Finance Bill

Public Bill Committee, 22 May 2008.

(Except clauses 3, 5, 6, 15, 21, 49, 90 and 117 and new clauses amending section 74 of the Finance Act 2003)

Jane Kennedy (Labour, Liverpool, Wavertree)

On a point of order, Mr. Hood. It is a pleasure to be here this morning on the last day before the Whitsun recess. Speaking for myself, I need a haircut and a holiday, although not necessarily in that order. My compliments to you, Mr. Hood, for stealing the hands of time and correcting the clock. It will help us to a great extent.

I wish to update the Committee. I undertook to publish amendments relating to residents and non-domiciles for a future debate. I said that they would be laid as soon as they were available and that full explanatory notes would be provided for each one. To provide the maximum opportunity for scrutiny before the debate, I propose to table each amendment formally when it has been prepared rather than release all the amendments at the same time. They will then be published on Her Majesty’s Revenue and Customs website to ensure that the widest possible audience can be informed of their contents before they are discussed in Committee. If the amendments are ready for release during the Whitsun recess, I shall place them on HMRC website in draft, having circulated them to the Committee, and then table them during the week commencing 2 June when the House returns from the recess. I anticipate that that will happen with the first such amendment, which is to paragraphs 37 and 38 of schedule 7.

Jimmy Hood (Labour, Lanark and Hamilton East)

That was not a point of order for the Chair. However, the Committee will be grateful to the Minister for the information.

Clause 50

Philip Hammond (Conservative, Runnymede and Weybridge)

I have a couple of points to make about the clause, but I wonder whether it would be more appropriate to make them when we speak to schedule 19, which contains the substance of the matters raised by the clause. I shall be happy to do so.

Schedule 19

Philip Hammond (Conservative, Runnymede and Weybridge)

The schedule introduces a provision for HMRC to make payments to charities in respect of donations that they receive that are subject to the gift aid scheme. It is to be called the gift aid supplement. The measure is intended to address the consequences of the reduction in the basic rate of income tax from 22p to 20p. An essential part of the symmetry of the arrangements of reliefs and allowances against income tax is that, when the income tax rate goes down, the value of the relief goes down. For my part, I certainly regard it as an important principle that tax reliefs are given against income tax, so when the rate reduces, the value of the relief will reduce.

Increasingly, however, we are debating the effect of reliefs, such as the impact on pension savings when the value of the tax relief is reduced. I am sure that other hon. Members who have a pension provision that they fund themselves will have had the same experience as me, and have received a letter from their pension provider telling them that because the income tax rate has gone down, their contribution will have to increase to maintain the benefit level.

Although the difficulties for charities were identified when the reduction in the basic rate of income tax was announced in the 2007 Budget, they are particularly vulnerable to the loss of income arising from the reduction. When that reduction was announced, it was also announced that there would be a thorough review of the take-up of gift aid. The implication—what was probably in the mind of the Government at that time—was a recognition that charities would face a loss of income. In a rational world, income tax-paying donors would give a little more, because they were being taxed a little less, and thus would compensate for the loss of the gift aid tax relief. In the real world, however, people do not make those fine-tuned adjustments. Certainly, when people are under pressure financially in other areas they are unlikely to make that adjustment. The thorough review of take-up was perhaps seen as a way of squaring the circle. If more effective use could be made of the gift aid scheme so that more of the money donated to charities was channelled through it, perhaps there was a way to increase the amount of income on which gift aid relief was claimed and thus compensate charities for the cut in the basic rate of income tax.

A consultation paper was published last summer and the view of the charitable sector is that there was not a great deal of meat in it. The sector responded by making various proposals, some of which were quite radical, about how the gift aid scheme might operate. None of those proposals, unless the Minister tells us differently today, has been taken up by the Government, who have no stated intention of doing so. The proposals included, for example, introducing some form of automatic refund gift aid contributions using an averaging process.

The announcement in the 2008 Budget of the measures in schedule 19 reflects the failure of the process that was kicked off in the 2007 Budget, to try to find another way of compensating charities by improving the uptake of gift aid. It would be useful if the Financial Secretary made it clear to the Committee whether it is still the Government’s objective in the long term to improve the take-up of gift aid in charitable giving, and whether what we have before us is, in fact, the Government’s medium-term solution. The schedule introduces a transitional relief, whereby charities will be compensated directly from HMRC for the reduced gift aid rebate and thus they will be kept whole, as it were, for a period of three years. That prompts the question, what happens after three years? Is that relief simply intended as a stop-gap measure? One or two cynics have remarked that three years gets us safely to the other side of the next general election. Is the period of three years related in a logical and explainable way to a longer-term strategy to address the underlying problem that has been created? Members of the Committee probably all agree that the best way to do that is to increase the take-up of gift aid so that charities no longer have to rely on the supplementary rebate that compensates for the missing income. Some indication from the Minister on the long-term thinking would be greatly appreciated.

The proposal in the Bill was welcomed by the charitable sector. If you were told, Mr. Hood, that you would be deprived of X per cent. of your income, you might worry about it for a year, but if you were then told that somebody would give it back to you for three years, your initial reaction would be one of gratitude. Perhaps only after two years would you start to think about what would happen after the three years. To some extent, this announcement has taken the pressure off the search for a longer-term solution to improve the take-up of gift aid or find another way of mending the hole in the fundraising of charitable organisations. We should try collectively to ensure that we do not allow this measure to distract attention from the underlying issue.

I have a specific but important question on schedule 19. Paragraph 1(5) will introduce condition D. There are four conditions on the receipt of gift aid supplement. Condition D is that the claim by the charity is allowed, which strikes the Opposition and most people in the charitable sector as rather an odd condition. It implies a degree of discretion by HMRC on whether to allow a claim by a charity. It is not a usual provision for an entitlement written into law that the claim to the entitlement is to be “allowed”, as if by some discretionary process.

I have not tabled an amendment to delete condition D because I would like to hear from the Minister how it is to be interpreted. Perhaps there is a technical reason for its inclusion, and the Minister can put on the record an assurance that properly made claims for gift aid supplement by charities will automatically be allowed, and that this is a mere piece of bureaucratic gobbledegook, not a real test implying that charities have to satisfy some additional conditionality that HMRC may introduce at an official level. That is the key issue that I wish to raise with regard to the schedule. If the Minister addresses it and the more general question about the medium-term solution, I should be very grateful.

Nick Palmer (Labour, Broxtowe)

I welcome the comments we have just heard, which were sensible and helpful. Going slightly wider, it seems that there is no overall rationale for how we work tax relief for charities. In effect, we say that if a person is taxed at the standard rate we will refund the tax to the charity, but if they are taxed at the higher rate, we will refund it to the individual. That is something that we have got used to, and it is not an unreasonable position in principle. However, as the hon. Member for Runnymede and Weybridge said, that system leads to uncertainty when the standard rate moves down or up. I wonder if, in the longer term, we should look at decoupling this and having a standard deduction that does not necessarily alter as the standard rate moves up and down.

Philip Hammond (Conservative, Runnymede and Weybridge)

Does the hon. Gentleman not accept that that would lead to the decoupling of the concept that charitable giving is something that an individual can do out of their gross income As I made clear, I attach a lot of importance to the idea that certain things, such as charitable giving and pension contributions, can be done by an individual from their gross income, before the tax man has his share.

Nick Palmer (Labour, Broxtowe)

That is an interesting point, but there is an essential difference between pension contributions and charitable ones. Pension contributions are, in effect, deferred income. If we, as individuals, have more immediately available income because tax rates go down, it is a rational and individual choice as to how much of that we choose to put into our pension funds. Whether we do, or do not, we are profiting directly. Charitable contributions are slightly different. Topping up our charitable contributions requires a separate decision. If we do not, do so the default position is that we profit but the charity loses. In the case of pension funds, we profit either way.

Basically, I welcome the principle that we need to consider the issues more widely. I am sure that the Financial Secretary will respond more fully to the specific point made by the hon. Gentleman, but HMRC has to protect itself against the possibility that the charity is unknowingly submitting a claim that is not valid—for instance, because the person who made a contribution to the charity is not a standard rate taxpayer.

Jane Kennedy (Labour, Liverpool, Wavertree)

This has been a helpful, brief discussion. All the proposals made during the consultation were considered and discussed across government. I met a number of organisations that made representations. The proposals are complex, requiring a full assessment of any risks to the current system and the funds that flow to charities through it. We are continuing to develop our thinking on gift aid, but at present our priority is to protect the status of this popular tax relief, rather than risk losing the benefits of the system.

We carried out a full and open consultation. As one might expect in such a broad area, views vary widely across the charitable sector. We responded to issues on which there was consensus: transitional relief, the provision of better guidance—and there has been a lot of effort from HMRC to offer a simpler approach, and tools to help charities drive up gift aid. In response to my hon. Friend the Member for Broxtowe, the consultation showed that opinions on higher-rate gift aid varied widely, with some people believing that the relief should go directly to the charity, and some people believing that basic rate relief should also go to donors. There was a wide divergence of opinions.

The transitional period is a three-year breathing space to allow charities to adjust to the change in the basic rate tax without it affecting their existing expenditure plans. During that period, charities can drive up more gift aid income with support from the rest of the gift aid package announced in the Budget. In addition, we will work with donors and charities to develop an understanding of donor behaviour, using that to inform further thinking about gift aid—again, in order to continue driving up the take-up.

The hon. Member for Runnymede and Weybridge asked specifically about condition D, and posed a fair question. The transitional relief will be due to a charity where only the underlying donation and claim meet the requirement of the gift aid scheme—it is an application. Condition D in paragraph 1 ensures that transitional relief will not be payable when the underlying claim is invalid. A claim for gift aid may be invalid for a number of reasons—for example, the claim form may not contain the required information. HMRC cannot be expected to pay the aid in those circumstances and it would be unsustainable to make transitional relief payable, but not the underlying gift aid, in such circumstances

Without the provision, if donor behaviour remained as it is today, it has been estimated that losses for charities would be significant across the whole sector, running to more than £100 million next year. The amount received by charities from the supplement will be proportionate to their eligible gift aid claims. For every £1 of gift aid that is donated, charities will receive 3.2p in supplements, so the charities will continue to receive 28.2p in total for every £1 donated under gift aid.

The proposals in the Budget were widely welcomed by the sector. I acknowledge that, for some, there was a feeling of relief that they could have certainty going forward. There is continuing dialogue with the sector, which was as keen as we were to maintain the nature of gift aid. That formed the basis of much our discussions, and I am sure that there will be a continuing dialogue in the area.

Philip Hammond (Conservative, Runnymede and Weybridge)

I shall respond to the Minister’s specific comments on paragraph 1(5). I understand the thinking behind it, but I ask her to consider the language. If she is seeking to say, in that provision, that the underlying claim must be valid, that is already taken care of, because condition A in paragraph 1(2) is that a

“gift aid donation is made”.

According to the definitions in paragraph 7, a gift aid donation means

“a gift which is a qualifying donation”.

If she is telling us that the gift aid claim has to be properly made, we understand that as well.

However, the word “allowed” implies a degree of discretion. The Minister, perhaps unintentionally, has not confirmed for the record that a valid claim is automatically allowed and that there is no discretion.

Jane Kennedy (Labour, Liverpool, Wavertree)

I accept the hon. Gentleman’s point. If a claim is properly made by a charity within the law and within the terms of the gift aid scheme, the claim will be allowed. When a claim is allowed, the supplement will automatically be allowed.

Philip Hammond (Conservative, Runnymede and Weybridge)

I think that the Minister has given the Committee the necessary reassurance.

Clause 51

Philip Hammond (Conservative, Runnymede and Weybridge)

I have a brief question on clause 51. It appears from the wording that the clause seeks to close an unintended loophole against devious mischief that the Government, the Treasury or HMRC have spotted. Would the Exchequer Secretary explain to the Committee what has given rise to the clause? What mischief has occurred that requires the provision to be introduced and, unusually, to be treated as if it has always had effect?

Angela Eagle (Labour, Wallasey)

I am happy to explain to the matter to the Committee. I would call it an unintended kink, rather than mischief. I do not think that there is any blame intended or that underhand behaviour has gone on that has led to the clause. My brief refers to a “minor deficiency”, but I think that quite a good way of putting it is that there is an unintended kink in the community investment tax relief scheme legislation that could prevent a bank from obtaining tax relief under the scheme if it invested money with one of its own customers. The Committee may not be aware that the scheme is intended to encourage companies and individuals to invest in community development finance institutions, which provide finance to enterprises in economically disadvantaged communities, helping to reduce economic disparities throughout the UK.

The tax relief is generous. It is worth up to 25 per cent. of the investment spread over five years, so it is right that the rules restrict relief to cases in which there is genuine investment of new money in the community development finance institution. There is no relief if the investment is returned to the investor, for obvious reasons, or if it is funded from money that originally came from the community development finance institution.

An obvious funding source for a community development finance institution is its own bank, and the most obvious home for any funds raised by such an institution for the period between raising the funds and investing them in the enterprises that it wishes to finance is the same bank. However, under the current rules, bank deposits made by a community development finance institution in the course of its ordinary banking transactions may reduce or eliminate the value of any relief available to the bank in respect of investments made under the scheme. That is the kink. It is not an intended result, because it means that to secure funding from its bank under the community investment tax relief scheme, a community development finance institution must in effect sever its existing business relationship with its bank and re-establish that business elsewhere. That was not intended when the scheme was put together, nor is it sensible. The change, which is entirely beneficial to community development finance institutions and banks, will have a retrospective effect, because an unintended wrinkle in the structures has created an anomaly.

Philip Hammond (Conservative, Runnymede and Weybridge)

I thank the Exchequer Secretary for her lucid explanation. I am sorry if I detected mischief and underhand behaviour where there is none. I am glad that she does not see mischief and underhand behaviour in every kink in the arrangements. I have some experience of dealing with predecessors of hers who often were more inclined to see mischief and underhand behaviour wherever kinks occurred in the tax code. Was the introduction of the clause prompted by an instance of relief being denied to an institution, or has the issue merely been flagged up and is being pre-emptively resolved?

Angela Eagle (Labour, Wallasey)

CITR was introduced in 2002. We examined how it had worked and talked to, and liaised with, the stakeholders in the sector—both those who wished to lend and the institutions that had developed to take advantage of the tax exemption. The issue came up in that discussion. We realised that the points that were made had merit, which is why the clause has been included in this year’s Finance Bill. I hope that, with that explanation, the Committee is happy to let clause 51 stand part of the Bill.

Schedule 20

Jane Kennedy (Labour, Liverpool, Wavertree)

I beg to move amendment No. 126, in schedule 20, page 264, line 36, leave out paragraph (a).

The amendment omits unnecessary words in paragraph 6 of the schedule. It is straightforward and technical, but I am happy to answer any questions about it.

Clause 53

David Gauke (Conservative, South West Hertfordshire)

Thank you, Mr. Hood. It is a pleasure to serve under your chairmanship once again.

Clause 53 ensures that anti-avoidance legislation applies fairly where a partnership carrying on the business of leasing plant or machinery transfers that business to a single company. As such, we welcome it. It corrects schedule 10 of the Finance Act 2006, which addressed a concern about how leasing arrangements could be used as a tax-avoidance mechanism, incurring losses in the early years and then transferring them so that there was a permanent deferral of tax. The mechanism ensured that sellers would face a charge, with relief being provided to the purchasers of the leasing company. That worked well in a partnership-to-partnership arrangement but, due to various technical reasons and definitions, it did not work for a partnership-to- single company arrangement, as there would be a charge to the departing partners but it would not deliver relief to the successor company.

During a debate on the Finance Bill two years ago, a concern about the internal restructuring of partnerships was raised in relation to paragraph 23 of schedule 10. Whereas paragraph 13 of schedule 10 of the Finance Act 2006 contained an exemption from the regime for a group of companies, there was no equivalent provision regarding a group of partnerships. With a further two years’ experience following the 2006 Act, and given that wrinkle regarding partnerships, will the Minister say whether any concerns have arisen on that issue and whether any group of partnerships involved in an internal restructuring has been caught, perhaps inadvertently, within the regime although that was not the original intention? Subject to that query, we have no other concerns about the clause.

Jane Kennedy (Labour, Liverpool, Wavertree)

It was acknowledged in the pre-Budget report that the schedule was having a detrimental effect on some transactions where there is no risk of a tax loss. It is difficult to deal with such transactions without opening up new opportunities for tax loss, and any action that we take must be taken in close consultation with the industry. We intend to do that, and we are looking closely at the problem.

The hon. Member for South-West Hertfordshire asked some thoughtful questions. The legislation in schedule 10 dealing with partnerships is complex because the partnership structures used by companies are complex, and the schedule had to deal with those complexities. Where a business is carried on by companies in partnership, the charge and relief are allocated to the partner in proportion to their shares in the partnership profits. That gives the right result as long as the business continues to be carried on by a partnership, but not where a business is transferred from a partnership to a single company. In that situation, the selling partners are charged for tax, but there is no mechanism for delivering relief to the successor company because it is not a partner.

More generally, clause 53 makes minor amendments to the anti-avoidance provisions introduced by schedule 10 of the 2006 Act. A minor defect means that the schedule does not work fairly when the whole trade is transferred by a partnership to a single company. The clause will ensure that schedule 10 operates fairly, even in that unusual situation. Furthermore, to ensure that no one can have been adversely affected, the changes introduced by the clause will be deemed always to have had effect. That degree of retrospectivity has been warmly welcomed.

Clause 54

David Gauke (Conservative, South West Hertfordshire)

I beg to move amendment No. 133, in clause 54, page 27, leave out lines 14 to 16 and insert—

‘(a) a transaction or arrangement entered into on or after 12th March 2008, or

(b) an asset acquired on or after 12th March 2008,but does not relate to an asset acquired on or after that date pursuant to a pre-commencement contract (see subsection (5)).

(5) For the purposes of subsection (4) a contract is a “pre-commencement contract” if—

(a) the contract is a contract in writing made before 12th March 2008;

(b) no terms remain to be agreed on or after that date;

(c) under the terms of the contract the acquisition of the asset on or after that date had already become obligatory on that date; and

(d) the contract is not varied in a significant way on or after that date.’.

I share the desire to get through some of the clauses as quickly as possible, but I am grateful that we can turn to amendment No. 133. With your permission, Mr. Hood, I will take this opportunity also to make one or two remarks about clause 54 in general, as that would, from my perspective, avoid the need for a full stand part debate.

The objective of clause 54 is to ensure that credit for any foreign tax paid on trade or professional earnings is no more than the UK income tax due on the same earnings. That is not an unreasonable objective, but we query the element of retrospectivity. However, I do not want to overstate that, and we will debate retrospective legislation at greater length when we discuss clause 55, which deals with a much more serious issue. The element of retrospectivity as regards clause 54 relates to the fact that subsection (4) applies to the

“payment of foreign tax on or after 6 April 2008, or...income received on or after that date in respect of which foreign tax has been deducted at source.”

That is retrospective in nature. An individual might have invested in long-term, income-generating assets, such as overseas properties, on the basis of the existing tax position but then find that they fall within the new regime very quickly—after 6 April 2008—and therefore get a different tax treatment than that which they anticipated when they made the investment. Amendment No. 133 proposes that we should instead consider the date on which the relevant transaction was entered into. If it was made after 12 March 2008, it should fall under the regime set out in clause 54, but if not, the person should continue to benefit from the existing provisions.

The amendment was tabled, in a slightly probing manner, for two reasons. First, and most importantly, there is a danger of creating a parallel system with two different tax regimes, the application of which would depend upon when the transaction was entered into, and that would create unwelcome complexity. Secondly, the Government argue that the changes confirm the existing practice but set aside doubts that have been expressed about how foreign tax credit is calculated following recent case law. I will take the words in the explanatory notes at face value, but perhaps the Minister could elaborate on the existing case law so that we can assess the level of those doubts, which can sometimes be more substantial than the Government are prepared to concede. I should like to test their position on that. We should tread carefully where there is an element of retrospectivity in legislation, and the onus is on the Government to justify the provisions that they have made.

The objective of the clause is to ensure that relief for foreign tax is given once and once only. There can be circumstances where the equivalent does not apply. For example, a UK investor in an overseas asset such as a US limited liability company might find that he was liable to tax overseas but would not benefit from any kind of relief. The Institute of Chartered Accountants has raised that point with the Treasury, giving the example of a UK business that has an interest in a US LLC. Under current law, no relief is available in the UK for tax paid in the US unless the LLC’s income is distributed, notwithstanding that the UK shareholder of the LLC will be subject to US tax on the LLC’s income as it arises—in other words, irrespective of whether it is distributed. Has the Minister considered that?

Jimmy Hood (Labour, Lanark and Hamilton East)

Order. Before I call the Minister to respond, I should point out that it would be convenient to have the stand part debate at the same time as the debate on the amendment.

Jane Kennedy (Labour, Liverpool, Wavertree)

The ICA wrote to us with several detailed requests for changes, but I do not want to be drawn into those as they are outside the scope of the clause. However, I would be happy to write to the hon. Gentleman with details of the consideration that is being given to those proposals and circulate that correspondence to members of the Committee.

The clause does not affect the entitlement to credit for any foreign tax paid before 6 April 2008, so it does not have the retrospective effect that the hon. Gentleman fears. It re-establishes a rule for foreign tax credit that has always been the accepted method prior to recent case law. I shall explain that in more detail in a moment. This is the internationally accepted method for calculating credit relief, and there has never been any basis for believing that the UK Government should allow unrestricted foreign tax credit. In that context, there is no justification for a change that would add substantial complexity and uncertainty to the rule. That is what the amendment would do, although I appreciate that it was tabled in a slightly probing fashion.

The Government have done nothing to encourage people to plan on the assumption that high rates of foreign tax will be subsidised by the Exchequer. We have always made it clear that the purpose of foreign tax credit is to eliminate double taxation and not to go any further than that. The clause merely restores that long-established view of how the law on tax credits applies. The case that has been mentioned involved Legal and General; it was a corporation tax case heard in 2006. The corporation tax position was restored by legislation in 2005, and the clause makes a parallel change for income tax. There is no justification for delaying the implementation of the clause, as the amendment proposes. That would introduce considerable complexity and uncertainty whereby different rules would apply to different foreign tax payments. The amendment would mean that for assets or contracts that fell outside the scope of the clause, foreign tax credit would be unrestricted, putting at risk tax due from wholly UK-based activities.

I will give some background to the clause, since we will have, as you have indicated, Mr. Hood, the main debate now. The effect of the clause is to restore the way of calculating foreign tax credit that was generally accepted before the recent case law. The rule that the clause re-establishes is endorsed by the OECD and overwhelmingly used by those countries that give foreign tax credit against foreign earnings. The clause amends how the maximum credit for foreign tax is calculated, when the foreign tax is paid on trade or professional income of an individual. The purpose of the clause is to ensure that the credit that we give for foreign tax is sufficient to eliminate double taxation, which is a risk. It does not go any further.

In particular, the clause prevents foreign tax credit being set against income tax due on UK earnings. For example, if a musician earns income from a performance abroad, he or she is likely to have to pay foreign tax on those earnings. The foreign tax can be set against the UK tax due in respect of the same earnings—those attributable to the foreign performance—but should not be set against income tax due on earnings from performances in the UK during the same tax year. The clause enables the year’s income to be subdivided, so that each activity that gives rise to foreign income is ring-fenced from other activity for the purpose of calculating credit due for foreign tax paid. The clause also ensures a result that is fair to the taxpayer, while placing a necessary constraint on credit for foreign tax to prevent it from spilling over into other activity, including wholly UK-based parts of the trade.

The amendment would require separate identification of the foreign tax paid by an individual in respect of contracts, arrangements, assets and so on, entered into or acquired before 12 March—Budget day—this year. That foreign tax would be given as a credit against income tax no matter how much or how little UK tax arose out of the contract or asset. That would mean that foreign tax would reduce UK tax on other earnings unrelated to the foreign tax payment, including wholly UK-based activity.

The amendment adds complexity and is unjustified. I appreciate that it was moved in a probing and questioning way. Nobody should expect the Exchequer to subsidise rates of foreign tax that exceed its own, or to allow foreign tax to reduce income tax arising on UK earnings. That is a reasonable position, and I hope that the hon. Member for South-West Hertfordshire will accept it and withdraw the amendment. If he does not, we will have to resist.

David Gauke (Conservative, South West Hertfordshire)

With respect to the Financial Secretary, there is an element of retrospectivity here, in that transactions entered into under one arrangement will be treated differently now, under the provision. That is not the clearest or most obvious example of retrospectivity—we will come to one in a moment. None the less, I recognise her argument. She referred to the Legal and General case of 2006, which she said had been dealt with as far as corporation tax was concerned in 2005. It appears that the Treasury was at least prescient in 2005. I imagine that those were various stages of the action.

Jane Kennedy (Labour, Liverpool, Wavertree)

It was exactly that. Clearly, Her Majesty’s Revenue and Customs was aware of that, and the dispute arose some time before. The law was fixed, and would have always been so, because it was never intended to work as was implied.

David Gauke (Conservative, South West Hertfordshire)

I am grateful for that. It raises a concern that we will come back to in a moment.

Philip Hammond (Conservative, Runnymede and Weybridge)

Will my hon. Friend reflect on what the Financial Secretary has just said? As I understand it, she said that a court case was in progress with Legal and General, a pretty powerful organisation. HMRC obviously realised that the law was defective because in 2005 the Government amended the law to close the defect. If I understand her correctly, the Government allowed the case to be pursued through the courts at public expense, only to be defeated in a way in which they knew they would be defeated. If they did not know that, they would not have changed the law in 2005. Does my hon. Friend agree that that is a perverse course of action for the Government to have followed?

David Gauke (Conservative, South West Hertfordshire)

I think two points have been raised. First, my hon. Friend has raised the point about the interrelationship between specific cases in case law and statutes. We will return to that point in a moment. The Committee may want to reflect on the Padmore case of 1987, which provoked a change in the law. At least that change in statute was without prejudice to judicial decisions being made in the matter before the change in law was announced. It seems a rather strange position to change the statute in the middle of a case. It goes against certain aspects of the rule of law.

Another point worth noting, which we will also come back to, is that it appears that this matter was on the radar of HMRC and the Treasury in 2005. Given the way in which these cases tend to work over several years, it was probably on their radar in 2004, if not earlier. If that is the case, why are we bringing in this legislation that has an element of retrospectivity in 2008?

Mark Field (Conservative, Cities of London and Westminster)

Does this exchange of views not sum up the concerns that my hon. Friend has put forward about retrospection? If a statute is changed halfway through a case, one can understand it if it is aimed to overcome loopholes in future. In such an instance, it is all the more important that there is no sense of retroactive intent for the very reasons that my hon. Friend has set out.

David Gauke (Conservative, South West Hertfordshire)

There are concerns about retrospective legislation. I do not take an absolutist line on the issue, but to minimise those concerns it is at least reasonable to expect the Treasury to produce legislation at the earliest opportunity. It is not reasonable to fail to address an issue and to leave some ambiguity within the law for three or four years, knowing that one can come back to it at a later date.

This measure is not the worst example because, to be fair, it talks about income received after 6 April 2008. My concern is that some transactions will have been entered into before that time. A transaction could have been entered into between the conclusion of the Legal and General case and 6 April on an understanding that that case had set the law. The interested parties would then find that the Government have come back and said that the law will be different and any income received as a consequence of the transaction will be treated differently.

This is a mere forerunner of our debate on clause 55. The amendment has successfully flushed out the issues. However, the Financial Secretary acknowledged that I recognised in my opening remarks that the amendment would create complexity and two parallel systems that would be far from ideal. Therefore, having put on record our concerns about how the Government have addressed the issue, I beg to ask leave to withdraw the amendment.

Clause 55

Colin Breed (Liberal Democrat, South East Cornwall)

I beg to move amendment No. 132, in clause 55, page 27, line 31, leave out subsection (4).

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following amendments: No. 134, in clause 55, page 27, line 31, leave out ‘are treated as always having had effect’ and insert

‘shall have effect from 6th April 2008’.

No. 135, in clause 55, page 27, line 33, leave out subsections (5) and (6).

Colin Breed (Liberal Democrat, South East Cornwall)

I say at the outset that we accept entirely the need for the Government to legislate against tax avoidance. We appreciate that the provision is designed to prevent tax avoidance by United Kingdom taxpayers on income from foreign partnerships using Isle of Man or Channel Islands partnerships. It is based on an interpretation of the 1987 rule that was introduced following the Padmore case.

We support the Government’s efforts to deal with tax avoidance, but we still believe that, in principle, tax changes should apply prospectively and not retrospectively as set out under the measure. It has been the theme not only of some clauses this morning—it has been growing over the previous two Finance Bills, whereby the Government are making a determined effort to use retrospectivity as a tool for tax avoidance. While it was implemented in respect of a few things to begin with, it now seems to be creeping in in a new way. We are worried particularly by the effect of subsection (4), which will treat the new provisions as “always having had effect”.

As a result of the change, established tax law that has been on the statute book since 1970 has instantaneously been rewritten. Rewriting of legislation in such a way does not meet the legitimate expectation test. It sends out a damaging signal about the stability of the UK tax system, whereby business transactions made under one set of laws can then become subject to a different tax outcome at a later date due to the retrospective change in the rules. It is for that reason that the amendment would remove the measure.

Although we understand that the clause is directed primarily at transactions involving Isle of Man or Channel Islands partnerships, the European Union law principle of legitimate expectation needs to be respected. Taxpayers are entitled to understand the implications of a transaction that they enter into. Treating the provision as “always having had effect” runs contrary to Parliament’s intent over the past 30 years, which is to lay down rules whereby the tax effect of particular transactions can be changed or advance warning can be given of a change in the tax treatment in clearly identified circumstances.

In the late 1980s, an approach was adopted to counter a legal decision that had gone against the Revenue and which the Government wished to reverse. Although the new law was stated to “always having had effect”, it did not influence judicial decisions made before the new law was announced. A more recent approach was the statement made by the then Paymaster General to the effect that legislation would be introduced and be effective from 2 December 2004 in relation to what the Government consider to be unreasonable tax-avoidance schemes involving employment income.

Following that, in one of its report, the Treasury Committee said:

“The Inland Revenue should, without jeopardising their position, publish a paper setting out their thinking on the principles which will guide the way they implement”

the then Paymaster General’s announcement. Such a paper has never been published, but we believe that the philosophy underlying retrospective or retroactive legislation should now be examined in conjunction with the current move to introduce principle-based legislation. If the underlying purpose behind legislation or an area of tax law is articulated clearly, a taxpayer who respects that purpose should have certainty about the tax outcome of their particular transaction. If the underlying policy is to be changed, then any change should have effect only in relation to future transactions.

In summary, the application of the legitimate expectation test to this provision should be that any amendment applies only from the date that the change was announced—Budget day 2008. In respect of periods before that date, if HMRC believes that these interpretations are based on a wrong view of the law, they should be challenged through the courts. We believe an appropriate modus operandi should be agreed by the Treasury, HMRC and the representative bodies and then published for the benefit of all taxpayers.

My hope—and the other amendments in this group have a similar theme—is that the Government will live up to some of their promises, particularly in respect of the then Paymaster General’s announcement that we would get a paper of principles. It would enable us to understand this policy of retrospectivity, which commenced a few years ago and is almost going full steam ahead without that paper. The purpose of the amendment is to bring the matter to a head so that by the time we get to Report the paper that was announced a few years ago will have been published. We will then be able to judge the resultant clauses that the Government want to introduce in this Bill against that set of published principles.

David Gauke (Conservative, South West Hertfordshire)

Whereas on the previous clause we made our points in a probing manner, we do so here with much greater force. I associate myself with the remarks of the hon. Member for South-East Cornwall. The retrospective nature of the clause is deeply troubling. We fully share the Government’s concern about the issue that it is trying to address. There is a problem with the arrangements and it is perhaps more than just a kink in the system, as the Economic Secretary put it. Trading profits derived from UK land are being received tax free by UK residents and domiciled individuals because of schemes involving the establishment of offshore trusts, specifically in the Isle of Man.

The existing legislation appears to deal with the issue where the UK residents or domiciled individuals are partners in the relevant offshore funds, but it does not seem to work where the partners are trusts and the UK individuals are benefiting from the arrangement. There is not a problem with trying to address that point, but there is a point of principle here. The proposal essentially states that the amendments contained in the clause are to be treated as always having had effect. Either the law exists or it does not. It is troubling when the Government state that the law in the past is something because that is what they say it is now. That is essentially what subsection (4) states.

This is partly an issue of simple democracy. It raises issues about EU law and legitimate expectations. I shall not pursue that point, but the hon. Member for South-East Cornwall is right to raise it. In part, it cuts to the question of the certainty and stability of the UK tax system. For investors, the idea that UK tax law is likely to be changed retrospectively is unattractive, and the UK is, for various reasons, acquiring a reputation for having an uncertain and unstable tax system, which is bad for the UK economy.

This clause is but one example, but it has attracted considerable attention. Indeed, one leading tax expert described it as unprecedented. The Minister smiles, but I would be grateful if she gave some examples. She may seek to give the example of the 1987 case, but distinctions can be drawn with that. The 1987 provision, with regard to section 62 of the Finance Act 1987, seeks to reverse the Padmore case, to which we have referred. It says that the measure is deemed to have an effect except in relation to any judicial decision made before the amending legislation was announced. That is an important carve-out. It benefited not only Mr. Padmore, but a number of other individuals who had entered into arrangements and waited for the conclusion of the judicial proceedings relating to Mr. Padmore. In doing so, they benefited from that carve-out.

None the less, concerns were raised, and understandably so. I think that there was a certain amount of nervousness from the relevant Minister at the time—Norman Lamont, now Lord Lamont—but it may well be worth pointing out the comments made by the Labour spokesman about what was then clause 62. He said:

“Parliament should oppose retrospective legislation, for a number of reasons. The principal democratic reason is that people are perfectly entitled to do whatever the law permits them to do and that it is wrong afterwards to make it unlawful.”—[Official Report, 15 July 1987; Vol. 119, c. 1179.]

That spokesman—

Jane Kennedy (Labour, Liverpool, Wavertree)

Who was it?

David Gauke (Conservative, South West Hertfordshire)

The Minister anticipates what I am about to say. That Labour spokesman was one Tony Blair. He did not always make the right comments, but on that issue he made a fair point. [Interruption.] I know that the words of Tony Blair do not hold much sway with those in the modern Labour party. That is a pity for them as well as the country.

There is the issue of timing, which we touched on in relation to the previous clause. I do not think that anyone would dispute that the provision is retrospective. It goes back at least to 1987, so that is 21 years. As I said earlier, there is the issue of HMRC and the Treasury not necessarily acting terribly quickly when becoming aware of the arrangements. The explanatory notes refer to the “new avoidance scheme”. This is not the first time in these proceedings that I have had to query the explanatory notes, but I am not sure that the expression “new avoidance scheme” is entirely justified. How long have the Government, whether through HMRC or the Treasury, been aware of the arrangements? There is certainly evidence that HMRC has been aware of the arrangements for some years. That raises the question that I asked earlier. It is incumbent on the Government to act reasonably quickly. If they become aware of a scheme that they do not like but they sit on their hands and do nothing about it, and then some years later say, “Okay, we will introduce retrospective legislation,” that raises real concerns, because again there is a continued period of uncertainty. I would press the Government to move quickly if they saw something wrong, rather than sit on it for a long time and then seek to introduce retrospective legislation.

Philip Hammond (Conservative, Runnymede and Weybridge)

I listened with great interest to my hon. Friend. He seems to imply that there is a concept of reasonable expectation. Where the Government are known to be aware of a practice and do not move to close it down, is it not the case that taxpayers have a reasonable expectation that the Government have chosen to tolerate that course of action, and plan accordingly?

David Gauke (Conservative, South West Hertfordshire)

My hon. Friend makes an important point. It comes back to legitimate expectation. If the Government do not act on something, perhaps they have taken the view that they will not pursue it. That argument has become stronger in recent years, as the Government now benefit from a disclosure regime. Schemes that result in people making tax savings are disclosed to HMRC, which has the opportunity to review the situation and introduce legislation. We have seen some examples of that in this and previous Bills.

It might be worth returning to the Rees rules, which we discussed on Tuesday. My hon. Friend the Member for Fareham discussed them with the Economic Secretary, and there was some disagreement over interpretation. However one looks as those rules, this provision does not comply with them. The rules set out three circumstances that apply with retrospective tax legislation. If anti-avoidance provisions are to be legislated, there should be a clear warning in the House of Commons, where feasible a draft law should be published as soon as possible—to give effect to the proposal—and the clause should be incorporated in the next available Finance Bill. I would be grateful if the Financial Secretary could enlighten us on the extent to which that process has been followed with these provisions. I am not sure that it has. The hon. Member for South-East Cornwall referred to the Padmore case and the previous Paymaster General’s warning about employment-related schemes going back to December 2004. When was the warning given and did legislation follow as soon as possible? The Government are not on particularly strong ground.

It is not acceptable that the Government permit something that they consider unacceptable to exist for some years, and then seek to introduce retrospective legislation to address it. That is what we see here. The comments from the professional bodies are universally critical. The Chartered Institute of Taxation described the retrospective nature as “extreme” and “unjustified”, the Law Society described it as “wrong in principle”, and the Institute of Chartered Accountants in England and Wales said that

“it sends out a very damaging signal about the stability of the UK tax system”.

In the light of that—I stress that we are talking about the retrospective element and not the intention of the clause—we are deeply concerned about the proposals. Hence, we have tabled amendments, which are in line with the intention of the hon. Member for South-East Cornwall in amendment No. 132. Looking at that, we have stated that the provision should have effect only from 6 April 2008. On reflection, we have been unduly harsh on the Government and it would be reasonable to say 12 March 2008, which was the date of the Budget as opposed to the beginning of the financial year, but given that the proposal has a retrospective effect of 21 years, I am not sure that one month here or there will make much difference. If the Minister wants to reassure us and say that she will introduce proposals to change the retrospective nature of the measure to date it back to 12 March 2008, I would happily withdraw the amendment and accept that as a fair compromise. I am being extremely reasonable—

Jane Kennedy (Labour, Liverpool, Wavertree)

As always.

David Gauke (Conservative, South West Hertfordshire)

As always, as the Financial Secretary generously concedes. The proposal raises serious questions, however, about the way in which retrospective legislation is increasingly being used and we have deep concerns about that.

Mark Field (Conservative, Cities of London and Westminster)

Unlike my hon. Friend the Member for South-West Hertfordshire, I am not merely troubled, I am very alarmed by the proposal, particularly when reading the words of subsection (4) that the hon. Member for South-East Cornwall rightly highlighted,

“are treated as always having had effect.”.

The argument about the retrospective effect of legislation is not merely an academic one, it reflects the potentially arbitrary and strong powers of HMRC. I suspect that later in our deliberations we will discuss precisely how those powers will operate, given the historical distinction between the powers of the Inland Revenue and those of Customs and Excise. It is of great concern that this particular wording is being used. I suspect that the Financial Secretary will tell us that this is a narrow case, but it sets something of a precedent. There are plentiful opportunities for the Government to examine anti-avoidance—we have a Finance Bill every year. All the time that I have been in Parliament, in Finance Bills year on year an inordinate amount of anti-avoidance provision has come into place, largely as a result of the fact that we have seen more complex arrangements being put in place. There are some broad philosophical issues about the arbitrary nature of the state’s power, but also some practical issues that other hon. Members have brought into play, about what this means for the stability of Britain as a place to do business, particularly for overseas investors.

Jane Kennedy (Labour, Liverpool, Wavertree)

It is important to challenge the suggestion that this is an attempt to introduce retrospection as a thin end of what hon. Members might quite properly fear is a large wedge. That is not our intention. I understand that the 1987 legislation had retrospection that was unlimited and in effect went back to about 1945. This is a specific case where there has been serious abuse of the tax system.

Mark Field (Conservative, Cities of London and Westminster)

As I understand it, the legislation 21 years ago made it absolutely clear that it was not in any way trying to unravel arrangements that had been put into place before the Padmore case of 1987, where as the wording of the subsection to which I referred, about the legislation being treated as always having had effect, should have alarm bells ringing in all of us as parliamentarians. We all know the tremendous power of the state and, in particular, the tax authority, and the detrimental effect that that is likely to have on external investment. I want to make the more general points only; I know that the specific points have been made from the Opposition Front Bench by my hon. Friend the Member for South-West Hertfordshire. I think that my hon. Friend the Member for Gosport also wishes to address the issue, but I hope that the Minister will give it serious thought. It is in the nature of having a Finance Bill every year that it allows the Government to make annual changes looking forward, but to have a retrospective effect with such stark words as those set out in subsection (4) should alarm us all.

Peter Viggers (Conservative, Gosport)

There is a place for retrospective legislation. One of the better known cases was when someone intelligent discovered just after the second world war that the activities of the London fire brigade had been non-statutory and illegal. Parliament, in its wisdom, therefore decided to legitimise the London fire brigade, failing which matters such as compensation would have been extremely complicated. There is a case for retrospective legislation, but it should be reserved for those extreme, obvious cases. For the Revenue to use retrospective legislation to mop up bits of revenue law is simply unacceptable. If the Revenue is confident that the law has always been as it is now intended to be stated, surely it should challenge the case through the courts. The explanatory notes say:

“This clause will put it beyond doubt that the legislation has always had that effect.”

and the right way to challenge that is through the courts.

As I understand it, the Revenue has demonstrated that it was aware of the practice, and that the statement

“the legislation has always had that effect”

is disingenuous. The Law Society has briefed me that paragraph 1660 of HMRC’s international tax handbook shows that HMRC had known for some time about the way that tax professionals have been interpreting section 858 of the Income Tax (Trading and Other Income) Act 2005. It also mentions that the original legislation to reverse the Padmore case, from which this tax planning arrangement derives, was controversial because it too was retrospective.

The way that HMRC operates provides for a tax-avoidance disclosure regime that allows the case to be put to Revenue and for clearance to be obtained. Given that the disclosure regime is available, there should be no need for any retrospective legislation. The current drafting of the Bill would give HMRC the right to turn a blind eye to a scheme and come back retrospectively and decide that it is illegal. That is an important point of principle, and I hope that the Financial Secretary will listen to those arguments.

Jane Kennedy (Labour, Liverpool, Wavertree)

I am conscious that we may have a Division on this. It is a shame that the calming effect of the music from outside has not applied in the Committee room. Hon. Members have become agitated over something that, after giving my explanation, I hope that I will be able to—[Interruption.]—

Colin Breed (Liberal Democrat, South East Cornwall)

I do not know about a calming effect; I think that they were praying for the soul of the Government.

Jane Kennedy (Labour, Liverpool, Wavertree)

TouchÃ(c). I was pleased to hear that the hon. Member for South-West Hertfordshire declared himself a Blairite, albeit a little late.

The Government understand some of the concerns about retrospectivity. It is right to be concerned about the use of that, and it is right for the Government to justify every case. The amendments would prevent clause 55 from being treated as always having had effect. That would take away a fundamental purpose of the clause, which is to put it beyond doubt that a wholly artificial avoidance scheme, which I will explain in a minute, does not work and never has done. As has been said, the avoidance scheme that the clause closes down was designed to frustrate legislation passed by Parliament in 1987 to prevent this type of avoidance, also with retrospective effect.

We have carefully considered what action should be taken against such artificial schemes, and we have not come to a decision lightly. In words similar to those used by the hon. Gentleman who spoke for the Opposition in 1987 and who I will come to in a minute, the now noble Lord Lamont of—

Mark Field (Conservative, Cities of London and Westminster)

Lerwick.

Jane Kennedy (Labour, Liverpool, Wavertree)

I am grateful, Lord Lamont of Lerwick.

I am satisfied that in these unusual circumstances, retrospective clarification of the law is fair, proportionate and in the public interest. That is the human rights test that we must apply.

It might be useful for me briefly to give some background. In 1979, Mr. Padmore, a UK resident, worked in the UK as a patent agent. He was also a member of a Jersey partnership, which had been set up to receive some of the income from Mr. Padmore’s activities as a patent agent. In line with the law as it was generally understood at the time, the Inland Revenue sought to tax him on his share of the foreign partnership’s profits. In December 1986, the courts upheld his claim that the tax treaty between Jersey and the UK meant that none of the Jersey partnership’s profits could be taxed in the UK, even those belonging to UK resident partners.

The decision was a surprise, not only to the Inland Revenue but to other tax authorities and most tax advisers. It overturned the generally held view that unless explicitly specified, tax treaties do not remove a country’s right to set taxes.

(Except clauses 3, 5, 6, 15, 21, 49, 90 and 117 and new clauses amending section 74 of the Finance Act 2003)

Jimmy Hood (Labour, Lanark and Hamilton East)

I remind the Committee that with this we are discussing the following amendments: No. 134, in clause 55, page 27, line 31, leave out ‘are treated as always having had effect’ and insert

‘shall have effect from 6th April 2008’.

No. 135, in clause 55, page 27, line 33, leave out subsections (5) and (6).

Jane Kennedy (Labour, Liverpool, Wavertree)

Before our break, I was explaining the impact of the court’s decision in December 1986 and how that decision came as a surprise, not to say a shock, to the Inland Revenue, to other tax authorities around the world and to most tax advisers. The problem was not confined to the UK-Jersey tax treaty. Parliament acted at the next available opportunity—in the 1987 Finance Bill—to make it clear that the UK’s treaties did not give, and never had given, tax exemption to a UK member’s share of a foreign partnership’s income. During the debate on the 1987 Bill, there was an exchange between the then Financial Secretary to the Treasury, now Lord Lamont of Lerwick, and my party’s spokesman, Tony Blair. If I may quote more widely from the Committee’s debate than did the hon. Member for South-West Hertfordshire (Mr. Gauke)—it is always good to make what was said clearer and not to draw on too narrow a quotation—the then Financial Secretary said:

“The hon. Member for Sedgefield has made some good and telling points—he always does in Committee.”

Tony Blair then said:

“I believe that the right hon. Gentleman has put as good a case as possible in defence of the retrospection within this clause”,

although he doubted whether the same argument would stand in other examples. The then Financial Secretary observed that although the provisions had caused him “considerable concern”, he had concluded that the clause should apply with retrospective effect. He noted that that did not involve the

“type of retrospection on which the House has normally looked with disfavour”

as all that it did was to

“restore the general understanding of the law to what it was before a decision of the High Court.” —[Official Report, 15 July 1987; Vol. 119, c. 1180-87.]

Colin Breed (Liberal Democrat, South East Cornwall)

Will the Minister tell the Committee how many years back that retrospection went?

Jane Kennedy (Labour, Liverpool, Wavertree)

I will seek to answer that later, but the retrospection was extensive.

UK individuals and companies have been artificially routeing their income through offshore trusts and partnerships and claiming that one of the UK’s many double taxation treaties exempts them from tax. That is in wilful contravention of the purpose of the treaty and the 1987 legislation. A fundamental purpose of the clause is to put it beyond doubt that a wholly artificial avoidance scheme designed to frustrate legislation passed by Parliament in 1987 to prevent such avoidance does not work, and never has. Some taxpayers were awaiting the outcome of litigation in the expectation that it would clarify their affairs. The legislative change in the clause will result in the necessary certainty, not litigation, thus enabling tax returns to be finalised.

Many descriptive terms have flowed in the discussions that I have had about this avoidance scheme, one of which is “an egregious case”. In such a case, the Government consider that the law already defeats the scheme and that it is clear to all concerned that the scheme is in defiance of Parliament’s intent. Used in such a context, retrospection preserves the expectation that tax will be applied fairly and consistently. That will build confidence and trust in the law. Nobody could seriously think that the clause is unfair to the people who will be affected by it. Users of the scheme have deliberately tried to frustrate the will of Parliament, and they will have been aware that Parliament had closed down similar schemes 20 years ago with retrospective effect. My understanding is that that retrospectivity was unlimited, in effect, until the end of the second world war.

The Committee might not be aware of the scale of the risk to the Exchequer as a result of this avoidance scheme. HMRC is aware of more than 2,000 scheme users, and it involves tax of £50 million a year—a not insubstantial sum. Given the increasing numbers using the scheme, the rapidly growing amount of tax at risk and the wilful attempt to circumvent the clear purpose of the legislation and of the UK’s tax treaties, we consider it appropriate to legislate to provide retrospective clarification and to put the matter beyond doubt. HMRC has learned that the large number of taxpayers who have been using the scheme has suddenly started to grow; I shall explain why in a moment.

David Gauke (Conservative, South West Hertfordshire)

I acknowledge that the number seems suddenly to have increased, but will the Financial Secretary clarify when HMRC first became aware that such schemes were being created?

Jane Kennedy (Labour, Liverpool, Wavertree)

I will do that in a moment, if the hon. Gentleman will allow me.

The scheme is similar to the Padmore scheme except that UK taxpayers set up offshore trusts as well as partnerships. The trusts are for their own benefit, and the trustees become members of the partnership. UK taxpayers agree to work for the partnership, so that once a scheme is set up, their UK income thereafter becomes payable to the partnership and, through the trust, it is paid straight back to them in the UK. They assert that such an arrangement circumvents the 1987 legislation so that the income is tax-free. HMRC does not believe that the scheme works, but we have taken into account its scale and the wilful attempt to flout the law that retrospectively clarified how tax treaties work. The Government have developed our approach on the detail of the legislation on anti-avoidance rules generally to ensure that they are effective and properly targeted. Business welcomes that approach, and it has led to better legislation.

Let me respond to the point raised by the hon. Member for South-East Cornwall. In 2004, the then Paymaster General gave a warning in relation to a particular abuse. Her statement gave no reassurance about use of retrospection on other matters, and certainly did nothing to suggest that the Government would act differently in relation to treaty abuse than they did in 1987.

The Government do not accept that the clause changes the meaning of the law. The law already applies to partnership profits, and we interpret that as including profits enjoyed through a trust. The measure clarifies rather than amplifies the scope of the 1987 legislation and puts beyond doubt what most people understand it to mean. We recognise and acknowledge the difficulties inherent in such legislation. Although the clause is strictly retrospective, as was the case in 1987, it does not change what is generally understood to be the meaning of the law but merely clarifies it.

The hon. Member for Gosport is not in his seat at the moment, but I should put it on record that HMRC guidance merely noted that some tax planners suggested that circumventions were possible. HMRC did not accept that view of the law, and it does not accept it now. It did not see evidence that such schemes were being used until 2001. However, their use has increased sharply in the past year, which is why we are acting now. The discourager regime provides HMRC with early information on tax avoidance. In many cases, it will respond to the information by challenging the avoidance in the courts. In some cases, it will be appropriate for the Government to legislate to prevent future use of a scheme or new variants on it. In rare cases, such as those we see today, it will be appropriate for us to act retrospectively to ensure that abusive schemes are closed down by legislation rather than litigation. There are no cases of litigation at the moment.

Mark Field (Conservative, Cities of London and Westminster)

We all accept that Parliament’s desire should hold sway, but the issue is surely one of clarification. The correct place to clarify the law is in the courts—it should not be done merely by ministerial assertion or Treasury diktat. That is the Conservative objection to the measure. Clarification must come through the proper legal process.

Jane Kennedy (Labour, Liverpool, Wavertree)

The hon. Gentleman and I will clearly have a disagreement on that.

Subject to an exception relating to judicial decisions made before 17 March 1987, the legislation applied retrospectively. Therefore, the provision did not apply to Mr. Padmore or to a few other taxpayers. In relation to the scheme, some taxpayers were awaiting the outcome of litigation in the expectation that it would clarify their own tax affairs, but no litigation has ever commenced. The change in legislation provided by the clause will provide the necessary certainty instead of litigation and enable tax returns to be finalised.

David Gauke (Conservative, South West Hertfordshire)

The Minister says that in the opinion of HMRC, the clause merely clarifies the existing law, and that there has been no litigation. That is presumably because HMRC has not pursued litigation. If HMRC is so confident that the measure merely clarifies the law—I am not making a case one way or the other—why is it not bringing litigation against the users of the scheme?

Jane Kennedy (Labour, Liverpool, Wavertree)

Because the opportunity arises to deal with the matter through legislation and to make it clear that, as HMRC already believes, the scheme does not work. The change that we are making has already had an impact on the number of notifications of the scheme. As I said, there is a risk to the Exchequer on the scale of millions of pounds.

Peter Bone (Conservative, Wellingborough)

I have been listening to the debate and I am not quite sure why the measure must be retrospective to save money for the Exchequer. If the Bill is enacted and taken forward, will that not save money? I must have missed something.

Jane Kennedy (Labour, Liverpool, Wavertree)

As I understand it, a number of people are proposing to use the scheme and some tax advisers will recommend the use of it unless we act to make it clear that the scheme does not work. The legislation will end the doubt about that.

Peter Bone (Conservative, Wellingborough)

I think the Minister is making my point: if we enact the measure now, there is not a problem going forward—I agree with her entirely. However, I do not understand why we have to throw back the measure.

Jane Kennedy (Labour, Liverpool, Wavertree)

I hope I get this right. It is because HMRC has not consistently made the case throughout the time period that the scheme does not work, that it is a deliberate and wilful avoidance scheme that flouts the 1987 legislation, and that it would be challenged.

Philip Hammond (Conservative, Runnymede and Weybridge)

The Minister has said that HMRC regards the scheme as a wilful flouting of the law, but apparently it has never brought a case. When she answers the question of my hon. Friend the Member for Wellingborough about why it cannot simply be a prospective proposal, can she say how much back tax—disputed tax—rides on the retrospectivity aspect of the measure?

Jane Kennedy (Labour, Liverpool, Wavertree)

That is a fair question, to which I have not immediately got an answer. I hope to have the answer, but if I do not, I will certainly write to the Committee.

It is not right to say that HMRC turned a blind eye to the scheme, did nothing and waited until legislation became necessary. HMRC’s early challenges around the scheme—although not litigation—did meet with some success. It strongly believes that this is an exceptional circumstance and that none of the scheme users could have been in any doubt that they were deliberately flouting the clear intention of the 1987 legislation.

Mark Todd (Labour, South Derbyshire)

My understanding is that if one did not make the measure retrospective, one would implicitly be saying that there was some validity in the evasion technique, and that that is the answer to the point made by the hon. Member for Wellingborough.

Jane Kennedy (Labour, Liverpool, Wavertree)

My hon. Friend is right. Looking back, the sum is around £200 million. As I have said repeatedly, in HMRC’s view, someone not would have used the scheme without knowing exactly what they were doing. Early scheme users did concede to HMRC arguments and the usual preliminary steps were taken towards litigation. However, the growing use of the scheme had begun seriously to threaten revenues, which led to unacceptable uncertainty. This was thought to be by far the most appropriate way of dealing with it. It was signalled well in advance that such a step would be taken.

I have received one or two representations on the matter, but I understood that there was broad acceptance that the Government were expected to take this step. The hon. Member for South-East Cornwall says that that is not the case, but I have seen only one or two representations, and I was not aware of that concern being widespread. I was about to speak about the Rees rules, but I happily give way.

David Gauke (Conservative, South West Hertfordshire)

I shall read again what some public bodies have said. The Chartered Institute of Taxation says, “extreme and unjustified”. The Law Society says, “wrong in principle”. The Institute of Chartered Accountants in England and Wales says,

“it sends out a very damaging signal about the stability of the UK tax system”.

At the HMRC and Treasury open day for the Finance Bill, a long list of representations were made by those bodies and others, including KPMG and the Institute of Chartered Accountants of Scotland. All were expressing great concern, not about closing the loophole but about the retrospective element.

Jane Kennedy (Labour, Liverpool, Wavertree)

I will reassure myself that my understanding is accurate. I shall consider the point made by the hon. Gentleman, because I want to be absolutely sure. However, given what I understand of the scheme, such representations are surprising to me. When we change the law to combat clearly abusive avoidance arrangements, we may exceptionally—very exceptionally—do so with retrospective effect.

Philip Hammond (Conservative, Runnymede and Weybridge)

I have not studied the subject like my hon. Friend the Member for South-West Hertfordshire, but does the Minister accept that there is a difference between a court making it clear that the HMRC interpretation is correct and that the taxpayer interpretation is incorrect and the Government then moving to legislate retrospectively, effectively in order to implement the court’s decision and what she is doing now? The Minister is merely asserting that the taxpayer is wrong and that HMRC is right without being prepared to let the courts test that view.

Jane Kennedy (Labour, Liverpool, Wavertree)

We regularly legislate in Parliament, and the legislation is often tested in court. If Parliament’s view of the law is found to be unjustified by a court and if Parliament believes that its view should carry, it is perfectly proper for the Government to revisit the matter—

Philip Hammond (Conservative, Runnymede and Weybridge)

That is what we are saying, but after the court hearing.

Jane Kennedy (Labour, Liverpool, Wavertree)

In 1987, a court judged the law to be deficient. As I said, the judgment was a complete surprise to everyone in the field; there was thought to be universal acceptance that the legislation was right. It was based on long-used double taxation treaty legislation. As one would expect, the court’s decision required a study of what had gone wrong and of where the law was deficient. I am happy and content, given the advice that I have received, that the decision I am asking the Committee to make today is right.

I am not going to dwell on the point, but it is a point worth making. We are engaged in discussions about a taxpayers charter, and have invited representations. The Chartered Institute of Taxation submitted suggestions of what such a charter might do. Section 13 includes this statement:

“Where we change tax law to combat clearly abusive avoidance arrangements, we may exceptionally do so with retrospective effect.”

I am not asking the Committee to do something absolutely outlandish and outwith the expectation of the industry, although I accept the point made by the hon. Member for South-West Hertfordshire about the number of representations that he has seen and will seek to reassure myself about the advice that I have had.

Mark Field (Conservative, Cities of London and Westminster)

I confess that I was unimpressed by the Minister’s answer to the earlier intervention by my hon. Friend the Member for Runnymede and Weybridge. A set mechanism is in place. In so far as the scheme can be challenged in the courts, she is absolutely right to say that the Government have an opportunity to come back and make new law to close any loopholes, but she is arguing that there is no loophole that the Government recognise. Does she not see our perspective? We fear that down that road—although, admittedly, a fair way down it—lies tyranny.

Jane Kennedy (Labour, Liverpool, Wavertree)

No. The hon. Gentleman will remember that the court decision led to the legislative decision in 1987, which related to the abuse of partnerships and the arrangements concerning them. We now see the scheme developing in a way that HMRC believes strongly will not work. I ask the Committee to agree to clause 55 because the Government are absolutely clear that the view taken by Parliament in 1987 was the right view. Even though it was taken by a different party, we stand by that decision. I believe that we can pass the clause with a clear conscience.

The Rees rules do not govern all possible situations in which the Government might introduce retrospective legislation; they apply where the Government seek to close down a scheme with immediate effect. There are a few exceptional cases, such as this one, where closure with immediate effect would not be adequate to counteract the avoidance in question.

Tax avoidance is unfair to the great majority of taxpayers who pay their fair share. We discussed the nature of avoidance earlier. I can understand that people want to reduce their liability, but where a scheme is in clear and deliberate breach of the law, Parliament has a duty to act to protect the Exchequer. None of the scheme’s users was entitled to artificially avoid paying their fair share of tax at the expense of others. They ought to have been aware of the likely consequences of their wilful attempt to flout the law. The 1987 decision to tackle treaty abuse with retrospective effect was a clear signal. I hope that the amendments will not be pressed to a vote. If they are, I hope that my hon. Friends will resist them and that clause 55 will join the rest of the Bill.

David Gauke (Conservative, South West Hertfordshire)

I do not think that the Minister has reassured Conservative Members at all. There is an essential contradiction in what she said. She said that HMRC is confident that the clause merely reasserts existing law, that it is not a change in law and that the schemes are in clear breach of the law, yet she suggests that some £200 million in back tax is at risk. If the law is as she says—I have no reason to doubt it—that sum is not at risk, because all that is required is for HMRC to litigate. It prompts the question why HMRC will not litigate. Why is it not prepared to take the matter to court?

It relates to the point made by my hon. Friend the Member for Cities of London and Westminster. The Government are saying, essentially, that they will pass new law if they think that the law is in some way flawed or there is an alternative interpretation of it that they do not like. Rather than allowing the courts to interpret that law, they will rewrite it retrospectively so that it says what they wanted it to say in the first place. Such an approach gives individuals and businesses no reassurance that the law is what they think it is, as it is written down and what has been passed by Parliament. The impression is that it is something that can be changed if not at a whim, at the discretion of the Government retrospectively.

Philip Hammond (Conservative, Runnymede and Weybridge)

Does my hon. Friend agree, that for the purpose of clarifying the law and sending out signals about it to the business community, the Government should have legislated to correct any confusion or doubt in the law as soon as they became aware of it? The Minister implied that the reason behind the need to move now is that the use of the avoidance technique has suddenly increased significantly. She should take on board the lesson that the way to avoid being in such an embarrassing situation is to legislate as soon as a defect is spotted. Everyone will then have a clear picture of what is going on.

David Gauke (Conservative, South West Hertfordshire)

My hon. Friend takes me to my second point. However, I must say first that certainty in the taxation system is important. We have a well-developed legal system that should work on the basis of laws being interpreted on the grounds of what they say, not what the Government want them to say—even if that is not what they said at the time.

Jane Kennedy (Labour, Liverpool, Wavertree)

Is the hon. Gentleman asking us to believe that his party, and to some degree the party of the hon. Member for South-East Cornwall, believe that aggressive tax-avoidance schemes such as that under discussion, which are widely seen as abusive, should be allowed to continue during litigation at risk to the Exchequer, and that there should be no circumstances in which he would do what his party did in government, which was to legislate and to apply it retrospectively?

David Gauke (Conservative, South West Hertfordshire)

A Government should pursue and litigate on the basis of the existing law. When they identify an abuse, they should issue a warning and announce that they will change the law at the first opportunity, and then do so. That takes me to the point made by my hon. Friend the Member for Runnymede and Weybridge. The Minister said that HMRC was first aware of the schemes in 2001, but they were not pursued widely because the warnings given by HMRC proved to be sufficient. None the less, there was an awareness at that time by HMRC of some ambiguity in the wording of the 1987 legislation.

Notwithstanding the fact that the schemes were not being pursued, why were such measures not introduced under the Finance Act 2001 or subsequent Acts? There has been plenty of them. Given that there were two Finance Acts in 2005, there have probably been about eight. The matter causes great concern, and the Government’s approach should be to pursue it rigorously and to litigate if there is some doubt about the law. In the meantime, warnings should be given and legislation should be made. The Government have not done that. They have sat on the matter, have come back subsequently some years later and taken action when the scheme started to develop, having been aware of the ambiguity under the 1987 legislation.

In response to the hon. Member for South Derbyshire, I must say that, if the Government fail to make the measure retrospective, it is an admission that the previous legislation was defective. Indeed, I am more inclined to interpret the proposal to make it retrospective as an admission that the 1987 Act does not do what the Government said it does. That is not based on a legal analysis but, if they were so confident that the 1987 legislation prohibits the behaviour that we are talking about, why on earth have they not litigated on the matter?

For those reasons I am more convinced than ever that the retrospective nature of the clause is unacceptable. Should the hon. Member for South-East Cornwall wish to press his amendment to a vote, we will support him.

Colin Breed (Liberal Democrat, South East Cornwall)

We are somewhat in danger of this aspect moving from retrospection to repetition. At the end of the day, I am not certain, although there has been much repetition, whether it has made any great difference. To begin with, we talked about reasonable expectation. I am a fairly reasonable chap, and I know that the Minister is a reasonable Minister. I thought that there was a reasonable expectation that the Government might accept the powerful arguments—made not only by Opposition Members, but by a huge number of interested bodies—about the central concern.

We all agree that we want to stop the tax avoidance. There is not much disagreement on that at all. The central concern is how the Government have decided to achieve that—first, not to go through the court situation, to clarify and confirm their thinking anyway, but then the wide nature of the wording in subsection (4). It cannot be beyond the experience, knowledge, skill and such of those who draft legislation to draft a subsection to bring about a tighter situation, clearly concerned with the tax avoidance that the Government wish to close down and clarify straightaway. The current wording is so wide—that is our concern and that of many others.

Some time ago now, we talked about whether the measure would be subject to human rights legislation. The Minister said that it would be fair, proportionate and in the public interest. It is difficult to think that undertaking such wide application of the subsection is fair or proportionate—it might well be in the public interest, in terms of the money derived for the Revenue, but one out of three is probably not good enough. No reference has been made to the whole principle of the method, although I understand that the taxpayers charter will refer to retrospection. As the Treasury Committee pointed out some time ago, it would be extremely helpful to have a real paper, so that we understand the principles of any potential future retrospection in any such legislation, so that we can see clearly how such retrospection might be applied and so that we do not have such wide drafting as we have in the subsection.

I am happy to indicate that we would support a clause, subsection or some other drafting that narrowly defined the retrospection to this particular tax avoidance scheme, so that there can be no doubt whatsoever that it applies only to that, which is what the Minister has said on a number of occasions. That is what we would be happy to support. I hoped that, even at this late stage, that might be the sort of thing that would be forthcoming, together perhaps with a draft paper on the principles of retrospection. In the absence of that, I feel that we have no option but to press the amendment to a vote.

Nick Palmer (Labour, Broxtowe)

On a point of order, Mr. Hood. Could we be updated on the health of the gentleman who had a problem on Tuesday? Will you consider sending him a card on behalf of the Committee saying that we look forward to seeing him again soon?

Jimmy Hood (Labour, Lanark and Hamilton East)

I appreciate the hon. Gentleman’s concern. I expressed my concern and that of the Committee this morning. I am assured that the gentleman is recovering and resting, and that it will not be long before he is back at work.

Schedule 21

Philip Hammond (Conservative, Runnymede and Weybridge)

I beg to move amendment No. 136, in page 274, line 22, at end insert ‘, and

(c) the trade is carried on with the intention of generating a loss for tax avoidance purposes.’.

I am sure that all hon. Members are delighted at the spurt of progress that we have just enjoyed and which I now intend to stop dead in its tracks. The schedule deals with restrictions on trade loss relief for individuals. That was not mentioned in the Budget speech, but was buried away in Budget note 63. It is effectively retrospective, not in quite the way that we have discussed in relation to previous clauses, but in the sense that it will impact on the treatment of decisions made before the measure was known about.

A significant step is being taken. The provision is being introduced under the guise of an anti-avoidance measure, so the Government, using their own principles, avoided extensive consultation on it. It removes what is in effect the oldest form of encouragement for enterprise in the tax code. I should be grateful if the Minister would tell us the scale of the mischief—I use the word again—that we are addressing. I understand that in conversation senior officials at HMRC indicated that HMRC has no idea of the extent of any “avoidance” through the use of sideways loss relief by individuals, no idea whether it is costing the Exchequer money, and thus no idea of what the relief is worth. That makes this look like a fishing expedition. We on these Benches are concerned that the Government are proposing legislation that will impact on not just the incentive to take business risks, but on individuals’ ability to take on risk, and that they are doing so without any clear idea of the loss to the Exchequer—if they believe that there will be a loss—or of how much they will gain from the measures.

Under current legislation, an individual who carries on a trade can offset losses arising in that trade against other income and gains. That is known as sideways loss relief. There is a provision, in section 66 of the Income Taxes Act 2007 in its most recent incarnation, which denies any such relief if the trade is not operated on a commercial basis. That is a perfectly reasonable restriction to impose and it ought to be sufficient to ensure that the measure cannot be used for the purposes of artificial avoidance.

A fundamental issue is at stake here; individuals are taxed overall on their total income—certainly within any of the particular silos by which income is taxed. The Government are effectively seeking to introduce a sort of mini-scheduler approach within trading income, so that an individual is taxed separately on their income from different trades. That would have a significant effect. We are all aware that the Finance Act 2007 introduced provisions restricting the ability of partners in a partnership who were not actively engaged in the business of that partnership to obtain sideways loss relief. That was introduced to prevent artificial constructions that allowed individuals to take advantage of the losses generated in partnerships.

Schedule 21 provides for similar restrictions to be applied where an individual carries on a sole trade in a so-called “non-active capacity”. That raises different issues. Under the measure, where the trader is defined as a “non-active trader”, the amount of sideways loss relief is limited to £25,000 annually, unless the trade relates to film expenditure, in which case there will be no such restriction. Amendment No. 136 inserts a motive test into that through a provision that means section 74A will apply only if the trade has been carried on with the intention of generating a loss for tax avoidance purposes.

In my humble opinion, my amendment is redundant—that may sound like a slightly strange thing to say—because section 66 of the Income Taxes Act 2007 already requires business be carried on for a commercial purpose, that is, for the purpose of making a profit. The amendment has been tabled to draw attention to that problem and to probe the Minister on the extent of the catchment of the clause by highlighting how a motive test would narrow it down.

What problems do we see in relation to the provision? According to schedule 21, an individual is thought to devote sufficient time to a trade for him to be considered an active participant, if he

“spends an average of at least 10 hours a week personally engaged in activities of the trade and those activities are carried on...on a commercial basis, and...with a view to the realisation of profits”.

The 10-hour rule is an arbitrary and unsatisfactory way of defining an individual’s contribution to a business. It does not begin to address many of the real world situations in which people find themselves. It will also create a bureaucratic nightmare, which is the antithesis of the entrepreneurial spirit that the Government say they want to foster. Imagine an enthusiastic entrepreneur engaged in starting up a part-time business. When he gets home from his hard day’s work in employment and goes out to his garage, where he is in the process of creating the next Hewlett Packard, he will presumably need to clock on and record on his time sheet the hours he is committing to that new venture in order to produce records to satisfy HMRC that he is committed to that enterprise for more than the requisite 10 hours a week averaged over the tax year.

If we really want to foster a culture of entrepreneurship in this country, not only is that requirement patently absurd and unenforceable, but even the thought that entrepreneurs should be encouraged to think in that way about the hours that they put in to developing start-up businesses is depressing. There are many wholly commercial reasons why an individual might not spend 10 hours a week personally engaged in a trade. Having taken the risk of establishing a business and built it up by the sweat of his own labour, an individual might be in a position to employ others to run it while he is engaged on the next venture, and I would have thought that the Government would want to encourage such serial entrepreneurship. The hard-working entrepreneur who, having built up a restaurant, small guest house, pub or hotel business, wants to move on and devote his time and energy to building up another venture will fall foul of these rules unless he goes back and spends 10 hours a week pulling pints at the bar in order to qualify under the tests that the Government are imposing.

Many individuals start up businesses while still in employment—a point to which I have already alluded. That is a sensible way of probing the viability of a new business venture without sacrificing the security of a regular income. Many people work full time or part time for an employer while conducting a part-time business, and sometimes more than one. Indeed, I remember meeting a constituent of mine shortly after I was elected who was employed in the catering department in the House of Commons—I can tell this story because he no longer works here—and who very enterprisingly was conducting a business as well, manufacturing and distributing hand-cooked vegetable chips, and very delicious they were too. He eventually left the employment of the House of Commons and has, I am sure, prospered elsewhere. That is not an unusual case. Hon. Members will know of many people who have tested the water with a new business project while retaining the security of their existing employment.

Some businesses are seasonal, such as furnished lettings, and there are also smallholding agricultural businesses, which people might not be able to turn into a viable full-time occupation. That is less part of the culture of this country than it is of some of our European neighbours, where part-time agriculture is a common business occupation. We believe that there could be a serious impact on start-ups and on the fostering of entrepreneurship, especially in the wake of the Government’s decision to abolish taper relief and the negative signals that that sent to those engaged in establishing new business enterprises.

I am afraid that it gets worse because new section 74A(6) provides that if an individual has received sideways loss relief in his capacity as a partner in a partnership, that amount has to be deducted from the cap that this measure proposes. That would be a further reduction in the capacity to absorb losses across the boundaries of different trades.

I have a number of other points to make on schedule 21. As I have gone this far, it might be better for me to complete my remarks, unless you indicate otherwise Mr. Hood. The Minister could then respond to the amendment and to the more general remarks, rather than have a separate debate on the schedule.

Jimmy Hood (Labour, Lanark and Hamilton East)

Order. I have no objection to the hon. Gentleman discussing other parts of the schedule, but we will not then have a separate debate on the schedule.

Philip Hammond (Conservative, Runnymede and Weybridge)

That was exactly my thinking, Mr. Hood. It is precisely because I fear that I may already have strayed into some of the more general points that I suggested that I carry on.

The Government say that these measures are aimed at tackling contrived arrangements. We have no problem with that, but the legislation is very widely drafted. It is our contention that it will also catch some wholly commercial arrangements. A normal, industrious trader who seeks to establish a new business, or businesses, could be inadvertently caught in this trap. New section 74B(3) and (4) provides that no relief will be available where loss arises as a result of relevant tax avoidance arrangements. That is fine, but the relevant tax avoidance arrangements are widely defined. When claiming sideways loss relief, will an individual have to prove that he had no expectation at the outset that such a loss could be relieved? In other words, it appears that one can benefit from sideways loss relief only if one is not aware that one could benefit from it. Perhaps the Minister would clarify that point.

Could somebody be caught by these provisions as the result of a negative decision? I return to my earlier example of somebody who has established a business that is running quite successfully. He has employees who are running it for him and he wishes to devote his attention to his next business venture. He is a classic serial entrepreneur. Could HMRC treat his failure to incorporate that first business as an act that was seeking to exploit the possibility of the use of sideways loss relief?

We are in uncharted territory. It has always been understood that people with an established line of business that is generating profits can, with the security of that profit income, invest in a new business activity or trade, and that any losses in that new trade can be offset against their income from the existing trade. By definition, one might think that asking them not to devote their full energy to the new trade, and to take a chunk of their working time and attention and continue to focus it on existing trade, to satisfy HMRC’s requirements in the test that is introduced by the legislation, would make the chance of incurring a loss in the early years of the new trade rather greater, because of the reduced attention and focus given to it.

The Budget day news release dealt with the purpose of the provisions, and said that the

“Government made clear that avoiding tax through the use of sideways loss relief is unacceptable.”

However, the provisions mean that genuine traders may not be able to claim statutory relief, which could lead to individuals being taxed on more than 100 per cent. of the net result of the profits and losses on all their business activities, where losses and profits cannot be offset.

A particular case that could arise is one in which someone who was setting up a new business was taking advantage of the annual capital allowance to invest in it but, because that new business had no profits, they would seek to offset the value of the capital allowance against the existing profit stream from their established business or businesses. That will now no longer be allowed beyond the £25,000 limit. In discussions on the matter, it has been suggested that investment in plant and equipment up to the annual investment allowance could be exempt when calculating the loss for the purposes of applying the cap. Otherwise there is a danger of hindering investment in plant and equipment in the new business.

Perhaps the Minister could give the Committee some examples of the contrived arrangements that, presumably, she fears, so that we can distinguish them from the normal trading arrangements that we fear will be caught by the wide scope of the legislation, with all the damage that that will do. The effect of paragraph 6 of schedule 21 is to make the provisions retrospective. If a loss arises in a basis period ending after 12 March 2008, that loss will be time-apportioned between the periods before and after that date, and the proportion deemed to arise after 12 March will be subject to the loss restriction, even though the loss may have arisen before 12 March.

I should like to return to the definition of a non-active capacity. In the modern world, where many businesses of all descriptions are pushing the boundaries and frontiers in technology and the way in which business is done, simply to use a test of the number of hours of direct personal involvement is simplistic. An individual might have specialist knowledge, for example, or some unique reputational value to the business that would mean that his presence—even his name on its letterhead—had a significant impact on its prospects. Someone might be absolutely essential to the functioning of the business, yet might not spend, or need to spend, 10 hours a week conducting that business. He might be the proprietor of the formula that the business is allowed to use without charge, for example. I urge the Minister to consider again whether the simple 10-hour test is really the message that the Government want to send about how they value individuals’ input into a business. We can anticipate, I think, the fact that the same argument will arise in relation to income shifting. Is it simply about how much time somebody commits to the business, or about the unique qualities and characteristics that they bring to it?

In conclusion, if there is abuse through artificial arrangements, we would support a targeted attack on that abuse, but that must not become an attack on risk taking, entrepreneurship, or start-up or spare-time businesses. The Opposition are deeply concerned that the Government are removing a fundamental part of the support system, particularly for new businesses, but also for serial entrepreneurs, which is absolutely not the direction in which the UK tax system should move, nor—this is perhaps more significant—the direction signalled in Government rhetoric.

HMRC appears to be saying in the proposals that individuals should not take risks; that, if they have an income from an established business or employment, they should not risk any of it. If they do take risks, that will be entirely at their own risk, and they will be taxed on the gross income from those other sources, rather than on the net income at the end of the process after taking into account losses incurred through investments made in genuine commercial ventures. I would differentiate between genuine commercial ventures and contrived arrangements. The Opposition believe that section 66 of the Income Tax Act 2007 already provides sufficient protection against contrived arrangements where HMRC can show that a business has been established for reasons other than generating a profit and running a commercial enterprise.

Mark Field (Conservative, Cities of London and Westminster)

Regrettably, the presumption behind the sideways loss-relief provisions proposed in schedule 21 seems to be that individuals are trying to take HMRC for a ride. As my hon. Friend the Member for Runnymede and Weybridge rightly pointed out in his extensive contribution, the Opposition do not wish to allow contrived schemes to go through, and it is quite right that they be stopped. However, the Government perhaps fail to understand simply how haphazard and lacking in calculation many new business ventures are. As he pointed out, in a world in which more and more people are entering consultancy work, running their own, and expanding, businesses, forming different partnerships and, therefore, receiving different income streams to help kick off those businesses, there is a real worry that a particularly eagle-eyed HMRC inspector could make such business expansion, which we all recognise to be in the interest of UK plc, ever more difficult.

Clearly, many such businesses are not contrived, but some individuals develop their businesses haphazardly. As my hon. Friend said, a business might start in someone’s garage and take up just a couple of hours at the weekend but, as the excitement and buzz of the new idea grow, so the business might take up ever more time and costs—both absolute and opportunity costs. It would be wrong if people setting up such businesses, many of which are in the service sector, are unable to utilise some of the sideways loss-relief provisions for business ventures that are already up and running. It is feared that the Government do not recognise how much change there is in the world of work. Individuals are no longer simply employees or self-employed. There is now much more of a mix, and people are willing to develop new ideas. Just as it would be wrong to encourage contrived schemes to avoid paying tax, we should, as far as we can, encourage provision for those individuals who are willing to take risks to be properly rewarded within the context of the tax scheme.

Amendment No. 136 makes it clear that out-and-out contrivances are not right. Neither the Treasury nor the Opposition would support them. The amendment states that the trade should not be carried on

“with the intention of generating a loss for tax avoidance purposes.”

However, I fear that the authorities believe that everything involved in setting up new businesses is far more regimented and organised than it probably is. We should do nothing to discourage that entrepreneurial spirit.

Jane Kennedy (Labour, Liverpool, Wavertree)

HMRC has received evidence through the disclosure regime and other means that there is up to £1 billion of avoidance activity through this scheme. The measure follows action taken against partnership avoidance last year, and the scored yield reflects this: the projected revenue that we are protecting is £245 million, £80 million and £50 million in the next three successive years.

Mark Hoban (Conservative, Fareham)

The Minister said that there was £1 billion-worth of avoidance activity in this area, yet the figures for the next three years come to less than half of that sum. Can she reconcile the two statements?

Jane Kennedy (Labour, Liverpool, Wavertree)

My advice is that that is the clear activity in this scheme, which is why the UK Film Council was very concerned to make sure that robust action was taken. I will provide a specific answer to the point made by the hon. Gentleman in a moment. It is important for the Committee to understand that this is not an unexpected response from the Government. Deloitte, in its full Budget commentary, said:

“This change was expected and shows how HMRC has benefited from the information received under the disclosure regime.”

The provision is working, and the UK Film Council states:

“We have made clear over and over again that the Government will take action against tax avoidance schemes and that’s what they’ve done today.”

Philip Hammond (Conservative, Runnymede and Weybridge)

I am not quite sure why the Minister is quoting the UK Film Council, as they are the only people who are exempt from the impact of the Bill. I made it clear that we would support measures to deal with contrived avoidance arrangements. I asked her to give examples of this scheme that allow a contrived arrangement that can be distinguished from the ordinary, commercial activity to which my hon. Friend the Member for Cities of London and Westminster and I referred. She talked about £1 billion, so there must be quite a lot of it. I should be grateful if she could explain how it works.

Jane Kennedy (Labour, Liverpool, Wavertree)

If the hon. Gentleman allows me to develop my argument, I will explain exactly how I arrived at my view that this is the right action to take. The hon. Gentlemen has made a reasonable argument and asked a reasonable series of questions—questions which I, too, ask when I decide whether an avoidance scheme of this nature should be tackled in this way.

I was quoting the UK Film Council, and I will address directly the point that the hon. Gentleman made about it in a moment. The council said that it had made it clear that action would be taken. It went on to say:

“The only specific tax relief for the production of films is the film tax relief, which has been structured to help filmmakers. Everything else has a large health warning attached to it.”

That was its quote on the day. The provision concerns only losses that arise from the old film tax reliefs for films completed before 31 December 2006, or for films in production on 1 January 2007, which are subject to the transitional rules. We had a pre-existing commitment to those films. The restrictions will apply to film losses generally, except those covered by the transitional arrangements.

The hon. Gentleman seems to think that the measure is retrospective. Neither the operation of the purpose test nor the annual limit is retrospective. The purpose test applies to arrangements made on or after Budget day—12 March 2008. The annual limit applies to a loss with a basis period ending on or after 12 March. This targeted and proportionate anti-avoidance measure is designed to prevent aggressive avoidance. However, I have acknowledged that there is some justice in the hon. Gentleman’s argument that it is possible—I have been concerned about this—that the measure will have an impact on a small number of non-avoiding, sole-trader businesses. I shall say more about that in a minute.

Mark Field (Conservative, Cities of London and Westminster)

I am interested to hear more. Given that there is allegedly a £1 billion problem, will the Financial Secretary give specific examples of the contrived schemes that are getting away with it, but which will be caught under schedule 21? I would like an idea of the type of contrivances that she has in mind.

Jane Kennedy (Labour, Liverpool, Wavertree)

I am advised that we do not identify individual schemes. The schemes that we are discussing are used by wealthy individuals to access large losses that they set against other income or gains. Large up-front losses are generated by exploiting the capital allowances rules and special tax reliefs and generally accepted accounting practices that provide accelerated deductions for expenditure. The individuals concerned use the losses to reduce their tax liability. I can give the hon. Member for Cities of London and Westminster examples of the features that are regarded as completely unacceptable.

Mark Field (Conservative, Cities of London and Westminster)

The Financial Secretary mentioned “wealthy individuals” who are creating very large losses for the purposes of offsetting in the way that she described. Can we take that as an assurance from her that people such as small entrepreneurs setting up their own consultancy business while in full-time employment to see whether an idea will run will not be caught under schedule 21? That is the reassurance that my hon. Friend the Member for Runnymede and Weybridge and I seek.

Jane Kennedy (Labour, Liverpool, Wavertree)

I will come to that in a moment, but first I would like to deal with one or two other points. However, I hope that I will be able to give the hon. Gentlemen that assurance.

Examples of other unacceptable features include: inflating the loss relief by the use of loans so that the relief exceeds the money contributed by the individual; and the buying of an asset by an overseas intermediary in a tax haven at a price far in excess of historical costs. There are other examples. On this issue, there is probably no difference between us. The debate relates to the proper concern about whether innocents would be affected by the measure, and I hope to offer some reassurance on that issue.

The proposed measure will still allow non-active sole traders to set up to £25,000 of losses sideways, with any unrelieved losses going forward against future profits. When genuine businesses make losses in the initial years, that will be on the expectation of profit in future years, the tax on which can be reduced by carrying forward the remainder of the losses not covered by the £25,000 limit. That concern was raised by the Chartered Institute of Taxation. This measure does not prevent losses from being set against profits from the same trade. An individual will not, therefore, be taxed on more than 100 per cent. of their net profits after losses from the same trade over the life of the trade.

Philip Hammond (Conservative, Runnymede and Weybridge)

The point made was that an individual could find that they were being taxed effectively on 100 per cent. of their income in a given year. The Financial Secretary rightly says that losses can be carried forward for use in the same trade, but that does not reflect the reality of somebody struggling to start up a business. It is of no help telling someone in that situation that he cannot pay the gas bill this year, but that he should not worry, because he can offset his losses against his massive profits in three years’ time. That shows once again that the Government do not understand the problems facing small businesses and entrepreneurs.

Jane Kennedy (Labour, Liverpool, Wavertree)

I am assured that that will not be the impact. As always, I listen to the hon. Gentleman’s arguments because his work is thorough. I have already accepted that there is some concern, and I have looked at that carefully. However, there will not be many individuals who carry on that kind of business on their own account in a non-active capacity—I will say more about the 10 hours in a moment—who make losses substantially in excess of £25,000 and have other income significantly above that figure against which sideways loss relief could be claimed. They will still be able to claim genuine losses of up to £25,000 against their other income and gains, and where losses are not immediately relievable they are not lost but can be set against income from the business for other years. I hear that the hon. Gentleman says that that is not realistic, but we have to balance the benefit of preserving unlimited relief for a small number of genuine non-active traders against the cost of the exploitation of the relief, which is a problem.

Philip Hammond (Conservative, Runnymede and Weybridge)

Will the Financial Secretary give way?

Jane Kennedy (Labour, Liverpool, Wavertree)

If I could just demonstrate the reality of that, the revenue figures that I quoted earlier are for this year’s measure. The £1 billion refers to the total sideways loss relief avoidance being closed down both this year and last year.

Philip Hammond (Conservative, Runnymede and Weybridge)

Will the Financial Secretary give way?

Jane Kennedy (Labour, Liverpool, Wavertree)

Yes, but I have quite a bit to say.

Philip Hammond (Conservative, Runnymede and Weybridge)

Perhaps it is easier if we deal with the issues as they come up, and as the Financial Secretary responds to them. She said that we have to balance the risk of damaging genuine sole traders and entrepreneurs against the risk to the revenue of abuse of the process. I say that we do not have to make that trade-off. We can target the legislation by introducing a motive test. None of us had suggested that people abusing the film tax credit scheme to siphon off hundreds of millions of pounds should not be dealt with, but she asks us to believe that it is beyond the Government’s capability to target the measure on contrived arrangements involving film tax credit claims. She could do that if she put her mind to it, and avoid overspill of the measure affecting entrepreneurs and start-up businesses in a way that she says she does not intend, and about which we have grave concerns.

Jane Kennedy (Labour, Liverpool, Wavertree)

I will come to the question of a motive test. I fear that we will not agree, although I had hoped—

Peter Bone (Conservative, Wellingborough)

I am interested in the Financial Secretary’s argument about the £25,000 relief. That is an interesting starting point, but why is it so low?

Jane Kennedy (Labour, Liverpool, Wavertree)

In looking to take anti-avoidance measures for this scheme, I was advised that on balance that was the best level at which to pitch the relief. We were satisfied that the £25,000 limit struck the right balance. It must prevent avoidance activity, but allow most individuals to remain unaffected. We will keep the amount under review. We are dealing with a particularly aggressive form of avoidance, where promoters have consistently adapted their schemes to challenge the intention of existing legislation. We had to deal with that last year when we looked at partnerships. Reliance on a motive test, as the hon. Member for Runnymede and Weybridge suggests, would be impractical and would give rise to unacceptable cost and risk. I will say more in a moment.

I have one or two more comments on the 10-hour rule. Many people involved in the avoidance schemes have no active involvement with the business. The 10-hour rule strikes a fair balance between allowing genuine part-timers to carry on without any effect, while ensuring that tax avoiders are not successful. The 10-hour rule has applied in the case of previous restrictions on partnership losses since 2004. It has proved an effective and practical test and I have no reason to believe that what the hon. Gentleman suggests would prove to be true.

The purpose test, which we propose, refers to arrangements made for the purpose of obtaining a reduction in tax. Whether there are avoidance arrangements is a factual matter. There will be many instances where the focus of the loss maker was not tax avoidance and relief will be due. Past experience of the abuse of sideways loss relief has made it abundantly clear that avoiders will take all possible steps to disguise the avoidance as commercial, and that a motive test will not deter them.

I wondered how the amendment tabled by the hon. Member for Runnymede and Weybridge would work, as on my understanding it is not technically correct. Trade loss relief is not available unless the trade is commercial. If a trade is carried on with the intention of making a loss, it would not be commercial and trading losses would not be allowable. The test would make the annual limit restriction redundant as there would be no losses to restrict if the trade was not commercial. That is an incredibly logical argument against the amendment.

We need a mechanism that will deter promoters from instigating such schemes and individuals from entering into them. The annual limit provides that extra deterrent by making it uneconomic to challenge the intention of the legislation. The proposed amendment would make the annual limit apply only when a trade is carried on with the intention of generating a loss for tax-avoidance purposes. Where that is the case, there is no need for an annual limit as losses would not be allowed because the trade is not commercial. It would not provide the necessary deterrent and it would give rise to unacceptable levels of cost and risk in enforcing the application of the motive and purpose tests.

I am convinced that the right combination is a purpose test and the annual limit of £25,000 provided for in the clause. I have a slim hope that the hon. Member for Runnymede and Weybridge will accept my response to his argument and that he will agree to withdraw the amendment. If not, I shall ask my hon. Friends to oppose it and support the schedule.

Philip Hammond (Conservative, Runnymede and Weybridge)

This is an important debate and the Committee stage is designed for exactly this purpose. At one level, what the Financial Secretary says is entirely reassuring. She tells the Committee that the measure is designed only to deal with artificial schemes being marketed to high-net-worth individuals using film tax credits. Our concerns relate entirely and exclusively to the impact of such measures on people who are not involved in any way in such schemes.

I could stand here, think that I have misunderstood the whole thing and accept the Financial Secretary’s reassurances at face value. The problem is that all the outside bodies who have drawn attention to the problems and the risks implicit in schedule 21, have not understood it in the way that she has presented it. Let me ask the Financial Secretary a specific question. At the beginning of her remarks she said that this related to the abuse of film tax credits only. That is why she mentioned the UK Film Council. In the schedule, there is no reference to the provision applying only to arrangements that involve the use of film tax credits. If it said that in the schedule, this debate would not have taken place and none of the concerns would have arisen. However, it does not say anything about film tax credits, except that authorised film funding arrangements are excluded from the scope of the provisions. Were she able to confirm for the record that in practice only arrangements involving film tax credits will be caught by the provisions, even if that means telling the Committee that the Revenue will use its discretion so that those who are not involved with film tax credits are not caught by the legislation, I would feel quite satisfied. I do not know whether my hon. Friends would agree.

The Financial Secretary also mentioned in the course of her last remarks that the Government were proposing a purpose test. She implied that their purpose test was superior to my motive test and that therefore the amendment was unnecessary. I can see the purpose test in relation to the disallowance of relief altogether under new section 74B, but my understanding is that there is no purpose test in new section 74A—if there is one and she can draw my attention to it, I stand to be corrected. It is precisely because new section 74A does not appear to be limited by an effective purpose test that we have sought to reinforce the existing provisions of section 66 of the Income Tax Act 2007 with the introduction of the motive test in amendment No. 136.

We are genuinely seeking after the truth. It may be that the schedule will not impact the serial entrepreneur who has never been anywhere near a film or any film funding arrangement, has never purchased an avoidance or tax-planning scheme from a firm of accountants and is simply someone who has established a small business and gone on to establish another and another; or, to take a different example, a highly paid investment banker in the City who, instead of consuming all his income on expensive champagne, decides to use some of it to start a business. That business might not trade successfully in its first year and might incur losses of £50,000, £60,000 or £100,000, which that individual might be reassured can be set against his six-figure income from his employment. It is those sorts of cases that we seek to protect and if the Minister can assure us in those terms we will be satisfied, but I have not heard such an assurance yet. I will be grateful if she can provide that assurance in the fullness of time, but if she cannot we shall have to press the amendment to a Division and resist the inclusion of the schedule, precisely because of our concerns about the unintended consequences of the measure.

Jane Kennedy (Labour, Liverpool, Wavertree)

I do not know whether I am supposed to ask leave of the Committee to take a second chance. Although it will not help to reconcile the differences, it will be helpful to the Committee if I clarify that the measure that we are debating applies to trades generally, except to old film reliefs and Lloyd’s. I do not know whether that offers the hon. Gentleman the reassurance that he seeks. The purpose test that he said he was looking for is in new section 74B. I undertake to study carefully the representations that he has made this afternoon and test them against the advice that I have had, but I cannot give him any further assurances at the moment.

Philip Hammond (Conservative, Runnymede and Weybridge)

To deal with the purpose test first, as I said, I see it in new section 74B, but that deals with the disallowance of any relief at all. It does not disapply the cap where mischievous purpose is not present.

That is our concern: even where there is no relevant tax avoidance arrangement, the £25,000 cap will still apply. Despite the Minister’s statement that the measures will apply only to the abuse of film tax credits, the Government have created a juggernaut. She says that £1 billion in tax is at risk from the abuse of film tax credits, but the measures are not tailored tightly to deal with film tax credits. Perhaps they could include a reference to the use of film tax credits. I do not see why not, as the film tax credit scheme is a specific scheme and, as far as I am aware, no similar arrangements could be substituted by those trying to develop avoidance schemes.

The Government have created a juggernaut to deal with the problem as they perceive it, and the Minister appears supremely unconcerned that along the way it will run down innocent entrepreneurs who are struggling or planning to start up businesses and seeking reassurance that if they make a loss, they will at least be able to offset it against profits from other businesses or earnings from employment. The £25,000 limit, although it will provide some reassurance to those operating at the bottom end on a small scale, will not really help where any larger-scale business operation is involved, particularly where capital investment is being made and amounts up to the new annual allowance might thus be available in the first years of a new business, in addition to any trading losses, to offset against other income streams.

If the Minister cannot offer us any further assurance, I must ask my hon. Friends to vote in favour of the amendment and against the schedule as it stands. If anything, her remarks have heightened my concerns. It is clear that there is a purpose that will drive HMRC in applying the measures—trying to shut down abuse of the film tax credit is a perfectly legitimate purpose—but it is equally clear that the Government have not succeeded in making their intervention a targeted one. There will be collateral damage, and we must make a stand to protect those who would suffer from it.

Clause 58

Philip Hammond (Conservative, Runnymede and Weybridge)

Briefly, the clause will amend the wording of a provision that was introduced only in the Income Tax Act 2007. The situation is becoming ludicrous. The Government thought that the definition in that Act was right, but now they are introducing the additional provisions that we have just discussed in schedule 21. They have a different definition, and wish to go back and change the definition that they introduced last year. Why can they not think ahead so that we do not constantly have to revise legislation that we have recently passed? More specifically, what caused the Financial Secretary to decide that the new definition in schedule 21 should be applied in the 2007 Act rather than import the 2007 definition into schedule 21? Why have they decided that they got the development of the definition in the 2007 Act wrong?

Jane Kennedy (Labour, Liverpool, Wavertree)

To a degree, this is a continuation of the previous debate. The change that we are discussing ensures that the measures that we were forced to put in place last year to tackle the continued misuse of sideways loss relief for tax avoidance purposes are consistent in this Finance Bill and the last for partners and sole traders. The clause aligns the definition of non-active partner for the purposes of restrictions on sideways loss relief with the new definition of non-active capacity for individuals other than partners. As we discussed in the last debate, the existing 10-hour rule requires an individual to spend an average of at least 10 hours a week personally engaged in activities carried on for the purposes of the trade. I have said that that has proved to be effective and a practicable test, but increasingly, avoiders are undertaking activities with no commercial value and claiming that they are for the purposes of the trade.

The reason that we need to keep amending the definition is that avoiders continue to push the boundaries of the definitions and to find ways around them. The hon. Member for Runnymede and Weybridge asks why we should import one definition instead of the other. We are making this change so that we can use the definition that we believe is effective and will work. We believe that it will deter attempts to circumvent the rules. I hope that clause 58 will be supported and will be put on the statute book.

Schedule 22

Philip Hammond (Conservative, Runnymede and Weybridge)

I beg to move amendment No. 137, in schedule 22, page 279, line 21, leave out from ‘(1A)’ to ‘when’ and insert

‘Any credits or debits relating to any amount which would otherwise fall’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss amendment No. 138, in schedule 22, page 279, line 26, after ‘advantage’, insert

‘as a result of that amount being treated as a distribution’.

Philip Hammond (Conservative, Runnymede and Weybridge)

On the version of the amendment paper that I have, the line number reference for the amendment is incorrect. I do not know whether that is a printer’s error or mine. The line that would be left out is line 21 on page 279, not line 26. I hope that no one on the Committee has been misled by that.

Jimmy Hood (Labour, Lanark and Hamilton East)

Order. The amendment paper that I am reading from refers to line 21.

Philip Hammond (Conservative, Runnymede and Weybridge)

I am glad to hear that the mistake has been corrected since this amendment paper was published on Tuesday. I wanted to ensure that nobody on the Committee was misled.

This is another measure introduced in the name of anti-avoidance. I understand that it, too, is the result of notification schemes under the legislation requiring such notification. Schedule 22 contains measures to prevent certain types of avoidance involving financial products, specifically the kind of products that give rise to interest-like income being delivered in a form that is non-taxable. The schedule will cover schemes relating to disguised interest where arrangements are entered into to avoid tax on returns that are economically equivalent to interest. It will cover the factoring of rents under a lease of plant and machinery, which makes rental receipts not subject to taxation.

The Government originally proposed in a consultation document of December 2007 that broadly drafted principles-based legislation would be introduced from 1 April 2008 to counter avoidance relating to disguised interest and sales of income streams—that is to say the factoring of leasing income. That consultation prompted a widespread concern among practitioners that the proposals were very broad and were likely to be drafted in a way that would create high degrees of uncertainty for taxpayers and once again give HMRC excessive discretion to interpret the law as it sees fit. Recognising that they cannot afford to inflict any more damage on the UK’s reputation as a stable and predictable place to do business, the Government have bowed to pressure from the professional bodies and deferred the introduction of the new disguised interest rules until 2009. I hope that the time between now and then will be used for proper consultation in an attempt to ensure some certainty about the measures when they are introduced. Unless the Minister tells us otherwise, the Committee must operate on the presumption that the measures will have a life of one year only and that we must expect alternative, principle-based arrangements to be introduced under the Finance Bill 2009 amending what will become the Finance Act 2008.

I turn to amendments Nos. 137 and 138. Paragraph 3 of schedule 22 will insert proposed new section 1A into paragraph 1 of schedule 9 to the Finance Act 1996, and is designed to counter certain arrangements, particularly those involving cross-border financing debt transactions, whereby payments corresponding economically to interest are treated as distributions and therefore fall outside the scope of the UK tax system. The proposed new section applies where amounts would otherwise constitute

“a distribution in respect of a loan relationship”.

Under the provisions, such avoidance techniques will be countered by a one-sided tax charge. The relevant amount paid by a UK resident company is treated as a non-deductible distribution for its tax computation purposes, but a UK resident recipient company will find that the payment is treated as taxable. However, overseas resident company are not be affected in the same way, which is the situation that the legislation is designed to counter. As I understand it, however, where a payment is received by a UK resident company, there will be a lop-sided, asymmetrical tax treatment.

The proposed new section is very broad in its potential application, in part because the arrangements to which it can apply are defined by reference to the broad definition of tax advantage—

Jimmy Hood (Labour, Lanark and Hamilton East)

Order. If the hon. Member for Wellingborough leaves the Committee Room, the Committee will be inquorate.

Peter Bone (Conservative, Wellingborough)

On a point of order, I shall remain to keep the Committee quorate, but is it not the job of the Government to keep the Committee quorate?

Jimmy Hood (Labour, Lanark and Hamilton East)

I take the hon. Gentleman’s point and thank him for keeping the Committee quorate. That is certainly something that the Government should keep their eyes on. Had it not been for his good grace, the Committee would have been inquorate.

Philip Hammond (Conservative, Runnymede and Weybridge)

During my 11 years in this place, people have resorted to various techniques to shut me up, but I do not remember anyone ever seeking to make a Committee inquorate to do so. I am grateful to my hon. Friend the Member for Wellingborough, but unfortunately he might have established a precedent.

I was saying that the application of the proposed new section is very broad. The arrangements to which it can apply are defined by reference to the definition of tax advantage in section 840ZA of the Income and Corporation Taxes Act 1988, whereas the target of this Bill is, or should be, arrangements where a tax advantage is derived from the treatment of the relevant amount as a distribution, rather than as interest on a loan relationship. I have some sympathy with HMRC’s approach. I suspect that that approach underlay our disagreement over schedule 21. I understand that people charged with undoing tax avoidance opportunities tend to prefer broader legislation, which will be one step ahead of the avoidance industry. However, the danger with that is that we get broadly drafted legislation, which may have unintended consequences specifically. More generally, that plays to what I am afraid is becoming an important theme: the UK is no longer a clear, certain place to do business, with a tax code that is easily understandable and applied consistently. As the UK tax code has got longer and more complex—it has doubled in length under the Government—it has become more and more difficult for people to predict how they will be treated. Uncertainty is a cost of business: uncertainty about the application of the tax code is as much a cost to be factored in to an investment decision as an extra tax. The complexity of the tax system has the negative impact for the economy of additional tax, without the positive aspect for the Exchequer of an additional tax. It is the worst of all worlds, moving us one stage further down the road of international uncompetitiveness.

The purpose of the amendments is to limit the new provision to its intended target. Amendment No. 138 specifically narrows the definition of “tax advantage” to one arising from the “amount” being “treated as a distribution”. It also seeks to ensure that the tax treatment is symmetrical in cases where the new rules could apply to transactions between UK resident companies. Amendment No. 137 includes reference to “credits” as well as “debits”, so that we ensure that there is symmetrical treatment. When a debit is taken out of calculation for the purposes of the tax computation of the paying company, then the corresponding credit is also taken out of the computation for the purposes of calculating the tax liability of the recipient company.

The amendments go some way towards refocusing the clause on its original intention. I stress to the Minister that we are not seeking to change the intended impact of the provisions—this is not a wrecking amendment. It is intended to give her an opportunity to reassure the Committee that the focus of the intended clampdown is narrow and is not intended to create an asymmetric treatment where the payment is made between two UK companies. Frankly, it might help her to bring some political clout to bear, ensuring that the understandable official preference for wider drafting is not allowed to prevail, but rather political common sense and the Government’s own political agenda. While the Government seek to close down tax avoidance, they are also seeking to maintain the competitiveness of British business and, by implication, the clarity and certainty of our tax code—that agenda prevails over the official convenience agenda, which HMRC quite understandably will always push.

Jane Kennedy (Labour, Liverpool, Wavertree)

Work on principles-based legislation is ongoing for the Finance Bill 2009 and will, as the hon. Gentleman suggests, replace possibly much of the detailed legislation. I hope that I can reassure him that this legislation only applies where there is a tax avoidance motive. If there is no such motive, the legislation does not apply. The principles-based legislation on which we are consulting seeks a simpler approach to countering tax avoidance.

In response to the hon. Gentleman’s regular attack on the length of the tax code, I will say that the tax law rewrite group has been involved in a major piece of work. I have debated that with officials within the Department since taking up the post, and it has become clear to me that using simpler language and breaking up the density of tax law to make it easier to understand and more accessible has led to greater length, but also to the benefit of clarity.

HMRC has been notified of a number of schemes that involve companies designing securities so that they are treated as paying distributions rather than interest. The amounts paid are equal to the returns that would be paid on an investment at interest but are claimed to be non-taxable because of the distributions rules. The debtor company will generally be party to an arrangement that allows it to obtain a tax deduction for the amount treated as a distribution, or it is unconcerned about whether it obtains such a deduction because it has losses and does not pay tax. On Budget day, we announced that we were countering those schemes by removing the tax-exempt status of distributions from loans where the distributions arise in consequence of or in connection with any arrangements that have as one of their main purposes the production of a tax advantage for any person.

We cannot accept the amendments proposed. If amendment No. 137 were accepted, companies would be allowed to obtain deductions for payments that are currently non-deductible because they are classified as distributions when paid in connection with tax-avoidance arrangements. That would provide companies with a fiscal incentive to facilitate tax-avoidance, based upon their entering into arrangements that are designed to allow another company to avoid corporation tax. Amendment No. 138 would confine the effect of the changes to one form of tax-avoidance where the tax advantage arises from treating interest as a distribution. In practice, it is highly likely that the tax advantage would arise from treating the interest as a distribution, but there is no reason to restrict the rule to such cases. For instance, if the tax advantage arose from some other aspect of the arrangement, such as a tax distribution being sought for a drop in the value of the loan relationship caused by the payment of the distribution, there is no reason for the new rule not to apply. Companies not actively engaging in tax-avoidance have nothing to fear from the changes.

After that short debate, I hope that I have been able to reassure the hon. Member for Runnymede and Weybridge and that he will not press the amendment.

Philip Hammond (Conservative, Runnymede and Weybridge)

I am not sure that I quite follow the penultimate paragraph of the Minister’s speech, but I will look at it in Hansard. Once again, she made a perfectly reasonable case, but I think that I, too, made a perfectly reasonable case. Members of the official Opposition are not saying that we want to protect artificial arrangements that give rise to artificial tax savings. She has acknowledged that it is likely that the abuse that she wants to target arises from the treatment of an amount as a distribution, but our sole concern is that by drafting the legislation widely and being unwilling to confine herself to a narrow definition, she is running the risk of collateral damage, and that is a recurrent theme.

We all agree about the 99.5 per cent., but on the one hand, we disagree on whether we should say, “Keep it narrow and run the risk that next year you will have to put something else in place if someone somehow gets into the last half per cent. and levers it open.” On the other hand, she is saying “Well, I don’t really care if there is some collateral damage and a few people we didn’t intend to be caught by the measure are unfairly caught by it, because we have a bigger job to do in shutting down a tax avoidance scheme.”

There is a difference in approach that reflects how one views the relationship between the citizen and the state. If we are of the view that it is important to maintain the balance and not allow the state always to take the over-mighty approach, we should err on the side of caution and apply anti-avoidance legislation that is properly targeted at the abuses that are occurring. We know, because the Minister has told us, that if other abuses open up, she has powers to intervene rapidly and, if necessary, retrospectively to the date of an announcement, to expand the scope of anti-avoidance legislation. However, such a generalised approach that does not target specific mischief runs the risk of causing collateral damage.

I am sure that we will return to this theme. I shall not detain the Committee by pressing the amendments, but I hope that the right hon. Lady will consider the general theme—I know that she thinks about such things—and challenge her own officials on whether the measures are necessary. My hon. Friends and I have not dreamed up politically motivated points; by and large, they reflect points that have been raised in discussion, particularly with the professional bodies, which see the potential for unintended consequences.

If the Minister thinks back to our discussions today, she will recall that on at least one occasion—in the Finance Act 2007—she had to introduce legislation to correct unintended consequences and ensure that the taxpayer was not disadvantaged vis-Ã -vis the Government’s intentions. I give her notice that we will come back to the matter later in the Bill’s progress, but I beg to ask leave to withdraw the amendment.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss Government amendment No. 128.

Philip Hammond (Conservative, Runnymede and Weybridge)

The Minister is making a good attempt at progress, but I am afraid that she will have to work for her ministerial salary.

As we have been discussing tax law rewrites and making things nice and plain, I draw the Minister’s attention to Government amendment No. 128. Proposed new paragraph (2D) of schedule 9 to the Finance Act 1996 says:

“This paragraph does not apply where—

(a) the transferor company is party to arrangements...in circumstances in which this paragraph would not apply”.

So the paragraph will not apply in circumstances in which it will not apply. To me, that does not sound like the kind of plain English of which the tax law rewrite project would approve. I cannot understand what the words at the end of new paragraph (2D)(a) mean when read in conjunction with the words at the opening of paragraph (2D).

I shall leave the Minister to ponder that for a moment. The changes introduced by the amendments are, as I understand it, designed to block tax planning where financial assets are sold without the market value of the proceeds being taxed and, effectively, without their being recognised. Of course we support measures to deal with any non-commercial, non-arm’s-length transaction that gives rise to a tax advantage. However, the wording of new paragraph 11B, which is inserted by amendment No. 127 into schedule 9 of the Finance Act 1996, could apply more widely than the right hon. Lady thinks—we go back to our familiar theme—and could catch normal commercial transactions where a loan is exchanged for shares in a company, for example because of a debt for equity swap. This is not an artificial transaction. This could be a transaction where, because of the financial condition of the borrower, the provider of the loan has no alternative but to exchange the debt for equity. Companies holding such loans would be taxed if they had a relevant avoidance intention, defined as the intention not to be taxed on the loan interest receivable.

Given that any debt for equity swap will result in an instrument giving rise to taxable income—the loan—being replaced with an instrument that is taxed on a capital gains basis—the shares—there is a concern that this provision will catch normal transactions. “Normal” is perhaps not the right term, as a debt for equity swap is fairly unusual, but it is a perfectly legitimate commercial transaction. Moreover, given the present conditions in the credit market, we might expect to see more forced debt equity swaps in the near future.

There is therefore a concern that a normal commercial transaction which replaces a loan with shares could easily be argued to have a purpose of avoiding tax on the loan income. When one swaps interest-bearing debt for equity, one surrenders the opportunity, albeit theoretical, of receiving interest on the loan. I should be pleased to hear the Minister’s specific answer to those questions. Can she reassure the Committee that this unintended consequence will not arise?

Jane Kennedy (Labour, Liverpool, Wavertree)

I have said before in Committee, in that well-known Liverpool phrase, “God loves a tryer”, and I did seek to try it on. Amendments Nos. 127 and 128 address two interchangeable avoidance schemes. It is estimated that unless both schemes are closed, the loss of tax will be £200 million per annum. The two schemes have been disclosed to HMRC under disclosure rules. The rules for taxing companies on their loans and derivatives are accounts based, with the result that profits are generally chargeable to tax only if the profits are recognised in the accounts in accordance with generally accepted accounting practice.

One scheme that has been disclosed allows companies to sell their loans and derivatives without triggering recognition of any accounting profit. Amendment No. 127 prevents a scheme from working where a loan or derivative is sold in return for shares. Then for tax purposes the full market value of the shares will have to be brought into account as the sale proceeds. But to ensure that this does not apply in inappropriate circumstances, the amendment can operate only where the disposal is made with the object of reducing the profits to be brought into account.

The hon. Member for Runnymede and Weybridge asked about transfer. I am grateful to him for drawing my attention to paragraph 3B. There is an explanation but, frankly, it is quite complicated and it is probably better if I write to the Committee about that. I shall deal with the second scheme which has been disclosed to HMRC. It also aims to allow companies to realise profits without attracting a tax charge. As the hon. Gentleman will know, the rules for taxing companies’ loans and derivatives have group continuity divisions.

In the newly notified scheme, companies with derivative contracts or loans with a market value in excess of their historic cost and their accounts carrying value sell the contracts or loans at full value to a partnership of which the other members are fellow group companies. That gives rise to an accounting profit to the transferor, but it is claimed that that profit is not taxable because the group neutrality rules apply. Subsequently, another company joins the partnership in return for making a contribution to the capital of the partnership equal in value to the asset transferred to that partnership. The new partner then becomes entitled to virtually all of the partnership’s profits, including any rights in respect of the asset. That means that, in substance, the asset has been sold to the new partner, but it is claimed that no tax charge arises.

Government amendment No. 128 prevents that scheme from working. The group neutrality rules will not apply where the transfer of an asset to which those rules would otherwise apply is made as part of an arrangement that aims ultimately to transfer the asset outside the group. Again, to ensure that that does not happen in inappropriate circumstances, the amendment can operate only where the disposal is designed to avoid tax.

Philip Hammond (Conservative, Runnymede and Weybridge)

I am sorry to break the Minister’s flow, but I would like to take her back to the first part of what she said. The Minister sought to reassure the Committee that the provisions would apply only where the activity is designed to reduce or eliminate taxable interest. I am seeking confirmation that that could not be deemed to have arisen because of a debt/equity swap and that a debt/equity swap per se would not be treated as a transaction designed to eliminate what would otherwise be taxable interest payments.

Jane Kennedy (Labour, Liverpool, Wavertree)

This is a very complex area, and I want to ensure that I get this right. I will study Hansard and read both what he and I have said to ensure that I have been clear. In a standard debt/equity swap there is no intention of reducing taxable profits—although that might be an effect, it is not the intention. Therefore, the legislation would not apply.

Philip Hammond (Conservative, Runnymede and Weybridge)

So, if I hold a loan note from company X that entitles me to receive £10,000 a year interest, which will be taxable in my hands, and I agree to swap it for equity in company X, which may or may not give rise to dividends, but certainly will not give rise to taxable interest payments, then that will not be regarded as an act taken to avoid tax on that interest stream. If that is what the Minister is saying, I think that that satisfies the concerns raised.

Jane Kennedy (Labour, Liverpool, Wavertree)

It is. As I have said, this is a very complex area, but that is my understanding of the arrangements. I have already explained Government amendment No. 127. Government amendment No. 128 will prevent the second scheme from working. I hear the hon. Gentleman’s point about the unintended consequences of some of this work. I am following this carefully and I hear the theme that he is developing as we go through the Bill. I am satisfied that the anti-avoidance action is necessary. As I have said, the schemes that Government amendments Nos. 127 and 128 deal with are interchangeable. Unless both schemes are closed, the loss of tax is estimated at £200 million per annum. Therefore, I hope that both amendments will be accepted.

Philip Hammond (Conservative, Runnymede and Weybridge)

I beg to move amendment No. 139, in schedule 22, page 280, line 7, at end insert

‘to the extent that such debits exceed the aggregate amount of credits brought into account under this Chapter in that or any previous accounting period in respect of that share’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following amendments: No. 140, in schedule 22, page 280, leave out line 8.

No. 141, in schedule 22, page 280, line 13, at end insert

‘to the extent that such debits exceed the aggregate amount of credits brought into account under this Chapter in that or any previous accounting period in respect of that share.’.

No. 142, in schedule 22, page 280, leave out line 14.

Philip Hammond (Conservative, Runnymede and Weybridge)

The main object of the provisions is to prevent the rules in the Finance Act 1996 under which certain shares are treated as debt from being manipulated deliberately to create artificial debits by reference to a fall in the fair value of the relevant shares. The Bill deals with the issue by denying the holder of such shares any debits under the loan relationship rules. That is fair enough. We have no dispute with the purpose of the provision, only with the fact that it is too broad.

If all debits are denied, a holder may, for example, be taxed on a fair value increase representing an interest accrual, but will be unable subsequently to claim relief if the return becomes unrealisable because the underlying debt is impaired. He will, in effect, have been taxed on the accrual of the interest when it was expected that it would be paid, but be unable to obtain an unwinding of the tax effect if that debt becomes impaired and it is apparent that he will not receive the payment.

Amendments Nos. 139, 140 and 141 would address the issue by allowing debits when credits have previously been brought into account. It is a restrictive set of circumstances, but something that seems entirely equitable. It would provide appropriate protection for the Exchequer by limiting the debits that are available in respect of such shares to amounts that are equal in aggregate to the amount of credit previously brought into account under the loan relationship rules. Our amendments would limit the scope of the changes so that they are more appropriately targeted. They would reflect circumstances when in a loan relationship debits would be allowed. When that would be the case in a loan relationship and the matter at issue was the fair value of shares, such measures would ensure that the debit was allowed to reflect the unwinding of a position that had previously given rise to an increase in value that causes a credit.

I hope that the Minister accepts that the amendments are intended to deal with circumstances in which the schedule would be unfair to the taxpayer. I am interested to hear her comments.

Jane Kennedy (Labour, Liverpool, Wavertree)

We announced on Budget day that we intended to introduce a package of measures to amend existing legislation known as the shares as debt rules. One of the changes was that, when the shares as debt rules apply, no losses may be brought into account in respect of any share to which the rules apply. That was in response to a number of schemes notified to HMC that were designed to create artificial losses through the use of intra-group, depreciatory transactions.

I appreciate that the amendments might be of a probing nature, but they would qualify the rule preventing relief for losses by providing that debits should still be allowed to the extent that they do not exceed profits that have previously been taxed in respect of the share in question. If a profit of, say, 10 is taxed in year 1, the amendment would mean that the company could claim relief for a debit of up to 10 in year 2. Shares as debt rules would apply only if the shares increased in value in the same way as interest, so debits will not arise in normal cases.

Philip Hammond (Conservative, Runnymede and Weybridge)

I think that I understand what the Financial Secretary is saying. I do not suggest that the debit be allowed where the underlying value of shares has fallen. In the example that I quoted, the fall in value was due to the impairment of the receivability of the accrued interest: an accrual of interest gives rise to a tax charge, but it then becomes apparent that the debt represented by that accrued interest has been impaired and will not be paid, and the value of the shares falls accordingly. That should be allowed as a debit on the other side of the calculation.

Jane Kennedy (Labour, Liverpool, Wavertree)

I hope that what the hon. Gentleman says is right.

Philip Hammond (Conservative, Runnymede and Weybridge)

Does the Financial Secretary mean that she hopes that I am wrong?

Jane Kennedy (Labour, Liverpool, Wavertree)

Yes; the hour is growing late.

We fear that the amendments would allow avoidance to continue. It is important to bear it in mind that the action that we are taking arises from a number of schemes that have been notified to us. I do not believe that what the hon. Gentleman fears will happen. The shares as debt rules apply only to contrived arrangements. It is the purpose of the arrangements that will be tested. Companies that had been taxed under the shares as debt rules in previous years could enter into a depreciatory transaction in a later year that generated artificial losses equal to past profits. Those losses could be set against other profits, with the result that any tax paid in respect of earlier years could effectively be paid back in a later year. If the amendments were accepted, there would continue to be loss of tax estimated at up to £100 million per year. I therefore hope that the hon. Gentleman will not press his amendments.

Philip Hammond (Conservative, Runnymede and Weybridge)

I hear what the Financial Secretary is saying. It was not the intention to create a further avoidance opportunity, and in the example that she just read out, the assumption was that the tax paid in an earlier period would be offset against a loss arising from another cause in a later period. Perhaps my amendment was not drafted narrowly enough. I sought to deal with the case where there had been an impairment of the value of the accrued income in the share transaction. Would the Financial Secretary be prepared to pursue that by correspondence? If what she says is right, our amendment is too widely drafted. In that case I would like to consider whether there was a narrower drafting that would address the concern that has been raised with me. That concern is the possible unfairness where something that effectively has not been received is taxed on an accrual basis and it then becomes apparent that it will not be received, not because of an artificial transaction but because of a genuine impairment. We must ensure that there is no asymmetry in the tax treatment of a genuine transaction. Even if it were right to tax the original accrued increase in value as part of the anti-avoidance regime, we must ensure that we do not maintain that tax treatment where it turns out that there was no increase in value because the accrual was impaired.

Jane Kennedy (Labour, Liverpool, Wavertree)

I assume that the hon. Gentleman would want a written exchange before Report so that he had an opportunity to look at the detail. I am happy to undertake to do so, if that would be helpful.

Philip Hammond (Conservative, Runnymede and Weybridge)

That would be extremely helpful, and would allow us to take the Financial Secretary’s concerns back to those who have raised the issues with us. We could look at those concerns with them and perhaps come back to her in correspondence to see whether there was something that could be done, or whether she could give on Report a specific assurance that would deal with that concern. On that basis, I beg to ask leave to withdraw the amendment.

Jane Kennedy (Labour, Liverpool, Wavertree)

I beg to move amendment No. 129, in schedule 22, page 280, line 40, at end insert—

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: Government amendments Nos. 130 and 131,

Amendment No. 143, in schedule 22, page 284, line 28, at end insert—

‘(2A) In section 91A(7) FA 1996 omit the words ‘(see section 103(3A)).’.

Jane Kennedy (Labour, Liverpool, Wavertree)

Since the publication of the Bill on 29 March, HMRC has listened to representations that in some cases the legislation might have unintended results. Government amendments Nos. 129 to 131 will therefore ensure that the legislation works as intended. In particular, it will not result in double taxation or double relief because the amendments clarify which companies have to bring profits and losses into account, disapply the legislation where companies have already been charged a tax in respect of the amounts that are equivalent to interest and omit a redundant reference to another provision. Amendment No. 143 would repeal a redundant reference.

Philip Hammond (Conservative, Runnymede and Weybridge)

It is the same.

Jane Kennedy (Labour, Liverpool, Wavertree)

It is the same as Government amendment No. 131 and is therefore unnecessary. I hope that the Committee will agree and that we can make swift work of this group.

Philip Hammond (Conservative, Runnymede and Weybridge)

I am grateful to the Minister for clarifying the situation. She is basically saying that after publishing the Bill, the Government have listened to concerns about an anomaly in the shares as debt rules that were introduced in 2005. They have come forward with a means of correcting that. We should be clear that this has become a pressing issue because of the change in the definition of “commercial rate of interest” introduced in the Bill, which will make the anomaly more widely felt than it was previously. This is therefore a necessary measure and not just a tidying-up exercise.

I must raise one point with the Financial Secretary. For some odd reason, the correction is effective only from 16 May 2008. Companies that are caught by the widened definition of “commercial rate of interest” and subsequently rescued by the amendment will therefore be within the shares as debt rules from 12 March 2008 and come out again on 16 May 2008. That will lead to some anomalous and arguably unfair results. My understanding is that such companies will be taxed not only on the income accruing between 12 March and 16 May, but on a deemed capital gain on 12 March. That seems to be a bizarre and, frankly, unnecessary problem that could easily be resolved by the Government aligning the two dates. It does not matter whether they are aligned on 12 March or 16 May, but it seems utterly bizarre to have the two dates, which produce this odd little bit of income that will be caught in what is effectively a double taxation.

On amendment No. 143, the Government clearly spotted the error before or at the same time as we were alerted to it. Government amendment No. 131 will take care of the problem and we are happy to support it.

Jane Kennedy (Labour, Liverpool, Wavertree)

The Government amendments were drafted in response to representations from business, as I have said. However, business has not been able to provide any examples of where these unintended consequences have arisen. We decided to table the amendments to eliminate even the remotest possibility of double charges arising. Retrospection is not an option in this case, even if we wanted to introduce it. There could be losers if retrospection were used. HMRC does not accept that the review of interest makes a difference. I think that this group is fairly straightforward and that it should be given a prompt fair wind.

Philip Hammond (Conservative, Runnymede and Weybridge)

I wish to raise a few matters that we have not yet covered in these debates, and I make no apology for delivering them as a series of points.

The concern is that the proposed amendments to sections 91A and 91B introduced by paragraph 4, which prevent debits from being brought into account, create a risk of double taxation when shares such as fixed-rate preference shares are treated by those sections as loan relationships and are taxed on the basis of notional fair value accounting. For example, market fluctuations in interest rates could result in fair value losses on shares in some periods and gains in others. The disallowance of debits representing fair value losses could lead to double taxation to the extent that there were credits representing equal and opposite gains in other periods.

Net debits are more likely to arise in intra-group preference share arrangements, as those are often long-term arrangements. A helpful suggestion might be to introduce something similar to the provision that I am told exists in paragraph 23 of schedule 26 of the Finance Act 2002—the Financial Secretary will be familiar with it—which effectively taxed only the cumulative net credits arising from exchange rate fluctuations. Obviously in this case we are not talking about exchange rate fluctuations, we are talking about interest rate fluctuations. Similarly, if shares are denominated in foreign currency, the fair value will fluctuate with the exchange rate movements. The disallowance of debits representing fair value losses would, on my understanding, lead to double taxation to the extent that there were credits representing equal and opposite gains in other periods. I would be grateful if the Financial Secretary could address that point and, if she has some reassurances, let the Committee know what they are.

There is concern about proposed section 91D (2), which is introduced by paragraph 11 of schedule 22. It extends the definition of redeemable shares to any share where

“it is reasonable to assume that the investing company will or might become entitled to qualifying redemption amounts.”

When that is coupled with the proposed repeal of the definition of the commercial rate of interest in sections 103(3)(a) and (b) of the Finance Act 1996, introduced by paragraph 15, virtually any preference shareholding could be argued as being within the scope of section 91D and therefore taxable as a loan relationship unless proven to have been acquired for a purpose other than tax avoidance.

No one wishes to support tax avoidance, but that places a lot more pressure on the motive test than we have under the current rules. Almost any preference share may be caught, unless the taxpayer can be confident that there is no aspect of its history that HMRC could characterise as “avoidance” of any sort. It seems to give excessive discretion to HMRC and a corresponding lack of certainty to the taxpayer. In the absence of any change to the legislation, HMRC will either have to apply the rule universally, or it will have to untax many companies by non-statutory discretion, meaning more complexity and more uncertainty for business. We believe that legislation that goes over the top and relies on a non-statutory discretion by HMRC is, quite frankly, bad legislation.

A third concern is that there is no holdover relief for shares coming into section 91A or 91B for the first time. The schedule will extend the scope of sections 91A and 91G of the Finance Act 1996 and shares newly brought within their scope are treated under the terms of section 91G as having been disposed of and reacquired on 12 March 2008 at fair value, but there is no provision for holdover of any chargeable gain, or indeed, allowable loss that is crystallised by the deemed disposal. That is in contrast to shares held at the time that sections 91A and 91B were first introduced in 2005. The gradual extension of the rules to catch what are known as sidestepping transactions, which we have seen in the last few amendments to the section 91B regime, has generally been so closely defined that disguised interest-type transactions only were caught and consequently, the resulting capital gains were not significant or at least were uncontroversial. By contrast, the current proposals are so wide in scope that they will catch many shareholdings where the shareholding has been in place for a long period and the shareholder has had no reason to believe that the section 91B regime might be extended to include them because there was no intention to create disguised interest. Consequently, there is much more scope for an unfair capital gain to arise and in some cases the resulting tax liability could do material financial harm to a company.

I have two other points to make. The effect of the amendment to section 91C(6), which is introduced at paragraph 9(3) of the schedule, is to bring within the scope of section 91B shares that would be caught but for the fact that the assets of the company were changed to prevent the shares appreciating in an interest-like way. Once the shares are within the scope of section 91B as a result of the amendment, they are taxed without regard to the effect of the changes to the value of the assets so the interest-like return only is caught. However, the transitional provision does not disregard the return-varying assets, so the section 91G capital gain or loss at the time the company comes into section 91B would be increased or decreased by the fair-value movement on the introduced assets. In a typical case, the interest-like appreciation may be avoided by transferring a derivative contract into the company that issued the shares—I hope the Minister is following this. Gains and losses on the derivative would be taxed under the derivative contracts rules, quite obviously, but under section 91G, the cumulative gain or loss would also be taken into account in computing the chargeable gain or loss arising on 12 March 2008. The point of all this is that the gain or loss at the time of its coming within the scope of section 91B would be double-taxed; once under these arrangements, and once under the derivative contracts rules. Those are areas of concern, and I would be grateful if the Minister addressed them.

I want to raise an issue that the Chartered Institute of Taxation has raised. In addition to the types of arrangements that have been notified under the anti-avoidance notification provisions, the use of bonus issue debentures occurs in a private equity context where a creditor’s ranking in the debt waterfall is upgraded from preferred equity to subordinated debt. There is some doubt—this is an important point that the Minister can answer with a yes or no if advice comes to her in due course—about the applicability of section 209 of the Income Tax Act 1988, and therefore, whether section 212 of ICTA 1988 will apply in those circumstances. Many advisers take the view that section 212 is not applicable, and it would be helpful if the Minister confirmed that if the payer of the interest is paying additional tax because of the non-deductibility of the interest, the fact that the payee is not paying tax on the interest will mean that a main purpose of such arrangements will not be regarded as securing a tax advantage for the purpose of proposed new sub-paragraph (1A) of schedule 9 to the Finance Act 1996. The hope is that the Minister’s officials might have been made aware of that concern following a representation that they have received and that the Minister might therefore be able to confirm in simple language whether those bonus issue debentures are caught.

Jane Kennedy (Labour, Liverpool, Wavertree)

Here goes. The hon. Gentleman asked me to answer yes or no on ICTA 1988, and I say, yes—a qualified yes—provided that tax paid by the company paying the interest is equal to, or more than, the tax saved by the company that receives it. He asked about transitional provisions regarding varying assets. HMRC considers that that is a theoretical issue only: no one has been able to find any example of it happening. HMRC guidance makes it clear that the payment of dividends does not give rise to fair-value losses, since the dividend is part of the fair-value return. Nor are any exchanged losses likely to reduce the overall return below nil. That means that it is unlikely that there could be debits.

The hon. Gentleman asked about redeemable shares, and he was concerned about what would be caught. There are a number of circumstances in which it is not reasonable to assume that the holder would be entitled to such amounts. For instance, if the subsidiary shares are held as part of the group’s core activities, it is not reasonable to assume that the investing company would sell those shares. There might also be regulatory reasons why it is not possible for certain shares held within a group to be sold off. The tax avoidance test provides protection for the taxpayer.

I hope that I can reassure the hon. Gentleman that HMRC will give case-by-case advice in accordance with its existing code of practice. It will advise companies on the application of the law to a particular transaction if the full facts and circumstances are set out. We have seen no evidence of any legitimate business transactions that rely on the upfront payment of interest. The announcement of this action in the 2007 pre-Budget report was accompanied by consultation with business, during which no evidence of such structures was received. He is right that there will be no hold-over relief. The absence of hold-over provision is not new, however, and was a feature of rules when they were first introduced in 2005. Although schedule 22 is large and complex, it deals with a number of aggressive avoidance schemes. Numerous financial product disclosures received under the regime introduced in the Finance Act 2004 show that the avoidance industry continues to be active. The tax at risk runs to hundreds of millions of pounds, so we believe that it is right to act in the interests of the public services and those taxpayers who comply with their obligations.

I might have missed one, two or possibly more of the detailed questions that the hon. Gentleman asked, but I undertake to write to him if that is the case, and I hope that we can see schedule 22 through to legislation.

Schedule 23

Philip Hammond (Conservative, Runnymede and Weybridge)

I will detain the Committee for no more than a moment. In fact, after reflecting on my notes, I will not detain the Committee at all.

Clause 61

Mark Hoban (Conservative, Fareham)

It is a pleasure, Mr. Hood, to serve under your chairmanship for the first time. There are a number of issues that I could have raised in the debate on the previous set of amendments, but I thought that I would focus on clause 61. It is worth bearing in mind the fact that a consultation on the control of foreign companies regime is being carried out at the moment. That is relevant to the clause, because one representative body questioned why changes needed to be made, given that significant reforms are expected in the 2009 Finance Bill. I am sure that the Minister will highlight some mischief that she and the Government wish to stop.

The consultation has moved away from looking at the status of individual entities to focus much more on income streams from things like finance payments, royalties and so on, and that focus seems to be creeping into the clause. There is a shift in definition from the emphasis on control of a company to some of the income that arises. The Law Society, in its comments on the clause, points out that subsection (3) discusses the concept of persons possessing, or entitled to acquire,

“the whole of the income”

of a company. The explanatory notes state that

“a person controls a CFC if they hold a majority of the rights to the CFC’s income or assets”.

The usual definition of control that applies is set out in section 416 of the Income and Corporation Taxes Act 1988, and focuses on someone’s ability to exercise, or be entitled to acquire, direct or indirect control over the company’s affairs. There appears to be a shift away from control, as we would normally see it, as being about the exercise and the power to intervene in the way that a company is run, to the economic rights that come from the income flows and who benefits from them. Would the Minister comment on what appears to be a shift in approach and almost a prelude to some of the things that were floated in the consultation paper? I suspect that the perception is that there is a bit of rowing-back.

Will the Minister define income for the purposes of subsection (3)? Is it distributable profits? If so, why has that not been emphasised in the Bill, and which generally accepted accounting practice applies? If it is not, what is it? Is it the gross income of a company, or is it some definition of chargeable profits? It would be helpful to have some clarification. Given that control appears to depend on who has the majority of the share of income, it would be useful to understand when the test of control applies. If, for example, there are fixed-rate preference shares, the income would accrue evenly over the year. If the company’s profits accrued unevenly and all arose in the second half of the year due to seasonal trade, it would appear that during the first part of the year, the holders of fixed rate preference shares would control the company because they are entitled to the majority of its income if the definition is about profits. In the second half of the year, those holders would lose control.

An alternative scenario is that if the profits of the company were low in one year, the preference shareholders would control the company, because they have the right to the majority of the income, but in a more profitable year, they would lose control of the company. There does not appear to be much certainty in this situation about where control is, because of the lack of definition regarding income. What would happen if someone owned 60 per cent. of the economic rights, but somebody else controlled 60 per cent. of the voting rights? How would income be appropriated between the two holders?

I have a couple of other points to make. The first refers to a previous group of amendments, but the issue flows through this clause. Proposed new subsection (7) refers to income being allocated

“on a just and reasonable basis”,

particularly where

“there is more than one settlor or beneficiary”.

However, “just and reasonable” is not an objective measure and could create uncertainty. The explanatory notes speak of guidance being produced to assist taxpayers. It would be helpful to know what that guidance will consist of, and whether there is a clearer rule that could be reflected in the Bill, rather than through guidance. Such a rule must not lead to opportunities for mischief at a later stage. Proposed new paragraph (ab) in subsection (2)(a) will create two new accounting periods: one that ends on 11 March 2008 and one that starts on 12 March 2008. If a dividend is received between 12 and 31 March, will it be accounted for on a receipts basis or can some of it be allocated to a prior period? Without that allocation, it will be possible for a company to fail the exempt test for the first period.

Finally, I want to raise the implications for the acceptable distribution policy. As I understand it, dividends paid under the acceptable distribution policy can be paid up to 18 months after the year end to which they relate. If a dividend was paid between 12 and 31 March 2008, it could be in respect of an accounting period ending on 30 September 2006. One of the issues is whether the changes under the clause will require people to go back and revisit the level of dividend and tax paid at that point.

It is perhaps worth explaining a bit about the acceptable distribution policy. To be exempt under controlled foreign companies legislation, a company has to distribute 90 per cent. of its profits by dividend. Under the changes, we think that the definition of income could expand so that 90 per cent. will be a percentage of a larger figure, which will require a larger dividend to be paid and therefore incur a larger tax bill. Because of the way in which the changes will interact with the acceptable distribution policy, it is not entirely clear whether people will have to reconsider the amount of dividend that they are paid. Of course, they determine that dividend on the basis of profits incurred before the legislation is introduced. There is therefore a sense of retrospectivity creeping in, because businesses that thought that they knew what their tax liabilities were will have them reassessed as a consequence of the clause. I could carry on discussing the wider issues around controlled foreign companies legislation and some of the problems that the Government have with it, but I am sure that the Committee would welcome the Minister’s response.

Further consideration adjourned.—[Mr. Blizzard.]