Finance Bill

Public Bill Committee, 22 May 2007.

(Except clauses 1, 3, 7, 8, 12, 20, 21, 25, 67 and 81 to 84, schedules 1, 18, 22 and 23, and new clauses relating to microgeneration) - Clause 34

Theresa Villiers (Conservative, Chipping Barnet)

The clause is targeted at so-called “booster” schemes designed to increase the amount of tax attributable to a foreign subsidiary and so increase the amount of double taxation relief that can be obtained. The Opposition have some sympathy with the objectives of the clause and certainly will not oppose it. However, I have some questions on how the clause operates and on the longer-term prospects for the reform of double taxation relief.

Which of paragraphs 2 to 6 of schedule 28AB to the Income and Corporation Taxes Act 1988 did the Government have in mind when amending section 804ZA, as proposed in the clause? Will the Chief Secretary outline which scheme is targeted, bearing in mind that the change in law was triggered by the disclosure regime? Will he also explain why this problem was not picked up at an earlier stage, as boosting by using UK as well as overseas tax has been known about since 2005? Why does clauses 34(4) refer to foreign tax paid

“on or after 6th December 2006”?

Does that mean that when a UK company pays a dividend to an overseas company out of profits on which tax was paid before 6 December 2006—tax paid in 2005, for example, or the first two quarterly instalments of 2006—these rules do not apply, even if the overseas company pays the dividends onward after that date?

On the longer-term prospects, the Committee should note that the clause and the provisions it will amend may soon be redundant along with the controlled foreign company rules to be amended by clause 47. Paragraph 3.39 of the Red Book states that the Government are shortly to publish a consultation document on the future of the rules on the taxation of foreign dividends. We welcome the Government’s indication that they are considering a general reform of the taxation of foreign profits, as there is a pressing case for reform and simplification of the law in that area. The rules on the taxation of foreign profits that we are considering—double taxation relief and the controlled foreign companies regime—are ferociously complicated, and one of the most difficult areas of our tax law, which has been subjected to frequent amendment over the last few years and involves significant levels of uncertainty. It can take several years for the foreign tax position to be finalised.

There are a number of technical flaws in the legislation. For example, it struggles to deal with situations where overseas companies pay tax as part of a consolidated group. There are also question marks as to whether the DTR rules are fully compatible with EU law. Chris Sanger of Ernst and Young said:

“The current system is cumbersome and acts as a deterrent to businesses seeking to invest in the UK.”

The Institute for Fiscal Studies, too, has questioned the effectiveness of the DTR rules:

“Overall, the trade off between the costs and benefits of the credit system compared with the exemption system is unclear, and the theoretical case for retaining the credit system does not appear to be compelling.”

Some illumination on that trade-off can be found in the Red Book. Table A3.1 discloses that the Government pay out about £10 billion in double taxation relief. The revenue collected through the taxation of foreign profits, while not de minimis, is certainly low enough to prompt the question of whether that revenue is worth the competitive disadvantage of requiring increasingly mobile multinationals to jump through all the relevant, highly complex hoops to ensure that they meet the requirements of the UK’s double taxation regime—a regime made just that bit more complex by the measures in the Bill.

The Committee might usefully consider whether the present rules get the trade-off between revenue collected and competitiveness right. There are some attractive arguments for simplifying that part of the tax system to incentivise the repatriation of foreign profits. That could make the UK tax system more competitive and boost investment in the UK. It could also make the UK more attractive as a destination for corporate headquarters and holding companies, which could strengthen foreign direct investment.

Recent studies by the International Monetary Fund have shown that there is considerable potential benefit in cases where companies are encouraged to repatriate their foreign profits. Changes in US law to facilitate bringing foreign profits back onshore have also proved successful. When looking at those matters, we should bear in mind the decision by companies such as Yahoo, Google and Amazon to locate their headquarters in Ireland rather than in the UK. Taking those factors on board, the Opposition have been looking at the merits of moving to a participation exemption for foreign profits, along the lines of those used in a number of countries in mainland Europe.

With that in mind, I have a series of questions for the Chief Secretary about the process of reforming DTR that the Government envisage undertaking. First, when will the consultation document promised in the Red Book be published? The Red Book refers to it being published “later in the Spring.” I am of course aware that climate change is doing some odd things to our seasons, but one would have thought that “later in the Spring” would mean by now, or by the end of the month at the latest. Do the Government expect to publish the document before the end of the Committee’s deliberations, as it would be useful in assessing the merits of this clause and clause 47.

My second series of questions concerns the options for reform and the long-term replacement of the DTR rules. Will the Government assess the potential that a sensible reform might in the longer term have to increase tax revenues as a result of the UK becoming a more attractive place for investment and for corporate headquarters? Have they carried out studies on the impact of the introduction of participation exemptions in countries such as Spain and Australia? Did they consider a participation exemption when they introduced the major legislative change in 2000 that governs the taxation of foreign profits? Why did the Government reject that at the time, and given that they are now apparently considering such an exemption, do they believe that it was a mistake to reject that option in 2000?

Thirdly, in embarking on the reform process, what constraints are placed on the Government by the EU? I understand that the Primarolo group criticised aspects of the Dutch participation exemption. Do the Government expect the Paymaster General’s work in Brussels to constrain their choices in reforming the UK’s system of taxation of foreign profits? Lastly, it would be useful for the Committee if the Chief Secretary expanded on the statement in paragraph 3.39 of the Red Book that the Government’s consultation document on the issue

“will also consider the implications of any such reform for other aspects of the UK tax regime, such as interest relief.”

Are the Government planning to abolish relief for interest on borrowing used to invest in foreign shareholdings, or only to restrict it? Is that move inevitable if a participation exemption is introduced? If so, what sort of impact assessment have the Government carried out on the effect of such a move?

One should also bear in mind the fact that the effect of abolishing relief on interest on borrowing to finance overseas investments would raise considerably more than the revenue that would be lost as a result of introducing a participation exemption. Does the Chief Secretary regard the upcoming reform process as a revenue-raising exercise? I would counsel a cautious approach. While moving to an exemption system would offer attractions in terms of simplicity, some of which I have outlined, we do not want to replace the highly complex DTR and CFC rules with another highly complex set of rules for determining when relief will be given on interest.

I close by referring to the Institute for Fiscal Studies, which carried out an interesting study on the issue:

“There are various ways in which the UK government could seek to recoup any significant amount of revenue lost by replacing the credit system with an exemption system. One suggestion would be to restrict the extent to which interest payments on debt that is used to finance overseas investments could be deducted against profits in the computation of UK corporation tax liabilities, along the lines of interest allocation rules used in the US. Unfortunately, since it is extremely difficult, if not impossible, to determine which particular borrowing funds which particular expenditures, restrictions of this kind run the risk of becoming both complex and arbitrary. It would be difficult to be confident that the combination of an exemption system with interest allocation rules would result in a system that would be significantly simpler than the current credit system. It is also very hard to estimate the net revenue consequences and precisely who the winners and losers would be”.

A well-structured programme of reform and simplification in that area of taxation could have a significant positive impact on the competitiveness of UK plc. In reaching the conclusion on the best option for reform, I hope that the Government will have full regard for the headaches that the current complexity of the DTR and CFC rules cause business, and their negative impact on our competitiveness in the increasingly globalised world economy.

David Gauke (Conservative, South West Hertfordshire)

First, may I reiterate a point made by my hon. Friend the Member for Chipping Barnet about the date of publication of the consultation document on the taxation of foreign profits? I know that there is considerable interest in that document, particularly in the City, and it would be helpful to know when it will be published.

Secondly, may I press the Chief Secretary on whether the clause is merely a clarification of the current law or a change? The reason I ask that question is that when flicking through the explanatory notes I found that such is the insistence that the provision is a clarification and no more that it is difficult not to be suspicious. We are told that the clause confirms that foreign tax

“includes UK tax for which double taxation relief is claimed.”

The explanatory notes go on to state that subsection (2) removes “any doubt” about that particular matter; subsection (3) “removes any doubt”; subsection (5) is a “clarification”; subsection (6) “makes it clear” that a particular point is the case; and finally, the background note states:

“The amendments put it beyond doubt that ‘foreign tax’ in this context includes UK tax.”

Such is the Treasury’s insistence on that point in the explanatory notes that one cannot help but being a little suspicious.

It is particularly important that the measure is a clarification and no more, in part because the commencement is backdated to 6 December 2006—the date of the pre-Budget report. I assume that an announcement of such measures was made at the same time. Given that it is in a sense backdated, it clearly should be a clarification and no more. Will the Chief Secretary confirm that the current law really does intend that UK tax should be treated as foreign tax for those purposes, that the Government are not simply trying to change the law to address a genuine loophole that had not been addressed, and that that is not a new point?

Stephen Timms (Labour, East Ham)

Mr. Gale, I bid you a warm welcome back to the Chair and welcome all Committee members back to a new day of scrutiny.

As the hon. Member for Chipping Barnet rightly said, the clause will introduce changes to section 804ZA of the Income and Corporation Taxes Act 1988. That section is anti-avoidance legislation, introduced in the Finance Act 2005 and aimed at schemes and arrangements designed to increase double taxation relief. Picking up the point made by the hon. Member for South-West Hertfordshire, I confirm that the aim of the measure is to put beyond doubt the issue of what should be regarded as foreign tax for the purposes of the legislation, rather than to introduce a change.

We were confident that the measure in the 2005 Act covered the point, but disclosures made to Her Majesty’s Revenue and Customs have cast some doubt on that—there is clearly doubt in the minds of some people—so the aim of the clause is to put the matter beyond doubt and to remove any uncertainty. HMRC has received disclosures of schemes that purport to avoid the effects of the 2005 legislation on the basis that the tax in respect of which DTR is claimed is UK tax rather than foreign tax. That is the point that the clause will clarify. We have always taken the view that such tax should be regarded as foreign tax and should therefore be included. The clause puts it beyond doubt that, in this context, the term “foreign tax” includes UK tax. It clarifies the fact that any reference to foreign tax in the DTR anti-avoidance legislation includes UK tax, ensuring that the anti-avoidance legislation works as originally intended.

The hon. Member for Chipping Barnet asked me which paragraphs of section 804ZA of the Income and Corporation Taxes Act 1988 are affected by the clause. It will cover section 804ZA as a whole; the booster scheme in question is countered by paragraph 4 of schedule 28AB to the 1988 Act. That may be the particular reference that she was asking about. Quite a number of avoidance schemes have been closed down following the introduction of the 2005 legislation, resulting in considerable tax savings to the Exchequer, so those measures were effective. However, we need the clause to put the original intention of the legislation beyond doubt. It is worth underlining the point that we will continue to challenge robustly any schemes that emerge where, in our view, the 2005 legislation has effect.

The hon. Lady has made the point, and the hon. Member for South-West Hertfordshire also referred to it, that we will be setting out our options for change for the taxation of foreign profits in the near future, and the consultation document will be published shortly. Any changes that may be made will, quite rightly, require extensive consultation and discussion. There will be a lot of interest in the matter and it is important that we get the details right. The change introduced by the clause is needed to put beyond doubt the application of the 2005 targeted anti-avoidance rules. The longer-term reform is a separate exercise and the measure before us cannot wait until the outcome of that review.

I have noted the points that the hon. Member for Chipping Barnet made about the long-term reform of taxation of foreign profits. She asked a number of questions about that consultation, but all I can say at this stage is that she must await publication of the consultation document for the launch of that debate. I am sure that there will be many who advance points of view along the lines of those she set out and others will no doubt have other perspectives to contribute to that debate. I can reassure the Committee that it will not be long before that document appears. Finally, picking up the point correctly made by the hon. Member for South-West Hertfordshire, we published draft legislation along with the pre-Budget report, which is why the changes will take effect from that date. No adverse comments have been received in response, so I commend the clause to the Committee.

Clause 35

Roger Gale (Conservative, North Thanet)

I have taken a look at the scope of the amendments to this clause and I am reasonably satisfied that, given some flexibility from the Chair, it will be possible to cover the stand part issues within the debate on the amendments. I therefore advise the Committee that I probably will not allow a stand part debate on the clause.

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 15, page 26, line 30, after ‘No’, insert

‘qualifying expenditure shall form any part of the residue of qualifying expenditure when a’.

Roger Gale (Conservative, North Thanet)

With this it will be convenientto discuss the following amendments: No. 16, page 26, line 33, after ‘Part,’, insert—

‘(ab) the qualifying expenditure in question is incurred after 21st March 2007 otherwise than pursuantto a relevant pre-commencement contract (seesubsection (7));’.

No. 17, page 26, line 38, leave out ‘before 1st April 2011’.

No. 18, page 26, line 40, leave out subsections (2) and (3).

No. 19, page 27, line 9, after ‘No’, insert

‘qualifying expenditure shall form any part of the residue of qualifying expenditure when a’.

No. 20, page 27, line 10, after ‘if’, insert—

‘(a) the qualifying expenditure in question is incurred after 21st March 2007 otherwise than pursuant to a relevant pre-commencement contract; and

(b) ’.

No. 21, page 27, line 12, leave out subsection (5).

No. 22, page 27, line 16, leave out ‘subsections (4) and (5)’ and insert ‘subsection (4)’.

No. 23, page 27, line 19, leave out ‘before 1st April 2011’.

No. 24, page 27, line 27, at end add—

‘(8) This section shall not come into force unless the Treasury have laid before Parliament a report setting out the impact of the abolition of balancing adjustments and of the agricultural and industrial buildings allowances.’.

No. 183, page 27, line 27, at end add—

‘(8) This section shall not come into force until the Treasury has laid before the House of Commons a report on consultations which it shall undertake with the agriculture and tourism industry within the period of six months from the date of the passing of this Act about the effects on those industries of the provisions of this section.’.

Mark Hoban (Conservative, Fareham)

Welcome to the Chair, Mr. Gale. I am grateful for your guidance on the breadth of the clause, which is just as well, given that my remarks are broad.

The clause marks the start of a long process of reform of the capital allowances system that the Chancellor highlighted in the Budget speech in March. Those reforms are designed to help offset the costs of the reduction—the 2p cut—in corporation tax, which we debated earlier. The clause sets the ball rolling on two particular groups of allowances—for agricultural buildings and for industrial buildings—by withdrawing balancing adjustments in connection with the disposal of qualifying industrial and agricultural buildings, unless that adjustment has taken place within a qualifying enterprise zone or pursuant to the relevant pre-commencement contract.

It is worth highlighting the fact that buildings allowances have been in place since the end of the second world war, when they were introduced to encourage post-war reconstruction and to give businesses an incentive to invest in buildings by enabling, as the law still states, the cost of investment in those buildings to be written off over 25 years, at a rate of 4 per cent. per annum. Those are quite valuable reliefs, and the HMRC website says that the value of claims for both allowances in 2004 was just over £3 billion. Therefore, the Chancellor is embarking on quite a significant reform, at significant cost to taxpayers.

As I said earlier, the clause withdraws balancing adjustments that arise when the proceeds from the sale of an industrial or agricultural building differ from its tax written-down value. Where the proceeds exceed the tax written-down value, there is a recovery of the allowances claimed to date. Where the proceeds are less than the tax written-down value—[Interruption.]

Roger Gale (Conservative, North Thanet)

Order. I have no objection whatever to hon. Members holding private conversations, but would they go outside if they want to do so?

Mark Hoban (Conservative, Fareham)

Thank you, Mr. Gale.

Stephen Hesford (Labour, Wirral West)

The hon. Gentleman mentioned the second world war. Does he agree that the economy has changed slightly since that time, as commercial buildings are at least as important to the economy these days, if not more so, than agricultural and industrial buildings, and it is about time that we modernised our economy? Is not that proposal part of such a measure?

Mark Hoban (Conservative, Fareham)

No one can escape the fact that the economy has changed somewhat since the end of the second world war. As I drive around the country, I see new industrial buildings springing up to house distribution centres and meet the needs of the growing retail sector. The leisure sector is becoming increasingly important as a source of employment in the economy, and I will come on to the way in which those changes affect that sector in particular. I agree in part that modernisation is needed to allow for the changing economy, but that does not mean that industrial buildings are redundant. They are still an important part of the productive and service sectors of the economy.

Notwithstanding that, the Chancellor announced a reduction in the rate of the industrial buildings allowance, so that it will be zero by 2011-12 and there will be no allowance for businesses to claim on industrial or agricultural buildings. As you might anticipate, Mr. Gale, that has caused concerns among various industry groups, which fall under four headings. The first is the lack of proper consultation on the change. It is a significant change because the value of the allowances is just over £3 billion.

I spoke to a senior tax adviser before the Budget and asked whether he thought that it would make any significant reforms to capital allowances. He replied, “No, it would not be possible, because the Government would have to consult first.” The reality is that the Government have not consulted on the scale and depth of the changes. It is worth looking at the remarks of the British Property Federation:

“The proposed changes are inconsistent with previous government policy statements. In December 2004, the government issued a consultation document on capital allowances and the conclusions from the consultation were announced in the December 2005 Pre Budget Report. The conclusions were that there were no current plans to take forward proposed reforms on a partial schedular system or the taxation of capital assets, but continue to consider the scope for the modemisation of capital allowances.”

The summary of the responses in paragraph 14 said:

“There was general support for a commercial buildings allowance, incorporating the current Industrial, Hotel and Agricultural Buildings Allowances.”

Paragraph 15 said of the consultation:

“Respondents indicated their dissatisfaction with the current IBA regime pointing towards the compliance costs involved and the shortcomings of a system which did not recognise the actual cost incurred when determining the level of allowances available.”

It appears from the consultation on which the Government embarked that there was widespread support for the continuation of IBAs and agricultural business allowances, which were seen as an important part of setting the costs of capital investment in property.

The second concern about the reforms goes back to the Chancellor’s announcement about the broader reforms of capital allowances and the fact that there should be a move to align more closely the writing-down allowances with the economic rate of depreciation on capital assets. Changes in subsequent years will reduce the writing-down allowance on plans from 25 per cent. to 20 per cent. per annum to reflect the change in the accounting charge that most businesses incur in relation to the depreciation of assets.

We are discussing something slightly different. Under FRS 15, most businesses make a depreciation charge against property. That is a change from the previous accounting regime, SAP 12, under which it was common practice not to charge depreciation. The overall package aligns accounting rates and the tax rates for plant and machinery, but there is a divergence from that policy in respect of property: the Government are abolishing the writing-down allowances, but businesses charge depreciation on property in their accounts.

The third worry that has been expressed most widely concerns the retrospective nature of the measure. Investment decisions taken 24 years ago when people expected to be able to claim industrial buildings allowance and ABAs are now called into doubt. Such decisions about investment were made on the assumption that they would receive capital allowances, yet capital allowances will be withdrawn over the next three or four years. That causes great concern to people whose investment plans were predicated on the basis that capital allowances would be available on their property. The fourth point concerns the impact on the profitability of a number of UK business sectors.

Brooks Newmark (Conservative, Braintree)

My hon. Friend might wish to consider the point made by the National Farmers Union. Farmers in my constituency consider that the phasing out of the agricultural business allowance will be a clear disincentive to upgrade and improve their facilities.

Mark Hoban (Conservative, Fareham)

My hon. Friend has just beaten me by a few paragraphs to the impact that such a measure will have on the farming community. He has highlighted the fourth worry, which is how the changes will have an impact on different sectors of the economy, of which agriculture is one. Another is the leisure sector, to which the hon. Member for Wirral, West referred. The small companies sector, too, will be particularly affected, as I shall explain later.

It is worth reflecting on some of the more general comments that have been made about the changes. The Tax Journal states:

“The removal of IBAs will affect not merely owners of traditional industrial buildings but many utilities and transport companies.”

It refers to the hotel sector and says that it is capital intensive. It argues that the economic case for the change would undoubtedly be more convincing if some measure of depreciation were allowed for buildings themselves.

John Whiting of PricewaterhouseCoopers, a well known commentator on tax matters, has said:

“Whilst there have been calls for years to rationalise the allowances on buildings, to deny any allowance seems perverse—property does depreciate. The transition is far too short: financing arrangements just set up on the basis of 25 years of hotel, industrial or agricultural allowances will now receive as little as 10 per cent. of the expected allowances.”

In addition, Property Taxation said:

“Property is generally the second highest area of business expenditure besides salaries and so all UK businesses will feel the brunt of these changes. Many will no doubt choose, in due course, to pass on to their customers the ultimate costs incurred through loss or reduction of allowances as proposed in the Budget.”

Clearly, there is widespread concern from business and tax commentators about the impact that removal of the allowances will have on the economy as a whole. However, let me address some of the specific sectors that will have an issue with the change. The tourism industry is the UK’s seventh largest industry, generating £17 billion per annum in export earnings and employing more than 2 million people. Bob Cotton, chief executive of the British Hospitality Association, has said that the association

“believes that the Chancellor’s decision will discourage investment at a time when there is more pressure than ever to build new quality hotels and restaurants, to add extra rooms and to upgrade facilities generally.”

He added that the association has

“one member who, with a £3 million extension to his hotel, would have been allowed to claim tax relief over the next three years alone on nearly £1.2m of the costs. Under the new proposals, his tax relief will be reduced by as much as £600,000 or possibly even more.”

It is not just hotels that are affected; every hospitality company that wants to expand will be affected too.

Rob Marris (Labour, Wolverhampton South West)

If the hon. Gentleman accepts—although he might not—that a regime that is 60 years old is somewhat outdated, surely the time to change it is when the sector is buoyant and not when it is depressed.

Mark Hoban (Conservative, Fareham)

The very same argument was deployed by the Chancellor back in 1997 when he made his tax grab on pension funds. He said that it was fine, because the sector was buoyant, but we know what happened—the pension sector declined as a consequence of the tax grab. So the argument does not constitute a particularly robust support for the Government’s proposed changes. I know that you would not wish me to be tempted down the tax dividend route, Mr. Gale, so I shall return to the impact of the proposed changes on particular sectors.

Graham Gross is the chairman of the British Hospitality Association. He is from the west country and he owns two hotels there. In a letter, he has said:

“As a result of the Budget, the extension to the Thurlestone will not go ahead as we were planning and we will have to severely curtail our plans to develop the Mullion Cove.

At a time when the hotel industry is being urged to refurbish its facilities and build new units to meet international competition and growing customer sophistication the consequences of the Chancellor’s Budget will be felt for many years into the future.”

That shows that the tourist sector is already having to adjust to the Chancellor’s changes. When we deal with amendment No. 24 I shall address some of the things that the Chancellor should perhaps be thinking about before proceeding to implement the regime.

My hon. Friend the Member for Braintree mentioned the plight of farmers. The NFU has been very vocal in its comments on the proposals and has pointed out that most of the assets that qualify for the agricultural buildings allowance—steel barns, structural parts of dairy sheds, and poultry and pig houses—have limited useful economic lives and are depreciating assets. Notwithstanding that, they will not benefit from the allowance.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

Does the hon. Gentleman share my concern that there might be a disproportionately negative effect on smaller farmers, who are exactly the farmers who might look to diversify into other industries and who might also be hit by the increases in the corporation tax rate for small businesses?

Mark Hoban (Conservative, Fareham)

Indeed. The hon. Lady makes an important point about the interaction of the reforms with other Finance Bill proposals that we have already debated. I shall address that later, because it is important to understand the impact that will be felt by different sized businesses that are subject to different tax regimes.

The NFU said that

“it is unjust simply to withdraw relief completely on expenditure already incurred. It is clear that the phasing out of ABAs will result in a significant loss of relief over what would have been the remaining tax lives of qualifying assets.”

One accountant in the south-east told the NFU that his firm’s larger clients currently have unrelieved balances totalling £12.5 million. That is a significant amount of tax relief that farmers felt would be due to them in the future that they will now no longer receive. If they seek to sell one of their agricultural assets when clause 35 comes into effect, they will not even receive the balance of the adjustment on that sale.

Therefore, there are concerns in the farming sector. In Oxfordshire, one accountant produced examples of a range of clients who currently have ABA balances ranging from £814,000 to £4.2 million. Those are significant sums for individuals working in the agricultural sector.

I come now to the argument of the hon. Member for Falmouth and Camborne. The Government have argued that the reform of capital balances, the abolition of balance adjustments and the phased withdrawals of IBAs and ABAs will fund the corporation tax cut that they announced at the time of the Budget; the 2p reduction in the headline rate. One can accept the loose argument that the reductions in one area will be funded by increases in tax in another, and that there will be winners and losers. There is a logic to that. However, as the hon. Lady points out, a problem arises for small companies; they will lose the historic tax balances that they would have received relief on and, in addition, will have to pay a higher corporation tax rate themselves. Therefore, there is a double whammy there. They will not be able to receive the benefit of tax relief on investment already incurred and they will have to pay the higher corporation tax rate as the Chancellor proposed in the Budget.

Mr. Gale, if you owned industrial property—and I do not know whether you do—you would see the loss of IBAs and ABAs but would not receive compensatory reduction in your tax rate as a consequence. The only people who seem to be potentially net in balance will be those companies paying the main rate of corporation tax. The small company sector will want from the Chief Secretary some acknowledgment of the impact that that will have on the sector when taken in conjunction with other changes to the tax system.

Amendments Nos. 15 to 23 are designed to achieve a degree of grandfathering for expenditure already incurred, or contracted to be incurred prior to the Budget. That means that, where there is a disposal, they will still be eligible for a balancing adjustment. That reflects the concern over the retrospective nature of the changes. It is worth remembering that there is a precedent for grandfathering in this area. When the industrial buildings allowances were increased from 2 per cent. to 4 per cent., only new investment qualified for the 4 per cent. rate. Therefore, when Governments have made changes on IBAs and ABAs in the past, they have thought about the issue and taken it into account. They differentiated between past and future investment.

In Amendment No. 24, and I think in Amendment No. 183 tabled by the hon. Member for Falmouth and Camborne, we ask the Treasury to lay before Parliament a report setting out the impact of the abolition of balancing charges, in particular in the abolition of IBAs and ABAs more generally. As Committee members on both sides will acknowledge, there are legitimate concerns about the impact that the abolition of IBAs and ABAs will have on those sectors that are heavily dependent on capital investment for their business. It is important that that analysis is made available by the Treasury and that it is able to work through that process more speedily. These issues would have emerged more properly through a process of consultation. Although the Government have often been congratulated on carrying out proper consultation in other areas—I will congratulate them myself later for that—it is a pity that we have a major change here that has really been introduced without proper consultation.

In conclusion, these amendments would provide protection for past investment and would also provide the Government with some time to think about the impact of the changes on property-intensive businesses such as tourism, leisure and agriculture. They would also give the Government the opportunity to think carefully about the impact of the changes on different types of business, whether they are small companies or larger businesses. I think that it is perhaps small companies that will have a great deal to lose from the abolition of these allowances, as they do not have the compensatory reduction in the corporation tax rate.

The Government have embarked on a major reform without carefully thinking through the consequences for different groups. By accepting amendment No. 24, the Government would create some room for manoeuvre and give them the opportunity to think again about the clause and how it might affect different businesses.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

It is a pleasure to welcome you to the Chair this morning, Mr. Gale.

As we have heard in the remarks made by the hon. Member for Fareham, the clause is the first part of proposals announced in the Budget to abolish the IBAs and ABAs as part of the wider package of reform of the capital allowance system. If one examines the timetable, the clause eliminates balancing adjustments but allows the existing writing-down allowance to continue. Then, in subsequent years—presumably we can expect legislation in next year’s Finance Bill—we will see the rate of allowance cut down from 75 per cent. ultimately to zero.

This package of reform has been portrayed as a balanced package and ultimately it may well be a balanced package. However, the difficulty for many businesses is working out how all these changes that they have heard about will interact with one another, and determining at what point they may benefit and at what point there may be significant difficulties or disbenefits for them.

We see a headline reduction in the rate of corporation tax, which will not benefit small businesses; instead, they will see an increase. Although such businesses may benefit from an annual investment allowance next year, in the meantime, they must work out what the impact will be. They are left with this huge package of change, which, as we have heard, there has not been much consultation about, and the wash of all these different decisions will affect different businesses in different ways. I have received representations from businesses that feel that they will be negatively affected, but I am sure that there are many other businesses that simply will not have any idea about how all these measures will interact with one another.

Of course, these changes will have an impact on future decisions, but they will also have an effect on areas where decisions have already been taken and investment has already been made. There will be significant changes to things that businesses have already set down in their budgets.

We have already heard about the concern over the lack of consultation. The Institute of Chartered Accountants in England and Wales recognised that this was a balanced package, but it said:

“Such a major change to the capital allowances rules should have been exposed beforehand for detailed consultation. We appreciate that reform of the capital allowances rules was mooted as part of the wider package of corporation tax reforms but no firm proposals were discussed and we think that most respondents thought it was a bad idea.”

The Chartered Institute of Taxation said:

“We welcome the extent of prior notice of future changes, although consultation would have been preferable.”

That brings us to an issue that has been raised by the Liberal Democrats on previous occasions. In some aspects of this Bill, we see that there has been detailed consultation that has resulted in widely welcomed proposals that are largely uncontroversial; in other areas of the Bill, we see that changes are being put forward unannounced and there is no opportunity for some kind of consultation before we have to debate those changes, either on the Floor of the House or in Committee. It is another example of how a limited, formal consultation procedure would assist our ability to go through the Bill and give it detailed scrutiny.

My concern is whether the Government have fully thought through the changes’ impact not only on businesses but on Her Majesty’s Revenue and Customs. Has a regulatory impact assessment been undertaken? Presumably, it must have formed the basis for the Red Book predictions of how much revenue the changes would generate for the Exchequer. There may be a regulatory impact assessment, but I have not seen one, so I should appreciate the Minister’s comments on whether one exists. Have the Government considered the differential impact of the changes on various sectors?

In amendments Nos. 24 and 183, we are trying to tease out what sizes of business and which sectors will be most disadvantaged by the changes. We have heard that tourism, agriculture and industrial building are among them. Has a regulatory impact assessment been undertaken, and will it be made available for Parliament to see on what basis the decisions were made?

The Chartered Institute of Taxation has raised concerns about whether businesses will end up re-categorising integral fixtures and plants. Before, it did not matter how such things were categorised, but now it will make a difference. The CIT said in its representation:

“Until now, the split of costs between buildings, plant and fixtures did not affect the sum of the long-term allowances given. However, the change, because it is to apply to existing buildings, might result in many companies that own industrial or agricultural buildings deciding to review open tax returns with a view to re-categorising integral fixtures or plants previously included as part of the building costs, as fixtures and fittings. If this were to occur, it would result in additional administration for those businesses and for HMRC. There is also the possibility of error or mistake in claims being made for earlier years.”

Stewart Hosie (Scottish National Party, Dundee East)

The hon. Lady will know that the guidelines on fixtures and fittings, plants and machinery are very well defined. If people try to redefine them, does she see the possibility of a new avoidance industry which we will have to tackle in two or three years’ time?

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

That may well be a problem. We shall revisit the issue in future Finance Bills to tackle the potential for avoidance. Again, I should like the Minister’s comments on whether the Government anticipate any such changes in behaviour, and what additional burden it might represent for Revenue and Customs.

I shall give some examples of the businesses that have contacted my colleagues and me, to demonstrate how they feel they will be adversely affected. The hon. Member for Fareham commented on examples from the tourism industry of how decisions to invest will be affected by the changes proposed in the clause, but I shall give an example relating to my earlier intervention.

A farm in my constituency has diversified into cheese production. It is a small farm struggling to get by. It was one of the first farms to benefit from a European objective 1 grant application, which resulted in the extension of the dairy. The farm already benefits from the agricultural buildings allowance, but has recently made a decision to make a significant investment in a dairy for cheese production, which has an IBA residue of more than £300,000.

The decision was made in good faith. It has resulted in the creation of jobs, is supporting the agricultural industry and is helping to develop one of the most underperforming economies in the country, but money that the farm could have reinvested will now be paid to the taxman. Unfortunately, the farm is a small enough business that it will not benefit from the higher rate of corporation tax—its corporation tax will increase. The farmers will be all-out losers.

Cornwall is one county among many that consists largely of smaller businesses. It has a lot of industrial buildings and small-scale businesses, whether agricultural or industrial. Its people will mostly lose out. I am interested to know whether any assessment has been made of the differential impact in terms of geography on places where there might be large numbers of smaller businesses.

At the other end of the country, my hon. Friend the Member for Orkney and Shetland (Mr. Carmichael) has written to me about Lerwick’s port authority, the deputy chief executive of which wrote to him to raise huge concerns about the changes to the industrial buildings allowance. She said:

“For 2006, Lerwick Port Authority has IBA’s of £680,000 resulting in a corporation tax saving of £204,000 (30 per cent.). The abolition of this is very detrimental—even on current projects the additional corporation tax due over 25 years is immense. More worryingly, the capital investment programme we have for developing the port will be affected”.

That, too, chimes with the hon. Gentleman’s comments. We are concerned about the impact on investment decisions that have already been made, and how the change will affect future investment decisions in the tourism industry and other sectors all over the country.

Many companies either fear that they will lose out or have not yet been able to get a handle on how this package of reform will ultimately affect them. Some are part of the way through the change process; others do not know what will happen at the end of it. I hope that the Minister will respond to my questions by reassuring those companies that the Treasury fully understands the cross-cutting effects of the range of changes.

Adam Afriyie (Conservative, Windsor)

The clause concerns the short-term phased removal of agricultural and industrial buildings tax incentives, which were designed to encourage the building of such buildings. It amends parts 3 and 4 of the Capital Allowances Act 2001. I would welcome the simplification of capital tax allowances if that were the sole purpose of the measure. Certainly, an alignment of all sorts of allowances throughout the economy and business taxation to coincide with a simple, straight-line depreciation method would be an understandable manoeuvre; it would be a simplification.

Given that we all accept that it is clear that the economy has changed since the second world war, it would be understandable if we were to review the incentivising of the building of agricultural and industrial buildings. However, it seems that the Government have, to a degree, misled investors. It is a bit like offering somebody a chair and then, as they position themselves to sit down, pulling it away. The agricultural sector, hoteliers and the industrial sector—manufacturing companies—have been working on the basis that the allowances would continue for 25 years, and have made decisions intended to last for that period. All of a sudden, the Government have changed direction and said, “Actually, we are removing those allowances,” but have not compensated them in some other way. Indeed, as the hon. Lady pointed out, not only are the allowances being removed, but the changes disproportionately affect smaller businesses. They face the corporation tax increase over the next two or three years and they are also having their allowances taken away. A pincer movement is being made on smaller businesses, smaller agricultural businesses, hoteliers and, in particular, manufacturers.

Rob Marris (Labour, Wolverhampton South West)

May I gently remind the hon. Gentleman that the Government that I suspect he supported did exactly the same thing in 1984 when I was taking out a mortgage? They got rid of life assurance premium relief and subsequently ran down mortgage interest relief at source over the 25 years of my mortgage.

Adam Afriyie (Conservative, Windsor)

There is the old adage that two wrongs do not make a right. I am not arguing that past bad decisions should persist into the future, but I would argue that businesses have had a clear framework—they have had the certainty that if they make investments for 25 years, the writing-down allowances will be available for that period. Then, all of a sudden, the rug has been pulled and people who purchased buildings only two or three years ago find that their reliefs have disappeared.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

Very small businesses might in future benefit from the annual investment allowance. However, their concern is that that still has no effect on past decisions to invest.

Adam Afriyie (Conservative, Windsor)

That is precisely my point. All hon. Members, not just those on the Conservative and Liberal Democrat Benches, must become very nervous whenever there is retroactive legislation, particularly on taxation, unless it is to close tax loopholes.

Edward Balls (Labour, Normanton)

Just to clarify the matter, we are anxious to point out the extent of the Opposition’s expenditure commitments. The hon. Gentleman said that the abolition of MIRAS—mortgage interest relief at source—and tax relief on life assurance was wrong. He said that two wrongs do not make a right; it was the wrong thing to do to abolish those tax reliefs.

Adam Afriyie (Conservative, Windsor)

That was a lovely schoolboy trick, but it is well outside the scope of our discussions. I was making a general observation that any retroactive tax legislation needs to be considered very carefully. I will not rise to the Economic Secretary’s schoolboy remark.

Brooks Newmark (Conservative, Braintree)

There is a more serious point that follows from my hon. Friend’s remark—that the retroactive legislation is saving the Government £3 billion, which will plug a £3 billion black hole in their finances.

Adam Afriyie (Conservative, Windsor)

My hon. Friend pre-empts me wonderfully, as he made exactly the point that I was coming to—that the Government are clearly in some difficulty because of their tax-and-spend attitude. They gave a reduction in corporation tax to large businesses, but they are now having to scrabble around to pull back the tax take from smaller businesses and businesses that felt there was a certainty in their investment framework. I am not comfortable with that behaviour.

My observation, to which the Chief Secretary may wish to respond, is that if the proposal was not designed as a tax-raising measure—a retrospective tax-raising measure to a large degree—why not allow the balances to be paid up front? Why not give businesses an option? If there are 10 years to run at 4 per cent., for example, on an agricultural or industrial building, the business can claim a 40 per cent. allowance. Why not just say, “It is your choice. You can either have 20 per cent. now or let it run.” If this is not purely a tax-raising measure, largely on smaller businesses, why not give them the option to take a larger amount or to have more of the allowances reclaimable? In that way, businesses which, without a shadow of a doubt, will be struggling, will have an option to do something different in the short or longer term. They may decide that they would rather continue taking the allowances for the next 10 years, but they may decide to take a lower amount of tax rebate now.

It appears that the Government have duped farmers, hoteliers and manufacturers, and then pulled away from the behaviour they were encouraging. I do not disagree with the argument that the investment environment probably needs to change; it is a fair point that we may not require more agricultural buildings, but if that is the case, why not announce that two or three years from now the allowances will disappear completely and enable those who are already claiming them to continue to do so until the end of the period?

I have two key questions for the Chief Secretary. First, why was there no consultation on this scheme when there was plenty on tax-avoidance schemes? Secondly, on tax allowances for the music industry, there are new, first-year capital allowances for new investment over a single-year period. What certainty is there that the Chancellor will not withdraw those allowances? If the Government are prepared to withdraw what I argue is a stabilising allowance for investment in the agricultural and industrial building sectors, what confidence can businesses have that the new allowances, which as yet are not clearly defined, will remain? Or are they going to offer single-year allowances and then withdraw those to rake in even more money for the Exchequer, in order to fill that black hole of several billion pounds that has been created over recent years?

Brooks Newmark (Conservative, Braintree)

I had assumed that we had finished the section of the Bill on anti-avoidance, and I would like to hear the Chief Secretary’s justification for the surprise with which this move has been greeted by those sectors that it affects. My hon. Friend the Member for Fareham alluded to two of them—the British Hospitality Association and the NFU. Given that the capital allowances referred to in clause 35 influence long-term investment decisions, it would not have been difficult for the Chancellor to consult—the point that my hon. Friend the Member for Windsor was pressing—and to give fair warning of these changes. After all, the Chancellor has had 11 Budgets in which to do so.

If I were cynical, I might be tempted to think that clause 35 has less to do with beginning to correct an anachronism within the capital allowance regime than it has to do with propping up the Government’s balance sheet to the tune of £3.042 billion in forgone revenue. The Government have justified the clause as the first step in the process of withdrawing the industrial buildings allowance and agriculture buildings allowance in order to prevent some businesses from obtaining an unfair or arbitrary tax advantage. However, the Chartered Institute of Taxation had to perform gymnastics to determine if any advantage might be possible. Try as it might, it could not find one that could be considered as unfair. Perhaps the Chief Secretary could give us some examples of the unfair or arbitrary situations that are intended to be caught by the clause.

On the wider issues raised by the Government’s interference with the capital allowances regime, there seems to be a number of flawed assumptions at play here, the worst of which is the fiction that industrial and agricultural buildings do not depreciate and should not therefore qualify for a writing-down allowance. Budget note 7 referred to the industrial buildings allowance and agricultural buildings allowance as “outdated and unjustified distortions.” As alternatives, the Red Book has “longstanding and unjustified”, as well as “distortive”, which I cannot help thinking is something of a distortion in itself. Nevertheless, that is fairly scathing language to describe what are admittedly well established and even venerable capital allowances. Whatever their provenance, the IBA and ABA reflect the fact that industrial and agricultural buildings depreciate. I say that that is a fact, but if I am wrong, I hope that the Chief Secretary will correct me for the record.

I represent a constituency that is largely rural, in which many people will be hard hit by the withdrawal of these allowances. If I were to suggest to a farmer in my constituency that his working buildings did not depreciate, as he thought they had for so many years on the basis of good empirical evidence of seeing them rusting or collapsing in front of him, I suspect that he would not be impressed by my argument. If I were to say that his buildings were appreciating in the manner of houses in Connaught square or the eco-homes in Gallions Park, he would laugh at me.

Agricultural buildings are worked hard and they have a useful life, after which they are replaced. That is the reason for the straight-line basis of the write-down over 25 years. Farmers are not going to be able to sell, say, an 18-year-old cowshed at a profit, on the basis of the appreciation of either the structure itself, or in the vast majority of cases, the land on which it stands. Those buildings depreciate from the day that they go up to the day that they are pulled down or replaced.

Adam Afriyie (Conservative, Windsor)

If I understand my hon. Friend correctly, is he saying not only that the Government were wrong about the IBA and the ABA but that they have cut off any route for taking into account appreciation in writing down these assets?

Brooks Newmark (Conservative, Braintree)

The Government have done that by removing that opportunity that my hon. Friend referred to in his speech. The image he used was of pulling the rug from under them. The clause is explained away in terms of removing an unjustified distortion, but the distortion accounts for a difference between a certain kind of working building and other commercial property. I want to explore that distinction a little further.

The Red Book claims in paragraph 2.38 that the IBA, and presumably by extension the ABA, is poorly focused and a historical anomaly. This lack of focus seems to derive from the Government’s inability to engage with the difference between commercial property, which might in the ordinary course of events be expected to appreciate, and agricultural property for which the opposite is usually true.

I can imagine the thinking in the Treasury when this idea cropped up. Sitting in the impressive new office building at 1 Horse Guards road it would have been easy to envisage the steady and inevitable appreciation of commercial property and to question why any special allowance for depreciation should be made for agricultural or industrial property. Likewise if this Committee had been sitting over the road in Portcullis House, we would have another example of a building that ought not to depreciate throughout its designed lifespan of in excess of 125 years. But commercial real estate in central London is worlds away from the cowsheds and pigpens in Essex and worlds away from the businesses that rely on the capital allowances hit by clause 35.

The Government have rolled these things together on the spurious grounds that they all involve, as the Red Book would have it, “land and buildings”. That is not robust reasoning. Rather than trying to tighten the focus to correct any potential inequity, the Government have simply charged in. I would say that they have gone like a bull at the gate but I do not think that anything as rural as that occurred to Ministers when they looked at this issue. If the distinction between the buildings that are likely to depreciate and those that are not needs to be tightened up, so be it. I would not disagree with that, but it should be tightened up after proper consultation and reporting has taken place.

I have two further brief comments to make. The first concerns the constant injunction that we should look at all of the Chancellor’s measures in the round or as part of a balanced package. What that really means is the process by which a tax-cutting budget is revealed as a tax-conning budget, but we should not stray too far from what we are talking about.

I share the concerns of my hon. Friend the Member for Fareham that small businesses and unincorporated businesses will not benefit from the 2 per cent. cut in the headline rate of corporation tax that sits in the balance against the withdrawal of IBA and ABA. What concerns me more than that is that the detailed shape of the whole package on capital allowance has yet to appear.

The Chancellor is withdrawing balancing adjustments and the recalculation of writing-down allowances now, but is also dithering over bits and pieces of the package that will appear in future Finance Bills. I suppose that once the Secretary of State for Trade and Industry is installed in No. 11, the case for industrial buildings allowance might conceivably be looked at again, but I doubt very much that the Secretary of State for Environment, Food and Rural Affairs will be able to effect a positive outcome for the farmers.

Rob Marris (Labour, Wolverhampton South West)

Could the hon. Gentleman explain what the effect of withdrawing balancing adjustments would be?

Brooks Newmark (Conservative, Braintree)

The effect of withdrawing the balancing adjustments will have the knock-on effect that we are talking about here. That is the removal of capital allowances and, to use my hon. Friend’s analogy again, pulling the rug from those businesses that have made certain assumptions about their cash flows in respect of commercial or agricultural buildings. It would be preferable to defer the beginning of this process until after the detailed study called for in amendment No. 24 has been undertaken.

My final point concerns one piece of the future package: the rate of writing down allowances for certain fixtures that are integral to a building. That raises the spectre of a raft of artificial manipulations in respect of what constitutes an integral fixture for accounting purposes. Paul Howard, a senior tax consultant with Chiltern plc, has said:

“You could always claim capital allowances on fixtures, but I suspect they will ring fence the definitions to restrict what you can claim as integral...This could make buildings and capital allowances more complicated than they already are.”

In other words, the prospective changes open the door to error, complexity and artificial manipulations. Rather than shutting the stable door after the horse has bolted, or indeed after the stable door has been reclassified as a plant, will the Chief Secretary give some indication of the Treasury’s thinking on this issue and the scheme set out in Budget note 2? Better still, will he agree to amendment No. 24, so he can set out his thoughts and listen to others at greater length?

James Duddridge (Conservative, Rochford and Southend East)

The bigger the tax grab, the less innocuous its title. If one were sat in the Treasury wanting subtly to plug a black hole with a large amount of money, one would choose something that sounded quite verbose and not very exact and would probably make it an acronym. In fact, that has been done with ABA and IBA. One would also try to disguise what was actually going on. In respect of the ABA—the agricultural buildings allowance—one would say, “Agricultural buildings allowance? The farming sector’s only 1 per cent. of GDP, so this must be about a small section of the economy.” However, the measure involves industry as well, in respect of industrial estates and property, and so forth, which is a significant, but not massive, part of our economy. The definition of industrial property covers not just farming, but all industry. We have received submissions from various sectors, including hotels, transport, distribution and tourism. It is effectively a tax grab from everyone, and a huge one at that. I had to re-read briefs several times to confirm that the figure of £3 billion was correct. That is an enormous sum.

A number of colleagues mentioned certain items: my hon. Friend the Member for Windsor talked about a chair and my hon. Friend the Member for Braintree spoke of a rug. Retrospective legislation is truly appalling—in the sense of carpets, that is, as mentioned by the hon. Member for Braintree, who is looking at me—and the issue of retrospection is critical in my assessment of the relevant clauses and the Bill.

Adam Afriyie (Conservative, Windsor)

The Chief Secretary may argue that the writing-down allowances are contained in clause 36. However, if a small or medium-sized business has invested in a building for the long term, that is its biggest capital expenditure, and their allowances will be cut off. It is incredibly unlikely that the first-year allowances will apply to any great degree.

James Duddridge (Conservative, Rochford and Southend East)

My hon. Friend is right. It is not only that business about which I am concerned, but the broader message that this measure is sending to entrepreneurs, which is that they cannot look at the present tax system with any certainty and know it will not be changed overnight, retrospectively in the Budget by the Government, effectively reducing capital investment in the United Kingdom, taking away business and jobs from the UK and removing in the longer term the absolute level of tax brought in to be spent on public services.

My hon. Friend the Member for Ludlow, whose constituency is rural in parts, unfortunately cannot be with us today. However, he was passed some information from a chartered accountant who specialises in the farming sector in Herefordshire. Mr. James Hutchinson of the Hutchinson partnership wrote to him and estimated that based on his client base, changes to the agricultural buildings allowance would lead to an effective tax increase of 8.5 per cent. for farmers. I specifically want to understand what the Chief Secretary’s assessment is of that and what advice he has received on it.

My constituency has one or two farms, but it is not largely a farming area. However, having visited those farms I realise that far from farmers being rich—the impression one might occasionally get from television programmes—they are instead suffering. It is ironic—I hope that I shall not be ruled out of order if I present the broader picture of what is happening in farming—that Europe and the Government are giving with one hand, by way of the common agricultural policy, while increasing taxation with the other. That seems completely inconsistent.

The chartered accountants’ letter points out, with no sense of irony, that

“the detail is not always apparent immediately”

from the Budget. That is a consistent theme of our debates, particularly in terms of these amendments and the substance of the legislation. The letter mentions the retrospective effect of the legislation and considers its likely impact on the client base of Mr. Hutchinson’s firm. I admit that that is only one example, but given that the Government have not done a systematic impact assessment, because they have not gone through a proper consultation, we are reliant on anecdotal examples. However, the firm does specialise in agriculture. Over the next four years, the firm’s client base will be left with £6.4 million of unused allowances that they would otherwise have had. That seems totally and utterly unfair.

Stewart Hosie (Scottish National Party, Dundee East)

The hon. Gentleman mentions the impact of the provisions. Does he think that it is perverse they will have an impact on low-margin sectors, such as agriculture and tourism? Does he believe that the law of unintended consequences will apply? When people consider the cost, there will be fewer new entrants to the agricultural sector. Tourism businesses that have been pressurised to invest and up their quality will no longer be able to do so. At a time when manufacturing industry in particular is being encouraged to invest to compete, it will be unable to do so because the forecasted financial plans will be thrown into turmoil.

James Duddridge (Conservative, Rochford and Southend East)

The hon. Gentleman is absolutely right. My constituency might be a long way from his patch, but there are further contradictions within the Thames Gateway area, where the Government are encouraging investment—this type of expenditure—prior to the 2012 Olympics. The Bill does not fit within the thrust of what they are trying to achieve.

The Government’s changes are bad. They are not transparent, and they represent an enormous £3 billion tax increase.

David Gauke (Conservative, South West Hertfordshire)

I add my voice to those who have expressed concern about the lack of consultation. A number of hon. Members raised that point and questioned why something that has been described as the biggest reform of business taxes since the mid-1980s has been undertaken with little or no consultation. I venture to suggest that the answer is that the Government have been slow to realise that the corporation tax rate was becoming increasingly uncompetitive. Other jurisdictions have been reducing their rates and the Government have been under pressure—not least from the Opposition. In an attempt to respond, they have hurriedly sought to reduce corporation tax and to pay for the reduction by reducing allowances.

I am not sure that I would disagree with that as a general policy direction. As the Chief Secretary said, the corporation tax rate is, in itself, an important point, as well as the overall burden of taxation. However, that suggests that the Treasury perhaps took its eye off the ball on corporation tax and business taxes as a whole. Hence, we have this rather hurried proposal, with all the disadvantages that hon. Members set out.

I want to return to two points that I raised on Second Reading. The first relates to the impact on major infrastructure projects, including the Olympics. The reason why I raised that was because of the evidence that the Select Committee on the Treasury received from, among others, John Whiting of PricewaterhouseCoopers, to whom my hon. Friend the Member for Fareham referred. In John Whiting’s oral evidence to the Select Committee, he identified those who will lose as a consequence of the proposals set out in the Budget. That will include:

“somebody in long-term property infrastructure including some very prominent projects that are around at the moment where commitments have been made on the assumption that allowances are going to come in over 20-25 years and suddenly they are not.”

When Mr. Whiting was referring to

“some very prominent projects that are around at the moment”,

I think that he was referring to the Olympics.

The Financial Secretary was good enough to respond to me on that particular point when he wound up the Second Reading debate. He stated that

“the changes to capital allowances have a largely temporary timing effect. Those will be more than outweighed by the dominant effect of the cut in the main rate that the Bill and Budget introduce.”—[Official Report, 23 April 2007; Vol. 459, c. 758.]

As a number of hon. Members pointed out, the cut in the main rate obviously only applies to those companies that pay mainstream corporation tax rate. It will not apply to small businesses.

I am not an accountant, but I would also question the claim that the changes to capital allowances have a largely temporary timing effect. They are clearly substantial raisers of revenue and if they are substantial raisers of revenue, presumably somebody is paying that revenue, or at least not claiming allowances of some description.

Mark Hoban (Conservative, Fareham)

Perhaps I can illuminate my hon. Friend on his point about temporary timing differences, and I say that as an accountant. If the Government varied the rate of capital allowances, that would accelerate or decelerate the rate at which that expenditure is recognised for tax purposes. Where an allowance is abolished and not replaced, there is a permanent loss of tax relief. So the changes in the subsequent clause accelerate capital allowances. The changes that we have debated in this clause—in subsequent years, we are talking about the abolition of IBAs—will lead to the permanent elimination of that tax relief.

David Gauke (Conservative, South West Hertfordshire)

I am extremely grateful to my hon. Friend for clarifying that—or at least it will perhaps be clarified in my own mind when I carefully read his contribution in the Official Report subsequently. For those who understand these matters, I suspect that that was a very useful contribution.

I would be grateful if the Chief Secretary agrees with my hon. Friend’s comments and further explains whether the changes announced in the Budget and contained in the Finance Bill could have a detrimental effect with regard to the Olympics and cause an additional cost as far as they are concerned. I am obviously conscious that the Chief Secretary follows these matters closely from a constituency point of view. If he is able to shed any light on them and on the concerns raised by John Whiting and others, I would be grateful.

The second point that I raised on Second Reading, which the Financial Secretary did not pick up on his closing remarks, related to the impact on certain private finance initiative projects. I raise this matter rather tentatively because I have only heard it discussed anecdotally, but there is a concern that some of the PFI projects that the Government have entered into in recent years contain clauses whereby changes to allowances that would be detrimental to the PFI provider might trigger additional payments from the Exchequer to that PFI provider. In other words, there might be a revenue cost as a consequence of the changes to the allowances.

Stewart Hosie (Scottish National Party, Dundee East)

Will the hon. Gentleman give way?

David Gauke (Conservative, South West Hertfordshire)

I gave way to the hon. Gentleman on this section on Second Reading, and I shall give way to him again.

Stewart Hosie (Scottish National Party, Dundee East)

I am glad the hon. Gentleman remembers that.

The total amount of capital in PFI projects at the moment is £53 billion. The total published outstanding liability to 2030-31 is £162 billion. Does the hon. Gentleman have any idea what the impact might be if he is correct and the changes trigger additional costs to the Treasury?

David Gauke (Conservative, South West Hertfordshire)

No. That is why I am raising that concern. For the sake of completeness, I have also said that the concern does not arise in many PFI contracts, but it appears to arise in some. I am grateful to the hon. Gentleman for providing numbers on the potential scale of the problem, but I should be grateful if the Chief Secretary clarified that point. As I said, I make the point tentatively, because I have heard it only anecdotally, but if there is something in it, as the hon. Gentleman suggested, it could create a considerable cost to the Exchequer, so we must consider it.

Stephen Timms (Labour, East Ham)

I shall start by outlining the purpose of the clause. The Committee is already familiar with the main features of the package of business tax reforms in the Budget. The main rate of corporation tax will be reduced from 30 to 28 per cent., giving the UK the lowest rate of corporation tax in the G7—lower than the EU15 and Organisation for Economic Co-operation and Development averages. A set of reforms will modernise and simplify the capital allowances system.

Adam Afriyie (Conservative, Windsor)

Will the Chief Secretary give way?

Stephen Timms (Labour, East Ham)

I will, but I need to get a bit of a move on.

Adam Afriyie (Conservative, Windsor)

The Chief Secretary mentioned the reduction in corporation tax. Will he also confirm, as I am not sure whether he is going on to mention it, the increase in corporation tax for small business?

Stephen Timms (Labour, East Ham)

Indeed, that was my next sentence. The refocusing of the small company taxation system will tackle the rising Exchequer costs of tax-motivated incorporation and provide a better-targeted incentive for investment in the shape of the new annual investment allowance, which was conspicuously absent from the comments of Opposition Members, although not from those of the hon. Member for Falmouth and Camborne. I shall refer to that in a moment. In addition, enhancements to both the large company and small and medium-sized enterprises research and development tax credits will increase business R and D and strengthen the UK’s competitive position.

The packages are designed to be fiscally neutral for both small and larger businesses in each of the years listed on the Red Book score card, maintaining and strengthening the UK’s international competitiveness and encouraging further economic growth through high levels of investment. To underline the point for the hon. Member for Windsor, the package will be fiscally neutral for small businesses in all the score card years, because the benefits of the additional allowances will be set alongside the increase in the small company rate of corporation tax.

Clause 35 paves the way for gradual withdrawal of industrial and agricultural buildings allowances over four years. The hon. Member for Fareham is right to point out that the allowances were first introduced more than 60 years ago. They replaced the old mills and factories allowance, which dated back to the early years of the 20th century. Sixty years ago, it made a lot of sense to assist in the post-war reconstruction of British industry, but as my hon. Friend the Member for Wirral, West pointed out in his intervention, the allowances no longer reflect the reality of the modern economy.

There is no good economic case for continuing to provide a selective subsidy for some kinds of business property but not others. It may come as a bit of a surprise to some listening to this debate, in the light of the slightly overblown rhetoric of Opposition Members, to hear that 13 per cent. of the stock of business property is eligible for industrial or agricultural buildings allowances—80 per cent. is not eligible. There really is no justification for having subsidies for this small proportion of business properties and no allowances at all for the rest. It is perfectly true that a case has been made for a general system of allowances for all commercial properties so that the other 87 per cent. would be eligible too, but given the performance in recent years of the commercial property sector, it would be hard to argue that a more generous tax arrangement for them would be the right thing to do.

Stewart Hosie (Scottish National Party, Dundee East)

The Chief Secretary says that there is no justification for the allowances for small industry sectors, but he makes a point about the commercial sector. The per footage rental for commercial retail space is buoyant and has been for many years. There is an expectation that it will stay buoyant. However, the small margins on agricultural businesses, the tiny margins in the hospitality sector and the huge pressures in the manufacturing sector surely show that there is a justification to provide the assistance to invest where investment is needed in those sectors that are most hard pressed by competition and very small margins.

Stephen Timms (Labour, East Ham)

The small businesses to which the hon. Gentleman refers are exactly the ones that will benefit from the annual investment allowance that we are introducing, which my right hon. Friend the Chancellor set out in the Budget. That is a much better-targeted form of support than this rather random and arbitrary arrangement that goes back 60 years. I can give a little example. A crèche attached to a factory is eligible for an industrial buildings allowance but a crèche attached to an office is not. There is no rationale for such anomalies, and it is high time that we put them right.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

While the annual investment allowance will bring benefits to many small businesses, it affects future decisions, not those that have already been made based on the current industrial and agricultural buildings allowances.

Stephen Timms (Labour, East Ham)

But many of those businesses, particularly farms, that will see an increase in what is due from them because of the withdrawal of allowances will see a reduction in what is due to them because of the availability of the annual investment allowance. Farm businesses are investing year after year. They will benefit. Small businesses will benefit very substantially from the annual investment allowance.

Mark Hoban (Conservative, Fareham)

Will the Chief Secretary give way?

Stephen Timms (Labour, East Ham)

I need to make a little more progress. I want to clarify a point that was made repeatedly in some of the slightly overblown comments from Opposition Members about the amount of money that is at stake.

The hon. Member for Rochford and Southend, East referred to a £3 billion tax increase. The hon. Member for Braintree made a similar point. The hon. Member for Fareham referred to the £3 billion figure, but I think he understood that the figure is the value of the claims. The cost to the Exchequer is £600 million, so we are talking about an order of magnitude smaller than Conservative Members appeared to believe. That may account for the slightly overblown character of some of their points.

The amount at stake is £600 million, and £540 million of that is in industrial buildings allowances, which incidentally is equal to about 4 per cent. of total allowances available to business. It helps to put this into perspective. The remaining £60 million is in agricultural building allowances: 95 per cent. of the benefit of these allowances goes to large businesses and 50 per cent. of the total amount of industrial buildings allowance—the £540 million—goes to the 100 largest companies. Those companies will gain substantially from the reduction in the main rate of corporation tax.

Let me pick up another point. Both the large business package and the small business package in the Budget are fiscally neutral in each of the years set out in the Red Book. Without these measures, those packages would not be fiscally neutral. I shall be interested to see how Opposition Members will vote. If they vote in favour of the amendments, they will be forgoing substantial sums—hundreds of millions of pounds of income for the Exchequer—to add to the £400 million that they decided to forgo when they voted against schedule 4 last week.

Let me pick up some of the other points that have been made. A good deal has been said about consultation. The rate of writing-down allowance remains unchanged for this year. It will be gradually reduced between 2008 and 2011. As my hon. Friend the Member for Wolverhampton, South-West said, it is not customary to consult on changes in rates of taxation or on the reduction or removal of tax reliefs. That is not the practice of this Government, nor was it the practice of previous Governments. However, we will consult later this year on the design of new measures such as the annual investment allowance, on which the hon. Member for Falmouth and Camborne commented, and the new credits for environmental technologies. We will certainly welcome contributions to those consultations.

Rather than withdrawing the allowances overnight, we have given businesses a year’s notice of their eventual withdrawal. From April next year, the writing-down allowance will be reduced by one percentage point per year until 2011. That will give businesses ample time to plan and adjust. The clause is designed in particular to prevent forestalling and other behaviours that would otherwise have allowed some businesses to accelerate allowances unfairly at the expense of others. It is not right to describe this as a retrospective change. Corporation tax is an annually set tax. We have pre-announced the withdrawal, and will withdraw the allowances in a phased manner.

Brooks Newmark (Conservative, Braintree)

I understand the Chief Secretary’s point, and he is absolutely right on corporation tax. However, when it comes to making capital investment and building decisions, one bases those on the amortisation or depreciation that one can get on a building over a certain period, because cash flows cascade off that. Making an annual decision on corporation tax is a different matter from having the taxation that is suggested in this clause.

Stephen Timms (Labour, East Ham)

There are a couple of points to be made in response to that. First, the value of a building plus the land on which it sits has commonly, in recent years, appreciated rather than depreciated.

Brooks Newmark (Conservative, Braintree)

Will the Chief Secretary give way?

Stephen Timms (Labour, East Ham)

Let me finish the point.

The hon. Gentleman is right in respect of agricultural buildings, but the picture is different because the tax system recognises depreciation in other ways. It is common to all commercial buildings that deductions against corporation tax are available for the costs of repair and insurance, and the depreciation of business premises is recognised at the point of sale in the capital gains tax system. The system properly takes account of that point.

On hotels, it is interesting that the industrial buildings allowance regime was extended to qualify hotels in 1978—it is a much more recent feature of the regime than most—to assist with the growth of UK tourism. I suggest that the rationale for giving extra help to hotels at that time does not apply today. There is not a good economic case for preserving that selective subsidy. In general, the sector is enjoying high levels of profitability and it will also derive significant benefit from the 2 per cent. cut in the headline rate of corporation tax from 2008. In the case of smaller hoteliers, the annual investment allowance will act as a big incentive for investment as well.

Stewart Hosie (Scottish National Party, Dundee East)

The tourism market has changed beyond recognition since 1978. The long weekend city break holiday, which generates huge amounts of money, particularly in urban areas where it did not previously exist, is now subject to competition from places such as Prague and Dublin, where people did not go, even for short breaks, in 1978. There is a constant demand to increase quality and availability in all those areas. Surely the demand to keep the quality of the service high and to improve constantly makes the argument that the world has changed and therefore we do not need to do it completely wrong.

Stephen Timms (Labour, East Ham)

No, not at all. People do not benefit from an industrial buildings allowance if they are upgrading a facility in the way that the hon. Gentleman talks about, and that is exactly the kind of investment that will benefit from the annual investments allowance. The new arrangements that we are introducing are much more effective for encouraging the kind of investment that he wants to see rather than the anomalous and outdated system that we are replacing.

On the Olympic games, I can give the hon. Member for South-West Hertfordshire the reassurance that the London Organising Committee of the Olympic games has been exempt from corporation tax since its incorporation in October 2004, and so will not be affected.

David Gauke (Conservative, South West Hertfordshire)

It is not so much that; the concern is that other property infrastructure providers may find themselves hit. That is the concern that the likes of John Whiting have raised.

Stephen Timms (Labour, East Ham)

I am not sure who will be hit. The only sector that I can think of that might be affected would be the hotel sector. We have just had an exchange about that, and it will benefit overall from the cut in the main rate of corporation tax or the annual investment allowance.

The main effect of amendments Nos. 15 to 23 would be to undo the main anti-forestalling purpose of the clause. That would give a big incentive to businesses without taxable profits against which to set allowances, having valuable, older industrial or agricultural buildings, to enter into sale and lease-back arrangements so that a taxpaying purchaser could access relief on a high market value over the remainder of the 25-year term. There would be a number of opportunities for forestalling if the amendments were agreed and if this clause were not agreed. The potential Exchequer cost of that is very large indeed—probably around £250 million in the first year. A number of other opportunities of that kind would open up.

I should also point out that there must be an error in the drafting, because as drafted the amendments would create new or increased balancing charges and would be a significant deterrent to businesses from selling qualifying buildings. I hope that for that reason as well, Opposition Members will not press the amendments to a vote.

Amendments Nos. 24 and 183 propose delays pending reports. We have set out in some detail the rationale for reform and the fiscal impact in this year’s Budget report. It is our intention to publish a regulatory impact assessment on the withdrawal of the industrial and agricultural buildings allowances, and on the package more widely, over the next year, in time for the implementation of the reforms. Those who are calling for a report may perhaps be reassured by that. That information will be published before the withdrawal takes place and will also address the regional impact, although I do not think that it will be large.

Adam Afriyie (Conservative, Windsor)

Will the Minister give way?

Stephen Timms (Labour, East Ham)

I will, but for the last time.

Adam Afriyie (Conservative, Windsor)

A regulatory impact assessment is to assess the impact of regulations. Surely it should be done before the regulation is drafted into legislation. If the regulatory impact assessment shows the complete opposite of what the Minister has said, will he then withdraw the regulation?

Stephen Timms (Labour, East Ham)

I can give the hon. Gentleman the reassurance that the regulatory impact assessment will not say the complete opposite of what I have said. The RIA will be published before the legislation puts the changes into effect. I refer him to clause 35, which is simply about balancing charges, and does not put into effect the wider changes to the allowances.

The real impact of this pair of amendments would be to introduce a delay. I do not imagine that Opposition Members want a delay in reducing the main rate of corporation tax. The clause is designed to stop forestalling, and any delay would re-create opportunities for that, and would give some businesses an opportunity to gain an unfair advantage over others. The right way of withdrawing these outdated allowances is in a fair and orderly way. I commend the clause, without the amendments, to the Committee.

Mark Hoban (Conservative, Fareham)

I want to make a few remarks about the Minister’s response to our extensive debate on the clause and the amendments.

From my perspective, the Minister’s response betrayed a failure to appreciate the interaction of a complex series of reforms on enterprises of different sizes. He was wrong to argue that the package of tax reductions for large businesses is ring-fenced from the refocusing, as we must now call it, of tax increases for small businesses. The two allowances—IBAs and ABAs—can be claimed by enterprises of different sizes and different forms of ownership. ABAs can be claimed by people who pay income tax or by small and large companies. It is therefore difficult to try to disaggregate them as the Minister sought to do in his remarks.

Stephen Timms (Labour, East Ham)

I am grateful to the hon. Gentleman for giving way, especially as I failed to give way to him, for which I apologise. The point that I emphasised was that for large businesses, and separately for small businesses, the packages are fiscally neutral in each of the years set out in the scorecard in the Red Book. It is not as a whole a business package, but it works separately for large and for small businesses.

Mark Hoban (Conservative, Fareham)

Given that the abolition of ABAs and IBAs has been justified in the context of the reduction of corporation tax for large businesses, there is a knock-on effect on small businesses and that is where the problem arises. I take on board the Minister’s comments about consultation and the fact that a regulatory impact assessment will be published before the next Finance Bill. Apparently, we all know the answer to that, so there is no point in professional bodies wasting their time responding to the consultation document because it is almost written as we sit here today.

Those are complex issues and there should be a clearer way of thinking through the impact on different sectors and different types of enterprise. The Chief Secretary said on several occasions, “Don’t worry about the abolition of ABAs and IBAs because there will be an annual investment allowance for small businesses”. However, in the past, small businesses evaluated projects on the basis of the available ABAs or IBAs, and their cash flow was based on that. Those businesses assumed that tax relief would come on-stream, but they will no longer receive it, which will make it more difficult for them to continue to invest. It is difficult to rationalise the matter by saying, “Don’t worry, there will be a new allowance for investment in the future,” because we are talking about the withdrawal of investment relief to which businesses expected to continue to be entitled. They have made financial projections on that basis, and taken that tax relief into account when determining whether the investment will go forward. That is an important issue.

The hon. Member for Falmouth and Camborne talked about the matter in the context of rural diversification, and many businesses have based those very difficult decisions on the assumption that the allowances would be in place, so they will now wonder how well they will stack up in the future.

Kitty Ussher (Labour, Burnley)

Can I take it from the hon. Gentleman’s remarks and those of his hon. Friends that a future Conservative Administration would reverse the abolition of IBAs and ABAs?

Mark Hoban (Conservative, Fareham)

No, the hon. Lady cannot take it; she falls into the same trap as the Economic Secretary has fallen into, with great delight and desire, throughout proceedings on the Bill. It behoves parties, whether they are in government or in opposition, to think through fully the changes that they make, but in this case, the Government have failed to do so. That is why there should be a report, which could consider the impact of the changes on small businesses, the agriculture sector and tourism and ensure that they have been properly thought through. The principal issue is the lack of thought.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

A lot of rural diversification is assisted by European funding. There are very strict criteria about the business planning that needs to take place before a decision is made to provide such funding. Plans have been made on the basis of the current tax system rather than a changed version. Businesses need certainty, not the greater uncertainty posed by the threat of more changes.

Mark Hoban (Conservative, Fareham)

That is helpful. I am sure that the hon. Lady and others know from having talked to those in business that one of the things that they want, particularly when considering long-term projects, is a degree of certainty in the tax regime. That is an important factor to bear in mind when proposing any set of reforms—[ Interruption. ] The Economic Secretary is itching to get in.

Edward Balls (Labour, Normanton)

When the shadow Chancellor made his proposals for corporate tax cuts two days before the Budget, saying that they were to be paid for by the abolition of allowances—after consultation, I am sure—was the allowance part of the package of allowances that he was going to abolish to pay for those tax cuts?

Mark Hoban (Conservative, Fareham)

My hon. Friend the shadow Chancellor referred to the reform of capital allowances generally. That is something that we will consider—[Interruption.] The Economic Secretary is desperate to help us write our 2010 Budget. I suppose that we should be grateful that he recognises that that is going to happen.

Let me repeat what I said to the hon. Member for Burnley. It is important that there should be proper consultation; changes should be discussed so that their impact can be understood. I do not think that the Government have done that properly in relation to the abolition of the two allowances. We are not going to stand here and write the 2010 Budget. We need to ensure that the changes are thought through and that we understand the consequences for different sectors—we object to the fact that that has not happened in this case.

Stephen Hesford (Labour, Wirral West)

Will the hon. Gentleman give way?

Mark Hoban (Conservative, Fareham)

I shall give way in a second to the hon. Gentleman, who will give us a breathtaking analysis of change in this country since the second world war. Such measures need to be thought through properly, and I am not sure that this one has been. It would have been better, given the package that the Chancellor announced in the Budget, for the regulatory impact assessment to be produced then; not at some time in the future. It would be much better to have a clear analysis now rather than having to wait. Does the hon. Gentleman still want to intervene?

Stephen Hesford indicated dissent.

Mark Hoban (Conservative, Fareham)

I want to draw this discussion to a conclusion. We have had a full debate on the topic at the same time as colleagues in Westminster Hall have been discussing the fate of the dairy industry. There is a curious irony—you see, Mr. Gale: accountants can do irony occasionally—in the timing of our debate and the debate in Westminster Hall. I beg to ask leave to withdraw the amendment.

Clause 37

David Gauke (Conservative, South West Hertfordshire)

With regard to insurance companies and gross roll-up business, the ABI submission to the Committee noted that the provisions are the outcome of detailed consultation with the industry. In responding to this debate, does the Economic Secretary share the view that consultation is an important part of the process? If so, are there any particular areas in which that has been the case? The ABI states that the Government have continued to consult on certain points of detail. Will the Economic Secretary outline the key areas that are still to be determined with the ABI and other industry representatives?

Edward Balls (Labour, Normanton)

In a moment, we are going to debate a series of detailed amendments to schedule 7, which have been—and still are—the subject of consultation. With your permission, Mr. Gale, I will respond to the point about the consultation when we discuss the detail of that schedule.

The broader point that the hon. Gentleman makes is absolutely right. When I participated in debates on the previous Finance Bill a year ago, we stressed the importance of consultation in the area of life assurance and insurance company business, especially given the difficult set of events in autumn 2005. It was generally acknowledged that while some necessary decisions had been made to deal with central tax avoidance, in retrospect, the consultation could have been more effective. As a result of the work that started at that point, we have undertaken extensive consultation in that area.

Last May, Her Majesty’s Revenue and Customs published a consultative document on various technical aspects of the special corporation tax rules that apply to insurance. People who have studied the consultation documents and the legislation will understand that that is a very complex area of tax law. In the 12 months since then, working groups made up of industry representatives, professional advisers, and HMRC officials have discussed at length various options for changing the life assurance company tax framework. The working group set out to identify and discuss areas of the regime that could be simplified, clarified or improved. They embraced policy options and detailed technical solutions and then the detailed consultation on the draft legislation. Therefore, the measures that we are debating both here and under schedule 7 and later schedules and clauses reflect the detailed consultation that has been conducted in a constructive spirit.

From a tax point of view, it was our intention that the outcome of the consultation on the changes would be broadly neutral. Although that is not true for every measure across the piece, this is not a tax-cutting or tax-raising exercise. Consultation work is continuing to which I shall refer later. As the hon. Gentleman said, the ABI has provided considerable time and resources, as have many other industry practitioners.

Rob Marris (Labour, Wolverhampton South West)

Can my hon. Friend assure me and the Committee that 24 pages of explanatory notes is a simplification?

Edward Balls (Labour, Normanton)

Commenting recently in the Tax Journal, KPMG said:

“I am sure that we are in a better position, with better legislation in place and on its way, for the consultation and co-operative approach”.

If my hon. Friend were to ask industry representatives, they would undoubtedly say that it is a substantial improvement to, and simplification of, the legislation. However, it is extremely complex.

Mark Hoban (Conservative, Fareham)

The Economic Secretary is right that the measure is a simplification as those who remember last year’s debate will accept. Schedule 7 rolls up five different types of business into one category. Will he explain why permanent health insurance still has its own separate taxation scheme?

Edward Balls (Labour, Normanton)

The hon. Gentleman is right to refer to simplification. I wish to preview the schedule a little. We shall be discussing the amendments in a moment but, as he said, schedule 7 contains a series of measures to simplify complex legislation substantially. It is based on technical consultation that started last May. Under current law, five similar, separate consultations are needed to calculate the profits or losses arising through the insurance company from its pensions business, its overseas life insurance business, its life reinsurance business, its individual savings accounts business and its child trust fund business. A result of having five separate computations is that, when a computation results in a loss in one category, it cannot be set against profits in other categories.

By introducing schedule 7, the clause will merge those five categories of life insurance business into a single new class of business called gross roll-up business. Instead of five separate computations, only one will be required. That means that losses can be offset from one old category and set automatically against profits in another.

Mark Hoban (Conservative, Fareham)

Will the Economic Secretary give way?

Edward Balls (Labour, Normanton)

I have not answered the hon. Gentleman’s previous question, but I shall give way.

Mark Hoban (Conservative, Fareham)

Will Economic Secretary clarify his remark about the carry forward of losses? My understanding is that, for old losses, there is an apportionment particularly when those old losses relate to pensions business. Can he confirm that?

Edward Balls (Labour, Normanton)

I was saying that, instead of five separate computations going forward, only one will be required. Under the new regime, losses arising from one old category will be set automatically against profits of another. I shall answer the hon. Gentleman’s detailed question in a moment.

We have taken time to consider the issues properly. Although the consultation has been very successful and the simplification is welcome, there is one qualification. There is a large bank of unused pension business losses throughout the life assurance industry, so allowing relief for all existing pension business losses against future profits arising from other categories of business would have an Exchequer cost.

The Exchequer set out to make the package neutral. Although that has caused some disappointment in the insurance company, the relief for existing pension business profits will be restricted to the pension business proportion for future and gross roll-up business profits. That is the consequence of our trying to make the change revenue neutral, but we shall review the position to see if our estimates of cost stand up in the light of more recent figures.

Some areas are still under consultation. The amendments to the schedule deal with several detailed points that have arisen from that consultation. We are still considering apportionment of income, transfers of business, contingent loans and funding arrangements, and the structural assets, which are all matters that we need to look at further. I hope that Committee members will see that this is a substantial simplification and that, although we could not deliver everything that the industry wanted, we have gone a considerable way to meeting its concerns.

Mark Hoban (Conservative, Fareham)

The Economic Secretary has not answered the question I asked in my first intervention about why PHI falls outside gross roll-up business.

Edward Balls (Labour, Normanton)

It is true that, at the outset of the consultation, we were attracted in principle by the additional simplification of six into one by merging the computation for permanent health insurance as well as the other categories that I mentioned. However, PHI is assessed on a different basis from the other five categories, which would make the merger process much more complex. Also, detailed work done during the consultation process established that six into one would have had a much greater Exchequer cost than we had previously believed. In our judgment, the combination of introducing greater complexity plus the Exchequer cost outweighed any additional simplification from six being merged into one.

The option of adding PHI to the newly merged gross roll-up category is not ruled out. We may be able to consider that in future Finance Bills, but the combination of additional complexity in meeting the test of my hon. Friend the Member for Wolverhampton, South-West plus Exchequer cost and our desire for neutrality meant that, following the consultations, we were not able to make the change. I commend the clause to the Committee.

Schedule 7

Edward Balls (Labour, Normanton)

I beg to move amendment No. 120, in schedule 7, page 118, line 23, after ‘being’ insert

‘all of the assets of the company’s long-term insurance fund which are’.

Roger Gale (Conservative, North Thanet)

With this it will be convenient to discuss Government amendments Nos. 105, 123 to 125, 87, 126 to 128, 88 and 89.

Edward Balls (Labour, Normanton)

The amendments would make a number of minor technical changes to the schedule and I think that you have agreed to take some minor amendments to schedules 8 and 9 at the same time, Mr. Gale. All those technical amendments arise as a result of representations made by the insurance industry and they reflect the detail of the consultation undertaken in recent months.

Mark Hoban (Conservative, Fareham)

I am slightly surprised at the brevity of the Economic Secretary’s comments—

Roger Gale (Conservative, North Thanet)

Order. So am I. I thought that the hon. Gentleman was intervening. I need to propose the lead amendment.

Mark Hoban (Conservative, Fareham)

I still remain surprised at the brevity of the Economic Secretary’s remarks given the number of amendments in the group.

David Gauke (Conservative, South West Hertfordshire)

Does the Economic Secretary think that we could save a lot of time if he just said that the Finance Bill contains various amendments to tax law?

Mark Hoban (Conservative, Fareham)

That may make for brevity in our proceedings, but it would mean that the scrutiny process would be all the poorer.

I shall not ask questions about every amendment, because that might try the Committee’s patience—although I am tempted—but will the Economic Secretary explain amendment No. 105, in which the words “linked assets” are replaced with

“assets linked to the relevant business so far as so referable”?

Edward Balls (Labour, Normanton)

I am surprised, because given the quality and fairness of the Opposition I was expecting probing questions about the group of amendments, but I am happy to put the issues in greater context. Paragraph 17 of schedule 7 rewrites section 432C of the Income and Corporation Taxes Acts 1988. However, a late change to the drafting approach here was not followed consistently through the whole section. Government amendment No. 105 ensures that the language is consistent.

Edward Balls (Labour, Normanton)

I beg to move amendment No. 121, in schedule 7, page 125, line 39, leave out from ‘under’ to end of line 40 and insert ‘section 444ABD(1).’.

Roger Gale (Conservative, North Thanet)

With this it will be convenientto discuss the following Government amendmentsNos. 122 and 129.

Edward Balls (Labour, Normanton)

Amendment No. 129 is a good example of the openness and trust between the industry and the Government that has been built up during the course of this major consultation on life insurance company taxation. As drafted in the Finance Bill, new section 444ABD of the Taxes Act 1998 gave what commentators described as an over-generous treatment of certain losses, which could lead to double counting. We are removing the part about losses, but that is not the end of the story. HMRC and the industry are continuing to discuss the tax treatment of transfers of business for reasons that I shall explain in due course and that we will discuss when we come to the stand part debate on the clause, if we have not already had it. I may have referred to some of those matters when I made my introductory remarks. If a revised or more focused rule about losses is needed, it can be done in the regulations. Amendments Nos. 121 and 122 amend schedule 7 and are purely consequential on amendment No. 129.

Mark Hoban (Conservative, Fareham)

As I indicated on clause 37, this is a simplification that has proceeded with the support of the insurance sector, and the engagement of its advisers. As the Economic Secretary rightly pointed out, this new spirit of openness and consultation comes from the consequences of the announcement made in autumn 2005, which caused considerable unhappiness and uncertainty in the life insurance sector. This is the second year running that we have discussed changes to the insurance sector. There were significant reforms in 2003, 2004, 2005, 2006 and 2007. It would be helpful if Economic Secretary could indicate whether we are going to have to go back round the hurdles on the matter in 2008, or whether he feels that this is a settled set of reforms that are unlikely to see major changes.

I have a detailed question about schedule 7. As I understand it, the losses of the gross roll-up business cannot be carried back for 12 months, whereas losses of ordinary businesses and enterprises can be. Why are life assurance businesses being treated differently in this context from other types of business? Can the Economic Secretary illuminate the Committee a little more on the issue of transfers, to which he alluded in the first group of amendments? My assumption is that transfers within a life insurance company should not give rise to a tax loss or gain. He gave the impression that that aspect of these rules has not been pinned down yet. It would he helpful to have greater clarity on that matter.

Edward Balls (Labour, Normanton)

On the former point, prior to 2006, there had been previous Finance Bills in which there were changes to life insurance and taxation. However, they had all been incremental and not first-principled. It was discovered in the autumn of 2005 that the operation of the life assurance taxation regime was so complex that neither Her Majesty’s Revenue and Customs nor the industry itself fully understood how the rules worked and how they interacted with a rapidly changing insurance world. An HMRC decision, announced in debates at that time, gave the impression of a small cost, which turned out to be a potentially substantial cost until the change was modified.

In order to avoid such problems in future, greater dialogue or consultation was needed, and we also needed to simplify the regime from first principles, which is what has been happening in the past year. The consultation and the changes we are introducing now are materially different from the changes to the tax regime for life assurance businesses in previous Finance Bills.

As I said, consultation is still ongoing on some matters, and our detailed technical amendments to the schedule following consultation are testimony to that fact. It would be foolish to rule out coming back next year or on Report with further detailed, consequential amendments following this reform and no member of the Committee, or anyone in HMRC or in the industry would want to do so. However, we will not need to make a first principle reform, as has been done in the last year.

If we make more progress in any respect on the matters I that listed a moment ago, including the transfers of business and apportionment of income contingent to the loans and funding arrangements of structural assets, we will be happy to return with further proposals in 2008. We will give the Committee a detailed update on the operation of the regime so far in a pre-Budget report, so there will be plenty of time for discussion and consultation if changes are needed next year. I will reply to the question on transfers asked by the hon. Member for Fareham when we come to clause 39 and schedule 9.

We have made a substantial amount of progress on this complex area; the clauses, schedules and relevant amendments before us are not controversial for the industry. They do not give everything that people want, but they go a substantial way towards doing so, and I hope that the Committee will agree to the schedule.

Mark Hoban (Conservative, Fareham)

Will the Minister answer my question about the carry-back of losses of gross roll-up of business, please?

Edward Balls (Labour, Normanton)

I am not sure if I will be able to answer that question. With your permission, Mr. Gale, I will answer it when we come to the next clause.

Roger Gale (Conservative, North Thanet)

The Minister is entirely responsible for his own contribution to the debate.

Clause 38

David Gauke (Conservative, South West Hertfordshire)

Briefly, I do not know whether the Economic Secretary plans to make a comment on the basis of taxation for insurance companies, but as I understand it, the arrangements will mean that there will be one basis of taxation. Previously, HMRC was able to alter the basis of taxation in particular circumstances from what is described as “I minus E”. Will the Economic Secretary explain the circumstances in which that would have happened and why? When the Treasury, or HMRC, no longer has the ability to alter the basis of taxation, what will be the effect on revenue?

Edward Balls (Labour, Normanton)

Schedule 8 and clause 38 carry on the process of simplification that I explained in my earlier comments. In particular, the measures abolish what is known as the Crown option—the ancient rule under which an HMRC officer can, even in these days of self-assessment, decide whether a life insurance company should pay tax on a trading profits basis or on the I minus E basis that nearly always applies to such companies. The current system has been part of the life insurance tax rules since 1915.

When HMRC published its technical consultation document in May 2006, there was a small passage about the Crown option. It became clear from the responses to the document that the uncertainty of not knowing when the Crown option would be exercised was causing problems for the life insurance industry, especially in the calculation by a company’s actuaries of its embedded value profits. There are ways for insurance companies to show more realistic profit figures than those that are given by the regulatory accounting rules of the Financial Services Authority. They require the actuary to predict the tax treatment of the business over the coming decade or so. The complete change of basis that is caused if the Crown option is exercised plays havoc with those calculations. HMRC and the industry have together devised a new approach to replace the Crown option, to which schedule 8 gives effect.

The schedule sets out unequivocally, with no element of choice for either HMRC or companies, the circumstances in which a company will be assessed on the trading profits basis. They are restricted to two types of specialist business. Pure reinsurers—companies that do reinsurance business only in the market—will, as they are now, always be taxed on the trading profits basis. The same will apply to companies whose only business is gross roll-up business, which we discussed in relation to schedule 7. All other business that is not gross roll-up business, such as ordinary life assurance business with UK residents, will be taxed only on the I minus E basis.

Schedule 8 sets out how changes between the two bases will be handled, which is particularly relevant for any change of basis that is caused by the schedule itself. There are a number of transitional provisions. As part of the agreed package, the schedule improves the mechanism for ensuring that the I minus E basis of taxation results at least in the taxation, at mainstream corporation tax rates, of the life insurance company’s profits that are not being accrued for policy holders.

The measure also ensures that losses and other reliefs that used to be permanently lost when there was a change from the I minus E basis to the trading profits basis are instead preserved and are restored if there is a subsequent change back to the I minus E basis. That change has been requested by and is particularly welcomed by the life insurance industry.

As a result of extensive consultation, the schedule provides a certain, modern and robust set of rules by which to decide basic questions about the taxation of life assurance companies in a way that does not have an overall revenue cost to the Exchequer. The rules will provide greater certainty. The life assurance sector and its taxation are very different from other parts of the economy. In answer to the question on why that sector is treated differently regarding losses that are carried back, let me say that it is one consequence of the I minus E regime for life insurance taxation. Another consequence of those rules is that we have to have different rules for the way in which losses are carried back. I hope that that answers hon. Members’ questions.

Schedule 8

Schedule 9

Mark Hoban (Conservative, Fareham)

I had expected the Minister to rise, because he suggested that he would give further information on transfers, which I think fall within the subject of the schedule. I should be grateful if he could clarify the matters for debate and discussion between HMRC and the Treasury.

Edward Balls (Labour, Normanton)

I am very happy to explain the amendments and the schedule. Schedule 9 deals with the taxation of transfers of insurance business. Government amendment No. 89 makes a minor clarification. Schedule 9 repeals section 83(3) of the Finance Act 1989 and associated rules, which apply to transfers of business. In general the repeal will have effect from an appointed day, which will be set by an order in due course.

Where a transfer of business took place before Budget day the repeal is intended to be effective for any period beginning in 2007. However, the life insurance industry has said that there is some doubt about whether the measure has that effect. To deal with that uncertainty, Government amendment No. 89 puts matters beyond doubt.

As I have said, schedule 9 contains a number of measures to reform the law relating to transfers of life insurance business between insurance companies. Transfers of business are a common feature within the insurance industry, particularly as the industry consolidates and reorganises. A merger of companies within a group can reduce the cost of capital significantly and make operations more efficient. The Government do not want in any way to stand in the way of such important transactions. Indeed, we are keen to facilitate them and to reduce the administrative and compliance burdens associated with genuine commercial transfers.

Transfers of business have also, however, presented opportunities for some to try to extract profits in untaxed form, against the intentions of Parliament. It has therefore been necessary for the Government to introduce a number of complex measures over recent years to block a succession of schemes designed to avoid tax on a transfer of life insurance business. That has led to the tax rules for transfers of insurance business becoming the most complex part of this very complex area, and there is anecdotal evidence that that complexity is inhibiting genuine commercial transactions. It will come as no surprise, therefore, that simplifying the transfer rules was an important objective for the industry in the consultation process. We want to facilitate that if we can.

Schedule 9 is designed to achieve those twin objectives by facilitating commercially driven transfers and protecting the tax base. The basic principle on which we worked in producing the legislation is that transfers of business should be tax neutral, but only where assets and liabilities pass from the long-term insurance fund of the transferor to the long-term insurance fund of the transferee. Schedule 9 achieves that by clarifying the existing rules and by adding new rules where previously there was only guidance.

To sit alongside those clarified and simplified rules, there is a targeted anti-avoidance rule. That will not affect “plain vanilla” commercial transfers, but it will protect the tax base where there is any attempt to reduce profits or create artificial losses during the transfer process. The TAAR will replace most of the intricate and mechanical anti-avoidance provisions introduced over previous years, leading to a considerable simplification, as I have explained and on which we had, I think, some agreement a moment ago. The TAAR will operate in association with a clearance process, so that where Her Majesty’s Revenue and Customs is satisfied that obtaining a tax advantage is not a main purpose of a proposed transaction, the TAAR will not be invoked. In addition, the TAAR will not apply where a group can show that one company in that group may have got a tax advantage but there is a corresponding tax disadvantage to another company.

In addition to the measures in the schedule, HMRC will be streamlining its processes where there is an insurance transfer. HMRC officials have talked to the FSA and will be talking to actuaries who make reports to the court on insurance business transfers, to see whether the requirements laid down by them about tax clearances can be made less burdensome on both HMRC and the applicant companies and their advisers.

As with the other schedules, there has been full consultation on the measure, but it is somewhat different with respect to its commencement rules: many of the new rules, including the TAAR, start from an appointed day. There is a power in the schedule to amend the legislation by regulations.

Roger Gale (Conservative, North Thanet)

Order. The Committee will sit again at 4.30, with Mr. Illsley in the Chair. Mr. Illsley will also be in the Chair on Thursday morning. From the schedule laid down by the House for the progress of the Bill, it is clear that we are running behind schedule. I therefore give the Committee notice now that I shall if necessary ask the usual channels to consider timetabling a third sitting on Tuesday 5 June, if that becomes necessary. I mention that now because I have always found that it is convenient to inform hon. Members, and more particularly the staff, who have their lives to plan as well, that that might happen. Hon. Members can then adjust their diaries if necessary.

Mark Hoban (Conservative, Fareham)

I welcome you to the Chair, Mr. Illsley.

I want to ask the Minister about the targeted anti-avoidance regime to which he referred before the lunch break. As I understand it, the supplementary avoidance rule contains a motive test and a pre-clearance test. I was surprised and taken aback when I saw that there was a pre-clearance test, because I remember the Minister lecturing me quite firmly in connection with clause 27, saying that there was no need for such a test. He said:

“The amendments are unnecessary because the clause contains a main purpose test, which means that it will apply only when a person has entered into arrangements that have the main purpose of securing a tax advantage, which is to say tax avoidance. Such schemes do not happen by accident. They are the result of contrived circumstances in which transactions are undertaken or carried out primarily to achieve a desired tax effect, as opposed to a genuine economic purpose”.

He continued:

“That main purpose may be inferred from the actions of the parties to the arrangements, but it is best understood by the person making the arrangements. It is therefore not necessary to set up a clearance regime when the person best placed to judge whether the rule applies is the person who makes a clearance application.”—[Official Report, Public Bill Committee Finance Bill, 17 May 2007; c. 223.]

It appears that there is one rule for clause 27 and one rule for schedule 9. Having re-read the Minister’s explanation in our debate on Tuesday morning, I am not clear why a clearance rule is right in schedule 9 but was not appropriate for clause 27.

Rob Marris (Labour, Wolverhampton South West)

Bearing it in mind that the Committee is scrutinising the wording of the proposal, among other things, I want to raise a rather more prosaic matter, and my hon. Friend the Economic Secretary may wish to write to me about what appears to be the most curious piece of drafting in the Bill, on pages 156 and 157. Paragraph (10)(2) substitutes part of a sentence, the final words of which are

“or as a business transfer-out,”.

The Bill continues:

“(3) In that sentence (as amended by sub-paragraph (2))—omit “or as a business transfer out”.

If I am reading that correctly—I might not be—sub-paragraph (2) inserts some words and sub-paragraph (3)(a) immediately removes some of them. That seems very curious to me. Perhaps my hon. Friend could write to me about it later.

Edward Balls (Labour, Normanton)

I am very grateful for my hon. Friend’s commentary. The claim, “This is the most curious piece of drafting I have ever seen in a Finance Bill” is, for him, one hell of a claim. Whether it would stand the test of true scrutiny I do not know. He has a fine track record of highlighting curious pieces of drafting. I can only encourage him to participate fully, not only in the next stage of our consultation but in the affirmative procedure that we will apply to ensure that that drafting is fully reflected in the final schedule. If I can shine any light on this particular curiosity I shall be happy to write to my hon. Friend. I shall ensure that all members of the Committee are copied and that the letter is worth framing.

I am grateful to the hon. Member for Fareham for having highlighted the fact that we on this side of the Committee do not take an over-dogmatic or idealistic approach to these matters but are happy to proceed case by case on the basis of the consultation and the evidence that arises in any particular circumstance. Before Conservative Members get over-excited, it would be foolish and wrong of me to lecture them, as Conservatives, on the importance of precedent. That is clearly an important part of conservatism, whatever—I will not go there. I fear that the issue of grammar schools might be ruled out of order, Mr. Illsley.

Clearance procedures for transfer of business are in place under existing legislation. We are replacing previous clearance procedures with a new and more streamlined one. Unlike the discussion on the previous clause, this is not a debate about whether to introduce a new clearance procedure. Perhaps because of the complexity of the tax regime legislation, clearance is judged to be desirable in this case from a Financial Services Authority and court point of view. It was desirable before and it will be in future. I hope that the hon. Gentleman finds that to be an accurate, non-ideological and conservative answer to his question.

Schedule 10

Edward Balls (Labour, Normanton)

I beg to move amendment No. 90, page 159, line 22, leave out from beginning to end of line 10 on page 163 and insert—

‘Contingent loans

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendments Nos. 92 and 94 to 96.

Edward Balls (Labour, Normanton)

I shall try to be brief, but at the same time to provide a bit of context for the amendments in order to satisfy Members on both sides of the Committee, who will be interested to know the detail of the schedule.

The schedule contains a range of measures to clarify and simplify miscellaneous life assurance tax provisions, most of which arise from the life assurance tax rules consultation process. I shall discuss the first of them, covered by paragraphs 1 and 2, when I highlight the amendments. The other important measure in schedule 10, packaged in paragraph 3, is a reform of the treatment of so-called structural assets held by a life insurance company in its long-term insurance fund. Structural assets are held by an insurance company as part of its trading structure, as opposed to assets that are expected to be turned over in the course of its trade. A major example, and one included in the Bill, is shares in subsidiary companies that themselves are insurance companies.

However, where structural assets are held in a company’s long-term insurance fund, inappropriate tax rules can arise, because the life insurance tax rules assume that all assets held in a long-term fund are held or sold in the course of the company’s insurance business. For example, dividends from insurance subsidiaries through structural assets are subject to corporation tax, whereas dividends from structural subsidiaries of other types of trading company are exempt.

As taxation of life insurance companies is based on their regulatory returns, it follows that write-downs can result in a tax deduction where there is no economic loss. Following consultation with the life insurance industry, we have introduced paragraph 3, which will reform the taxation of structural assets, treating them as capital assets rather than trading assets. Dividends from structural assets will be exempt from tax, giving the insurance industry parity with other traders.

A further measure in paragraph 4 will remove the restriction on use of capital losses where a life insurance company sells holdings in an authorised unit trust or an open-ended investment company to the manager of that trust or company, and that manager is a member of the same group of companies as the life insurer. The capital gains rules impose restrictions on the use of capital losses on all disposals between connected parties, such as members of the same group. The policy reason is that connected parties have opportunities to manipulate the circumstances of the disposal that are not available to independent parties.

However, where a life insurer disposes of holdings in unit trusts or open-ended investment companies, both Financial Services Authority rules and life insurance tax rules ensure that the disposal is at market value and minimise opportunities for manipulation, regardless of who acquires the assets. For that reason, the life insurance industry has argued that it is unfair to restrict any losses arising. The Government accept its argument, and schedule 10 will remove the restrictions.

The remainder of the schedule comprises a general tidying up of life insurance tax rules, modernising definitions, removing duplication by putting all definitions in one place and repealing spent or obsolete provisions. I look forward to the scrutiny of my hon. Friend the Member for Wolverhampton, South-West and to seeing whether obsolescence and obscurity have been fully tackled.

The amendments will modify the new provisions in response to our consultation. Paragraph 3 will reform the taxation of structural assets, treating them as capital assets rather than trading assets. Dividends from structural assets will now be exempt from tax, giving the insurance industry parity. The schedule defines structural assets initially as shares in and loans to subsidiaries of insurance companies that themselves write insurance business. The measure also includes a regulatory power to add to or amend the list of structural assets; however, the life insurance industry will be consulted before that power is exercised.

A short time ago, the Association of British Insurers and other parties sent a number of representations to Her Majesty’s Revenue and Customs about the new measures. At the time, it was thought that the schedule would be debated last week, so HMRC was able to deal immediately with only two straightforward points, which are covered by Government amendments Nos. 91 and 92. But when debate on the schedule was deferred to today, I agreed that further amendments—Government amendments Nos. 130 to 133—should be tabled now, rather than on Report, to give effect to many of the ABI’s requests for clarification and relaxation.

Mark Hoban (Conservative, Fareham)

On a point of order, Mr. Illsley. I am slightly confused as to whether there are two groups of amendments to schedule 10 or one. There seems to be some interrelationship between the two. I am not sure whether we are debating one group or two separate groups.

Eric Illsley (Labour, Barnsley Central)

There are two groups—Government amendments Nos. 90, 92 and 94 to 96, and Government amendments Nos. 130 to 133, and 91 and 93. I assumed that the Economic Secretary was referring to a group of 10 amendments, that he was not moving amendment No. 130, which will be in the following group, and that he was simply referring to the fact that they all apply to schedule 10. However, there will be separate debates on both groups.

Edward Balls (Labour, Normanton)

I apologise to the hon. Member for Fareham: I did not read fully and correctly the punctuation of the schedule before us. It seemed to me that, to understand these amendments, it was important to put them in the context of the schedule. With your permission, Mr. Illsley, I should like to frame all the amendments together, accepting your right not only to determine that we should vote on separate groups but to allow a second debate on the second group, if you prefer. It seems that the amendments are all of a piece, as they emerged from a detailed set of consultations that I have been able to update in recent days. There was not a principal distinction between the two groups, but I am happy to take your guidance, Mr. Illsley.

Eric Illsley (Labour, Barnsley Central)

I will be guided by the wish of the Committee. If it has no objection to taking both groups together, I have no objection. If hon. Members have no objection, we can proceed on that basis, in which case with Government amendment No. 90 it will be convenient to take Government amendments Nos. 92, 94 to 96, 130 to 133, 91 and 93.

Edward Balls (Labour, Normanton)

This is not about a difference of scope or subject. Because we have had more time, we have been able to add further amendments in recent days at the request of the ABI, particularly Government amendments Nos. 131 to 133. We have tried to add those amendments to meet the needs of the industry. There is one case where we have changed the legislation to ensure that a company cannot generate a loss earlier than it would do so naturally by moving the asset around the company or its group.

That is not fully to the liking of the industry, but it was necessary to ensure that we protected the Exchequer. However, I have asked HMRC to monitor that rule carefully to ensure that it works properly, and not harshly. I also know that the industry does not like the way in which section 83XA(6) deals with the capital gains treatment of structural assets. That is not something that we have been able fully to bottom in the consultation. The ABI’s preferred solution seemed to skew the results too far towards an Exchequer loss, and both sides accept that that may be a theoretical, rather than a substantial, point of difference. However, it is an area where we are trying to do the right thing, while protecting the revenue base. I am happy to give an assurance to both the ABI and Opposition Members that we will keep that under review. The amendments ensure that the structural assets are given in all cases, including where the substantial shareholding exemption is relevant, and where there is a transfer of business. I am happy to commend the amendments to the schedule to the Committee.

Mark Hoban (Conservative, Fareham)

I thank the Minister for his explanation of the amendments, and of paragraph (3) on structural assets, which is a difficult part of the legislation, as it affects life assurance companies. Many such companies hold many structural assets in their funds, which are available for use in certain circumstances to meet the policy holders’ liabilities. There are some quite difficult interactions with FSA rules and tax rules about the valuation.

I should like to raise three areas with the Minister in connection with those rules. The first is the treatment of gains, which he has already touched on, but I want to come back to it in a little more depth in a minute. As I understand it, paragraph (3) excludes the movement in value on insurance dependants from tax, so ending the double taxation of insurance subsidiaries. Certainly in the past, although I am not sure that it is the case now, life funds have held other trading businesses within their funds. A distinction has been between those involved in insurance business and those involved in non-insurance business. I should like to understand why it is only insurance dependants that have been excluded from tax.

The second point concerns interest. Movements in value on loans for insurance subsidiaries will not be taxed and nor will the interest on those loans. However, my understanding is that the interest deductions on the other side of the loan transaction will be relievable against tax credit. If the interest payable is subject to relief, why is the interest receivable not going to be taxed? Does the Minister think it appropriate for debts and loans to be included in our structural assets? There is a slight risk that an asymmetrical treatment will arise where life assurance companies engage in tax planning, recognising the difference in treatment on the interest payable on loans.

The third point goes back to the central issue of the treatment of gains, on which there is most debate between the Treasury and the ABI. Taxation is charged when a qualifying asset leaves the long-term fund of the life assurance company. That is determined by taking the difference between the historic cost of the asset and its admissible value at the relevant time, which is 1 January 2007 for existing assets, and the time that the non-profit fund of the life assurer acquired the assets, for assets acquired after that date.

The ABI believes that such gains should be taxed as capital gains and therefore should attract indexation to give them the same tax treatment as other companies. There should also be an opportunity to compute such gains using either the higher of the original base costs or, where relevant, the market value at March 1982. Again, that is the same treatment that is available to other businesses. It is a consistency point between assets held by life assurance companies and assets held by other companies. Will the Economic Secretary give us some background on the reason why there is a difference in treatment? Certainly, other businesses go through the process of being able to have indexation gains and looking at the base cost of the 1982 market value cost where that is appropriate. There seems to be a mismatch between general business taxation and the taxation of life assurance companies. Some issues of shareholder capital losses also float through. It is not a particularly straightforward piece of legislation which is why, despite the consultation that has been taking place since June last year, we are still making changes as we approach the end of May. The Government are still proposing changes, with the tantalising prospect of further amendments to come. I should be grateful for some clarification on those points.

Rob Marris (Labour, Wolverhampton South West)

This is the last time that I will raise this matter, but I do so because I am getting sick of it. Amendment No. 93 starts with the word, “But”. It is not only ungrammatical but completely redundant. I have been making the point throughout the Bill that I hope at least in next year’s Finance Bill we can have some decent and grammatical wording and not include redundant words.

David Gauke (Conservative, South West Hertfordshire)

This morning, the Economic Secretary waxed lyrical about the consultation process. He stressed its importance and the openness and trust that has built up between the industry and the Government. Indeed, he was very open and honest about some of the difficulties that arose in the autumn of 2005, which he put down in part to a lack of consultation. Why, therefore, does the ABI state in its briefing to members of the Committee:

“HMRC have tabled last minute amendments, which have not been subject to the consultation process and we are concerned at the late changes to legislation that had previously been discussed at length”?

Edward Balls (Labour, Normanton)

Let me answer those questions as briefly as I can. On the subject of the word, “But”, we shall reflect and try to draw wider lessons as part of the Finance Bill process about the excessive use of that word at the beginning of sentences. The hon. Member for Fareham made three points. The first concerned the definition of structural assets and insurance dependants. Insurance dependants are by far the most significant set of assets, which is why the provision provides for them expressly. However, the schedule includes the power to add other assets by means of regulation. Discussion will continue, and if other assets need to be added to the same category, that will be possible.

There is a misapprehension on the second point; interest receivable will be taxed, so there is no asymmetry. On the third point, I refer the hon. Gentleman to the industry views that I quoted in my introduction to this part of the Bill. Ernst and Young’s Budget website said:

“A key lesson from the life tax consultation is the efficiency of the working group approach. The use of the working group as the primary means of progressing issues of both broad policy and fine detail is now deeply embedded as a feature of the regular working relationship between HMRC, industry and advisors.”

That constitutes substantial progress from where we were 18 months ago, so although I do not hesitate to say that improvement was clearly needed, I hope that that has been delivered.

There were late representations from the ABI and others in relation to the new provision—I do not use the word “late” in a value-loaded way, I mean merely that the issues arose late in the consultation. We could easily have decided to postpone any attempt to sort those issues out, but we decided that we could deal with Government amendments Nos. 91 and 92 consensually, when more time was available. The ABI requested clarification and indeed relaxation, and our judgment in relation to Government amendments Nos. 130, and 131 to 133, was that clarification was the right course, even if we could not deliver the degree of relaxation that the ABI wanted. I know that it is disappointing that we cannot go as far as the industry would like, but we judged that maximum clarity at this stage would be the better choice.

As I have said, the issues are very complicated—even more so than some of those that we have already debated in connection with the relevant clauses. We do not know how much the problem is theoretical rather than real, and the best commitment that I can give to the ABI and to the Committee is that we shall closely monitor the operation of the system. If it works heavy-handedly or if there are indeed problems in relation to capital gains treatment, we shall revisit the legislation. I have already expressed my willingness to table further amendments or regulations before next year if necessary.

Mark Hoban (Conservative, Fareham)

I was not sure whether the Minister was about to conclude, so may I prompt him to deal with my point about the different treatment of gains on structural assets. Structural assets held by a non-life insurance company will be subject to a different capital gains tax regime from that which will apply to structural assets held within life assurance funds. I should like to understand the reason for the difference.

Edward Balls (Labour, Normanton)

I believe that I already answered that when I referred to the discussions on differential treatment in section 83XA(6), which deals with the capital gains treatment of structural assets. It is a complex issue, which we are still trying fully to understand, and the best that I can do is repeat that discussions with the ABI will continue in the coming weeks. If I can give more detail to the hon. Gentleman after that, and after further expert consultation, I shall be happy to write him a letter. Pre-empting that would be foolish, however.

Mark Hoban (Conservative, Fareham)

I am grateful for the Economic Secretary’s offer, but I would quite like to know now why there is a difference rather than hear about how the problem might be resolved.

Edward Balls (Labour, Normanton)

With your permission, Mr. Illsley, to avoid further detaining the Committee by attempting a detailed, complex definition, I shall write to the hon. Gentleman, which will enable him better to understand the ongoing consultations.

Schedule 11

Edward Balls (Labour, Normanton)

I beg to move Government amendment No. 76, in schedule 11, page 172, line 38, leave out from first ‘the’ to ‘and’ in line 40 and insert

‘reinsurance to close amounts of the members,’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendments Nos. 77 and 78:

Edward Balls (Labour, Normanton)

The schedule repeals complex mechanical tax rules that were introduced in 2000 to limit any tax advantage if general insurers’ provisions to meet policyholders’ claims were greater than necessary. It provides for transition and a new set of rules that will provide a more proportionate response for the tax risk. The rules will be supplemented by regulations.

The Government amendments to the schedule arise from discussion with Lloyd’s. Government amendments Nos. 76 and 77 will substitute for “reinsurance to close contracts” the term “reinsurance to close amounts”. Reinsurance to close is a mechanism by which a Lloyd’s syndicate closes its accounts. The commercial definition of reinsurance to close has evolved over time. The amendments ensure that the tax rule reflects the definition in Lloyd’s rules and that the schedule has its intended scope.

Government amendment No. 78 is a response to the concern of Lloyd’s that the schedule could have unintended unfair results in particular circumstances. It will enable the making of regulations to deal with those circumstances, which include members leaving syndicates and members having their own reinsurance arrangements in addition to arrangements that the syndicate may have. Officials are discussing with Lloyd’s an appropriate solution to the issue, so draft regulations are not yet available to us or to the Committee. Any regulations that are passed under the new power would reduce or eliminate the effects of adjustments that would arise under the schedule. They will be discussed in detail with Lloyd’s before they are laid. I commend the amendments to the Committee.

Clause 46

Mark Hoban (Conservative, Fareham)

I think that there is a degree of consensus around this clause, certainly from people in the industry. In its representations on the clause, the Chartered Institute of Taxation said that in the Budget press release, BN15, it was implied by paragraph 3 that existing repos would be “grandfathered”, but that is not mentioned in the Finance Bill. It is seeking confirmation that it will be included in the regulations made under subsection (3). I would be grateful if the Minister could confirm whether that is the case.

Edward Balls (Labour, Normanton)

Mr. Illsley, would it be helpful to introduce schedules 13 and 14 as they are mentioned under clause 46?

Eric Illsley (Labour, Barnsley Central)

Again, I am in the hands of the Committee. If it is the Committee’s wish or if it would be easier to take a general debate on clause 46 and the Government amendments to schedule 13, we can do that.

With the stand part debate, it will also be convenient to take Government amendments Nos. 102 to 104 to schedule 13.

Edward Balls (Labour, Normanton)

Clause 46 introduces schedules 13 and 14. Schedule 13 constitutes a comprehensive new regime for the charge to corporation tax of sale and repurchase transactions entered into by companies. Those transactions are widely known as repos.

Schedule 14 contains a number of consequential amendments to other provisions of the Income and Corporation Taxes Act 1988 made necessary by the repeal of the existing provisions for taxing repos and their replacement by the rules in schedule 13.

The three Government amendments make a minor modification to schedule 13. They correct a defect that might have led to loss of tax. The new rules for charging sales and repurchase agreements to corporation tax provide that where a company sells securities under a repo, it is to be taxed on income arising on the securities as if the sale had not taken place. That is subject to the requirement that the company must recognise the income in its accounts during the period of the repo.

That requirement may result in income falling out of the charge to tax in which the borrower is taxed on a receipts basis in respect of income arising on the securities. For accounts purposes, it recognises that income before entering into the repo. In that case, it will not recognise the income again during the repo. If the amendments were not made, the income could not be charged to tax. The amendments, therefore, omit the requirement that recognition of the income for accounts purposes must take place in the same period in which the arrangement is in force. That ensures that companies remain taxable on the income, provided that that is reflected in their accounts.

The amendments allow us to move forward with schedules 13 and 14. Repos are widely used in the financial markets as a form of secured loan. They involve the sale by a person of securities—shares or debentures—under an agreement that those will subsequently be repurchased at an agreed date at a price agreed at the outset. The sale of the securities realises cash that is economically equivalent to a loan that is repaid with interest, in the form of an increased repurchase price, when the securities are bought back.

As hon. Members know, at the time of the pre-Budget report we made a formal announcement of our intention to consult on new legislation in this area. Since then, there has been detailed consultation. HMRC has sought the views of interested parties on the way forward, including on the draft legislation. The consultation has been very constructive; we believe that we have given all interested parties an opportunity to ensure that the new legislation works properly. However, if business representatives consider that there are difficulties or strong reasons why the commencement should not happen on 1 October as specified, we will consider what they say.

This is a complex area. However, given our consultation, we should be able to go for commencement on 1 October. That will give business sufficient time to prepare for the new rules and accounts and for how lenders will be taxed. As I said, this is a modernisation of the interaction of tax and accounting; it will reduce the amount of legislation devoted to repos and simplify the current rules.

The answer to the question put by the hon. Member for Fareham is yes. The details will be set out in the regulations, which will follow in due course.

Schedule 13

Schedule 15

Mark Hoban (Conservative, Fareham)

I beg to move amendment No. 108, in schedule 15, page 196, line 5, leave out from first ‘amount’ to end of line 7 and insert

‘is created directly by genuine business activities, and which—’

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss the following amendments: No. 109, in schedule 15, page 196, line 11, leave out subsection (5).

No. 110, in schedule 15, page 196, line 27, leave out from ‘subsection (4)’ to end of line 33 and insert

“genuine business activities” means business activities which—

(a) are actually carried on in any EEA territory in which the controlled foreign company has a business establishment in any part of the relevant accounting period, and

(b) are actually carried on in that territory through that establishment, having regard to premises, staff, equipment and assets.’.

No. 111, in schedule 15, page 196, line 39, leave out subsection (9).

Mark Hoban (Conservative, Fareham)

Thank you, Mr. Illsley, for that rapid canter through the provisions on insurance. Now I shall slow down the Bill’s progress—[Interruption.] Well, I shall slow it just a little, to ensure proper scrutiny of this important schedule about how the Government have chosen to effect their response to the Cadbury Schweppes judgment on controlled foreign companies.

It is worth starting with a general point about the whole interaction between our taxes and EU law; my hon. Friends will be keen for me to make it. We had a lengthy debate on the issue in last year’s Finance Bill Committee, although we do not intend to reprise that at any great length this year.

As the European Court of Justice judgment recognises, it is the sovereign right of member states to determine their policies on direct taxes. However, there are conflicts between that principle and other areas of EU policy; later, when we consider some of the changes to the rules on venture capital trusts, we shall come to another issue in which that conflict exists.

If I might summarise the European Court of Justice judgment on Cadbury Schweppes, it is that where a company was incorporated to undertake a genuine economic activity in another member state, the fact that the motivation to do so—or to use a more familiar term, one of the main purposes of so doing—is to enjoy the lower rates of tax in that territory does not mean that the company’s profits should be taxed at the higher rate applying in the UK. In particular, that issue emerges when the mainstream rate of corporation tax in the UK diverges from rates elsewhere in the EU.

The Court ruled that the profits of a business established in another European economic area state can be taxed at the UK rate only if the arrangements were wholly artificial. Let me quote from the Court judgment:

“If checking those factors leads to the finding that the CFC is a fictitious establishment not carrying out any genuine economic activity in the territory of the host Member State, the creation of that CFC must be regarded as having the characteristics of a wholly artificial arrangement. That could be so in particular in the case of a ‘letterbox’ or ‘front’ subsidiary.”

The Government have taken the Court judgment and sought to apply it to UK law; that is what schedule 15 seeks to achieve.

Indeed, when one examines the schedule and particularly the guidance that was published at the time of the pre-Budget report, one sees that the Government’s view is that the only form of legitimate economic activity in the context of CFC legislation is one that is based on labour, as it profits only from labour that can fall outside UK taxation. If the profits are generated by capital, then broadly they must be included within UK taxable profits. So a company that decides to manage its intellectual property in one member state rather than in the UK would find that its profits from that intellectual property were taxable at the UK rate.

Even the definition of what the Government consider to be labour for the purposes of the rules is tightly defined. If a UK company sets up a subsidiary in another EU state and that company outsources some of its functions, the value created by the outsourcing does not count towards genuine economic activities. It is to broaden that definition that we have tabled amendment No. 111. Furthermore, the schedule also assumes that seeking a lower tax charge is not a valid creator of economic value, which I suppose is rather odd to all those companies that have sought to leave the UK for lower tax rate jurisdictions elsewhere in the EU. Amendment No. 109 would remove the relevant subsection from the Bill.

In a way, it is odd that we have this quite narrow definition of what constitutes genuine economic activity, since it is predicated on the basis of labour. As the hon. Member for Wirral, West perceptively pointed out, the economy has changed somewhat since the second world war and we are now a more knowledge-based economy. There is much more intensive use of intellectual property and different types of assets to generate revenue, so it seems rather strange to create the distinction between profits from labour that is not outsourced, which is a good thing, and profits from outsourced labour and from the utilisation of capital and other assets, which are a bad thing.

What I have sought to do in tabling amendments Nos. 110 and 111 is broaden in two ways the range of activities that can be deemed to be genuine business activities. Amendment No. 110 would define general business activities by reference to the wording used in the Court judgment and amendment No. 111 would eliminate a rather artificial and old-fashioned distinction between staff employed by the company and other labour, in order to recognise that a large number of companies seek to outsource part of their activities as a way of maximising value.

Amendment No. 110 would also change the period from

“throughout the relevant accounting period”

to during the accounting period, to ensure that where, say, something has been set up or closed during the accounting period, its profits can be excluded from UK taxation for the purposes of this legislation.

The wording that I have chosen in amendment No. 110 comes from the ECJ judgment: it deals with an establishment having regard to premises staff, equipment and assets and also reflects the Government’s representations during the hearing. Let me quote from paragraph 66 of that judgment:

“That incorporation must correspond with an actual establishment intended to carry on genuine economic activities in the host Member State”.

It is also worth listening to the opening of the judgment. Paragraph 67 states:

“As suggested by the United Kingdom Government and the Commission at the hearing, that finding must be based on objective factors which are ascertainable by third parties with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment.”

My amendment No. 100 reflects Government representations made at the time. It is odd that they have not sought to reflect those representations in their definition of economic activities under schedule 15.

With your permission, Mr. Illsley, I should like to make two further comments to preclude the need for a stand part debate on schedule 15. The schedule changes procedure so that a UK company has to make an application for the profits of a EEA entity to be excluded from UK tax computation. Seeking that approval increases uncertainty and could be an impediment to reasonable tax planning. Could there not be a pre-transaction clearance procedure? In the previous debate we discussed one in respect of the insurance clause. The Government are not dogmatic in their opposition to pre-clearance procedures, so perhaps they could again demonstrate their flexibility by introducing one.

The schedule contains no deadlines setting out a time by which HMRC has to grant or refuse approval. The Chartered Institute of Taxation suggested in its submission that the onus should be on the tax authorities to show that the arrangements are artificial, rather than on the company to persuade the tax authorities that they are genuine. The CIOT also thinks that the list in the appendix to the explanatory notes of the 20 items that a business must provide to HMRC to get clearance is deliberately long and unduly onerous and almost suggests that it is a disincentive for people to apply for such clearance.

I shall conclude with an extract from the CIOT’s representations, which captures part of the problem with the measure. Last year, we discussed a similar problem when considering the treatment of group relief on the Marks and Spencer case, where the Government took a fairly narrow interpretation of the ECJ judgment which I think is now subject to challenge. The CIOT is probably right in saying:

“We think the whole approach is fundamentally defective and unacceptable, even as an interim measure pending conclusion of the discussions on the reform of...taxation”.

Even given the further reforms that my hon. Friend the Member for Chipping Barnet mentioned this morning, the schedule is defective and unacceptable in the eyes of industry experts.

Julia Goldsworthy (Liberal Democrat, Falmouth and Camborne)

Again, echoing the comments of the hon. Member for Fareham, I shall make observations relating to the stand part debate so that we do not need to have the same debate again.

First, in addition to the representations made by the Chartered Institute of Taxation, the Institute of Chartered Accountants in England and Wales has some serious concerns and has noted that the provisions in schedule 15 are identical to the draft schedule published at the time of the 2006 pre-Budget report in December last year. I should like the Minister to confirm whether the schedule is identical to the draft schedule, and if that is so, whether the Government took into account the serious concerns of various professional organisations.

Secondly, I am trying to understand the basis on which the decision was made to introduce the schedule as a stop-gap before more detailed, permanent formulations are introduced. I understand that a consultation is due to start in the next few weeks. However, the Institute of Chartered Accountants has stated that

“we do not believe it is appropriate to attempt to introduce UK domestic legislation, even for a short period, which is contrary to the EC Treaty as determined by the Judgment in the Cadbury Schweppes case. Aside from the uncertainty and litigation that will inevitably follow, the approach brings UK tax policy formulation into disrespect internationally, undermining efforts to ensure that the UK remains an internationally competitive location to do business.”

I should appreciate a more detailed explanation from the Minister about why it was necessary to introduce the stop-gap legislation now, rather than engage in proper consultation that would have resulted in legislation that did not provoke the number of concerns that organisations such as the Chartered Institute of Taxation and the Institute of Chartered Accountants have raised.

David Gauke (Conservative, South West Hertfordshire)

As my hon. Friend the Member for Fareham mentioned, we discussed at some length last year the consequences of ECJ judgments on corporation tax. He will be pleased to know that I do not intend to revisit that debate at any great length, other than to say that the judgments collectively have cost the Exchequer billions of pounds; they have on occasions caused complications for British business; and Parliament has not at any point consented to direct taxation being under the jurisdiction of the ECJ.

In holding that belief, as I do, I can have some sympathy with a Government who wish only grudgingly to implement ECJ judgments. However, the difficulty is that that leads to uncertainty, and the remarks that my hon. Friend the Member for Fareham and the hon. Member for Falmouth and Camborne made highlight that point. The hon. Lady referred to a consultation document on the taxation of foreign profits, which we discussed this morning. The word from the Chief Secretary was that the document would be published shortly; I do not know whether the Financial Secretary can be any more precise about that point. The document was due to be published in the spring, but we still do not have it. I do not know whether “published shortly” means later this month or next month. I understand that the Treasury is somewhat distracted by other matters, but it would be useful to know whether there has been any progress.

As the hon. Lady mentioned, and as I believe is the case, the contents of the schedule are the same as were published at the time of the pre-Budget report in 2006. Several bodies have made representations highlighting the difficulties with that situation. Since then, the ECJ has also made its judgment on the thin capitalisation legislation, in respect of which measures introduced by the House were again reviewed to check whether they were appropriate and allowable. It covers similar ground to that which we are discussing, particularly with regard to whether a national measure restricting freedom of establishment may be justified in particular circumstances. The ECJ’s judgment on 13 March was that it may be so where it specifically targets wholly artificial arrangements.

In light of that judgment, I should be grateful to know whether the Financial Secretary still considers the schedule consistent with the attitude of the ECJ to the extent that we can anticipate a future case on the matter, whether he thinks that the thin capitalisation case can give us clues about whether the schedule’s wording is appropriate and whether he has considered revising that wording as a consequence of the judgment.

John Healey (Labour, Wentworth)

May I welcome you, Mr. Illsley, back to the Chair this afternoon, and Committee members back to the proceedings? If the amendment is pressed, I shall ask them to reject it, and I shall explain why in a moment.

I shall first deal with a couple of the points raised by the hon. Members for Falmouth and Camborne and for South-West Hertfordshire, after which I shall cover the purpose of the controlled foreign companies rules, because that will put the matter into context and help explain why the amendments tabled by the hon. Member for Fareham would not help, and in some ways, would hinder the proper operation of the rules.

The hon. Lady and the hon. Member for South-West Hertfordshire were both concerned about consultation and the timing of the proposals. We published the draft for the measure alongside the pre-Budget report for the purpose of consultation and, since then, we have been in detailed discussions with those with a direct and representative interest in the matter. Most of the comments then were about the guidance that accompanies the operation of the rules. We will be issuing revised guidance shortly to reflect those comments. We have carefully considered the points that were made and how they applied to the Bill, and it remains essentially as it was set out in the pre-Budget report. That is not because we have taken no notice of the responses that we received. We considered them carefully, and we believe that we are taking the correct approach as I shall explain.

In response to the hon. Member for Falmouth and Camborne, I want to explain that we are taking such an approach now rather than waiting for the UK court judgment for two reasons. It is important that we act as soon as possible after the judgment to be able to deal with any potential uncertainty that can remain in light of the judgment if we do not amend the rules. Moreover, it is a fact that the UK court may take some time before it reaches it own judgment, and it does not seem sensible to wait for that.

I say to the hon. Member for South-West Hertfordshire that we do not implement such rules on the CFCs grudgingly. We implement them accurately and in a way that we judge to be fully and rightly in accordance with the European Court of Justice’s judgment.

David Gauke (Conservative, South West Hertfordshire)

A similar comment could be made about the real estate investment trust relief provisions last year in the Marks and Spencer case. Since then, a court judgment held that what the Government did last year was inadequate to meet the ECJ’s judgment on Marks and Spencer. I am merely pointing out that the same thing might be about to happen.

John Healey (Labour, Wentworth)

If a court such as the European Court of Justice makes a judgment that has ramifications for, or is relevant to, our legislation, we have to take it into account as we are doing under schedule 15. We doing so in a way that we believe is entirely in accordance with the judgment and as accurately as is necessary. We are taking such action in that spirit, not grudgingly.

I shall now deal with the rules themselves after which I shall come to the points made by the hon. Member for Fareham. They are designed to prevent groups of companies from avoiding UK tax by diverting profits artificially to low-taxed foreign subsidiaries and therefore play an important role in protecting the UK tax base. Similar rules are in place and are in common with those in many other major economies. Their use is endorsed internationally by the Organisation for Economic Co-operation and Development, which also helpfully provides established principles for international taxation.

Our rules were subject to the challenge in the Cadbury Schweppes case at the European Court of Justice. The judgment in 2006 confirmed that the CFC rules are in principle compatible with European law providing that they are not applied to profits from genuine activities undertaken in an actual business establishment located in another member state. I may keep coming back to that because it is at the heart of the principles that the European Court of Justice affirmed in its judgment.

Let me quote from the judgment. The hon. Member for Fareham did, and I do not want to miss out. It states:

“By providing for the inclusion of the profits of a CFC subject to very favourable tax regime in the tax base of the resident company, the legislation on CFCs makes it possible to thwart practices which have no purpose other than to escape the tax normally due on the profits generated by activities carried on in national territory...such legislation is therefore suitable to achieve the objective for which it was it adopted.”

The court said that the parent company must be given an opportunity to produce evidence that a controlled foreign company is established in another member state and that its activities are genuine, which, incidentally, is what our clearance process is designed to do. If that is the case, the CFC rules must not be applied to the profits of those genuine activities.

UK rules already provide a number of generous exemptions to cover genuine activity undertaken by controlled foreign companies. However, we believe that there may be circumstances at the margins where the application of the rules is not entirely clear in light of the court judgment. For that reason, we announced our intention to amend the rules in the pre-Budget report.

It is important to be clear about what the European Court of Justice did and did not do; what it did and did not define. The ECJ did not define in any detail what might constitute profits arising from genuine economic activities undertaken in a business establishment in another member state. To provide the clarification that is needed, schedule 15 first establishes a clear and more certain application procedure through which a UK company should produce the evidence to prove the extent of a CFC’s genuine economic activities in a business established in another member state. Secondly, the schedule provides clear statutory tests on what constitutes such activities and, thirdly, it states how to calculate the profits arising from them. The schedule provides that profits are those created for the group as a whole by staff working for the controlled foreign company in a business establishment that has genuine substance in another member state.

The clause and the schedule have a particularly focused role: to provide clarity about how the CFC rules will operate following the judgment. The legislation achieves that without undermining the effectiveness of the existing CFC rules in preventing as far as possible the artificial diversion of profits from the UK. If I understood the remarks of the hon. Member for Fareham correctly, he did not dispute the importance or the principle behind having the CFC rules, but he was concerned about the practice of their implementation. His amendments would increase the uncertainty of the situation and the scope for the artificial diversion of profits. I will say why in a moment.

On the particular points that the hon. Gentleman raised, when he quoted the court, he talked about wholly artificial arrangements, which was a term used in the judgment. At that level, it is not a term that can be taken literally or can be considered outside the context of the rest of the judgment, which focuses on the purpose of the freedom of the establishment and the importance of ensuring that CFC rules do not tax profits from genuine business activity. It is clear that when the judgment was read in the round, the ECJ intended a meaningful distinction between profits from genuine activities and artificial transfers of profit within the same economic group. The legislation is designed to achieve that clarification.

The hon. Gentleman also suggested that the definitions and the workings of schedule 6 somehow entirely exclude the profits from capital. That is not the case as long as they arise from genuine business activities that are carried out in another member state and not from the artificial diversion of profit to that member state. The ECJ has spoken clearly about the purpose of the freedom of establishment and about the objective factors that indicate that a business is genuinely established and undertaking a genuine activity. The draft guidance makes it clear that that implies a distinction between profits created in another member state and profits diverted within the same economic group so that they can be located artificially in a member state with a lower tax rate.

The hon. Gentleman posed two questions, one of which was: why not have pre-clearance arrangements? Such arrangements are not normally established in this sort of procedure, and I do not see any good reasons to establish them here. There are established clearance arrangements, which after all underpin the operation and the application of the CFC rules.

The hon. Gentleman also asked about the idea of a timetable, set out perhaps in statute, for HMRC to respond. HMRC operates very tightly according to performance expectations. To a large extent, particularly in cases such as this, its ability to come to judgments and assessments, which is what we are discussing, depends on the quality and the comprehensiveness of the information that it receives from taxpayers.

The amendments, as I think the hon. Member for Fareham said, attempt to broaden the scope of the exemptions and application of the CFC rules. He said that particularly in relation to amendment No. 110, but more generally as well. He seems to have attempted to frame the amendments using the type of general language used in the ECJ judgment but when the ECJ hands down a judgment, it is not writing legislation. It is our job to write legislation in a way that captures the principles that underpin the Court’s judgment and puts them in our own tax code. The reason why we are introducing clause 47 and schedule 15 is to make explicit how the rules will apply in accordance with those EU principles, so that we have a firm basis for both HMRC and taxpayers to operate and apply the rules in practice.

If the clause and schedule were amended as the hon. Gentleman proposes, they would have the opposite effect. They would leave the legislation in a state that neither dealt with the uncertainty arising from the judgment nor protected the UK tax base against the artificial diversion of profits.

Amendment No. 109 appears to be explicitly aimed at facilitating the sort of tax avoidance that we are concerned about, because it would delete the provision in the schedule that excludes a reduction or elimination of a tax liability from the scope of the new legislation. If we accepted that, we would in effect be allowing some big businesses to avoid tax by unfairly exploiting the ECJ’s decision, leaving the general taxpayer to pick up the bill. It is not in the interests of business or the Government to make the effect of the new legislation unclear and to make it potentially open to abuse. I therefore hope that the hon. Member for Fareham will not press his amendments to a vote. I ask my hon. Friends to reject them if he does.

Finally, I want to emphasise the point with which I started. The Government are not acting grudgingly to ensure that the ECJ’s judgments are given proper effect in our rules. The potential revenues are very significant. In the pre-Budget report, we identified the revenue impact of the changes that we propose in this legislation. The forecast of our tax revenues will be adjusted as a result of the changes that we are making—from this year by £100 million and next year £175 million, and by 2009-10 we are talking about a reduction in the forecast tax revenues through the changes that we propose of £0.25 billion. The sums potentially at stake are very significant. Therefore, the onus on us is great to get the legislation right in a way that gives effect to the principles of the ECJ judgment but protects properly the UK tax base by preventing the artificial location of profits.

The amendments do not focus on genuine business activities. If they were made, groups would be able to set up tax avoidance schemes within the new rules. They would undermine our controlled foreign companies rules and would put the public purse at substantial risk. They would also put the measures at odds with aspects of the ECJ judgment. The proposed changes would increase, not decrease, uncertainty for business and HMRC in operating the rules.

Mark Hoban (Conservative, Fareham)

I thank the Minister for his thorough and well-reasoned response to the amendments and for his justification of the Government’s activities. My hon. Friend the Member for South-West Hertfordshire hit the nail on the head when he went back to last year’s debate on the Marks and Spencer case. The way in which the Government have sought to interpret and implement that judgment through schedule 15 leaves them open to challenge. People out there will push back and challenge the rules, and they may well prove to be right, in which case the Government will have to reconsider the matter.

It is difficult to strike a balance between what is a genuine business activity and what is wholly fictitious, to use the language in the judgment. In considering that point, I looked at the draft guidance that was published at the time of the pre-Budget report. Diverting profits to a controlled foreign company using intra-group loans is given as an example that would involve some deliberate tax avoidance through the structuring of the transaction. I found the next example, about relocating intellectual property in another European economic area member state, less clear. It could be managed there, rights could be sold and value could be generated, and the guidance says that there could be some profit related to the administration of those activities. That example illustrates the difficulty of putting the judgment into practice, because I should have thought, from my reading of the judgment, that a business could reposition a property in an EEA state and have all those profits chargeable at the lower rate, rather than simply the return on the administration costs.

Part of the problem with future interpretations will lie with whether the Government have complied with the ECJ judgment. This afternoon’s debate is partly intended to probe the Government’s thinking; I suspect that the place where the measures will really be scrutinised and tested is not here, in this Committee Room, but in court. We might well come back to this topic next year, just as we have been referred back, this year, to what happened in the Marks and Spencer case. I beg to ask leave to withdraw the amendment.

Clause 48

Adam Afriyie (Conservative, Windsor)

I shall not speak for long. I simply want to make two, related, observations on this clause and the next about the vaccine research and development credit, or tax relief, which is designed to encourage investment in research on vaccines. The clause is welcome, because it corrects a loophole, and neither I nor, I am sure, hon. Members on either side of the Committee, object to its overall thrust.

My main observation is that we in the United Kingdom have a currency called sterling that is familiar to everyone. Everything that we do in our everyday lives is denominated by it: company accounts are denominated in sterling, and it is clear and overt. For small and medium-sized businesses, accountants and everyone else, turnover is clear and they can predict pretty well what their turnover and profit will be. Consequently, they are able to ascertain whether they qualify for certain reliefs and what size of business they are classified as.

Exchange rates fluctuate and are uncertain, however. At times over the past five to 10 years, we have seen sterling move quite dramatically against the dollar and the euro, so businesses might be caught unawares. As I said, I do not object to the clause in principle, but businesses might not know into which category they fall. A business might be working on the basis that it falls within the small or medium-sized category, which might be clear from the staffing levels. However, it might not be clear whether that business falls into that category in terms of either its balance sheet value, which does not necessarily move dramatically during the year—although the exchange rate might fluctuate—or its turnover, which would enable it to qualify for the credits under clauses 48 and 49.

Throughout the Bill, pretty much everything is denominated in sterling. Duties, corporation tax, grants, credits, the reliefs for investment in the music industry and a lot of the capital and asset transfers—they are all denominated in sterling. Therefore, why is uncertainty being created in clause 48? I am sure that the Minister can tidy the issue up fairly quickly. Is the answer that we are subject to EU regulations? If so, which EU regulations tie the Minister’s hands in that regard? Why are we denominating turnover and balance sheet value in sterling, which creates an enormous amount of uncertainty and makes it difficult to plan during the year, as to whether a tax credit will be achieved? I urge the Minister to make a small change and denominate those figures and values in sterling.

John Healey (Labour, Wentworth)

If the hon. Gentleman checks the record, he will realise that he just asked me why we were denominating in sterling, but then urged that we do denominate in sterling.

Adam Afriyie (Conservative, Windsor)

Excuse me, I meant euros.

John Healey (Labour, Wentworth)

I thought that that was what the hon. Gentleman meant, but it was not quite what he said.

In a sense, the approach that we have taken is the established approach in the tax system. Clause 48 makes a minor amendment. It does not seem sensible at this point to make such a significant amendment as that which the hon. Gentleman has suggested.

Clause 49

Adam Afriyie (Conservative, Windsor)

I had not wished to speak on this occasion, but I want to re-emphasise the point that we have a great opportunity in this clause to denominate in sterling, not in euros. I did not find the Financial Secretary’s previous answer in any way satisfactory or reassuring, given the hundreds and possibly thousands of businesses that will be at those thresholds. I wonder whether he can reflect a little longer and give a reasoned answer as to why we are denominating in euros rather than in sterling, which seems to cover every other aspect of the Bill. I understand tradition and convention, but will he give a clear answer as to why he wants to perpetuate that uncertainty for those businesses?

John Healey (Labour, Wentworth)

If the hon. Gentleman studies the provisions covering the research and development tax reliefs and the vaccine research relief, he will see that some of the qualifying criteria that we use for companies are established at the European level. As he will appreciate, not only do we have to take into account the size of a company, based on the definitions of small or medium-sized companies and large companies, but, where turnover or similar criteria or tests apply, we have to use the European set standard, which is denominated in euros.

The reason we have to take account of those criteria is that, in order to put in place a tax relief system such as the one that we have for research and development, it must receive clearance under the state aid rules. In other words, we are restricted in our ability to introduce direct support to firms for particular activities and policy purposes in the UK, in order to ensure that it is consistent with state aid rules. That is the established process within the European Union, to which we signed up as part of our membership of the Union and the single market. Where the European Commission exercises its judgment in setting criteria, it denominates in euros. We have transferred that approach into our domestic legislation, and have done so from the start.

As I said on clause 48, we are making what are, in essence, minor or technical amendments to the operation of the tax reliefs. Therefore, it is not appropriate to revisit questions about the integral design of the approach that we have established for R and D tax relief since 2000.

Schedule 16

Vincent Cable (Liberal Democrat, Twickenham)

I beg to move amendment No. 181, in schedule 16, page 200, line 4, leave out ‘50’ and insert ‘250’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss amendment No. 182, in schedule 16, page 200, line 10, leave out ‘50’ and insert ‘250’.

Vincent Cable (Liberal Democrat, Twickenham)

This is my first contribution to the work of the Committee. It is a tribute to the excellence and stamina of my hon. Friend the Member for Falmouth and Camborne that we have not had to make more use of those on the substitute’s bench.

These are probing amendments. Our understanding is that there is at present a restriction on the size of companies—from 250 to 500 employees—that can take advantage of the reliefs, and that the Government are imposing this restriction because of limitations set by the European state aid rules. In essence, the purpose of the amendments is to try to establish the Government’s thinking behind the legislation.

The state aid rules are summarised in a set of guidelines that were produced last year, “Community guidelines on state aid to promote risk capital investments in small and medium-sized enterprises”. We understand that the Government must comply with the rules, but we have some questions about them.

A quick reading of the European guidance suggests that Governments have a fair degree of flexibility in interpreting the rules. The first question is why the Government have interpreted the provision in such a restrictive way. Many medium-sized companies will be removed from the provisions on venture capital because of this legislation. Could the Minister explain why he had to interpret the European rules in this way?

It appears that the Government have set the maximum restriction, with a number of employees—50—that is below the present level. On the other hand, it appears that the number of employees has increased for R and D tax credits, which are also governed by European state aid rules. We are trying to understand why the rules should be interpreted in a particularly permissive way for R and D tax credits but in a more restrictive way for venture capital.

The Institute of Chartered Accountants in England and Wales is particularly perturbed by this measure because its judgment, which is based on its research, is that venture capital measures are more helpful than the R and D tax credit in encouraging innovation by this group of companies. The institute cannot understand why the Government have apparently moved in the opposite direction. They have reduced the range from 250, which is the normal threshold for medium-sized companies, to 50, which is the threshold for small companies. What in the guidelines required the Government to make that shift for these provisions but not for the R and D tax credits?

There may be perfectly good legal reasons for the wording in the schedule. We understand that the Government have to comply with the guidelines, but, given that the rules offer some flexibility, we wish to find out from the Minister why he has interpreted them in this way.

Mark Hoban (Conservative, Fareham)

I want to echo the hon. Gentleman’s comments. We see in the Red Book that the changes to various venture capital schemes have been made in response to the new guidelines on state aid that were published last year. Like him, I am rather surprised that the Government have felt the need to make the changes, as it appears from examining those rules that if a robust case has been made and there is evidence to back it, the EU is prepared to grant exemptions.

For example, in paragraph 5.1(a) of the rules there is a safe harbour whereby an investment below €1.5 million is not deemed to be state aid, and if a member state can produce evidence of a market failure affecting that limit, state aid can be used in connection with stimulating small and medium-sized enterprises. In paragraph 5.1(b) permission is given for Governments to support schemes providing finance to medium-sized companies. Does the Financial Secretary believe that firms employing 50 full-time equivalents are medium sized? I am not sure whether I would see them as medium-sized businesses.

There are other examples in the state aid rules that would create an exemption allowing the Government to continue with venture capital trusts and perhaps set a more generous level. Will the Financial Secretary clarify whether the Commission has given approval to the VCT rules as set out in the Bill? The Red Book is a little opaque as to whether that permission has been received. It would be useful to know whether it has, and to understand more about the case that the Government employed for retaining the status quo prior to the schedule being introduced. The hon. Member for Twickenham also highlighted, appropriately, the contradiction between this schedule and schedule 15—a more generous number of employees is set for R and D tax credits and a tight number for venture capital schemes.

I congratulate the Treasury, for a change, on other changes made in the schedule. On Report of last year’s Finance Bill I discussed an amendment on the 70 per cent. rule, and we also debated inadvertent breaches. I am grateful to see, a year later, that the Minister has listened to my representations and that those changes are in the schedule.

John Healey (Labour, Wentworth)

I welcome the hon. Member for Twickenham to the Committee’s proceedings. If the Liberal Democrats have that sort of quality on the substitutes’ bench, they match Chelsea. It is a pleasure to see him reappear. [Interruption.] Indeed—they did not actually win this year, but there we are.

Why have we interpreted the rules as we have? As we set out in the Budget text, we are required to introduce the employee head count test, on which the hon. Gentleman focused his questions, to meet the requirements of the European state aid obligations. I shall be honest with the Committee: we did not want to introduce the head count test or the new employee limit. We are acting essentially to ensure that we can secure the future of the venture capital schemes.

The corporate venturing scheme, the enterprise investment scheme and the venture capital trusts are important elements in helping to tackle the equity gap, but to continue they need to meet the state aid requirements set out by the European Commission, particularly the new state aid rules on risk capital that were introduced last August. We have spent a good deal of time and effort, particularly since then, on submitting strong evidence about UK market failures in such investment.

Our situation is not necessarily the same as that of other European states, particularly as we have a mature market. Of course, the state aid risk capital rules, with some flexibilities, are designed to apply across Europe. We argued that we need national policy measures if we are to respond to the structural problems affecting our national capital markets. The Commission did not accept our argument that the additional provision that we wanted to make in all areas for mid-size companies—the sort of provision that is set out in these amendments—would be compatible with the Common Market.

If we were to persist with that approach or, indeed, if we were to amend the Bill in the way that the amendments suggest, it would bring the continuation of these schemes into question. Therefore, we will continue to propose amendments and to discuss the matter. I hope that, in conjunction with the industry, we can collate further evidence that might encourage the Commission to make greater use of the flexibilities that can be found within the rules that it introduced last year. For the moment, our schemes need to be judged as compliant by the Commission by August this year. Because of our detailed discussions with the Commission, particularly in the past 12 months, I am confident that we will get clearance. However, we have not formally had it yet.

Finally, I welcome the comments of the hon. Member for Fareham on our amendments about the inadvertent breaches and the 70 per cent. rule. He did indeed raise those points in our discussions last year, and I took them seriously. They were raised by others as well and we have had the chance to examine them over the past 12 months. For that reason, I am glad that we have able to cover them in the Bill.

Vincent Cable (Liberal Democrat, Twickenham)

Will the Minister comment on the further point that both the hon. Member for Fareham and I have raised, which is: if the Commission was so tough on the 50-employee rule, why were the Government allowed to move in the opposite direction on the R and D tax credits scheme? Does a different set of principles apply, or is there an inconsistency in the Commission?

John Healey (Labour, Wentworth)

The rules that we are trying to meet in the three schemes are set out in the state aid risk capital rules, which were introduced by the Commission in August last year. They clearly apply to this policy territory, but they do not apply in the same way to the R and D tax credits. The changes that we are making to the R and D tax relief scheme are being made not because we are required or encouraged to do that by the Commission, but because we have established that there is evidence of under-investment in innovation and research and development by mid-size companies. It is an area of the economy that we want to support, and in which we want to see greater activity. There is clear evidence and a clear policy purpose for what we are proposing in the R and D tax credits. The circumstances that apply there are different from those that apply to venture capital and EIS schemes.

Vincent Cable (Liberal Democrat, Twickenham)

I want to acknowledge that the Government have confirmed on the record that they approached the Commission and pushed as hard as they could on this point. We have accepted in this short exchange the potential for damage to middle-level companies in the industry, which is a particular problem for regional funds that are struggling to establish themselves. However, I accept what the Government say. It was pointed out to me that the Chartered Institute of Taxation has accepted that the Government have done the best that they can. The Institute of Chartered Accountants in England and Wales was a little more sceptical, but I accept the Minister’s word that he has tried and that this is the most that can be done within the rules. I beg to ask leave to withdraw the amendment.

John Healey (Labour, Wentworth)

I beg to move amendment No. 165, in schedule 16, page 205, line 39, leave out from beginning to ‘for’ and insert—

‘(1) Paragraph 29 of Schedule 15 to FA 2000 is amended as follows.

(2) In sub-paragraph (3),’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendments Nos. 166 to 174 and 159 to 164.

John Healey (Labour, Wentworth)

I shall be brief, unless members of the Committee want to dwell in detail on any of these measures. Government amendments Nos. 166 to 174 concern paragraphs 9 to 11 to schedule 16 and are designed to bring two improvements that will benefit companies seeking to raise finance under the enterprise investment scheme, the corporate venturing scheme and the venture capital trust scheme.

Government amendments Nos. 159 to 164 attempt to achieve the same thing in relation to the enterprise management incentives legislation. They provide first for the transfer of relevant intangible assets within a corporate group structure to newly incorporated subsidiaries, thus providing a greater flexibility for the venture capital schemes. Clause 60 makes the equivalent changes to the enterprise management incentives legislation. The changes have been welcomed by the Enterprise Investment Scheme Association—Opposition Members will be familiar with its chairman, who is doing a good job—and respond to a good dialogue that we have with the sector in recent months.

We have also had good discussions with interest groups that have raised further technical points, so we have tabled amendments to ensure that some technical changes to the legislation mean that it achieves its objectives. I commend these amendments to the Committee.

John Healey (Labour, Wentworth)

I beg to move amendment No. 175, in schedule 16, page 210, line 27, leave out ‘wholly for money’ and insert ‘,

(aa) the consideration for the disposal does not consist wholly of new qualifying holdings’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendments Nos. 176 to 180.

John Healey (Labour, Wentworth)

Quite simply, the amendments would enable venture capital trusts to dispose of investments that they have held as qualifying holdings for a period of at least six months for cash without jeopardising their approval status for the following six months. The change has been widely welcomed by commentators across the industry. The director general of the Association of Investment Companies, for instance, said:

“We have had an extremely constructive dialogue with the Government over this issue and are delighted with this decision.”

The amendments would widen the scope of the disregard rules to cover disposals made wholly or partly for consideration other than cash and have again been warmly and widely welcomed by representatives from the sector. I commend them to the Committee.

Clause 51

Edward Balls (Labour, Normanton)

With your permission, Mr. Illsley, it might be possible to discuss our amendments to schedule 17 while we debate clause 51, as it introduces the schedule. I will be guided by you.

Mark Francois (Conservative, Rayleigh)

For procedural reasons that will become apparent, I would rather do clause 51 first and then come on to the amendments.

Eric Illsley (Labour, Barnsley Central)

We will start with clause stand part and take it piece by piece.

Mark Francois (Conservative, Rayleigh)

I hope my reasons will become apparent, and I welcome you to the Chair, Mr. Illsley.

Last year, during the Finance Bill, I debated with the Economic Secretary the introduction of the new regime of real estate investment trusts, which subsequently went live in the United Kingdom on 1 January 2007. Since that time, the Government have had the opportunity to consider the initial operation of the scheme. Via clause 51 and the associated schedule 17, they have introduced what might be characterised as a number of tweaks to the regime, designed to improve its operation. Unfortunately, some important issues have still not been addressed.

Clause 51, which introduces the schedule, allows some of the changes contained therein to be backdated to the introduction of the introduction of the REIT regime on 1 January. Moreover, the changes proposed in schedule 17 include relaxing some of the qualifying conditions that must be met in order to achieve REIT status. That the Government are still tweaking the REIT regime is evidenced by the fact that schedule 17 is now being amended by 20 Government amendments—amendments Nos. 138 to 158—which in practice all relate to demergers and are largely corrective. In other words, they represent a further tweaking of the tweak.

I have relatively little to say about the Government’s drafting amendments to schedule 17, aside from an important procedural point that I shall come to when we get there. However, I want to give you notice, Mr. Illsley, that when we come to schedule 17 stand part, I want to raise several points about the schedule and how it effects the REIT regime to date and in the future.

Schedule 17

Edward Balls (Labour, Normanton)

I beg to move amendment No. 138, in schedule 17, page 214, line 11, leave out ‘transfers’ and insert ‘disposes of’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendments Nos. 139 to 158.

Edward Balls (Labour, Normanton)

I shall be brief because it is clear that the hon. Gentleman does not intend to raise detailed issues about the amendments. It is for you to make a judgment, Mr. Illsley, but from my point of view it would be fine if we range widely.

The clause that we have just agreed to introduces schedule 17, which amends provisions in part 4 of the Finance Act 2006. As the hon. Gentleman reminded us, we debated that set of clauses in great detail a year ago in a spirit of co-operation, and we made progress in mutual understanding of some of the issues.

The regime came into force on 1 January after some years of detailed and constructive consultation and engagement with the industry. By allowing indirect investment in property to enjoy the same tax treatment as direct investment, the UK REIT regime will improve the quality and quantity of finance for investment in property, promoting a wider range of savings products for individual investors and supporting structural change in property markets

I am pleased to say that the UK REIT regime is already proving a success with 13 companies converting to the regime from a wide variety of sectors, and now a 14th company setting up with the express purpose of being a UK REIT. The total market capitalisation of the UK REIT sector is now £35 billion, and two of the UK REITs include both commercial and residential property in their portfolios.

Since last year’s Finance Bill, we have continued our consultation with the industry to ensure that the regime works as effectively as possible. The changes in the schedule are the result of that consultation and were announced at the time of the pre-Budget report. As the hon. Gentleman suggested, they are minor changes clarifying some of the definitions and powers in the existing legislation.

We also announced at the time of the pre-Budget report that we would introduce changes to the regulations to extend the regime to make it easier for companies to become UK REITs, and the Chief Secretary circulated draft regulations for that purpose to Committee members on 9 May.

Since publication of the draft clause and schedule at the end of March, the Law Society has come forward with a further representation on the technical detail of the regime as it relates to demergers from UK REITs. Continuing that spirit of consultation, we are keen to accommodate those points, hence the amendments.

I am happy to respond to questions or requests for clarification, although I have the impression from remarks by the hon. Gentleman on the previous clause that he accepts that these are minor, technical drafting amendments.

Mark Francois (Conservative, Rayleigh)

It is entirely up to the Economic Secretary to decide how to play this, but I prefer briefly to debate the amendments first, and then to move on to schedule stand part, but I am in your hands, Mr. Illsley.

Edward Balls (Labour, Normanton)

Given that the hon. Gentleman made some introductory remarks about the REIT regime, I was making some introductory remarks about it, too, and the changes that we are making in the schedule. It is for him to decide how he frames the debate, but I thought it would be helpful for me to put on the record for hon. Members the context within which his detailed points occur.

As I understand it, his detailed points do not concern the amendments, but given that the amendments are to the schedule and that they and the wider context cannot be understood without understanding the schedule, I thought it would be helpful to make a few remarks about the schedule. However, I shall be guided by you, Mr. Illsley.

Eric Illsley (Labour, Barnsley Central)

We are discussing the amendments, and if the hon. Member for Rayleigh then wants a stand part debate on the schedule, the whole aspect of it can be debated then. He can speak just to the amendments at this stage.

Edward Balls (Labour, Normanton)

Then I am very happy to sit down now and wait until the schedule stand part debate.

Mark Francois (Conservative, Rayleigh)

We got there in the end. As I said in my remarks on clause 51, these amendments are essentially drafting in nature. They modify the elements of the schedules specifically relating to demergers. As such we have no quarrel with them and I have only one specific question to put to the Minister about them. However, there is a procedural point which I do not want to let pass without comment. I raise it more in sorrow than in anger because last year we debated REITs in a rather consensual manner and managed to cover a lot of the detail as a result.

We have already had one occasion in Committee when Ministers were taken to task because details of draft Government regulations had been circulated in advance to selected members of the Committee but unfortunately not to others. After that, as I recall, Ministers, including the Chief Secretary, apologised to the Committee and said that they would do their best to prevent that sort of thing from happening again. However, when I returned to my office this lunchtime, newly arrived in my e-mail inbox was an electronic copy of a letter dated 16 May from the Economic Secretary to my hon. Friend the Member for Chipping Barnet. According to the electronic copy, there was a hard copy for the hon. Member for Falmouth and Camborne, the Chairman and Clerk of the Committee, but to no one else. Among other amendments, it refers to the REITs amendments, which we are debating this afternoon, and it was the first time that I had seen or heard of that letter.

If Ministers are going to write to members of the Committee explaining the reasoning behind their amendments, which is a laudable aim and quite often the right thing to do, could they please try harder to ensure that they circulate the information to everyone on the Committee—Back Benchers and Front Benchers—as simple courtesy would suggest? As this has already happened once on this Committee, I hope that we will not get a hat trick. I make a plea through you, Mr. Illsley, that Ministers do their best to take this point on board. If the Minister wishes to intervene, I will sit down, but I still have a question for him.

Edward Balls (Labour, Normanton)

I conducted the Finance Bill on the REITs clauses. I remember us having a substantive consensual discussion, with some areas on which there was disagreement. As I understand it, we have operated this year in exactly the same way as in previous years in ensuring the circulation of letters and amendments to members of the Committee. I am happy to be corrected by the hon. Gentleman if there has been a change in our procedure. As I understand it, we have done things in the same way as in previous years when no difficulty arose at all.

I do not know whether there is a problem because once again the circulation has not been carried out by the Committee Clerks or the hon. Member for Chipping Barnet has not circulated it to her colleagues. The hon. Gentleman said that he was making his point more in sorrow than in anger. If he suggests that there has been a procedural mistake, it would be helpful to us if he specified what we have done differently this year from last year so that we can rectify it.

Eric Illsley (Labour, Barnsley Central)

Order. To clarify matters for the Committee, as far as the Chair and the Clerks are concerned, any correspondence from a Minister to members of the Committee should go to every member of the Committee. That is the limit of the Chair’s involvement. It is a matter for the Government and members of the Committee.

Mark Francois (Conservative, Rayleigh)

I am grateful for that clarification, Mr. Illsley. I do not think that we want to do this to death, but as I understand it, it is not the responsibility of the Clerks to ensure that members of the Committee get correspondence from the Minister; it is the Minister’s responsibility. I hope that this will not happen again and that we can move on.

Edward Balls (Labour, Normanton)

Will the hon. Gentleman give way?

Mark Francois (Conservative, Rayleigh)

I will, but the Minister has heard the Chairman’s ruling. I know that he is new to this game, but he would be wise to listen to it.

Edward Balls (Labour, Normanton)

As the hon. Gentleman said, last year we went about these matters in a very different way from the way that he is choosing to go about them this year. I should like to understand what accusation he is making. Is he suggesting that we have changed the way we do things this year compared with last year? If so, is he saying that it was done in order to prevent him from having sight of the regulations? If that is the accusation, I refute it entirely, and am upset by the insinuation that he is making.

Mark Francois (Conservative, Rayleigh)

As I said, we will not do this to death.

Edward Balls (Labour, Normanton)

We have done it to death already.

Mark Francois (Conservative, Rayleigh)

I am not accusing the Minister of not letting me see the regulations—they are amendments, not regulations. I am saying that he wrote to some Committee members explaining the rationale behind those amendments, but not to others. My understanding is that, normally, when a Minister does that, he should write to all Committee members. He cannot just e-mail one or two and expect them to circulate it on his behalf. That is my understanding; I think that you have confirmed from the Chair, Mr. Illsley, that, as a rule of thumb, if a Minister writes to one Committee member with information relevant to a debate, he should write to everybody.

So that the Minister understands me, let me say that I behaved as I did simply because this has happened once already in the Committee and we were told, in essence, that it would not happen again. It has happened a second time, so I did what I did. I hope that he understands that and that it will not happen a third time. I hope that the lesson can be learned. With that, I would like to ask the Minister about the amendments, which I believe, he is here to answer. Amendment No. 138 replaces the word “transfers” with the words “disposes of” an asset—others make similar provisions. For clarity, will the Minister explain the technical reasoning behind that change in drafting?

Edward Balls (Labour, Normanton)

I am happy to explain the thinking behind all the amendments. As I said, we put the amendments out to consultation, and since their publication, the Law Society has made further representations on the technical details of the regime for demergers from UK REITs. The Government amendments will ensure that schedule 17 provisions relating to demergers within UK REITs apply where a demerged property or subsidiary is transferred to a new company that then becomes a UK REIT itself.

The amendments will ensure also that the terminology used to describe the demergers is consistent with that used elsewhere in UK REITs legislation by using the word “disposal” rather than “transfers”. Amendment Nos. 138 to 148 will mean that the provisions in paragraph 11 of schedule 17 will apply to a company that acquires a subsidiary company to which the ring-fenced assets have been transferred. The amendments allow also the company time to satisfy the conditions for entry to the UK REITs regime. That extends the same flexibility to disposals of ring-fenced assets by a single company UK REIT, as paragraph 16 proposes already for demergers from group UK REITs. That accords with our policy of aligning the treatment of single company and group UK REITs.

Amendments Nos. 149 to 158 will mean that the provision in paragraph 16 of schedule 17 will apply where a demerged company becomes a member of a new group UK REIT, rather than, as originally provided for, a parent of such a group. In summary, the amendments ensure that schedule 17 provisions relating to demergers from UK REITs have their intended scope and include additional flexibility. Just to be clear, amendments Nos. 138, 142, 146 and 147 substitute “disposal” for “transfer”, which will mean that the terminology in that part of the Bill is consistent with other sections of UK REITs legislation—for instance, section 125(2) of the Finance Act 2006, which deals with the movement of assets outside the ring fence, as well as chargeable gains legislation.

Mark Francois (Conservative, Rayleigh)

Schedule 17 contains a number of detailed changes to the REITs regime, which began operation on 1 January 2007. For instance, paragraph 2 of the schedule alters the definition of the types of loans that REITs may undertake without breaching the regime, and paragraph 3 modifies the restriction on income from owner-occupied property that REITs are allowed to generate. We debated that last subject in considerable detail last year, under what is now part 4 of the Finance Act 2006.

Paragraph 5 amends section 109 of the Finance Act 2006, effectively allowing certain previously non-listed companies to benefit from the REITs regime. That relates specifically to close companies which technically have difficulty in satisfying the requirements of the REITs regime on their first day as listed companies. It is a modest relaxation of the section 109 requirements, about which the British Property Federation said:

“There is currently a problem for new REITs at the time of listing and converting to REIT status because there could be a very short period during the first day of converting, when they were not actually listed.”

The Opposition welcome the changes so far as they go. However, even when revised by the 20 Government amendments that have been tabled, the changes proposed by the schedule still do not address two key issues on the REITs regime that were highlighted to the Economic Secretary by the Opposition a year ago.

The first issue is the continuing denial of REITs status to those companies listed on the alternative investment market of the London stock exchange—AIM, as it is more popularly known. According to recent figures from the British Property Federation, some 14 companies with a total market capitalisation of some £36 billion have converted to UK REITs status since 1 January 2007. That figure looks impressive at first glance, but it is important to note that approximately £30.1 billion of that value—more than three quarters—is represented by just five companies: Land Securities, with £9.4 billion, British Land, with £7.8 billion, Hammerson with £4.8 billion, Liberty International at £4.5 billion, and SEGRO at £3.6 billion. In other words, the regime has been dominated to date by the larger property companies, which were always likely to convert to REIT status.

The British Property Federation argued in its May 2007 briefing, which lists the 14 REITs that have converted so far, that:

“Whilst this represents an encouraging start it should be noted that the above list is almost entirely represented by those existing, listed property companies that have always been viewed as best placed to convert to REITs.”

The federation goes on to say:

“We have concerns that, under the current legislative framework for UK-REITs the medium/long-term growth of the UK-REIT market will be limited and that actions need to be taken in the short term in order to address these concerns.”

That brings me to the issue of allowing REITs to be listed on AIM as well as on the principal stock exchange. As the Economic Secretary will recall, we debated that issue as well in considerable detail last year, including on Report. So that it is not said that I have misquoted him, let me say that he did not commit to launching a formal review—he was clear about that, and I remember what he said. He did, however, say that he would keep the issue broadly under review. I hope that I have not misrepresented him. In light of that, is it still Government policy that REIT status should be denied to property companies that are listed on AIM, even at the risk of inhibiting the potential growth of the UK REITs market? In other words, has the Government’s position moved since last year?

The second important issue that the changes to schedule 17 fail to address, and which the Economic Secretary should likewise recall from last year’s debates, is the lack of establishment of residential property REITs. Those established so far have been almost entirely commercial property REITs. On that point, the British Property Federation said:

“It is noticeable that there is no material residential property within the existing REIT regime. This is despite the fact that the development of a tax efficient listed residential property market and the wider benefits that this could bring to the UK economy was one of the key policy objectives for introducing UK REITs.

The UK Government should actively seek to use the REIT structure as a tool to encourage the growth of a listed residential sector. This will be achieved by working with the industry to develop the REIT regime so that it is more suitable for a residential business model.”

When I raised that issue with the Economic Secretary last year in Committee, in advance of the launch of the new regime, he said:

“Over the course of this year and not just when the regime begins, we will be monitoring closely whether residential companies enter the regime. I explained that I was not surprised that early indications had come from the commercial sector, because of its larger scale and sophistication, but I also said that there had been private and public indications that residential property companies would come forward.”—[Official Report, Standing Committee A, 8 June 2006; c. 507.]

He then committed to keep that matter as well under review during the year ahead.

Almost a year on, and now that the regime has been operating since January, will the Economic Secretary explain to the Committee why, despite his encouraging prediction a year ago, the REIT regime remains overwhelmingly dominated by commercial property and hardly any residential property companies have converted to REIT status? He attempted to fudge it by saying that two REITs had both a commercial and a residential property element, but a REIT can have a very small residential property element and still meet that description. Have any out-and-out residential REITs entered the regime? I ask because, if part of the Government’s aim was to create a REIT regime to foster the development of new residential housing, particularly affordable housing, they appear to have failed thus far in that important objective. I should like to press the Economic Secretary to reply to those points.

Stewart Hosie (Scottish National Party, Dundee East)

I mirror some of those questions. Debate on Report last year was particularly heated about allowing REITs to be created not simply with full stock exchange listings but by other means of funding. I recall perfectly well that throughout the process, the Economic Secretary said—I think that it was in good faith—that he would monitor the situation and keep it under review. I mirror the questions asked, particularly in relation to small REITs providing social housing. Many of us saw a great deal of potential in the tax benefits of REITs that do not require the massive start-up costs of a full stock exchange listing.

I also have a question about schedule 17. Paragraph 7(b) deals with section 116, “Minor or inadvertent breach”. Proposed new subsection 3A(b) states:

“The regulations may make provision about, or by reference to, anything done by or in relation to a company or any sum arising or treated as arising...in the calendar year during which the regulations are made”,

rather than the financial year, tax year or accounting year. Why is the calendar year specified?

Edward Balls (Labour, Normanton)

I shall investigate the matter brought before the Committee earlier about the circulation of proposed amendments and I shall happily give a full report in writing to you, Mr. Illsley, and to all Committee members. If the Treasury, my office or I have failed in any way to follow the proper and normal procedure for circulating amendments to all Committee members, I will wholeheartedly and unreservedly apologise. I am unclear about whether we have made such an error, and because of how the hon. Member for Rayleigh chose to raise the issue, I have not been able to find out—

James Duddridge (Conservative, Rochford and Southend East)

Perhaps I can help to clear up the point absolutely so that the Economic Secretary can apologise now to Committee members. As a Back-Bench member, I did not receive that communication as I expected to. I found that disrespectful to all Committee members.

Edward Balls (Labour, Normanton)

As the hon. Member for Rayleigh said, I have served on only two previous Finance Bills, so I am still a novice compared with him in the procedures and courtesies. That is why I said that I shall look into the matter. If I find that we have made a mistake, I shall apologise unreservedly. I fear that, like me—perhaps more than me—the hon. Member for Rochford and Southend, East is a novice in such matters. He would do better to wait for me to look into the issue before he reaches a judgment.

Mark Francois (Conservative, Rayleigh)

I made my point in that way because the problem appeared to have occurred twice in the Committee. If the Minister will listen, I will say that I will take him at his word. Last year, he dealt with the issue courteously. If he agrees to look into the matter, I hope that he will discover exactly what happened. I genuinely think that there has been a mistake, and that is why I raised it. I understand that the Minister will look into it. We shall try to establish exactly what did and did not transpire.

Can we make it the norm that everything should be circulated to Committee members? That is normally what happens and it would avoid problems in the future. I hope that the Minister will take my comments at face value and that he will go back and double check.

Edward Balls (Labour, Normanton)

As I said, I am very happy to do so; indeed, I said that I would. I have always endeavoured to conduct myself with Opposition Committee members in a courteous and proper manner when it comes to how we go about these proceedings. It seems entirely appropriate that we should disagree on the politics; however, in my previous debates with the hon. Member for Rayleigh, I have always conducted myself in that courteous manner. Indeed, when the issue arose last week—I had had no knowledge of it until the Committee started—I said not only that if we had made a mistake we would apologise, but that I would shift us from negative to affirmative procedure to clear up the matter if that could be done in consultation with the business managers.

Obviously, like the hon. Gentleman, I am annoyed—to put it mildly—at the possibility that normal past procedures have not been followed. I shall look into that.

Eric Illsley (Labour, Barnsley Central)

Order. For the sake of the rest of the Committee, we will draw a line there. The Minister will do his checks; we should now return to the debate.

The rest of the debate is in Hansard.