Finance (No. 2) Bill
Public Bill Committee, 25 May 2006.
Standing Committee A
Mark Francois (Conservative, Rayleigh)
On a point of order, Mr. O’Hara. I estimate that at our current rate of progress, we shall reach the matter of real estate investment trusts shortly after we return from the Whitsun recess—probably, I should guess, sometime on Tuesday 6 June.
The Bill contains 43 clauses relating to REITs, and on a number of occasions it makes it plain that the detail of the REITs regime will be found in regulations to be issued by the Government. We have pressed the Government to make those regulations available to Committee members so that we shall have good time to examine them in order to inform our debate.
When we raised the subject in Committee of the whole House on 3 May, the previous Economic Secretary, the hon. Member for Bury, South(Mr. Lewis), said that he would try to ensure that we did not get the regulations the day before:
“My undertaking could, theoretically, mean the night before, but I will do my best to ensure that the hon. Gentleman and other members of the Committee have sight of the regulations much earlier than that.”—[Official Report, 3 May 2006; Vol. 445, c. 1040.]
If we are to have a constructive, well-informed debate, it will be genuinely helpful to have those regulations as soon as possible. Have you had any information, Mr. O’Hara? I see that the new Economic Secretary is in his place. Perhaps he might be in a position to update the Committee and give us a firm date on which those regulations will be available.
Edward O'Hara (Labour, Knowsley South)
That is certainly not the sort of information that the Chairman could provide, but I am looking to the Government Front Bench, where I am sure I will find an answer.
Edward Balls (Labour, Normanton)
The proceedings of the Finance Bill Committee have so far been constructive and extremely well-informed, as are my hon. Friend the Member for Wolverhampton, South-West (Rob Marris) and others. I should like to ensure that that continues when we come to debate REITs.
I thank the hon. Member for Rayleigh(Mr. Francois) for giving me advance notice of his point of order. It is my intention to fulfil the commitment made by my predecessor, and I assure him that officials are working flat out to produce the regulations. As my predecessor made clear, it is the Government’s intention to publish the draft regulations much earlier than the night before. We hope to have them all published by Thursday 3 June at the latest, although we might be able to publish some parts before that. That will of course happen during the recess, but the regulations will be available for Members to access on the HMRC website.
I can also tell the hon. Member for Rayleigh that a significant amount of detail on the regulations’ intentions for the UK REITs regime was set out in the commentary published alongside the Budget, which is also available on the HMRC website. I remind him that they will be draft, illustrative regulations and that there will be further time for consultation with industry experts during the summer. Final regulations will be laid in September or October, in advance of the regime’s 1 January start date.
If possible, all the regulations will be published by or before next Thursday. That should give the Committee more than one night to prepare for debate.
Mark Francois (Conservative, Rayleigh)
I am grateful to the Economic Secretary for that clarification. We should all like as much notice as possible so that we can consult with outside bodies and interested parties, but he has at least given us a firm commitment to 1 June. In light of that, we shall do our best to be as well prepared as we can. I thank him for that date.
Edward O'Hara (Labour, Knowsley South)
Having got that roadblock out of the way, we now hit the track running.
Schedule 8
Theresa Villiers (Conservative, Chipping Barnet)
I beg to move amendment No. 187, in page 202, line 23[Vol I], leave out from ‘if’ to ‘the’ in line 24.
Edward O'Hara (Labour, Knowsley South)
With this it will be convenient to discuss the following amendments: No. 188, in page 213, line 25 [Vol I], leave out from ‘is’ to ‘that’ in line 26.
No. 189 page 215, line 19 [Vol I], leave out from ‘if’ to second ‘the’ in line 20.
Theresa Villiers (Conservative, Chipping Barnet)
Before turning to the amendments, I include a few brief words to put into context the subject that we are discussing. We face the important task of scrutinising an entirely new framework for the taxation of leasing transactions.
The new structure for taxation of leases was triggered by two considerations. Section 109 of the Capital Allowances Act 2001 was felt to breach EU law because it gave less favourable treatment to persons resident in other member states, and I gather that the Revenue believes that some structured leases were really finance leases dressed up to look like operating leases in order to avoid tax. Responding to those two concerns, the Government have introduced the concept of the long funding lease, which is at the heart of the structure that we are examining. If a lease falls within the definition of a long funding lease set out in the schedule, capital allowances will be transferred from the lessor of the equipment to the lessee, or lost if the lessee is not eligible for them—a point that is particularly relevant to the public sector and that I will address later.
The Government have built around that concept the highly complex and detailed regime set out in schedules 8 and 9, and linked anti-avoidance provisions are included in schedule 10 on the sale of lessor companies. I have tabled the amendments in response to concerns expressed about new sections 70C, 70S and 70V of the 2001 Act, proposed in paragraphs 6 and 7 of the schedule. They reflect points made by the Law Society that are of sufficient gravity to merit consideration. Its concerns are similar to those expressed earlier in the week on another part of the Bill, but it is appropriate to put them again in this context because of their significance.
The new provisions will restrict the availability of capital allowance where
“the circumstances are such that it would not be unreasonable to conclude from them that the purpose, or one of the main purposes”
of entering into a transaction is to gain capital allowances in the circumstances prescribed. The Law Society points out that that contrasts with the formulation normally adopted in anti-avoidance legislation, which simply asks whether the purpose, or one of the main purposes, of entering into a relevant transaction is to obtain a tax advantage. As I have said, the matter was raised earlier in the week, and I imagine that the Financial Secretary will be as unmoved by the concerns as his colleague was then.
Under the traditional formulation the Revenue must prove in court, on the balance of probabilities, that obtaining tax advantages was one of the main purposes for entering into a transaction. The parts of the schedule that I seek to delete would alter that requirement; the Revenue would no longer have to provide such proof. Under the new sections, it would have to show only that it was not unreasonable for the inspector to reach the conclusion that tax avoidance was a primary motivation. That seems to allow for the possibility that the Revenue might succeed in a case despite failing to show on the balance of probabilities that the purpose was to obtain a tax advantage, if it could show that it was not unreasonable to conclude that there was such a motivation. It would then be up to the taxpayer to show that the tax inspector’s decision was unreasonable. That alters the ordinary onus of proof and therefore gives rise to constitutional problems. I hope that the Government will reconsider the inclusion of the new formulation.
David Gauke (Conservative, South West Hertfordshire)
Further to the comments made by my hon. Friend the Member for Chipping Barnet (Mrs. Villiers) on the main purpose test, I shall mention that we debatedthat test earlier in the week on an amendment moved by my hon. Friend the Member for Wycombe(Mr. Goodman) in an attempt to alter the test in a slightly different context. We all hang closely on the words of the Paymaster General, who stated last Tuesday morning:
“There are many examples of the main purpose test in UK tax avoidance legislation”.
She also said:
“The test is well used, and HMRC has issued detailed guidance, which it continues to update, to provide as much certainty as possible to business. The system is working. The main purpose test is included not only in clauses 69 to 71 but in a lot of other places. The phrase is well understood by business and its advisers, and guidance and support is given by HMRC.”—[Official Report, Standing Committee A, 23 May 2006; c. 324-325.]
Those of us who were here earlier this week found those comments extremely persuasive and therefore one has to ask why in this context the drafting does not pursue the main purpose test as is customarily the case, but applies a very different test that seems somewhat lacking in certainty and may create some difficulties as a consequence.
John Healey (Labour, Wentworth)
I welcome you to the Chair, Mr. O’Hara. I look forward to progress on this next set of clauses. The hon. Member for Chipping Barnet made a few useful general comments on this part of the Bill and, in particular, on how schedules 8 and 9 introduce effectively the new regime for tax treatment of leasing. It may therefore be helpful if I make one or two general comments and then deal with her specific amendments to which the hon. Member for South-West Hertfordshire (Mr. Gauke) has just spoken.
The measure that we are considering in schedules 8 and 9 introduces a new and improved structure for the taxation of leased plant and machinery, the basic principles of which were announced in the pre-Budget report in 2004. Since then the new regime has been the subject of extensive and constructive consultation. The Government are particularly grateful for the significant input we have had from the leasing industry. I am also pleased that the CBI went out of its way to describe that consultation as an example of good, responsive Government policy making.
It may help the Committee’s consideration of these and the next groups of amendments if I make it clear that the reforms we are putting in place have four main objectives. I will also pick up the hon. Lady’s point about the EU. First, under the existing tax regime, the taxation of plant and machinery purchased with a loan differs widely from the taxation of the acquisition of the same assets using lease finance. Yet the commercial results are very similar. The difference in tax treatment therefore potentially distorts the choice of finance, particularly in connection with longer leases.
It should be a principle that is widely accepted, and accepted on both sides of the Committee, that wherever possible, business decisions should be motivated by commercial and economic considerations, not simply tax treatment. This new regime ensures that tax-motivated distortions in the choice of finance are minimised. Secondly, the existing rules mean that UK lessors are usually able to undertake the advantages and opportunities of leasing abroad. This new regime therefore allows us to remove these restrictive rules and open up new opportunities by increasing the market for overseas leasing from the UK.
Thirdly, in the past the financial sector has had significant success in exploiting the leasing rules to benefit lessees in ways that were not consistent with Government policy. Previously, as the hon. Lady will know, we have been required to tackle these issues on a case-by-case basis. The new regime and the reforms we are proposing here give us a sounder basis for the taxation of leasing. It will allow us to counter exploitation more effectively and to do so without inhibiting genuine business transactions.
Fourthly, and this is the point that the hon. Lady was making, the current regime has been the subject of some commentary by academics and professionals about the compatibility of the current leasing regime with EU law. Generally this is speculation and we remain confident of the legality of the previous regime. But what I would accept is that such commentary and questioning creates a degree of uncertainty. The fourth objective of the new regime is to enable us to remove that uncertainty. The provisions that we are examining have all been drafted to be fully compliant with EU law and to provide a stable and more certain basis for the taxation of leasing in the future.
The three amendments Nos. 187 to 189 relate, as the hon. Lady rightly said, to the main purpose test. As the hon. Member for South-West Hertfordshire pointed out, we have discussed the main purpose tests in previous proceedings of the Committee. The concept of schedules 8 and 9 is indeed that the relevant rules apply where
“it would not be unreasonable to conclude”
that the main purpose, or one of the main purposes of a particular type of transaction is to avoid tax.
The hon. Lady is right in saying that the Law Society has raised that point with us, as part of its representations on the Bill. However, its concerns do not appear to be shared by the leasing community. I am told that we received only one other comment on that question, which was simply to note what was, and is, a novel formulation in the provisions of the clause. However, in our view the test is similar. It still relies on the main purpose test, although it is intended, if one wants, to lower the bar and make it easier to apply the anti-avoidance rules. It will still be challengeable, including legally, as is the main purpose test in other parts of legislation.
However, given the points that the hon. Lady has underlined and those that the Law Society has submitted as part of its representations, I shall look again at the formulation under the Bill. I hope, on that basis, that she will not press the amendments to a Division.
Theresa Villiers (Conservative, Chipping Barnet)
It is welcome that the new framework will provide new opportunities for leasing overseas. I acknowledge that the consultation has been lengthy and expensive. While there are certain points that the Government have not taken up as a result of the consultation, as I will make clear later on, they have been extremely responsive, in a constructive and welcome way, to the concerns of those affected by the legislation. I was interested to note in the Financial Secretary’s statement that he believes that the current rules are compatible with EU law, but that the new framework simply seeks to put that beyond doubt. That is a useful clarification of the Government’s approach to the framework of the existing rules.
It is fair of the Financial Secretary to acknowledge that the new formulation, which is the focus of the amendments and concerns the primary motivation test, is intended to lower the bar. It will have an effect on the standards that Her Majesty’s Revenue has to show to demonstrate that one of the primary motivations was avoidance. As my hon. Friend the Member for South-West Hertfordshire pointed out, we are worried that it is inconsistent with most of the other similar provisions under the Bill. I welcome the Financial Secretary’s commitment to look again at how those tests will work in practice. In the light of that, I should be happy if the Committee will permit me to withdraw the amendments.
John Healey (Labour, Wentworth)
I beg to move amendment No. 112, in page 214 [Vol I], leave out lines 4 and 5.
Edward O'Hara (Labour, Knowsley South)
With this it will be convenient to discuss Government amendment No. 190.
John Healey (Labour, Wentworth)
I hope that the Committee will consider that amendments No. 112 and 190 are constructive additions to the Bill. Proposed new section 70R of the Capital Allowances Act 2001 excludes what is referred to as “background plant or machinery” from the scope of the reform. The statutory definition of background plant or machinery is set out in proposed new section 70R(4). As is suggested by the description, “background plant or machinery” contributes to the background functionality of a building, and includes assets such as lifts, central heating and air conditioning systems. The exclusion’s primary effect is that the reform will only rarely affect the property leasing industry. We think that that is the right approach, because property leases rarely have the characteristics of financing transactions, with which we are concerned in the reforms proposed in the new regime.
Although the main definition of “background plant or machinery” is in the primary legislation, we propose supplementing it by a Treasury order that will provide further details. A draft of the additional material to be included in that order was published before the new regime came into effect. The two amendments will make the Treasury order effective from 1 April 2006, as was intended, thereby ensuring consistency of approach from the start of the new regime. The amendments also ensure that in future it will only be possible to make further Treasury orders necessary to respond to building design and construction changes with prospective effect. I hope that the Committee will welcome and support the proposal.
Theresa Villiers (Conservative, Chipping Barnet)
Both amendments in the group are to be welcomed. As we have heard, they relate to proposed new section 70T of the Capital Allowances Act 2001. The proposed new section deals with the legislative carve-out of leases of plant and machinery that are incidental to the lease of a building. I particularly welcome amendment No. 112 because the provision that it seeks to delete—section 70T(3)(a)—posed a particular problem of retrospective effect, as the Financial Secretary has acknowledged. For instance, it would have permitted orders containing provisions effective up to 15 months before the making of the order. As was observed in the Law Society’s helpful briefing, that would have constituted a retrospective tax, because it would have been possible for such an order to remove categories of plant and machinery from qualification for capital allowances in the hands of the lessor or the lessee, depending on whether they fell within the new framework or within the carve-out for property-related leases. I welcome the fact that the Government have chosen to think again about paragraph (a).
John Healey (Labour, Wentworth)
I beg to move amendment No. 113, in page 216, line 6 [Vol I], after ‘lease' insert ‘(“the new lease”)'.
Edward O'Hara (Labour, Knowsley South)
With this it will be convenientto discuss the following amendments: Government amendments Nos. 114 to 116.
Amendment No. 163, in page 246, line 2 [Vol I], leave out ‘April' and insert ‘September'.
Government amendment No. 117.
Amendment No. 164, in page 246, line 6 [Vol I], leave out ‘April' and insert ‘September'.
Government amendment No. 118.
Amendment No. 166, in schedule 9, page 261, line 29 [Vol I], leave out ‘April' and insert ‘September'.
Amendment No. 167, in schedule 9, page 261, line 37 [Vol I], leave out ‘April' and insert ‘September'.
John Healey (Labour, Wentworth)
I shall briefly explain the Government amendments and then say a few words about the four Opposition amendments. Amendments Nos. 113 and 114 define the term “the new lease” in certain sections of the Capital Allowances Act 2001. They are designed merely to add clarity to the legislation. Amendment No. 115 proposes removing an unintended interaction within the commencement rules. As they stand, they could allow lessors to move to the UK and exploit its capital allowance regime, which was never intended. The amendment ensures that that cannot happen and that lessors who move to the UK do so in a way that is fair and does not bring with it the risk of exploitation.
Amendments Nos. 116 and 118 correct a minor technical defect that has become apparent and which would deny some leases the benefit of the transitional provisions. Amendment No. 117 corrects a second minor technical drafting error in the commencement provisions, in paragraph 15 of schedule 8.
We are also debating amendments Nos. 163, 164, 166 and 167, which were tabled by the hon. Member for Chipping Barnet and other Conservative Members,so perhaps I could say a word about them. The amendments would change the new regime’s start date, but I am confident that that is neither appropriate nor necessary for the following reasons. Details of the core of the new regime were first announced in December 2004 and the start date of 1 April was announced in July 2005. Businesses have therefore been able to plan for that start date for some time, and it has not come as a surprise to them. In fact, the Government’s open and consultative approach to the legislation, which the hon. Lady, the CBI and others have acknowledged, has given businesses a great deal of certainty about the new arrangements. Changing the start date at this late stage, however, would undermine the reforms that we are looking to put in place.
I am aware that administering a new scheme brings certain challenges for businesses, and we have made great efforts to ensure that businesses are as well supported as possible over this period, but simply pushing back the start date is not the solution. If the hon. Lady thinks about it, she will see that such an approach would create practical issues, particularly for businesses that have already put in place systems to cater for the new regime. Furthermore, many businesses have already written business in the expectation that the new regime will come into effect on 1 April, as we announced last year. We are trying to bring greater stability and certainty to the taxation of leasing, and changing the treatment of existing leases would entirely undermine that objective. Delaying the start date will delay the implementation of the new and, according to most commentators and those involved, improved regime. I therefore urge the hon. Lady not to press the amendments, but if she does, I shall have to ask my hon. Friends to oppose them.
Theresa Villiers (Conservative, Chipping Barnet)
The Government amendments all provide useful remedies for minor defects in the original drafting. I therefore welcome them, and the Opposition will make no objection to their being incorporated into the Bill.
As the Financial Secretary said, amendments Nos. 163, 164, 166 and 167, which my hon. Friends and I tabled, would postpone the start date for the new rules until 1 September. Shortly before he sat down, he indicated that the industry broadly welcomed the new framework, but that is not really the impression that I have received. Indeed, there is great concern about the complexity and structure of the new rules, although there is also a degree of resignation about the fact that they will nevertheless be implemented. Therefore, the welcome for the overall new framework is not as uniform as the Financial Secretary suggested.
I acknowledge that the Financial Secretary made an important point about those businesses that have already planned for the 1 April start date, but in light of the significant challenges of meeting that target date, I shall still speak to my amendments on the subject, because it is an important issue for the Committee to discuss. They are essentially probing amendments to allow this discussion to take place.
The Committee should note that the postponement date does not give rise to avoidance opportunities as, because of the way in which the Government structured the Bill, only contracts that were well under way or finally concluded before 21 July 2005 can continue to operate under the old rules. Contracts concluded since that date will be governed by the transitional provisions, although those provisions are not without problems themselves; in particular, there is the so-called “under construction” test to determine whether work under the contract is sufficiently advanced to fall within the transitional provisions.
The delay that I propose in my amendments will simply give market participants more time to prepare for the new regime. That is needed for a number of reasons. As we heard, the provisions in schedules 8 and 9 compose an entirely new framework for the taxation of leases. They introduce highly complex new provisions and concepts, a number of which are unknown in any tax and accounting systems anywhere else in the world.
Under the Bill as drafted, the provisions for new deals took effect on 1 April this year, before the final version of the rules was known. I acknowledge that the impact is mitigated by the extensive and lengthy consultation that the Government carried out, including circulation of earlier drafts of the rules. However, the full draft of the new rules was published only about 24 hours before the 1 April implementation date. Furthermore, as we see today, the final form of the Bill is still subject to change, as there are Government amendments on the table before us. The new regime will require all lessors to carry out extensive work in reviewing their range of products and services. Clearly, significant IT changes and upgrades, and extensive staff training programmes, will be necessary, and of course it will be important to take time to ensure that customers know the impact of all the changes. All that will take considerable time and effort on the part of those affected by the changes.
The Committee and the Government should consider giving that extra time because of the enormously significant role that the leasing industry plays in our economy. The tax treatment of leasing transactions may seem like the driest of dry Finance Bill backwaters, and many Members may feel that it simply the barrier between us and the Whitsun recess, but a thriving leasing industry is crucial to two of the key drivers of economic prosperity in this country, namely business investment and productivity. To support that statement, I rely on a 2004 paper produced by Oxford Economic Forecasting for the Finance and Leasing Association entitled “The economic impact of proposed changes in the corporation tax treatment of finance leases.” That is not completely up to date, as it was prepared in response to the initial August 2003 consultation document on the new regime, but it is still usefulin highlighting the important role that leasing plays in making the capital market operate more efficiently.
Leasing helps to bridge the information divide between firms and their financiers by linking finance to specific assets over which the lessor retains ownership. That can make it easier for firms to obtain finance for investment, because the specialist knowledge that lessors build up about the equipment that they lease means that they may be more willing to provide finance than more generalist operators. Leasing can be enormously useful to start-up firms, which may be temporarily unprofitable and so may find finance difficult. It also helps business to respond to economic shocks that cause periods of lack of profitability. Leasing is heavily used by small businesses, particularly when they have short-term cash-flow constraints, and leasing provides important additional competition for business finance in a market. That is particularly significant for small and medium-sized enterprises, and the Competition Commission has in the past expressed concern about the limited degree of competition in the finance market.
However, the most striking point made by Oxford Economic Forecasting is about the degree to which leasing facilitates investment. Leasing is used to fund a significant proportion of investment by business. According to the figures provided in the paper, finance leases made up to 8 to 9 per cent. of UK gross fixed capital formation, when one excludes buildings. When operating leases, hire purchase and other asset and lease-related transactions are taken into account, the proportion was about 30 to 35 per cent. of UK gross fixed capital formation. The Finance and Leasing Association reports its members as achieving£93 billion in new business in 2004, representing more than a quarter of all fixed capital investment in the UK in 2004.
In conclusion, leasing finance plays a highly significant role in relation to business investment inthe UK, which is vital for improving productivity. The Chancellor once described productivity growth as the fundamental yardstick of economic performance. In the light of poor productivity growth in recent years, we should be making every effort to facilitate a thriving leasing industry, which plays such a significant part in enabling business to make the necessary investment to improve productivity.
I hope that the Government will respond to the concerns of the leasing industry and provide as much flexibility as possible in the transition to the new rules. As Martin Hall, chairman of the Finance and Leasing Association, said, these new rules are
“the biggest change in leasing taxation for a generation.”
Like him and the FLA, I hope that the Government will at least consider postponing the implementationof such a radical new change to enable an importantand successful UK industry, which is vital to our competitiveness, to prepare properly for the changeover.
Theresa Villiers (Conservative, Chipping Barnet)
I shall continue with some general remarks about the framework, as there are several matters that relate to schedule 8 that it would be useful for the Government to consider and for the Committee to be aware of. First, I acknowledge that some sensible changes were made to schedule 8 and the draft legislation during the consultation process. For example, the new rules cover only leases of five years or more, which will exclude a significant proportion of SME business, since their transactions are often less than five years. That is a welcome change. The Government have also given ground in some technical areas—for example, the definitions and concepts surrounding net present value, economic life and the lease payments test have all been improved, reducing risks that commercial transactions will be treated in an inappropriate way by the new rules.
The definition of “funding lease” no longer includes the problematic specialist use test, which could have led to many legal disputes and would have been good for the lawyers but not much good for anyone else. Allowing businesses to opt into the new rules when that makes sense is also very useful. That is also very welcome, as it should reduce compliance costs; I am told that it is particularly welcomed by the IT industry, which for various reasons would find it very difficult to run leases according to the two parallel structures.
A number of concerns remain: first, the structure is very complex, as anyone who has grappled with the three schedules we are discussing will be aware. Secondly, in that context there are some difficult questions related to the interaction with EU law. As with other aspects of the Bill, one reason for the introduction of new rules is to ensure compliance with EU law; and alongside film tax, group relief and a number of other aspects of the Bill, we now have a further example of the increasing impact of EU rules on our tax system.
I welcome the Financial Secretary’s response to the suggestion by some people that the new framework may still cause problems in relation to EU law. I refer to proposed new section 70V of the Capital Allowances Act 2001. The Institute of Chartered Accountants in England and Wales highlighted the concern that in cross-border leasing, when a British company leases equipment to an overseas company, no allowances will be available for the UK lessor or the foreign lessor, but that in UK-UK leasing, the lessee will be able to claim the allowance. The Chartered Institute of Taxation expresses similar concerns. The comparison between the UK-foreign lease and the UK-UK lease indicates that there might be less favourable treatment in the UK-foreign lease.
I hope that the Financial Secretary can reassure the Committee that in that specific context there is no problem with EU law—expanding on his overall comments that there is nothing in the new framework that will cause a problem when it interacts with EU law.
I have received a number of representations from people who are anxious that the new framework could disadvantage business start-ups and impact negatively on inward investment in the UK. They include comments from the Finance and Leasing Association and the ICAEW. The old rules provided business start-ups with an advantage. As they might not have been generating profits in the early years, the rules enabled them to use their capital allowances on the equipment that they were using. It therefore made sense for businesses to use leasing, which would be cheaper because the lessor would receive the capital allowance benefit that the lessee could not. The ICAEW acknowledges in its briefing that the impact on start-ups will not cause a major problem, presumably because many start-ups will prefer to go for leasing arrangements of less than five years, which are excluded from the new rules, and therefore mitigate that concern.
However, that does not deal with the concern about the impact on inward investment in the UK. Many inward investors might not be able to make significant profits in their early years, and they will therefore benefit from cheaper leasing costs, because the lessor gets the benefit of capital allowances.
Unlike indigenous small business start-ups, large inward investors will certainly be interested in longer-term leases. The 2004 Oxford Economic Forecasting paper, to which I referred the Committee earlier, highlighted the popularity of leasing as an option for inward investors. I believe that the Government have themselves in the past highlighted the old leasing rules as an important incentive to inward investment. Will the Government outline the research that they have conducted into the economic impact of those measures? Are they confident that the measures will not impact negatively on inward investment?
There is a third, horizontal concern about the new rules’ impact on the public sector. It is difficult to find figures about leasing transactions and the public sector, but some people have estimated that the leasing contracts in public sector and private finance initiative projects are worth up to £500 billion. NHS trusts have made increasing use of leasing arrangements in recent years, as local authorities have made use of them for school equipment in particular.
The current rules—the old ones to which we are saying goodbye over the next few weeks—have been a big advantage to the public sector. The lessor, not the lessee, of the equipment had the benefit of the capital allowances. A public sector body such as an NHS trust could never use the capital allowance anyway, because it does not pay any tax. Its lease costs were effectively discounted because of the allowance that the lessor company could claim and the public sector body could not. The new rules abolish that advantage. As we well know, NHS trusts already have difficulties balancing their books, and there can be no doubt that the rule changes will make that process more of a challenge. Those changes are likely also to put further pressure on council tax payers as local authorities find it more expensive to lease equipment, for the reasons that I have outlined.
Although the extra revenue raised by the Exchequer as a consequence might offset the costs paid by public sector institutions, there is no guarantee that the extra money will find its way back into the departmental budgets of the institutions subjected to the extra leasing costs or, for example, to the specific local authorities and NHS trusts that will face the increased costs. Again, I would be interested to hear the Financial Secretary’s thoughts on the research that the Treasury has done on the financial impact that those changes will have on the public sector, and whether there will be any qualifying reallocation of departmental budgets in consequence of the changes.
I shall now turn to a concern highlighted by the Law Society, which has raised a number of interesting points on the new regime. One point relates to proposed new section 70Q(2)(d) of the Capital Allowances Act 2001. Under the new rules, whether a lease counts as a long funding lease can vary between lessor and lessee; the test is applied differently between the two parties. Theoretically, a lease might count as a long funding lease for one party, but not for the other, and therefore both the lessor and the lessee might be entitled under the rules to claim the relevant capital allowance.
New section 70Q has been included to prevent that from happening by not allowing the lessee to claim the allowance in certain circumstances, for example, where the lessor is entitled to reliefs at the commencement of the term of the lease. The overall goal of new section 70Q is of course welcome because we will not have the lessor and the lessee claiming the same allowances. However, paragraph (d) causes a problem. It prevents the lessee from claiming the allowance where the lessor would have been entitled to the relief if they had been subject to UK income or corporation tax.
That seems an odd provision to include in a section designed to prevent a double claim for allowance. It relates to lessors not in the UK income or corporation tax regimes. By definition, those parties are unable to claim the allowance so there seems no sensible reason why the lessee should not be able to claim it. If the proposed new section is designed to prevent double counting, and the lessor is outside the UK tax regime and therefore cannot claim the allowance anyway, there is no danger of double counting.
The compliance cost of paragraph (d) is of even more serious concern. In order to claim the allowance, the lessee will have to establish the tax position of their immediate lessors and all superior lessors in the leasing chain. The burden will be particularly heavy because we are talking largely about lessors that are overseas companies outside the scope of UK corporation tax, as I have said. The lessee will have to identify all lessors in the chain, their tax status and their hypothetical tax position were they liable for UK corporation tax. It will be necessary therefore to establish whether the lessor would have been able to claim the capital allowance if they fell hypothetically in the UK tax net and accounted hypothetically the lease under international financial reporting standards, not their local accounting system.
To be honest, few lessors will be keen to undertake that exercise, and even if they were, they would presumably expect the lessee to meet the costs of the expensive accounting and tax advice needed to answer those hypothetical questions. As pointed out by the Law Society, that seems to oppose the compliance burden which is disproportionate to any benefit provided by the enactment of paragraph (d).
The next concern about schedule 8 relates to property. The Opposition welcome the Treasury’s move to exclude from the new framework leases that are primarily focused on land and buildings. Clearly, leases of real property might often contain terms relating to plant or machinery as an add-on to the main purpose of the contract. Typical examples are where the lease of a building also covers the lease of air conditioning units, and heating and lighting systems.
The Government’s carve-out is achieved via three different parts of schedule 8. Background plant and machinery is excluded from the definition. As we have heard in respect of earlier amendments, a list of different types of property-connected plant is provided for and designed to be updated by Treasury rules as and when necessary.
Last of all, new section 70U(4) introduces a de minimis limit to sweep up leases of minor value that are clearly not the Government’s target and should not fall within the definition of long funding leases. It provides that leases of plant and machinery will be considered as de minimis, and therefore fall outside the new framework, when they constitute no more than10 per cent. of the value of the background plant and machinery or 5 per cent. of the market value of the relevant land and buildings. The British Property Federation said:
“This measure is welcome, but there are concerns that the limit may have been drawn too narrowly and perhaps does not meet its objectives of ensuring that unintended background plant and machinery leases are outside the scope of the new long term funding lease provisions”.
It would be useful to hear from the Financial Secretary why those particular value limits have been chosen. What research has been carried out to ensure that they meet the Government’s stated objectives of keeping leases that primarily concern real property out of the new framework? There is a case for arguing that the limits have been drawn too narrowly and that leases that should be treated as de minimis and incidental to the real property transactions to which they are linked will fall within the definition of long funding leases.
Rob Marris (Labour, Wolverhampton South West)
Will the hon. Lady explain whether her argument would be the same if she had read new section 70U(4) correctly? In fact, 70U(4)(a) uses a conjunction—“and”; she said “or” in respect of the two limits. There have to be both; there is no either/or.
Theresa Villiers (Conservative, Chipping Barnet)
Yes, I did not express that clearly. However, either way there is concern that the de minimis exception has not been drawn sufficiently widely, and I should be interested in the Financial Secretary’s response on that.
I have two brief final points to make on schedule 8. The finance lease test in new section 70N introduces an unfortunate element of subjectivity, as the borderline between a finance lease and operating lease is often blurred and subject to conflicting interpretations in different cases. Finally, the Chartered Institute of Taxation has expressed concern that the definition of the term of the lease set out in new section 70YF of the Capital Allowances Act 2001 is insufficiently clear. It has particular concerns about the approach taken to break clauses in the new section.
For those reasons, the Opposition have a number of reservations about schedule 8, on which we would welcome the reassurance of the Financial Secretary.
John Healey (Labour, Wentworth)
I hope that I can give the hon. Lady reassurance on her main points. She began, quite rightly, by making a couple of general comments about the importance of the leasing industry. It is indeed an important part of our economy, accounting for almost £14 billion of investment each year.
As one would expect, we have looked carefully at the potential impact of the new regime on such investment, and our analysis shows that the overall effect on investment in the UK economy will be very small—we estimate a reduction of about £80 million per annum. When we put that into the context of the total annual business investment in the UK economy, about£110 billion, we see that that reduction is very small, at roughly 0.07 per cent.
The hon. Lady was particularly concerned about small companies, but in a sense she provided the answer to her own concerns. Most leases of up to seven years will not be affected by the reform. Our analysis and feedback consistently suggest that, partly for the reasons suggested by the hon. Lady, very few leases to small companies exceed seven years. The effect of excluding short leases from the regime is to exclude the vast majority of leases to small firms. I explained earlier the four principal objectives of the reforms that we propose, including our belief that the new regime is fully compliant with European Union law. She pressed a particular concern about section 70V, the purpose of which is to prevent cross-border tax avoidance schemes that otherwise could lead to a significant cost to the Exchequer without any economic benefit to the UK. We believe that this specific provision of the regime—rather than the general provisions—is proportionate, appropriate and compliant with EU law.
The hon. Lady was concerned about the potential effect on inward investors. Our conclusion, drawn from explicitly encouraging, during the consultation process—[Interruption.] During the consultation, officials were not given any evidence that the availability of lease finance significantly affects decisions to invest in the UK. Even where it is used, our assessment, based on the discussions and the evidence that we have gathered through the consultation, is that any loss of tax benefit is unlikely to be significant enough to affect the choice of the UK as a location for significant inward investment.
Brooks Newmark (Conservative, Braintree)
If I may indulge the Financial Secretary for a moment, it would be helpful to explain something. I thought that my hon. Friend made a valid point with respect to proposed new section 70V. The Financial Secretary has said that he believes that it is compliant within EU law. I am curious about what discussions he had with the Chartered Institute of Taxation, which I respect—it is well respected—which raised a valid issue with respect to new section 70V, as did my hon. Friend. I should be interested to hear a little bit more detail about why the Financial Secretary has a different view on this matter from the Chartered Institute of Taxation.
John Healey (Labour, Wentworth)
I also respect the Chartered Institute of Taxation; it has been active in its contributions to the development of our thinking on this new regime and has, as it generally does, made a useful contribution during the consultation period. The long and the short of it is that our judgment, as I have explained to the Committee, is that this part of the new regime—as with the generality of it—is appropriate and proportionate and, specifically to answer the hon. Lady, compliant with EU law. That is the legal assessment that we have made in drafting its provisions.
The hon. Lady also asked a series of questions and was concerned, quite reasonably, about compliance costs. HMRC is doing important work in that area at the moment with business to try to assess where we can reduce the compliance costs. If the hon. Lady has had representations on this matter from bodies that fear the level of compliance costs, I encourage her to encourage them to contact us directly, because that area of work is live at the moment and is important to us and we welcome any further contributions.
Theresa Villiers (Conservative, Chipping Barnet)
On that last point, there may be a particular problem where it becomes necessary fora lessee to know the hypothetical tax status of its lessor, and the chain of lessors. There may be a number of extra-statutory methods that the Revenue could use to lighten the compliance burden. I will be urging those concerned about this point to be in contact with the Treasury and the Revenue, but I urge the Financial Secretary to ensure that there are ways to reduce the compliance costs, because the situation could potentially be complicated, as I have outlined. If a pragmatic approach is taken, we can, hopefully, get to a point where the compliance burdens are not significant.
John Healey (Labour, Wentworth)
I had finished my remarks, but we would welcome contributions on the operation of section 70Q.
Schedule 9
Theresa Villiers (Conservative, Chipping Barnet)
I beg to move amendment No. 185, in page 258, line 1 [Vol I], leave out from beginning to end of line 17 on page 259.
The amendment concerns the tonnage tax exclusion from the new leasing framework. It seeks to delete new paragraph 91D of schedule 22 to the Finance Act 2000. As we have discussed, ships that are leased into tonnage tax companies are generally excluded from the new framework set out in schedules 8 and 9. Concern has nevertheless been expressed that elements of schedule 9 will make it more difficult to finance large assets such as ships and aircraft, and will interact negatively with the tonnage tax regime.
In particular, I have received a number of representations concerning paragraph 10 of schedule 9 and new paragraphs 91B, 91C, 91D and 91E of schedule 22 to the Finance Act 2000, which it introduces. Those paragraphs place restrictions on the breadth of the exclusion for tonnage tax companies. The Chamber of Shipping was reported in the Financial Times as having said that the proposed new rules had already led to the cancellation of plans to base a significant number of additional ships in Britain. David Astbury, head of shipping policy at the chamber, said of the new rules:
“For international groups which are thinking of coming to the UK, it is a turn off. It is an indication that...the rules...are not as stable as they might be.”
The paragraph that the amendment seeks to delete, new paragraph 91D, provides that the exemption from the new rules applies only where certain conditions relating to chartering the tonnage tax leased vessel are met. In particular, with a few limited exceptions, such charters must not exceed seven years. That imposes significant commercial constraints on how companies manage their vessels. I am sure that the Financial Secretary will immediately respond that most such charters are for less than seven years. That is true, but there is no guarantee that that is how the market will continue to be structured, and concern has been expressed that a seven-year limit will fetter the business flexibility of the companies affected. Those constraints are likely to have an impact on the competitiveness of UK tonnage tax companies by comparison with their non-UK tonnage tax operator rivals.
The Revenue has indicated that it considers that the measure is needed to prevent UK tonnage tax regime advantages from subsidising international operators, and I can understand that concern. However, shipping is, by definition, an international business—surely almost all shipping companies are international operators. The whole point of a low-cost tax regime is to reduce costs in order to attract international operators and enable services to be provided at competitive rates.
Commenting on the seven-year restriction, solicitor Louise Higginbottom of Norton Rose told a national newspaperthat the new provisions gave rise to
“a serious risk that the UK shipping sector will decline...There is Revenue paranoia that the benefits of the new regime were enjoyed by companies internationally. But what’s the point of a low cost regime if you don’t pass savings on to your customers?”
Given the importance of the tonnage tax regime, I hope that the Government will reconsider some of the restrictions that they have placed on the carve-out for tonnage tax, particularly the one relating to the duration of charters.
John Healey (Labour, Wentworth)
The tonnage tax, as hon. Members will be aware, is an especially generous regime, which was introduced by this Government in 2000 specifically for shipping and which has had significant success in reinvigorating the UK shipping sector. I assure the Committee that the reforms set out in the Bill will not undermine the success of that regime. To ensure that they do not, we have introduced in these provisions a very generous carve-out for tonnage tax companies from the leasing regime reforms. We have taken that decision in recognition of the special circumstances facing the shipping sector and the benefits that that shipping brings to the UK. I am aware of the representations from the Chamber of Shipping about the matter, and its concerns about it, but I do not accept them because I believe that the Bill contains the appropriate balance of provisions.
We have ensured that the carve-out for leasing into tonnage tax is not open to exploitation. The reforms ensure that the leases are excluded from the reform only where the significant cost to the UK Exchequer and the public purse is commensurate with the returns. It has become clear, since the introduction of the tonnage tax in 2000, that some firms come into the UK not to benefit from the tonnage tax regime itself but to benefit solely from the arrangements that they can make for leasing within the regime. That was never the Government’s intention in introducing the tonnage tax; I hope that the hon. Lady will accept that. Therefore the Bill introduces three conditions that must be met before the carve-out from the new regime will apply.
As I have said and as the hon. Lady has, I think, recognised, the tonnage tax and the ability to lease into the tonnage tax are extremely generous provisions. It is therefore right that the Government should ensure that the UK taxpayer will get value for money from the cost and the arrangements. The rule will affect only a small minority of leased ships. It does not affect all long-term charters. It does not affect long-term charters where the rate is reset to the market rate at least once every seven years and it also has no impact, of course, if the ship is not leased. It affects only long-term charters of leased ships that are chartered out at a fixed rate.
I dwelt on the third of the three rules, because that is what the hon. Member for Chipping Barnet did, but in summary the issue is that long-term charters are attractive because of the combination of lower rentals under a UK lease and fixed income under a long-term charter guarantee—a net amount of income with which to meet running costs and make a profit. It is a low-risk strategy, which makes the UK an attractive place to base ships—which may have little or no contact with the UK for their entire working life, thus bringing little if any economic benefit to the UK.
The result can be a significant cost to the public and the Exchequer for such transactions, which correspond to little economic benefit to the UK. In effect, therefore, the UK Exchequer and the public provide a subsidy in those cases to the international shipping communities, and we cannot allow that. I hope that that helps to explain why we have set up not just the carve-out to benefit shipping but the rules to prevent it from being exploited. I hope, therefore, that the hon. Lady will not press her amendment, as that would undermine our ability to act in that way.
Theresa Villiers (Conservative, Chipping Barnet)
I am in two minds about whether to press the amendment. I think that I will not on this occasion, but I continue to entertain serious concerns about the provision, as well as other restrictions in relation to the tonnage tax regime, which I shall outline in the debate on clause stand part. I beg to ask leave to withdraw the amendment.
Theresa Villiers (Conservative, Chipping Barnet)
I beg to move amendment No. 165, in page 260 [Vol I], leave out lines 17 to 31.
Edward O'Hara (Labour, Knowsley South)
With this it will be convenient to discuss Government amendment No. 119.
Theresa Villiers (Conservative, Chipping Barnet)
The amendment would delete paragraph 11 of schedule 9. Paragraph 11 abolishes accelerated first-year capital allowances for environmentally friendly and energy saving equipment, which are currently contained in section 46 of the Capital Allowances Act 2001.
The schedule and the interaction between the statutes are opaque and not always easy to understand, so I should be delighted if the Minister would say right now, “No, that is not the effect,” and explain that the accelerated capital allowances for environmentally friendly and energy saving equipment will continue. However, I understand that it is proposed to abolish them. The amendment would retain the allowance both for both equipment that is rented and that which is bought outright. The Bill would retain the accelerated allowance for equipment that is bought outright, but not for that which is leased.
The proposal to abolish the allowance in relation to leases seems to go against the Chancellor’s stated ambition that this year should have a green Budget. It was he himself who introduced the scheme in 2001 and, only a few weeks ago in New York, he addressed the United Nations ambassador’s honest commitment to tackle climate change. He outlined his ideas on how to protect our environment, secure our planet and safeguard our future for our children and generations to come.
When the scheme was extended in 2002, the Financial Secretary told the House:
“We are now satisfied that extending those special allowances to ‘green’ equipment for leasing will ensure the widest assistance to the uptake of those technologies, for increasing environmental gain. That is the key aim of the ‘green’ technology allowances.
The change will encourage all businesses to look towards ‘green’ alternatives when they make their equipment investment decisions. That choice may be made by the user of the equipment, but it might also be made by the person who will lease, let or hire the equipment.”—[Official Report, Standing Committee F, 11 June 2002; c. 269.]
A little later on the same day, the hon. Gentleman also said:
The clause will ensure that such schemes reach the widest number of businesses and encourage the highest uptake of technologies for the widest possible environmental gain.—[Official Report, Standing Committee F, 11 June 2002; c. 271.]
Rather than abolishing the scheme, if the Chancellor really does want to prove his green credentials, surely the Government should be promoting its uptake.
Rob Marris (Labour, Wolverhampton South West)
Has the hon. Lady read explanatory note 54a to the schedule? It provides an exception for energy saving and environmentally beneficial plant or machinery, but I may have misread it. The hon. Lady is right: the area is complex.
Theresa Villiers (Conservative, Chipping Barnet)
I found the explanatory notes puzzling, too. I consulted the experts, but I should have consulted the hon. Member for Wolverhampton, South-West. That was why I prefaced my remarks by saying that I hoped the Financial Secretary would tell me that my understanding of the clause was wrong. The explanatory notes refer to the retention of the accelerated allowance when we buy the equipment, but the Bill does not save the allowance when the equipment is leased. However, like the hon. Gentleman I shall await clarification from the Financial Secretary. I hope that the way in which I have read the clausewas wrong.
It is true that, to date, the uptake of the scheme has been limited. However, if it were relaunched and promoted, the measure could play a useful role in tackling climate change. We should have thought that leasing will be a particularly attractive option in relation to the environmentally friendly equipment area because of the swift pace of change in such matters. We could go for rather shorter-term arrangements than necessarily having to buy outright. Given that technology is moving so fast, people might not want to make such long-term commitments.
I am informed that the Revenue believes that the clause could amount to a tax loophole, but I find it difficult to see how that could be the case, especially in light of the fact that the allowances have not been used much so far. We have heard a lot from those on the Government Front Bench about the industriousness of the tax avoidance industry. The scheme has been around since 2001 and, if it were such a great loophole, surely someone would have been seeking to exploit it.
Responding to the Revenue’s request for information on the uptake of the scheme, the Finance and Leasing Association said:
“We understand that the authorities wanted this data because they were considering abolishing the enhanced capital allowances on the grounds that they could be a significant source of leakage from the new regime...We do not think our survey supports those fears...On the contrary, this looks like an example of a relief that has been underpublicised...Given the level of oil prices currently and the need for the UK to respect the Kyoto Agreement, it would seem very odd to abandon a policy that encourages a more economical use of energy...The FLA would gladly work with HMRC and the Treasury to publicise this relief in the industry and the lessee community.”
Rather than abolishing the scheme, I very much hope that the Government might consider taking up the FLA’s offer to help relaunch it, perhaps in the same way as the home computing initiative was successfully repackaged and relaunched a couple of years ago. I hope that they will reconsider the decision to abolish the scheme that is designed to tackle climate change.
John Healey (Labour, Wentworth)
Government amendment No. 119 is technical and helps to clarify the meaning of proposed new section 67(2B) of the Capital Allowances Act 2001. On amendment No. 165, I remind the hon. Lady of one of the main purposes of the provisions, which is to open up the new market of overseas leasing from the UK. As we have discussed, that will bring significant new opportunities for the leasing industry in the UK, but also requires a review of the costs and the implications for the UK of other elements of the regime.
I know that the hon. Lady understands how things work and will appreciate how the workings of the enhanced capital allowance are different from those of the mainstream capital allowance, as they incentivise investment by giving a 100 per cent. allowance, instead of the normal 25 per cent. for writing down. That means that even short leases can carry a significant tax timing benefit.
Under the old regime, we could confidently grant such allowances to lessors in the knowledge that any additional cost to the UK Exchequer would equate with environmental benefits for the UK. However, under the new rules, with the new opportunities for overseas leasing, that is not necessarily the case. Without the restriction that we are introducing, the UK Exchequer could be forced to subsidise investment across the world. Potential additional costs could not be justified and would be significant, whereas the benefits to the UK would not be commensurate.
We have also carefully considered the effect of the reform on the Government’s environmental goals. The impact of the reform will be minimal. Our research has shown that lessors rarely claim the allowances in the environmental field. In other words, the impact on the levels of investment in certain types of technologies is likely to be minimal, because the device is not used in that field.
We have also sought to retain the present treatment wherever possible, to minimise the effect on environmental objectives. The ECAs will continue to be available to lessors with cars with low carbon dioxide emissions and for background plant or machinery leased with property. Let me be clear to the hon. Lady and my hon. Friend the Member for Wolverhampton, South-West: generous enhanced capital allowances for environmentally friendly assets will continue to be available to businesses that purchase such assets directly.
I hope on that basis that the hon. Lady will notpress the amendment to a Division. I welcome her commitment to environmental concerns. I especially look forward to seeing that carried through into her interest in and commitment to the climate change levy, when the Committee discusses that later.
Debate adjourned.—[Mr. John Heppell.]