Finance (No. 2) Bill

Public Bill Committee, 6 June 2006.

Standing Committee A

Schedule 9

Edward O'Hara (Labour, Knowsley South)

I remind the Committee that with this we are discussing Government amendment No. 119.

Theresa Villiers (Conservative, Chipping Barnet)

I wish to emphasise that professional associations continue to be worried about several aspects of the schedules that we examined before the recess. Indeed, subsequent to our debate, the Finance and Leasing Association wrote to the Minister about its continued concern at the loss of the tax break for leased environmentally friendly equipment. It repeated its invitation to work with the Government to ensure that the proposal worked productively to help the urgent need to tackle climate change. It also emphasised its support for the worries that I expressed about earlier amendments in respect of the breadth of the terminology used for the motivation for tax avoidance and the change of wording that has been adopted by the Government to switch, as the Law Society said, to the formulation that it would be sufficient to prove that it was reasonable in all circumstances to believe that tax avoidance is the motivation for a transaction. In the light of that and our earlier discussions, I ask the Committee to press the amendment to a Division.

Theresa Villiers (Conservative, Chipping Barnet)

The Committee may or may not recall the worries that I expressed about tonnage tax companies in the debate on amendment No. 185 and the proposed new paragraph 91B of schedule 22 to the Finance Act 2000 that it would introduce. Similar concerns apply to proposed new paragraphs 91B, 91C and 91E of schedule 22 to the Finance Act 2000. On proposed new paragraph 91B, concern has been expressed that the requirement of a direct relationship between a tonnage tax company and a lessor is unduly restrictive. Will the Financial Secretary confirm whether any sub-leasing will still be permitted under the framework set out in the schedule? I have been informed that restrictions on sub-leasing will make it much more difficult to syndicate leasing transactions related to tonnage tax companies, and the inability to split risk via syndication can be expected to reduce the availability of finance to such companies. I am told that there have been avoidance problems in the case of sub-leases, but I hope that the Revenue will find a way to interpret the new paragraph in such a way as not to disrupt genuine non-tax related syndication, an aim that is an important part of the way in which the tonnage tax regime has worked to date.

Proposed new paragraph 91C provides that the exception to the new rules for tonnage tax companies will apply only to a company that remains responsible for the operation of a ship and for defraying substantially all voyage-related expenses. The solicitors Norton Rose, to whom I am grateful for providing a briefing, point out that to fall within the tonnage tax regime in the first place a company must have strategic and commercial management of a vessel. The degree to which sub-contracting can take place is thus already limited. Norton Rose is concerned that further restriction is not necessary and could be damaging to the success of the regime. We must bear in mind that the UK is a reasonably high-cost environment for the shipping industry, so we must make every effort to make it as competitive as possible if the Government’s tonnage tax regime is to have the success that they wish.

Proposed new paragraph 91E is on anti-avoidance, and there is anxiety that it is drafted very widely and could act as a deterrent to the new regime. Will the Financial Secretary outline some of the avoidance schemes that the paragraph is designed to target? I highlight comments made by Louise Higginbottom, the somewhat outspoken shipping lawyer to whom I referred shortly before the recess. She pointed out that the anti-avoidance provisions were so widely drafted that they would cause a crisis of confidence and uncertainty all round.

One further general point should be considered on the interaction of the new leasing framework and tonnage tax companies. I gather that representations are being made to HMRC that existing restrictions on the security that a lessor can receive on a tonnage tax lease are overly restrictive and could inhibit refinancing initiatives that do not have a tax motivation.

I am confident that the Financial Secretary aspires to maintaining a competitive tonnage tax regime, so I hope that he can reassure me and the Committee on the points that I have made.

John Healey (Labour, Wentworth)

I welcome you back to the Chair, Mr. O’Hara.

In her broad comments on the schedule, the hon. Member for Chipping Barnet (Mrs. Villiers) doubled back to the earlier debates that we had on shipping and the relation of the new provisions to the tonnage tax regime. Before answering her specific questions, I shall remind her and the Committee of the specifics of tonnage tax and the principles that underpin it. It is, of course, an extremely generous regime, introduced by this Government to support the shipping industry. Leasing benefits and tonnage tax companies have always been a difficult area. Although the hon. Lady did not say so, I think that she would recognise that. If she re-examines the work of Lord Alexander, which helped us to lay the groundwork for the introduction of the tonnage tax, she will see that he recognised the difficulty of the matter.

There have always been anti-avoidance rules on leasing and tonnage tax, and arrangements have always been developed in and around the industry to try to sidestep them. Shipping has not only a special form of support in the tonnage tax but a special carve-out within the proposed leasing rules and regime, as I have previously explained. That carve-out will apply only if the three principal conditions that we examined are met.

The short answer to the hon. Lady’s specific question about sub-leases is no. Sub-leases will not be allowed under the legislation. Syndication might be possible, and we will examine that with the industry. On the question of anti-avoidance, the expert adviser’s opinion that she cited, which suggested that some of the arrangements would cause a crisis of confidence in the industry, is far from the mark. It is a huge overstatement that does not do a great deal to help sober and proper debate on the subject.

Schedule 9 completes the legislation for the new and improved structure for taxation of leases of plant or machinery. First, it will create a regime that meets the four principal objectives that we established to deal with the long-standing distortion in the tax system that has driven business decisions on long-term finance. Secondly, it will open up opportunities for overseas leasing from the UK. Thirdly, it will create a sounder structure for the taxation of leasing in future. Finally, it will remove any uncertainty about the compatibility of UK leasing rules with those of the European Union.

The Government have recognised the importance of the leasing industry to UK business and the UK economy. We have consulted with industry interests and discussed in detail the specifics of the regime. At all stages, we have sought to minimise the potential negative impacts of the new regime and particularly to ensure that the rules are framed in a fair way that will minimise impact on small firms. It has not been easy, but I believe that the set of clauses and supporting schedules set out a sound regime for the future. I hope that the Committee will back schedule 9.

Schedule 10

John Healey (Labour, Wentworth)

I beg to move amendment No. 215, in page 19, line 25 [Vol II], leave out sub-paragraph (2) and insert—

‘(2) No person is to be treated as receiving an amount of income, or as incurring an expense, as a result of any provision of this Schedule in so far as the income or expense arises by reference to the relevant plant or machinery subject to a lease which is disposed of.

(2A) If, as a result of sub-paragraph (2), no income is treated as received by a company, no accounting period of the company ends or begins as a result of any provision of this Schedule.

(2B) In relation to any disposal made before 2nd June 2006—

(a) sub-paragraph (2) applies as if the words from “in so far as” to the end were omitted, and

(b) sub-paragraph (2A) applies as if the words from “If” to “a company,” and the words “of the company” were omitted.'.

The amendment corrects a defect in the drafting of paragraph 40 of schedule 10. At this point, it might help the Committee if I say a little bit, but not too much, about schedule 10. I see a chuckle of approval from the Government Whip at the suggestion that I should introduce the schedule without going into it at great length.

The schedule deals with transactions resulting in a loss of tax when a lessor company changes hands. It also covers situations in which a company carries on a leasing business in partnership and the company’s interest in the partnership decreases. Tax has been lost because groups have taken advantage of capital allowances to reduce the profits of a lessor company in the early years of a leasing transaction. The lessor company is then sold to a loss-making group when the leasing transaction is about to become tax profitable or the lease is about to terminate. The sale of a company to a loss-making group turns an acceptable tax deferral into an unacceptable permanent tax deferral or sheltering.

I am sad to say that the practice has become widespread. It is widely recognised that action is necessary to deter such behaviour while ensuring that sales, when they are bona fide commercial transactions, between profit-making groups of lessor companies are not deterred. The schedule achieves that. The leasing industry has been expecting action to prevent such tax loss, and the Government acted on 5 November 2005 in the pre-Budget report with the introduction of draft legislation. That measure was brought into effect immediately with that announcement.

As I said, the amendment relates to paragraph 40, which applies if a company sells an asset subject to a lease and retains a part of the lease income stream on the same day as the company itself changes hands. The paragraph is intended to deal with an unusual pattern of events, but as it stands goes too far and makes schedule 10 ineffective when schedule 228K to the Capital Allowances Act 2001 has effect on the same date. It therefore gives an unfair advantage to companies that find themselves in such an unusual situation, and also opens up the opportunity for other companies to contrive such a situation in order to prevent the schedule from having effect. The amendment will close off that opportunity.

In summary, the schedule, with the amendment, is necessary. It has been expected. It was announced at the pre-Budget report and will prevent ongoing tax losses, such as the £35 million lost this year. The changes are therefore timely and appropriate, and I hope that the Committee will back the amendment.

Theresa Villiers (Conservative, Chipping Barnet)

I shall not detain the Committee for long. I agree with the Financial Secretary that there is a genuine problem to be tackled, although certainly it would have been desirable if a way could have been found to have done so more simply. However, he and I are at one in saying that the situation as it is leads to revenue loss and therefore that action is needed to deal with it.

I shall raise two or three points about the impact of schedule 10 and how it will operate in practice. I understand that there were initial discussions as to whether a motivation test could be incorporated into the schedule, but that it proved difficult to draft. Some anxiety has been expressed therefore that certain transactions that are not tax related could be affected by the new charge. In particular, I would be grateful to hear the Financial Secretary’s comments on whether that could have an impact on takeovers of companies with leasing operations, such as banks.

I gather that Revenue and Customs indicated that in such a case a purchaser should receive a corresponding tax benefit to offset any problems caused by schedule 10, but the circumstances of the purchaser might be different from those of the vendor and the relief not capable of being used. I welcome the Financial Secretary’s assurance that schedule 10 is not capable of operating effectively as a poison pill where there is an attempt to take over a bank with a leasing operation.

I received the useful briefing from the Chartered Institute of Taxation which asserted on another point that,

“the provisions go further than dealing with the perceived mischief at which they were aimed. The provisions will not simply prevent the acquiring company or group from setting off losses against profits attributable to the reversal of the timing difference, but will impose a penal tax charge on a deemed disposal of assets. This charge will effectively reverse the intended effects of the capital allowances system in relation to the lessor.”

Again, I should be grateful if the Financial Secretary addressed the concerns expressed there, and the suggestion that a more effective way of dealing with the problem at which schedule 10 is aimed would be to provide that post-acquisition profits attributable to the reversal of the timing difference should not be available for group relief in the acquiring group.

On the rest of the schedule, I welcome a number of points that have emerged from what the Financial Secretary described as a very lengthy consultation process. A welcome change since the initial draft of schedule 10 is that companies that lease what is primarily real property, although it contains an element of plant and machinery, are not included in the schedule 10 regime. As hon. Members will recall, that is consistent with schedules 8 and 9. That will be particularly important in relation to private finance initiative projects in which the main item leased is land and buildings.

A concern was expressed in relation to intra-group transfers, and I welcome paragraph 13. In response to other concerns expressed during the consultation, the Government have made it clear that where a qualifying change of ownership occurs as a consequence of the internal reorganisation of a group of companies, no charge will be triggered so long as all the companies involved remain 75 per cent. subsidiaries of the principal company. That should alleviate concerns that the charge might be triggered merely by the internal restructuring of a group. However, there is a concern that the exemption contained in paragraph 13 has not been extended to the situations covered by paragraph 23, which concerns the transfer of interest in partnerships. Just as corporate groups might be internally restructured, the internal restructuring of partnerships is also a relatively common practice. It would be welcome if the Government were to consider whether a paragraph 13-type savings provision might also be necessary in the paragraph 23 context of partnerships.

Finally, a number of people who are concerned about schedule 10 have pressed me to seek one further point of clarification. It relates to sub-paragraph (2) of paragraph 23, which deals with tax relief to new partners. For example, if there are three partners, A, B and C, and C sells its share in the partnership to D, does the relief set out in paragraph 23 go to the incoming partner, D, alone, the existing partners or the existing partners and the incoming partner? I should be grateful if the Financial Secretary gave me an indication as to how paragraph 23(2) will work in that context.

John Healey (Labour, Wentworth)

I welcome the general welcome that the hon. Member for Chipping Barnet has offered to the schedule. As she said, it is relatively complex. To be effective, the legislation must anticipate the inevitable tax planning developments that would take place to avoid a simple charge on the outright sale of a lessor company. That might involve—in our experience it often does—complex arrangements such as the useof consortia or partnership structures, and the fragmentation of the leasing business. Any company that chooses to stray into such complex fields will do so deliberately. It will almost certainly do so on the basis of sophisticated advice that it has received as part of the tax planning process. It is reasonable to argue, therefore, that it must accept that the legislative remedies must also be sophisticated in order for the legislation to meet its objectives and to deal with such situations.

The hon. Lady asked me about the effect on the sales of lessor companies. The measure does affect all sales of lessor companies, but will have a significant tax effect only when the sale is to a loss maker. That means that it targets the transactions that the Government want to deter.

It may help the Committee and the hon. Lady if I explain in general terms the way in which the charge works on the sale to a loss-making company. It is designed to pull back the timing advantage given through the capital allowances and taken by the selling group through access to losses. It was never intended that that timing difference would be permanent. The measure deals with situations in which the transaction would have the effect of turning a tax-timing advantage into a permanent deferral. That is the underlying principle and purpose of the legislation and the way in which it works.

The hon. Lady was also concerned about the potential for modest or trivial changes in partnership arrangements to trigger this complex process. In our analysis and judgment of the discussion we had with the industry, it is clear that leasing business is typically carried on by companies that are 100 per cent. subsidiaries and that sales are typically 100 per cent. sales. Where a business is carried on by a company owned by a consortium, the relationships typically remain constant. Where a business is carried on by companies in partnership, their interests in the business usually remain constant. It is therefore unlikely that there will be numerous small changes that would trigger the charges that the provision and the legislation make.

Once again, the schedule must deal with partial sales to ensure that it is not possible to sell a lessor company in a piecemeal fashion and thereby escape the charge. Therefore, there are provisions in the legislation that deal proportionately with such changes in holdings. I hope that those points of explanation allow the hon. Lady and her colleagues to accept the schedule.

Clause 84

John Healey (Labour, Wentworth)

I beg to move amendment No. 96, in clause 84, page 79, line 18 [Vol I], leave out from first ‘the' to ‘all' in line 19 and insert

‘lessor remains entitled immediately after the disposal to some or'.

Edward O'Hara (Labour, Knowsley South)

With this it will be convenient to discuss Government amendment No. 97.

John Healey (Labour, Wentworth)

As the Government have tabled two amendments to the clause, I ought to explain the purpose of the clause and the amendments.

As with clauses 83 and 82, clause 84 is part of a range of measures designed to prevent companies from arranging their affairs in such a way that losses from a leasing business are fully utilised while the profits fall out of tax. The clause as drafted deals with the separation of a leased asset from its lease by the company selling the asset and keeping all or some of the income from the lease. It has been used as the first step in an arrangement that shelters the training company from taxation, usually by taking the lessor company offshore.

The measure in clause 84 was published in draft form in the pre-Budget report. A number of changes were made to the draft legislation introduced then to ensure that it operates fairly. Government amendmentsNos. 96 and 97 are a response to further recommendations. They ensure that clause 84 of the Bill operates appropriately when a lessor sells part or all of the income stream from a leased asset and then sells the asset. I commend the amendments and the clause to the Committee.

Clause 86

Edward Balls (Labour, Normanton)

I welcome you to the Chair again, Mr. O’Hara.

Clause 86 introduces schedule 11, which contains a series of measures dealing with the taxation of life insurance companies. They provide a rule for inherited estate assets pending the outcome of consultation; protect the tax base where there is demutualisation and when investment profits are not recognised by a non with-profits company and they prevent unintended tax charges on a transfer of business.

Celia Barlow (Labour, Hove)

I welcome the new clause, which introduces schedule 11. The measures have been taken to counter tax avoidance in life insurance schemes—for example, taxing a possible surplus after a demutualisation and in other cases.

As the life insurance market is in flux it is a very good time to iron out tax problems that arise after the transfer of business. I am sure that many hon. Members sometimes have difficulties, as I have, in understanding the details of their own life insurance policy, and it sends out a reassuring signal to all policy holders that their financial position will not suffer if their insurer is taken over by another company, for example, or in the case of demutualisation.

I commend the Government on their constructive approach to the matter, having spoken to all relevant players in the industry, which after initial resistance has brought about a consensus in a difficult and complex area. It is no wonder that the Association of British Insurers has therefore welcomed all the propositions.

Edward O'Hara (Labour, Knowsley South)

Order. The hon. Lady is speaking to clause 86 stand part of the Bill. Clause 86 is a hollow clause, which introduces schedule 11. Her substantive remarks should perhaps be reserved for the debate on schedule 11.

Celia Barlow (Labour, Hove)

I stand corrected, Mr. O’Hara. I shall speak later in the debate.

Schedule 11

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 170, in page 22, line 3 [Vol II], leave out from beginning to end of line 16.

Edward O'Hara (Labour, Knowsley South)

With this it will be convenient to discuss amendment No. 171, in page 22 [Vol II], leave out lines 8 to 16 and insert—

‘(2) Accordingly, in section 432A of ICTA 1988 insubsection (5) (power to extend orders under subsection (3) in relation to periods of account ending before 1st October 2007), substitute “1st October 2006” with “1st October 2007”.'.

Mark Hoban (Conservative, Fareham)

I, too, Mr. O’Hara, add my welcome to those of my hon. Friend the Member for Chipping Barnet (Mrs. Villiers), the Economic Secretary, and the hon. Member for Hove (Ms Barlow).

Before I comment on the two amendments I want to make a general point about the amendments we are tabling to schedule 11 and perhaps echo the point made by the hon. Member for Hove on clause 86. These are probing amendments and I do not intend to press them to a Division, but they give us the opportunity to understand the reasoning on which HMRC and the industry, as represented by the ABI, reached a consensus on schedule 11. Clearly, there were a great many discussions between the ABI and HMRC and their consensus demonstrates how effective consultation can be in shaping legislation. As an aside, I say that the most contentious areas are those on which there has been the least consultation.

Paragraph 1 of the schedule would make permanent the provisions of S.I. 2005/3465, which came into force on 6 January 2006 and which modified sections 432A and 432B of the Income and Corporation Taxes Act 1988. The purpose of the statutory instrument as stated in the explanatory memorandum was

“to ensure that...income and gains from certain assets of the company which are in excess of the regulatory solvency and other requirements of the company are not treated as referable to categories of business the income and gains of which are exempt from tax but to basic life assurance and general annuity business”.

I shall return to basic life assurance general annuities business later on. The memorandum continues:

“Where any income or gains are so treated, an adjustment is made to computation of profit from the exempt categories of business to prevent double counting.”

I think that there is agreement on the nature of the statutory instrument, but originally it was subject to a sunset clause, as agreed during the Committee stage of the Finance (No. 2) Bill last year. As a result of representations made at the Committee stage and on Report, the Government pledged to introduce changes through primary legislation. However, although it is a rare occurrence for the Opposition to chide the Government for keeping a promise, will the Minister explain why the Government have introduced primary legislation on the matter when, as we shall discuss shortly, there is extensive ongoing consultation between HMRC and the industry on the future taxation of life assurance business?

Edward Balls (Labour, Normanton)

I welcome the comments of the hon. Member for Fareham (Mr. Hoban) and of my hon. Friend the Member for Hove, who referred to an ABI briefing note of which I have a copy. The briefing is consistent with what the hon. Gentleman said, in that it describes the consultation that has taken place on the issues over recent months, and concludes:

“Whilst we recognise that amendments 170 to 183 provide opportunity for debate on this issue, we ask that the Committee support clause 86 and maintain it in its current form within the Bill.”

Clearly, therefore, the consultation has been effective and there is now an opportunity to set out the issues and explain the current position.

Those Members who served on the Committee that examined last year’s Finance (No. 2) Bill will remember the debate on the regulation-making power and the sunset clause. As I recall, it was most memorable for the lengthy lesson in procedure given by the Chairman and Opposition Members to the hon. Member for Eastleigh (Chris Huhne), who unfortunately cannot be here today, but who made a number of contributions, not all of them truncated. Rather than dwell on the past, however, I shall reflect on the lessons that we have all learned over the last year in arriving at this year’s Finance Bill.

Last year’s Bill was an interlude in a process that began with the pre-Budget report 2004. There was an announcement at that time that regulations would shortly be laid to change the tax treatment of incomes and gains of a life company’s inherited estates; inherited estates being assets built up in a company over time which are not needed to pay policy holders. The insurance industry had known for some time that the Government were unhappy about the way in which companies with inherited estates could use the existing rules. Indeed, my predecessor read an extract from a court judgment about an insurance business transfer in 2000, in which the company concerned said that it expected the loophole to be closed, so insurers were aware of the Government’s need to act. Paragraph 1 of schedule 11, which concerns inherited estate income, is a key step in a principled reform of the tax treatment of income from inherited estate assets in particular, and of income and gains from assets in general.

After the pre-Budget report of 2004, the industry’s observation was not that the principle of acting was wrong, but that it needed a longer consultation time, so the draft regulations were withdrawn and consultation occurred in order that legislation could be introduced in the Finance Bill 2005.

It is fair to say, as the hon. Member for Fareham hinted at, that there was desire throughout the process to ensure that the provision occurred in primary legislation with full scrutiny. There were intensive consultations and discussions. However, in the spring of 2005, it became clear that it would not be possible to get all the detail sorted out in the Finance Bill 2005. It was therefore agreed with the industry that it would be better to get the measures right rather than to move quickly. In that memorable Finance Bill 2005, we introduced a regulation-making power but made clear that it would only operate for a limited period, the so-called sunset clause to which the hon. Gentleman referred. Any longer term changes to the treatment of life company apportionments would have to be included in primary legislation and subject to full parliamentary scrutiny.

Since last year’s discussions on the Bill, as the ABI note makes clear, there have been further extensive consultations. Last December, we reached a point when an order was laid giving the new rules for inherited estate to 2005 only. As discussions were not complete, a further amending order was laid on 19 May, which still only applied to 2005, as required by the sunset clause.

As the hon. Gentleman said, one of the first decisions I made as a new Treasury Minister was to approve the consultation document for publication. That is now informing discussions with the industry about a broader reform of life insurance taxation. As those who listened to the debate last year will appreciate, that is a complex area to understand. I emphasise that we are not intending to overhaul the entire life insurance tax rules. The consultation document on 16 May covered a number of issues, including apportionments. It included some draft clauses for discussion. Our intention is to look at responses in the autumn and to come forward with changes to next year’s Finance Bill across the wider piece.

However, if we have a sunset clause which ends at the end of 2005 and we are now consulting on changes for next year, we have an issue about 2006 because the sunset clause meant that the regulations only applied to 2005. We could have decided to use existing powers to extend the regulations by a further year—to postpone the sunset. However, that would not have been in the spirit of the use of the sunset clause. Instead, we decided that it was right to have open scrutiny in the Bill on the measures that we are setting out for this year, but fully in the knowledge that we are also consulting on measures for next year’s Bill, which will take forward the process for the longer term.

I hope that members of the Committee will appreciate that we have tried to use primary legislation to ensure that there is proper debate in Committee rather than that happening through an extension of regulations. However, it is not a permanent extension. It is not our intention to leave the rules in place in the medium term. Instead, the current consultation will continue so that we can come back with further and more thorough reform, with the apportionment rules for the 2007 Finance Bill.

Amendment No. 170 would return to the state of affairs that existed before 2005. It is clear that that is not an acceptable position. That is why we acted in the first place. In last year’s Finance Bill debate, that was accepted by both sides of the House. The hon. Member for Runnymede and Weybridge (Mr. Hammond) said:

“We accept that there is scope for tax avoidance where genuinely surplus funds are allowed to roll up at a lower rate of deduction and then potentially transferred out to the benefit of shareholders at a later date.”—[Official Report, 7 June 2005;Vol. 434, c. 1145.]

It was accepted on both sides of the House that we needed to act, possibly by the hon. Member for Eastleigh as well, but he did not always get a chance to make his point. An amendment that seeks to go back to the status quo ante and take away the powers we introduced for 2005 and seek to now apply them to 2006, would be a backward step. Therefore, I encourage the Committee to reject the amendment.

Amendment No. 171 would limit the extension of the effects of the orders just for one year to reflect in primary legislation the effect of extending the regulations by a year. I have to make it clear that I have substantial sympathy with that view. It is not our intention for this legislation to sit for more than a year. That is our best hope. As I said, we are actively consulting at the moment. Our judgment is that although that consultation is going on, we cannot guarantee that this matter can be sorted out for next year. We have already seen, from the consultation over the past year, that these things take time to get right. As the hon. Member for Fareham said, the fact that the consultation has been carefully done and is iterative with the industry means that we are now getting things right. For that reason, we decided that it was better to legislate in the Finance Bill, rather than have effectively only a one-year extension, under amendment No. 171. I urge the Committee to reject both amendments.

Mark Hoban (Conservative, Fareham)

I thank the Economic Secretary for his response to amendments Nos. 170 and 171. I understand his commitment to seeing through the consultation process and doing all that he can to achieve the changes to the taxation of life assurance business in the 2007 Finance Bill. Given the positive remarks that he made about that consultation, I beg to ask leave to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 193, in page 22, line 30 [Vol II], at end insert—

‘2A (1) Sections 439B and 441 ICTA 1988 shall cease to have effect and section 436 shall be amended by substituting “Gross Roll-up Business” for “Pension Business” in each place that it occurs.

(2) “Gross Roll-up Business” means all long-term business written other than Basic Life Assurance, General Annuity Business and Permanent Health Insurance.'.

The amendment strikes to the heart of one of the aspects in the consultation document that the Economic Secretary mentioned earlier. Perhaps it would help if I gave the Committee some background to the taxation of life assurance, to assist in its understanding the reasoning behind the amendment. I suspect that this is a slightly esoteric issue, but any hon. Members wishing to understand taxation of the life assurance industry would find that their time would be well spent looking at the consultation document, which gives clear background on why we are where we are now and acts on the proposals about which the Government are consulting.

The principal stream of business tax under life assurance rules is abbreviated to BLAGAB—basic life assurance general annuities business—and is subject to the I minus E basis of assessment that considers the income and expenditure on that business. One feature of the I minus E basis, with which I should like to deal now because it recurs later in other amendments, is that the gains made on investments on behalf of policy holders are taxed as they arise. If it were only BLAGAB, that would not be a problem, but the problem faced by the life assurance business is that there are different rules on taxation for six other streams of life assurance business grouped and known as non-BLAGAB: pensions business, life reinsurance business, overseas life assurance business, individual savings account business, the child trust fund and other long-term business that is not life assurance. That final category principally covers permanent health insurance, but it also contains other lines of business. It is clear, from that list of non-BLAGAB businesses, that the different streams have arisen as circumstances have changed, so with the introduction of individual savings accounts and the child trust fund, within some businesses, insurance policies linked to those two products require separate taxation consideration.

The main categories of non-BLAGAB business are taxed in line with case 1, schedule D, although with specific rules for insurance companies, whereas permanent health insurance is taxed differently, on a basis that is comparable with general insurance.

The amendment recognises that there are similarities between the streams of non-BLAGAB business, and that it would therefore be easier if they were merged. In the consultation document, the industry calls such business gross roll-up business. There seems to be a degree of consensus within the industry that the streams of business need to be rationalised, and given the complexity of the matter even a layman can see why that would be beneficial. The consultation document holds out the tantalising prospect of a reduction in the number of pages of legislation. Paragraph 3.23 of the document states that the move from six classes of business to one would require the addition of six pages of law and four pages of transitional provisions, but the removal of 20 pages. Those of us who are lucky enough to serve on the Committee considering the 2007 Finance Bill will see whether that tantalising prospect comes to fruition.

One of the areas of debate mentioned in the consultation document and highlighted by the amendment is whether gross roll-up business should include permanent health insurance. The amendment is intended to probe the Government’s thinking on why it should remain outside gross roll-up business. That is a matter for the Treasury and the industry to decide through consultation rather than something that we should vote upon in Committee.

The industry has a number of concerns about the inclusion of permanent health insurance in gross roll-up. The first is on the treatment of dividends and the inclusion in the investment return on gross roll-up business of all dividends from UK companies. It might strike the Committee as a perfectly reasonable move, but the dividends are currently excluded because permanent health insurance is taxed on the same basis as general insurance for which dividends are taxed. If permanent health insurance is brought within the definition of gross roll-up business and the dividends are taxed, there will presumably be an impact on the pricing of permanent health insurance policies. The price will have to reflect the tax that will be charged. Will the Economic Secretary advise us on what modelling is happening within the Department to assess the consequences for the price of permanent health insurance of a change in the tax treatment of dividends earned on such business?

Rob Marris (Labour, Wolverhampton South West)

I am not certain that I am following what the hon. Gentleman says. Will he go back a couple of sentences? I appreciate that this is a probing amendment, but does it suggest that permanent health insurance should have a different tax regime from that which he proposes for everything else, to keep down the cost of premiums?

Mark Hoban (Conservative, Fareham)

I am grateful to the hon. Gentleman. I saw from the quizzical expression on his face that he might probe me on the matter. At the moment, as I understand it, dividends received on shares held in a pool of assets supporting permanent health insurance are not taxed, in line with other general business. If permanent health insurance is incorporated in gross roll-up business, those dividends will be taxed. Hon. Members might say, “Well, we would then be entitled to look at all other types of life assurance-type business with dividends that are taxed,” but there is clearly an economic consequence of taxing the dividends in question, as it may well force up the price of permanent health insurance. The appropriateness of that is a matter of debate for the Treasury and the industry, but one of my concerns is that a change in the pricing structure could make it less attractive for people to take out permanent health insurance, putting them and their families at risk if they suffer health problems.

The second matter raised by the industry is the loss of flexibility in the use of losses. Losses in permanent health insurance are currently carried forward, set off sideways against the shareholders’ share of BLAGAB profits, or carried backwards. The industry’s concern is that if permanent health insurance were to be included in non-BLAGAB business, it might limit the ability to offset losses on permanent health insurance business against BLAGAB profits, as can currently be done.

The Economic Secretary indicated that he hoped that the consultation would be concluded by this autumn with a view to including measures in the 2007 Finance Bill. Does he anticipate a further circulation of draft clauses prior to their inclusion in that Bill?

A number of discussions and disagreements about the interpretation of legislation have taken place at different stages between the industry and the Treasury. I shall return to that point when I discuss a later amendment. Given that long-term planning is involved, if significant changes are proposed beyond those set out in the consultation document, further consultation with the industry would be beneficial to ensure that the spirit of consensus achieved by the Government on the present changes continues.

Edward Balls (Labour, Normanton)

As the hon. Member for Fareham said, we are in the early stages of a new consultation process following the publication of the consultation document on 16 May. It is fair to say that there is consensus in the Government and across the industry that a further round of consultation is a good idea. The Association of British Insurers says in its briefing note that it looks forward to being fully involved in the consultation and to having the opportunity to consider legislation further.

There is a consensus on the need for action and consultation, but we are at far too early a stage for any consensus within the industry, let alone between industry and the Government, about what form changes should take. We are holding a consultation to examine precisely those matters. We have set up a series of working groups to consider the issue between now and the end of September, and once we have received their feedback, we will know what steps to take next.

One of the major issues covered in the consultation and the consultation document is the question of amalgamating a whole load of different business categories into a single category. The general view is that amalgamation is a good thing, but there are two different ways that it can be done, as the consultation document makes clear with the pros and cons of each way. The consultation process will take and consider industry views on which of those two approaches would be better. Amendment No. 193 would effectively pre-empt that consultation by choosing one of the two options. More than that, it proposes one amendment to one clause, whereas our consultation document published consultation on 20 clauses to try to achieve our desired outcomes. The issue is much more complex than the amendment allows.

Amendment No. 193 would pre-empt our consultation with the industry. I assure the hon. Gentleman that it will be done properly. The Government intend to publish a further set of draft clauses following that consultation, at or around the time of the pre-Budget report. I also assure him that the issue of permanent private health insurance will be covered in that consultation, but it is too early to comment on the outcome. The Committee will note the interest that the hon. Gentleman has taken in private medical insurance.

Mark Hoban (Conservative, Fareham)

It is not private health insurance but permanent health insurance, which is altogether a different product.

Edward Balls (Labour, Normanton)

I understood the hon. Gentleman to be talking about permanent private health insurance.

Mark Hoban (Conservative, Fareham)

To clarify, PHI is permanent health insurance. It has nothing to do with BUPA or PPP. It provides cover for those who are unable to work in the event of a serious accident or illness. It is a form of income protection policy rather than the choice to go to a Nuffield hospital or somewhere similar for an operation.

Edward Balls (Labour, Normanton)

I am grateful to the hon. Gentleman for that clarification. I was about to note his interest in the issue. I remember the frustration of the hon. Member for Eastleigh during the debate last year about the fact that he was unable to propose amendments to the Finance Bill that would have an Exchequer cost. That was why, in the end, his points were ruled out of order by the Chair. I can see the hon. Member for Fareham champing at the bit to make proposals, but because he understands the procedure very well he will not be doing so. I ask him therefore simply to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I wish at times that my neighbour, the hon. Member for Eastleigh, were here to defend himself in person. I am sure that one of his colleagues will leap to his defence at some point even if their remarks are truncated.

I must chide the Economic Secretary for being slightly more obsessed with settling old scores with the hon. Member for Eastleigh than with tackling the point of the amendment. It has nothing to do with giving the Exchequer tax-raising powers, but with understanding the structure of life assurance business and its taxation. Perhaps, he and the hon. Member for Eastleigh will consider our conversations somewhere else—without their jackets, maybe—rather than involving the Committee.

Edward Balls (Labour, Normanton)

I should like to clarify the situation for the hon. Gentleman. I was on the Back Benches and I had no dispute with the hon. Member for Eastleigh who at that time, as we all were, was learning the processes of the Committee: what we were allowed to do and when we were allowed to speak, and the fact that we were unable to make the kind of amendments that he was attempting to make because they would have had tax and spending implications. I noted only that the hon. Member for Fareham has a particular interest in such areas, but obviously it is not for him to make such amendments today.

Edward O'Hara (Labour, Knowsley South)

We shall call that clarification.

Mark Hoban (Conservative, Fareham)

I beg to ask leave to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 172, in schedule 11, page 29, line 30 [Vol II], leave out from beginning to end of line 41 on page 30.

I promise to make no reference whatever to other Committee members who have served in previous years on the Finance Bill.

Edward O'Hara (Labour, Knowsley South)

Order. Great minds are thinking alike; a little less reference to the past might be in order.

Mark Hoban (Conservative, Fareham)

That is a salutary warning to us all.

Amendment No. 172 is a probing one. Paragraph 5 of schedule 11 addresses the taxation of surpluses arising when mutuals seek to demutualise. As indicated by the explanatory notes, it seeks to prevent companies from using surpluses that arise prior to demutualisation and using those surpluses to prevent tax rising in the future by reducing taxable profits in the post-mutualisation period. Those measures were announced on 29 September 2005, have been consulted upon, and form part of the consensus between the Association of British Insurers and Her Majesty’s Revenue and Customs.

I understand and believe that most of paragraph 5 is right and is the result of the consultation process, but will the Economic Secretary put on the recordthe reason behind proposed new section 444AK of the Income and Corporation Taxes Act 1988, which the amendment seeks to remove? That proposed new section levies an additional charge if there is a reduction in the unappropriated surplus below the amount as at 31 December 2002. The notes indicate that that applies to a mutual that, prior to demutualization, seeks to increase the unappropriated surplus and then decrease it post-demutualisation, creating a tax reduction. Arguably, given that it is a mutual, there would be no reason for it to create a surplus as there is no profit attributable to shareholders. Typically, mutuals tend to break even for tax purposes, or even suffer a slight loss due to some relatively small adjustments. Therefore, it would seem odd, at first glance, to introduce new section 444AK.

The measure is also one sided in that there is no provision to create a tax deduction when an unappropriated surplus is increased. That lack of symmetry has caused a degree of concern, and I should be grateful if the Economic Secretary would comment on that.

Edward Balls (Labour, Normanton)

I shall clarify the position and then respond to the amendment. The measure will affect not just one demutualisation, nor is it aimed at just one company. In the past few years, there have been a number of demutualisations and transfers of business between insurance companies in different circumstances. While those have been instigated for commercial reasons, companies carrying out demutualisations or transfers of business occasionally use them as opportunities for tax avoidance, potentially on a large scale, which the Government have prevented in the last three years’ Finance Acts. We have done so in this one, too. We see no reason to offer former mutual companies the advantages that arise when, on transfer, a former mutual business is able to reduce taxable profits or create allowable losses in that way. That is the purpose of the Bill.

Amendment No. 172 would allow the former mutual company, or one that has transferred from a former mutual business, to reduce taxable profits or to create allowable losses for various categories of business, most importantly pensions business, by paying bonuses or expenses out of a surplus that accrued untaxed in the former mutual. We do not think that that is right. It has been discussed fully with the ABI as part of the consultation, and the ABI urges this Committee to reject amendments Nos. 170 to 183. Given the consultations that have gone on and the consensus that has been reached, I urge the hon. Member for Fareham to do the same.

Mark Hoban (Conservative, Fareham)

I thank the Economic Secretary for his comments. I understand why the Government want to clamp down on mutuals using surpluses to avoid tax, and it is important that that is borne in mind. However, there is a degree of asymmetry in the measure on which the Government might think further as part of the consultation process. In light of the Economic Secretary’s remarks, I beg to ask leave to withdraw the amendment.

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 173,page 33, line 18 [Vol II], leave out paragraph 7.

Edward O'Hara (Labour, Knowsley South)

With this it will be convenient to discuss the following amendments: No. 179, page 33, line 40 [Vol II], at end insert—

‘(3A) Where the line 51 amount for the straddling period is greater than the line 51 amount for any subsequent period, and the line 51 amount is then increased in a period following that subsequent period, the adjustment produced by subsection (3) above shall be reduced by an amount equal to the lower of:

(a) the difference between the line 51 amount for the straddling period and the line 51 amount for the current period of account; and

(b) the line 51 amount for the current period of account, and the line 51 amount for the immediately preceding period,

but the amount computed under this subsection shall be reduced by the total sum of adjustments made in periods prior to the current period of account under this subsection.'.

No. 174, page 34, line 39 [Vol II], at end insert—

‘(12) Where this section applies then the company may make a claim requiring that a loss arising under section 436, 439B and sections 441 ICTA 1988 be set off against profits of the same description arising in the proceeding accounting period.'.

No. 180, page 35, line 9 [Vol II], leave out ‘to' and insert ‘from'.

Government amendment No. 195

No. 183, page 35, line 16 [Vol II], leave out from beginning to end of line 19 and insert—

‘(b) the line 51 amount of the transfer or in respect of the business transferred to the company, as computed in the transferor's periodic return.'.

No. 181, page 35, line 41 [Vol II], leave out ‘to' and insert ‘from'.

Government amendment No. 196

No. 182, page 35, line 43 [Vol II], leave out ‘to' and insert ‘from'.

Government amendment No. 197

No. 176, page 37, line 1 [Vol II], leave out ‘two-thirds' and insert ‘one-sixth'.

No. 177, page 37, line 5 [Vol II], leave out ‘one-third' and insert ‘one-sixth'.

No. 178, page 37, line 6 [Vol II], leave out ‘period' and insert ‘five periods'.

Mark Hoban (Conservative, Fareham)

Perhaps I can commence by making some general remarks on this long series of amendments, and on what paragraph 7, which they seek to amend, is trying to achieve. The taxation of life assurance companies is driven not so much by their accounting profit as by their regulatory returns. We also need to remember the issues that arise from the investment gains of life assurance companies. Paragraph 7 addresses those two issues. Prior to 2004, many life assurers established resilience reserves so that there could be some comfort that the life assurer would have the funds available to pay policyholder claims should there be a negative movement in the investment markets. Those reserves were referred to in line 51 of the regulatory return and were treated as tax deductible.

In 2004, the reserves were replaced with a Financial Services Authority requirement to hold an additional amount of resilience capital in the long-term fund of the life assurer. Those capital requirements were in addition to the usual solvency capital requirements of life assurers. Many life assurers then had to release their resilience reserves, which created taxable income.

There is a second aspect to the issue, which relates to line 51 and the reserves that life assurance companies maintain. Life assurance companies can elect to hold their investments at cost rather than at market value if market value is greater. The combination of such elections throughout their portfolio of investments is often referred to as an investment reserve. Such reserves are usually maintained as a prudent measure to protect against downturns in equity markets. Life assurance companies are about long-term investments, so assurers will often seek to smooth increases in equity markets over a long period to give a better indication of their performance. That is entirely appropriate and acceptable under UK accounting laws. It particularly applies to with-profits business, in which investment reserves are held to smooth the performance of policies for a long period and to reduce the variability between good and bad years.

Following the release of resilience reserves, many life assurance companies sought to increase their investment reserves or to establish new ones. In effect, the taxable income that they would get from the release of the resilience reserve would be offset by the deduction they would receive by setting up a new or enhanced investment reserve, so there would be no tax effect across the business as a whole.

When the life assurance companies discussed the matter with the Treasury—discussions that predate the September 2005 announcement of the then Economic Secretary—they believed that the establishment of the new investment reserves, which replaced the resilience reserves, would be tax deductible. However, HMRC clarified the position on 29 September 2005 when it announced that the investment reserves would cease to be tax deductible from that day. That decision caused significant concerns in the life assurance sector. Legal and General issued a profits warning on 5 October 2005 suggesting that its profits would be hit by £500 million, which is a significant and material item.

There were then further discussions between HMRC, the ABI and the industry. The outcome was a consensus reflected in paragraph 7 of schedule 11. There are three key elements to highlight. The measure now applies only to companies that have no or minimal with-profits business. It applies only to increases in reserves since 2003, and the tax on the recipients’ element of the investment reserves would be spread over the years until 2008. That gives the general background to the amendments.

Amendment No. 173 would delete paragraph 7 in its entirety. The point that I want the Minister to respond to is on the distinction between mergers and the consensus being reached with the ABI. In effect, as I understand it, paragraph 7 will enable investment reserves for non-profit businesses to be taxed, but only where the company is a non-profit business—it does not have much with-profits business. A life assurance company that has with-profits business can establish an investment reserve equal to its resilience reserve and not pay tax on it, whereas a non-profit company cannot do so. It would therefore appear that a non-profit company writing the same type of business as a with-profit company could have a higher tax charge on the same non-profit business. That is the thrust of amendment No. 173, which seeks an understanding of why businesses with non-profit business can be taxed in a different way from those with with-profits business.

Amendment No. 179 is more complicated. It considers changes that may have taken place in the investment reserves since 2003. A key part of paragraph 7 is that it considers only changes in the investment reserve, or line 51 amount, since 2003. The provisions mean that, when there is an existing line 51 amount—the investment reserve—and a reduction in that amount, there should be no tax relief for that deduction. That appears to be reasonable as the intention of new sections 83YA and 83YB to the Finance Act 1989 are to set the line 51 amounts in 2005 in stone.

However, the way that the legislation works at present is that if there is a subsequent increase in the investment reserve due to, for example, a year of strong equity performance when the insurance company seeks to smooth its returns and still has to retain its resilience capital against that, the entire increase in the line 51 amount will be taxable, including the element between the opening line 51 amount at the start of the period and the line 51 amount during the straddling period, even though no tax relief was obtained when the reserve was reduced. That seems to cause a gap in that it does not enable life insurance companies that reduce their investment reserve to have tax relief. However, when they increase their investment reserve, there is a tax charge.

I will give a numerical example to help to clarify the point for the Committee. If a non-profit companyhad a form 14, line 51 investment reserve of £100 at31 December 2003 and that reserve was reduced to £20 in 2006, no relief would be given for the reduction of £80 in 2005. However, if there was an increase in investment reserve to £200 in 2006 from £20, the increase of £180 would be taxed even though the reduction of £80 had not qualified for tax deduction originally. That would appear to be unfair and I should be grateful if the Economic Secretary would look at the matter and comment on it when he responds to the debate.

Rob Marris (Labour, Wolverhampton South West)

Will the hon. Gentleman remind me what a straddling period is? I cannot find the term in the amendment or the Bill but it may be in the Act that the Bill amends.

Mark Hoban (Conservative, Fareham)

It is not a very elegant expression and the lawyers among us may come up with a better description. It refers to the gap that arises between when the investment reserve was set in stone and its subsequent changes. This is a probing amendment, but if the Government were minded to accept it, the Treasury draftsmen might come up with more elegant phraseology.

Amendment No. 174 considers the way in which the losses on various non-BLAGAB businesses can be used. Section 436 refers to pension business; section 439B to life reinsurance business; and section 441 to overseas life assurance businesses as reasons to establish whether there can be more flexibility in offsetting losses arising on those business streams and especially where there may be an exceptional shareholder profit due to the implementation of section 83YA.

I refer now to amendments Nos. 180 to 182 and Government amendments Nos. 195 to 197. Our amendments would leave out “to” and insert “from”, while the Government amendments would leave out “to” and insert “by”. We are happy to accept the Government’s amendments because they would clarify the issues in respect of shareholder loans. I shall not dwell on amendment No. 183. It is very technical and concerns the value to which assets are transferred between businesses and what their appropriate value should be. There may be some tax planning opportunities for the industry if the amendment were not accepted.

Amendments Nos. 176, 177 and 179 would spread the release of the resilience reserve. The change in temporary practice under schedule 15 on page 78 of volume 11 of the Bill has led to the tax implications being spread over six years. However, under schedule 11, the policy change in tax implications is spread out only over three years. Why are the Government seeking to do that over three years instead of six years, which seems to be the norm in respect of taxation impacts of changes in policy? The amendments are technical, but I hope that they give the Committee a flavour of the issues to which I have referred.

Edward Balls (Labour, Normanton)

I will take advice from experts on the precise legal meaning of “straddling period” in due course although, in parliamentary terms, I tend to think that it means the gap that we have to straddle between hearing a question and reaching the point of understanding the answer. However, I doubt that that is an accepted tax definition.

I turn to the amendments that cover paragraph 7 of schedule 11. I am sure that it would help the Committee if I explain why we have reached such a stage and deal with some of the points made by the hon. Member for Fareham. He referred to the issues dealt with under paragraph 7. They were announced originally in September last year to protect the tax base when investment profits are not recognised by a non-with-profits company. As the hon. Gentleman said, proposed section 83YA was initially controversial when it was first announced last September. Its purpose was to prevent companies that had no with-profits business from deferring tax for lengthy periods by not recognising gains on their assets. It is a difficult area of tax. There is a complex set of relationships between different types of life insurance business and the use of reserves to support them.

However, as for why we need a distinction between profits and non-profit companies, in general business with a not with-profit business does not require the smoothing of investment return for tax purposes that is available in with-profits business through the use of so-called book-value election. Non-profit companies do not need to have excess assets and do not need to have profits set aside tax free to achieve their business aims, and until very recently none did. However, in 2004 in particular, some companies that had never used the election before began to do so and the amount of income equal to the amount of the election, which in some cases was in the tens of millions, was escaping tax—possibly for ever.

The actions of the few companies that in 2004 adopted the practice of creating reserves to defer gains were a pure raid on the Exchequer, because the gains that are not brought into account for tax as a result would never be taxed if the section 83YA measures were not put in place. The counteraction in schedule 11 ensures that the few companies that have started to do that do not get an advantage over their competitors arising solely from tax saving. The measure that was announced prevents this deferral of tax and treats the company as if it had not made the election.

The measure initially had a wider impact than intended, because some companies that write both with-profits and non-profit businesses may agree with the regulator to maintain some reserves in their non-profit funds to support the solvency of the with-profits fund should the need arise. When the section 83YA draft legislation was published in September, it was in that type of case that the unintended impact arose. Following representations, these cases were removed from the scope of the legislation in my predecessor’s announcement of 4 November, which ensured that the measure was focused on the targeted avoidance—the use of the book value election where there was no with-profits business that needed supporting. Following that announcement, some companies that had initially considered themselves affected confirmed that they were not.

After the 4 November announcement, there was continuing consultation to ensure that the legislation worked appropriately in all circumstances. The hon. Member for Fareham raised one of the issues put to HMRC concerning the spreading of adjustments where a company had what is called a “resilience capital amount”. After full consultation, the agreement reached with the industry was that it was appropriate that there should be some spreading and that the spread amounts would not be brought back into tax until 2007 at the earliest. The result of the agreements, to which the hon. Gentleman referred, is in paragraph 7 of schedule 11, which represents the agreed outcome of the discussions.

At a major conference on life assurance taxation a few weeks ago, the head of tax at ABI said, in commending the way in which the consultations have gone on and regular meetings have occurred, that

“this approach has already resulted in benefits in the form of better draft legislation for the taxation of investment reserves.”

I am told that “investment reserves” is industry jargon for section 83YA and probably HMRC jargon for legislation that was introduced at that time.

Mark Hoban (Conservative, Fareham)

Will the Economic Secretary explain why HMRC did not adopt the practice set out in schedule 15 of spreading the adjustment over six years and why it opted for three years?

Edward Balls (Labour, Normanton)

I will come to that point in a moment when I speak to the amendments that the hon. Gentleman has tabled, some of which would change the length of the period in question. Before I do so, let me just say that although we fully appreciate that these are probing amendments, we have had an extensive consultation, which the ABI recognises, and it urges us to reflect that in the legislation rather than accept the amendments. However, I shall answer his question in the spirit in which the amendments were put.

Amendment No. 173 would leave out the paragraph that tackles the avoidance problem. As was set out in the Red Book, the cost to the Exchequer of doing so would be £150 million in 2006-07 and £85 milliona year after that. Obviously, we will reject the amendment, because it would do away with the intent to tackle the avoidance problem, which, as I said in my opening remarks on these clauses, was recognised by Opposition Members when these issues were discussed last year. The other amendments in the group would apply if amendment No. 173 was rejected, because if it were accepted, all the following amendments would be moot.

Amendment No. 174 is slightly unusual. It would allow a company affected by new section 83YA to carry back any loss on its pensions business to the previous period. No other company in similar circumstances would be allowed to do that. We urge the Committee to reject that amendment because we cannot see any justification for giving a wholly unconnected relief to a company just because it happens to be a company to which paragraph 7 applies and when companies not in that position would not be allowed that flexibility.

Amendments Nos. 176 to 178 change the spreading mechanism in paragraph 7, which applies where a company had a resilience capital amount for 2005. In a case where that happens the charge under the paragraph is reduced by that amount. That reduction was asked for by industry because it was under the impression that HMRC had agreed that companies could reduce their profits in that way. However, it cannot be right to allow that amount to escape tax for ever. Therefore, the Bill contains a provision bringing it back into tax at a later date. Again, at the industry's request, we delayed the tax charge until 2007 and allowed one third of it to be introduced in 2008.

The amendment would spread that period beyond 2008 to 2012. While it is true that a six-year spread is sometimes allowed when there is a transition from one basis of accounting to another, it is also true that other periods apply—three years, 10 years or no spread at all. A three-year deferral, brought in the last two years of that period, is a sufficiently generous provision. That was agreed with the ABI, as its briefing note makes clear. I hope that I have clarified the position for the hon. Member for Fareham.

The hon. Gentleman gave us a numerical example of amendment No. 179. He proved to the Committee that the proposal is complicated. It proposes a complicated mechanism that appears to be capping the charge to tax in a particular set of circumstances. The matter was discussed in detail with the industry and HMRC officials, whose view was that it was far too complicated to deal with, in what was only a theoretical case. Industry representatives agreed that the matter should be parked for the moment. That is not to say that it cannot be raised and discussed in the ongoing consultation, to which I referred earlier. The circumstances in which the amendment would operate cannot apply in 2005 and are unlikely to apply in 2006. If it turns out that there is a real and substantial problem in later years, we can consider the points that have been made.

Amendments Nos. 180 to 182 change “to” to “from” as the hon. Member for Fareham explained. Both he and the Government noted that the word “to” was wrong, but changing it to “from” would cause complications. Government amendments Nos. 195 to 197 achieve the same purpose, but follow our iterative consultation with clarity.

Amendment No. 183 allows an adjustment to be made where a company acquires business from another insurer. Paragraph 7 allows that adjustment where a company has made an election under a provision in the Income and Corporation Taxes Act 1988. That is because that election will only be relevant where a company is one to which paragraph 7 might apply. The amendment would allow a company that forgot to make the election to still benefit from the adjustment. That was discussed with industry before the Bill and the general view seemed to be, as the ABI briefing note makes clear, that the amendment was not appropriate.

With the exception of the Government amendments which correct a drafting problem, we ask the Committee to reject the remaining amendments. I hope that, in the spirit in which they were tabled, my remarks have clarified some of the matters for Opposition Members.

Mark Hoban (Conservative, Fareham)

I am grateful to the Economic Secretary for his response to the amendments. The area is not as straightforward an area of legislation as the discussions between the HMRC and the ABI suggested. The announcement in December 2005 caused great consternation among life insurers. It has taken some time and discussion to reach a settled position with the ABI on the matter. Sadly, debates such as this cannot do justice to the complexity of the issues, but they demonstrate the complexity of industry issues in specialist areas and the need for proper consultation and debate. I hope that the debate on schedule 11 and the preceding discussions with industry will ensure that we think carefully about how the consultation document is implemented in future legislation. The interaction with regulatory terms, resilience reserves and such things demonstrates that a broad consensus is needed on such issues to ensure that problems do not recur.

Given the importance of life insurance companies in our economy, springing changes upon them that lead major companies to issue profit warnings is perhaps not the most satisfactory way to proceed. We recognise and accept the consultation process that led to paragraph 7. On that basis, I beg to ask leave to withdraw the amendment.

Rob Marris (Labour, Wolverhampton South West)

I welcome you to the Chair, Mr. O’Hara. I declare an interest as a policyholder in Standard Life, one of the 32,000-odd, or less than 10 per cent., that voted against demutualisation recently. Sadly, we lost by more than 90 per cent.

I refer my hon. Friend to paragraph 5 of schedule 11, which deals with surpluses of mutual and former mutual businesses. Can he give a little bit of background on the taxation situation between mutual and non-mutual life insurance companies? I am concerned that we as a Labour Government might be creating a tax regime that encourages organisations to demutualise. If that is the case, it would be most regrettable. Our tax regime should discourage organisations from demutualisation. It should gently encourage organisations to remain mutual, not put them in a cast-iron straitjacket.

The provisions understandably discuss taxation where there is demutualisation and a kind of locked-up surplus that has been hidden, in an accounting and not a legalistic sense, and then comes out of the woodwork so as to avoid tax. What would the position be if it were the other way around? I appreciate that it is perhaps not a very likely possibility, but one remains an optimist as a Labour Back-Bench Member that life insurance companies might decide to mutualise. What would the tax situation be with any surpluses or non-surpluses? Will my hon. Friend say a little bit about the background of the taxation of mutuals vis-Ã -vis non-mutuals?

Mark Hoban (Conservative, Fareham)

A straddling period.

Edward Balls (Labour, Normanton)

If I wanted to, I could read out to hon. Members opposite the precise definition of a straddling period, but I choose not to do so. I shall move on to the substance of what my hon. Friend the Member for Wolverhampton, South-West (Rob Marris) said. The decision as to whether companies should be mutual or demutualised is a matter for individual companies. I have some sympathy with the points that he makes. As a Co-operative as well as Labour Member of Parliament, I believe that mutuals have an important role to play. The mutual sector and the third sector have important parts to play in relation to my wider responsibilities for financial capabilities and financial inclusion.

As part of the follow-up to the issues that arose on equitables, Paul Myners did a review for the Government. That consulted widely, and before I was elected to this House I was involved in those consultations. In order that we understand the role that mutuals can play in the financial services industry, and the great strengths that they can bring to certain aspects of business, I am going to meet with Mr. Myners to assess his view of progress since the publication of his report. I assure the Committee that I shall take the matter very seriously.

More broadly, our aim in this legislation is to ensure that the tax system is neutral between being a mutual and demutualising. Some concern has been expressed from the other side that, by tackling an avoidance problem, the legislation was creating potential barriers to demutualisation. My hon. Friend the Member for Wolverhampton, South-West will probably applaud, but others might not. The Government’s view is that it should be a matter for individual companies. Any company that has created an exception surplus while mutual will be no worse off should it demutualise than it would have been had it never created a surplus. There is no down side in the shape of unexpected tax changes, but the tax advantage at the time of demutualisation will be gone. I hope that that reassures him that we are neither erecting a barrier to demutualisation nor allowing the continuation of an incentive to demutualise. I would therefore encourage him to pursue the wider discussions that we would like to have about the role that mutuals can play in the delivery of financial services and the Government’s wider agenda—but at another time; not during this stand part debate.

Schedule 12

Theresa Villiers (Conservative, Chipping Barnet)

I beg to move amendment No. 198, in schedule 12, page 41, line 45 [Vol II], leave out paragraph 2.

Before turning to the substance of the amendment, it might be useful to make some general points on schedules 12 and 13. The aim of the schedules, as I understand it, is to introduce more consistency in the income and capital gains tax treatment of trusts. The goal of making the tax treatment of trusts more consistent and transparent is certainly sensible. However, the modernisation of trusts project, from which the provisions originally flowed, sought to secure more consistency between the income tax and capital gains tax treatment of assets held on trust and those held outright. It is a desirable goal that trusts should not confer tax advantages, but nor should they suffer a fiscal penalty. As we shall see in the debate on schedule 20, that principle seems to have been abandoned.

Schedule 20 has an impact on our discussions on schedule 12 also because the modernisation of trusts project was subject to a lengthy consultation with the professional bodies on the income tax and capital gains tax proposals and ideas. A serious concern is that the consultation on the taxes took place without any indication that the Government were planning the significant changes to the inheritance tax regime that are proposed in schedule 20. It is difficult to view the capital gains tax and income tax changes set out in clauses 88 and 89 in isolation from the inheritance tax charges in schedule 20, and it is therefore unfortunate that the lengthy consultation process took place without those involved being able to examine the three taxes in the round. The regimes governing the three taxes overlap and problems may arise if they are not all considered together, some of which I shall outline this afternoon.

It makes sense to examine the tax regime for trusts holistically. There are good arguments, as we shall see when discussing schedule 20, for postponing the implementation of clauses 88 and 89 until there has been a full consultation and discussion of how the provisions interact with one another. That point was well made by the Chartered Institute of Taxation in its briefing on the Bill, in which it stated:

“Given that the Tax Law Rewrite Bill covering settlements provisions is currently in progress, and parts of the trust modernisation project remain outstanding (eg income tax streaming and tax pools), it seems even more compelling that implementation of this legislation be postponed until 6th April 2007, so that a single comprehensive and comprehensible corpus is enacted.”

Amendment No. 198 would delete paragraph 2 of schedule 12, which is intended to repeal sections 69(1) and 69(2) of the Taxation of Chargeable GainsAct 1992. Section 69(2) of that Act provides that UK-based trustee companies can opt to be treated as being resident overseas for capital gains tax purposes if they are dealing with a trust set up by a person who has no connection with the UK tax system; that is, if the settlor is not domiciled or resident in the UK and is not subject to UK taxes. The residence of trustees is important because their residence determines where a trust is deemed to be resident and therefore which is the applicable tax jurisdiction. Section 69(2) allows trustees to attract business from foreign clients without bringing the tax affairs into the UK tax system. It was intended to enable UK-based trustee companies such as banks to compete in the market for the overseas trust business. That approach is echoed in other jurisdictions, such as New Zealand and Canada, with the intention of ensuring the competitiveness of their locally based professionals.

I gather that the matter was pressed strongly by the professional bodies during the consultation; they actually wanted the exemption to be extended to cover income tax as well as capital gains tax. During the consultation it seemed to be assumed that the section 69 exemption would continue into the new regime. There were indications that the Government might even be sympathetic to extending it, which seemed to have been contemplated in earlier consultation papers and in draft legislation published by the Government, such as the documentation accompanying last year’s pre-Budget report. I have received a number of representations from those who are concerned about the change that eventually appeared in the Bill.

The Government may have been motivated by the anxiety that section 69(2) of the 1992 Act might have breached European law. Will the Paymaster General confirm whether that was indeed a concern? If so, will she share with the Committee the legal opinions on which that concern was based? I am sure that there are all sorts of rules that would entitle the Government to withhold the legal advice if they wished but if that is a concern it would be useful for the Government to share some of the legal advice that they have received. Even if it is the case, moreover, some form of amendment would still be welcomed by the affected professionals.

Professional practitioners have also questioned whether it would be possible to apply an exemption. The Chartered Institute of Taxation has said that

“The benefit to the UK economy of retaining global trust business in the UK could still be achieved, it seems to us, by the simple expedient of amending the original draft clauses so that the trustees’ residence requirement were enlarged from the UK to the rest of the European Union.

Any person resident there could act as professional trustees with the same tax consequences.”

They go on to say

“This was one area where the representative bodies felt very strongly in favour at the consultations.”

I should be grateful for the Paymaster General comments on that.

The Institute’s solution has considerable appeal and seems to deal with any anxiety that may exist regarding the impact of the clause on EU law. I cannot imagine that retaining section 69(2) is likely to have a negative revenue consequence, because the settlors and trusts in issue are not subject to UK tax. Deleting section 69(2) would have a negative impact on revenue, however, because the fees earned from international trust business would be lost to UK firms and would no longer be available for taxation. I hope that the Government will therefore reconsider deletion given its potential negative impact on the competitiveness of the professional service industry—an industry that plays an important part in maintaining invisible exports and a healthy British economy.

Rob Marris (Labour, Wolverhampton South West)

The hon. Lady mentions the Chartered Institute of Taxation and a change from the UK to the European Union. Where would that leave places such as the Isle of Man, Guernsey, the Canary islands and Gibraltar, given their different tax regimes? Would that not be a problem?

Theresa Villiers (Conservative, Chipping Barnet)

I have to confess that I do not know the answer to that because I have only considered trust companies based in the UK, but I do not think that the amendment would have any impact on those jurisdictions, as they have their own rules. The Paymaster General may be able to answer more effectively, but the amendment relates purely to UK companies and companies based in the rest of the EU, and my understanding is that it would not have any impact on such offshore jurisdictions.

Dawn Primarolo (Labour, Bristol South)

I am always grateful when the hon. Lady explains what my clauses do, because it means that I do not have to. It shows how well they are drafted.

The amendment would leave intact the capital gains tax residence test for trustees, including professional trustees, whereas the test would otherwise be replaced by the new residence rule in schedule 12. I have sympathy with the motives behind the amendment but, as I shall explain, I cannot support it. Schedule 12 makes several changes to capital gains tax legislation for trusts and mirrors the changes to the income tax regime that were introduced in clause 89 and schedule 13.

At present, trustees have to grapple with two quite different sets of rules that determine trustee residence for income tax and capital gains tax purposes. Some trustees are resident in the UK for income tax purposes, but are non-resident for capital gains tax purposes, and vice versa. Schedules 12 and 13 introduce a new, common residence test for trustees, both for income and capital gains tax purposes. The test has been widely consulted upon as part of the trust modernisation package, and has been broadly welcomed as being clearer and easier to apply than the current capital gains tax test, particularly for smaller trusts. However, the proposed residence test does not include an equivalent to the current capital gains tax rules on the residence of professional trustees. As the hon. Lady mentioned, Her Majesty’s Revenue and Customs received representations that the special rule should be retained to enable UK professional trustees to continue to attract businesses administering foreign trusts.

In response to those representations, HMRC included new rules on professional trustee’s residence in the draft legislation published in January 2006. However, those new rules that resulted from consultation were published with a strong warning that they might be withdrawn if they were found to be a state aid. I think that the hon. Lady knows perfectly well what that would mean; she was a Member of the European Parliament and I have debated with her in that forum the concept of unfair tax and state aid rules.

Shortly after publication, the Department of Trade and Industry advised HMRC that the new test would constitute state aid—it would have been unfair competition against professional trustees in other European states—and that there were no grounds on which the European Commission would approve the proposed measure as a state aid. Based on that advice, the Department withdrew the proposals covering professional trustees, and it would be inappropriate therefore to retain the existing capital gains tax rule.

The hon. Lady asked if I would like to share that legal advice. The answer is that I would not like to share that with her, the Committee, or anyone else. That was advice to the Government, and to do so would be to breach a fundamental legal and professional privilege, which is a matter that Opposition Members go on about at some length. The Government are entitled to do the same.

I can assure the Committee that the new residence rule still allows professional trustees to attract business to the UK in largely the same way as did the old rule. The only difference is that the trust will need to have one non-resident trustee. Given that the vast majority of professional firms have reciprocal arrangements with overseas firms, all non-residents setting up a trust in the UK can appoint a non-resident friend or relative as a trustee. Frankly, I do not see that that will cause practical problems as some have feared, and under the circumstances I hope that the hon. Lady will withdraw her amendment. However, if she decides to push it to a vote, I will urge my hon. Friends to oppose her.

Theresa Villiers (Conservative, Chipping Barnet)

I am grateful to the Paymaster General for her comments. I shall not press my amendment to a Division, but I shall mention one or two matters in response to her remarks.

I understand that the Paymaster General is entitled to keep the Government’s legal advice confidential should they so wish, but it would have been a productive addition to the debate. Given the clear advice it seems that she has received from the Commission, I can understand that maintaining section 69(2) in its current form would create problems.

I press the Minister on whether any consideration or thought was given to the idea that the Chartered Institute of Taxation put forward of giving the same treatment to companies based in the UK as to those based in the rest of the European Union. Would that be feasible? It seems to me to meet all the concerns of the professionals without breaching the state aid rules.

The right hon. Lady explained that the consequence of the measure would simply be the appointment of one non-resident trustee. I acknowledge that that would be one of the key impacts of the loss of section 69(2). However, I am informed that that would lead to significant additional cost implications. We must bear in mind that the UK is a popular jurisdiction for offshore, overseas trust business because we are known as an entirely respectable jurisdiction. The necessity of adding a Swiss trustee, or one from another jurisdiction, will add costs to our trustee companies and undermine competitiveness. As I said, provisions similar to those in section 69(2) are still in operation in other jurisdictions—for example, in Canada and in New Zealand. It is unfortunate to add the extra cost to our professional companies, if there is a way to retain a section 69(2) type provision, so long as that provision is adapted to comply with EU law.

I beg to ask leave to withdraw the amendment.

Theresa Villiers (Conservative, Chipping Barnet)

There are a number of important issues about schedule 12 that the Committee should consider. First, as I suggested, one of the goals of the schedule is to harmonise and ensure consistent definitions of trust-related concepts in different pieces of legislation, in particular to harmonise legislation relating to income tax and to capital gains tax. Paragraph 1 of the schedule seeks to insert new sections 68A to C into the Taxation of Chargeable Gains Act 1992. Those provide a new definition of settlor and settlement for the purpose of capital gains tax. Schedule 13 seeks to introduce the same changes to the Income and Corporation Taxes Act 1988 for the purpose of the income tax trust.

However, the unification of the definitions is not complete. For example, in sections 97 and 286 of the Taxation of Chargeable Gains Act 1992, the definitions of settlement found in the Income Tax (Trading and Other Income) Act 2005 are to apply, whereas the settlor will have its new Finance Bill meaning. So there is a degree of unification of the definitions but that unification is not complete.

More seriously, a number of problems arise relating to the new definitions proposed in paragraph 1(2) of schedule 12. Given the changes to the definition of settlor interested trusts, which are set out in paragraphs 3 and 4 of the schedule and to which I will turn in due course, there is an urgent need for clarification of the issues relating to the definitions. They will have a significant impact on a number of trusts. There is some guidance in the explanatory notes but any further reassurance that the Paymaster General can give the Committee on how the new definitions will operate will be welcomed by the people affected.

New section 68A sets out the definition of “settlor” but it seems to pay insufficient regard to situations in which there is more than one settlor. Such cases can be common—for example, where husbands and wives set up trusts together. Given the provisions as drafted, it will not always be easy to work out who the settlor is. In many cases, it may be difficult to determine when someone ceases to be a settlor.

The first point on which I would be grateful for clarification relates to the meaning of “made the settlement”, which appears a number of times in new section 68A. The Chartered Institution of Taxation indicates that there is need for clarification on the situation when a person who is not the original settlor adds property to an existing settlement. Does she create a settlement or become settlor of the existing one? That is a matter of particular importance when one takes into account the changes made by paragraphs 3 and 4 of the schedule.

Another concern relates to subsection (6) of the new section 68A, which governs the issue of what happens when someone ceases to be a settlor. The Institute of Chartered Accountants highlights concerns about the words in subsection (6)(a) which provide that someone ceases to be a settlor if

“no property of which he is a settlor is comprised in the settlement”.

That may sound simple enough, but a complication can arise when more than one settlor has transferred property into the trust and when there is a mixed fund of property contributed by different settlors. For example, the original property may have been sold, new investments may have been bought and the original investments donated to the trust may have been sold and the proceeds transferred into new investments. It then becomes rather more difficult to distinguish which asset is which in terms of the settlor who donated it to the trust. The provisions in the Bill are not clear about deciding in that situation how the question whether someone has ceased to be a settlor is to be answered.

Rob Marris (Labour, Wolverhampton South West)

In respect of subsection (6)(a), if the hon. Lady is talking about property that has been sold and churned around, if I may put it in that way, is it not straightforward that the standard legal procedures of tracing would be used?

Theresa Villiers (Conservative, Chipping Barnet)

That probably makes sense as there is an available set of rules that could be used in this context. The explanatory notes seem to suggest that a proportionate approach is taken, but I agree that the rules on equitable tracing could be applicable in this respect and for clarification it would be useful if the Minister could indicate whether that would be the case.

The same issue arises in relation to the rules for transferring property. In order to answer the questions about where property is transferred between settlements it is crucial to know whether the relevant people remain settlors of the old settlements, whether they have become settlors of the new one or if they are settlors of both settlements. Again, there is the issue of whether there should be a proportionate approach to this type of transfer or whether, as the hon. Member for Wolverhampton, South-West suggested, we should take a more sophisticated approach and rely on the rules in respect of equitable tracing.

There is some difficulty in relying on a simple, proportionate approach because that might mean that where property that is identifiably and obviously from one original trust or settlor is transferred, it seems unfair to taint all the other settlors of the original trust with that transfer. There is a good case for dispensing with the proportionate approach and opting for a more sophisticated one in terms of identifying and apportioning the transfers made.

That is important because of the changes introduced in paragraphs 3 and 4 of schedule 12, which dramatically increase the scope of trusts that are deemed to be settlor-interested and thus denied holdover relief. The identity of the settlor therefore becomes even more crucial as a result of the operation of those paragraphs. My understanding is that all the professional bodies such as the Society of Trust and Estate Practitioners, the Institute of Chartered Accountants and the Chartered Institute of Taxation have protested about the impact of paragraphs 3 and 4, which in their view extend the definition of settlor-interested trusts much too widely. The effect of the changes proposed in new subsection (2A) of section 77 of the Taxation of Chargeable Gains Act 1992 will be that the trusts set up by parents for children under 18 will automatically be treated as settlor-interested trusts. As a consequence, capital gains relating to the trust property are treated as though they are gains made by the settlor and are taxed accordingly. As the Institute of Chartered Accountants points out, it is difficult to understand why the new provisions are needed in the capital gains tax context, as all trust gains are already taxed at 40 per cent. It does not seem to be an avoidance issue that is being tackled.

The trust rate could be higher than the settlor’s rate because the trust will not, as I understand it, be entitled to taper relief. The changes proposed to section 77 through new subsection (2A) are supposedly designed to import an income-tax-based rule into the law on CGT and thereby to achieve the consistency that is the overarching goal of the project on the modernisation of trusts. Under income tax rules, there is provision to deem the income of a trust for children to be that of the parent setting up the trust, although the rule bites only if the income is distributed to the child. The new CGT rule goes much further, impacting on all property going into the trust.

The income tax rule was enacted to prevent the settlor from claiming the benefit of his children’s income tax personal allowances. If the Treasury really wanted to implement the same rule in the CGT context and to prevent attempts to use the annual CGT exemptions for child beneficiaries, it could have proposed provisions targeted on distribution of property to the child. That could have been taxed as gains by the parent.

Rob Marris (Labour, Wolverhampton South West)

The hon. Lady has referred to income. One needs to differentiate between income and property, because if we are talking about property, particularly realty, there is a huge difference. One can use the property—live in it—as a minor on whom a settlement has been made. In terms of undistributed income, to which the hon. Lady referred, it is undistributed. The minor has no benefit from it, so there is potentially a big difference.

Theresa Villiers (Conservative, Chipping Barnet)

There is a big difference, but it is still a harsh penalty to deny these trusts holdover relief, which is the impact of paragraphs 3 and 4. Property going into trust no longer has holdover relief. I do not believe that aligning the income tax and CGT rules requires denial of holdover relief for property going into the trust, but that seems to be the result of the changes in paragraphs 3 and 4. As I am sure the Committee is aware, where holdover relief applies, the gain on the asset is held over to the point at which the CGT is applied.

The professional groups have expressed their serious concern about the removal of holdover relief in this context. The Institute of Chartered Accountants points out some of the undesirable anomalies that the new rules seem to produce. For example, the transfer of the same property to be held by trustees as bare trustees for a child under the age of 18 would be eligible for holdover relief, as would a transfer to a non-bare trust for the benefit of children over 18. However, a transfer to a non-bare trust for under-18s does not attract holdover relief. The ICA states with some justification:

“There seems no purpose in creating this bizarre discontinuity and we request that it is removed from the Bill.”

It describes the change as “particularly unwelcome and illogical”.

As well as creating that anomalous result, the denial of holdover relief conflicts with well established tax law principles. Generally, if a disposal attracts inheritance tax, it will not be subject to capital gains tax. Historically, CGT holdover relief has therefore been available where inheritance tax is levied. In the case of trusts for minors, it seems that schedule 20 of the Bill will apply IHT and schedule 12 will apply CGT without holdover relief. Thus, unless either schedule 12 or schedule 20 is amended, CGT and IHT will both bite on the same transfer.

The Treasury seemed to be unaware that schedule 12 would have that effect when it stated in Budget note 25 that assets settled in trust for minors would qualify for holdover relief because they were now chargeable transfers for IHT purposes.

Further complications arise where a parent makes a contribution to a trust that was set up by someone else for children under 18 years old. That is where the rules on transfers between and into settlements become important, which is why Iasked for clarification at the start of the discussion. For example, a parent might pay professional fees or add money to the trust to meet a particular expense, and it seems that under the new rules that is enough to make the trust settlor-interested, merely because a parent who was not the original settlor writes a cheque for a trust expense as a matter of administrative convenience. The original settlor might know nothing about it and might be completely unaware that it has happened.

Section 169C(2)(a) of the Taxation of Chargeable Gains Act 1992 denies holdover relief so long as the clawback occurs, dating back to when the property is paid in. That applies so long as any settlor is settlor-interested for the purposes of section 169C. Hence, even if the original settlor is not a parent and is unaware that the arrangement has been made, the whole trust becomes settlor-interested as a result of the parent’s involvement in paying a trust expense. The whole trust becomes tainted. If that interpretation is wrong, I should be grateful to the Paymaster General for pointing out how, because it is a real anxiety.

The loss of holdover relief seems a harsh penalty to impose merely because someone pays some professional fees, and I should be grateful if the Paymaster General would therefore give the Committee some further explanation of the rationale behind paragraphs 3 and 4, particularly on the issue of contributions to the settlement by an external person who happens to be a parent.

Paragraph 6 deals with sub-fund settlements. It will introduce a new schedule 4ZA to the TCGA 1992 which will contain a provision allowing trustees to elect that sub-funds be treated as a separate settlement. In principle, such a change is welcome, because breaking up a trust into sub-funds can enable more efficient management, and many larger trusts already use that device. In the past, a degree of uncertainty and complication has arisen due to sub-funds being treated as part of the overall settlement for some CGT purposes but separately for others, and because of variations between the CGT and income tax rules.

However, professionals such as the Society of Trust and Estate Practitioners and others to which I have referred have pointed out a problem with the operation of the new provisions. The Institute of Chartered Accountants believes that the provision will not be used in practice because the consequence of electing that a sub-fund be treated as a separate settlement is that there is a deemed disposal and a CGT charge. The savings to be made in administration costs for setting up a sub-fund are unlikely to outweigh the additional tax liability of a CGT charge. The professionals point out that the provision will therefore not be used and will have no effect unless holdover relief is granted that deems the property to pass on a no gain, no loss basis. Without that change, this quite complicated provision could effectively end up as a dead letter.

Paragraph 8 of new schedule 4ZA deals with who might be a beneficiary of a sub-fund. It will limit the power to elect to treat sub-funds separately from the main trust. Again, the professionals are critical. The provision provides, with limited exceptions, that a sub-fund election can be made only when there is no beneficiary under the sub-fund who is also a beneficiary under the main settlement.

It is quite difficult to understand the rationale for that restriction, and I should be grateful for the Paymaster General’s views, because I cannot identify a loophole or problem that would be covered by the provision. It would seem further to undermine the usefulness of the sub-fund facility that the Government are seeking to introduce to try to make life easier for trustees and settlors. Particularly in the context of family trusts, there is often some commonality between the beneficiaries of the principal fund and the sub-funds. I hope that the Paymaster General will throw some light on the rationale for that restriction.

Paragraph 12 of new schedule 4ZA on sub-funds concerns information requirements. It sets out the information that must be provided to Revenue and Customs when trustees elect to create a sub-fund. That information includes:

“such information as the Commissioners for Her Majesty’s Revenue and Customs may require in relation to the principal settlement (which may, in particular, include information relating to the trustees, the trusts, property which is or has been comprised in the settlement, the settlors or the beneficiaries)”.

That provision seems very wide indeed, and it is difficult to see how it could be justified in thatcontext. Again, the Institute of Chartered Accountants commented:

“There is a growing tendency to make information provisions much wider than are strictly necessary. There is no reason at all to know about property no longer in the settlement or anything about the settlor or the beneficiaries as these are not relevant factors.”

It could be argued strongly that the information required in paragraph 12 is too broad and should be narrowed.

In conclusion, there are a number of uncertainties in relation to the schedule, on which I would be grateful for clarification from the Paymaster General.

Philip Dunne (Conservative, Ludlow)

I declare my interest as a settlor and investment beneficiary of a trust. I was going to speak at some length to schedule 12, but my hon. Friend the Member for Chipping Barnet has ranged widely and comprehensively over all the issues that I wanted to pick up.

I should like to make one specific observation on paragraph 19 and settlor-interested trusts for minors. Paragraph 96 of the explanatory notes, which covers paragraph 19, seeks to link the provisions to an exemption for disabled dependent children’s trusts set up for disabled children as part of the inheritance tax regime exemptions. Will the Paymaster General clarify whether the statement in the explanatory notes means that trusts covering disabled children will be exempt from the capital gains tax regime? It is not apparent in the drafting of paragraph 19 that it covers the disabled exemption; it appears to cover all minors rather than merely those who are disabled.

My hon. Friend made a telling point: the measures seek to impose capital gains tax charges on assets put into trusts for minors. That has the potential to create double taxation on such trusts, not to deal with an avoidance problem, but to provide belt and braces for the Government in generating more revenue.

Dawn Primarolo (Labour, Bristol South)

I was surprised at some of the comments made by the hon. Members for Ludlow(Mr. Dunne) and for Chipping Barnet. I remind the Committee that consultation on the modernisation of trusts began in December 2003. That has been a very good consultation looking specifically at how the arrangements for trusts could be simplified and, where possible, definitions brought into line. There was considerable discussion on last year’s Finance Bill as well.

The schedule sets out two principal changes to the capital gains tax rules with a number of consequential and minor amendments to provide a better and clearer environment in which trusts can operate. The Government were not motivated by the pursuit of revenue or the need to deal with avoidance, as was suggested. The first change concerns the alterations to capital gains tax definitions affecting the taxation of trusts in such a way as to align them more closely with income tax rules. It is easier to have it that way. It is not possible to align them entirely because of the nature of the two different tax bases—income tax and CGT—but that was the point. There is a common test for the residents of a body of trustees and what constitutes a settlor entrusted trust, to which the special tax rules apply.

The changes are designed to ease the burden for trustees, particularly lay trustees, which hon. Opposition Members are usually keen on. I remember that, during discussions on an earlier part of the Bill, some Opposition Members felt that the Finance Bill should be capable of being read by anybody who cared to pick it up and wondered what it might be saying. Yet now, apparently, they want to swing the other way to respond to complex situations.

The second change, suggested by the trust industry representatives, was the introduction of a facility for trusts to elect a sub-fund of a settlement to be treated for tax purposes as if it were a separate settlement. The opportunity to elect a sub-fund will be particularly useful to trustees of older settlements who do not have the power to set up new settlements—but where trusts within the settlement are administered separately for tax purposes. Taken together, these are positive, good changes.

The hon. Lady asked various questions. I shall deal with those and make a general point at the end. Most of the questions come from those who are motivated to plan rather more complex forms of trust. Her first question concerned the new definition of “settlement”. The term “settlement” applies wherever one has settled a property. It is necessary to retain—not to create—the anti-avoidance definition of “settlement” for the purposes of the legislation in the Income Tax Acts and for certain limited capital gains tax purposes, because it covers a much wider set of circumstances than situations where property is held in trust. As the new definitions are based on current capital gains tax meanings—the key trust-related terms—it should, in future, be easier for trusts to navigate the income tax and capital gains tax regimes.

The hon. Lady then asked about a property in settlement with two or more settlors. The legislation determines the identity of the settlor of the transferred property. If the property cannot be identified as originating from a specific settlor, it is attributed to all settlors in proportion to their relevant contribution to the original trust. In most cases, it should be possible to attribute property that has not been turned into cash by the original settlors.

Whether a settlor ceased to be a settlor of a settlement would depend on the facts of the case. The hon. Lady made a point about what would happen in respect of ceased settlors if there were nothing to show the source of the cash paid in. If there is nothing to show the source of the cash paid out, the reasonable conclusion would be that it came pro rata from all the cash in the trustee’s possession. There is nothing new here.

Standing Committee A

Schedule 12

Dawn Primarolo (Labour, Bristol South)

Good afternoon, Sir John. I welcome you to the Chair. I am grateful that my back is to the window and, although I cannot see the beautiful blue sky, I am sure we shall make good progress this afternoon.

Before lunch I was responding to certain questions that had been asked by the hon. Member for Chipping Barnet (Mrs. Villiers) on the operation of schedule 12, one of which was about the definition of “making” in relation to settlors and settlements. Many of her questions are technical, but I shall respond as well as I can and make some general comments at the end.

The legislation refers to a settlor making or entering into a settlement. A settlor will make a new settlement or enter into an existing settlement. When trustees declare new trusts over settled property by way of a deed of appointment, the property may be held on a new settlement trust, provided that that is within the powers of the trustees. The question, however, is one of fact and law, and the particular issue that the hon. Lady mentioned has been the subject of several court decisions. The position under the proposed legislation is therefore the same as previously.

The hon. Lady also asked about new settlors adding property to an existing trust. Whether there is an addition to an existing trust or a new settlement is a matter of general law. As was the case before the drafting of the schedule, the tax rules apply by reference to the legal status; they do not themselves determine the question. So I wish to reassure her that the purpose of the provisions is to achieve exactly the changes that were identified by the Government.

On the definition of settlor interest, the purpose of the trust modernisation package is, as I have already said, to harmonise as much as possible the treatment of trusts for income tax and capital gains tax purposes. That will help with compliance by trustees—especially in the case of smaller trusts—because it will help them not to be tripped up inadvertently by differences between rules.

The capital gains tax rules on settlor-interested trusts are more generous than the income tax rules, and lend themselves to avoidance opportunities that we do not want to extend to the income tax regime. It is true that some people have created trusts for their children in order to take account of the annual exempt amount. The main purpose of the new rules, however, is not to stop that abuse but to align income tax and capital gains tax treatment more closely, as I said originally. Tackling one small area of avoidance in isolation would increase complexity rather than simplify matters, whereas the driving imperative for the provisions is one of simplification.

All trusts set up by living parents for their minor children will now be treated as settlor interested. We think that it is right that the tax system should reflect the effective financial dependence of minor children on their parents, so parents will no longer receive capital gains tax advantage if they choose to set up a trust for their children. The principle of charging tax on gains of settlor-interested trusts at the marginal tax rate of the settlor remains a fair policy.

Mrs. Theresa Villiers (Chipping Barnet) (Con) rose—

Dawn Primarolo (Labour, Bristol South)

I shall give way, but I shall just conclude this point, because the hon. Member for Ludlow (Mr. Dunne) asked about it.

Trusts set up for children on the death of a parent will benefit from the favourable tax regime for vulnerable beneficiaries provided that the conditions are met. The hon. Gentleman specifically asked that question with regard to disabled children. The short answer to his question about whether they would receive the beneficial arrangements is yes. The benefit of the regime would apply in those circumstances—uniquely, because of the carve-out that the Government have already made.

Theresa Villiers (Conservative, Chipping Barnet)

The Paymaster General outlined an underlying rationale for equating capital gains tax in respect of trusts for under-18s with that of the parents. Are the professional associations correct in asserting that the new rules will not apply to bare trusts for under-18s? If so, why are the Government introducing different rules for non-bare trusts in that instance, which is so controversial, while retaining the old approach for bare trusts?

Dawn Primarolo (Labour, Bristol South)

I was looking quickly through my papers, because the hon. Lady referred to bare trusts. The answer to her question is yes. The measure does not affect gifts to dependent, minor children other than gifts to a trust, because there is a difference between an outright trust and a gift into a trust where the settlor generally retains a degree of control over the assets. She need not worry about the problem that she identified. It will not be an issue.

The hon. Lady then moved on to a discussion about holdover relief. Parents have used the tax rules favouring trusts for minor children in various ways—by protecting family assets and enhancing family income. The new rules reflect the principle with which we are familiar from income tax, in which a minor child’s income that originates from a parent should be regarded as the income of that parent. Assets held in trust for minor children, with the exception that the hon. Gentleman raised and I have confirmed, should be regarded in the same way for capital gains purposes.

The hon. Lady asked whether there might be a double charge, and she identified a possible interaction with inheritance tax. Such a scenario is highly unlikely, because there will be no inheritance tax charge if the asset qualifies for agricultural or business asset relief, or if the transfer falls within the nil-rate band. There will be no capital gains tax charge except to the extent that the assets put into the trust are chargeable assets standing at a gain. In the unlikely case that a charge to inheritance tax arises on the transfer, it will be deductable in calculating the gain on the disposal by the trustee to whom the transfer was made.

The hon. Lady referred to the Budget note. I can confirm that she is correct in her assertion that it was wrong—[Hon. Members: “Ah!”] Her Majesty’s Revenue and Customs has already apologised for that and made the correction. I understood that she would raise that query if she were working from the Budget note. She might have been about to ask me about that next.

Theresa Villiers (Conservative, Chipping Barnet)

I was, yes.

Dawn Primarolo (Labour, Bristol South)

Okay, fair cop. The Budget note was wrong, but it has now been corrected and apologies have been made.

The hon. Lady asked about sub-funds. As I said in my introduction, their creation was at the request, in specific circumstances, of some people whom we consulted. We were happy to provide for that. The option to make a sub-fund election, which she mentioned specifically, will assist trustees whose trust deeds do not allow them the freedom to treat sub-funds as a separate trust. It puts them in the same position for tax purposes, including the availability of tax relief where the relevant conditions are met, as, for example, trustees whose deeds already allow that degree of flexibility.

The hon. Lady went on to talk about holdover relief. Providing a general holdover relief would give more favourable tax treatment to trustees who opted to make a sub-fund election compared with the trustees of trusts who set up a new trust under the existing power. That would clearly be unfair and would be an accident of timing as well as of drafting. It would be illogical and could open the door to pretty substantial capital gains tax avoidance opportunities. I am not attracted to that. As I said, the measure for the election of the sub-fund is designed to solve a specific problem that was raised in the consultation period. It is therefore entirely appropriate that it is structured in the way that it is.

The hon. Lady identified in her opening remarks that this is a complex issue. I have tried to explain in my contributions this morning and this afternoon that this is about attempting to align as closely as possible the treatments for capital gains tax and income tax. Much of this is underpinned by the written rule of law and the courts as opposed to tax determining the situation in the first place.

Despite the fact that this matter was consulted on from December 2003, with draft clauses made available, HMRC will publish new guidance. If Members of the House or those outside it who read our proceedings have particular points that they consider need clarifying further, HMRC officials will be available to discuss them and ensure that the guidance issued would put them beyond any doubt. I hope that the hon. Lady finds that helpful and that most of her fears have been assuaged.

Theresa Villiers (Conservative, Chipping Barnet)

I welcome the last part of the Paymaster General’s address to the Committee. There is clearly a case for additional guidance about these laws. On many occasions during our consideration of this Finance Bill, I have been able to take great reassurance from clarifications and undertakings given by Ministers. However, in this case, I remain worried about what is in the Bill. It might be something that the Opposition should consider coming back to later in the discussions on the Bill.

The Paymaster General refers to the advantages provided by these schedules in terms of simplification for the trustees of smaller trusts, because they would have to deal with fewer definitions. It is difficult to classify the phenomenally complex provisions, and I have struggled with them at length over the past couple of weeks. I therefore have a degree of doubt that they contribute to simplification.

I am genuinely anxious about the imposition of penal treatment of transfers into trusts and the extension of the definition of settlor interest in trusts. I heard what the Minister said about why it is being done, and it seemed that the key reason was simply to align the treatment for income tax with that for capital gains tax. Given the significant penalty involved, we need a stronger benefit to justify the change. I do not accept that trustees will gain so much advantage from a simpler system that they will not mind paying a whacking great CGT charge. The Paymaster General and I are simply not as one on the matter.

I continue to be worried about the arbitrary distinction which means that bare trusts for under-18s will be treated differently from substantive trusts for under-18s and trusts for over-18s, which will not receive the same penal treatment. One type of trust—an ordinary trust for under-18s—will be penalised. Even after the Paymaster General’s helpful and extensive discussion of the schedule, I cannot understand why that distinction is being drawn. She tried to assure us that very seldom would cases occur in which there is an IHT hit and a CGT hit, but she drew our attention only to the exemption from CGT for agricultural business assets and the fact that there will be an allowance for CGT. That still leaves a range of ways in which trusts could be hit. There will be a significant extra tax charge, and if the motivation is simplification and the wish merely to harmonise two sets of legislation, there will be sufficient negative consequences for the measure not to be justified on a cost benefit analysis.

As I acknowledged in my speech on clause stand part, I accept that the request to set up sub-funds came from the professionals themselves. However, there is a case for distinguishing the setting up of sub-funds from the setting up of a wholly new settlement. They are part of the existing settlement, so it seems only reasonable to allow a holdover into the sub-fund. In essence, such funds are not being transferred. I end by repeating my point that if the Government want to respond to the request for sub-funds made in the consultation, they must create a system that people will use. People will not use the proposed system, because any administrative savings that they might make as a result of being able to run sub-funds rather than running everything as part of one trust will be outweighed by the new tax charges. I am grateful to the Paymaster General for her clarifications, but I remain concerned about the schedule.

Schedule 13

Theresa Villiers (Conservative, Chipping Barnet)

I beg to move amendment No. 186, in schedule 13, page 66, line 19 [Vol II], leave out paragraph 2.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss Government amendments Nos. 191 and 192.

Theresa Villiers (Conservative, Chipping Barnet)

I assure the Committee that this contribution will be much shorter than my previous one. I should make it clear that the Opposition have no objection in principle to Government amendments Nos. 191 and 192, which seem to make useful improvements to the Bill, although we believe that there are other problems in the schedule that they do not cover.

Amendment No. 186 is a probing amendment designed to deal with an anxiety that has been raised about paragraph 2, which it would delete. Previously, trustees of settlor interested trusts were not charged income tax under section 686 of the Income and Corporation Taxes Act 1988 because the income was deemed to be that of the settlor, who was charged instead under section 619 of the Income Tax (Trading and Other Income) Act 2005. Paragraph 2 deletes section 686(2)(b)(ii) of the 1988 Act and the effect is to remove trustees’ immunity from tax in that situation, which they currently enjoy because the tax is paid by the settlor. There does not seem to be a corresponding credit anywhere else, so at the moment, paragraph 2 of the schedule will make trustees liable for a tax that the settlor is also being asked to pay. I am sure that it is not the Government’s intention to levy tax on the same income twice, so I have tabled my amendment to give them the opportunity to reassure the Committee that there will not be a double charge in this case.

Dawn Primarolo (Labour, Bristol South)

I shall give the hon. Member for Chipping Barnet the assurance that she is looking for. I could explain why the amendment is defective as well, but she has said that the amendment is a probing one designed to get my assurance that there are not two tax charges. That is not the case. The total is 40 per cent. and under the old regime, it was the proportion paid by the trust, topped up by the settlor if necessary—if they were a higher rate payer. The 40 per cent. figure is not covered by specific tax legislation but by general law. The provisions are only arranging for it to be paid in one place, rather than having an administrative process where the top-up is paid subsequently to the 40 per cent. figure. The provisions do not prevent the 40 per cent. tax being made available as a credit to the settlor, if they are not liable for the 40 per cent. Some people outside the House have misread the provisions, which has led them to believe that there might be the 40 per cent. and the 37, which is not the case. It would be underscored slightly more if that were the case.

I am not going to speak to the Government amendments, except to say that I am glad that the hon. Lady welcomes them. It was noted that the way in which the regime was drafted was slightly harsher—to put it mildly—than intended and the Government amendments restore the position to that set out previously, which should have remained all along. That has been widely welcomed. With that assurance, I hope that the hon. Lady will withdraw her amendment.

Theresa Villiers (Conservative, Chipping Barnet)

I am grateful for the Paymaster General’s clear assurance that there will be a credit, and that, where the settlor has paid the tax, the trustees will not have to pay. I beg to ask leave to withdraw the amendment.

Theresa Villiers (Conservative, Chipping Barnet)

Again, I can assure the Committeethat the debate will be much shorter than that on schedule 12. I am conscious that people do not find this the most exciting thing in the Bill. [Interruption.] I am trying.

As we heard, schedule 13 introduces changes to income tax similar to the ones we discussed on capital gains tax. I want the Paymaster General to consider some of the points raised by the professionals. The first of those concerns new section 685 of the Income and Corporation Taxes Act 1988 and the meaning of separate property. I am told that the new section will mean that some trusts become bare trusts for income tax purposes, so that the beneficiaries rather than the trustees will be liable to pay the tax. The Institute of Chartered Accountants has pointed out how significant an administrative change that will be for the trusts involved. It asks whether there is a possibility of postponement of implementation to give trustees the opportunity to prepare for the measure.

A point that runs through the changes that we are discussing in schedules 12 and 13 is that they will involve more work for the Inland Revenue on specialist trust taxation. Two of the specialist centres dealing with trusts and tax were recently shut down by the Inland Revenue. It would be useful to have the Paymaster General’s assurance that the additional implementation costs and administrative burden on the public sector, because more trusts will be making tax returns than was previously the case, have been taken into consideration in the decisions taken by the Government on the Bill.

On new section 685(B) of the Income and Corporation Taxes Act, the same issues arise on the meaning of “settlor” as do on schedule 12. I need not delay the Committee with them but put on record that the same anxieties apply here as we just discussed on capital gains tax. The same point can be made about new section 685 on transfers between settlements.

The last point about the schedule concerns paragraph 4, which introduces new section 686(E) of the Taxes Act. It deals with multiple settlements and is an anti-avoidance provision. The concern is that the measure is a complicated response to a problem that will not arise. It is not a disaster if it goes on the statute book, but it is a complicated reaction that is not necessary. It provides for new rules to be applied where a settlor sets up multiple settlements. In this situation, it provides that the basic rate tax band of £1,000 will be split between the settlements with a minimum of £200. The avoidance that it is concerned with is the idea that a settlor might set up many trusts to try to take advantage of the £1,000 band.

However, it has been pointed out by the professionals—for example, by the Chartered Institute of Taxation—that the costs and hassle associated with setting up trusts are so significant that there is not much risk that the abuse that the Government fear will happen. I have sympathy with those concerned, given the significant costs of running separate settlements. While I do not have a huge problem with new section 686(E), I query whether it is necessary considering the significance of the problem with which it is designed to deal.

There are significant problems on schedule 13, but they are largely the same as those that we discussed extensively on schedule 12. Therefore, I need not detain the Committee further on them.

Dawn Primarolo (Labour, Bristol South)

The hon. Lady has considered the issue closely. She says that there are substantial problems with the two schedules. All I can say to her is that, given the points that were made during the consultation on draft clauses from December 2003, her fears are not borne out by an overwhelming reaction. The Government would have expected such a reaction to the proposals about the clauses.

I have been sitting here thinking that the next time my civil servants say to me, “Trustees think it would be a good idea to simplify things a little so that instead of operating two sets of rules on capital gains and income tax, we align them as closely as possible—wouldn’t that be a nice thing to do, Minister?”, I shall say no.

This whole discussion, preceded by the consultation, demonstrated how clearly the alignment and changes were welcomed by those in the specific field. That just goes to show that, no matter what a Government do with the tax system, nobody ever believes a Treasury Minister when they say, “Trust me, I’m from the Treasury and I am here to help you.”

Bare trusts have never had to self-assess. They are blind trusts and are described in various ways. They are, and always have been, taxed in a slightly different way. That was clearly spelled out in tax bulletin 32. The hon. Lady has studied a great deal, but even she may not have trawled through every single tax bulletin—[Interruption.]. Okay, she has; congratulations. Bare trusts remain able to self-assess with respect to their income, although not their capital gains tax.

The hon. Lady asked also about whether the impact on the public sector had been taken into account. The answer is yes; if anything, administration costs will be marginally reduced—only marginally, as a complicated area is being brought together. Finally, the hon. Lady asked about the standard rate band. It is at a relatively modest level, having been increased to £1,000 this year.

There will now be a minimum £200 standard rate band applying to all trusts created by the same settlor, regardless of how many trusts that settlor has made; that strikes the correct balance between assisting on this issue and trying to deter anyone who wanted to abuse the standard rate, although I am sure that no one will. There is a combination of measures. Raising the level to £1,000 takes another 5,000 trusts out of the self-assessment system, on top of the 25,000 that were taken out by the £500 change last year.

I have listened carefully to the hon. Lady; perhaps I shall listen more closely next year. I sincerely hope that her fears are unfounded and shall do my best to ensure that the clauses and schedules operate exactly as the consultation indicated. Taxpayers expect the issue to be taken forward.

The hon. Lady said that she did not know whether the change should be called a simplification, but that depends on where one starts. The provisions are better than previous ones. It is most definitely a simplification, but this will never be an easy area of tax.

Clause 90

George Young (Conservative, North West Hampshire)

The clause seems wholly commendable. It reduces the tax payable on trusts for which tenants and leaseholders have paid their service charges from a higher to a lower rate, and I am sure that it will be welcomed by social landlords and local authorities.

I have two questions for the Minister. We are amending the Income and Corporation TaxesAct 1988, so I assume that for the past 17 or 18 years registered social landlords and local authorities have been paying the high rate of tax—either 40 per cent. or 32.5 per cent. As directors of finance in both kinds of organisation are shrewd individuals, why has it taken them so long to put up their hands and protest at the relatively high rate of tax that they have to pay? Perhaps the Paymaster General can explain how the problem came to light. My other question is related to that, but the Paymaster General may not have the figures at her fingertips. How much extra money have local authorities and registered social landlords paid over the odds by being subject to the high rate of tax instead of the lower one that the clause introduces, and as a gesture of benevolence would the Treasury consider giving back to local authorities and registered social landlords the excess sums that they have paid?

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

I have just one further question to ask the Minister on the issue. I have received representations about concerns that some regimes may fall outside the changes to the special trusts’ tax treatment. In particular, residents’ associations that set up sinking funds rather than having service charges may set up discretionary trusts without realising it, and so may not fall under this new tax treatment. I would appreciate the Minister’s reassurance that efforts will be made to inform the associations that there is a more beneficial means of undertaking such treatment of service charges, or a reassurance that the new treatment will be extended to such sinking funds.

Rob Marris (Labour, Wolverhampton South West)

I welcome you to the Chair, Sir John. My point is on similar lines to those of the previous two speakers. I understand that the provision does not apply to private landlords, but can my right hon. Friend the Paymaster General say whether it applies to housing co-operatives and/or tenant-managed co-operatives?

Dawn Primarolo (Labour, Bristol South)

I do not want to go down the route of giving money back—not today, anyway. I can tell the right hon. Member for North-West Hampshire(Sir George Young) that the issue came to light as a consequence of the rate change for trusts in 2004, so it has not been going on for long. The Office of the Deputy Prime Minister and the Housing Corporation had it drawn to their attention, so they came forward to the Treasury on the basis that the problem was the interaction with service charges, sinking funds and the use of regulations. Of course, the smaller cases are covered by the exemptions, which were £500 and then £1,000. We are not talking about a substantial amount of money, and the changes are negligible in terms of calculations for the Treasury. As the right hon. Gentleman will know, being an ex-Treasury Minister, that means that the amount is less than £500 million and is not calculated. [Interruption.] £5 million; did I say £500 million? Well, then I should apologise to the Committee, because that would be a large error. I am sure that the Chancellor would be very cross with me.

With regard to who else the clause will cover, whether it will cover tenant-managed co-operatives, and the points raised by the hon. Member for Falmouth and Camborne (Julia Goldsworthy) and my hon. Friend the Member for Wolverhampton, South-West (Rob Marris), I will need to check those points. I hope that the clause will cover tenant-managed co-operatives, because the whole point was to cover that sector. The clause does not cover private landlords. I intend to monitor the measure, which is clearly sensible, when it comes in and will see what benefit it has with regard to the social housing sector. Then, if it is clear that we need to make further changes, we will bring them forward at the correct time.

With my clarification of my inadvertent slip, and having assured the right hon. Gentleman that this is a good measure and that the issue only recently came to light, I hope that the Committee will accept the clause, which I commend to it.

Clause 92

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 135, in clause 92, page 84, line 34[Vol I], leave out subsection (2).

John Butterfill (Conservative, Bournemouth West)

With this it will be convenientto discuss the following amendments: No. 136, inclause 92, page 84, line 35 [Vol I], leave out

‘insert at the beginning “securities”'

and insert

‘after “options”, insert “other than an option which is acquired pursuant to a right or opportunity made available under arrangements the main purpose (or one of the main purposes) of which is the avoidance of income tax or national insurance contributions”.'.

No. 137, in clause 92, page 84, line 39 [Vol I], after third ‘of', insert ‘income'.

No. 138, in clause 92, page 85, line 1 [Vol I], at beginning insert

‘Subject to subsection (6) below,'.

No. 140, in clause 92, page 85, line 1 [Vol I], leave out from ‘after' to end of line 4 and insert ‘22nd March 2006.'.

No. 139, in clause 92, page 85, line 4 [Vol I], at end add—

‘(1) Where any liability to income tax or national insurance contributions arises by virtue of this section, such liability shall not fall to be collected through the PAYE system unless the option in question was acquired on or after the date Royal Assent is received to this Act, and it shall be sufficient defence for an employer to any proceedings concerning non-compliance with the PAYE regulations that they have taken all reasonable steps to notify any employee or former employee of their obligation to pay any liability created by this section.'.

Mark Hoban (Conservative, Fareham)

I welcome you to our proceedings,Sir John. I made my debut as a shadow Treasury spokesman during debates on the National Insurance Contributions Bill late last year. In some respects, I was fortunate to have participated only at the tail end of those debates, but they were all about employment-related securities. As a result, when I looked at the measures before us to prepare for this debate, I felt rather like Yogi Berra, the baseball player—it was dÃ(c)jà vu all over again.

According to Budget note 33, the clause is intended to deal with

“complex and contrived schemes to avoid paying the proper amount of income tax and National Insurance contributions, exploiting the tax rules relating to options over shares and securities.”

Under UK tax law, options are specifically excluded from the definition of securities and are therefore not taxed on grant, but on exercise or a similar event, when the option holder realises some benefit from the option. Clause 92 further tightens the rules on options, and subsection (3) amends the definition of securities in the Income Tax, (Earnings and Pensions) Act 2003 so that it excludes only securities options, which are defined as a right to acquire shares. The change proposed in subsection (2) ensures that all other types of options are deemed to be securities and, therefore, to be taxed on grant, rather than on exercise.

In its submission on the clause, KPMG suggested that the new definition captures some fairly mainstream schemes for incentivising employees. Those include, for example, put options, which allow the employee to force the employer to take back or buy shares from them, share appreciation rights, phantom share option schemes, and share options and awards granted to those who are not ordinarily resident in the UK. Having said that, KPMG understands that HMRC now considers phantom share option schemes not to be options and therefore not to be caught by the clause, but I would be grateful if the Minister could confirm that. None the less, the range of incentive packages that are caught by the clause demonstrates how broad it has become, and some external observers of these proceedings believe that it goes beyond the statement of 2 December 2004 that the measures before us should relate to complex attempts to avoid paying tax.

In effect, the change in definition creates a wide class of options that will be taxed on grant, even when it is not clear that any benefit will accrue to the employee. Currently, the employee is taxed only when they have obtained some benefit through exercise. However, there could be good commercial reasons for using some of the structures that might fall outside the definition of a securities option. For example, it might be the right answer commercially for an enlisted company to issue put options to its shareholders, given the lack of a market for the shares. Although the Government might suggest that such issues could be tackled more satisfactorily using non-statutory concessions where there was uncertainty and ambiguity, some think that it might be better to have targeted, well-directed legislation to give those responsible for drawing up such schemes greater certainty.

Amendments Nos. 135 to 137 would change the focus of the clause. Amendment No. 135 would delete subsection (2), which inserts the words “options and”. In their place, amendment No. 136 would insert a main purpose test so that those schemes could be taxed differently when the main purpose is to avoid income tax or national insurance. That might be a more satisfactory way of targeting schemes and tackling the anti-avoidance practices that have grown up in that area.

Rob Marris (Labour, Wolverhampton South West)

The hon. Gentleman brings us on to the thorny question of who defines “main purpose” and what it really means, particularly when we talk about incentives and so on, to which he referred. Would his amendment not be unworkable?

Mark Hoban (Conservative, Fareham)

That is a very interesting question, and I am surprised that the hon. Gentleman raises that because throughout the Bill there are references to “main purpose”. For instance, when one of the principal purposes of a particular scheme is to avoid tax it should be under threat and consequently taxed. The Revenue is familiar with that, and I am sure that if we dig back through the annals of this Bill or others, we will find times when Opposition Members were critical of the use of a main purpose test. [Interruption.] Only two weeks ago.

That test is used, and it is an alternative approach to tackling the problems that we have discussed. Some of us are concerned that broadening the definition of an option scheme could create greater uncertainty than going down the route of “main purpose”. That is why the amendment has been proposed; it is a probing amendment, as are a number of our amendments, so that we can understand the schemes that the Government are trying to tackle.

Amendment No. 137 is a relatively small one seeking to insert “income” in front of “tax” at the end ofline 39. There is a concern that “tax” might be interpreted rather broadly. For instance, is it the Government’s intention to capture corporation tax as well?

Dawn Primarolo Yes.

Mark Hoban (Conservative, Fareham)

The Paymaster General nods and gives verbal assent that the Government’s objective is to test that as well.

We come to another familiar debate: on retrospection and the tackling of schemes already in place, and on the date when the rules will come into effect. I have tabled amendments Nos. 138 and 139 which address the collection of liabilities from employees, particularly when a scheme has been in place historically and falls within the scope of the anti-avoidance provisions. They address also the question of who should be responsible for paying that tax, unpaid as PAYE, and national insurance—whether that burden should fall upon the employer or the employee.

I shall return to retrospection and the start date for the measures because concerns have been expressed about the breadth, variety and number of schemes that can be caught by the provisions, now or in the future, which would create added uncertainty in the minds of advisors about which schemes are available to use and which should be ruled out of order. Where legislation is more targeted and focused, it is easier for advisors to understand the use of retrospective legislation. Where legislation is more broadly drafted, advisors are much more conscious about the risk of retrospection and the danger that schemes that looked and were understood to be legal, and whose main purpose was not to avoid tax, are picked up. I tabled this brief series of amendments to probe the Government’s thinking on clause 2, and to push them on issues of the breadth and variety of schemes to which it will apply. What effect will it have on companies’ tax planning and how they seek to incentivise their employees?

Celia Barlow (Labour, Hove)

In reference to the hon. Gentleman’s representations, I want to speak in support of clause 92 and its scope. The proposition has attracted some criticism from City institutions. I argue that such representations miss the point. The issue is fairness and justice.

For many years, we have been confronted with ever more sophisticated attempts by financial high flyers to avoid income tax or national insurance contributions, and sometimes both. I am sure that Members from all parties will agree that that is unacceptable and that we need to ensure that everyone earning money in the UK pays their fair share.

It is therefore necessary for the Government to clamp down on tax avoidance schemes, which not only lose Revenue money but also hurt the ordinary citizen’s common sense. In her written statement on 2 December 2004, my right hon. Friend the Paymaster General announced that complex and contrived attempts to avoid paying tax would be tackled in this Finance Bill if abuse of the system continued.

Briefings from financial institutions complain about the provisions’ alleged retrospection. The submission from KPMG mentioned by the hon. Gentleman argues that retrospective legislation is unwarranted in any case except in extremis. It states that the clause should come into effect with the announcement on Budget day. However, I believe that my right hon. Friend’s written statement was sufficient warning to the tax avoidance industry that, sadly, has developed.

Jeremy Wright (Conservative, Rugby and Kenilworth)

Does the hon. Lady think that it would have been helpful if, during the course of her statement, the Paymaster General had given the financial services industry some indication of what sorts of avoidance the Government had in mind?

Celia Barlow (Labour, Hove)

My hon. Friend made some reference to those areas, and indeed has done so today. It is only right and proper to send a clear signal that we will not accept tax avoidance by those who have more than enough money to pay their fair share. It is a question of fairness, common sense and justice for all.

Philip Dunne (Conservative, Ludlow)

On the subject of fairness, does the hon. Lady agree that the wording of subsection 5 in particular appears to be open-ended? She used the words “alleged retrospection”. It is clear from my reading that the drafting of subsection 5 applying the measures to

“an option acquired before that date”—

namely, 2 December 2004—

“where something is done on or after that date”

is very wide-ranging. My question relating to fairness is whether she or the Paymaster General interprets that as potentially applying to years that have already been closed off by the Inland Revenue. Will those limits continue to apply?

Celia Barlow (Labour, Hove)

The indication was clear. I shall read out my notes on that issue. On 2 December 2004, the Paymaster General made a statement setting out how the Government would deal with future tax avoidance schemes, warning that any counter-measures would be backdated to 2 December 2004 if necessary. Despite that warning and the Finance Act 2005, schemes continued to be promoted that sought to avoid income tax and NICs on employment reward using securities. Indeed, some employers have continued to engage in those schemes. I support the Government’s uncompromising stance and urge all Members to support the clause in its unamended form.

Dawn Primarolo (Labour, Bristol South)

Let there be no mistake about it; the clause has a retrospective effect, potentially back to 2 December 2004, the date of the statement. It is not for accounts that are closed off, but a clear line was drawn for money that is still trying to cascade through the many and varied schemes. Indeed, Opposition Members have been very supportive of the need for such action.

We are talking about payments, bonuses and forms of employment remuneration that are disguised, and successive Governments have tried to deal with them. It started in 1991 with unit trusts; in 1993 it was gold bullion and other tradeable commodities, and in 1994 it was diamonds and fine wines. In 1995, there was anti-avoidance legislation on tradeable assets and vouchers, and in 1996 grants of share options in third party companies had to be dealt with, as did company share awards and options. In 1997 there was more on vouchers; and in 1998 it was conditional shares. Again in 1998, we dealt with readily convertible assets and with convertible shares; and in 1999 we dealt with the exercise of options.

The relentless march against those who seek to take employment remuneration without it being properly taxed continues. The evidence is that by 2003 £1.4 billion was going through those known schemes. Interestingly, the spokespersons for Her Majesty’s Opposition have supported such action. For instance, when discussing last year’s Finance Bill in Committee—it is a mirror image—the hon. Member for Cities of London and Westminster (Mr. Field) said:

“No one on the Opposition Benches will defend the payment in wine, gold or in other ways that was clearly an abuse of the system.”—[Official Report, Standing Committee B, 21 June 2005; c. 44.]

The hon. Member for Runnymede and Weybridge(Mr. Hammond) said

“No Conservative Member would defend highly contrived arrangements.”—[Official Report, Standing Committee B, 21 June 2005; c. 47.]

I could go on, but I utterly agree with them. In 2003, as we were wading through complex anti-avoidance legislation, the hon. Member for Yeovil (Mr. Laws), then spokesperson for the Liberal Democrats, said:

“The question is not only how much money has been lost— how much tax avoidance there has been”—

that is bad enough—

“but why we continue to have legislation year after year to deal with such avoidance schemes...surely we must consider whether we can introduce legislation specifically to address avoidance of income tax and national insurance contributions on remuneration in a way that will deal with the matter once and for all”.—[Official Report, Standing Committee A, 24 June 2004; c. 757.]

When I made the statement in December 2004, a clear line was being drawn.

I understand the points that the hon. Gentleman makes, but I must tell him in the gentlest possible way that the amendments will restrict the will of Parliament and not delivering the taxation that Parliament clearly wants for such remuneration. The amendments open up the possibility for remuneration in one form or another not to be taxed. I am sure that he does not intend that, but I want to explain why that would happen.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

In order to catch schemes that try to avoid what clause 92 attempts to overcome, does the right hon. Lady think it would be appropriate to have a pre-clearance scheme, so that HMRC could establish whether such schemes fell foul of the rules before they were introduced?

Dawn Primarolo (Labour, Bristol South)

I have said it before: why should we give tax avoiders a pre-clearance scheme on how to get round the tax system? The law is clear, as is the statement, so there would be absolutely no point.

To deal with the two points that the hon. Member for Fareham raised, there is an issue with regard to phantom option plans and what are called the put options. The matter has been brought to the attention of my officials by some in the accountancy and legal professions, and HMRC officials have already made it clear on the website that, following the new legal advice, typical phantom option plans are not within the definition of securities options. Put options are rare but are sometimes used in takeover situations. Officials have examined the typical commercial situation and have confirmed that the put options used therein do not deliver employment reward. The Department therefore anticipates no adverse impact from their retention as securities.

Those inquiries have not identified any adverse impact on genuine commercial share option plans. However, if companies had concerns regarding the use of options in commercial circumstances not involving avoidance, they could seek a ruling from HMRC officials under the usual code of practice 10 procedure, as we have discussed before. In those circumstances where, as the hon. Gentleman mentioned, there is legitimate use that might be inadvertently caught, the position is quite clear. The operation of the code of practice 10 procedure means that once all the facts are put on the table and made clear to HMRC and an opinion has been given on that, companies are bound by that opinion.

The hon. Gentleman has sought to deal with those concerns, but unfortunately amendments Nos. 135 to 137 place a severe limit on the clause’s effectiveness in dealing with tax and national insurance avoidance. They would lead only to further revenue loss and provide opportunities for further exploitation of the legislation. To make it quite clear, the statement to Parliament in December 2004 drew the line and said, “That is the end. Whatever happens, you cannot use the schemes,” hence the backdating.

Amendments Nos. 135 and 136 have the admirable intention of simplifying the clause. However, the clause makes it clear that all options, other than those that are a right to acquire securities and were not acquired with the main purpose of avoiding tax or national insurance contributions, are within the normal charging provisions for securities and hence subject to existing anti-avoidance measures. Amendments Nos. 135 and 136, far from simplifying the clause, would therefore remove the clarity and lead to uncertainty, since the rules would be silent on the position of an option that was neither a securities option nor acquired with the main purpose of avoiding tax or national insurance contributions, such as an option that was a right to sell securities.

Amendment No. 137 seeks to narrow the effect of the clause by restricting its application to income tax and national insurance only. That would be an unacceptable weakening of the proposals.

My statement of 2 December made it clear that

“This Government are determined to ensure that all employers and employees pay the proper amount of tax and NICs on the rewards of employment, however those rewards are delivered.”—[Official Report, 2 December 2004; Vol. 428, c. 44WS.]

The phrase “however those rewards are delivered” in that sentence is crucial to the schemes that are devised. Avoidance schemes are being marketed to engineer a corporation tax deduction on employment reward, without a commensurate matching income tax charge on the employee. The schemes defer taxation indefinitely or until a considerable time after the employee has received the employment reward. I cannot see that using a wholly uncommercial option is anything other than avoidance, depriving the Exchequer of the proper amount of tax and national insurance and employment reward. I gave fair warning on 2 December 2004 that we would no longer accept that.

Amendments Nos. 138 and 139 attempt to prevent retrospective PAYE and seek to transfer from employers to employees the obligation to pay HMRC the tax arising, by virtue of clause 92, on earnings received prior to the date of Royal Assent for the Bill, thereby removing any obligation on the employer to account for the tax under PAYE. Since it is the employer who decides to pay earnings in such contrived ways, it is only right that, in accordance with the existing underlying principle of PAYE and national insurance, the employer should be held to account to pay the tax and national insurance. Amendments Nos. 138 and 139 would undermine the principle of PAYE and negate the timely payment of tax to the Exchequer by those who have chosen to pay earnings in a manner expressly intended to avoid a liability.

Amendment No. 140 would limit the backdating of the clause to the date of the Budget—22 March 2006—when the provisions were announced and published. That would undermine not only the clear warning that I gave on 2 December 2004, but future Government action to tackle avoidance. It would also give entirely the wrong signal to those who abuse security options to avoid tax and national insurance by allowing them to keep some of the tax and national insurance that they have avoided.

Let me dispel the notion that uncertainty prevails among practitioners—some of whom, I am sorry to say, perhaps supplied the amendments that we are discussing—by quoting from a post-Budget publication, issued by a firm of active advisers, appropriately called the “Tax Planning Newsletter”. It states:

“The main problem area for our clients would have been for those...who used one of the schemes which enabled bonuses to be taken from companies tax free. We had been warned by Dawn Primarolo that there was a danger of retrospective legislation in this area and we passed that warning on to clients. For some, however, it was a risk worth taking but it now appears that she meant what she said.”

Absolutely; I meant what I said. If clause 92 were only made effective from the date of the Budget, it would return us to the cat and mouse games of the past, where there was always a window of opportunity to manufacture and use an avoidance scheme before remedial legislation could be enacted.

We are determined that we will not return to these types of games around employment reward and that they should end. Avoiders will no longer have such an unfair advantage over those who have paid their fair share of tax and national insurance. The effect of the clause is clear: it applies only if security options are acquired or something is done to existing security options on or after 2 December 2004 that is part of an avoidance arrangement. The avoiders know exactly what they are doing, as Opposition Members have acknowledged at each point when we have discussed the various schemes over the years. Those who do not attempt to avoid paying the proper amount by participating in complex and contrived avoidance arrangements will have the certainty that these provisions do not apply to them.

Parliament is clear. It expects employment remuneration to be properly taxed. That is exactly the intention of the clause and it is regrettable that some people sought to test whether I meant what I said on behalf of the Government about a retrospective effect. I meant it and I hope that they take the lesson now and that a line has finally been drawn.

Mark Hoban (Conservative, Fareham)

I am sure that readers of the “Tax Planning Newsletter” will take note of the Paymaster General’s comments. If they were uncertain, they must be certain now.

I want to make it clear that we support measures to tackle tax avoidance. The list of abuses that the Paymaster General read out included measures that we closed down when we were in Government, so we are cognisant of the risk of tax avoidance and the way in which people seek to hide remuneration through schemes that are dressed up as share option schemes and so on. People are always inventive and I am sure that they are even now looking at the Bill and wondering what measures the Government are introducing that they can use to their own advantage. As the Bill has progressed, various changes have been made to schemes introduced by the Government that have been used for tax avoidance.

I welcome the Paymaster General’s clarification of phantom share option schemes—it is good to have that clarification in the Committee as well as on the Customs and Excise website—and put options.

I will leave to another day how the code-of-practice-10 process for clearance of schemes differs from the pre-clearance scheme mentioned by the hon. Member for Falmouth and Camborne, but the fact that the process exists for those with legitimate schemes is welcome. Those who use that process should recognise the important words used by the Paymaster General when she referred to full disclosure of the facts of those schemes. That is important.

On retrospection and clarity, I do not wish to relive in gory detail the Report stage and Third Reading of the National Insurance Contributions Bill—[Hon. Members: “Go on!”]—despite the temptation from my hon. Friends who are egging me on. Before this debate, I checked to see whether I said anything that I might regret and I am pleased to say that I said nothing then that I regret now. In response to the hon. Member for Hove (Ms Barlow), the import of the Paymaster General’s statement on 2 December 2004 was not clear to a number of people and we discussed it on Report and Third Reading. Some advisers did not read her comments as broadly as they turned out to be. Today’s debate has emphasised the breadth of those comments, but for a number of people the statement on 2 December 2004, in conjunction with the Government’s later actions, came as a surprise and any doubts they may have had have been dispelled. I am sure that that will be reinforced in subsequent debates.

I beg to ask leave to withdraw the amendment.

Clause 93

John Healey (Labour, Wentworth)

The clause takes us to the enterprise management incentive scheme. It is designed to correct a small defect in the rules on corporation tax relief that we introduced under schedule 23 of the Finance Act 2003. The change under clause 93 will allow the intended corporation tax relief when restricted and convertible shares acquired under the enterprise management incentive options are granted at a discount to market value.

At present, the amount of corporation tax relief allowed is equal only to the amount of the discount. That is not intended, so the clause gives the correct corporation tax deduction for both the amount of the discount and the amount that would have been taxed on the employee but for the income tax relief given under enterprise management incentive legislation. The change will ensure that a company offering enterprise management incentive options will not be disadvantaged by receiving a smaller corporation tax deduction compared with one that offers fully taxed share options.

There was no intention to disadvantage EMI options that were granted in the discount in that way when the original schedule was introduced in 2003. The measure under clause 93 has therefore been backdated to 1 September 2003, which was the date on which the relevant income tax legislation relating to restricted and convertible shares came into force. I commend the clause to the Committee.

Clause 95

Edward Balls (Labour, Normanton)

We now come to a short series of four clauses. They take forward the work that has been proceeding since 2003 and, in particular, since last year’s Finance Bill to address Islamic finance and the importance of providing financing vehicles that are available to people from the Muslim community and consistent with their religious beliefs in order for them to access financial products.

The objectives of the package of measures begins under clause 95. The provisions provide a level playing field and fair tax treatment for alternative finance products that, in turn, remove obstacles to innovation in financial markets. They build on the measures that were introduced last year to provide a level playing field for basic financial products and extend them to cover further products, following ongoing and substantial consultations with industry and interested parties. The measures will be of benefit to everyone who wants to access to financial products that do not involve interest, but they will be of benefit in particular to those members of the Muslim community who wish to avoid interest for religious reasons. The existing tax laws can be difficult to apply to such products and can give awkward results. The clause is designed to provide consumers with certainty in their tax position.

The clauses are developed in partnership with business and its professional advisers, and bring the tax treatment into line with equivalent products that involve interest. Clauses 95 and 96 set out the tax treatment of two particular financial products and align the tax treatment to that of their conventional equivalents. Clause 97 ensures that beneficial loans legislation applies to alternative finance arrangements as well as to conventional products. Clause 98 contains a regulatory power to allow further similar products to be incorporated into the tax system by Treasury order and provides the Government with the flexibility to respond quickly to developments.

Clause 95 enables a new long-term finance product in the form of an agency relationship that gives a similar income account fund to a deposit of money at interest. The Finance Act 2005 provided a return on particular arrangements, calling the legislation a profit share return, to be taxed in the same way as interest. The clause extends that definition to include the return from a profit share agency arrangement under which certain conditions are met. It means, for example, that the rules on deduction of tax from bank or building society interest apply to the return from profit share agency arrangements. It ensures that both the investor and the financial institutions are taxed fairly on the financial return that each makes on the arrangement. It also contains some further changes to the legislation to ensure consistent treatment between the agency-based product and conventional interest-based products. I commend the clause to the Committee.

Theresa Villiers (Conservative, Chipping Barnet)

I must start by apologising to the Chairman and to the Economic Secretary for missing the first few seconds of his presentation. I will follow his example in addressing clauses 95 to 98 together. I am slightly worried that I find myself in agreement with him on the proposals. They are welcome because, as we have heard, they provide a legal and tax framework to accommodate two further sharia-compliant finance arrangements.

The Koran provides:

“Oh you who believe, you shall not take usury compounded over and over. Observe God that you may succeed”.

At another point, it states:

“God does not bless usury, and he causes charitable deeds to prosper”.

Some interpret the prohibitions in the Koran to cover only usury. However, it seems more generally accepted that the ban extends to the paying of interest or riba in any transaction. Considerable effort has therefore been made over recent years to develop financial products that suit the needs of the Muslim community, but which also enable it to comply with sharia law and avoid interest, as we have heard from the Economic Secretary. Last year’s introduction of a financial framework for two sharia financial products, morabaha and modaraba, were widely welcomed.

Clause 95 provides similar legal certainty for the wakala contract, which involves profit share agencies. Clause 96 performs the same function in relation to diminishing musharaka products, which use diminishing shared ownership arrangements. There are a number of reasons why it is important to ensure that the United Kingdom’s tax and regulatory structures embrace sharia-compliant products such as those. It is important to ensure that the UK’s Muslim community is encouraged to save and deal prudently with managing its finances. I recently had the pleasure of visiting a mosque in north Finchley. It falls just outside my constituency, but its catchment area covers my constituents. The much respected imam at the north Finchley mosque, Mr. Mufti Barkatullah, is an expert on Islamic finance. He advises several banks, including Lloyds TSB, on sharia-compliant products. He believes that providing such products is vital to improve prosperity levels in the Muslim community.

At a recent meeting in north London, Mufti Barkatullah was quoted in the papers as saying:

“Much of the deprivation among Muslims is because they don’t find the financial world friendly to their ethics. They find it hard to believe that financial institutions are becoming friendly. I am here to reassure them.”

I am sure that the Committee will be aware of the tensions that we have seen in some cities with large Muslim communities where deprivation levels are high. No doubt action on many fronts will be needed to reverse that, but a thriving Islamic finance sector could be helpful in that regard.

Ensuring that we are an attractive location for Islamic finance could give us an important competitive edge. The Islamic financial sector has been experiencing high levels of growth. The law firm Clifford Chance recently estimated that the sector is worth about $2 billion with very fast growth in areas such as sukuks, which are Islamic bonds. Moody’s, the credit ratings agency, recently announced that it was setting up an office in Dubai to provide credit ratings for those bonds and other Islamic financial instruments. It estimates that the world’s 200 Islamic mutual funds are handling assets worth £161 billion and, of course, serving the vast Muslim population of India’s increasingly successful economy is also likely to open up huge business opportunities.

Other areas of growing business include Islamic leasing or ijara, Islamic hire purchase or ijara-wa-iqtina, Islamic asset-backed securities, and Islamic risk-mitigating instruments. Insurance, once frowned on in the Islamic world, is also growing with the spread of takaful products. HSBC Singapore manages about 280 million such funds. HSBC has also developed a number of sharia-compliant mortgages and pension plans in this country.

Using a 1,400-year-old law to govern modern contracts is not without its challenges. Such is the dramatic success of the Islamic finance sector that the Financial Times on Friday reported an increasing shortage of scholars with the expertise to advise on such matters. The procedures required before a product can be authorised as sharia-compliant can make the Financial Services Authority process look positively tame and simplistic. In many cases, authorisation is needed from a board of 15 scholars that meets only twice a year in Mecca and Medina.

Another reason for supporting the Government’s attempts, this year and last year, to adapt our legal framework to encourage Islamic financial products is that in a world in which there is increasing anxiety about the relationship between the Islamic world and western Governments, it is good to see an area in which financial institutions at the forefront of our capitalist economy are working harmoniously to meet the needs of the devout and the Muslim community.

Finally, I sound a note of caution. While these clauses facilitate sharia-compliant finances, in schedule 20 the Government are undermining the freedom to create sharia-compliant wills. I shall explore the issue when we debate that schedule, but it is another reason for the Government to look afresh at schedule 20 and to review the proposals in it.

Sadiq Khan (Labour, Tooting)

I am afraid that my Arabic is no better than that of the hon. Member for Chipping Barnet and the Economic Secretary.

I welcome the provisions in this Bill and in last year’s for sharia-compliant wakala and musharaka products. I agree with the compliments that the hon. Member for Chipping Barnet paid to Mufti Barkatullah. It is pleasing to see not just a fantastic British Chancellor leading the way and making sharia-compliant products feasible, but HSBC doing so too. The good thing about clauses 95 to 98 is that they provide opportunities for British citizens of Islamic faith and British companies that wish to pursue an Islamic ethos, as well as letting overseas companies know that the UK is Muslim-friendly. We have here examples of alternative financial arrangements that are beneficial for loans to employees, for those who wish to have diminishing shared ownership and for profit-sharing agencies.

Let me formally welcome the Economic Secretary to his new position. I know that he has been welcomed by every member of this Committee over the past seven years—sorry, six weeks—but my question is, can he assure us that the fantastic work that we have seen over the past two years will continue? In particular, will Her Majesty’s Treasury and HMRC continue to consult representatives of banks, businesses and the Muslim community on the tax treatment of arrangements that achieve the same result as conventional financial instruments without involving payment or receipt of interest? The hon. Member for Chipping Barnet has given examples of some of the things that are prohibited by sharia law. The important assurance that my hon. Friend the Economic Secretary can give us will be that the excellent work undertaken hitherto will continue in the weeks, months and, dare I say, decades of this Labour Government.

Clause 96

Edward Balls (Labour, Normanton)

The clause has already been discussed in so far as it refers to musharaka arrangements, which are basically partnership-based products that are economically similar to secured loans. I can confirm that in this instance and the previous one we consulted widely with the Muslim community and with the financial industry and its advisers. In each case, the product was highlighted as being one for which there is a demand that cannot be met because of the current uncertainty about tax treatment. These clauses provide the certainty that will allow such trade to go ahead.

I can also assure my hon. Friend the Member for Tooting (Mr. Khan) that over the coming months we will continue to consult the community and its financial advisers. As London is increasingly accepted around the world as a centre of expertise for such products, it is important for the strength of the City of London that we continue to support the parts of the City that provide special products. I definitely will be having meetings and will be seeking his advice on the best people to consult to ensure that we are at the forefront of thinking in this area. I can also tell him and others that the Chancellor of the Exchequer will be speaking at a conference in the next few weeks at which these issues will be addressed directly in discussion with members of the community and experts. I can definitely give him the assurance he seeks that in the months, years and decades ahead we will continue to consult as we have been doing.

Clause 99

Paul Goodman (Conservative, Wycombe)

It is a pleasure to welcome you to the Chair, Sir John. Although I am half hypnotised by the beautiful blue sky outside that the Paymaster General referred to earlier and which, alas, she cannot see, I do have a few questions on clause 99. I hope that she and Ministers will allow me to sketch out briefly what the clause does before I ask them.

In essence, the Energy Act 2004 reorganised the nuclear industry. It made accounting entries of certain publicly owned companies—I stress the word “publicly”—in the British Nuclear Fuels group not liable for corporation tax purposes, dependent on certain events of reorganisation taking place. Those events duly took place, but the European Commission launched an investigation into state aid in respect of nuclear decommissioning. Transitional financial arrangements were then set up, which meant that the intention of section 29 of the 2004 Act to exempt transactions from corporation tax no longer applied. The clause seeks to reapply them. So far, so dry.

There is, however, a rather more interesting development. It is worth noting that since the Budget it has been announced that one of the BNFL companies—British Nuclear Group, which is its specialist site management and nuclear clean-up business—is to be transferred from the public to the private sector. During the Budget debate, the then Trade and Industry Secretary, who is now the Secretary of State for Education and Skills, stated in words that did not apply to the deputy leadership of the Labour party but to this subject:

“We must...ensure that elements in public ownership that do not need to be in public ownership to meet our objectives on decommissioning are put into the private sector.”—[Official Report, 28 March 2006; Vol. 444, c. 699.]

That sounds reasonable in principle. Obviously, Members on this side of the House look sympathetically—although not favourably in all cases—on the case for transferring services from the public to the private sector. However, this is where the questions arise.

If I am not mistaken—Ministers will correct me if I am—it seems that an exemption from corporation tax that applied to a public body is now to be applied to a private body, and in circumstances in which there is a sale. Can Ministers explain what connection there is, if any, between the exemption and the sale? It was put to me, perhaps wrongly, that the exemption could simply have been intended to make the sale more attractive. I would like to know whether that is the case and, if so, what the cost of the exemption will be. Finally, are there precedents for this kind of exemption? If so, what are they? The Paymaster General may be able to refer me to a large number of exemptions in the years of Conservative Government, but I am curious about that.

Rob Marris (Labour, Wolverhampton South West)

I find the clause difficult to understand, perhaps because it comes under the Energy Act and I am not an energy expert. However, I understand the explanation given in his introductory remarks by the hon. Member for Wycombe (Mr. Goodman). But further to that understanding it appears to me—I may have got it wrong—that, under the Energy Act 2004, a certain tax regime was set up. The European Commission said, “Well we think it might be unauthorised state aid,” so clause 99 of this Bill was drafted to rejig it slightly. That prompts the question whether we have still got unauthorised state aid, albeit in a different form, overlaid, as the hon. Gentleman rightly pointed out, with the possible privatisation of British Nuclear Group, a site management and clean-up company, which seems to be shadowed in clause 99(4)(a)(b)—for the anoraks among us, it is on page 93, line 11—which states:

“a company that immediately before 1st April 2005 was a wholly-owned subsidiary of BNFL”.

That would count under the Energy Act 2004 as the definition of a BNFL company, even though it may have been privatised since 1 April 2005.

Stepping back from that to the politics of the matter which, heaven forfend, we have in the Finance Bill, it appears at first glance that not only section 29 of the Energy Act 2004 but the proposed amendment to it looks like another subsidy to the failed nuclear industry, which uses old-fashioned technology, has never paid its way anywhere in the world and has left us and succeeding generations for the next 186,000 years, or whatever is the half-life of a uranium atom, with a huge clean-up problem.

Clause 99 appears to further a subsidy for an industry that is a failure financially and works around the world only with continuing subsidies from the states in which it operates, as evidenced by the fact that, as far as I am aware, there are no applications around the world for permissions to build new nuclear power stations unless they are state sponsored or state subsidised, whether they are in Finland or in China. Anyone could apply to build a nuclear power station in the United Kingdom now; the head of E.ON UK which is, I think, wholly owned by the German E.ON company, could say, “Well, I think we need new nuclear power stations,” but not actually put in an application to build any.

We cannot have the whole nuclear debate now, as you would not allow it, Sir John, but I would like reassurance that clause 99 is not a further subsidy to the nuclear industry.

Helen Goodman (Labour, Bishop Auckland)

I echo the questions already asked by hon. Members on these two clauses; I simply want to ask Ministers to explain how the proposals will operate and what the cost will be.

Dawn Primarolo (Labour, Bristol South)

May I first respond directly to my hon. Friend the Member for Wolverhampton, South-West? The answer is no; it is not a further subsidy, and I shall explain what happens. The clause amends section 29 of the Energy Act 2004, as the hon. Member for Wycombe said.

Section 29 was intended to prevent a BNFL site licensee company from incurring corporation tax charges as a consequence of accounting entries made to reflect the assumption of financial responsibility for decommissioning and clearing up certain civil nuclear sites by the Nuclear Decommissioning Authority. Section 29 proceeds on the basis that the recognition of the assumption of financial responsibility by the NDA would relate to specific events. That is not the case.

The amendments are required to ensure that the appropriate accounting entries are included and to ensure that the companies will not incur tax charges solely because of the accounting for the recognition of the assumption of financial responsibility. It is to do with the interaction between those companies, as the hon. Member for Wycombe mentioned.

To take the matter further, let us deal with the question of precedent. In 2005, the Government took over responsibility for British Energy plc’s liability for decommissioning and certain other liabilities. The resultant credit in the accounts was exempt from tax by way of similar provisions to these in section 4 of the Electricity (Miscellaneous Provisions) Act 2003. Section 29 of the Energy Act 2004 was intended to prevent a large amount of money moving in circles, and to take account of the accounting practices. The reorganisation could not have gone ahead if tax charges had arisen, and this clause preserves the intended tax treatment. It is a case not of giving up forecast revenues, but of preventing an inconceivable and unexpected charge that would arise solely because of the timing of events and the accounting for reorganisation. It has been done before.

The hon. Gentleman asked me for examples of precedents in the transfer between public authorities. Although I recognise that the BNFL group includes the private sector, tax and liabilities follow the normal tax provisions. The provision goes no further than that; it is simply a tidying-up measure. It was originally undertaken in an Energy Act, and the reason why it is being undertaken in the Finance Bill is because there is no suitable vehicle for dealing with it apart from the Finance Bill. The provision could have been included in another Energy Bill had there been one.

With regard to the hon. Gentleman’s point about any proposal to sell off British Nuclear Fuels or part of it, the Energy Act 2004—not this Bill—provided that the Nuclear Decommissioning Authority would be given responsibility for decommissioning and clearing up the designated nuclear sites and installations. Section 29 was a practical measure to prevent a large amount of Government money moving in circles from one Department to another. Under ordinary tax rules, the account in credit arising when the NDA takes over responsibilities would count as a taxable income resulting in a liability that BNFL would not be able to fund from its own resources.

Section 44 of the 2004 Act stripped BNFL of its tax losses. It represents the other side of the coin in this removal, ensuring that they are both in accord. This clause preserves the intended effect of section 29 of the 2004 Act, and it is included in this legislation for no other reason.

Rob Marris (Labour, Wolverhampton South West)

This is complicated, revolving-door finance, but taking my right hon. Friend back a couple of sentences, I understood her to say—or words to the effect—that without section 29 and because of nuclear liabilities moving over to the Nuclear Decommissioning Authority, BNFL would not have been able to meet its tax liability. I think that that was what she said, and she will correct me if I am wrong. If that is the case, is not it an indication that BNFL does not work financially?

Dawn Primarolo (Labour, Bristol South)

As my hon. Friend said, this is not the place to discuss an Act that went through the House in 2004. The provision before us simply ensures that the 2004 legislation follows the accounting practices and reflects the reality. It would not be appropriate for me to go over discussions that took place when that legislation went through the House.

The hon. Member for Wycombe asked me one further question, and I cannot remember whether I have covered it. He asked whether there are examples of a similar arrangement being made to prevent the circular movement of Government finances. There are such examples. I do not have them to hand, but I am happy to let him know what they are. There is nothing unusual about this measure; there are precedents. There is not a huge number, but there are examples and if the hon. Gentleman would like to know about them, I will do my best to write to him.

Clause 100

Mark Francois (Conservative, Rayleigh)

On a point of order, Sir John. I apologise for troubling the Committee with a point of order, but if I remember rightly—admittedly, I am going back to April—when we had the debates on the Budget resolutions, the Liberal Democrats specifically broke out the issue of nuclear decommissioning because they wanted to vote on it. Procedurally, it is rather an odd thing to do to call something out for debate and then not even to touch on it in Standing Committee.

John Butterfill (Conservative, Bournemouth West)

Order. The hon. Gentleman has made his point, but it is not a point of order for me.

Helen Goodman (Labour, Bishop Auckland)

We also asked the Minister whether she knew what the costs of the measure were, and she was not able to give us an answer in her speech. I can understand if that information is not available this afternoon.

Dawn Primarolo (Labour, Bristol South)

I answered my hon. Friend’s point. When she asked about the cost, I said that the measure was to prevent a large amount of Government money from moving in circles. There is not a cost; the measure is to prevent the shifting of that money. I am happy to amplify the point by writing to my hon. Friend and to other members of the Committee, but we are talking about bringing things in line with accountancy facts, according to the transfers.

Clause 101

Theresa Villiers (Conservative, Chipping Barnet)

The Opposition welcome the clause, which extends the temporary tax and accounting regime for securitisation companies to the end of December 2007. It confirms that, during that period, securitisation companies can continue to calculate profits under UK GAAP—generally accepted accounting principles—rather than switching to IFRS, or international financial reporting standards.

The clause is important because of the crucial role played by securitisation companies. As I am sure the Committee is aware, securitisation is a type of shock-treatment finance used to pool assets and income streams into a single tradeable security. The assets can be any financial assets, such as mortgages, corporate loans or rent receivables. The companies at issue here are special purpose vehicles that have beneficial ownership of the assets and receive the income that they generate. They use the value of the future income stream to issue securities—generally, debt instruments that are traded on the market.

Securitisation has revolutionised the operation of financial markets. It has enabled a range of diverse financial assets to become tradeable and has opened up a whole new investment area by enabling risk to be split much more easily between multiple lenders. It has enabled groups of lenders to be linked with borrowers in a way that was never possible before. The global market for securitisation is worth about $6.6 trillion, or at least it was in 2003—the figures have probably increased since then. It is well worth putting it on the record that maintaining the right tax and regulatory framework is crucial to securing a thriving bond market in London and a healthy financial centre in the City of London.

The issue that the clause is designed to tackle results from the move to international financial reporting standards, which causes a particular problem for securitisation companies. Because securities are issued by SPVs and are traded, it is crucial that they can attract a good credit rating for those securities, because without that the costs of borrowing spiral. One of the factors taken into account by the ratings agencies relates to the level and consistency of tax charges.

Under the UK generally accepted accounting practice, profits are broadly calculated as income receivable from the assets less interest payable on the traded security, and tax is payable based on those profits. In short, the SPV is taxed on the income it receives net of the interest charged. However, international financial reporting standards require that the traded security is accounted for on a marked-to-market basis. That means that it is revalued for each balance sheet date based on its market value, and the difference is booked to the accounts via an income statement or the reserves.

The differences are taxable and that gives rise to significant fluctuations between taxable profits from one year to the next. The effect is that instead of the smooth taxable result that one gets under UK GAAP, the tax charge becomes highly volatile. Despite the SPV having a stable income stream, large peaks and troughs in its tax bill could threaten its ability to pay, which would be of considerable concern to the ratings agency and could have a significant impact on the rating of the bonds issued by the SPV.

So, the switchover to IFRS could cause ratings previously given to securitisation companies to be downgraded, hence the welcome decision to allow such companies to continue to use the old UK GAAP rules. However, that solution was only ever intended to be temporary. It is not ideal because it means that securitisation companies effectively have to draw up two sets of accounts and there is, as yet, no indication of when a new permanent set of rules will be developed and published.

I urge the Minister covering this issue to give the Committee some indication of what stage the Government have reached in preparing those long-term rules. I urge them to prioritise making progress on this important matter, given the highly significant role that securitisation companies play both in our financial markets and in our economy. It is important to bear in mind that most securitisations are done on long-term debt issues, where long-term certainty in respect of the tax regime is obviously highly desirable. I also emphasise the importance of providing for effective consultation in finalising the rules.

Lastly, will the Paymaster General consider giving some kind of undertaking that the temporary provision will stay in place until the permanent new rules are introduced. I hope that she will be able to give us assurances on the issues that I have raised in relation to this matter.

John Butterfill (Conservative, Bournemouth West)

I am happy for the Paymaster General to reply to the questions on international accounting standards raised by the hon. Member for Chipping Barnet. However, I do not think that it would be appropriate for this then to develop into a debate on the various merits and demerits of the international accounting standards.

Dawn Primarolo (Labour, Bristol South)

I shall briefly respond to the points raised. The hon. Member for Chipping Barnet is right that a temporary arrangement was made and it is desirable that we should move to a permanent arrangement as quickly as possible. The temporary arrangements are far better than moving now to the international accounting standards for the reasons that she has given.

The hon. Lady asked me to give an indication of the Government’s plans in trying to move towards the permanent regime. I hope that draft clauses will shortly be available for consultation with the industry on how to move to a permanent arrangement. Given all her points about the importance of liquidity, I would like, as I am sure the industry would—that is the advice I have received—the consultation to be concluded in good time to enable the permanent regime to become operational on 1 January 2007. Obviously, that means that we need to get the drafts out as quickly as possible, and that is what we intend to do.

As the hon. Lady rightly says, the clause is a temporary extension of a temporary arrangement. It is important in this crucial area of availability of finance that we seek to make permanent arrangements as quickly as possible. I hope that she finds that helpful.

Theresa Villiers (Conservative, Chipping Barnet)

I do find that helpful, and I welcome that indication regarding timing.

Schedule 15

Theresa Villiers (Conservative, Chipping Barnet)

I beg to move amendment No. 216, in page 77, line 13 [Vol II], leave out ‘22nd June' and insert ‘10th March'.

John Butterfill (Conservative, Bournemouth West)

With this it will be convenient to discuss amendment No. 217, in page 80, line 27 [Vol II], leave out ‘22nd June' and insert ‘10th March'.

Theresa Villiers (Conservative, Chipping Barnet)

The amendments would backdate the relief to the date of the publication of document UITF 40 on 10 March 2005. To show the rationale behind the amendments, it is necessary to set out the background to the issues that we are discussing. Clause 102 and schedule 15 deal with the taxation of work in progress and the impact of FRS 5 and UITF 40, which was issued by the urgent issues task force of the Accounting Standards Board. Affected businesses include service providers such as solicitors, marketing and advertising firms, accountants, insurance brokers and consultants of various descriptions. That covers a number of Committee members, in one way or another. I believe that one or two of the provisions in schedule 15 also impact on barristers, so I suppose that I should admit that I was one, at one stage.

In broad terms, FRS 5 is the UK accounting standard that seeks to look through legal form and account for the substance of transactions. It is one of the most complex and hard to understand of all the UK accounting standards. Application note G of FRS 5, which was issued in November 2003, sought to deal with service businesses with large contracts. It set out new rules for the accounting treatment of the period when the contract was ongoing. In the past, the profit on the contract was recognised when it was completed and taxed, which tended to be when the payment was received.

Application note G required that the amount was brought into account as soon as there was a contractual right to payment as a result of performance under contract. Problems arose because it was interpreted differently by different accountants. Some required professionals whom it affected to bring amounts into account evenly over the performance of the contract, whereas others felt that it was sufficient to bring amounts into account when performance occurred.

The urgent issues task force looks into such areas of uncertainty in relation to application of accounting standards. It issued UITF 40 to deal with the question of whether profit should be recognised as the contract progressed under the new method, or on completion of the old method. The key factor is the point at which consideration is legally due. UITF 40 considered that it accrues as time goes by, hence the new method was adopted.

The overall effect of UITF 40 is that a large, one-off tax bill arises for solicitors and other service providers affected. That caused considerable anxiety, as did the prospect of having to pay tax on ongoing work for which the firm might not yet have been paid. To its credit, the Revenue has recognised that problem by introducing schedule 15 essentially to spread that one-off tax charge over three to six years. It does not reduce the tax charge, but merely spreads the time over which it is payable.

In principle, the change provides some welcome relief, but serious concern has been expressed by the professional associations regarding the implementation dates. As drafted, the relief set out in schedule 15 applies only to businesses that adopted UITF 40 from its official start date on 22 June 2005, but many businesses adopted the approach in UITF 40 before then. That may have been because their auditors advised them to do so, or simply because they wished to follow best practice. However, paragraphs 1 and 9 of schedule 15 deny the relief to any firm that adopted UITF 40 before its start date.

The Chartered Institute of Taxation and the Law Society have both pointed out that it seems unfair to penalise such firms because they acted swiftly in seeking to apply the highest accounting standards, and the amendment seeks to backdate the relief so that those firms can claim the spreading relief.

The Institute of Chartered Accountants has stated that

“this sends out a powerful message to business that early adoption of accounting standards in accordance with the highest standards of corporate governance will be encouraged and will not result in such businesses being penalised.”

The amendments are modest, and as many firms started to amend their procedures for drawing up accounts even in advance of the publication of UITF 40 there might even be an argument for backdating the measure further, as the Law Society has suggested. The Law Society also observed that the proposal is not for a tax reduction; instead it would allow more time for firms to spread the cost of what the society has described as a one-off windfall tax for the Treasury.

As drafted, the Bill perversely rewards those who left it as late as possible to adopt best practice. Given the need to encourage high standards of corporate governance, I hope that the Government might be prepared to consider the amendments that I have proposed.

David Gauke (Conservative, South West Hertfordshire)

I declare that I am a non-practising solicitor. My attention was drawn recently to an article in Taxation magazine. I do not know whether that is a publication that should be treated with the same scorn as a tax planning magazine, but I am told that it should not. The article was by Mr. John Endacott, a partner at Winter Rule chartered accountants. [Interruption.] No, it was not by Mrs. Gauke, though Mrs. Gauke drew it to my attention; I should perhaps declare that my wife is a practising solicitor. The article, which was published in January 2006, stated that around 70 per cent. of the top 100 law firms had already decided to adopt the new standard by the end of 2004 and that it was likely that the remaining 30 per cent. would have done so by the time of publication of the article. Mr. Endacott was extremely critical of the Treasury in its approach to spreading. He stated that

“What we have here is firms being penalised for adopting good accounting practice...It is therefore a very limited relief being introduced in a mean-spirited and divisive way”

—given that most firms will already have changed their accounting systems. He added that

“firms embracing modern approaches have to suffer the tax consequences of doing so, whilst the laggards benefit from some relief.”

Schedule 15 attempts to address an unfortunate circumstance, but it fails, because for the vast majority of firms it will be unavailable. Most firms that are likely to seek to comply quickly will have been required to do so by their auditors and will already have changed their accounting systems, so there is nothing in the schedule to assist them. That is petty, and I should like to know why the Treasury has adopted that route rather than making the provision effective as of 10 March 2005 or November 2004 when the accounting standards were developed.

Dawn Primarolo (Labour, Bristol South)

I should make it clear that the Government are not penalising those who followed the UITF 40 interpretations in accounting periods ending before 22 June 2005. They will pay the same tax as they would have paid had the Government not included the measure in the Bill, and on the same date. They will pay the same tax as they would have paid had the Government not included the measure in the Bill, and on the same date. They will face no additional charge that they could not have anticipated when they decided on their accounting policy for a period, at which point they would have examined the matter carefully and taken advice. The amendments ask us to do something that is incredibly complicated and could result in more tax liability in years that have already been dealt with. I shall explain why.

Rob Marris (Labour, Wolverhampton South West)

I think we should vote for it. [Laughter.]

Dawn Primarolo (Labour, Bristol South)

I thank my hon. Friend.

Even those who are not accountants will understand that it would be difficult to set a start date of 10 March. Income tax payers’ accounting dates are up until 5 April 2005, so we would have had to include the effect of the first year’s spreading in 2004-05 tax returns, which were due at the end of January this year. The provisions of the Bill were not available to help people at that point, and they would be able to take advantage of the new laws only by amending their returns. Spreading adjustment income from 2004-05 would also reduce taxable income from that tax year, but would consequently increase taxable income in 2005-06 and subsequent years. The amendment would therefore impose a tax charge for the first time in 2005-06, rather than in 2006-07 as would be the case with a start date of 22 June 2005.

David Gauke (Conservative, South West Hertfordshire)

Will the Paymaster General give way?

Dawn Primarolo (Labour, Bristol South)

Hang on. Let me answer the points. If I have not dealt with them, the hon. Gentleman can reinforce them.

In setting dates, it is always difficult to establish who knew what when about the changes being made, but I took the view that it is fair to put the start date for spreading at the date on which the new accounting interpretations became compulsory rather than at some interim point that can be justified only because it was the start of a new tax year. That would still leave a group of early adopters feeling unfairly treated. I emphasise nobody will be penalised because they adopted early. They will not face any additional tax charge but will pay the same tax on the same date as they would otherwise have done. Even the hon. Member for South-West Hertfordshire (Mr. Gauke) can see that to go back into tax years that are already closed off would present untold problems, particularly in the case of complex partnership arrangements. It is a matter of judgment, and my judgment is that the right start date for spreading is the date on which the requirements were finally introduced. That is the decision that the Government have made.

David Gauke (Conservative, South West Hertfordshire)

I hear what the Paymaster General is saying, and I can see some of the practical difficulties involved. Is it not a fact, however, that most firms changed their accounting practices before it was compulsory to do so? If the policy objective of the schedule is to relieve the burden on firms that are changing their accounting systems and to spread out the windfall cost, did not the Treasury miss a trick a year or two ago? It should have brought in legislation equivalent to the schedule earlier, so that we would not be in a position in which there is practical difficulty and in which we cannot go back to before 22 June? Is that not the problem?

Dawn Primarolo (Labour, Bristol South)

No, it is not. It is not for the Treasury to anticipate when accounting standards and directions will be made and to legislate accordingly. Those companies that looked at the statements that were being made and the possible changes that were coming forward took decisions about whether or not to be early adopters. That was sound advice for their business, and they moved in that way. As long as they are not disadvantaged, which they are not, I cannot see what the problem was.

In this example, the Opposition are seeking to put phenomenally complex legislation in place that could result in a tax charge on those who currently do not face one. If the Opposition want to put their amendment to the vote I shall ask my colleagues to oppose it. If they do vote it in, I do not think that they will be thanked by those companies that might find themselves with a tax charge.

David Gauke (Conservative, South West Hertfordshire)

I hear what the Paymaster General is saying about it not being the role of the Treasury to anticipate what firms will do when it comes to changing their accounting practices. However, as we have just heard, 70 of the 100 largest law firms had already changed their accounting practices by the end of 2004. It is not a question of anticipation, as during the course of 2005 the Treasury might have noticed, received representations and acted then. Instead, it is acting now with schedule 15. Presumably its purpose is to try to help firms and there is an objective that is meant to be achieved, but that objective will not be achieved because the vast majority of firms that will be affected will not benefit from the schedule as they had already done changed their accounting by the end of 2004. We are talking about a whole year when the Treasury did not act and should maybe have done so.

Theresa Villiers (Conservative, Chipping Barnet)

I share the concerns of my hon. Friend the hon. Member for South-West Hertfordshire and think that it is unfortunate that the Paymaster General is not prepared to accept the amendment. I will withdraw it and will not press it to a vote, bearing in mind the practical difficulties with the amendment that the Paymaster General has outlined. I echo the points made by my hon. Friend; it was clear that the shift was underway and it was entirely desirable that it would be underway at an early stage. I appeal to the Paymaster General to try to ensure in future that early adoption of best practices in accounting is encouraged by the tax system and not, as in this case, discouraged. I beg to ask leave to withdraw the amendment.