Finance Bill

Public Bill Committee, 16 June 2009.

(Except clauses 7, 8, 9, 11, 14, 16, 20 and 92) - Clause 56

Greg Hands (Conservative, Hammersmith and Fulham)

Thank you, Mr. Atkinson, and welcome back to the Chair for what I think will be a very interesting day for the Committee. May I also welcome the hon. Member for Burnley back to her previous Department? We went head to head last year on a particular clause in the previous Finance Bill, so it is good to have her back.

Clause 56 relates to the tax treatment of Members of the European Parliament. It gives tax relief against United Kingdom tax for the new, or maybe not so new, Communities tax that the European Union will levy on MEPs’ salaries and benefits. The relief will operate in broadly the same way as if the MEP had paid, for example, Belgian tax on his or her earnings. The peculiarity involved, however, is that the UK has no dual taxation treaty with the EU.

The explanatory notes state that, in subsection (1), the clause

“extends the application of ‘double taxation relief’ under the Income and Corporation Taxes Act 1988 (ICTA) to European Community tax deducted from the pay, transitional allowances and pensions of members of the European Parliament (MEPs) under the new Statute for Members of the European Parliament”.

It is worth placing the statute’s reference number, 2005/684/EC, Euratom, on record, as I will refer to it in due course. The explanatory notes go on to explain that, in subsection (2), the clause

“also amends the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) to provide that payment of transitional allowances to MEPs under the Statute will be treated as termination payments in line with the current treatment of other, similar payments.”

It is important for us to consider whether the termination payments are indeed in line with the current treatment of other similar payments, at least in the UK. I intend to examine MEPs’ pay, transitional allowances, pensions and termination payments, all of which are covered by the clause.

Let me begin by giving some background information on why the payment of MEPs is changing at all. MEPs’ pay will be going up as a result of the new scheme of central payments by the EU, rather than payment by the Cabinet Office as is currently the case in the UK. In practice, the new common salary for all MEPs across the EU will mean a significant pay increase in sterling terms for UK MEPs. To be fair, the situation is a result of the decline in the value of the pound thanks to the Government’s policies against the euro since the statute was voted on. At the time of the vote, MEPs were voting for a pay rate that was very similar to the current rate, and that was the same as an MP’s pay rate.

Kitty Ussher (Labour, Burnley)

I cannot resist asking whether the hon. Gentleman feels that that is an argument in favour of joining the euro.

Greg Hands (Conservative, Hammersmith and Fulham)

It most certainly is not. I have heard some fairly spurious arguments in favour of joining the euro, notably from the noble Lord Mandelson in recent days, but that particular argument may be the most spurious of them all, so we reject it.

Peter Bone (Conservative, Wellingborough)

Does my hon. Friend share my concern that the Labour party—sorry, the Government—is now encouraging Britain to join the euro?

Peter Atkinson (Conservative, Hexham)

Order. I do not think that we will go any further down that route.

Greg Hands (Conservative, Hammersmith and Fulham)

I thank my hon. Friend for his intervention. He is quite right. I recall that there were a number of tests involved, but they seem to have been thrown out by the Minister, who has returned to the Treasury from the Department for Work and Pensions. Perhaps she came under influence while she was at the DWP.

The fact that the salary, at the time it was voted upon, would be broadly similar to that of an MP was an important factor in Conservative support for the new statute at that time. As far as MEPs’ tax arrangements are concerned, UK MEPs are currently paid monthly via the Cabinet Office, and under those arrangements they pay tax through PAYE, along with national insurance contributions. After the end of the tax year they have to complete a self-assessment form, send it to Her Majesty’s Revenue and Customs at its public department No. 1 office and pay any tax that was not already paid under PAYE. On the face of it, that looks pretty much like the arrangements for any other taxpayer.

However, once the new Europe-wide statute is in force, UK MEPs who were re-elected in 2009 will have the option of staying in the current pay arrangements for as long as they remain MEPs. If they do so, they will continue to be paid their present salary with no change in the tax and national insurance contributions arrangements that currently apply. If, however, they decide to opt for the statute instead—new MEPs will have no choice in that matter, as they must go for the new, standardised, Europe-wide statute—they will be paid directly by the European Parliament, their salary will be paid by Brussels and they will pay that Community tax on it.

Under current plans to implement the statute, the Government have decided to exercise their right to apply UK tax as well, and we in the Conservative party strongly support that. We have consistently argued that it would be iniquitous for MEPs not to pay tax at the same rate as their electors. They will therefore pay UK tax on their salaries but will, under clause 6, be given credit for any Community tax already paid, which is what is proposed in clause 56. They will therefore be taxed at the same rate as a UK resident earning the same salary in the UK.

My understanding of the new statue is that, because MEPs will be paid by the European Parliament, tax will not be deducted under UK PAYE. Instead, any additional UK tax liability will be collected through their self-assessment. MEPs will therefore need to set aside money from their salaries to pay their prospective UK tax bills at the end of the financial year. They will also continue to be liable for employee-rate UK national insurance contributions on their salaries and will work out their contributions each month and make payments, so UK MEPs face a complicated regime.

So, that is a rough synopsis of the provision before us. It is just a shame that the clause could not have been debated a couple of weeks earlier, before the European elections, when it would have been rather more topical. In fact, I wonder whether the Government’s approach will be coloured by the loss of five of their 18 MEPs earlier this month. There are now so few Labour MEPs that I wonder whether the Government were considering a late volte-face on clause 56 and dropping its provisions altogether. With only 13 seats, Labour scored less than parties it loves to criticise.

Peter Atkinson (Conservative, Hexham)

Order. The hon. Gentleman did mention clause 56, but he is nevertheless straying wide of the clause. I would be grateful if he came back to the matter at hand.

Greg Hands (Conservative, Hammersmith and Fulham)

You are of course right, Mr. Atkinson, but I will just finish the sentence. They won only 13 seats, fewer than the Polish Law and Justice party, which is one of—

Peter Atkinson (Conservative, Hexham)

Order. I am quite happy to give some latitude, but the hon. Gentleman is now taking liberties.

Greg Hands (Conservative, Hammersmith and Fulham)

I apologise, Mr. Atkinson.

Jeremy Browne (Liberal Democrat, Taunton)

Will the hon. Gentleman show the leadership for which he is renowned by encouraging all Conservative MEPs to forgo any additional salary?

Greg Hands (Conservative, Hammersmith and Fulham)

I am not quite sure about the leadership for which I am renowned, but what other salaries might be available to MEPs? Did the hon. Gentleman mean outside employment?

Jeremy Browne (Liberal Democrat, Taunton)

No, I did not. I understand that they could decide unilaterally to pay themselves the same amount, in pounds sterling in equivalent terms, as MPs in this House, so any increase that they might enjoy, as a result of either a higher rate of pay or exchange rates, could be forgone.

Greg Hands (Conservative, Hammersmith and Fulham)

We obviously have many more MEPs than any other party, so I have not been able to check those arrangements with each of them, but I understand that they will all be following the rules precisely. I refer the hon. Gentleman to a document on the conservatives.com website, “Our Commitment To The British People”. I accept that we are straying from the debate a little, but precisely how our MEPs will accord with the rules is there chapter and verse.

So, when it comes to clause 56, I find it interesting that the Government are proposing tax relief for MEPs, deciding to hide it from public view before the European elections, and have almost no MEPs for the clause to refer to.

Let me say a little about the new rules for MEPs pay, coming into effect next month, which, as mentioned, are the background to clause 56. The new rules will have the most impact in poorer countries, such as Bulgaria, where MEPs earn around 50 times more than the average domestic salary. As we know, the rules will set a standard salary for all 736 MEPs, regardless of the economic conditions of the relevant member state. The think-tank, Open Europe, has said:

“The huge gaps in pay will tempt the most talented people away from national politics.”

That particular issue is probably beyond the remit of today’s debate, but I notice that the Government seem to have decided that there is too little talent left for them in the House of Commons, as shown by the appointment of seven Peers to attend Cabinet.

Peter Atkinson (Conservative, Hexham)

Order. The hon. Gentleman is trying my patience. I urge him to keep to the essence of clause 56, which is about double taxation relief for MEPs.

Greg Hands (Conservative, Hammersmith and Fulham)

Indeed, Mr. Atkinson. Ironically, the Government are bringing back MEPs to serve in the national Government. I was going to come back later to the tax treatment of a member of the European Parliament joining the Government.

As the explanatory notes say, the new pay regime takes effect from the new Parliament, which will assemble in a few weeks. The new package has certainly raised some eyebrows, not least because it was voted on by the European Parliament itself. New MEPs will automatically be subject to the new package and re-elected MEPs will be able to choose which package suits them best. I am not aware of any legislature in the world that has that luxury. The consequence is that MEPs will be paid directly by the Community, rather than by their mother country, and will be subject to tax by the Community.

One obvious area that the Minister needs to explain is the EU’s ability to raise tax in its own right—the so-called “tax for the benefit of the Communities”. At first, I thought that the EU having tax-raising powers must be entirely new, but can the Minister confirm that the European Community tax referred to in the explanatory notes is derived from Council regulation No. 260/68 of 29 February 1968? It was designed for Commission staff and later European Investment Bank staff. I shall be grateful if she will explain whether the tax has existed for a long time. The tax is paid back into the EU budget and clause 56 extends the scheme to MEPs. Can the Minister confirm that?

The Minister needs to explain which part of the EU raises the tax and where it goes—for example, to which part of the EU budget. What is more, even if the European Community tax is not new, I am sure that I am not alone in being worried about its extension into fields not foreseen in 1968. The ability to raise taxes would confirm broader fears of a European superstate and measures to give it tax-raising powers should generally be resisted—not least, powers over elected representatives from the member states.

I found that most sources on this Community tax were extremely opaque. The best explanation that I could find was on the website of the EIB:

“Some key-concepts concerning the community tax:

Progressive tax scale: as with the majority of national taxation systems, Community tax is based on the principle of a progressive tax scale: the greater the taxable income the higher the rate of tax.

Brackets: Progressive taxation is achieved by dividing the scale into brackets. The taxable amount in each bracket is taxed at the rate applying to that bracket.

Top bracket: the lowest bracket is zero-rated for tax purposes, the second is taxed at 8%, and so on up to the top bracket, which is taxed at the maximum rate of 45%.”

Many of us will find it ironic that the Finance Bill, which sees an enabling clause to create a new 50 per cent. tax rate for all British subjects, is the same Bill that allows our MEPs to be taxed by this “tax for the benefit of the Communities” at a maximum rate of only 45 per cent. Having said that, it looks as if the HMRC reserves the right, as I have said, for UK MEPs to pay tax on the difference between this “tax for the benefit of the Communities” and UK tax. However, the Minister will need to make that clear and it would be interesting to know whether other states’ MEPs have to pay that. Knowing in which states that is not the case would inform the debate a great deal.

If this “tax for the benefit for the Communities”, as referred to in the explanatory notes, has been in place since 1968 and the UK has had no double taxation treaty with the EU, which is actually the origins of clause 56, have there been cases in the last 41 years of someone working for the EU—perhaps the Commission, or a body such as the EIB—actually being taxed twice? That is the implication of the Government’s argument for introducing these measures.

I suppose that all those subject to the Community tax are probably resident in Belgium, but that is not necessarily the case, perhaps, for a member of staff of the EIB working in a London branch. I would be grateful for an explanation of whether they are paid by the EU, but have effectively been subject to taxation by both authorities in the period since 1968. It would be helpful to have some light shone on that, because we are talking about introducing a new clause which may have been needed in 1968, but not in 2009.

The Minister will also have to explain the coefficients being used for these taxes. Returning again to the EIB website, the best explanation I could find of this “tax for the benefit of the Communities” was:

“The original tax scale was laid down by regulation 260/68: coefficient of 100%. This coefficient is readjusted on a regular basis by the Council of Ministers of the E.C. The current coefficient adapting the tax brackets is 486.7097%.”

So the Committee needs to know what has been increased almost five fold since 1968 in this “tax for the benefit of the Communities” referred to in the explanatory notes. Is it the level of the tax brackets, or the actual percentage taxed on the lowest band? I simply do not understand what these coefficients are, but it is very important for us to know what they are.

It is worth having a look at what sort of sums might be involved in clause 56. The think tank Open Europe published a comparison last week between the costs of the UK and the European Parliaments. Their findings are that the European Parliament cost taxpayers a staggering £1.8 million a year for each MEP. That is in contrast to the House of Commons, which cost taxpayers only £364,000 for each Member for each year. The other place costs only £208,000 per member per year. So the overall bill is over five times the level of a national MP, or nine times the level of a peer.

Brian Binley (Conservative, Northampton South)

Are they worth it?

Greg Hands (Conservative, Hammersmith and Fulham)

I do not think that that is in the scope of today’s debate, but I certainly do not think that our national MPs are worth only a fifth of our MEPs.

Mark Todd (Labour, South Derbyshire)

I do not want to stray too far, but perhaps the hon. Gentleman could consider the proportionality of media attention given to the expenses of the two categories.

Greg Hands (Conservative, Hammersmith and Fulham)

The hon. Gentleman makes a very interesting point. In recent months perhaps five times the media attention has been given to ourselves as has been given to MEPs. Over the years, MEPs have been given a little attention, but perhaps a little more light should be shone on those things. I commend, again, my party colleagues in the European Parliament who have published the excellent document “Our commitment to the British people”. That is a code governing expenses and allowances for Conservative MEPs, to which I refer the hon. Gentleman.

Graham Stuart (Conservative, Beverley and Holderness)

Does my hon. Friend agree that finance Bill clauses such as this would be better scrutinised and understood by our constituents if we turned away from the list system under which practically nobody knows who their MEPs are, and returned to a constituency system in which representatives were elected on a first-past-the-post basis?

Peter Atkinson (Conservative, Hexham)

Order. Nice try, but no good.

Greg Hands (Conservative, Hammersmith and Fulham)

I am sure that we are all grateful for your guidance on that particular matter, Mr. Atkinson.

I return to Open Europe’s comparison, as it is important here. According to that comparison, based on the respective Parliaments’ budget allocations, national MPs at Westminster claim £148,297 in allowances each year on average, while our counterparts in Brussels can claim up to £363,000 per annum, which is two and a half times as much. Furthermore, MEPs, in contrast to national MPs, do not have to produce receipts to claim their allowances, although that is changing. Mr. Atkinson, I apologise if this is outside the scope of today’s discussion, but I am yet to hear of plans for any Liberal Democrat or UK Independence party MEPs to publish their receipts.

Importantly, the Open Europe study found that 22 UK MEPs retiring this year will receive a share of a £20 million pay-off, in both pensions and benefits. Each will be paid—

Peter Atkinson (Conservative, Hexham)

Order. We are straying again. The clause is to do with tax.

Greg Hands (Conservative, Hammersmith and Fulham)

Thank you for that guidance, Mr. Atkinson. I was coming on to describe the tax on those pensions and benefits. Each of those MEPs will be paid up to two years’ salary to help them adjust to their new life, and will share a £10 million index-linked pension pot. This is where the important matter of the transitional payments comes in. Earlier, I mentioned the Government’s argument that the tax treatment of those transitional payments is essentially the same as the tax treatment of redundancy payments in the private sector. I am going to doubt whether that is the case. That is the importance of the transitional payments. Each of those MEPs gets a transitional payment of more than £30,000, up to £55,000 to close their offices and lay off staff, and a pension worth between £175,000 and £235,000.

It is not entirely clear to me whether those extremely generous transitional payments and pensions will be subject to the tax regime that was in place prior to 2009 or the one that will be in place afterwards, or whether some choice might be involved. The explanatory notes state that existing MEPs can chose to

“retain their existing remuneration package.”

Does that apply to the tax treatment of moneys that they receive after 2009, if they have stood down? In other words, will Community taxes or UK taxes be paid on those transitional payments? That is not entirely clear. I read in The Times of 2 June that the first £30,000 of the transitional allowance will be tax-free, but who will tax the amounts on top of that is not yet clear.

As we debate the clause, we should be mindful of the generosity of the regime in Brussels, but to be fair, and in the interests of balance, the degree of generosity is the cause of some dispute. The head of the UK office of the European Parliament recently told The Guardian that an MEP’s allowances are

“comparable to an MP’s allowance”,

and accused British media reports of being “inaccurate or tendentious”. Open Europe’s analysis, however, is extensive and attributive, and I have yet to see any detailed counter argument.

Mark Field (Conservative, Cities of London and Westminster)

My hon. Friend and I, as central London Members, are perhaps unaffected by this, but will he also note that there is a similar scam in section 292 of the Income Tax (Earnings and Pensions) Act 2003, which ensures that the additional cost allowances are tax-free? That is basically a scam that our own MPs play on each other, and one hopes that the Treasury will pay immediate and urgent attention to ensuring this particular situation is entirely—

Greg Hands (Conservative, Hammersmith and Fulham)

I thank my hon. Friend for that intervention.

Brian Binley (Conservative, Northampton South)

On a point of order, Mr. Atkinson. Is the word scam a parliamentary term and should I feel offended?

Peter Atkinson (Conservative, Hexham)

I think it is a suitable word and I hope the hon. Gentleman does not feel too offended. I am sure he is robust enough.

Greg Hands (Conservative, Hammersmith and Fulham)

It would be dangerous for me to give an opinion on my hon. Friend’s intervention. He has made his point and perhaps it might be more appropriate for others to respond in due course when considering any reforms of the allowance structure in this place. Nevertheless, the UK office of the European Parliament misleadingly claims that MEPs’ pension rights are the same as for a Westminster MP when in fact, under the new rules coming into force following the European elections and giving rise to clause 56, MEPs will be entitled to a far more generous pension scheme than MPs. My understanding of the MPs’ pension scheme is that if we contribute the standard 10 per cent. of our salary over a 10-year period—that is, a whole year’s salary of £63,291, although I am not sure that is the latest figure—we will have access to a pension of £15,822 per annum.

By contrast, under the new rules to come into force after the election, MEPs will receive an annual pension of £27,954 which is almost twice as much, after paying in nothing from their own salaries over the same 10-year period. This is what Open Europe has said about the whole package:

“The European Parliament has introduced some reforms to come into force after tomorrow. However, under the new rules, UK MEPs will get a huge payrise, and while receipts will for the first time have to be produced for travel expenses, the vast majority of expenses will continue to be available without a receipt. On top of that, the pension becomes even more generous than before—dwarfing the pension that national MPs are entitled to.”

When we debate the tax treatment of MEPs, we need to be aware of what we are paying for, previously directly and now to be indirectly.

Another aspect on which the Government will need to provide reassurance is what happens to MEPs and whether they need to pay any tax to the Belgian or French national authorities if they declare themselves to be resident in Belgium or France—the two locations of the Parliament. With the new tax for the benefit of the Communities, are MEPs now exempted from Belgian taxation if they are mainly resident in Brussels? I do not know the answer. That question has probably cropped up on a number of occasions over the decades but I am not sure of the situation.

One of my London MEPs wanted me to raise a question relating to the tax treatment of those who are or might be deemed non-domiciled MEPs. Independent of any questions relating to MEPS, it would appear that HMRC is increasingly taking the view that EU citizens working in the UK are generally to be treated as non-domiciled. There is a very important issue in London. My constituency has the second highest proportion of non-UK EU citizens in the country. Kensington and Chelsea is the first and the two Cities is probably the third or fourth along with Camden. That means that over 9 per cent. of my constituency are non-UK EU nationals. There is an important point about whether they will normally be deemed non-domiciled, which I believe is the view increasingly taken by HMRC.

Interesting questions arise with MEPs who were not previously UK residents. Let me try to explain by using a specific example. This question to date has been more theoretical than practical. I recall that either in the 1984 or 1989 European Parliamentary elections, David—now Lord—Steel stood in Italy to become an Italian MEP, if my schoolboy memory is correct.

Brian Binley (Conservative, Northampton South)

He did not win.

Greg Hands (Conservative, Hammersmith and Fulham)

I think my hon. Friend is right. I cannot remember whether he had any chance of winning, but that is a debate for another day. Other than that, I am not aware of a trans-national MEP either coming from the UK or representing the UK. However, as Dr. Tanner pointed out to me, that changed on 4 June, with the election of Marta Andreasen as an MEP for the south-east of England. Some might argue that her election was a little incongruous for UKIP, but that would be to digress. I must say that I have no personal axe to grind against Ms Andreasen at all. In fact, three or four years ago I spent a pleasant half-hour or so with her on the Commons Terrace, being briefed on the hows and whys of the EU not having its accounts properly signed off. She seemed to be a very pleasant lady and I have nothing against her being elected in this way. I am just using her example, more or less at the request of one of my MEP colleagues, to try to establish what the status might be of somebody who is a non-domiciled but UK-resident MEP.

So, looking at Ms Andreasen’s case from a tax perspective, it throws up more questions than answers about clause 56. This particular MEP for the south-east of England was, as I understand it, born in Argentina of Danish descent, is married to a Spaniard and lives in Spain and has been elected to a Parliament that is based in both Belgium and France. For a moment, I will ignore the policy of UKIP that all UK citizens working in the UK should require a work permit; I will ignore it as I do not think that it is within the scope of today’s debate.

However, I want to pose a tax question. Ms Andreasen seems to be someone who is not domiciled in the UK but she may also wish to declare herself to be resident here. Therefore, are the Government expecting that this type of MEP will be taxed only by the new tax for the benefit of the Communities, or do they expect that a non-domiciled UK MEP will also be subject to UK taxation? Furthermore, how will the Government’s proposals for non-doms, as outlined in the Finance Act 2008, be applied to non-dom MEPs if they are also deemed to be resident in the UK?

As we know, timing can be key with the Government when it comes to changing the remuneration and tax treatment of politicians. In last year’s debate on the severance payments for the Mayor of London, we saw just before the election that the Government seemed especially keen on a favourable tax treatment and severance package for any outgoing Mayor. The timing for that was really most curious; I think that it was in the last days of April 2008. The Government told us that the severance payments given to Greater London assembly members and to outgoing Mayors would be akin to private sector redundancy arrangements. They argued that the same was true for Members of Parliament here. As I understand it, a MP who retires here is treated in the same way as one who offers themselves for election but fails to be elected; at least that was the situation until it was reviewed last year.

Thanks to the Finance Act 2008, similar arrangements will be in place for the GLA. The payment is not so much the equivalent of a redundancy payment in the private sector; it is a payment that will be made in all cases to MPs, Mayors and Greater London assembly members when they stand down.

The same now appears to be the case with MEPs and the Government’s treatment of them, according to clause 56 and the explanatory notes. Clause 56(2), which is about termination payments, puts the new scheme on to the same basis as the old scheme and gives exemption to EU termination payments in the same way as House of Commons termination payments. Nevertheless, it is still worth pointing out that these rules, for both sets of parliamentarians, are more favourable than those affecting the vast majority of the population. If there was an entitlement in an ordinary employee’s contract along similar lines, it would normally be taxable in full and the first £30,000 would not be tax-free, as is the case with MEPs. I think that the HMRC website says:

“While the first £30,000 of redundancy can be received tax-free, this tax-free limit only applies to ex-gratia payments, which means those made to compensate for the end of employment. Therefore, unpaid wages, notice period payments and bonuses are taxed as normal employment income.”

So it would be helpful to have a clarification of the tax status of the termination payment of £30,000—in fact, it is more than £30,000—paid to MEPs.

As I have said, this matter, in relation to termination payments, was debated with regard to the Mayor of London and the Greater London assembly in the discussions about the Finance Act 2008. The general rule is that redundancy payments of up to £30,000 are not taxable if they are ex gratia and are not provided under the terms of the contract of employment. Interestingly, HMRC has been seeking to widen the definition of what is provided for in the specific terms of a contract to benefits that are provided on a routine or customary basis upon termination. Employees have long been able to argue at tribunal that something has been customary in their employment, so it is understandable that HMRC now seeks to extend that logic to attack payments that are non-contractual, but customary on termination of employment.

Yet, once again, in this year’s Finance Bill HMRC seems quite happy to allow tax-free termination payments to politicians. I certainly do not argue that Members of Parliament should have special treatment—in fact, quite the opposite. Why, therefore, are payments like this given favourable statutory tax treatment when any other termination payment has to be defended on a case-by-case basis against the Revenue? It is not clear why Members of Parliament, MEPs and Mayors of London should be offered statutory protection from such a challenge. I would again be grateful for the Minister’s views.

Peter Bone (Conservative, Wellingborough)

I think I am going to take issue with my hon. Friend here and ask him to explain the logic. Redundancy is where a job disappears, normally because the company is closing down or is having to cut back. The position disappears. In the case of politicians, the position is not disappearing but involuntarily the person is not allowed to continue in that post. I can understand why there is different tax treatment.

Greg Hands (Conservative, Hammersmith and Fulham)

My hon. Friend makes an interesting point. He is right: it is not exactly the same. The easiest thing for me to do is to refer him to the lengthy debate that was held on this very point during the consideration of last year’s Finance Bill by the Committee of the whole House.

It would also be helpful to get clarification from the Minister about cases where an MEP gives up his or her position voluntarily to take on office in a national Government. The Government do not appear to be particularly expert at these provisions. Indeed, my hon. Friend the Member for Rayleigh (Mr. Francois) drew attention to the case of an MEP who was appointed Europe Minister recently, rather embarrassingly in the course of the Prime Minister’s press conference, the day after the European elections. He pointed out that she would be unable to take on the role unless she first stood down as an MEP. That seemed to be news both to the MEP and the Government, despite the fact that anyone familiar with the European Parliament will know that MEPs come in and out of national Government quite often in other countries, requiring them to step down.

Returning to clause 56, what will be the tax status of the severance arrangement for that particular MEP who is now, or maybe is not or perhaps soon is the Europe Minister or is perhaps just the acting Europe Minister? I am still not sure of her status. I think the public have a right to know, not least because she is listed on the No. 10 website as being a recipient of a full ministerial salary, unlike many of her Lords colleagues, or soon-to-be colleagues, who have also been appointed to the Government and/or attend Cabinet.

I have asked the Minister a number of questions during this short debate on MEPs’ pay arrangements. I shall summarise them again. [Interruption.] I have eight questions. First, is the assumption correct that the tax for the benefit of the Communities is the one derived from the 1986 Council regulation? Secondly, which part of the EU does the tax raising and where does the tax go? Thirdly, have there been cases since 1968 where someone has been paid by the EU Commission or the EIB and has been taxed twice because of the lack of this clause? Is the clause absolutely necessary?

Fourthly, the Minister will need to explain the obscure coefficients I mentioned earlier when referring to the EIB website to try to see whether we really are comparing like with like on these matters. Fifthly, which tax regime will apply post-2009 to MEPs’ pensions and transition payments? Sixthly, are MEPs as a class of persons now, or were they ever previously, exempted from national income taxes raised in Belgium, France or any other country where they declared themselves to be resident? Seventhly, what about a UK-resident but non-domiciled MEP, like the UKIP MEP I mentioned earlier? I cannot say with any degree of certainty that that is her status—I have made a number of inferences—but I would be grateful for an explanation of how that sort of person is, or might be, treated under clause 56. Finally, what will be the tax treatment of any severance package of an MEP who steps down voluntarily under the new statute, and how will that compare with the existing arrangements?

We do not, of course, oppose the clause. It would not be right for MEPs to be taxed on their full salaries and other entitlements in their entireties by two separate tax authorities. However, we have many questions and seek a number of clarifications on the whole matter.

Jeremy Browne (Liberal Democrat, Taunton)

Thank you for giving me the opportunity to make the main speech on the clause, Mr. Atkinson. I also support the Government’s intentions, although I may express my support in different terms. I congratulate the hon. Member for Hammersmith and Fulham on his customary rigour in seeking ministerial clarity on some individual cases, as well as on the broad principles under discussion.

I wish to make three brief points. First, I see the logic behind all MEPs being paid the same, although some may feel that it is another step down the path towards an EU Parliament that assumes a national profile, rather than one that is an amalgamation of different nation states. Similarly, I see the merit and wisdom of UK MPs being paid the same, regardless of their individual contributions to our deliberations. I am comfortable with that broad principle.

Secondly, I see the logic of phasing in the arrangements. I am willing to be corrected, but I vaguely remember the Conservative party leader, the right hon. Member for Witney (Mr. Cameron), recently talking about closing the existing parliamentary pension scheme to new entrants. If he did make that point, it would similarly involve a phasing, interim arrangement whereby existing MPs would continue to benefit from the current system, rather than a blanket arrangement whereby all MPs, regardless of the length of their service, were required to switch over to the new arrangement. In that context, I see some sense in applying interim arrangements to the European Parliament as well.

Thirdly, I see the sense in taxing MEPs at the same rate as their constituents. Of course, there is a slight difference in that the provision should very much apply to us in this House, because we set the rates of taxation for our constituents, which is not true of MEPs. Nevertheless, I see the sense in MEPs paying the same rates of taxation, whether they be higher or lower than at present, as the people they represent. However, under the salary level, MEPs would not, as was perhaps inferred by the hon. Member for Hammersmith and Fulham, be eligible to pay the 50 per cent. rate on their income unless there was a massive change in the rate of exchange between sterling and the euro. That causes some difficulty, as we have seen in trying to work out whether football transfers have broken records, because the pound is at such a weak level that it affects comparisons between the UK and the eurozone. However, seeing as the dominant EU currency is the euro, it seems logical to pay MEPs at the euro rate rather than at, for example, the Danish krone rate, or at a more significant currency rate, such as sterling.

Greg Hands (Conservative, Hammersmith and Fulham)

I am trying to follow the hon. Gentleman’s argument. We all know that the Liberal Democrats’ policy is to join the euro at the earliest possible opportunity. I wonder how he feels about national parliamentarians who are elected by a country but who are paid directly by the EU, rather than by their national taxpayers. Will that have an impact on whether they view their duties as being to their home country or to the EU?

Jeremy Browne (Liberal Democrat, Taunton)

That is not something that causes me sleepless nights. I can see the merit in having the European Parliament administer the pay of its Members. I would of course expect the six MEPs who represent the south-west of England to have foremost in their mind the concerns of the residents of the south-west of England, but I would not expect them to have those concerns exclusively in their minds. If they were able to advance animal welfare standards across the EU, for example, in a way that was advantageous to farmers in Somerset, who currently feel that they have to adhere to superior standards of animal welfare, I would regard them as discharging their function effectively. There are all kinds of roles that MEPs may play, and they might feel that they can make a contribution by advancing some of our European values in other parts of the world to the advantage of citizens there, so I do not wish their remit to be too narrowly confined.

Greg Hands (Conservative, Hammersmith and Fulham)

I certainly agree with part of the thrust of the hon. Gentleman’s argument: that MEPs have a responsibility to their constituents and also to look at the wider picture, in the same way as debating the clause in Committee is beyond our remit in relation to our constituents in Taunton and in Hammersmith and Fulham. I wonder what his view is on the change of who is making the payments. Does he feel that the fact that Europe is paying UK MEPs, rather than the UK Exchequer, will make no difference to how they view their loyalties, or that that will make some tangible difference?

Jeremy Browne (Liberal Democrat, Taunton)

My feeling is that it would almost certainly make no difference, but I have never served in the European Parliament and so have difficulty putting myself in the mindset of one of its Members and trying to decide what my primary motivation would be. I imagine that I would be highly motivated by the desire to serve the people in the region that elected me and consider the interests of the people in the country I came from. I would also be motivated by a desire to see the EU shaped in a way that conformed to my ideals and values. All those factors would be considerations that would rest with me, regardless of whose name was on the payslip I got at the end of each month.

Mr. Binleyrose—

Jeremy Browne (Liberal Democrat, Taunton)

I give way to the hon. Gentleman.

Peter Atkinson (Conservative, Hexham)

Order. Before the hon. Gentleman intervenes, I say that the Chair is motivated by wishing to discuss clause 56. I think that we had perhaps better leave the motivations of MEPs to one side.

Brian Binley (Conservative, Northampton South)

With respect, Mr. Atkinson, does not the hon. Gentleman recognise the old phrase, which I am sure most west country people would recognise, that he who pays the piper calls the tune? There is a symbolic aspect to this business that ought to be taken into account. One owes one’s loyalty to the person who hands out one’s pay packet. That is the point; will he recognise it?

Jeremy Browne (Liberal Democrat, Taunton)

The Conservatives are obsessed by symbolism, with regard to the EU, and I am interested in practicalities. I apologise for having a less romantic view of politics than the hon. Gentleman does. I observe that the EU is funded through contributions made by member states, and the question whether MEPs are paid directly by that money raised in the UK, or through the mechanism after the money has gone to the EU, I suspect, will not have as big a bearing on their deliberations as some members of the Conservative party fear.

Mr. Stuartrose—

Jeremy Browne (Liberal Democrat, Taunton)

However, I am always open to more conspiracy theories.

Graham Stuart (Conservative, Beverley and Holderness)

Perhaps it is not surprising that the hon. Gentleman, as a Liberal Democrat, is not too worried about where the money comes from, but I put it to him that receiving one’s pay cheque from an organisation that never has its accounts signed off because they are subject to so many questions would undermine the confidence with which one served. If I were an MEP, I would wish to be paid by the Exchequer of this country.

Jeremy Browne (Liberal Democrat, Taunton)

All I can say is that I hope that Conservative MEPs, who will share the hon. Gentleman’s anxiety, will forgo their pay until they feel that the auditing arrangements within the EU are administered to a more satisfactory standard. That seems to be the logical inference.

I am extremely concerned about value for money, so I am concerned by all kinds of statements made by different parties in the House, but I do not wish you to think that I am straying from clause 56, Mr. Atkinson. The Conservative leadership could certainly pay their stamp duty, for example, which would be helpful to the Exchequer.

John Pugh (Liberal Democrat, Southport)

Is it not the case already that MEPs claim from the European Union for travelling expenses and other things? We know that certain prominent Conservatives made ample use of that fund.

Jeremy Browne (Liberal Democrat, Taunton)

That is my understanding. I have been shocked by the loose attitude that some Conservative MEPs have adopted towards value for money for the taxes that I pay in good faith hoping to see improvements in public services. That point is directly relevant to clause 56, Mr. Atkinson, and I am more than willing to take interventions on it. If you are not keen to expand to that conversation, I will move on to my concluding remarks.

One can only observe that the Conservatives are keen to talk in broad-brush principles and are keen on symbolism, but are less keen on value for money when it comes to Conservative MEPs. Everybody who sees the formation and the practical workings of the European Union and its Parliament in pragmatic and non-paranoid—that may be an accurate way to describe it—terms can see merit in an administrative system of this type. It is important that politicians who serve constituencies in the United Kingdom pay levels of taxation commensurate with those of other UK residents. On that basis, I, like the Conservative party, am an enthusiast for clause 56.

Peter Bone (Conservative, Wellingborough)

It is a great pleasure to follow the hon. Member for Taunton and my hon. Friend the Member for Hammersmith and Fulham, who made such an excellent but unfortunately short speech. I owe the Government Whip an apology because I was very annoyed at the last sitting that we could not continue into the evening as he had choked off debate on the clause. I now understand why—he had obviously anticipated a longer debate on it than I had.

My hon. Friend the Member for Hammersmith and Fulham was right in putting the Conservative Front-Bench position and saying that we would not vote against the clause. However, my leader, my right hon. Friend the Member for Witney, has shown great leadership in saying that Back-Bench Conservative Members do not have to follow the Whip in Committee, so do not be surprised if there is a Division, Mr. Atkinson.

The clause gives rise to a number of interesting points but I will try to keep entirely to the clause. It has opened up a lot of new ideas that I was not aware of. The Government are right that double taxation should not be allowed and, if a country is taxing a British citizen, that tax should be allowed against British tax. Unfortunately, we are not talking about another country; it is that thing called the European Union, which is supposed to be a Union of nation states so, by that definition, it cannot have tax-raising powers. Before we debated this, I thought that that was the position. Now I understand that it may not be the case.

Mark Field (Conservative, Cities of London and Westminster)

Without wishing to put too many cats among the proverbial pigeons, does my hon. Friend agree that if the EU were a tax-raising institution, it might spend less money, which might be a good thing?

Peter Bone (Conservative, Wellingborough)

I quite agree. The problem we have is that the Government are rightly trying to solve a problem for British citizens, who should not be taxed in two places and should get relief against it. That is what clause 56 does, and I agree with it. However, should we be allowing that taxation in the first place when it is not another country but this organisation that is imposing a tax on British citizens? Should not the Government fight this tooth and nail and tell the MEPs not to pay the tax because it is an outrage?

I hope that the Minister will be able to deal with the following technical point. The taxation that will be charged will be through self-assessment at the end of the year. I assume that MEPs receive their money in euros each month. How will that be converted into sterling for taxation purposes? Will it be done on a monthly basis when the money is remitted or at the end of the year when the tax is decided? That could be a significantly different tax charge. As I understand the clause, it will mean a loss of money to the Exchequer. I stand to be corrected, but it appears that there is a European tax charge that will go into the European Union’s coffers which will then be set against the tax that the MEPs would have paid. That difference will be a loss to the UK Exchequer. How much will that loss be?

Jeremy Browne (Liberal Democrat, Taunton)

The hon. Gentleman raises a legitimate concern about currency fluctuations within the year and the effect on tax liability. Does he conclude that the Conservative policy of shadowing the deutschmark in the early 1990s would be wisely replicated by shadowing the euro now so that those difficulties could be avoided? That is not my view, but it seems to be the view of Conservative Back Benchers.

Peter Bone (Conservative, Wellingborough)

Mr. Atkinson, I am sorry that I accepted that intervention. It would be quite out of order for me to deal with it. I promised to stick to the clause and I will do my best to talk about this and the technical issues that come up.

There is an important point here that I had not understood before. In the past, MEPs were taxed on their salary as though they were British citizens. That made a lot of sense, and I understand it entirely because there was no Community tax involved. We now know that there was a Community tax, and I am not sure on whom this was charged. There is an issue. Were these officials or employees of the European Union? If they were, were they just being taxed as citizens of some European Union state and not being taxed here, or was there double taxation? That is a really important point. How much money was involved?

Greg Hands (Conservative, Hammersmith and Fulham)

I expect that the Government will answer that all of the people affected were not resident in the UK, but I suspect that the EIB has some kind of London representation. It would be interesting to hear from the Minister whether those people have been affected since 1968.

Peter Bone (Conservative, Wellingborough)

My hon. Friend makes a very important point to which I hope the Minister will respond.

I was just about to refer to clause 56(1)(c) which reads:

“Article 14, 15 or 17 (pensions for old-age, incapacity and survivors)”.

Can I move straight on from there to the Secretary of State for Business, Innovation and Skills, with responsibility for regulatory reform, enterprise and science, First Secretary and Lord President of the Council—and deputy Prime Minister—the noble Lord Mandelson? He was a commissioner. What was his tax position? Was he being taxed in this country or was he paying some sort of Community tax? Is it something new? Has there been a loss to the Exchequer or has the poor Lord Mandelson actually been paying tax twice? Will there be some sort of retrospective relief for commissioners? I assume that the commissioner is regarded as ordinarily resident in this country.

Lord Mandelson is a high-profile case, but there must be many other people who were caught in this position. It is important to know whether they were paying UK tax, both UK tax and EU tax, or only EU tax. People will want to know that information.

Clause 56 is right in principle, in that it saves British citizens from paying tax twice, but it has opened up a can of worms. Therefore, I hope that the Minister will be able either to answer now all the questions that have been raised or, if that is not possible, to write to the Committee with that information.

Kitty Ussher (Labour, Burnley)

May I start, Mr. Atkinson, by saying what an honour it is to serve under your chairmanship? I think that I am serving under you for the first time and I welcome you to the Chair.

It is a pleasure to debate with the hon. Member for Hammersmith and Fulham. I thank him for his kind words. Indeed, as he said, I recall that we had a lengthy debate during the deliberations on the Finance Bill last year. My memory is that it was about sovereign debt issuance and he gave an extremely interesting and, I am sure, historically correct account of various currency crises and sovereign debt issuances by various countries, including the UK. I also seem to remember that my contribution to that debate was principally to point out—rather continually—that although that account was very interesting, it was perhaps not entirely relevant to the specific point on the issuance of Islamic bonds that we were discussing at that time. I feel a strange sense of dĂ(c)jĂ vu now, one year on.

Greg Hands (Conservative, Hammersmith and Fulham)

With your forbearance, Mr. Atkinson, I want to point out that the Minister is right that that debate was about sukuk bond issuance, but the question was whether or not it was advisable for a sovereign issuer to be issuing structured notes, regardless of the structure. The debate was not actually about Islamic finance; it was about whether or not sovereign issuers should be going down that road.

I must say that now might be the opportunity for the Minister to apologise for misquoting me later that week to an audience in the City of London in a talk about Islamic finance, by claiming that Conservatives were opposed to Islamic finance, which is certainly not the case. So the debate today gives her an opportunity to apologise for misquoting me, which happened in the same week as the debate that she referred to.

Peter Atkinson (Conservative, Hexham)

Order. I think that honours are even in this respect.

Kitty Ussher (Labour, Burnley)

Thank you for your clarification, Mr. Atkinson. All I will say is that my sense of dĂ(c)jĂ vu has now increased.

I have enjoyed the debate today hugely; I always enjoy it when the Conservative party splits very openly in front of our eyes. I have also enjoyed the revelation by the hon. Member for Taunton, when he said that it was difficult to put himself in the mindset of someone who served in the European Parliament. I do not know whether we should draw anything from that comment about his relationship with his leader.

Graham Stuart (Conservative, Beverley and Holderness)

May I gently give the Minister a word of advice? It is possible that there is a difference of opinion within a party, but when it happens people should try to disagree without rancour.

Kitty Ussher (Labour, Burnley)

Opposition Members are obviously the best of friends. Moving on swiftly, I am of course grateful for the support of at least the Front-Bench spokespersons of both the main Opposition parties.

As today is the first time that I have served under your chairmanship, Mr. Atkinson, in an attempt to ingratiate myself with you I will attempt to keep my remarks specifically related to the clause. I remind the Committee that the clause simply does two things. Since the European Community is not a territory, as defined in double taxation law, we therefore need another piece of primary legislation to ensure that MEPs will not be subject to double taxation under the new regime. So, we are simply aligning the situation of MEPs with the existing provisions under double taxation law.

The other thing that the clause does is to ensure that the new transitional allowance, as it is called, which is now available to MEPs under the new system, has a basis in law, by linking it to the legal concept of a termination payment.

Peter Bone (Conservative, Wellingborough)

Is that a unique situation, or are there other organisations that are not territories that deduct taxation?

Kitty Ussher (Labour, Burnley)

I think that it is unique. If my view on that changes, I will let the hon. Gentleman know.

Greg Hands (Conservative, Hammersmith and Fulham)

Can the Minister explain to us, therefore, why the situation is unique? My understanding is that the United Nations or the World Bank will pay their staff whether or not the Minister believes that they level a tax. If that is not the case, why not? Why is it only the EU that decides that it wants to have those tax-raising powers?

Kitty Ussher (Labour, Burnley)

Perhaps I can add that to the list of eight questions that the hon. Gentleman has put and that I shall attempt to answer.

Moving on to the specific points, I am delighted by the summary of the eight questions, although perhaps we could have cut to the chase and gone straight to them. I am slightly concerned because I think that I have more than eight answers, but I will do the best I can.

One of the first questions that the hon. Gentleman seemed to ask was whether this was a secret plan and why we were talking about this after the European elections of a fortnight ago. I am delighted exclusively to reveal that our policy was communicated to MEPs in a letter from the Minister for Europe in July last year. We also wrote to MEPs of all parties in March this year. So there was no intent to reveal it only now.

Greg Hands (Conservative, Hammersmith and Fulham)

Will the Minister give way?

Kitty Ussher (Labour, Burnley)

I will, but I will not always give way if the hon. Gentleman seeks to intervene at this rate in future.

Greg Hands (Conservative, Hammersmith and Fulham)

I thank the Minister for giving way and apologise if I am intervening too often. Can she tell us when she told the House of the Government’s intention to do that?

Kitty Ussher (Labour, Burnley)

Well, it is in the Finance Bill, so it will have been in the First Reading of the Finance Bill.

Moving on, I am delighted that the hon. Gentleman has been looking at the EIB website with such diligence. I will write to him on the precise point about coefficients. The substantive point seems to be that, as a result of the double taxation, MEPs will now be subject to an effective tax rate of 27.95 per cent. If we did not introduce the clause in the Finance Bill, their effective tax rate would be 21.84 per cent. So they will be paying more tax at the same effective tax rates as their constituents as a result of the clause, which I think all Members of the Committee would agree with.

The EC tax that is applied to MEP’s pay is the same tax that EU officials have paid since 1968.

Peter Bone (Conservative, Wellingborough)

I must have misunderstood that point. She is saying that MEPs are paying extra tax. Are they getting a refund? She seemed to imply that. What I thought the Minister was saying was that the Community tax was higher than the basic income tax in this country. If that was the case, there would be a refund. Am I wrong in that?

Kitty Ussher (Labour, Burnley)

I hope to be able to come back to the net position of the UK Exchequer as a result of all the changes. What I think his question was getting at was that marginal rates, and the way in which they are tiered, are actually higher in the UK than the EC rates. Therefore, as a result of the double taxation treaty, they will pay more tax in total, although there is a sort of credit put in as part of that process.

How will the tax work if an official is employed by the EU, but, for example, works in London? We have heard members of the Committee mention, perhaps, the EIB staff in London and, of course, the European Commission has staff in London. EU officials working in this country will generally be liable for UK tax. Those working in Brussels will generally be liable for Community tax, but obviously each individual situation will be looked at individually.

Are there any cases in which someone working for the EU has been taxed twice? We are not aware of any such cases. The clause is required only because a specific statute has been introduced which provides for MEPs to be paid by the EU instead of by national Governments. That was not previously the case, so MEPs were not previously subject to Community tax.

There was a specific question about Community taxes being levied on transitional allowances. Those MPs who have recently stood down are entitled to resettlement grants under existing pay arrangements. Resettlement grants are subject only to UK tax; they are not subject to Community tax. There were a lot of questions about people who were not, perhaps, UK residents and what their situation was with respect to other member states. Not being a Minister for another member state Government, or indeed a tax administrator for the European Community, I am not able to provide specific answers. However, I will write to the hon. Member for Hammersmith and Fulham to answer the question whether MEPs need to pay tax to the Belgian or French authorities if they are resident there.

Greg Hands (Conservative, Hammersmith and Fulham)

Can I take the Minister back to the point that was mentioned a moment ago? Although the MEP whom I mentioned might be an exception at the moment—going to be a UK resident but a non-dom—there will possibly be more cases in future. I mentioned that 9 per cent. of my constituency were EU nationals. It is not impossible—I think that the fourth Conservative candidate on the London list is probably an EU national. Will the Minister clarify the position of UK-resident MEPs who are non-doms?

Kitty Ussher (Labour, Burnley)

I am coming to that point. An MEP who after the elections of a fortnight ago ceases to become an MEP will be eligible for the transitional allowance under the new regime that the European Parliament has now agreed.

I come now to the specific points about residents and non-residents, and domiciled and non-domiciled status. In summary, the rules regarding resident and domiciled status for MEPs are no different from those for any other category of person. We know of only one UK MEP who has ever claimed non-residence in the UK. That might be useful background information. It follows that an MEP representing a UK constituency would not then be fully liable for UK tax because they are non-tax resident. It is unlikely that the situation would arise because most UK MEPs obviously have ties, duties and work to undertake, which means that they will be here.

Mark Field (Conservative, Cities of London and Westminster)

What checks would the Treasury undertake to ensure that an individual was not trying to suggest they were not domiciled anywhere—in other words, that there was some domicile that they were admitting to and therefore had tax liability in some territory?

Kitty Ussher (Labour, Burnley)

We take great pains to ensure that the tax law is not abused and that there is no fraudulent activity, avoidance or evasion. MEPs would be no different from any other category of person in that regard.

A non-resident, non-domiciled MEP would not be fully liable to UK tax. However, if they were non-resident —as I said, there has been only one case so far—like all other non-residents they would be liable to UK tax on the portion on their employment duties carried out here. Broadly speaking, days spent working in the UK would be liable to UK tax, as is normally the situation for other people, but employment duties carried out abroad would not be liable to tax.

A resident but non-domiciled MEP using the remittance basis would also be liable to UK tax on those employment duties carried out in the UK and, in some circumstances, as is normal, also liable to UK tax on their duties carried out abroad. I do not want to imply that this is something we are routinely looking into because, as far as we are aware, there has been only one case.

I apologise to the Committee, as I need to clarify what I said previously about whether this is a unique situation. There are some similar circumstances, as hon. Members rightly said, relating to the UN and NATO. I will write to the Committee to explain the parallels.

The hon. Member for Wellingborough asked about exchange rates used for the purposes of self-assessment. If an MEP is paid in euros, the conversion to sterling is at the time of payment, which is normal for any person paid in a different currency. I do not want to confuse the Committee further, and I am mindful of the fact that we have spent a lot of time on this, but I mention for the record that MEPs have the option of being paid in sterling. I do not know whether Conservative MEPs will be taking up this option.

A theme running through some Back-Bench Conservative Members’ remarks was whether the EU should have tax-raising powers and whether this was the thin end of the wedge. I wish to reassure the Committee that this is an extremely limited tax, which applies exclusively to EU officials and MEPs. It does not imply any wider EU tax-raising powers, and indeed has no basis in law to do so.

Peter Bone (Conservative, Wellingborough)

I do not know whether that was a slip of the tongue in the Minister’s last sentence or so. She linked EU officials and MEPs, as though the clause applied to both. I thought that it applied only to MEPs. There are a couple of issues. How have the tax affairs of officials who are resident in the UK been treated? Have they been paying Community tax and British tax, or just Community tax? What was the loss of revenue to the UK Exchequer due to the double taxation relief mentioned in the clause?

Kitty Ussher (Labour, Burnley)

The clause applies only to MEPs. The tax applies to EU officials and MEPs. As I have tried to explain—I apologise if I was not clear—if there are such categories of people who are working in the UK, they will normally pay UK tax. However, I obviously cannot comment on every individual case.

Greg Hands (Conservative, Hammersmith and Fulham)

The question remains as to which part of the EU does the tax-raising and where that money goes. I understand that payments will be made by the European Parliament. Presumably the European Parliament is not a taxing authority, so where do the moneys go?

Kitty Ussher (Labour, Burnley)

I presume—I shall correct myself if this is not the case—that under European Community treaties there is a small provision to do that, precisely in the circumstances mentioned.

As I promised, I shall also write to the Committee with the net position of the Exchequer as a result of the changes introduced by the new MEPs’ agreed statute, and shall add into that the effect of the clause. I am sure that I have answered more than eight questions, and I therefore now commend the clause to the Committee.

Clause 57

Stephen Timms (Labour, East Ham)

I beg to move amendment 206, in clause 57, page 27, line 27, leave out subsection (2).

Peter Atkinson (Conservative, Hexham)

It might be convenient for the Committee to treat this as one debate on a technical matter, rather than to debate the amendment and then clause stand part.

Stephen Timms (Labour, East Ham)

I, too, welcome you back for this morning’s deliberations Mr. Atkinson.

After the giddy heights of political drama in our debate on clause 56, we reach a substantial set of clauses that aimed mainly at scams of various kinds designed to facilitate tax avoidance. I think that we will find some drama in these clauses as well, although not so much in clause 57.

The clause changes how the amount of double taxation relief available to UK companies is calculated. Subject to certain criteria, UK companies in receipt of dividends paid from abroad are entitled to relief for tax charged on the original profits out of which the dividends have been paid; that is relieved against the UK corporation tax due on receipt of those profits. The recent reduction in the corporation tax rate caused a mismatch in how the relief is calculated. The clause corrects that by ensuring that the amount of relief available to UK companies is calculated by reference to the actual rate of corporation tax suffered on their UK profits.

An HMRC review of the clause found that subsection (2), which restricts the change to corporation tax cases, simply restates a restriction already contained in the Finance Act 2000, which first introduced the relevant legislation. The amendment removes the unnecessary duplication, which would otherwise have created some uncertainty and could have given rise to tax avoidance opportunities. I hope that the Committee is satisfied with the amendment.

The problem addressed by the clause was recognised last year, on Third Reading of the 2008 Finance Bill. My predecessor as Financial Secretary committed to rectifying the problem, after consulting with interested parties. HMRC has discussed the draft clause with business representatives, and the simple solution provided by the clause ensures that credit is given in line with my predecessor’s commitment.

The clause is retrospective and applies from 1 April 2008. The retrospective action is such that it can only apply to the benefit of companies by increasing the amount of foreign tax credit available. The clause is likely to have limited application after 1 July this year, because of the introduction of legislation that exempts from UK tax almost all foreign dividends, which we have already debated.

Greg Hands (Conservative, Hammersmith and Fulham)

We agree with the Government’s amendment. I will talk mainly about the general issues that arise from the clause.

The clause is a result of the changes enacted in the Finance Act 2008 that changed the corporation tax rate in the middle of a company’s accounting year, and the unforeseen consequences of that. As the Financial Secretary has said, the clause deals with foreign source dividends, which are subject to corporation tax at the effective rate applicable for the accounting period in which they were received. Companies with accounting periods straddling 1 April 2008 have an effective corporation tax rate between 30 and 28 per cent.—29.5 per cent., for example—depending on how much of the tax year is in the relevant accounting year. However, the double tax relief mixer cap formula, which limits the amount of credit relief available for foreign dividends, operates by reference to the statutory rate of corporation tax in force on the payment date—either 30 or 28 per cent. in that particular tax year, but not a combination of the two. That potentially results in an unintended restriction on the amount of double tax relief that might be available.

HMRC first acknowledged that mismatch in September 2007 and confirmed in July 2008 that the rules would be amended with retrospective effect from 1 April 2008, as introduced in the Bill. The impact of the discrepancy is to be eliminated by calculating the mixer cap by reference to the blended effective rate for the period. My understanding is that the formula used would be: (actual number of days in period 1 divided by 365, multiplied by the corporation tax rate effective in period 1) plus (actual number of days in period two divided by 365 multiplied by the corporate tax rate effective in period 2).

Foreign dividends are chargeable to UK corporation tax and in calculating the relevant income one has to show the dividend gross of all taxes suffered. Dividends received may have also suffered withholding tax. Withholding tax is always recoverable, subject to the limits for credit relief. However, in addition, as dividends are paid out of post-tax profits, the dividend will also have suffered what is called underlying tax. A credit for underlying tax can be claimed only when a company holds, directly or indirectly, 10 per cent. of the voting power of the company paying the dividend, or is a subsidiary of such a company.

The underlying tax, which is referred to as U in the legislation, is initially calculated by using the following formula: (dividend paid divided by relevant profits) multiplied by actual tax paid. The relevant profits are the profits of any period shown as available for distribution in the company accounts; they are not taxable profits. The underlying tax available for relief is found by using the formula: (D + U) x M, where D is the dividend—the amount received plus withholding tax; U is the underlying tax; and M is the relevant rate of UK corporation tax at that time, which is 28 per cent. The (D + U) x 28 per cent. formula is referred to as the mixer cap.

The clause has been welcomed by tax commentators, but I have one immediate question and one that is more fundamental. First, it is not entirely clear to me why subsection (5) is to take effect immediately, while all the other subsections are backdated to 1 April 2008. I thought the whole provision was supposed to be backdated to 1 April 2008. Perhaps I am just misreading the clause.

There is another important and technical question. The clause and everything that the Minister and I have mentioned so far refers to dividends, by which I assume that we mean dividends on all financial instruments, not just equities. If it were to refer to coupons or the interest rate payable on bonds or other fixed income instruments, an important consideration may arise on the precise day count used in those fixed rate instruments. For example, in this country the day count convention used is actual over 365 fixed, whereas in Japan it is actual over 365, and most eurobonds are denominated on a 30 over 360 basis.

When calculating the relevant corporation tax using the blended rate, what consideration will need to be given to the accounting method of the coupon—or, in this case, what the clause calls a dividend but is effectively a fixed income coupon—and the different day count conventions that may be involved in those coupons? What effect might that have on the blended mixer cap rate? As I said, we broadly welcome the clause and I await the Minister’s response to those two questions.

John Pugh (Liberal Democrat, Southport)

I rise to agree with the Minister that we have come to an important and surprisingly interesting set of clauses. A bit like the dull books of the Bible, such as Leviticus, which contain all the things that Hebrews got up to, some of the clauses reveal the dodges and scams that companies get up to.

I seek clarification on a simple point. I understand that the clause is about the interaction of something called the mixer cap—a terms I had only associated with bathroom showers—and corporation tax. Essentially it deals with the unintended consequences of lowering corporation tax in 2008. The clause is meant to have retrospective effect. The explanatory notes make it clear that a concerted effort has been made to limit any potential disadvantages, and I thought I heard the Minister say that the effect of the clause was wholly to the benefit of companies—that nobody is disadvantaged by the original change in corporation tax. Can the right hon. Gentleman confirm that? If he cannot, can he tell us who was disadvantaged and who is still disadvantaged?

Stephen Timms (Labour, East Ham)

I welcome the support that has been expressed for the clause and the fact that it has commended itself to the Committee. The change to the rate of corporation tax took effect from 1 April 2008, so it is right that the change takes effect from that date as well. The hon. Member for Hammersmith and Fulham asked me why subsection (5) is not retrospective. In very rare situations subsection (5) can have a negative impact on business and that is why we are not applying it retrospectively. Nevertheless, I can confirm for the hon. Member for Southport my previous comments about the overall benefit for business from the change that we are making.

The circumstances where there could be an increased burden for companies are rare. There could be an increased burden for some companies, but only where dividends paid between foreign companies were paid before the change in the corporation tax rate. The subsequent case 5 dividend is paid after 5 April 2009 and is not exempt. Given the introduction of the dividend exemption with effect from 1 July 2009, that would occur only in very rare situations. Indeed, that aspect of the legislation is not retrospective so as to ensure that there is not an unfair negative retrospective impact on business.

John Pugh (Liberal Democrat, Southport)

I understand the Minister’s point that the provision is entirely for the benefit of business and will in no way disadvantage business. My question is simply this: as a result of the decision to alter corporation tax in 2008 and the difficulty that has occurred with the mixer cap, is it now the case that no one has lost out at all?

Stephen Timms (Labour, East Ham)

Yes, it is. There will, no doubt, need to be some adjustments in the light of the clause, but I can give the hon. Gentleman that reassurance.

The hon. Member for Hammersmith and Fulham asked about some detailed aspects of the profit calculations. There are two steps involved: calculation of profit and taxation of profit. The blended rate applies to all profits, however calculated, and there is no need to consider the precise details of the calculation when considering the relevant tax rate.

Greg Hands (Conservative, Hammersmith and Fulham)

To press the Financial Secretary a little on that point, can he be absolutely clear that the clause also relates to bond coupons and payments on fixed income instruments? It is surely the case that, if the accounting basis of the bond and the day count convention is different, calculating the mixed rate, where one looks at the actual number of days over 365, times each of the relevant corporation tax rates, will in turn depend on whether the coupon rate, for example, has changed during that time. If there is a step-up bond, and if the coupon rate has changed during that time, surely the corporation tax calculation would have to be aligned in accordance with the way in which the bond is paid.

Stephen Timms (Labour, East Ham)

The clause is about correcting an unintended hit to double taxation relief and it is effective, whichever way the profit is achieved. The clause is not specific to one particular form of profit.

Clause 58

Greg Hands (Conservative, Hammersmith and Fulham)

Clauses 58 to 64 relate to anti-avoidance and we broadly support them. Since the Finance Act 2008, various attempts have been made to eliminate so-called MODs, which are manufactured overseas dividends, not the 1960s bikers seen in films such as “Quadrophenia”. Clause 58 and schedule 29 refer to repurchase agreements, or repos. The essence of the clause is that tax credit is being given for deemed payments on repos, rather than for actual payments, and the clause seeks to ensure that tax credit is only given for actual payments.

I might be the only member of the Committee who has ever carried out a repo, or repurchase transaction, so, seeing as that is the subject of schedule 29, it may be helpful if I explain what it is. An explanation will not necessarily help, however, because even though I might have an advantage in understanding the sorts of financial instrument behind clause 58 and schedule 29, that knowledge does not give much assistance in understanding the technical nature of the clause and schedule.

A repo allows a borrower to use a financial security—an equity, a bond or pretty much any financial instrument—as collateral for a cash loan at a fixed rate of interest. In a repo, the borrower agrees to sell immediately a security to a lender and also agrees to buy back the same security from the lender at a fixed rate at some later date. A repo is therefore equivalent to a cash transaction combined with a forward contract; it is a little bit like a foreign exchange, or forex, swap, where the price of the trade-back is a function of the relevant interest rate for that period. The cash transaction results in a transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is the interest on the loan, while the settlement date of the forward contract is the maturity date of the loan.

A repo is therefore economically similar to a secured loan, with the buyer receiving securities, or a security, as collateral to protect against default. There is little that prevents any security from being employed in a repo: for example, probably one of the most frequently repo’d instruments would be a gilt, or a US treasury bond. Corporate bonds can be repo’d, as well as stocks and shares. The relevance to clause 58 is this: coupons or dividends, which are paid while the repo buyer owns the securities, are, in fact, usually passed directly onto the repo seller. It might seem counter-intuitive that the ownership of the collateral technically rests with the buyer during the repo agreement; however, that is where—I am guessing from the clause—that the problems arise in relation to the avoidance of tax, or more specifically, the creation of a manufactured overseas dividend.

As I understand it, HMRC has become aware of complicated schemes involving intra-group sale and repurchase agreements undertaken by bank groups—that is, within two parts of the same banking family—which are intended to produce a perceived tax advantage. As a result of the structure of the transaction and the prescriptive nature of the UK rules relating to manufactured overseas dividends, one party to the transaction is deemed for UK tax purposes to receive a MOD. In addition, that deemed MOD is treated as having been subject to deduction of foreign withholding tax and the recipient of the MOD is entitled to relief for that foreign tax. However, since the receipt is deemed an MOD rather than an actual payment, there is no actual deduction of foreign tax from any amount actually received by the recipient. Therefore, as I understand it, HMRC’s view—I would be grateful if the Minister confirmed this explanation—is that the recipient does not actually bear the economic cost of the foreign tax, despite the fact that it is entitled to relief for that tax.

That is the technical explanation I have been given, but it seems to me that certain foreign securities have been repo’d solely or mainly for the purpose of creating a credit or a debit against foreign tax paid or received, typically within the same banking group. The purpose of the clause, as I understand it, is to prevent that practice.

I am also puzzled by the fact that the clause, according to the explanatory notes, relates to repos that would normally relate in terms to fixed income instruments, or bonds. My understanding is that most of the MODs are actually created from equities, so I would be grateful for more explanation of what sort of underlying repo transaction we are considering that has been used in the pursuit of avoiding UK tax.

It would also seem sensible, if we are looking at repo agreements, to examine their stablemate, the buy-sell agreement, or the buy-sellback agreement. Those differ slightly from repos in that, with the sell-buyback agreement, any coupon payment on the underlying security during the life of the sell-buyback agreement will generally be passed back to the seller of the security by adjusting the cash paid at the termination of the sell-buyback agreement. In a repo, the coupon will be passed on immediately to the seller of the security. My guess, therefore—and I would be grateful in the Minister could confirm it—is that it is not possible to manufacture an overseas dividend, or an MOD, using a sell-buyback transaction. It would be important to have that confirmed by the Minister; otherwise we might have to reconsider all of this again if people stop using repos and start to use sell-buyback agreements instead.

The Bill counters that type of transaction by preventing relief for foreign tax, either by credit or deduction, when the recipient of a manufactured overseas dividend does not bear the economic cost of the foreign tax. In other words, relief for overseas tax in excess of the amount borne cannot be claimed. The legislation, as I read it, takes effect for dividends paid on or after 22 April 2009. We will have no problem supporting the clause if the Minister is able to confirm that my understanding of the situation is correct, that the clause covers equities as well as fixed income, and that sell-buybacks and buy-sellbacks are accounted for on the same basis and we do not need to be troubled by whether they might be used for the manufacture of overseas dividends in the future.

John Pugh (Liberal Democrat, Southport)

I thank the hon. Gentleman for that useful lesson. I shall now test my understanding of this fairly complex schedule and clause.

As I understand it, it is intended that manufactured overseas dividends will qualify for exemptions from double taxation, as real dividends do. Manufactured overseas dividends are characteristics, as the hon. Gentleman has said, of repo deals. I believe that the scam to be targeted involves one might call an illusory repo deal between two companies in the same group—phantom dividends, an allowance for foreign tax liability but no actual foreign tax liability. If I am correct that that is what the Minister wishes to target, my only question is: how prevalent is the scam and what are the savings to the Exchequer in closing that loophole?

Stephen Timms (Labour, East Ham)

I am grateful to both the Opposition spokesmen for their support.

The clause and schedule 29 counter a complex tax avoidance scheme whereby the recipient of a manufactured overseas dividend claims relief for overseas tax that he has not paid, as the hon. Member for Southport described. The description of what is going on given by the hon. Member for Hammersmith and Fulham is broadly correct. The manufactured payments arise under repo or stock-lending transactions. They are payments that are representative of interest or dividends paid on securities such as gilts or shares, and are intended to compensate the transferor of the securities for not receiving the real interest or dividends.

Nearly all manufactured payments are made by companies under routine transactions involving banks, securities houses and insurance companies. Earlier this year, we became aware of a complex tax-driven scheme involving the sale and repurchase of a foreign shareholding between two group companies. Part of the repo agreement involves what is, in substance, an obligation to pay a manufactured overseas dividend, which does not bear any overseas tax and is equal in amount to the gross overseas dividend. Despite that, the recipient claims relief as if overseas tax had been deducted. That is the heart of the scam.

The hon. Member for Southport asked about the potential losses from the scheme. Our assessment is that more than £150 million per year would be at risk if the measure was not put in place. Tax avoidance is unfair to the majority of taxpayers. It can undermine the funding of public services, and we are determined to take appropriate and prompt action to counter it. The set of clauses before us contain a number of instances of such action being taken.

The hon. Member for Hammersmith and Fulham asked about the extent to which the measure is applicable in slightly wider circumstances. Other non-avoidance legislation deals with transactions other than repos, but repos cover sale and buyback transactions, and the legislation will apply to those. Only dividend repo transactions are affected by the avoidance legislation in the clause and schedule, because only dividends can give rise to double taxation relief. I therefore commend the clause and the schedule to the Committee.

Clause 59

Stephen Timms (Labour, East Ham)

The clause contains a provision to counter an avoidance scheme that abuses the double taxation relief rules. The provision will not bring in substantive additional corporation tax, but it is estimated that it will prevent losses to the Exchequer that would be up to £100 million a year if the abuse continued unchecked. The double taxation relief rules are designed to give relief in the UK for foreign tax paid on the same income or profits charged to UK tax. If any of that foreign tax is reduced, UK tax should be reduced by the same amount.

HMRC has become aware that in some circumstances it is possible for a UK parent company to obtain a payment by reference to the foreign tax paid by a subsidiary company. The payment is made when the subsidiary pays a dividend, so the parent company receives the profits with little or no foreign tax suffered. That has been exploited by groups in an avoidance scheme that seeks to obtain relief for foreign tax where the group has not borne the economic cost of that tax.

It is a long-standing principle that if foreign tax is repaid, credit for foreign tax should be reduced by the amount of the repayment. The clause ensures that the same reduction in credit occurs if the payment, by reference to the foreign tax, is made not only to the company that originally paid the tax, but to a different person connected with that company. Typically, that will be the parent company. However, it has been brought to our attention following the publication of the Bill that the clause may affect the operation of commercial cross-border loan arrangements arising from the London loan market.

The Government amendments would have provided that the clause applied only to payments made under the laws of a territory outside the UK. Opposition amendment 217 addresses the same point differently and perfectly appropriately, although not, technically, in the correct way. The Government amendments reflected agreement that HMRC reached with industry legal advisers and had the advantage of following existing legal precedent that applies for the purposes of controlled foreign company legislation. The Government amendments would have covered the overwhelming majority of cases where refund of foreign tax might arise from commercial contracts. However, since formulating the Government amendments, we have received further representations—I am grateful to the Chartered Institute of Taxation for those—which show that there may remain situations where the amendments do not go far enough to ensure that the clause does not hit any unintended targets. Although these are unusual circumstances, it is right that we should take account of them.

The Opposition amendment would restrict the operation of the clause across a wider range of circumstances than the Government amendments because it limits the clause to those cases where the repayment is made by the foreign tax authority only. By contrast, the Government amendments would have left the clause in operation whenever the repayment arose out of the application of foreign law. In view of the further representations that we have received, I accept that the Government amendments would not have gone far enough in restricting the scope of the clause. Therefore, I have not moved the Government amendments. I will reconsider the position and return to the matter with further Government amendments on Report.

The Opposition amendment is broader in scope but has some technical difficulties. The reference to a taxing authority would be novel in tax law and its effect is not altogether clear. Although I am grateful to hon. Members for tabling it, there needs to be further reflection in order to get this right on Report.

Greg Hands (Conservative, Hammersmith and Fulham)

I reiterate that we broadly support clause 59. As the Minister said, it targets a specific avoidance scheme. In essence, as I understand it, this relates to where the UK gives credit for tax paid elsewhere but where separate relief has already been granted to a connected party. The Minister used the term “group” and I would be interested to hear from him what sort of groups he means. Would they typically be financial institutions, as with the last clause, or would another type of corporate structure be involved in this sort of scheme?

Currently, a UK company which has claimed double tax relief in respect of foreign tax paid must notify HMRC and amend its claim if there is a subsequent change in the amount of foreign tax, for example, as a result of a repayment. However, if the tax is repaid to a person other than the claimant, it is arguable that there is no obligation to amend the double tax relief claim. This can arise, for example, because in some foreign territories when a resident company pays a dividend, a refund of tax paid by that company is made to the recipient of the dividend rather than to the company. Clause 59 ensures that a double tax relief claim will have to be withdrawn or amended where there is a repayment of a foreign tax to a person other than the company that made the claim—that is, to a connected party, as the Minister described another party within that same group. Relief will then be given only for the net amount of foreign tax paid, less the payment to the connected person. As we know, the clause is effective for payments made on or after Budget day, 22 April 2009. We very much agree with that point.

I am going to explain our amendment and consider where we would go from here in relation to the three amendments. In our view—and I think the Minister is saying the same thing—the clause does not specify that the payment must come from a taxation authority. There are situations between private companies where one company may pay another in respect of foreign tax. For example, on the simple sale of a company, the selling company will normally indemnify the purchaser against any outstanding tax liabilities, which would include foreign tax. Under the current drafting of subsection (2) —the proposed new section 804G of the Income and Corporation Taxes Act 1988—the person making the payment is not specified. Therefore, in our view it has great potential to catch unintended matters that are entirely commercial and at which the legislation is not aimed.

The Minister said that our amendment does not deal with these matters in technically the same way. I am slightly at a loss. I think he is probably right and I am going to take his word for it in this circumstance. I am slightly disturbed that we are now going to have to come back to this on Report. We have had two Government amendments, two attempts to get this right, since the Finance Bill was published. I must minute our disappointment that we are going to have to bring back this measure on Report, even after today’s reasonably full debate. However, we will not oppose either the clause or the Government’s intention to return to it.

Clause 60

Greg Hands (Conservative, Hammersmith and Fulham)

I beg to move amendment 218, in clause 60, page 29, line 34, after ‘costs’, insert ‘, and

‘(c) the taxpayer has entered into a scheme or arrangement a main purpose of which is to secure that the included funding costs are less than the national funding costs’.’.

Peter Atkinson (Conservative, Hexham)

With this it will be convenient to discuss Government amendments 209 to 212.

Greg Hands (Conservative, Hammersmith and Fulham)

The clause deals with anti-fragmentation, a term I had not heard of until I started working on the Bill. However, I have been trying to get my head around the term and I will give it the best that I can.

The clause is another anti-avoidance measure that has our support. In essence, it is about banks, and in particular how they might find ways to book income and expenses in different accounting units to avoid tax. Following the decision in a 2005 court case, Legal and General Assurance Ltd v.Thomas, in front of the special commissioners, the Finance Act 2005 introduced legislation restricting the availability of double taxation relief for foreign taxes paid on schedule D case 1 income, which now of course are treated just as “trading income” under the Corporation Tax Act 2009, or income computed on a similar basis for UK tax purposes. The rules aim to ensure that the double taxation relief claimed cannot exceed the equivalent corporation tax on the net profits attributable to that source of income, after deducting an appropriate allocation of expenses, and are often referred to as a “mini-D1 computation”.

HMRC believes that certain banks have sought to avoid the impact of this legislation, either by routing loans through subsidiaries, which are taxed differently, or by financing in such a way that funding costs are not directly attributable to the income and therefore are not deducted in calculating the double taxation relief restriction. Although HMRC considers that the existing legislation should already have the desired effect, clause 60 is intended to put the matter beyond doubt.

The current rules provide that, where income that would otherwise have formed part of the trade receipts of a bank but instead is received by an affiliate that is differently taxed and can claim double tax relief without the restrictions affecting the bank, the income is treated as trade income of the subsidiary. With effect from Budget day, the new measures will extend the existing wording, with the intention that its scope mirrors HMRC’s interpretation of the current rules. Furthermore, when allocating bank funding costs in calculating the relief due, this must now be done on the basis of a proportion of average funding costs, even when specific funds are used to finance an investment.

My understanding is that, if one has a pool of investments and a pool of different vehicles funding those investments, one would have to allocate things on a proportion of the average funding cost for the whole portfolio rather than specific funds underlying a specific asset and how that asset in particular has been funded. That is my understanding of the situation; I would be grateful if the Minister could confirm whether that is correct. These changes have effect from 22 April 2009.

Amendment 218 was suggested to me by the Law Society, which believes that both sets of amendments, as they are aimed at artificial manipulation of double tax relief, should be subject to a tax avoidance motive test. The basic rules, as they stand, already contain provisions relating to the allocation of expenses and these rules should apply over and above those rules only in exceptional cases where there has been deliberate manipulation for tax reasons.

That is what our amendment seeks to do. My understanding is that the language used is entirely normal for these tax avoidance motive tests and I would be grateful for the Minister’s view on whether he will accept the amendment and on the importance of attaching motive to tax avoidance in this case.

John Pugh (Liberal Democrat, Southport)

I rise to test my understanding of the term “anti-fragmentation” in the clause. It seems to me that the term restricts the banks in two ways. First, it restricts them in how they proportion the cost of overseas transactions under the Finance Act 2005. Secondly, it curtails their ability to dodge that regime by arranging income to be received by a non-banking company under their control. The explanatory notes say that clause 60

“will clarify the existing legislation that prevents banks avoiding the intention of the DTR legislation by artificially arranging for income to be received by a non-banking company”.

That rather creates the perception of the banks as a slightly slippery customer, if one considers what might be behind it. It certainly makes the case for HMRC vigilance and Treasury intelligence. It also endorses the strong public suspicion over banking behaviour in general. Can I tempt the Minister to indicate which bank’s behaviour is being targeted and how many banks are in receipt of taxpayer funds?

Stephen Timms (Labour, East Ham)

Again, I welcome the support of both Opposition spokesmen for the clause. It contains further clarification of the double taxation relief rules to prevent the abuse of those rules by banks through tax avoidance schemes. This is the last of the four clauses that deal with double taxation relief. The double taxation relief rules are designed to give relief in the UK for foreign tax paid on foreign profits and to ensure that UK tax paid on profits earned in the UK is not reduced by foreign tax. Some companies, banks in particular, devised sophisticated schemes to abuse those rules by using foreign tax to reduce the UK tax payable on profits.

The hon. Member for Southport has drawn attention to the general public view of behaviour of that kind. There has been some press coverage of it in recent months, which the banks are sensitive to. I am not able to name names in this debate, as he knows, but the Chancellor has announced that we will publish for consultation a code of conduct for banks in this area in the hope of changing some of the practices that have grown up over the years.

Greg Hands (Conservative, Hammersmith and Fulham)

Will the code of conduct apply just to partly or fully state-owned banks or to all banks? When will it be published?

Stephen Timms (Labour, East Ham)

The code of conduct will be published shortly. The intention is that all banks will sign up to it. It will be a voluntary code, but I am pleased to say that broad support has been indicated across all banks.

Some banks have attempted to avoid the intention of the double taxation relief legislation by separating foreign receipts from the expenses of earning them to maximise their double taxation relief claims, hence the fragmentation. One method has been to divert what is in substance trade income into investment subsidiaries that are not subject to the same requirements. Another is to purport to fund avoidance schemes involving receipt of foreign income with money that does not have an associated funding cost, such as customers’ deposits in non-interest bearing current accounts.

The clause will amend rules introduced in the Finance Act 2005, as hon. Members have said. That legislation is working well, but the clause will clarify its intention by putting two matters beyond doubt. First, where there is an avoidance scheme, the assumption is that any income received by a member of a banking group is trade income, unless that assumption is not reasonable. Secondly, a bank’s funding costs should always be taken into account when calculating the double taxation relief due.

The clause will apply to avoidance schemes, and I believe only to avoidance schemes. Its effect in all cases will be to ensure that a fair amount of tax credit is given. There are no circumstances in which double taxation relief should be given without regard to bank funding costs, so a restriction to avoidance schemes or arrangements is not necessary. My concern about amendment 218 is that, since the aim of the clause is to put the matter wholly beyond doubt, the additional requirement that it applies only in cases of avoidance would be an unnecessary obstacle to its proper implementation.

Greg Hands (Conservative, Hammersmith and Fulham)

I expect that the Minister knows more about motive clauses than I do. Given the fact that there are a lot of motive clauses on anti-avoidance measures, what kind of parameters have the Government used? I think that he is saying that it would be too burdensome or difficult to have the motive clause in the case under discussion. Is there a particular point at which the motive clause makes sense and another point at which it becomes too administratively difficult?

Stephen Timms (Labour, East Ham)

The hon. Gentleman is right that those tests are appropriate in a range of circumstances, but they are not appropriate in the case under discussion because the purpose of the clause is to make things absolutely clear. To apply a test in this case would add uncertainty, which the clause exists to remove. To add an avoidance purpose test risks undermining the clause’s aim of ensuring that the point is unarguable.

Mark Field (Conservative, Cities of London and Westminster)

The Minister, in the course of our discussions on this and previous clauses on double taxation and avoidance, has referred to avoidance as undesirable, and he has also referred to the abuse of rules. We are trying to clarify the Treasury’s position. One of our concerns, both moral and ethical, is also a concern that we hear loud and clear from outside interest groups, and it does not relate to a lack of certainty. I appreciate that our amendment adds an element of uncertainty by discussing the main purpose, but the issue is surely that some emphasis should be placed on intentions, as well as outcomes.

The Government’s strong view on the undesirability of any sort of tax avoidance, which has manifested itself in some of the retrospective and retroactive legislation of recent years, effectively centres just on outcomes, rather than on intentions. Is it the case that the Treasury, not only in relation to clauses such as this but also more generally, wants to remove motive-type clauses in order to produce total certainty? If that is the case, no attention whatever is being paid to the intention of the main purpose; it is being paid, rather, towards the outcome of the avoidance of tax, which is wholly undesirable from the Government’s perspective.

Stephen Timms (Labour, East Ham)

I do not think that that is an accurate description of what has happened. For example, we have had a debate about principles-based legislation in relation to the Bill, and a very clear statement has been included in it about the intended principles. We had a debate about whether uncertainty was being created by that, so I do not think that the general direction described by the hon. Gentleman is right. However, in the case under discussion, the clause will apply to avoidance schemes only. There may well need to be a motive test in a case in which there might be a risk of inappropriate application, but there is no such risk in this particular case. It is a fair result in all cases, so there is no need for the test to be added.

Greg Hands (Conservative, Hammersmith and Fulham)

I think I understand what the Minister is saying, but there seem to be two ways of looking at the issue. Option A is that such practice never happens unless it is done through deliberate anti-avoidance, and option B is that, if such practice does happen, the party involved may have innocently carried out the transaction, but such transactions should be forbidden to prevent similar avoidance schemes. The clause seems to conform to option A, which states that such transactions never happen unless they are wilful and deliberate avoidance.

Stephen Timms (Labour, East Ham)

Double taxation relief for a bank should always take account of the bank’s cost of funding. The clause does no more than ensure that that is the case. If the qualification was added, it would give tax avoiders an excuse for arguing that the legislation should not apply and, for as long as they carried on arguing the point, they would not be paying their tax. I therefore hope that the hon. Gentleman will withdraw the amendment.

The Government amendments avert a risk of an excessive reduction in tax credit. The clause requires a bank or a company associated with a bank to use the average costs that the bank would incur to fund a transaction, known as its notional funding costs, for the purposes of its DTR claim, rather than the funding costs actually used in its calculations, where the notional funding costs are significantly higher. Normally, banks fund all their transactions from a single undifferentiated pool of assets, but in very limited circumstances a company associated with a bank may fund a particular transaction with a loan taken out for that specific purpose and thus have legitimate direct funding costs.

The amendments ensure that all funding costs, whether direct or indirect, will be taken into account in the DTR calculation, so relief will not be restricted where companies associated with banks have incurred legitimate direct funding costs. I hope that the Committee will feel able to accept the Government amendments and the clause.

Greg Hands (Conservative, Hammersmith and Fulham)

I beg to ask leave to withdraw the amendment.

Clause 61

Greg Hands (Conservative, Hammersmith and Fulham)

My contributions so far to this year’s Finance Bill seem to be in inverse proportion to the length of the material in front of us. Schedule 30 is extremely lengthy—six pages from page 258 to 264. As they continue the anti-avoidance theme of the clauses that we discussed earlier, I do not intend to speak at length on it.

Bob Blizzard (Labour, Waveney)

On a point of order, Mr. Atkinson. I thought that we were discussing clause 61.

Peter Atkinson (Conservative, Hexham)

We are discussing clause 61, which introduces schedule 30. It would be perhaps more convenient for the Committee to discuss them together, given that clause 61 is simply a one-line clause introducing schedule 30. The Chair is content with that.

Greg Hands (Conservative, Hammersmith and Fulham)

Thank you, Mr. Atkinson. It would certainly be more convenient, but I must commend the Government Whip for being on the ball. I was lost in schedule 30 before I realised that we were officially debating clause 61.

The schedule proposes, in some detail, various new measures to stop specific tax avoidance schemes and practices, which seem to arise from the tax avoidance disclosure regime of recent years. It is a bit of a motley schedule—paragraphs 2 to 5 could make some sense together, but paragraph 1 appears to be something rather different, at least in my interpretation.

Paragraph 1 relates to various structures akin to the previously favoured film partnership structures, which were tackled, I think, in the Finance Act 2006. Interest paid on qualifying loans, such as loans taken out to buy into a partnership or shares in a close company, is deductible. It was announced on 19 March 2009 that legislation would be introduced in the 2009 Finance Bill to deny individuals relief for loan interest on investments in partnerships or close companies, where the interest is paid as part of an arrangement and the deductibility of the interest means that the investor is guaranteed to make a profit. In other words, it is a no-lose investment scheme. Draft legislation was released on 19 March and will be retrospective to that date.

It is understood that that anti-avoidance measure is principally aimed at several arrangements that were being offered to partners in old sale and leaseback film partnerships—people who had previously gone down that road of tax avoidance. They purported to produce an interest deduction for borrowings to participate in the new arrangement, which could then be used to offset the reverse in film sale and leaseback income. There were other arrangements whereby a significant loss, funded by debt rather than personal investment, would be generated in the first year that an individual joined a partnership and would then give a “guaranteed” return of funds over the life of the partnership. Put another way, some companies had been getting full tax relief for making only a partial investment. As I understand it, the legislation is not intended to affect genuine commercial investments in businesses where there is uncertainty as to the return that will be produced from the arrangements.

Paragraphs 2 and 3 relate to amounts not fully recognised for accounting purposes. Their provisions block certain tax avoidance schemes that involve derivatives. Under a certain scheme and its variants, a company would derecognise in its accounts a derivative that is carried at fair value, with the result that profits arising to the company on that derivative fall out of the account for tax purposes. Where a derivative contract of a company is matched with shares, securities or fixed income instruments issues by it, it might be permissible under generally accepted accounting principles for the contract or amounts arising in respect of the contract not to be recognised in determining the company’s accounting profits or losses for the period. The new legislation requires the profits and losses on the derivative to be fully brought into account for tax purposes, even if they are recognised separately or not at all in the account.

Paragraph 4 relates to amounts not fully recognised for accounting purposes. That is another scheme that involves an intra-group convertible loan that is highly likely to convert into shares of the issuing company. The debtor company accrues and obtains a tax deduction for more than the corresponding taxable amount in the creditor company. The new legislation will input additional taxable credits into the creditor company to make the tax treatment symmetrical.

Paragraph 5 deals with credits and debits for manufactured interest. Again, as announced on 27 January by the Financial Secretary, the paragraph is being introduced to ensure that the tax treatment of manufactured interest payments is consistent with the treatment of such payments in company accounts prepared in accordance with UK GAAP. The announcement followed a decision in the High Court—DCC Holdings (UK) Ltd v. HMRC—relating to the treatment of deemed manufactured payments. It was felt that that decision could result in payers of real manufactured interest obtaining excessive deductions and recipients being taxed on amounts greater than those they actually received.

The legislation will apply to real manufactured interest payments made both before and after 27 January and to manufactured interest payments deemed to be made on or after 27 January. HMRC has indicated that the legislation is not intended to apply to the type of deemed manufactured payments that were the subject of the High Court case. I would be grateful if the Minister would confirm that that is correct.

We look forward to the Minister’s explanation for those proposals, to check that we understand schedule 30 correctly. There is, however, one area on which we would especially like to question the Minister: the retrospective nature of the provision in paragraph 5 following the DCC Holdings case. As I understand it, there was a widely held, but not universal, view on how the legislation should apply, but that did not accord with the Court’s decision on the case. The Chartered Institute of Taxation argues that neither taxpayers who have followed the letter of the law, nor taxpayers who have followed the accepted practice, should be penalised. I would be grateful for the Minister’s view on that.

John Pugh (Liberal Democrat, Southport)

I had not intended to speak, but have been inspired to do so by the hon. Gentleman, who referred to this as a motley schedule, because that was exactly my perception. It seems rather like Leviticus, listing a set of financial sins in no particular order. I would like to make a brief comment on anti-avoidance, which is at the heart of the debate. There seem to be two essential processes in the Bill. First, there is a kind of anti-avoidance catch-up process of identifying things that have gone wrong and tabling clauses to deal specifically with them. The other choice that the Government have is of the kind that one always has in these dilemmas—to go for a set of broad principles against which firms can judge for themselves whether they are on the right side of tax law. With either choice, there is some difficulty. With a broad set of principles, there is a wide scope but certainty is lacking. With a measure such as schedule 30, on the other hand, there is certainty but much may be missed and other things might evolve that have to be dealt with.

My hon. Friend the Member for South-East Cornwall, who arrived in the Committee recently, has been at a meeting of the Treasury Select Committee, which has been discussing this issue today. Let me read from the notes that were presented to him:

“One should also not overrate the capacity of standards to ensure appropriate national regulation”.

I guess that is why we have schedule 30 and why we will have schedules precisely like it in every financial Act to come.

Stephen Timms (Labour, East Ham)

I do not quite understand the parallel with Leviticus, but I shall reflect on the hon. Gentleman’s point.

John Pugh (Liberal Democrat, Southport)

When one reads Leviticus, which has a long series of very detailed clauses, one finds that the ancient Hebrews must surely have been getting up to some very strange and diverse activities, which were obviously identified as the sins of Leviticus. When one reads schedules such as this, one reaches similar conclusions about the financial sector.

Stephen Timms (Labour, East Ham)

I am grateful to the hon. Gentleman. I shall bear that in mind the next time I read Leviticus, and I shall look for those similarities.

The schedule tackles three tax avoidance schemes and responds to a recent High Court decision that could give rise to avoidance. The hon. Member for Hammersmith and Fulham has talked us through the measures, but let me go through them. Paragraph 1 involves exploitation of the tax rules for interest relief under which individuals can claim relief against their general income for interest paid on loans used to invest in some small companies and partnerships. The existence of relief for interest in those circumstances encourages investment in small businesses that are carried on commercially and with a view to profit.

In the schemes that have been notified to HMRC as a result of the disclosure provisions that we have put in place, the interest relief provisions are artificially exploited by means of arrangements that are almost guaranteed to allow the investor to exit the arrangements with more money than was originally invested. That will be achieved by the interest paid being set against other income, which is unrelated to the business in which the cash is invested, for UK tax purposes, while the matching gain is not chargeable to tax. The legislation will not deny relief to anyone who makes legitimate investments in businesses that bear a normal commercial risk.

Paragraphs 2 and 3 relate to a scheme that involves a company exploiting a rule in the tax provisions for corporate debt and derivative contracts, which is intended to deal with revaluation issues on transition from one type of GAAP to another. A company transfers risk and rewards of a loan or derivative contract to a connected party and, in consequence, is required by GAAP to derecognise the asset and so to reflect a loss in its accounts equal to the value of the loan or derivative contract.

In relation to paragraph 4, the scheme involves avoidance of corporation tax by large companies using convertible loans. A company lends money to another member of the same group—the debtor company—in return for the issue of a bond that is likely to convert into shares in the debtor company. Initially, no interest is payable, but interest will be paid if the loan does not convert. The debtor company accrues a deduction for that interest from the start, because under UK GAAP it must not anticipate conversion and it must spread the expected interest evenly over the length of the loan. The creditor company, though, accounts for the loan on the more realistic assumption that it will convert and so does not accrue any receivable interest. As a result, the deduction for the debtor company is greater than the income that the creditor company brings into account, so although there is no economic loss for the group, the debtor company is able to claim a tax deductible expense while the creditor claims not to be taxable in respect of any corresponding amount.

Finally, paragraph 5 responds to the High Court decision, in the case of DCC Holdings, that might allow some companies to reduce their tax liabilities inappropriately and other companies to be taxable on profits not received. The case was concerned with the deductibility of manufactured interest and suggested that it might be possible for companies to claim deductions in excess of the amounts appearing in their profit and loss accounts. Not making that change would result in companies being able to release their profits artificially, and therefore their tax liabilities. The total tax protection of all those four measures, over the next four financial years, is expected to be, or thought to be, in excess of £2 billion.

Greg Hands (Conservative, Hammersmith and Fulham)

I thank the Minister for giving us that figure. In the previous couple of clauses he mentioned annual figures—I think the amount in the previous clause was £150 million and the one before that was £100 million. Will he tell us why he is suddenly giving us a four-year forward projection? Is he able to break down that £2 billion on a per annum basis? How much will it save in this financial year?

Stephen Timms (Labour, East Ham)

I do not have the figure for the current year. I can check whether we have such an estimate and, if we do, I can send it to him, but the hon. Gentleman will accept that it is a very substantial sum indeed. When we have seemingly arcane debates on these topics, we need to bear in mind just how much revenue is at stake for the Exchequer.

Greg Hands (Conservative, Hammersmith and Fulham)

The right hon. Gentleman is right in pointing out that £2 billion is a very significant amount to save the UK taxpayer by ending these avoidance schemes. Could he therefore tell us something about the breakdown of the £2 billion between the various paragraphs? We have already discussed the power of one in particular being rather different to the other paragraphs. Surely he must have some idea of how that £2 billion breaks down across the various paragraphs.

Stephen Timms (Labour, East Ham)

I am happy to drop the hon. Gentleman a line setting out our assessment of how that is made up, both between the four things being addressed here and how it looks as though they would fall over the coming four years. Let me also respond to his point about the application of the schedule to deemed payments. He is right, legislation does not apply retrospectively to deemed payments—only to real payments. The High Court litigation on deemed payments has not yet finished; it is still continuing.

(Except Clauses 7, 8, 9, 11, 14, 16, 20 and 92) - Clause 62

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: that schedule 31 be the Thirty-first schedule to the Bill.

Greg Hands (Conservative, Hammersmith and Fulham)

I begin by welcoming you back to the Chair for this afternoon’s sitting, Mr. Hood.

We are in the middle of a set of clauses that relate to anti-avoidance, with another three to go. Clause 62 and schedule 31 are anti-avoidance measures, designed to prevent the creation of leases that only ever make losses.

Anti-avoidance provisions were introduced in schedule 10 to the Finance Act 2006 in relation to changes in the ownership of companies carrying on a leasing business. Before that legislation was passed, a tax advantage could arise when a lessor company was sold to a group that expected to have tax losses available for surrender by way of group relief. The 2006 Act made provision to target changes in the economic ownership of a plant or machinery leasing business carried on by a company on its own or in partnership. That legislation applies to simple sales of shares in a leasing company and to changes in partnership sharing arrangements, in addition to any other route by which the economic ownership of a business could be changed.

The legislation aims to prevent an unacceptable permanent deferral of tax. It was previously possible for a leasing company to generate losses in the early years of a long leasing contract as a consequence of the availability of capital allowances, with such losses being available for group relief. In the later years of the lease, the capital allowances would be reduced and the company would become profitable. If the leasing company was sold in the interim to a loss-making company or group, the leasing company’s profits would be covered by the new owner’s losses. Thus, an acceptable temporary deferral of tax became a permanent deferral of tax.

The tax advantage arose because the tax relief available via capital allowances normally exceeds the commercial depreciation at the outset of a lease. The timing advantage reverses later in the lease period. The effect of the accelerated capital allowances is that a lessor company will often realise tax losses to begin with, which will be available for surrender by way of group relief. Therefore, the sale of lease-tails, when a lessor company is sold to a group with tax losses, had the effect that no tax was payable on the profits arising in later periods on the reversal of the capital allowances.

The 2006 Act tried to counter that practice by ensuring that an accounting period ends on the sale of a lessor company. The company is treated as receiving income in the accounting period ending on the change of ownership, to the extent that the tax written down value of the assets is less than the account’s value. A deduction of the same amount arises in the next accounting period of the lessee company.

Schedule 31 includes Government proposals to change the 2006 Act, most of which should ensure that the legislation works as intended in all circumstances, including in complex transactions. Schedule 10 to the 2006 Act introduced a charge for lessor companies when sold to recover the tax timing advantage they received from capital allowance claims. That charge was an amount of income introduced by reference to the difference between the balance sheet value of assets owned by the lessor company and their tax written down value—that is, the amount still eligible for capital allowances. Clearly, if the lessor company did not own the assets, the balance sheet value of assets would be zero.

Lessor companies had been trying to avoid the consequences of schedule 10 to the 2006 Act by entering into sale and leaseback arrangements so that they no longer owned the asset subject to the lease, but could still claim capital allowances. I understand that schedule 31 removes the requirement for the lessor company to own the asset and makes provisions for ascertaining the value of an asset that may not be on the company’s balance sheet. The changes apply to all accounting periods that end on or after 22 April 2009, and we support the changes proposed.

Stephen Timms (Labour, East Ham)

I, too, bid you a warm welcome to the Chair for our deliberations this afternoon, Mr. Hood. I am grateful to the hon. Member for Hammersmith and Fulham for setting out what the clause does, but let me add a little to what he has said.

The sale of lessor companies legislation, which was introduced Finance Act 2006, prevents a potential loss of tax when a lessor company is sold. It does that by bringing into charge an amount that reflects the difference between the value for capital allowances purposes and the commercial accounting value of assets that the company owns. Where the lessor company is an intermediate lessor—one that leases an asset in from one party and leases the same asset out to another party—it may be able to claim capital allowances even though it does not own the assets that it leases out. It therefore benefits from the capital allowances in the same way as a lessor company that owns the assets, but because it does not own the asset, the legislation fails to bring the appropriate amount into charge when the company is sold.

We gather from disclosures under the tax avoidance scheme disclosure rules that groups have entered into sale and leaseback arrangements that turned what was a head lessor—a company that owned the leased asset—into an intermediate lessor before selling the lessor company. The arrangements made it possible to sell a lessor company without incurring a schedule 10 charge, but the changes we propose will ensure that the legislation captures an appropriate charge even when the lessor company does not own the asset it leases.

The legislation was first published in draft on 13 November 2008, and has been effective from that date. I am pleased to say that HMRC has received no negative representations about it.

Clause 63

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: that schedule 32 be the Thirty-second schedule to the Bill.

Greg Hands (Conservative, Hammersmith and Fulham)

The clause and schedule relate to long funding leases of plant and machinery and to anti-avoidance. Long funding leases are a special type of lease that, following the Finance Act 2006, break with the traditional rule that the owner of the asset is the person entitled to any capital allowances available in respect of it. Instead, under a long funding lease, the lessee—the person to whom the asset is being leased—has the right to claim allowances.

The measures in schedule 32 were announced on 13 November 2008, just before the pre-Budget report, and seek to address the following problems, most of which look to us like genuine loophole avoidance and ought to be blocked. The explanatory notes to the clause, particularly the “Background Note” from paragraph 38 onward, indicate that the measures arise out of disclosure, but give only a broad indication of the problems with key definitions such as that of sale and leaseback.

It is thought that the offending schemes worked along the following lines. First, before 13 November 2008, it was possible for the owner of an asset to sell the right to future rentals from the asset, then grant a long funding finance lease of the asset to a third party—again, usually a connected party; perhaps another group company—and then take the asset back from that third party on a long funding operating lease under the Finance Act 2006. The combined accounting treatment lead to the owner receiving capital allowances equal to the market value of the asset that he was still using under the operating lease. The mechanics of the scheme seemed to turn on the fact that, by selling the rentals first, the net investment that has to be recognised for accounting purposes at step 2—on the grant of the finance lease—is greatly and artificially devalued. However, on taking the asset back under the operating lease, the owner is deemed to incur expenditure equal to the current market value of the assets—on the one hand, the value is being depreciated and, on the other hand, the current market value is being used.

Secondly, where an asset had appreciated in value, it could be advantageously sold and leased back under a long funding lease because the sale proceeds could be limited to the unappreciated value. However, the capital allowances under the lease back would accrue to the former owner at the current market value, thereby giving an uplift. Thirdly, before 13 November 2008, at the end of a lease, the asset owner could avoid bringing any disposal value into account if a residual value guarantee agreement was in place. Fourthly, a leasing company that is part of a group could avoid the charge imposed under schedule 10 to the 2006 Act if it wished to leave the group by selling its assets and leasing them back, so that it ceased to own them in that sense for tax purposes. The book value of such a company for schedule 10 purposes was thereby depressed.

Schedule 32 will operate as follows. Paragraphs 1 to 5 prescribe the current market value of the asset to be the disposal value on the grant of a long funding finance lease, thereby targeting steps 1 and 2 of the first scheme that I outlined, as well as the second scheme. The concept of net investment is abolished. Paragraphs 6 to 8 effectively prescribe the disposal value on lease termination for the purposes of calculating the balancing charge, so that a disposal value has to be brought into account regardless of any guarantee arrangement. That will put a stop to the third scheme.

Paragraphs 8 to 11 provide that if the capital payment made on the grant of a long funding lease is brought into account as a disposal value, to the extent that it is so brought into account, it will not bear income tax under section 785C of the Income and Corporation Taxes Act 1988. That appears to be a tidying up exercise that will assist taxpayers. Paragraphs 12 to 14 will prevent the annual investment allowance and first year allowance being claimed by the lessees. Paragraphs 15 to 17 deal with leases made in favour of connected persons—providing a further impediment to the first scheme—but they are principally aimed at ensuring that market value is used for schedule 10 purposes where the owner has become lessee of his own assets. Paragraphs 18 and following repeat the exercise for plant and machinery taken on hire purchase agreements. All in all, there is nothing here of great controversy and I can see nothing that the Opposition would oppose.

Stephen Timms (Labour, East Ham)

I am grateful to the hon. Gentleman for his explanation and support for the clause. As he said, the schedule introduces legislation to counter avoidance involving the leasing of plant or machinery—avoidance that was disclosed to HMRC under the disclosure rules. The schedule also deals with a technical defect in the Capital Allowances Act 2001 that could lead to a loss of tax when a long funding lease ends.

The disclosed schemes involve sale or lease and leaseback that is designed to provide tax relief by way of capital allowances in excess of the net capital cost of the asset to the person entering into the arrangements. As the hon. Gentleman described, arrangements are used that result in the disposal value brought into account for capital allowance purposes being less than the capital allowance relief that can be claimed on reacquisition of the asset under the leaseback. The measure deals with that.

On the technical defect, under the long funding lease rules, a lessee is entitled to claim tax relief for the leased plant or machinery. When the lease ends, an adjustment may be needed to ensure that the total relief is limited to the lessee’s costs. It became apparent last autumn that if the lease is structured in certain ways, the lessee might obtain relief in excess of their expenditure. The measure ensures that at the end of a long-funding lease, a lessee obtains relief for no more and no less than the amount they paid.

The measure also corrects a minor flaw in the definition of sale and leaseback transactions. It makes small changes that ensure that initial payments under a lease are taxed in full and that ensure consistency with the taxation of chargeable gains.

Greg Hands (Conservative, Hammersmith and Fulham)

The Minister might already have explained this but what is the flaw that has been corrected?

Stephen Timms (Labour, East Ham)

I am glad to do so. As the law stands, the sale of plant or machinery followed by a leaseback to someone connected to the other seller who was already leasing the asset does not fall within the existing definitions. This arrangement, although not common, could be used to take sale and leaseback transactions outside the scope of the existing anti-avoidance rules.

The hon. Gentleman referred to the fact that draft legislation was published on 13 November last year. As is normal with anti-avoidance rules, the main provisions will have effect from the date of publication. The amended definitions, the change to the taxation of an initial payment and the amendments to the taxation of chargeable gains rules will apply from 22 April 2009, in line with the Budget date. As well as protecting the Exchequer, early publication allowed time for comments from businesses and their advisers. There has, however, been little comment on the measure; no concerns about any unintended effects have been expressed by businesses. I am grateful for hon. Members’ support and I ask that the clause and schedule stand part of the Bill.

Clause 64

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: that schedule 33 be the Thirty-third schedule to the Bill.

Greg Hands (Conservative, Hammersmith and Fulham)

The clause and schedule are the last in the series of anti-avoidance measures. The provisions relate to long funding leases of films and are designed to target a specific avoidance scheme. The scheme is apparently being used by film-makers who have already claimed capital allowances for the cost of making a film under section 42 of the Finance Act 1992, or section 48 of the Finance (No. 2) Act 1997, or sections 138 to 140 of the Income Tax (Trading and Other Income) Act 2005.

In essence, the scheme, the success of which is disputed by HMRC, appears to have been used in the case of films on existing leases for long periods of, it is generally said, 15 years, at rents which are subject to tax. By terminating the existing lease and replacing it with a long funding finance lease, the tax treatment of the rents is greatly mitigated. Not only that, but there is no recapture by the Revenue of the capital allowances already given. In effect, a film-maker could recover the cost of a film through capital allowances and still enjoy a low tax income.

The provisions of schedule 33 remove that treatment in respect of all long funding finance leases granted after 13 November 2008. There is a degree of retrospection, inasmuch as in the case of a long funding lease granted before that date, the rentals accruing due will receive the new tax treatment, but only for rents falling due after the 13 November cut-off.

Paragraphs 1 to 3 of the schedule exclude the income tax and corporation tax provisions normally applicable to long funding leases, when the subject of the lease is a film and the lease is granted after 13 November 2008. Paragraphs 4 and following exclude those treatments in the case of pre-existing leases that continue to subsist, but only in respect of rents falling due in periods of account commencing on or after 13 November 2008. They include transitional provisions based on time apportionment, where a rental period straddles two periods of account.

We have studied the schedule and find nothing to oppose, but I look forward to hearing whether the Minister agrees with my explanation.

Stephen Timms (Labour, East Ham)

The hon. Gentleman is right that the clause introduces schedule 33, which counters avoidance involving the leasing of films. It was introduced in response to information received by HMRC and was announced on 13 November 2008, with draft legislation published at the pre-Budget report. The schedule prevents avoidance that, if unchecked, would have led to a substantial loss of tax—perhaps as much as £1.5 billion over 10 or so years.

Greg Hands (Conservative, Hammersmith and Fulham)

This intervention is similar to the one I made this morning. HMRC is rightly trying to recover money that should have been paid. However, the Minister gave some annual figures for two different schemes, then he cited, I think, prospective moneys to be recouped over two or three years, and he has just now given us a figure for a 10-year period—the significant sum of £1.5 billion. How much of that is likely to be recouped in year 1 of those 10 years?

Stephen Timms (Labour, East Ham)

Governments have supported the film industry for a long time. One way in which they have done so is through special reliefs, which have allowed the acquisition costs of a qualifying British film to be written off more quickly by the acquirers for tax purposes. The cost of the film was often recouped by investors through leasing out the film, so that over time the initial tax relief should have been recovered by taxing the rental received under the leases. In practice, most such investment took place via partnerships of wealthy individuals who were able to reduce their taxable income by using the losses generated by the write-off of the cost of the film. The investors received a timing advantage which they would share with the film producers, giving a benefit to the industry.

Those rules were abolished, and in 2007 they were replaced by a relief focused more directly at film producers but—this is the point that the hon. Gentleman has asked about—many film partnerships remain. They can last for up to 15 years, so the clause tackles the long-term impact of the avoidance. We estimate the tax at risk to be £90 million for 2009-10, £110 million for next year, £120 million for the following year and £140 million for the year after that. It all adds up, as I have said, to about £1.5 billion over 10 years.

Last November, HMRC became aware of a scheme that was intended to turn the taxable lease rental income into largely untaxed rental income. That would have been achieved by converting the leases into long funding leases—the hon. Gentleman mentioned that—the income from which, as a general rule, is largely not brought into account for tax purposes.

Greg Hands (Conservative, Hammersmith and Fulham)

The film industry is extremely important in my constituency: Hammersmith is one of the bases of the UK film industry. The film industry has told me that probably the most important thing is certainty in the tax system. That £1.5 billion seems an awful lot of money to be recouped from anti-avoidance action on film schemes. Has the Minister assessed the likely impact on the UK film industry? How prevalent is the practice with which schedule 33 deals?

Stephen Timms (Labour, East Ham)

I think that I can reassure the hon. Gentleman. The special reliefs that gave the initial losses were abolished in 2006. They were replaced by a new relief, which has been in place since January 2007. The measure that we are debating now will therefore have no impact on the new relief, as it relates only to arrangements made before 2006. I reassure the hon. Gentleman on the important point about investment in the British film industry this year and in future years. The measure will have no effect either on previous investments, other than to ensure that the tax that should become payable over time does indeed remain payable. I do not think that there is a problem for the industry, although I take the hon. Gentleman’s point about the benefit of certainty.

I am glad that the hon. Gentleman sees nothing to object to, although it may be of interest to the Committee that HMRC has been advised informally that the announcement of the measure last November killed the scheme “stone dead” before it could be promoted.

Clause 65

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss the following: that schedule 34 be the Thirty-fourth schedule to the Bill.

David Gauke (Conservative, South West Hertfordshire)

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

Clause 65 and schedule 34 deal with real estate investment trusts—REITs. Those of us who served on the Committee that considered the Bill that became the Finance Act 2006—I do not know how many here today had the that pleasure, other than myself and my hon. Friend the Member for Fareham—will recall the legislation that introduced REITs, which came into force in January 2007. REITs were introduced with the intention of allowing investors to make indirect liquid and diversified investments in real estate in a way that attracted a similar tax treatment to direct investment. REITs were important in that they avoided the double taxation experienced by investors in other listed property companies.

Schedule 34 contains provisions relating to the REIT regime, and I have one or two questions for the Minister. If I may, Mr. Hood, I shall take the opportunity to ask about certain aspects of the reform of the REITs regime not included in the schedule, although I appreciate that that issue will be considered in the other place and, indeed, we may return to the REITs regime on Report.

Under paragraphs 3 and 4 of the schedule, REITs can offer convertible, non-voting preference shares in addition to the current categories of permitted investments, such as ordinary share, non-voting preference shares and convertible loan stock. It might help if the Minister were to explain the reasons for that extension.

The Government announced last year that they would stop property-rich groups such as operators of hotels, pubs and retail businesses restructuring and converting to REITs. I understand why the Government did that, but it is clear that the Government are not using schedule 34 to prevent conversion of landlords that let property to pubs, rather than operate them as tied houses. Rent from pubs is to be treated as rental income and not trading income. We have no objection to that liberalisation, but it would be helpful if the Minister explained what representations were made for the change, how many businesses the Government believe will be affected, and why the change has been made, given their steps to prevent property-rich groups from restructuring and converting to REITs.

My main point is an issue on which the Government have received representations—the requirement for REITS to distribute at least 90 per cent. of their property income annually—and I know that the British Property Federation raised it. Given the current state of the economy, the housing market and the real estate market more widely, and at a time when credit is not easily available through banks, is it good stewardship to distribute 90 per cent. or more of property income annually, as REITS are required to do? Property companies need cash at the moment, first to strengthen their balance sheets, and secondly because, in the event of an upturn in the property market, which may or may not be imminent—I do not want to speculate—REITs will want to buy new properties and retaining cash would be helpful to them. In addition, the rental market is weakening, cash flows are under pressure, and REITs may need to build up cash reserves to persuade lenders of their ability to sustain borrowings.

In such circumstances, the Government could take steps, which they have not taken in schedule 34, to provide greater flexibility in the REIT regime. The British Property Federation has suggested three ways in which that could be done. First, distributions paid by a firm could be paid in the form of new shares—stock dividends—and they could count towards the mandatory distribution requirement. Secondly, the mandatory distribution could be deferred by, for example, three years from one year to four years. That would provide REITS with some current flexibility. Thirdly, and perhaps less radical, because breach of the 90 per cent. requirement results in a tax charge and the risk of expulsion from the regime—that is not automatic, but a REIT would be vulnerable—perhaps it would be possible, as a short term measure, to consider whether breach of the 90 per cent. requirement could simply result in a tax charge without the risk of expulsion from the regime. The Government have received representations on that, and perhaps the Minister will help by giving the reason for not going down that route. We will consider returning to the matter on Report.

I want to raise a second technical point about REITs—the anti-avoidance provisions relating to interest payments. Property income distributions may be liable to a withholding tax, depending on the recipient, but interest payments tend not to be liable to tax. For that reason, which is a perfectly good one, the PFCR—profit financing cost ratio—rule, which is an anti-avoidance provision, prevents REITS from restructuring their arrangements in such a way that distributions are made through interest. We fully understand the need for that, but two points have been raised by the BPF in the context of how that rule may act in a way that was not intended.

First, a REIT might hedge market value movements in debt with a derivative contract. There are perfectly good commercial reasons for doing so: so that a profit or loss involved in repaying debt is matched by a loss or profit in a derivative contract. However, the PFCR does not take account of any profit on debt, but does take account of matching loss on the derivative. Consequently, the loss is counted as a financing cost which may be considerable and cause the REIT to be in breach of the PFCR.

The second circumstance in which the same thing may happen is when market value movements in the debt and the derivatives used to hedge the debt are deferred—the costs involved are deferred until the debt or derivative is repaid or closed out. That can have a distorting effect because all the cost then occurs in one year. It could be that over a period of time a derivative is entered into but the cost all crystallises in one year, which may have a distorting effect in that year. The effect of such distortion is that the REIT may have a penalty charge as a consequence of entering into perfectly sensible hedging arrangements, or of market values moving in a particular way.

I would be grateful to know whether the Government have looked at the definition of financing costs and whether they would consider amending it to address those issues. I appreciate that the Minister has not had notice of all those points, but any light that he can shed on them would be of benefit to the Committee.

A more general question is about the Government’s strategic vision for REITs. When they were introduced, there were great hopes that they would take off as a product. That they have not is not to do with failures in the original drafting of the REIT legislation, which schedule 34 seeks to address. These nagging concerns are perfectly reasonable, but there is a concern that the Government are simply not addressing the REITs regime, that it is sitting on the back burner and has not received the focus that it might have.

REITs have clearly worked in encouraging conversion of existing listed commercial property companies. That has happened, but REITs have not attracted new entrants, as was once hoped would happen. I appreciate that this is a difficult time for the property market, but it is also an opportunity. For example, perhaps the best way of addressing banks’ holdings of unwanted exposure to properties and of finding equity investment would be to create REITs. Indeed, there is some evidence that in the period following a recession, which hopefully we will be in shortly, the equivalent of REITs in countries such as France and Japan tended to prosper. I ask whether we are prepared for that, and whether the Government are showing sufficient flexibility in respect of the REIT regime to benefit from what may be a considerable opportunity.

A point that has been made whenever we have debated REITs, certainly in 2006 and subsequently in various orders where we have amended the regime, is that there is a great opportunity for them to become significant players in the private residential rented sector, and that they could provide professional management that is not always available otherwise. There is an opportunity for greater liquidity for people who want to invest in the private rented market rather than go down the buy-to-let route, particularly given that the reputation of buy to let may well have taken significant damage in recent months. There is an opportunity there for REITs, but it may be necessary to take a more proactive view of the regime.

That is not a criticism of the original regime. However, organisations such as the British Property Federation feel that more could be done to ensure that we have an active and thriving REIT sector in the UK.

Stewart Hosie (Scottish National Party, Dundee East)

The hon. Member for South-West Hertfordshire reminds us of 2006 when the REIT regime was introduced. He will also remember the very strict criteria for the creation of the real estate investment trust. There was a residential criterion, a minimum profit distribution criterion and a criterion that the REIT had to have a full stock exchange listing. The trust could not be a company traded on the alternative investment market or the off-exchange market, and it could not be a private company.

New section 136A(3)(a) states that the regulations may

“treat a specified person, or a person in specified circumstances, as forming part of a REIT group”.

New section 136A(3)(b) states that the regulations may

“provide for a specified provision which applies in respect of members of a REIT group also to apply”

to others. I want to ask the Minister whether those others, who have been deemed to form part of a REIT group, would also be obliged to follow the same conditions that have been set up for a REIT proper? I am talking about the size of the company, the stock exchange listing, and so on and so forth. I just want to understand for myself how someone can be deemed to be a REIT or part of a REIT if they do not meet the other conditions that were set out in 2006.

Let me go a little wider and ask the Minister the same question that the hon. Gentleman just asked about the strategic vision for REITs. It was clear at the time, I think, that because there was a requirement for REITs to have a full listing on the stock exchange, they would tend to buy high-yield residential and commercial property and there was less incentive, or almost no incentive, for the small-scale investment trusts to build in the for-profit sector rented accommodation in local areas, which is something that I was very keen to see. I know that the Minister at the time said that that was an issue that would be kept under review.

Will the Minister tell us whether there is an intention to remove some of the restrictions, particularly the full stock exchange listing criterion, to allow smaller entrants into the REIT field? The reason for that would be to provide the core profit for housing in the private rented sector which is so desperately needed. Moreover, it will be very helpful if he can answer my specific question on paragraph 7 on connected persons so I can understand how someone connected to a REIT can be defined as part of a REIT group if they do not meet the original criteria.

Stephen Timms (Labour, East Ham)

The origins of the UK real estate investment trust model go back to Kate Barker’s review of the housing market, which recommended that there was merit in considering a vehicle that was based on the US REIT model. Such a model has been introduced elsewhere, as the hon. Member for South-West Hertfordshire rightly mentioned, to encourage increased institutional investment in housing. We implemented that proposal and extended its scope to include commercial property. The main objectives of the model, which was launched at the beginning of 2007, was to promote greater efficiency in property investment and to provide smaller-scale investors with access to commercial property returns.

We have seen that the model works well. Some 21 companies so far have announced that they have become UK REITs, including most of the big listed UK property companies. The scheme is still less than three years old, and we expect other companies to join in the future, as investors become more confident in the UK REIT market.

Effectively, the regime removes the tax distortion between investing in property directly and investing in property indirectly by exempting both income and gains made on property from corporation tax provided that the company or the group meets some specified conditions.

We announced in the pre-Budget report that the Bill would amend the conditions to be met by a company or group in the UK real estate investment trust regime to ensure that those conditions could not be circumvented by the artificial creation of new group structures. The conditions include the requirement that at least 75 per cent. of total profits must come from the rental of property to tenants. We confirmed our intention to legislate in the Budget.

Schedule 34, which is introduced by clause 65, amends part 4 of the Finance Act 2006 to introduce a power for the Treasury to make regulations concerning the use of artificial structures to circumvent the existing UK REITs legislation. The regulations, which are available in draft form alongside the clause, are to be made by the affirmative procedure. Regulations to exclude owner-occupied properties from the REITs regime have also been made using existing powers under schedule 6 to the 2006 Act.

Schedule 34 also amends the 2006 Act so that section 98 of the Income and Corporation Taxes Act 1988 is disqualified for companies or groups of companies seeking to join the REITs regime. That will allow a business with tied premises—a pub business, for example—to treat the rental income from those premises as part of the property rental business of a REIT. Tied premises are those where a company supplies goods to a third party for sale on a premise that the company rents to the third party. Before the amendment, such income would not have been treated as rental income. That created an arbitrary barrier to the REITs regime, which schedule 34 removes.

In addition, following discussions with the industry, schedule 34 makes minor amendments to UK REITs legislation that will have effect on and after 22 April 2009. They address some of the points raised by the British Property Federation, although there are other points that it wishes to promote, a number of which have been mentioned by the hon. Member for South-West Hertfordshire. The minor amendments allow UK REITs to issue an additional type of share; provide a consistent definition of asset; clarify how apportionment of funds between the tax-exempt and non-tax-exempt part of the business should operate; and ensure that the regime’s requirements do not create unnecessary barriers to entry.

The hon. Gentleman asked about the extension to convertible preference shares. The extension allows REITs to use such shares where they previously could not, and is made in response to a consultation with the industry. On the general question whether we can do more to help REITs, it is certainly true that UK REITs, along with other parts of the economy, are struggling in the current economic climate. We have announced a wide range of policies to support businesses through what is a difficult period for them and, indeed, for households. The measures will provide help to all parts of the UK economy, and I expect UK REITs to benefit as well. I am less certain that there is a need for very targeted help for UK REITs beyond what we have done to support businesses in general, but we are very happy to listen to representations that people may wish to make to us.

David Gauke (Conservative, South West Hertfordshire)

One of the BPF’s proposals that I have outlined may involve the deferral of tax revenue, but the other two are likely to be fiscally neutral. Indeed, one of them may raise some revenue. The Government may therefore be able to address the issue without a cost, so I urge the Minister to look at the matter very closely.

Stephen Timms (Labour, East Ham)

We will certainly be happy to look at those representations. No amendments have been tabled, but we will, of course, look at proposals.

The hon. Gentleman also asked why we had not relaxed the profit financing cost ratio restriction. The restriction on gearing helps to ensure that profits are available to be distributed in the first place, which helps to protect both the Exchequer and the investor, but we will continue to talk to the BPF on the detail of the profit financing cost ratio. He made the point that stock dividends do not cost anything and asked whether there had not, therefore, been an opportunity for the Government to act. Allowing REITs to issue stock dividends as part of their mandatory income distribution could harm some investors. For instance, any investor who elected to receive cash would see their percentage stake in the company reduced by those electing to receive stock. There is a debate to be had on that proposition.

David Gauke (Conservative, South West Hertfordshire)

I acknowledge the Financial Secretary’s point, but does he not accept that REITs will have their own incentives to keep investors happy and that the management of a REIT would be careful about pursuing a route that could cause them disadvantage with an investor, because of commercial pressures if nothing else? I acknowledge his concern, but that flexibility would probably not result in the management of a REIT acting recklessly, as far as the interests of investors are concerned.

Stephen Timms (Labour, East Ham)

I take the hon. Gentleman’s point. My point was simply that there are issues to be weighed when considering a change of that kind, and the effect on investors is one of them. It is not necessarily a showstopper, but it needs to be taken into account.

The hon. Gentleman asked why the Government had not allowed deferral of part of the distribution requirement. It is important to note that each of the conditions of the regime is in place for good reasons. The requirement to distribute 90 per cent. of the profits from the property rental business within 12 months of the end of each accounting period helps to ensure that profits are distributed to shareholders who then pay tax on them, and it also helps to ensure that the investor gets a good deal.

We touched on the use of REITs for residential property investment, but there are difficulties with that in the current economic environment. Doing much about that problem would require significant changes to the regime, and we could then run into some EU state aid difficulties, which is another factor to be borne in mind.

Stewart Hosie (Scottish National Party, Dundee East)

All of the criteria for being a real estate investment trust, such as the profit distribution and the residential qualification, are met, so what EU state aid barrier could there be that would be different for residential property than exists for commercial REITs?

Stephen Timms (Labour, East Ham)

The current difficulty is the cost of setting up a REIT for investment in residential property. The model currently works fine for commercial REITs, but there is a cost problem for setting up a REIT for residential investment, and changing that so that is was more attractive for residential investment could lead us into difficulties with EU state aid. The barrier is a cost barrier, but fixing it could cause problems with state aid. Certainly, there would have to be some work to address that.

The hon. Member for Dundee, East asked whether other connected persons would be obliged to follow the REITs conditions. We want the connected person to be part of the existing REIT, rather than a separate REIT, so they would not need to meet all the conditions of the regime. The purpose of that legislation is to prevent a group artificially meeting the requirements of the regime by bringing into the REIT any part of the group that has been artificially removed. I hope that that is helpful and commend the clause and schedule to the Committee.

Clause 66

David Gauke (Conservative, South West Hertfordshire)

I have one brief question on clause 66. It has something in common with clause 67, and our debate will focus on that clause. Both clauses relate to anti-avoidance provisions. The test that is inserted for arrangements that fall foul of those provisions is that

“the main purpose... is the avoidance of tax”.

Most new avoidance legislation seems to include in its main purpose test the phrase “obtaining a tax advantage” or something similar. What is the reason for the change in terminology? Is this the terminology that we can expect to see in future in these anti-avoidance provisions and is there not a danger of some complexity or confusion here? The phrase “the avoidance of tax” seems narrower. I do not know whether that is the intention.

Stephen Timms (Labour, East Ham)

Clauses 66 and 67 are an interesting case. Early in the new year, HMRC received information about a particularly abusive avoidance scheme, which relied on deliberate default to generate artificial liabilities, which are then set against the otherwise taxable income of the individual concerned at a potential cost to the Exchequer of about £200 million in the first instance. So on 12 January, to head off this threat to the public finances, I issued a ministerial statement announcing the closure of this scheme with effect from that date.

Following that announcement, HMRC received further information that a variant of the scheme—this time involving the legislation on employment-related losses—was being used to similar effect at a potential loss to the public purse of at least £200 million in the first instance. So I took further action on 1 April, but also effective from 12 January, to close this down. We will come to that in the debate on the next clause.

Clause 66 gives effect to the original 12 January statement. It works by amending sections 346 and 555 of the Income Tax (Earnings and Pensions) Act 2003. As they stand, these sections allow relief to employees where either they, or their employer on their behalf, meet the costs of insuring against employment-related liabilities, or the actual cost of those liabilities, such as damages relating to their jobs or legal costs to defend against such damages.

The particular scheme that clause 66 addresses took a rather tortuous route to exploit these provisions and make sure there was no real loss to the scheme users. The arrangements would have involved the use of a number of both companies and trusts, some of them offshore. A key element was the creation of a contrived employment, the duties of which included entering into financial arrangements with another party. During the course of the contrived employment, the individual would deliberately default on some aspects of the financial arrangements. Under the terms of the arrangement, this would trigger automatic damages payable by the individual. The individual would borrow the money to pay the damages, through a loan made by another entity in this rather complex structure, and in reality the individual would not need to repay the loan.

I have gone into that in detail so the Committee has a sense of what we are dealing with and of the degree of contrivance and artificiality.

It is a highly abusive, completely contrived arrangement, with the sole aim of avoiding paying the tax due to the Exchequer. We are providing that that relief be allowed only where there are not arrangements in place designed to avoid tax. Any real employment-related liabilities will still be eligible for relief in the normal way.

The hon. Member for South-West Hertfordshire asked why the main purpose test in the clause uses the phrase

“the main purpose...of which is the avoidance of tax.”

when most new avoidance legislation uses the tax advantage test, as he rightly said. The main goal is to ensure that all wording is effective in achieving its primary purpose, which we are satisfied that the wording achieves. The words used are in keeping with those used elsewhere, such as the Income Tax (Earnings and Pensions) Act 2003, so they are not novel.

By taking swift action, we are preventing exploitation of the tax system by the schemes of a small number of wealthy people. Honest taxpayers rightly expect the Government to identify such schemes quickly and block them effectively. That is what we have done.

Clause 67

David Gauke (Conservative, South West Hertfordshire)

I beg to move amendment 73, in clause 67, page 32, line 6, leave out ‘12 January’ and insert ‘1 April’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this it will be convenient to discuss amendment 74, in clause 67, page 32, line 7, leave out subsections (3) and (4).

David Gauke (Conservative, South West Hertfordshire)

I thank the Financial Secretary for setting out details of the arrangements. He describes them as particularly abusive, which is perfectly accurate given that it is a deliberate default in relation to arrangements entered into during employment to create employment income offsets that can reduce tax on personal income. It is highly contrived. I want to make it clear that we fully support his statement that such loopholes and such contrived and artificial arrangements should be identified quickly and blocked effectively, so we support clauses 66 and 67 in their attempt to do that. We are concerned about the potential retrospective element—I wish to stress that that is a narrow concern—which is the purpose behind tabling these amendments. I know that we will debate the extent to which it is retrospective later.

This is not the first time that the some of us have debated retrospective taxation. On 22 May last year, I debated the issue with the Financial Secretary’s predecessor, the right hon. Member for Liverpool, Wavertree (Jane Kennedy)—may I say on behalf of the Opposition that we hope that she is safe and well? A similar point was raised in the context of double taxation treaties and retrospective provisions on Isle of Man partnerships. It would be fair to say that the case against the Government then was stronger than it is today, because then we looked at retrospection going back 21 years for something that HMRC had known about for a long time and not sought to address. One could argue that the arrangements that we debated last year were less abusive then the arrangements that we have today. None the less, there is a principle to do with the nature of retrospective legislation in this field. Last year, the right hon. Member for Liverpool, Wavertree said:

“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.”——[Official Report, Finance Public Bill Committee, 22 May 2008; c. 371-372.]

I therefore make no apology for raising this issue, notwithstanding the aggressive and abusive nature of the loophole that the Government are closing. The point is whether the announcement of 12 January 2009 to which the Financial Secretary referred was sufficient to close the loophole or whether this matter was not addressed effectively until 1 April 2009.

When debating the retrospective nature of taxation, it is customary to refer to the Rees rules, which date back to the Finance Act 1978. The shadow Chief Secretary of the time stated that it is important that clear and specific warning is given prior to a Finance Act implementing any such legislation. My right hon. Friend the Member for Charnwood (Mr. Dorrell) went on in the early 1990s to argue that in addition to those clear and specific warnings being given in advance, there must be exceptional circumstances for legislation to be retrospective. It may well be that the abusive nature of these arrangements and the considerable potential cost to the Exchequer are exceptional circumstances.

I will turn to what the Government said in considering whether the Rees rule was met. In the press release of 12 January 2009, HMRC stated:

“The specific avoidance arrangements of which the government is aware aim to exploit the provisions of sections 346 to 348 and 555 to 559 Income Tax (Earnings and Pensions) Act 2003, (ITEPA).”

Those references are picked up in clause 66, which we debated earlier. Paragraph 9 of the press release states:

“The specific avoidance arrangements being countered are outlined above but the government is aware that it might be possible to use different structures to achieve a similar outcome. As a result the proposed legislation will deny any deduction under section 346 or section 555 ITEPA where the liability in respect of which the deduction would otherwise be due has been paid in connection with arrangements the main purpose, or one of the main purposes, of which is the avoidance of tax.”

The press release, which reflects the Financial Secretary’s written statement, highlights certain specific arrangements and broadens it further. However, it does not broaden the identification of the scheme used in the loophole as widely as the subsequent press release and technical note of 1 April 2009, to which the Minister referred.

That press release announced further action and was entitled “Government taking further action to prevent artificial avoidance schemes”. Having outlined the contents of the January provisions, in paragraph 5 the technical note goes on to state:

“The Government is aware of a similar scheme or schemes that seek to exploit S11 ITEPA 2003 and S128 ITA 2007.”

The essential point is that we are concerned about backdating those anti-avoidance provisions to 12 January, when that announcement addressed certain specific arrangements; indeed it slightly broadened it out to beyond the arrangements of which it was aware, but was not as broad as the 1 April arrangements. We consider that the risks of retrospective legislation are very considerable. That is important as it damages stability and certainty in the UK tax system. If we have a tax system that is unpredictable, it undermines confidence. We are therefore concerned that by backdating the effect of clause 67 to 12 January as opposed to 1 April, the Government are going beyond what we accept as allowable under the Rees rules, the Dorrell doctrine and, indeed, by the statement made by the former Paymaster General, the right hon. Member for Bristol, South (Dawn Primarolo). In December 2004, she referred to remuneration planning, an area where there has been retrospective legislation for some time. This would appear to be broader than that and my attention has been drawn to comments made by the right hon. Lady on 6 June 2006. I interpret her remarks to mean that the approach to remuneration planning applied merely to the extraction from a company of income otherwise taxable in the form that was rendered free of national insurance, PAYE and income tax. I do not think that this is quite what we have here, so we are concerned about these provisions.

Perhaps I can take this opportunity to ask the Minister where the Government stand on retrospectivity in general. In what circumstances do the Government consider that a retrospective provision is justified? Does the Minister recognise that there is a risk that HMRC may use this as a fallback against its mistakes? That was very much the nature of our case last year on partnership income and Isle of Man partnerships. HMRC should have addressed that matter much earlier and it sought to address it through retrospective legislation. What constraints are there on the use of retrospective legislation and do the Government recognise that there are problems caused to the UK tax system if it is overused? It may well be that the Minister’s remarks today can provide some reassurance, but it would be a damaging attribute to our tax system if there was frequent use of retrospective legislation in this area.

More specifically, on clause 67 and amendments 73 and 74, may I ask the Minister why the announcement on 12 January was thought to cover more than that which is specifically mentioned in that announcement? I suppose the question that should be asked is why section 11 was not mentioned in it. How does the Minister justify including section 11 in something that was not mentioned for another two and a half months or so? With those questions—I have tried to present this case in a probing manner—I have to warn the Financial Secretary that we may well seek to divide the Committee. We are concerned about this use of retrospective legislation. We are not convinced by what we have heard so far that the Government are fully justified in dating the provisions back to 12 January rather than 1 April, notwithstanding the fact that the Government are absolutely right to seek to close that loophole.

Brian Binley (Conservative, Northampton South)

May I say what a pleasure it is to serve under your chairmanship, Mr. Hood? I am grateful to have the opportunity to speak on the clause, and I congratulate my Front Bench colleagues on emphasising its importance. It seems to me to be one of the most disturbing clauses in the Bill, not least for the wider reasons. My hon. Friend the Member for South-West Hertfordshire made the point that an announcement on certain issues was made on 12 January 2009—indeed, I am told that it was made clear that the rules would not apply to payments made after the date of the announcement—and the industry ceased to use the scheme. That is the information that I have received.

The crime comes when we consider the announcement of 1 April 2009, when the Government widened the scope of the provision, and did so retrospectively and without notice. It is said that the measure will impact upon only 600 people, but retrospective legislation that impacts upon one person, particularly in such an activity, is not good enough. For 600 people, of course it is not good enough. However, it is the wider questions of perception and the breaking of what many businesses see as a genuine understanding between business and the Department that is the real danger inherent in the provisions.

I understand that the hard-working people of the Treasury are keen to protect the interests of the Government and the nation by stopping tax avoidance. To most people, tax avoidance is unacceptable. I would love to get certain people who live on certain islands and then, through their own newspaper organs, make their own moral judgments, and many Members of the House would agree. In this instance, however, we are not talking about the normal practice of announcing a measure and giving people due warning. We are talking about the Department making an announcement, with no warning, of a measure that would be used retrospectively. Therein lies our concern.

To date, it has been generally accepted practice to apply retrospective tax legislation only when HMRC has announced that it will do so. It is that element that has been broken in the clause. I do not need to tell the Committee that retrospective legislation is bad legislation, no matter what the issue, as it is a fundamental requirement that legal frameworks should provide certainty for individual behaviour at the point when that behaviour takes place and not retrospectively. That is generally accepted as good, fair and proper government. It is the undermining of that concept that is so damaging in the wider sense.

It is the question of perspective that concerns me immensely. I come from a world where certainty is vital—the business world. I come from a world that believes that treatment between business and the Department is fair and proper. Action of this sort undermines that concept. If it happens more and more, business will begin to think that it cannot trust the Department, and therein lies the real danger. The perception of HMRC itself is under threat when the Government decide to act retrospectively in such a fashion. I recognise that accountants rarely take perception into account, but business men do, because the perception of their business is vital to the well-being of their customers. That is the point that I fear the Treasury is unable to grasp, and which I would particularly like the Minister to address.

The Government tell us that the measure will prevent a loss to the economy of some £200 million. That is pure accountancy talk; it fails to take into account the image of this country doing good and fair business. It is another little brick in that wall that will prevent more and more people from wanting to do business here. What assessment has there been of the impact on people who might want to come to the UK to do business, but might be put off by the thought that they could be taxed retrospectively without their knowledge? That also needs to be taken into account.

Stewart Hosie (Scottish National Party, Dundee East)

I rise to support the Government’s attempts to end contrived avoidance schemes. The scheme to which clause 68 is addressed is seriously contrived, and I am sure that when the Minister gets to his feet later, he will have a similar description of the scheme relevant to clause 67. However, I also share the general concerns about retrospectivity. I could have made this argument under any number of the clauses, but I am doing it here because it allows me to raise another matter. I hope that I am not out of order, Mr. Hood, if I engage in a clause stand part debate. I assume that we are taking the amendments and clause stand part together.

Jimmy Hood (Labour, Lanark and Hamilton East)

I have not made my mind up as to whether we will have a stand part debate, so I suspect that the hon. Gentleman had better make his point now.

Stewart Hosie (Scottish National Party, Dundee East)

I will be as careful as I can, Mr. Hood.

I understood that the practice of those engaged in schemes such as those to which clauses 66 and 67 relate was to notify HMRC shortly after commencement. Was the scheme that the Minister described, and the variation dealt with in clause 67, also notified to HMRC shortly after commencement? That is important.

One thing that we need to do to avoid retrospective taxation—the Bill contains lots of it—is to ensure that those working in tax and financial management and planning are able to behave in a proper manner and do not find themselves doing something that their lawyers and advisers tell them is within the law, but which ends up being subject to retrospective legislation days, weeks or even a few months after the commencement of the scheme. That is the point that I wanted to raise in relation to clause 67. Instead of giving post-commencement notification to HMRC, would it not be far better if those engaged in tax and financial planning and management could have pre-commencement approval of schemes, so that they knew that everything they were doing was on the straight and narrow and that they would not then be subject to a large amount of retrospective legislation? Most important, people wishing to use the services of those providing tax and financial planning and advice would then be able to do so with the confidence that they would not fall into schemes that were legal when they handed over the cash, but which ended up being illegal very soon thereafter due to retrospective taxation.

I am sure that I was well wide of the mark, Mr. Hood, but there was no other way I could go. I hope that the Minister will tell us why we do not have pre-commencement approval and why we only have post-commencement notification.

Stephen Timms (Labour, East Ham)

As I said, following the action we took in January, we discovered that a highly similar scheme was set up by the same provider, using the same approach and aimed at exactly the same people. The scheme used a loss like that referred to in the clause 66 scheme, which is created by an act of deliberate default during the course of a contrived employment, to exploit the provisions of section 128 of the Income Tax Act 2007. That allows employees to claim loss relief in certain circumstances where that loss arises from the conditions of their employment.

I will run through the measure again. Some of what I say will seem familiar because of the close similarity between the arrangements that clause 66 addresses and the arrangements that clause 67 tackles.

The scheme that clause 67 addresses used a number of entities—companies and trusts, some of which may be offshore. A key element is the creation, again, of a contrived employment, the duties of which cover financial arrangements with another party. During the course of the employment, the individual would deliberately default with regard to one or more aspects of the financial arrangements. Under the terms of the arrangement, that would trigger automatic damages payable by the employer that the individual was obliged to share by virtue of their contract of employment. The individual would borrow the money to pay the damages, not through a normal commercial loan from a high street bank or some other lender, but from another entity in the structure. The individual would not in reality repay the loan and, as a result, they would suffer no genuine loss in paying the sum designated as damages—indeed, the only real cost the individual would suffer is the cost of buying entry to the scheme.

David Gauke (Conservative, South West Hertfordshire)

I recognise that there is a clear similarity between the section 11 schemes and those schemes identified on 12 January. Does the Financial Secretary also accept that clause 67 will apply to any arrangement that uses section 11 of the Income Tax (Earnings and Pensions) Act 2003, whether it is in relation to an employment loss that arises from a deliberate default or otherwise? I accept that a particular scheme caused HMRC, or the Minister, to make an announcement on 1 April, but the clause is somewhat broader than that and has a retrospective effect. I do not know whether any schemes are caught up as a consequence, but the similarity point is not a clinching argument because the application of clause 67 is broader and applies to schemes that are not quite so similar.

Stephen Timms (Labour, East Ham)

I think the similarity is striking. In a moment, I will explain how that affects the argument. I am confident that clause 67 will not damage proper and appropriate uses of the provisions already in legislation. Let me just go a little further.

Despite the arrangements that I have described, the individual would claim that they are entitled to deduct the amount of the damages from their income, because the damages rank as a liability that was incurred when acting in the capacity of an employee.

The general theme of artificial loss creation has been a common feature of tax avoidance for some years, with people wanting to shelter income and gains from tax. A number of previous arrangements around that general theme, but using different parts of tax legislation, have already been closed down. The avoidance that the Government are moving to close down with clause 67 is the individual seeking tax relief against genuine income for a contrived loss that the individual never actually suffered. I acted on 1 April to do that. Because it is a variant on the loophole we closed on 12 January and featured the same individuals, we made it effective from 12 January.

The hon. Member for South-West Hertfordshire asked how targeted clause 67 is. I do not think that it is broadly drawn. The intention is to ensure that it will not be necessary to seek further legislation if more schemes involving claims for loss relief under the 2007 Act are devised. It will also remove any doubt about our view of loss relief claims that are contrived in that way.

David Gauke (Conservative, South West Hertfordshire)

Perhaps I am approaching the matter from a different angle, but if the Minister is arguing that there was great similarity, why were section 11 arrangements not picked up on 12 January? Was any consideration given to doing so, or did it come as a surprise to HMRC that there was a way, as the Minister sees it, of achieving the same aim through the other provisions to which we referred?

Stephen Timms (Labour, East Ham)

We did not know on 12 January about the device to which the statement of 1 April refers. Information about that arrangement emerged later through a disclosure. I accept that the fine detail of the second scheme is somewhat different from that of the first, but the underlying approach is the same. Both schemes depend on the use of deliberate default to trigger artificial liabilities or losses for which relief would be claimed under legislation intended to provide relief for exceptional circumstances of genuine employment liabilities or losses. The people subscribing to the scheme would have known exactly what they were entering into when they decided to do so.

Jeremy Browne (Liberal Democrat, Taunton)

The Minister is giving a helpful explanation. What is his estimate of the potential cost to the Exchequer were the Government to be defeated on any vote on the clause or the amendments to it?

Stephen Timms (Labour, East Ham)

It would be £200 million—precisely the same as if clause 66 was not included in the Bill, because it deals with the same kind of avoidance targeted at precisely the same people by the same promoter who, having been thwarted by the announcement of 12 January, would, if allowed to do so, have simply switched all their customers into the device that clause 67 addresses.

Jeremy Browne (Liberal Democrat, Taunton)

I assume that the £200 million is an annual figure. If that is the case, is there any expectation that the figure would in time come down, or would others see the opportunity to exploit the same loopholes and, for example, make the aggregate figure over the lifetime of the next Parliament more than £1 billion, rather than just £200 million multiplied by five?

Stephen Timms (Labour, East Ham)

We are getting into speculation, but if all those people got away with avoiding £200 million-worth of tax, it is entirely possible that the promoter would find that other people were attracted to use the same device and that the loss would increase.

David Gauke (Conservative, South West Hertfordshire)

We are talking about the period from 12 January to 1 April, so we are not talking about ongoing costs. Surely this is a one-off hit. I understand that the Government rightly believe that the scheme was a fraud arrangement anyway and want to avoid the uncertainty.

Stephen Timms (Labour, East Ham)

I was asked what would be the cost if clause 67 did not appear in the legislation, and that is the question I answered. A separate question is what would be the loss to the Exchequer if amendments 73 and 74 were agreed. The answer to that is £200 million. That would be a one-off loss.

Amendments 73 and 74 would ensure that clause 67 did not take effect until 1 April. The backdating of the clause was essential to preserve the intent and effect of the January announcement. The scheme, unlike the first, came to our notice through the disclosure regime. It was sufficiently advanced at that point that, had we not backdated the clause, we would have put at risk the entire £200 million protected by the clause and the announcement of 12 January, because all those individuals who had moved to the new variant scheme prior to 1 April would have been able to crystallise the artificial losses to claim against their real taxable income.

Brian Binley (Conservative, Northampton South)

Will the Financial Secretary give way?

Stephen Timms (Labour, East Ham)

I will. I was just about to come to the point the hon. Gentleman made in his speech.

Brian Binley (Conservative, Northampton South)

The Financial Secretary has just used the phrase “would have put at risk”, but what does that actually mean? Does it mean that he is not sure whether it is £200 million at risk or not?

Stephen Timms (Labour, East Ham)

There is of course a degree of uncertainty about that, depending upon precisely who had taken advantage of the scheme and made a claim accordingly, but £200 million is our best estimate, soundly based, of the loss to the Exchequer if the backdating had not occurred. The hon. Gentleman said that was disturbing and that about 600 people were involved—a figure I had not heard, but he might well have information to which I do not have access on how many are affected. I hope that, on reflection, he would find it far more disturbing if those 600 people, having had their large-scale tax avoidance thwarted by my announcement of 12 January, were able simply to switch across to that other, equally contrived and similar scam and obtain their £200 million between them as a result. That would be much more disturbing than the measure we have announced. I have seen correspondence from the promoters of the scheme rather echoing his points and suggesting that it really was not cricket for the Government to act in that way. I must tell the Committee that, where abusive tax avoidance is being promoted, we will take action to block it and will do so time and again.

Brian Binley (Conservative, Northampton South)

There is nothing at all in the amendment that stops the avoidance process of the scheme the Financial Secretary is talking about. It is simply the concept of the provision being a retrospective reaction to the matter, which has much wider implications than the scheme he is talking about. There are many examples of circumstances in which people in this country feel that others are avoiding tax unfairly—I alluded to one, but there are many others. There is a bigger principle, and that is that HMRC is seen to be acting fairly and decently and not retrospectively, which is not seen as fair and decent in the main. One could still stop the scheme but keep one’s honour, and that, too, has relevance.

Stephen Timms (Labour, East Ham)

I can certainly reassure the hon. Gentleman that HMRC’s action has been fair. He is arguing for bolting the stable door after the horse has bolted, but that would indeed have led to a loss in revenue of £200 million. Had there been no retrospection when closing down the scheme, those 600 people, if that figure is correct, would have been able to make off with that sum. That is unfair. That is what honest taxpayers are worried about. They are worried that people who know exactly what they are doing and are who employ the services of highly paid advisers to devise those ingenious schemes are, by that route, avoiding paying tax like the rest of us.

Mark Todd (Labour, South Derbyshire)

I am struggling with a couple of questions for my right hon. Friend. First, what sort of fees must have been payable to those who devised such a contrivance? We must be wondering whether those people deserve our sympathies as widows and orphans seeking relief from the taxpayer. Secondly, does he believe that that type of activity bears any resemblance to the honest business activity referred to by the hon. Member for Northampton, South?

Stephen Timms (Labour, East Ham)

My hon. Friend is absolutely right. We are talking about a scam. The people who promoted it know exactly what they are doing and the people who wished to use the scam knew exactly what they were doing. I am sure that he is right and that substantial fees were paid or were due to be paid—I do not know how far the payments had gone. One can only surmise that it would have been some proportion of the £200 million. I would suggest that between 5 and 10 per cent. would have been the likely fee, so the promoters stood to gain perhaps £10 million to £20 million from having facilitated a very substantial tax avoidance scam.

Jeremy Browne (Liberal Democrat, Taunton)

Although I share the Minister’s view that the scheme is a scam and I would much prefer that the Treasury had the £200 million of additional revenue, particularly in these straitened times for the public finances, would he not agree that the hon. Member for Northampton, South holds his view with great integrity? He should not feel inhibited, and nor should his colleagues, about voting for these amendments merely because Labour Back Benchers choose to describe them in those unfavourable terms.

Stephen Timms (Labour, East Ham)

That is a matter for judgment by Opposition Members. We will wait with interest—[Interruption.]

Jimmy Hood (Labour, Lanark and Hamilton East)

Order. I am sure we are all interested in hearing what the Minister has to say, not what each other is saying.

Stephen Timms (Labour, East Ham)

Thank you, Mr. Hood. We shall certainly wait with interest to see what Opposition Members decide.

The hon. Member for Northampton, South said that he wants certainty. He can be absolutely certain that when we find out about an abusive scam we will shut it down. Anyone who is interested in participating in such an arrangement can be certain of that. My hon. Friend the Member for South Derbyshire is right such arrangements have nothing whatever to do with the provision of a good and fair business environment in the UK. We are committed to that and everybody knows that we take a very dim view of tax avoidance.

We acted on 1 April to make it clear that the second version of the scheme covered by clause 66 was equally unacceptable. Just like the scheme we closed on 12 January, it relies on abusive and contrived actions over a short period which ignore fiduciary duty to get a tax advantage. It would have been deeply unfair to have allowed that scam to proceed. The Government’s response to the second scheme is reasonable and proportionate in the circumstances. There is a degree of retrospection here—that is perfectly correct. I hope that the Committee will accept that that retrospection was justified in the circumstances.

We ensured that all the relevant legal considerations were taken into account, including the Rees rules, the similarities between both schemes, the need to protect the human rights of potential users and previous announcements. In that respect we took account of the announcement on 12 January and the ministerial statement made the following day, as well as the statement made by the then Paymaster General, my right hon. Friend the Member for Bristol, South, on 2 December 2004, which was referred to by the hon. Member for South-West Hertfordshire.

Brian Binley (Conservative, Northampton South)

Will the Minister give way again?

Stephen Timms (Labour, East Ham)

Let me just say a couple of words about that statement. My right hon. Friend’s statement in 2004 warned that where we became aware of arrangements that attempt to frustrate our intention that employers and employees should pay the proper amount of tax, we would introduce legislation to close them down, where necessary from 2 December 2004. It therefore remains the Government’s view that in rare cases like this it is appropriate for us to act retrospectively to make sure that abusive schemes are closed down rapidly and effectively. That takes account of the doctrine named after the right hon. Member for Charnwood, who recognised that retrospective legislation should be introduced only in exceptional circumstances and only where the Government consider such action to be necessary to protect the general body of taxpayers. I agree with that view, and this measure is certainly consistent with those criteria. We have met the Rees rules, the Dorrell doctrine and perhaps what we should refer to as the Primarolo doctrine as well.

David Gauke (Conservative, South West Hertfordshire)

Try to be more alliterative.

Brian Binley (Conservative, Northampton South)

I shall now try to create the Binley doctrine, with your permission, Mr. Hood. We have a situation in which the Government, rightly and properly, are intent on cutting back on those people who act outside the rules of decency by avoiding tax. The Minister calls such behaviour a scam, which is a bit subjective, bearing in mind that it must have been legal or there would not have been a need for this particular piece of legislation. Can I assume, therefore, that we need many more retrospective pieces of action should similar so-called scams turn up in the future?

Stephen Timms (Labour, East Ham)

The hon. Member for South-West Hertfordshire accuses me of failing to achieve consistent alliteration. He is right; I should have referred to the Primarolo principles. I did not entirely understand the question that the hon. Member for Northampton, South asked. If his question is whether we would act similarly again in similar circumstances, the answer is most certainly yes. Anyone who thinks of promoting or taking part in such arrangements needs to understand very clearly that the Government take an extremely dim view of those arrangements and are determined to close them down, as we successfully did in this case.

The hon. Member for Dundee, East asked me about pre-commencement approval. There is provision for that in code of practice 10. Taxpayers can ask about the HMRC view of arrangements before they decide to go ahead with implementing them. That alerts taxpayers to note that HMRC may take action against their proposal. If anyone is in doubt, they can seek clarification.

Stewart Hosie (Scottish National Party, Dundee East)

The Minister said earlier that the scheme that he was talking about had been disclosed. Now he talks about taxpayers being able to check out schemes that they may enter into, and that is all good and well, but can I confirm that promoters are able to seek confirmation of the schemes in advance, or is it only in post-commencement notification that some of the difficulty may arise?

Stephen Timms (Labour, East Ham)

Promoters can seek that clearance as well. They are required to disclose, but they can seek clearance if they wish.

David Gauke (Conservative, South West Hertfordshire)

Can the Minister tell the Committee the date on which the promoters first started to market the scheme? It appears from what he says, or we can surmise, that it was after 12 January, in the sense that it was an innovation to the scheme that was outlawed on 12 January. At what point was it notified to HMRC? We know that HMRC took action on 1 April, but it might be helpful to the Committee if we knew the other dates.

Stephen Timms (Labour, East Ham)

I think that the hon. Gentleman’s surmise is correct. It must have been after 12 January and before 1 April. I do not have the precise date in front of me. I am not sure whether we know it. As far as I am aware, the disclosure took place properly, in accordance with the requirements of the rules.

So, this was a completely artificial and contrived arrangement. It was clear to both the promoters and to anyone who was considering taking advantage of the scheme that it was open to abuse. It was essential to backdate the effectiveness of this measure to 12 January. Otherwise, people could have taken advantage of this very big tax avoidance opportunity. I hope that the hon. Gentleman will agree to withdraw his amendments and that the Committee will agree that clause 67 stand part of the Bill.

David Gauke (Conservative, South West Hertfordshire)

The Financial Secretary defended the Government’s position with much vigour, as we would expect, but I am slightly disappointed in his response. I shall look in general at retrospective legislation in this area before turning to the specific case in front of us, because a balance needs to be achieved between creating certainty within the tax system and the desire that the Minister rightly expresses to close down scams as quickly as possible. As I said earlier, we enthusiastically support the Government’s attempts to close down these scams. There is a balance to be achieved; there is a tension.

There is an argument, as the Minister knows, as to whether this scheme falls within the scope of the Primarolo principles. It can be argued, as I did earlier, that that is too narrow to encompass this particular scheme, although I appreciate that there is an alternative view. He is right to say that this scheme is very similar to that identified on 12 January, although as I understand it the 1 April provisions could capture some schemes that are quite dissimilar from those identified on 12 January. He is also right to say, as I acknowledged from the beginning, that this is a particularly abusive scheme, and that there is clearly a substantial cost to the Exchequer.

I am disappointed that we did not get an answer on the Government’s general approach to retrospective legislation. As I said earlier, I thought that the legislation that we had in front of us last year was stronger ground to make the case against retrospective legislation than the scheme that we are debating today. In those circumstances, with some concern at the failure of the Government to address the wider issue of retrospectivity, I beg to ask leave to withdraw the amendment.

Clause 69

David Gauke (Conservative, South West Hertfordshire)

I have a couple of questions about clause 69, which takes us into the rather arcane and complicated world of the taxation of goodwill and intellectual property. The clause seeks to deny tax relief for deductions derived from the amortisation of goodwill arising and recognised for accounting on the purchase of a business from an unrelated party.

As I understand it—I am sure that the Minister will correct me if I am wrong—the perceived mischief that these new provisions aim to thwart is transactions involving the sale of businesses between related parties, with the recognition of goodwill on acquisition by the purchaser. The purchaser would then no doubt claim deductible amortisation for tax purposes by writing down the purchased goodwill. I know that there is a view that the clause is unnecessary because the goodwill would not exist in the accounts or for tax purposes prior to the acquisition; that internally generated goodwill is prohibited by accounting standards and therefore the clause is not necessary.

I would be grateful if the Minister could say why the clause is necessary. It has a particular effect where the transaction involves a purchaser and the seller that are related. Are there concerns that the same mischief could occur between unrelated parties? To reiterate, is the clause really necessary at all? I think that this is one of those cases where the provision is there for the avoidance of doubt. However, if the Minister will elaborate on that point, we shall be grateful.

Stephen Timms (Labour, East Ham)

Clause 69 introduces legislation to confirm the tax treatment of goodwill by the corporate intangible fixed asset regime. The rules for the taxation of corporate intangible assets were introduced in the Finance Act 2002 after widespread consultation and they were widely welcomed by businesses. However, some companies acquiring a business carried on prior to 1 April 2002 by a related party have been incorrectly claiming relief for goodwill where none is available.

As the hon. Gentleman was suggesting, that is the reason for changing the rules. The legislation is being clarified to put what HMRC believes to be the correct interpretation of the law beyond doubt, because some people have doubted it. HMRC does not accept that such relief as has been claimed is, in fact, available. The regime treats goodwill of a business carried on by a related party prior to 1 April 2002 as a pre-existing asset. It is brought into the regime only if and when the business is acquired by an unrelated third party.

HMRC will continue to challenge past claims that some companies have tried to make for relief, if necessary through the courts. To complement HMRC’s operational response to the problem, the clause confirms that the corporate intangible asset rules function as intended and it aims to put beyond doubt the correct interpretation.

Clause 69 should safeguard up to £2 billion worth of future tax revenue spread over the next 20 years, and I commend it to the Committee.

Clause 70

Stephen Timms (Labour, East Ham)

I beg to move amendment 213, in clause 70, page 34, line 24, leave out ‘section 105A’ and insert ‘sections 105A and 105B’.

Jimmy Hood (Labour, Lanark and Hamilton East)

With this, it will be convenient to discuss Government amendments 214 to 216.

Stephen Timms (Labour, East Ham)

The amendments are required to ensure that the full amount of a lease premium, payable in respect of a lease term up to a maximum of 10 years, is spread evenly across the term of the lease for the purposes of calculating the living accommodation benefit in kind charge.

At the Budget, we announced our intention to change the rules for taxing the benefit in kind charge, where employees are provided with living accommodation as a result of their employment, to stop attempts to avoid tax through payment of a lease premium rather than the full market rent for the use of the accommodation.

Clause 70 introduces a rule that means that the value of a lease premium, payable in respect of a lease of 10 years or less, will be taken into account when calculating the benefit in kind charge. The clause contains an anti-avoidance provision to prevent manipulation of the new rules by entering into a lease with an artificial term of more than 10 years and inserting an earlier break clause.

However, in cases involving leases with a break clause that is not exercised, the legislation will not spread the value of the lease premium across the term of the lease. In certain cases, it may not operate to bring the full value of the lease premium into charge in any taxable period.

The Government amendments ensure that the new rules for taxing the living accommodation benefit in kind charge operate as intended to bring into charge the full value of a lease premium and to spread it evenly across the term of the lease. Without the amendments, it would be straightforward to structure a lease premium arrangement in such a way that only a small proportion of the lease premium payable would fall to be taxed under the new rules.

David Gauke (Conservative, South West Hertfordshire)

We fully appreciate the thinking behind clause 70 and the amendments that the Financial Secretary explained. We agree that, but for the amendments, it would be relatively easy to avoid the purpose of the clause, but I have a couple of questions. First, what is the cost to the Exchequer of the existing loophole historically and in future? Secondly, will the Financial Secretary explain the reason for 10 years? I realise that there must be a limit, but I would be grateful to know what the thinking was that caused the Government to settle on 10 years as the necessary test.

Living accommodation is a significant cost in bringing internationally mobile employees to the UK, and that goes back to the point that I raised about the saving that will arise from the clause and the amendments. I do not have many comments to make, and I can pick them up on stand part if you are happy with that, Mr. Hood, but if the amount of revenue from additional tax on mainly internationally mobile employees is likely to be substantial in the context of a rise in higher rate income tax, has the Treasury or HMRC assessed what it is likely to be? That raises questions about the overall ability of the UK and specifically the City to attract internationally mobile employees, and whether there is any concern that in some small way the tax burden on them will increase, thus making the UK less attractive to those employees and damaging the competitiveness of the UK and specifically the City. I do not want to make an issue of that, but I would be interested to know whether any assessment has been made.

Stephen Timms (Labour, East Ham)

The estimate is that the clause will protect £45 million of revenue in the current year.

David Gauke (Conservative, South West Hertfordshire)

I am sorry to intervene before the Financial Secretary has got going. Within that £45 million, does he have any idea of how many individuals will be affected so that we can have an assessment per person?

Stephen Timms (Labour, East Ham)

HMRC may well have an estimate, but I do not have it in front of me. If the matter is drawn to my attention, I will certainly let the hon. Gentleman know what it is. He is right about the sort of people about whom we are talking. The truth is that everyone knows what the rules are, and that tax should be paid, but it has become apparent that arrangements are entered into involving a front payment lease premium and a small rent to reduce tax. That arrangement is artificial, and I do not believe that closing the loophole will have a material impact on UK competitiveness.

I think I understood correctly that the hon. Member for South-West Hertfordshire asked about leases of different lengths. When a lease is less than 10 years with a break clause, the same rules apply. When it contains a relevant break clause that is not exercised, the new rules in the amendments will deem that, for the purposes of the legislation, a separate, notional lease had started immediately after the time at which the original lease would have ended had the break clause been exercised. The lease premium payment will be spread across the full terms of the original and notional leases, which would not have been the case under the Bill as drafted. Without the amendments, the total lease premium payment for the full original term of the lease would be spread across the shorter period to the date of the break clause whether or not it was exercised. That is unintended, and the amendments ensure that the new rules apply as intended.

The hon. Gentleman asked about the numbers affected. I cannot give the full number, but the costing was based on 47 cases of individuals employed by 19 companies using those arrangements.

David Gauke (Conservative, South West Hertfordshire)

I am grateful for that information, but it suggests a sum of about £1 million per person, which seems extraordinarily high, and I cannot believe that it is right. I do not know whether that is a sample from which the figures were extrapolated, but if we are talking about £1 million per person, it is quite a consideration.

Stephen Timms (Labour, East Ham)

My advice is that the costings are based on 47 cases of 19 trusts gaining a tax advantage. They are based on actual cases in which employers have used the lease premium arrangements, and the estimate that I gave does not involve extrapolating from those cases to assume higher levels of tax avoidance. We are indeed discussing some very up-market accommodation.