that British companies, particularly our indigenous film producers, are heavily dependent on co-production to get their projects off the ground, and we are talking particularly about co-productions with other European countries. If the framework is to work, we must ensure that it works for co-productions. Clearly, in the past, there have been problems with partnerships that have been used as part of the avoidance schemes. I think that there is a consensus that we want to see the back of them. However, my understanding is that many of those tended to be partnerships between individuals, and such individuals cannot take advantage of the tax break because it applies only to companies.

Perhaps there is also anxiety about partnerships between a film producer and a financial company and the Government wishing to prevent the financial entity from being a partner and gaining the tax break designed for the film production company. However, as we have already explored, where there is a partnership, it will be the company working on the film that qualifies for the tax credit; it is clearly provided for in subsection (5) that only one company can qualify, and that is the one most directly engaged in film making. It would be useful to hear the Economic Secretary’s thoughts on what yardstick will be used to determine which company is most directly engaged in film-producing activities.

Rob Marris (Labour, Wolverhampton South West)

Will the hon. Lady give way?

Theresa Villiers (Conservative, Chipping Barnet)

Yes, but then I would like to make a bit of progress.

Rob Marris (Labour, Wolverhampton South West)

The hon. Lady says some interesting things about co-production, but subsection (4) refersto a qualifying co-production, which is specifically defined in clause 36. As far as I can tell it is nothing to do with the interesting and important point that she is making about co-production.

Theresa Villiers (Conservative, Chipping Barnet)

I will take the hon. Gentleman’s word on that, but still I think that there is an important point to address. I would welcome the Economic Secretary’s reassurance on how co-production will be treated under the framework generally.

Amendment No. 34 deals with clause 34, which defines production expenditure and core expenditure. My amendment is about the definition of the latter. Core expenditure has a crucial part to play in the framework before us, because it determines the size of the tax break. Amendment No. 34 seeks to add development costs to the expenditure that can qualify as expenditure giving rise to the tax break. Development costs include scouting for a film, looking for good film ideas, purchasing an option to buy the film rights of a book at some point in future, and script development. Such activities have genuine costs that make up part of the production process.

Edward Balls (Labour, Normanton)

The hon. Lady made the case that we ought to exclude the development or pre-production phase from the ambit of the relief, because it is only when one starts the principal photography phase that engagement should occur. However, she now makes the case that development costs should come within the ambit of the tax relief. Is that not an inconsistency?

Theresa Villiers (Conservative, Chipping Barnet)

No, I do not believe so, because we are talking about two different concepts. I am arguing that development costs should be taken into account as core expenditure because they are expenditure that needs to be incurred to make the film. The fact that a particular company may not have been involved in the development process should not bar that film from qualifying for the tax relief. The terms are used in two different contexts in the statute, and it is overly restrictive in the definition of “film production company” to require companies to be involved in development and pre-production. However, I see no reason why development costs should not be part of the expenditure that qualifies for the tax break.

Certainly, many in the industry share the feeling that development costs should be considered part of core expenditure. It would be useful to hear from the Economic Secretary why those costs have been excluded. One of the problems is that the distinction between development and pre-production is blurred; it is difficult to see where one starts and the other stops. That blurred distinction could give rise to disputes with the Revenue about the quantum of the expenditure, and about which expenditure counted for the purposes of the tax break, thus giving rise to the uncertainty that we are seeking to avoid. That, of course, is compounded by the fact that there is no definition of either term in the Bill.

There is a particular problem with the issue of purchase of rights—copyrights, and rights to script and music that are necessary for a film. It is a specific example of the blurred line between development and pre-production, which may cause difficulty if development is not included as part of the core expenditure.

Rights acquisition costs are normally viewed by the industry as part of pre-production rather than development, although at the initial stage the purchase of an option to buy rights such as book rights tends to be viewed as falling into the category of development. Using that argument, most rights acquisitions would fall under the clause as they are part of pre-production. However, the Treasury’s frequently asked questions document states that the acquisition of pre-existing rights is a development cost, which therefore falls outside the scope of subsection (1). It would be helpful if the Economic Secretary could expand on the distinction drawn in the document between the purchase of pre-existing rights, which it states cannot be taken into account in quantifying core expenditure, and rights that are generated during the production of the film. Further detail about that would be very useful.

To close my remarks, I want to mention the concern expressed by the company that I quoted before on the matter of development costs. It said:

“These are not phantom costs but genuine ones.”

It argued:

“Development expenditure is and always has been nothing but a genuine cost of film production and we cannot see your rationale”—

it is the Treasury that is being addressed—

“in excluding it from the definition or meaning of core expenditure.”

Amendment No. 35 and Government amendment No. 26 relate to clause 35, which is another of the controversial clauses and defines UK expenditure, which, along with core expenditure, will be a key determinant of whether and how much tax credit is payable. Subsection (1) provides that UK expenditure covers services performed in the UK and goods supplied in the UK. The film producers association, Pact, has stated that

“the requirements for EU approval (under State Aid rules) of the new credit have resulted in a narrow definition of UK qualifying expenditure being adopted, which is very unhelpful to lower budget co-productions.”

Given the amendments that have been tabled, there seems to be consensus among the Front-Bench teams that we need a clearer definition of goods and services in this context. First, clarification of the distinction between the two would be useful. Would that distinction, in this context, echo the VAT rules under which the supply of goods tends to cover cases in which there is transfer of title, and the supply of services covers all other cases, including equipment rental?

We also need further clarity on the place of performance of the supply of goods and services. Both amendment No. 35 and Government amendmentNo. 26 would address that point, albeit in slightly different ways. Paragraph (a) of my amendment is intended to gain clarification of what is meant by

“services performed in the United Kingdom”.

It provides that if goods and equipment are used in the United Kingdom, although they are rented or bought from an overseas supplier, they would qualify as UK expenditure. Paragraph (b) is intended to clarify the meaning of

“goods supplied in the United Kingdom”.

It would deal with the situation in which costumes and cameras are supplied in the UK and transported overseas.

The Government amendment covers, I think, the same ground as the first part of my amendment; it deals with the concerns behind it to make it clear that goods or services that are consumed in the UK count as UK spend for the purposes of clause 35 and it is clearly an improvement on the Bill. From that perspective I welcome it, but it seems to exclude the latter part of my amendment—the possibility that goods and services supplied in the UK and used overseas could count as UK spend. That is unfortunate given that the type of work that can be done in the UK and consumed abroad is an important part of the UK film business.

The Government amendment confirms the Government’s statements that spending on British crew, actors and craftsmen cannot count as UK spend when it takes place overseas. I see the appeal of that restriction, in that films made in the UK are likely to have a more direct effect in the promotion of UK culture around the world. However, one should bear in mind that films set overseas can promote British culture effectively as well.

One example that springs to mind of a very successful British film is “The Constant Gardener,” which was set largely in Kenya but filmed partly in the UK and Germany. Presumably, it would have a problem qualifying under the UK spend rules in the new framework.

Many small UK producers are worried about the extent to which the restriction on the UK spend is likely to curtail the usefulness of the tax credit. They argue that British talent can be showcased on overseas shoots as much as on domestic ones, and I should be grateful if the Economic Secretary would outline the rationale behind the restriction. It seems that it is motivated purely by the views of the European Commission and the threat of action in the European Court of Justice. As we have already heard today, it is a matter of concern that despite the Government’s tough rhetoric on tax harmonisation, the involvement of the European Commission and the ECJ on tax matters is still progressively increasing. That was extensively discussed in relation to group relief.

The Paymaster General chairs the Primarolo group, which has examined the UK’s film tax rules in the past. It would be useful to hear from the Minister whether any problem is anticipated in respect of the new rules by the group that bears her name. I am sure that the Committee would also value an update on whether the Minister anticipates any problem in clearing the new rules with the Commission. As I have said on several occasions during debate on this part of the Bill, uncertainty has a crippling effect on the British film industry. I am sure that it would value reassurance that there is no danger of sudden changes forced on the Government because the Commission felt that there was a problem in respect of EU rules in this context, or in any other part of the Bill. With that, I look forward to the comments of the Committee.

Philip Dunne (Conservative, Ludlow)

I remind the Committee of the history of the Government’s plans for the film industry, which have been somewhat turbulent, to put it politely. Shortly after they took office in 1997, they set up the ill-fated film partnership scheme. It is a cause of constant surprise to me that despite the wealth—I use the word advisedly—of experience of the film industry and the entertainment industry more widely of Labour-appointed Members in another place, the Government were not able to call on them for help in devising a scheme that would meet the objective of encouraging the film industry in this country without exposing it to the concerns that we are now trying to address—that is, the extent of tax avoidance by the very wealthy.

Helen Goodman (Labour, Bishop Auckland)

Surely the hon. Gentleman’s point is absolutely ridiculous. Finance Bills are considered in this House. They never go to the other House. It does not have any input into Finance Bills.

Philip Dunne (Conservative, Ludlow)

I am grateful for that opportunity to expand on my point.

John Butterfill (Conservative, Bournemouth West)

Order. We are possibly getting into a debate on something that is not the subject of the amendment. I should therefore be grateful if hon. Members on both sides would confine their comments to the amendment under consideration and the other amendments to be considered with it.

Philip Dunne (Conservative, Ludlow)

Do I take it from that guidance that we can discuss all the amendments in one go? Or should we confine our remarks to one amendment at a time?

John Butterfill (Conservative, Bournemouth West)

I remind hon. Members that if they wish to discuss any of the amendments in this group, now is the time to do so. Once the group is finished with, it will not be possible to discuss the amendments again, even though some of them may relate to later clauses. However, they could conceivably be voted upon at a later time, if Members wished to press them to a Division.

Philip Dunne (Conservative, Ludlow)

I am grateful to you, Sir John, for reminding us how this section of the debate is being conducted.

Very simply, my point is that all the clauses and the amendments that we seek to make to them are required to deal with the Government’s policy for encouraging a vibrant British film industry, as they have so palpably failed in their previous efforts. It is worth rehearsing some of the statistics that both the Front-Bench spokesmen have mentioned. Mine are slightly different. I am sure that it is a matter of definition.

Slamming the door to tax avoidance schemes for film partnerships in February 2004 had a significant impact on the British film industry. I understand that the number of films commencing production in the UK, which is slightly different from the numbers discussed by other hon. Members, fell by almost half, from 44 in 2003 to only 27 in 2004. That is a very significant impact. It is even more significant when spending on films is taken into account: it fell from £269 million in 2003 to£118 million in 2004, with a similar but slightly less marked reduction in the number of UK-US co-productions during that period.

That takes me to the amendments, particularly those tabled by my hon. Friend the Member for Chipping Barnet, relating to clause 32 and the definition of a film production company eligible for relief. We are looking to encourage medium and small-budget films, not the major studio productions. The Minister is shaking his head. I understand that less than £20 million is the criterion that we are applying, but perhaps he will clarify if I have got it wrong. I take it from his assent that I have got it right.

Most films with budgets of that size are organised by production companies that seek to bring in production finance from whatever sources are available globally. That involves co-productions with film production companies, distribution companies or other companies around the world that are involved in some element of the film process. It might involve more than one UK company, frequently a company involved primarily in television finance and one involved primarily in pure production.

Confining the benefit of the reliefs to any one company in the context of one film under clause 32(2) misunderstands the way that the industry works. I should be grateful if the Minister would clear up the matter if I have misunderstood it. A number of companies can take on a significant role in a film, and that might be hindered if only one company per film is eligible for relief.

That brings me to amendment No. 34 to clause 34, which would define what expenditure is eligible and what is not. I am perplexed that development costs have been excluded from the definitions of production expenditure under clause 34, as we are trying to encourage the development of an industry. We must encourage it at its roots—at the smallest start and at the origin of a film.

The origin of a film typically involves taking an idea and working up to the point at which it is bankable, so that funding can be sought on the back of the proposition. That is done in what the film industry calls development. A producer engages a writer, typically either a screenwriter or an author, to develop a treatment for the film. That is what is involved in the development cost, which is the seed money for beginning a production.

If that expenditure is excluded from the benefit of relief, there will be no incentive to start making a film in this country. The funding will all be geared toward the making of the film at a later stage. Much of that is undertaken by mature and established companies, not the early stage producers seeking to develop careers in the industry. Can the Economic Secretary tell us whether his intent is merely to help established film producers in this country or rather, as I would hope to be the case, to seek to encourage new, early-stage entrants? If that is the intent, surely development costs should be included within the definition. I support my hon. Friend’s amendment.

Jeremy Wright (Conservative, Rugby and Kenilworth)

May I belatedly welcome you to the Chair, Sir John, and congratulate the Financial Secretary on his promotion?

I want to make a few remarks about the way in which clause 32 may or may not reflect reality in the world of film. I speak not as an expert but, like other members of the Committee, as somebody who watches the occasional film when I have the time. I notice when I do so that a number of production companies feature in the credits before the film starts. It seems to be increasingly common for more than one production company to be involved in the making of a film. That being so, it must be the case that clause 32 makes it extremely difficult for that situation to occur and for each of the companies involved to obtain any kind of UK tax relief, notwithstanding the ingenious machinations of any lawyer who might be involved to redefine the words “responsible”, “engaged” or “direct”.

None the less, I accept that any assistance for the UK film industry is a good thing. I invite the Financial Secretary to consider ways in which he can make it better and more effective. I made the point in relation to an intervention on my hon. Friend the Member for Chipping Barnet that there is a contradiction between clause 32—a rigorous and restrictive structure, designed to prevent more than one company from being involved in the making of a UK film and obtaining tax relief—and clause 41, which indicates clearly that in order for a company to obtain UK tax relief it is necessary only for it to have spent 25 per cent. on UK expenditure. That being so, the Government must envision that 75 per cent. of the expenditure could be spent abroad. If it is, it must be spent on companies that are based abroad. Surely if 75 per cent. of the expenditure is going abroad, 75 per cent. of the work is going abroad, so it must be obvious that lots of other companies are involved in the making of the film. The rubric of clause 32 is too restrictive.

The other difficulty that I foresee, and which was alluded to by my hon. Friend the Member for Chipping Barnet, relates to subsection (5). It is clear that the way in which the Government propose to resolve the difficulty that more than one company may appear through the first parts of the clause to be a film production company is that they require that potential conflict to be resolved by determining which company is most directly engaged in the activities listed in subsections (3) and (4). If I may put it delicately, in an industry that is not necessarily averse to litigation, there might well be a great many long, complex and no doubt expensive legal disputes simply to establish which of several companies involved in the production of a film is the one entitled to UK tax relief. I am sure that the Financial Secretary would not wish that to happen—I certainly would not—and I invite him to reflect on that when he responds.

Stewart Hosie (Scottish National Party, Dundee East)

A great many issues have been discussed, and I will not go over them again. I shall restrict my remarks to Government amendmentNo. 26. The objective would appear to be to change clause 35 to insert

“goods or services that are used or consumed in the United Kingdom”

in the context of the meaning of “UK expenditure”. In the only example that I am aware of in life outside Parliament, a blockbuster film employed a very expensive team of scriptwriters—it was a large part of the cost of production of the film. As the script was the basis of the movie, that was certainly a service consumed in the UK, in Scotland, where the film was wholly set and shot. However, the primary scriptwriter and his team were based in Hollywood. Given that the script, as a service, was wholly consumed in the UK as part of the production of the movie, is it the Minister’s intention that that would be covered under the meaning of “UK expenditure”? It certainly would be if amendment No. 26 were accepted, but from the general tenor of the clause I am not sure whether it would if it were not. Will the Economic Secretary advise the Committee on that?

Edward Balls (Labour, Normanton)

The debate that we have had on the amendments shows how wise you were, Sir John, to group them together under this clause, which defines how a film production company will qualify for relief. The essence of the reform is to try to move away from the past difficulties of avoidance.

The contributions made by some members of the Committee show the two ways in which one can attempt to critique or amend the Bill. In her opening remarks, the hon. Member for Chipping Barnet acknowledged, as have the Government, that although there has been growth in the number of UK films being produced and in cinema audiences, there has been an avoidance problem. The scale of expenditure on relief therefore needs to be dealt with. She is broadly sympathetic with the conceptual framework that I have established. Her amendments are intended to strain against and dilute the definitions set out and the requirement that eligible films be British films, made by British film makers in our country. We must tackle the problem of avoidance and move away from the idea that we are simply offering a tax relief to a financier or a partnership. I shall respond to all of her points.

On the other hand, the point made by the hon. Member for Ludlow (Mr. Dunne) was factually incorrect. He gave the impression that we are discussing enhanced tax relief for only small films. In fact, a film costing under £20 million will benefit from 20 per cent. enhanced relief, and a large film with a budget of more than£20 million will also benefit from enhanced relief, just not quite as much: 16 per cent. The reason why I—

David Gauke (Conservative, South West Hertfordshire)

Paused.

Edward Balls (Labour, Normanton)

The reason why I paused was that I wanted to check that I was right to tell the hon. Member for Ludlow that he was wrong. Having checked that I was right, I can now tell him that he was wrong on that point.

The hon. Lady said that the rising scale of relief was a potential problem, and the hon. Gentleman said that we slammed the door on the film industry in 2004-05. He gave the impression that he would have preferred the status quo ante, before the reforms—the tax regime that was put in place in 1992, and which we inherited in 1997. One of the problems is that, despite repeated amendments, that regime is flawed and needs to be replaced so that we can tackle the problem of avoidance. He is right; we have slammed the door on the risk of avoidance and are instead putting in place a new model that will be fit for purpose.

Theresa Villiers (Conservative, Chipping Barnet)

Is the Economic Secretary seriously saying that the problems with film tax relief since 1997 are due to the previous Government? He may be trying to slam the door, but it is taking quite a long time.

Edward Balls (Labour, Normanton)

To be fair, I was not trying to make a party political point. A regime was put in place in 1992 and has been allowed to operate for well over a decade. In that time, the industry has seen an opportunity for tax avoidance. Despite repeated attempts to tackle the problem since 2000, we have all reached the conclusion that the fundamental model is flawed and needs to be replaced. All that I was saying to the hon. Gentleman was that if, as he believes, the scheme is a failure for tax avoidance reasons, that is a collective failure of the model inherited in 1997. If, as I heard him say, the failure was not the avoidance, but the fact that we have tackled the avoidance, we have a fundamentally different view of our responsibilities for the tax system. Our responsibility is to make sure that the tax reliefs are used for the purpose that we intend, which is to make sure that British films are made in Britain, not simply to allow people to avoid tax.

If the hon. Gentleman’s criticism of the Government’s approach in the past 18 months is that it has caused uncertainty and a fall in the number of “films” or the tax relief by slamming the door on avoidance, I think that that is the right approach. My sense was that, while we may debate some of the details, there is a consensus across the Benches about the importance of replacing a flawed model.

Philip Dunne (Conservative, Ludlow)

I am most grateful to the Economic Secretary for allowing me to respond to his remarks. My criticism was not that the provision was a belated attempt to deal with the problem of tax avoidance after the event. It was that tax avoidance had been progressively worse for a number of years and, instead of the Government coming up with measures to encourage the film industry at the same time as dealing with the avoidance, they chose to slam the door on the avoidance and spend the next 18 months coming up with an alternative regime. It would have been better to have done the two in tandem because the Government had plenty of warning that the avoidance was taking place.

Edward Balls (Labour, Normanton)

It is certainly the case that measures were put in place over a number of years in an attempt to tackle the avoidance, such as those I read out earlier in respect of the Finance Bill. There were repeated attempts to do that. The conclusion was reached that the model was flawed and that we needed to move to a better way of supporting the film industry, one that was in line with the way in which the modern film industry works and which achieves what needs to be achieved. We did not simply scrap the old reliefs. As part of the Bill, they are being removed as a new regime comes into place. We wanted to consult as widely as possible to make sure that we had a fit for purpose regime that could last into the future.

From reading the comments of experts and practitioners during the consultation, my sense is that, while there may be some debate about the details, that is what we have achieved. The Bill will provide a model that will allow the British film industry to go from strength to strength. To take the time to do that in order to get it right is the right approach to tax policy. Last summer’s consultation paper, to which the hon. Member for Chipping Barnet made reference, outlined the diagnosis of the problem and also the principles which were to guide the approach. Those principles are all being enacted in the Bill.

In the main, the consultation paper has been preserved in the legislation. However, we have made one important concession. We said originally that there had to be 40 per cent. British expenditure to qualify for the enhanced relief, but following the consultation, the Government generously decided to reduce that to25 per cent. to make sure that even more British films could benefit. The consultation was good; it was well conducted by officials as well as Ministers. If we get this right today, we will have a model which will be of benefit to the British film industry.

Moving on to discuss the amendments, the first of which has been moved and the rest of which will be moved in due course—

John Butterfill (Conservative, Bournemouth West)

Or may not be.

Edward Balls (Labour, Normanton)

Or may not be. We will be able to cover all of the issues that are relevant to the clause as a whole. I will take them in a different order because they fall into a number of discrete groups. Amendments Nos. 31, 32, 64 and 65 are about change in the definition of a film production company for the purposes of the chapter. Amendment No. 34 seeks to widen the base upon which film tax relief will be provided. AmendmentNo. 47, which we referred to in the earlier debate, would exclude films not made to be shown in cinemas, such as TV programmes, from the basic tax treatment set out in schedule 4. Amendment No. 35 attempts to refine and clarify the meaning of UK expenditure and has been referred to by other hon. Members.

I shall make a few general conceptual comments about what we are trying to achieve, which will help to meet some of the hon. Lady’s concerns, in particular those about what a “film production company” means and why it has been defined as it has for the purpose of the clause.

As I said earlier, the most important feature of the new relief, and a fundamental way in which it differs from its predecessors, is that it is directed at the film makers, not the financiers, a partnership or a middleman. That is deliberate, because we do not want the tax incentives to be diverted to intermediaries or investors; we want them to go to the film makers themselves. That is the fundamental goal that we are trying to achieve in order to tackle avoidance.

The purpose of the clause is to define those film makers as film production companies and ensure that those people benefit. The definition in subsection (3), to which hon. Members have already referred, follows extensive consultation with the industry. I shall not spend a huge amount of time talking about it, but there has been a reference to the nature of the film-making process. Unfortunately, I do not have a direct family member involved in the film industry, so I cannot claim the degree of knowledge that the hon. Lady possesses. She was eloquent in her use of technical terms, but I shall attempt to come close to matching her with my discussion of the creative process.

By having one “film production company”, the important thing we are trying to do is make it clear that in the making of the film and in the essence of that film, there is a being, a person, a film production company that controls the process, and that that entity, the individual or vehicle, is consistent throughout the different stages of film making, from pre-production to completion.

The first requirement is that a film production company be responsible for the development phase—the initial concept or idea for the film. In advance of the pre-production phase, there is the development phase, as the hon. Lady mentioned. It is the period before the film-making proper starts. With the development phase, in which the initial idea is put together and the film is conceived, one could say that J. R. Tolkein played a very important role in the conception of “The Lords of the Rings” film trilogy. It was an essential part of the development phase, but we would not think of the film having been made at that stage. The making of the film proper begins at the end of the development stage, when one has the story and has conceived of the idea. At that point, the tax support that we envisage for the making of the film kicks in.

Stewart Hosie (Scottish National Party, Dundee East)

The Economic Secretary mentions—

Iain Wright (Labour, Hartlepool)

The hon. Gentleman is an expert on “The Lord of the Rings”.

Stewart Hosie (Scottish National Party, Dundee East)

No, not in the slightest.

The Economic Secretary mentions Tolkein. What if Tolkein had been commissioned to write a Lord of the Rings-type, swords and sorcery, elves and demons concept as part of production? Would that have counted, or would it have been outside the scope?

Edward Balls (Labour, Normanton)

The hon. Gentleman helpfully allows me to make it clear where the line is drawn. It is absolutely right that one has to draw a line to delineate the point at which we believe the making of the film begins. It is clear that when writing the book, J. R. Tolkein was not part of the making of the film. It was a much earlier stage than that. There is a long development stage, which often involves people trying to commission or write scripts. There could be a book, or the script could be for a film, a television show or whatever. During that creative process and in that development stage,the production of the film has not begun. To obtain the enhanced tax relief that supports the making of the film, the line has been drawn after that conceptual development stage.

Stewart Hosie (Scottish National Party, Dundee East)

Would the storyboarding of “The Lord of the Rings” be part of production, before the detailed script is written?

Edward Balls (Labour, Normanton)

The process in the consultation has been to separate the stages of the film-making process. The development stage takes place before the pre-production stage begins. A lot of thinking goes on in the development stage, including the writing of a script and consideration of which actors might be part of the film. All those activities take place before the pre-production stage begins and would fall under the definitions set out in the legislation. The initial conception of possible story boards for a film would take place in that development stage. That is not to say that there are no costs involved or that they could not be set against income for tax purposes. However, if we are trying to incentivise the making of a British film, we must draw a line between developing the conceptual framework and moving into pre-production. One starts to contract for the making of the film at the pre-production stage.

On the basis of the consultation, it is understood in the industry that there is a distinction between amuch broader conceptual, speculative phase, which is development, and saying, “This is a film; this is a script. We’ve gone beyond the point of creative speculation. We’ve decided to make the film and we’re now going to commission all the things that we need for it in the pre-production phase.” That is understood in the industry and therefore reflected in the amendment. There is a process called pre-production, which is a clear phase in the making of a film that comes only when one has gone beyond the speculative, creative phase and decided to make the film.

Brooks Newmark (Conservative, Braintree)

The Economic Secretary is floundering slightly. The definitions that he is offering are open to interpretation. My concern is that there will be an incentive for smart tax accountants to shove what might generally be viewed as pre-pre-production into pre-production. I am curious as to how he will get over the problem of who will play Solomon in those decisions.

Edward Balls (Labour, Normanton)

It is widely understood in the industry that after the development phase, when the conceptual phase is taking place, there is a particular point called green light. At the point of green light, the film gets the go-ahead, the studio is booked, the financiers come in, the legal documentation is brought together and the special purpose vehicle is created to bring together all the different elements of the creative phase—people, rights, obligations and risk—into one legal entity. At that green light stage, when a film moves from development into pre-production, the tax incentive starts to kick in.

Brooks Newmark (Conservative, Braintree)

Once again, the Economic Secretary shows that he perhaps does not understand the creative accounting that tends to go on. My concern—I still do not understand how he is going to get us over this hump—is that the definitions that he has come up with will not be clear and that there will be a tendency to show what was pre-green light as pre-production. I still do not understand how the Government propose to oversee that and decide who should play Solomon in those very decisions.

Edward Balls (Labour, Normanton)

The hon. Gentleman makes a good point. In defining the stages, we must ensure that the opportunities for ambiguities or avoidance are reduced as far as possible. That is exactly why we are specifying clearly that there must be one film production company responsible for all the phases from the beginning of the pre-production phase right through to completion, rather than a number of overlapping entities. There has been extensive consultation with industry figures to ensure that the terms pre-production, principal photography and post-production of a film, as set out in subsection 3(a)(i), are clearly defined and understood in the industry.

In a way the difficulty we face was the point I was going to make in response to the hon. Member for Chipping Barnet: we need flexibility in the way in which the legislation is enacted. We need flexibility in guidance and the way in which the tax authorities treat the production company. We are not saying, as was suggested earlier, that the film company must do all the pre-production, principal photography and the third stage itself. We are not saying that it cannot work in partnership or subcontract part of the work to other companies. The important point is that, through these phases, an entity must be actively engaged rather than simply being a financial shell in order to divert tax revenues.

The way that the FPC will operate will be differentin every case and there has to be flexibility in the way in which we interpret the amount of its engagement in each of the three stages. It will not be a black-and-white situation. The important thing is that we will be able to track the responsibility of the FPC through all the three stages. Companies have to be actively engaged in making a film. The tax relief is for making a film, not for writing a book or for simply saving or avoiding tax.

Brooks Newmark (Conservative, Braintree)

I very much appreciate where the Economic Secretary is trying to go. On the one hand, he is trying to create specific definitions of what is pre-pre-production and what is pre-production, but on the other, he says that there must be some flexibility. To me, flexibility means ambiguity, so my concern is how the Revenue will interpret a piece of an advice given by an accountant as opposed to what the Government want it to be.

Edward Balls (Labour, Normanton)

It goes to the very essence of making tax policy to ensure that there are rules that are understood by people who are going about a piece of businessor undertaking a project and that have common application, while ensuring that there is flexibility to deal with the circumstances of each individual trade. No two films will look the same, or be financed or produced in the same way. The question is whether we have a model that allows us to be confident that, when attempting to subsidise through the tax system the making of a film, the FPC is actively engaged in each of the three stages.

On the basis of our consultation with the industry, we have come up with a definition that is much better than the previous one because it makes clear that, to some extent, there should be active engagement by the company in each of the three stages involved in the making of the film. The FPC could be making a film, but not rolling the cameras; it could be making a film, but not actually booking a studio or getting actors in; or it could be making a film without being involved in distribution. However, if it is not involved in any of those three activities, it is not making a film. The guidance and the tax case law, as it develops, will make clear exactly how that will be applied in practice.

Philip Dunne (Conservative, Ludlow)

It is now clear where the Economic Secretary is seeking to draw the line. I happen to think that he is making a mistake in that development cost expenditure ought to be included as a legitimate expense of a film production company, but I would like to draw his attention to a couple of clauses.

The Economic Secretary is creating confusion through the drafting. In clause 33, there is a definition of film-making activity that includes the word “development”. That is picked up in paragraph 5(1)(a) of schedule 4 which refers to

“film-making activities in connection with the film”

thereby picking up development costs from clause 33. The first line of paragraph 4(1) of the schedule refers to the development costs of a film, so the Economic Secretary seems to be clearly expressing an intent to the Committee that is not reflected in the drafting of the Bill.

Edward Balls (Labour, Normanton)

I do not think that that is right. The hon. Gentleman should find that clause 32(3)(a) is very clear. A film production company is defined as a company that is responsible:

“(i) for pre-production, principal photography and post production of the film, and

(ii) for delivery of the completed film”.

To qualify for the tax relief it needs to be involved in all three stages and the definitions are commonly understood in the industry. In the earlier phases, the costs that can be set against tax in the normal way are not part of the making of a British film for these purposes so they are not included. We had to draw the line somewhere and we consulted widely with the industry before coming to that view.

Jeremy Wright (Conservative, Rugby and Kenilworth)

I want to take the Economic Secretary back to what he said about subsection (3) when he indicated that it would be remarkable if a British film or, indeed, a film of any other nationality, did not involve one of the activities in subsection (3)(a), (b) or (c). I agree, but the difficulty is that because of the way in which the clause is drafted, the provisions in those paragraphs are conjunctive and not disjunctive. All three must be done to qualify. The difficulty that Opposition Members have highlighted is that there are situations when companies may not be involved in all those activities, but may still qualify in ordinary language as a film that deserves tax relief.

Edward Balls (Labour, Normanton)

We are trying to put into statute definitions that ensure that that the tax relief is properly applied and goes only to genuine British film makers. We do not want to introduce loopholes that allow the tax resource to be diverted elsewhere to shell companies and so on.

If “responsible for” meant that a company had to finance the relevant activities in their entirety, if “actively engaged in” meant that it had to do everything, or if

“directly negotiates, contracts and pays for”

meant that it could not involve or buy in expertise to advise it or to do some of those things, the hon. Gentleman would be making a good point. However, that is not the absolutist way in which this is being set up. We are requiring active engagement, which does not mean absolute engagement. We are not being prescriptive and we are not saying that, to qualify, a company must be responsible for every aspect of every activity. Clearly, the degree of activity will vary film by film, case by case and with some films there will be much more active engagement by the film production company in the pre-production phase or the completion phase than in others. The important point is that to qualify the film production company must have some engagement in the pre-production and completion phases. It cannot opt out of one phase or the other.

I hope that that provides some clarity for the hon. Member for Chipping Barnet because she made the same point earlier. We are not saying that a special purpose vehicle cannot be used or that the company must either work in isolation or do everything itself. We are saying that it must be engaged in, have responsibility for and negotiate each aspect of those three phases, but it may do so in partnership with others or by bringing in other services from Britain or overseas. The important point is that we will not allow the tax relief to go to a partnership. There may be a partnership, but the tax relief will go to the British film maker and the British film maker must be a film production company—a vehicle that meets each of the three tests in the clause. I hope that that provides clarity.

I come now to the details of the amendments. First, amendment No. 31, as the hon. Lady said, would remove the obligation on a film production company to have responsibility for pre-production activity. As I explained, we believe that a film maker must be actively engaged in, and be responsible, for the pre-production phase. We are not saying that that is an absolute or inflexible definition and it is possible to have a greater or lesser engagement in the pre-production phase but, on the basis of our consultations, we believe that it would be a mistake for the provision to apply if there is no engagement as that would suggest that we did not properly understand the delineation between speculative development and the beginning of the production process.

Likewise, amendment No. 32 would weaken the definition of a film production company by removing the requirement that it must be involved in negotiating, contracting and paying for the various rights, goods and services that together make up the expenditure on making a film. Again, and for reasons that I hope I have made clear, any company that is not involved in negotiating contracting and paying for the fundamental elements of making a film cannot be the controlling entity or the essence of the making of that British film, which is what we want to achieve in the provision. I stress that that does not mean all of the film.

Debate adjourned.—[John Heppell.]