FINANCE BILL

Public Bill Committee, 21 May 2013.

(Except clauses 1, 3, 16, 183, 184 and 200 to 212, schedules 3 and 41 and certain new clauses and new schedules) - Clause 17 - Cash basis for small businesses

Nigel Mills (Conservative, Amber Valley)

I beg to move amendment 3, in clause 17, page 7, line 24, at end add—

‘(2) The Chancellor of the Exchequer shall instruct the Office for Tax Simplification to publish a report on the effectiveness of the provisions in Schedule 4 and other tax rules on encouraging small businesses to expand and increase employment; and the Chancellor shall place a copy of the report in the House of Commons Library.’.

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss the following:

Clause stand part.

Amendment 55, in schedule 4, page 162, line 10, at end insert—

‘(8A) The Treasury shall publish an assessment of the impact that the relevant maximum set out in subsection (5) will have on the receipt of revenues by Her Majesty’s Revenue and Customs when compared with a relevant maximum set at £30,000.’.

Amendment 4, in schedule 4, page 162, line 18 , leave out ‘H’ and insert ‘I’.

Amendment 5, in schedule 4, page 163, line 3, at end insert—

‘(9A) Condition I is that at any time within the period of seven years ending immediately before the basis period for the tax year, the person was convicted of an offence relating to the evasion of tax or the fraudulent claim of one or more benefits.’.

Amendment 6, in schedule 4, page 163, line 15, at end insert—

‘(1A) For the purposes of subsection (1) an election made on or before the date of filing of the relevant tax return for tax year shall be deemed to have been made on the last day of the tax year to which the return relates.’.

That schedule 4 be the Fourth schedule to the Bill.

Nigel Mills (Conservative, Amber Valley)

It is a pleasure to be back here this morning. I welcome the measures in the clause. If we are trying to encourage people to start their own business and try to grow those businesses, it is right that we introduce measures to make it as simple as possible for them to do so. It is absolutely right that we try to make their experience of the tax system, perhaps for the first time as a self-employed person, as simple, straightforward and painless as we can.

We have some very welcome measures that take us in the right direction. As a qualified accountant, I say that with a heavy heart, because for many years we were told that the important thing for a business was to understand all its revenues and costs and to work out whether it was making a profit out of each individual transaction. Using a cash basis is far too simple and can give a misleading picture. Because there is more cash coming in than going out each week, the business thinks it is doing really well, until some large bills turn up at the end of the year. Conversely, the business thinks that a large piece of expenditure might be a bad thing, because it does not have the cash at that minute, but that piece of investment would provide a much larger return in future. So there is some downside to moving to a cash basis of accounting.

Over the years, accounting practice has cycled from cash to accruals to ever more complexity, and then back to the simplicity of cash. There is some attraction for very small businesses—the one-man bands—to try to get the income on which they pay tax to be as close to the increase in cash that they have earned over the year, rather than having to go through complex calculations of allowances, tax expenditure and all manner of complicated rules. What the Government are trying to do is absolutely right. The Office of Tax Simplification should get credit for the suggestion it made last year, although I am not sure we are entirely in the situation that it intended.

There has been some concern that what is proposed is perhaps not quite as simple as everyone expected. We can all picture a “Yes, Minister” sketch in which the Minister says, “I want to make a really simple system for very small businesses”, and the official says, “That’s a good idea, Minister, but have you thought about what happens if they buy an expensive car and get tax relief up front? Perhaps that is a bad idea. Perhaps we should make an adjustment for that. What about this scenario and that scenario?” Somehow, rather than paying tax on the increase in cash over the year, we end up with a rather long schedule with complicated situations, and the very small businesses that we were trying to take out of complexity then have to try to work their way through them.

Chris Leslie (Labour, Nottingham East)

The hon. Gentleman makes a very important point about an idea that perhaps started sensibly, but then was picked up by Ministers and officials and changed in a slightly untoward way. Does he agree that quite a good parallel can be drawn, because the Exchequer Secretary has many similarities with Jim Hacker?

Nigel Mills (Conservative, Amber Valley)

It would probably be foolish to go that far. It is a while since I have watched any episodes. I tried to watch the new series, but it does not compare with the old one. I am sure that the Minister’s career will be as successful as Jim Hacker’s. That remark might rescue me.

Our tax regime, with our support, should encourage someone not only to start a business but, if they are successful, to try to grow it. If we could get sole traders to the stage where they could employ somebody to take the business forward, that would be a powerful way to improve the position of our economy, especially where we have youth unemployment. We should be careful that we are not creating a big ceiling beyond which it is hard or painful to grow a business. I am thinking of a scenario in which perhaps a self-employed plumber is doing quite well and making a nice income, perhaps £30,000 to £40,000 a year, and the turnover is getting pretty close to the VAT threshold. They do not employ anyone, so there are no PAYE responsibilities. They pay no VAT, so they have no VAT duties, and they can file a relatively simple tax calculation based solely on cash in surplus that year, effectively ignoring all the complexity.

Someone might think, “I could make a bit a more money if I took somebody on and trained them. I could give that person a start in life, train them and give them a career and a skill. But, if I do that, my income will go above the VAT threshold. I will have to cope with all the PAYE reporting and now I have suddenly got myself into doing proper accounting that I have not had to do before.”

The implication is that the price goes up by 20%. That is probably a real cost, because the person is now competing with people who are not having to pay that 20% of VAT. There is all that additional complexity and the risk of employing someone. It is not unreasonable for someone in that situation to think that they are making a nice living, and have a successful business and a good reputation and to wonder whether they want all the hassle of taking on that first or second employee.

I accept that the Government have rightly come up with a policy that starts next year whereby payroll taxes will be exempted for a while. That is clearly welcome news. We need to graduate the tax system so that people start out simply and easily and get used to running their own business and making some money. Then all the complexities involved in getting bigger come in one by one on a graduated scale and do not all hit at the same point.

Someone might get their turnover up to the high £60,000s and think that that is as far as they want to go; that it is too hard to go any further. There was some merit in the OTS setting the rules at £30,000 to £40,000 turnover, rather than the VAT threshold. That would then have been graduated. Those are the reasons for tabling amendment 3, which asks the OTS to have another look at all the tax systems and where they all start, and to ensure that we do not, with the best intentions of trying to help, accidentally create a ceiling through which it is hard for businesses to grow.

The OTS could have another look at whether the regime that has been introduced is a little too complex. Some of the rules that have been introduced to meet sensible concerns have perhaps gone too far beyond the intended simplification. I have no view on when the report should be done. Perhaps we should give these rules a year or so to see what the take-up is. I accept that tax returns must be filed, which might take quite a while to achieve. If we are to get this radical change right, it is worth ensuring that we have not introduced something that is too complex to be helpful and might create a barrier that we did not intend.

There are clearly other issues with cash accounting. It lets people play games. We do not want to encourage clever accountants or people of dubious morals to play clever games, but people could clearly reduce their tax bills by just forgetting to collect any cash from customers until the day after the tax year. Someone might delay receipt of income by only a few days, and delay the tax bill by about a year. That could be just a one-off saving, but I am not sure that it is the sort of thing that we want to encourage.

Where people have previously tried to avoid or evade tax or engage in benefit fraud, I am not sure that we want to give them the flexibility to put income on this simplified cash basis. That is the reason behind amendments 4 and 5. If there is experience of someone trying to defraud various systems, perhaps they should not be allowed this more relaxed way of preparing their tax calculations. Perhaps we ought to insist that someone keeps proper accounts on a proper basis so that it is known what is really earned.

I will next talk to amendment 6. When someone starts a business for the first time, there are many complexities to deal with when they just want to get started and find the first customers and the equipment that they need. They might not get round to all the tax compliance at the start. Someone might think that the tax year end is the time; that they need to file a tax return and find out what they need to do. The way the rules are written means that the cash basis cannot be used for the first year of trading if the deadline of the tax year end has been missed.

With amendment 6, I am saying that someone should be able to elect the cash basis when they file a tax return, rather than be required to have done so during the tax year. That would make the system a little easier for people who are starting their first business and are not used to all the compliance. I can see risks, and we do not want people to be yo-yoing between the cash basis and the accruals basis, thinking, with retrospective knowledge, “The cash basis favours me, so I will choose it.” However, people should be able to make that election for the first time in their first tax return, rather than during the year. Once they have made it, it will stick for five years, so that they cannot yo-yo each year and choose whichever basis benefits them.

I have some questions for the Minister. I would like to understand how the system will tie in with universal credit. Clearly, a lot of people who will benefit from this system will also be claiming universal credit to top up their self-employed income. When people report their income fortnightly—or whatever it is—for universal credit, that will be on a simple basis of cash in, less cash out. We want the 12-month total of what they report to be the same as their taxable income under this system, so that we do not have any strange adjustments or differences; we do not want it to be the case that when they file their tax return, their universal credit calculation is found to be wrong. I am not entirely sure whether the two sets of rules—those for universal credit and those that we are considering—will get us to similar answers.

There is one minor point: the schedule talks about someone being “entitled to universal credit”. I presume that what we mean by “entitled” is that someone is both entitled to and is claiming universal credit during the year, rather than being entitled without ever actually claiming. It could cause confusion if people were legally entitled to claim something but never actually did; would they get the extra benefits of this system? Perhaps “entitled” means that someone has to make a claim and prove their entitlement, but will the Minister give some clarification on that issue?

This is a welcome change. It is clearly a positive thing for very small businesses, which we need to help. However, there are some issues with the change and perhaps some further tweaks would make the system the best it could possibly be.

Chris Leslie (Labour, Nottingham East)

Good morning, Mr Crausby. It is a pleasure to be moving on to clause 17 of the Bill, although the main substance of the measures is really in schedule 4. I am sure that hon. Members, basking in the warm feeling that they will have from receiving a nice e-mail from their leader this morning saying how much he loves them, and cherishes and values their contribution, will be delighted that the hon. Member for Amber Valley has tabled amendments that are in no way, shape or form swivel-eyed. In fact, they are sensible, prudent and eminently supportable amendments. The Opposition value his hard work and diligence in keeping the Government on their toes—something a lot of his colleagues have also been doing recently, although in a perhaps less constructive way.

Looking at this issue, I agree with the hon. Gentleman. We see where the Government and the Office of Tax Simplification are coming from in trying to remove a burden from micro-businesses and sole traders, and in this case from partnerships as well. Those groups might find it easier in some circumstances to account for their income and expenditure on a cash basis and report their income for tax purposes accordingly. The trouble is that experts, having looked at these particular provisions, have been increasingly concerned about how the Government have picked up the recommendation from the Office of Tax Simplification and have turned it into something that might have a number of unintended consequences.

To dwell for a moment on what exactly it is that we are talking about, an accruals basis for accounting—for a small business or for any business—is essentially a process of recognising income and costs as they are earned or incurred, but not as the money is received or paid, so that they are dealt with in the profit and loss account for the period in which they are earned or incurred. So far, so good, and a lot of accountants—I am not one myself, so I am not versed in the details—will be familiar with that process. Indeed, it could be argued that hon. Members are quite familiar with these issues for the purposes of the Independent Parliamentary Standards Authority. We lodge our expenses for the period in which they are incurred, not necessarily for the period when we part with the money and pay the Revenue. That can often fall on either side of a financial year. But the move to the cash basis would mean that an individual could bill someone for work done in the 2013-14 tax year, for example, and does not need to account for that until the bill is paid. If the bill is not paid until after 5 April 2014, the sum of money would not need to be recognised in those accounts until the financial year 2014-15.

Let us say for the sake of argument that the Exchequer Secretary commissioned me today to do some work for him, perhaps a bit of plumbing or window cleaning around his large estate in Hertfordshire. He might well say to me, “Thank you very much for doing that work.” Under the cash-basis arrangements I could say, “Wink, wink. Don’t pay me until after 5 April next year. That is quite a good arrangement as this year I don’t want to part with too much tax. How about I invoice you in 11 months’ time and you pay me on the other side of 5 April 2014 as I would rather not pay tax this financial year.” As a sole trader, technically I would not need to pay income tax on that until January 2015, which is quite a long way off if I were doing that window cleaning or plumbing for the Minister today. It is quite a good way of deferring my tax burden. It might be perfectly justifiable, but it is an interesting point.

Sheila Gilmore (Labour, Edinburgh East)

My hon. Friend suggests that someone might do that to relieve their tax burden, particularly when entering self-employment. There is a danger that people might see these extended tax periods as almost being over the event horizon, and fail to put aside enough money to meet their tax bill. Presumably we do not want to exacerbate that situation.

Chris Leslie (Labour, Nottingham East)

My hon. Friend has led me neatly to the rationale behind amendment 55. Essentially, it asks the Treasury to set out what it anticipates the effect on revenues and receipts for HMRC will be from this change. After all, we know that the Chancellor has been very keen to do everything he possibly can to maximise income in the years in which his deficit figures required urgent attention, to bring in as much income as possible and, under the Budget exchange process, kick the expenditure beyond the financial year. There are all sorts of little accounting tricks that the Chancellor has been involved with so that he can try to make it appear as though the deficit is at least static at the £121 billion it was the year before last, the last financial year and is predicted to be this financial year because deficit reduction has totally stalled.

It is interesting that the Chancellor has sanctioned this move, which might mean that quite a lot of income and revenue for HMRC that might normally be accrued within this financial year can now be kicked forward into the subsequent financial year. Such is the insight of the Treasury that it has decided to increase this threshold from £30,000 of turnover to at least £79,000. In other words, it has aligned it with the VAT threshold. Of course, because of the rolling accounting processes involved with the VAT thresholds, I am told that, in reality, that will mean income projections of double that amount: £158,000. That is a large amount, which probably covers the majority of small businesses as 96% of small businesses are defined as micro businesses: those with fewer than nine employees.

It would therefore be helpful if the Minister would confirm his understanding that this provision will cover most sole traders and partnerships. He could also help the Committee by putting on the record that that is not intended to apply to incorporated companies and that the effect will be mostly on income tax. I ask that question because in schedule 4, on page 161, the drafting refers frequently to firms; for example, it states:

“Condition B is that, in a case where the person is either an individual who controls a firm or a firm controlled by an individual”.

The Treasury uses “firm” a lot in the drafting, but as there is no definition of what a firm is, I am worried that many traders and partnerships who might be on the verge of incorporation could be confused into thinking that cash basis accounting would still be available to them post-incorporation. It would be helpful if the Minister would clarify that his definition of firm does not cover incorporation and explain why that is not set out in the schedule—perhaps it is, but I could not find it.

It would also be useful if the Minister would explain how this measure will work with partnerships. It is all very well if I am a window cleaner or plumber pulling my forelock as I look for work at the Minister’s Hertfordshire towers, but if I am in a partnership, there are two of us in that endeavour, so how do we decide on the basis of accounting that we will use in that partnership? For example, my hon. Friend the Member for Newcastle upon Tyne North may have a determined attachment to accrual basis accounting for our window cleaning partnership while I may say, “No, I want to go to a cash basis”. What is the mechanism for resolving which basis of accounting we would pursue? If I am quite adamant that it should be cash basis, while she likes the accrual basis, how does a partnership resolve by election—[Interruption.].

David Gauke (Conservative, South West Hertfordshire)

Labour splits!

Chris Leslie (Labour, Nottingham East)

The Labour party, of course, is united in wanting to use the basis that is best for the taxpayer. Perhaps HMRC’s advice would be to toss a coin, but I make a flippant point to highlight a serious issue: how will a partnership resolve the question of which accounting system to use?

It was Yvette Nunn, the president of the Association of Taxation Technicians, who concluded that:

“This is a good idea gone bad.”

She has been open about how small businesses informed her organisation that the tax system is the bane of their lives, yet the offer on the table today is not much different from before. It is important that the Minister listens to what the experts say and it is incumbent on the Treasury to explain why it has overruled the Office of Tax Simplification’s suggestion that this measure should be for just £30,000 of receipts, payments and turnover, and instead went for this large figure. Various rumours are circulating that it is something to do with alignment with universal credit accounting provisions, so it would be useful if the Minister could explain why the Government have chosen that basis.

The legislation links the threshold to the VAT threshold at the end of the tax year, not at the start. VAT thresholds are linked to financial years, as I understand it, whereas the cash basis is linked to tax years. There are obviously a few days of anomaly between the two—I wonder whether the Minister has found a clever way of addressing that, because obviously some businesses run to 31 March for VAT purposes, but cash-basis accounting on a tax-year basis would run to 5 April. The Chartered Institute of Taxation has pointed out that we are left with 24 pages of legislation to effect a simple idea.

The Institute of Chartered Accountants in England and Wales has done a considerable amount of work on this subject and I pay tribute to it for highlighting these issues. It does not think that the proposals should be implemented from 6 April 2013 in their current form, and has suggested a delay to iron out some of the anomalies. It has also pointed out that there is a danger of moving away from horizontal equity across taxpayers. All taxpayers in similar circumstances should be treated the same. There is a risk that if some are operating on a cash basis and others on an accrual basis, we could end up with unintended consequences.

It is always dangerous to resort to reading out things that are posted on the internet; I know that some Government Members have been caught out doing so in different circumstances. However, I spotted an interesting thread—I think that that is what they are called—of comments on a blog on a site called AccountingWEB. After the announcement of this £154,000 or £158,000 threshold, quite a lot of concern was expressed by a number of tax experts about what the consequences could be. I am told that the Government will allow total freedom for micro-businesses to switch between cash-basis and accrual-basis accounting, in or out, as often as they like. It is that ability to switch backwards and forwards that has caused a bit of consternation. In those circumstances in particular, will the Minister explain how HMRC will capture abuse or unintended adverse consequences that could flow from that switching process?

For example, if I decide to bill the Minister for odd jobs around his estate after 5 April next year because I have moved to cash-basis accounting, essentially I do not have to pay tax on that income accrued in this financial year. However, if I get to 4 April or 5 April and decide that I will flip it back—we know that flipping has caught people out in the past—to an accrual basis on that day, I do not have to account for work undertaken in a previous year. Are we therefore going to lose certain amounts of money that have been moved from one tax year to another? I am sure that that cannot be right, but queries have been raised about whether, if I move to an accrual basis in the next financial year, I may be receiving money in that period, but I have not done the window cleaning or the plumbing in that financial year so I do not have to account for it in my tax return for that financial year. The Minister must address the ability to flip between cash-basis and accrual-basis accounting.

John Cryer (Labour, Leyton and Wanstead)

Does this potentially imply that the flow of cash into the Treasury may rise and fall with a more exaggerated effect than previously? It may increase sharply, but it may drop sharply if the behaviour of a large number of SMEs follows the pattern that my hon. Friend has talked about.

Chris Leslie (Labour, Nottingham East)

My hon. Friend is entirely correct. That is why we tabled amendment 55, which seeks a proper assessment of the likely effect of this choice of threshold on the revenues for HMRC. We need to know what that is not just because extra volatility may be created as a result of the threshold, but because of the possible effect on deficit reduction. Obviously, it is important for Ministers to cling to the pretence that they are reducing the deficit year on year. It might jeopardise their ability to make that claim, so I am sure the Chancellor is concerned about it as well. As I say, concerns have been raised about this arrangement.

I know this is a bit crude—I often counsel against people spending too much time on the internet—but one comment on this blog is:

“Yippy, going to have fun with that loophole...In Out In Out In Out...It will be like making love to HMRC…Pst, can we all be good now and NOT explain how that might work—I feel a gold rush of new work coming our way.”

That was from one of the accountants who made a comment—anonymously, it has to be said.

There was another set of comments. I did not want to read too much further into the outer reaches of the comments, but one was:

“legalised tax evasion. Lots of ‘loopholes’. Am going away to bang my head against a wall.”

There is another comment here:

“So, for y/e 31st March 2014 elect to use the cash based scheme. All March sales are invoiced on 31st March, cash is received in April and is therefore excluded. Purchases and stock relating to the later year are purchased in March and are therefore included. For y/e 31st March 2015, elect to use the accruals basis and this same income and expenditure is excluded. Keep swapping every year from one scheme to the other and HMRC are going to lose a large amount of dosh; even given the fact that this is for businesses below the Vat threshold.”

Another commented:

“Abuse of in-and-out is going to be rife. The advice is to buy all your stock in year 1 and prepay all your expenses under cash accounting and sell the stock in year 2 under accruals accounting. So essentially you get a double deduction for expenditure. Consultancy types who can control their income”—

we know there are certain individuals in those circumstances—

“will make a huge saving by getting their clients to pay up front on the last day of year 1, pay nothing in year 2 and pay in arrears on the 1st day of year 3. The income would appear to escape taxation altogether.”

Another blogger commented on the headline of one article:

“‘Tax avoidance is now for the little people’…What a brilliant headline. I love it. I wonder if we are now going to get the protesters camping outside Fred the Plumbers or Joe the Greengrocers instead of Starbucks with the signs reading ‘Turnover £76,999—Tax nil’…Do they honestly think that taxpayers are not going to take advantage of switching every year?”

Another commenter says:

“That will be the Christmas gift that will keep on giving for years to come. A lovely new loophole to play with until the powers that be work out what’s going on and stop it in about 3 or 4 years time. I really really hope that isn’t the case as it will be grossly unfair to gain an advantage just by switching schemes.”

Those are the sorts of concerns that have been voiced on that particular issue.

I turn to the amendments from the hon. Member for Amber Valley. As I say, I think he made some important points. I like amendment 3 very much. I think a report should be published on the effectiveness of these provisions, on employment in particular. Obviously, we want to do the right thing for small firms. In most cases, I am sure the cash basis arrangement for small micro-firms can be made to work. We do not entirely rule out the benefits that that could bring, but it is important that we get some evidence that the Treasury is not rushing headlong in a dogmatic direction without thinking things through properly. Heaven knows, we know it has made that mistake before. I thought amendment 5, about not letting those with convictions in the past seven years for tax evasion or fraud use the new arrangement, was particularly good and very sensible. I can see circumstances in which there might be abuses of the regime unless things as they stand are tidied up.

I am taken with the amendments. Important points were made in the discussion on the amendment in the name of the hon. Member for Amber Valley. Although I look forward to hearing the Minister’s assurances that I am wrong on many of the points, there are significant anxieties.

David Gauke (Conservative, South West Hertfordshire)

It is a great pleasure to serve under your chairmanship again, Mr Crausby.

Clause 17 and schedule 4 introduce an optional, simpler income tax regime, commonly referred to as the cash basis, for the simpler small business. The cash basis will make it easier for small businesses to meet their tax obligations and give them greater certainty that their tax affairs are correct. It will not suit every business; there will be many circumstances in which formal accounts are more appropriate.

The nature of the business should determine whether the cash basis is appropriate, not tax. The cash basis will give small, unincorporated businesses the choice to be taxed based on the money that passes through their business. They do not have to apply the tax rules designed for larger or more complex businesses. Perhaps, at this point, I should confirm that, yes, it is unincorporated businesses—sole traders, partnerships and so on. As for the definition of “firm”, customarily, in legislation in this context, it applies to unincorporated businesses. That is certainly what I was taught at law school and I do not believe that it has changed.

The Government believe that the tax system should support work and be simple, predictable and fair. In 2011, the Chancellor asked the Office of Tax Simplification to identify the areas of the tax system that cause the most day-to-day complexity and uncertainty for small businesses. The final report of February 2012 identified the possibility of introducing a new approach to taxation for the smallest unincorporated businesses.

The report confirmed that business owners are trying to get their tax right, but it identified that a significant proportion worry that they may have made unintentional errors in, for example, preparing a taxable income figure or claiming for capital expenditure. To address those concerns, in Budget 2012 the Government proposed a new cash basis for small unincorporated businesses, to apply from April 2013. I thank the Office of Tax Simplification for its work. The changes before us are a significant simplification that will help many businesses.

Sheila Gilmore (Labour, Edinburgh East)

Why, having accepted the recommendations of the Office of Tax Simplification, did the Government not accept the threshold the OTS suggested, which was set much lower—at about £30,000—than the VAT threshold that has been adopted?

David Gauke (Conservative, South West Hertfordshire)

We looked at the recommendation. The concept of the cash basis is sensible, but many businesses with receipts of more than £30,000 are not complex and the principles and approach that the OTS set out for some businesses up to £30,000 a year could apply more broadly.

The increased eligibility limit makes the cash basis available to more businesses. It is a step in the right direction and we want to go further. There are dangers in making comparisons with other jurisdictions, but I recently read a note on current tax issues in the US, where there is a debate about the cash basis—currently, I believe, at £500,000—and whether it should be increased.

To be fair, there is no exact like-for-like comparison between the systems, but we believe that the OTS proposed sensible recommendations and that the benefits should apply to more businesses, up to and including the VAT threshold. Since the announcement, HMRC has engaged extensively with businesses to ensure that we get the design of the regime right.

Schedule 4 sets out that use of the cash basis for unincorporated businesses and partnerships is entirely optional. To be eligible, a business must have receipts not exceeding the VAT registration threshold in the tax year. Certain, more complex business types and trades are excluded from the cash basis. The schedule provides that a business may calculate its profits based on receipts when they are received and expenses when they are paid. Tax relief for assets purchased, other than cars, is given as an expense instead of using capital allowances rules.

The schedule also sets out that deductions for interest on cash borrowings are restricted to £500 and that sideways loss relief is not available to businesses using the cash basis. In addition, no market value adjustment needs to be made when taking stock for one’s own use. The schedule also repeals the existing rules for new barristers, but they, too, will be able to use the new cash basis.

Amendment 55, tabled by the Opposition, asks the Government to publish an assessment of the impact on tax receipts of setting the entry limit to the cash basis at £30,000 instead of the current entry limit of £79,000. We do not believe that such an assessment is required. The cash basis is not a tax relief; it is intended to simplify tax for small businesses. The Exchequer cost of any entry limit is a one-off timing effect. That is due to adjustments made by businesses that switch to the cash basis. The money is recovered in later years as businesses cease trading. The cash basis is effectively revenue neutral over time.

The OTS proposed an entry limit of £30,000 and an exit limit of £40,000, which I assume is why the Opposition are interested in the Exchequer cost at the limit. However, the Government have opted for a higher limit because they wanted a larger number of businesses to be able to use the cash basis, if they want to. As I said, 3 million businesses are eligible at £79,000, more than 500,000 more than at £30,000. The Federation of Small Businesses has praised the Government for offering the simplification to more businesses. In addition, the entry limit is tied to the VAT registration threshold, an existing threshold in the tax system that small businesses recognise. We think that that will be helpful.

My hon. Friend the Member for Amber Valley tabled a number of amendments to the schedule. First, he suggests that the Government ask the OTS to publish a report on the impact of the cash basis and other tax rules on encouraging small businesses to expand and increase employment. Secondly, he proposes an additional category of persons excluded from using the cash basis—those who have been convicted of an offence relating to tax evasion or the fraudulent claiming of one or more benefits. Thirdly, he tabled a technical amendment concerning the date, or deemed date, on which an election to use the cash basis has been made.

As my hon. Friend is aware, the proposals in schedule 4 are the result of the Government’s response to the OTS review of small business taxation. The Chancellor set up the OTS in July 2010 with a remit to review specific areas of the tax system and make recommendations on how to simplify them. The remit does not extend to reviewing the impact of changes to the tax system on business growth or employment.

The Government, of course, keep all tax policy under review. Also, HMRC and the Treasury routinely monitor the impact of economic reforms on a case-by-case basis. As such, we do not think it necessary or within the OTS’s remit to assess the economic impact of the cash basis or any other changes to tax.

The cash basis is designed to help the smallest businesses by allowing them to calculate their taxable profit on a basis that is appropriate for their business. As such, the Government consider that the cash basis is not a benefit that should be withdrawn as a punitive sanction. To do so could force a business to use an accounting basis that is not appropriate and would be counter-productive.

Existing procedures are in place to control and monitor the compliance of defaulters and, additionally, there are technical issues with the amendment that would prevent it from operating effectively. I appreciate that my hon. Friend tabled it as a probing amendment. The Government do not recognise that an amendment to the date of election to use the cash basis is necessary. The election is made when filing a return and so any election outside a return might cause an additional administrative burden.

Chris Leslie (Labour, Nottingham East)

I am interested that the Minister is not persuaded by amendment 5 on the grounds that he does not want to add a further exclusion to those persons who might be eligible to use this scheme. I worry that he dismisses it too lightly. If we know individuals have been convicted of fraud or tax evasion in the past, are there not legitimate grounds for thinking that this constant switching in and out might be too tempting a regime in respect of abuse? There are a number of other exclusions and I do not quite see why he turns his back on that one.

David Gauke (Conservative, South West Hertfordshire)

I was going to turn to the issue of switching in or out—the hon. Gentleman’s “hokey cokey” argument—in a moment. It is worth pointing out that the aim of the cash basis is to provide an appropriate means of assessing tax liability. It would be unfortunate if we forced the business not to use the most appropriate accounting basis.

The essence of the argument is that there will be greater vulnerability to avoidance or evasion, but I am not sure that that is necessarily the case. Indeed, one could look at sideways loss relief, which is not allowed under the cash basis. Sideways loss relief could be abused, but only under the accruals basis. I am not sure that I necessarily accept the premise of the concern.

I turn to the potential risk that, with a business moving from the cash basis to the accruals basis, tax might not be paid. The comments that the hon. Gentleman read out from the website were based on the original proposals. Since then, the rules have been tightened. He set them out in a somewhat tentative form and rightly so. Following the consultation, it is clear that the cash basis is an opt in and stay in regime that allows a person to opt out, but only when business circumstances change.

In circumstances where a business is expanding and wishes to claim more than £500 interest deductions or to claim sideways loss relief or it decides to register for VAT, it could move from the cash basis to the accruals basis. But a business changing between cash and accruals basis would need to make transitional adjustments such that income was only taxed once and relief for expenditure was only given once. I hope that that has addressed the hon. Gentleman’s concern.

Chris Leslie (Labour, Nottingham East)

I am grateful to the Minister for addressing the point. He says that there is now to be an opt in and stay in basis until business circumstances change. Just so that I can find it and be clear, where in schedule 4 is “a change in business circumstances” defined? If it is self-defined—“My business has grown by x amount,” or, “I am moving into some sort of different state”—it is important that we see how strong the rules are on the stay in part of that opt in and stay in arrangement. Where is that business change defined?

David Gauke (Conservative, South West Hertfordshire)

I will turn to the definition immediately. If the hon. Gentleman cares to look at part 31D of schedule 4, on page 163 of the Bill, he will see:

“An election made by a person under section 25A ceases to have effect if…there is a change of circumstances relating to any trade, profession or vocation carried on by the person which makes it more appropriate for its profits for a subsequent tax year to be calculated in accordance with generally accepted accounting practice”.

The point is that, as the hon. Gentleman has set out, there is concern that frequent switching from one system to another could result in benefits for particular expenditure being given more than once, or in income not being taxed at all. However, there are constraints on that, and I think he will find that the concerns he has seen were raised about an earlier version of these proposals.

Chris Leslie (Labour, Nottingham East)

I am grateful to the Minister for his response, because this is a learning process for the whole Committee—I had not spotted that provision in part 31D on page 163. However, is he really confident that he can get away with describing this as an opt in and stay in regime when the only constraint on a business regarding flipping and switching between cash-basis and accrual-basis accounting is that they have to say that there has been a change in their circumstances, which is undefined, and that

“the person elects to calculate those profits in that way”?

I do not really see that that is a strong constraint that he can describe as a stay in provision. It is essentially a meaningless legislative provision, is it not?

David Gauke (Conservative, South West Hertfordshire)

I do not accept that. There are transitional arrangements: if somebody moves between the cash basis and the accruals basis, there is a need to make transitional adjustments such that income is taxed only once and relief for expenditure is given only once. That protects the Exchequer in such circumstances.

Nigel Mills (Conservative, Amber Valley)

The Minister will be aware that there is precedent elsewhere such that where someone has elections to choose what regime they apply, they have a five-year window. Once they are in, they are in for five years, and if they leave, they are outside for five years. That way, people cannot yo-yo around by choice if they think that they could benefit from changing each year. There is some attraction to that here—we want people to think, “This is better; I want to be in,” and then once they are in, they are there for five years unless they blast their way out of the upper threshold.

David Gauke (Conservative, South West Hertfordshire)

I appreciate the point that my hon. Friend makes. There are, however, some challenges if we are too prescriptive. For example, if a business wants to make use of sideways loss relief, greater use of interest deductions and so on—essentially, if their business becomes more complex before they have even gone beyond the VAT threshold—it would be a pity to constrain it in such a way that they could not go down that route. I believe we have got the balance right. As I say, transitional adjustment will have to be made to ensure that all income is taxed at some point and all expenditure receives relief only once.

I now turn to some of the other issues. The concern that a partnership might not be able to reach a conclusion is no different from any other issue that affects partnerships. I hope that any partnership seeking to clean my windows would be able to reach an agreement on that. Given the concerns the hon. Member for Nottingham East raised, I will not be looking to employ him as a window cleaner or a plumber.

Chris Leslie (Labour, Nottingham East)

What about my hon. Friend the Member for Newcastle upon Tyne North?

David Gauke (Conservative, South West Hertfordshire)

Perhaps the hon. Member for Newcastle upon Tyne North has got a better chance. This is a matter for normal partnership arrangements. It is for partnerships to determine how they wish to do it. It is normally the controlling partner who makes the final decision, and if there is no controlling partner, then a nominated partner. But it is a matter on which partnerships must reach a decision in the normal way. I see no reason why partnerships cannot deal with it.

I hope that those answers have helped explain to the Committee how the cash basis will work. The Government appreciate that UK small businesses make a significant contribution to the economy and public finances, and it is right that the Government support those businesses. The clause and schedule give 3 million small businesses the option to simplify their tax calculations and have greater certainty over their tax affairs. I hope that the Committee welcomes them.

Sheila Gilmore (Labour, Edinburgh East)

It has been suggested that these changes will help to align the system for universal credit. Will the Minister explain how?

David Gauke (Conservative, South West Hertfordshire)

I am grateful to the hon. Lady for raising that matter. Indeed, I should also respond to the point that was raised by my hon. Friend the Member for Amber Valley. The calculations for cash basis and universal credit have been aligned as much as possible. Some differences do remain, as the calculations are for different purposes. Just to give one example, payments of tax and national insurance contributions are included as deductions in the universal credit calculation, but are not deductions for income tax purposes. There are some differences, but as far as possible we have tried to align those definitions.

Chris Leslie (Labour, Nottingham East)

I sense the Minister’s peroration is coming. Before he does so—I might have missed this in the blink of an eye—on amendment 55 we sought a figure for the impact that the shift to the cash basis will have on HMRC receipts. Has he calculated what that figure is, because it is quite crucial?

David Gauke (Conservative, South West Hertfordshire)

Those numbers are included in the Red Book and the tax information note. In terms of Exchequer impact, overall the shift is revenue neutral. I think this may be in the Budget 2012 documentation. To help the Committee, there is a cost to the Exchequer in 2014-15 of £165 million, a benefit in 2015-16 of £25 million, a cost in 2016-17 of £5 million, and then after that it is negligible. Essentially, this is a timing issue. There is a cost in 2014-15, but it is not because less tax is paid; it is because the tax is paid in subsequent years.

Chris Leslie (Labour, Nottingham East)

I have found the figure on page 66 of the Red Book. If the measure is revenue neutral, why will the Exchequer lose £165 million in 2014-15, recoup only £25 million in 2015-16 and then lose £5 million in 2016-17? That does not look revenue neutral to me.

David Gauke (Conservative, South West Hertfordshire)

It is essentially about timing: the tax is paid, but in later years. On such issues, the difficulty is that the Red Book does go to the end of time. The money will be paid, but it is shifted to the right. There is no total cost over a period that incorporates everything. As sometimes occurs in the tax system, there is a delay to the payment of the tax, but it will be paid in total.

Chris Leslie (Labour, Nottingham East)

The Minister suggested that the tax had been shifted so far to the right that it goes beyond the frame of the Red Book, which is to 2017-18. If that is the case, why does the measure go back into loss in 2016-17? I could accept his point if the figure was minus £165 million in the first year—2014-15—and that it somehow recovers even beyond 2017-18, but it is back into loss again in 2016-17.

David Gauke (Conservative, South West Hertfordshire)

Let me see whether I can make the issue clear for the hon. Gentleman. There is a delay in a certain amount of tax being paid each year. For example, certain sums that would have been paid in 2014-15 will be paid in 2015-16, but, equally, some of the sums that would have been paid in 2015-16 are then paid in 2016-17 and so on. The scorecard cannot reflect the fact that there is a shift to the right, as it were, because a sum of money is now consistently paid later than previously. The first year, as we adjust from one system to another, can be seen on the scorecard, but the reality is that the same total amount of tax will be paid.

Chris Leslie (Labour, Nottingham East)

Will the Minister give way?

David Gauke (Conservative, South West Hertfordshire)

I will give way for one last time. I fear that the hon. Gentleman and I may be struggling to understand what we are saying to each other, although I think that I have been clear to the Committee.

Chris Leslie (Labour, Nottingham East)

One of us is struggling for sure. Essentially, the Minister seems to be saying that the effect of the shift in the Red Book figures is a cost of £140 million to the Treasury, which is a loss to the Exchequer of a considerable sum of money. He says, “Oh well, it will be recovered further down the line,”, but that is a big example of kicking the can down perhaps a very long road, with that £140 million never being recovered by the Exchequer.

David Gauke (Conservative, South West Hertfordshire)

As I say, the issue is tiny. The costs have of course been certified by the independent Office for Budget Responsibility, and a published note on the costing can be found on the Treasury website, which I am sure that the hon. Gentleman has visited.

In conclusion, the change is a significant simplification for a large number of businesses. It is a consequence of the hard work of the Office of Tax Simplification. It will make a difference to many businesses by reducing some of their concerns about complying with the tax system. It is consistent with what the Government are doing to make life easier for small businesses. The employment allowance will come in next year, which will also be of substantial benefit to small employers. Given my clarification, I hope that hon. Members will not persist with their amendments but will support the clause and schedule.

Nigel Mills (Conservative, Amber Valley)

I am grateful to the Minister for his clarifications. Given the amount of work that the Office of Tax Simplification has, moving it into the field of economics would probably not be the most productive use of its time, so I will happily seek leave to withdraw amendment 3.

One of the perils of being a humble Back Bencher is the difficulty of drafting amendments that can be legally operative; it is clearly beyond my drafting talents. I will therefore not seek to press amendments 4 to 6 to a Division.

Chris Leslie (Labour, Nottingham East)

I am not convinced that the Treasury has a proper grip on the financial impact on the Exchequer of the move to the cash basis. It looks as if it will cost the taxpayer at least £140 million, at a time when the Government’s finances are in difficulty and, in many ways, worsening. We should at least have a proper and open assessment about when and how far the can will be kicked down the road. I will seek to test the views of the Committee on amendment 55.

The hon. Member for Amber Valley has tabled some interesting amendments, particularly amendment 3, which I wish to support. He has indicated that he wants to seek leave to withdraw it, but I would like to test the Committee’s view on that as well.

Nigel Mills (Conservative, Amber Valley)

I beg to ask leave to withdraw the amendment.

Schedule 4 - Cash basis for small businesses

Clause 18 - Deductions allowable at a fixed rate

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss that schedule 5 be the Fifth schedule to the Bill.

Chris Leslie (Labour, Nottingham East)

I would have thought that the Minister would have the good grace to introduce the provisions here; after all, they could affect hon. Members significantly if, for example, they make claims for mileage expenses with IPSA. Hon. Members will see in schedule 5 that the Minister made some interesting choices on their behalf—we should all declare an interest on those matters.

The schedule deals with deductions that are allowable for certain business expenses, predominantly in relation to using a vehicle for business journeys or a home office for business purposes. In paragraph 2, on page 185, the Minister elects that the appropriate mileage amount for vehicles used in business journeys is:

“45p for the first 10,000 miles”

and 25p thereafter. For hon. Members who use motorcycles for that purpose, the rate is 24p per mile.

The Minister has also decided that he wants to set a rate for the use of a home for business purposes. The amount depends on how many hours are worked in that home office over a month, or part of a month. The table is a little confusing because it just lists an applicable amount, which I am assuming is deductible relief to be related to that particular month. Therefore, if 25 hours or more are worked, £10 is allowed; if 51 hours or more are worked, £18 is allowed and if 101 hours or more are worked, £26 is allowed. For other premises that are used both as a home and a business, I presume that, when a trade is actually taking place on those premises, the amounts would be more significant depending on the number of relevant occupants. It would be helpful if the Minister explained the figures in the table under schedule 5.

Simplicity is essential for small businesses, which is why it is important for there to be consistency in the rules set out under Budgets. We have had a few U-turns in recent years on certain provisions, but it is important to put some of the deduction systems on an even keel so that businesses can plan ahead. The Institute of Chartered Accountants in England and Wales asked a series of questions and expressed concern about schedule 5. It argues that the amount specified for deductions is too low and that the set rates need to be reviewed regularly to keep pace with inflation.

Government Members seem to be under the impression that, when most people fill up their tanks with petrol at petrol stations, they are all thanking the Chancellor for his decisions on fuel duty. However, in my experience, most people who fill up their tanks with petrol still think that it is a pretty expensive business and that running a vehicle is not a cheap endeavour, given that it is becoming quite expensive in not only fuel costs, but running and maintenance costs, and the other costs that are involved. The Minister needs to justify his 45p per mile relief and explain why that figure falls to 25p after 10,000 miles.

Brooks Newmark (Conservative, Braintree)

Given that the hon. Gentleman and all of us in Committee face enormous pressure from constituents on keeping the price of petrol low, can he congratulate the Government on ensuring that the price per litre is at least 10p lower than it would have been had Labour been in power?

Chris Leslie (Labour, Nottingham East)

As the Education Secretary knows, answering such hypothetical questions is probably impossible. I do not accept the premise of the hon. Gentleman’s claim that somehow such a position would have been the scenario today. In fact, he supported enthusiastically the increase in VAT to 20%, which resulted in an extra 3p on a litre of petrol or diesel, so he needs to be a little careful when he tells his constituents that they should be thanking him for the price of petrol, which is still considerable. It has risen a lot during the hon. Gentleman’s time in office.

Ben Gummer (Conservative, Ipswich)

The hon. Gentleman has clearly slept badly, given that he is being uncharacteristically churlish this morning, casting aspersions on the size of my hon. Friend the Minister’s grants and refusing at least to admit that the increase in the allowance for businesses is surely a good move. He abstained on the increase in VAT. He has also refused to admit that, at the previous election, he fought to re-enter Parliament on the basis of a fuel escalator, which would have left petrol prices 10p higher than they are now. I would have preferred a Conservative Member, but if there must be a Labour Member, I am glad that it is him, but at least he should admit that he got it wrong.

Chris Leslie (Labour, Nottingham East)

The hypothetical nature of the scenario that the hon. Gentleman paints is that there would have been no response to economic circumstances. Of course, under the previous Administration, there was a deferral or changes to the fuel duty arrangements. Government Members are not swivel-eyed this morning. That is such an insult—the Opposition would not dredge up that level of epithet against them; only their side would do that. However, they are out of touch with reality if they think that their constituents, while standing on the forecourt filling up, are thanking them, thinking, “Thank goodness the Chancellor is helping me with my fuel costs,” when those costs are as high as they have ever been.

Brooks Newmark (Conservative, Braintree)

I have been enjoying this Finance Bill Committee enormously, but I have to make the observation that the hon. Gentleman’s 150% tax on bonuses, his uncosted VAT cut and his hypothetical cut in fuel duty show once again that Labour’s numbers do not add up.

Chris Leslie (Labour, Nottingham East)

I am hurt, actually. That is uncharacteristic of the hon. Gentleman. I do not accept his points. We have just seen the Minister spend £140 million of taxpayers’ money on the previous schedule. There might be justifications for that but it is interesting to see where revenues are being depleted. That was just in this morning’s sitting. The hon. Gentleman just voted against having a proper assessment of the effect on the taxpayer of some of the proposals. It is the Opposition who are looking after taxpayers’ money—[ Laughter. ]—and Government Members do not like to hear it.

Ian Mearns (Labour, Gateshead)

Denial.

Chris Leslie (Labour, Nottingham East)

They are in denial; they are certainly somewhere.

Schedule 5 has prompted concerns at the Institute of Chartered Accountants. There are anxieties that there should be only one rate for using a private car for business. For example, it thinks that the 45p level would be better if it were sustained and could be more easily aligned with universal credit rules, which are based on a monthly rather than annual usage. I would be grateful if the Minister explained how universal credit will be affected by the different arrangements for declaring those sums, given that we have universal credit systems based on a different time frame.

The ICAEW has also warned that minicab drivers, driving instructors and others whose businesses require extensive use of a car will be unfairly disadvantaged. Ministers have in some cases dispensed with their own in-house ministerial cars and are now using private hire vehicles on a regular basis. I would encourage private hire drivers who spend a lot of time with the Exchequer Secretary, for example, to bend his ear about this matter. When they are driving him from Gauke Towers in south-west Hertfordshire to the House, they will have about an hour to talk to him about that 45p per mile deduction that he is allowing. No doubt, he will explain at great length why the reduction to 25p after 10,000 miles is justified. Those private hire drivers will certainly want to raise that with him. This is one of the few Budget measures that could affect Ministers in that way.

I have some specific questions for the Minister on the schedule. New section 94H(4) of the Income Tax (Trading and Other Income) Act 2005, in paragraph 2 of the schedule, contains a table setting out the relevant number of hours worked from home by a person; but what of those persons working from home the nature of whose work requires them either to leave their home temporarily or to travel elsewhere during the work day? Will the Minister also explain whether the Government have considered the additional administrative burden on businesses of keeping track of how many hours people work from home or how many miles they travel? I know that there are existing arrangements for those under the current tax rules, but I do not know whether an assessment has ever been made of the administrative costs involved in keeping track of those things. Really, I am looking for justification for why the figures in the schedule have been chosen, and I would be grateful if the Minister could elaborate.

David Gauke (Conservative, South West Hertfordshire)

As always, it is worth hearing the hon. Gentleman ask his questions first, giving him the opportunity to set out the contents of the clause and schedule. Clause 18 and schedule 5 make changes to introduce optional simplified expenses for all unincorporated businesses. As I outlined on clause 17 and schedule 4, in 2011, the Chancellor asked the Office of Tax Simplification to identify areas of the tax system that caused the most day-to-day complexity and uncertainty for small businesses. The Office of Tax Simplification published its recommendations in February 2012. Its report indicated that many businesses do not understand what they are allowed to claim as a deduction against income when calculating their taxable profits, and fear that in areas where an element of judgment is needed HMRC may challenge them and charge extra tax and penalties. The report confirmed that business owners are trying to get their tax right, but certain types of expense claim seem to give more problems than others, for example, use of home for work and use of vehicles.

Businesses also suggested that the effort of keeping receipts and records for large numbers of small items of expenditure outweighed the potential tax saving. In response, the Government proposed in Budget 2012 the introduction of simplified expenses from April 2013, to reduce the administrative burden on businesses. Those proposals were consulted on last summer and again following the publication of draft legislation in December 2012. HMRC has also been undertaking user testing with small businesses to inform both the design and the implementation of the new rules.

Schedule 5 sets out that all unincorporated businesses and partnerships can use simplified expenses on an entirely optional basis. There are no receipt or turnover restrictions. The schedule introduces simplified rules for motoring expenses, for the costs of business use of a home and for personal use of business premises as a home. Those are areas where business and personal expenses can be most closely intertwined, making the calculation of actual business expenses particularly difficult and uncertain for businesses.

Schedule 5 sets out that businesses have the option of using a mileage rate to calculate expenses for vehicles used in the business. That covers all forms of motoring expense, including the purchase of a vehicle, maintenance and repairs, and daily running costs. Within the cash basis, the alternative is to claim a deduction for the full cost of purchasing a commercial vehicle, or capital allowances for a car, and to claim actual expenses when paid. Outside the cash basis, the alternative is to claim capital allowances on actual expenses when incurred. If a business has previously claimed capital allowances on a vehicle, the mileage rate cannot be used for that vehicle.

The schedule provides that businesses can have a deduction for using homes for business purposes, based on the number of hours spent working at home.

Chris Leslie (Labour, Nottingham East)

I have a specific question—a genuine question—on what the Minister said about an individual who had claimed against a vehicle under the old regime not being able to claim under the new scheme for the same vehicle. I think he is saying that the arrangements would not be available until somebody bought a new vehicle. Is that right?

David Gauke (Conservative, South West Hertfordshire)

I was going to deal with the various points raised by the hon. Gentleman at the end, but given that he has intervened on this particular point, it may be helpful if I explain why there are different rates for cars, because giving an answer may bring greater understanding of the policy behind that.

The rates of 45p for the first 10,000 miles and 25p thereafter are aligned to the rates for employees, so that there is consistency with what is happening elsewhere in the tax system. The two rates reflect the decreasing proportional capital costs included in motoring expenses as mileage increases. The mileage rate is an equivalent to running costs and capital expenditure. If a business has previously claimed capital allowances on a vehicle, it has already received tax relief for all of the appropriate part of the capital cost. It is that same principle that explains why there are different rates. I hope that clarifies that point.

The schedule provides that businesses can have a deduction for using a home for business purposes based on the number of hours spent working at home. Alternatively, businesses can continue to have a deduction based on the business-related proportion of actual expenses. The schedule also provides a simple method for calculating the private-use element of costs when a business premises is also used as a home, which is calculated according to the number of people living on the premises. Alternatively, a business can continue to calculate a proportional adjustment based on actual costs.

HMRC has consulted extensively on the proposals and the legislation and subsequently made some changes to the design of simplified expenses. There were two main areas of concern. First, the respondents argued that simplified expenses should be completely optional and distinct from the cash basis. That approach is introduced by clause 17 and schedule 4. Secondly, respondents also argued that the rates proposed were too low. The Government have considered the comments carefully and, for reasons of fairness, decided that the rates should continue to align with those for employees.

Whether they are appropriate will clearly vary according to circumstance, but many businesses will prefer the simplicity of claiming at an average rate rather than on actual cost. Now that the simplified expenses are optional, those businesses that want to base their calculations on actual costs are free to do so.

Chris Leslie (Labour, Nottingham East)

The Minister makes an interesting point about the actual cost, but can he help the Committee by saying what would be the effect on HMRC if, for example, the rate were set at 50p? I am not suggesting that it should be, but I want to get a sense of the effect. Is there a ready reckoner or a sliding scale that shows what would happen were the Minister to set the rate at 46p, 47p or 48p a mile? Is there a cost per 1p of allowance? What is the method of adjusting for inflation? Does the Minister envisage a process for reviewing and updating the rate depending on the actual costs?

David Gauke (Conservative, South West Hertfordshire)

I will perhaps return to the issue of costings in a moment, but on the rates that were the main thrust of the hon. Gentleman’s questions, the Government will review them at the same time as it reviews the rates for employees. Such matters are reviewed from time to time.

How have the amounts for private use of business premises been arrived at and how have the Government assured themselves that the amounts are fair? We based our figures on the most recent living costs and food survey, produced by the Economic and Social Data Service and published by the Office for National Statistics. He asked whether the rates for business use of homes reflect the true costs; the rates are aligned to those in place for employees, and therefore reflect the average current additional costs. If a business operates in a way that might incur significantly increased costs for the business use of a home, it can always use actual expenditure instead of the simplified expenses regime.

As to the concern over whether it is more time-consuming and complex to keep a record of hours spent using a home for business purposes, I can tell the Committee that the research HMRC undertook indicates that the burden will not be unduly onerous. In addition, businesses might have records, such as appointment books or work diaries, that provide a ready source of the information required. It is worth stressing that the regime is optional and that all unincorporated businesses can use any or all of the simplified expenses. The purpose of the measure is to make life easier for businesses, so that they do not have to spend a great deal of time dealing with tax administration.

Universal credit has adopted the same mileage rates as those in schedule 5, but apportioned for the period for which a universal credit is made. I hope that provides clarification on the interaction with universal credit. The hon. Gentleman asked about a ready reckoner to show what would happen if the rate was 50p rather than 45p and so on. I do not have the numbers to hand, but I shall see what information I can provide. If there is anything I can shed light on, I will write to him. I hope that those answers provide clarification on the purpose behind clause 18, which I hope will stand part of the Bill.

Chris Leslie (Labour, Nottingham East)

I am glad that the Minister was able to elaborate on some of the points about schedule 5. He said that there will be reviews from time to time; I assume that that is an annual process as part of Finance Bill legislation. I think the public would like to know that the effects are being kept under review. A lot of people, small firms and others will be watching closely the amounts set for both mileage and the use of a home as an office, because they affect their livelihood and income. It is important that we, as a Committee, send the message that we are aware of the increased costs of living and of maintaining a home, particularly if an individual is juggling a business or is reliant on their car or business vehicle for their day-to-day work and business activities. It is important that Ministers recognise that costs are high and are getting higher and that the Treasury finds a way to support such individuals more effectively.

We need to find out the effect on the Exchequer of changes to the reliefs, so that we can assess properly whether it is possible to do more in certain circumstances to help affected individuals. I do not have any particular evidence to hand to contradict the sums that the Minister has elected to bring to the Committee. I am concerned that there is no device to reflect the actual costs of living with inflationary pressures; ideally, there would be and officials ought to look at that. In general, I think that simplifying the expenses arrangement is a good thing. Making things clearer removes some of the burdens involved in collecting receipts and the arrangement of papers, so I do not wish to contest schedule 5 at this stage.

Clause 19 - Employment income: duties performed in the UK and overseas

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss that schedule 6 be the Sixth schedule to the Bill.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

We now turn to some rather technical clauses, but I am sure the Minister will illuminate the detail with his customary enthusiasm. Clause 19 introduces schedule 6, which in turn introduces the special mixed fund rules. According to the explanatory notes to the Bill, the rules

“broadly replicate the treatment that international employees who meet certain qualifying conditions currently receive under Statement of Practice 1/09”.

Schedule 6 also provides for such employees

“to apportion on a just and reasonable basis their earnings from an employment which covers UK and non-UK duties when they are entitled to overseas workdays relief.”

Again, this is intended to replicate the treatment currently available under statement of practice 1/09.

I am sure Committee Members will be aware that statements of practice serve to explain HMRC’s interpretation of legislation and the way in which HMRC applies the law in practice. I am sure Committee Members are also aware that SP1/09 provided a simplified tax treatment of income for employees who are

“Resident but Not Ordinarily Resident”

in the UK; taxed on a remittance basis, rather than a normal arising basis; and carry out duties both in the UK and overseas under a single contract of employment. Such individuals will usually have their employment income paid into a single overseas bank account. There are around 15,000 such employees according to the tax information and impact note. They will, by definition, hold a mixture of UK and overseas earnings, making up the mixed fund. Mixed funds are accounts containing more than one kind of income—capital gains or capital—or containing income, capital gains or capital of more than one tax year.

Such individuals are of course liable to pay UK tax on their UK source income and gains, but employment income attributable to duties performed outside the UK is not normally subject to UK tax, provided it remains overseas through what is known as overseas work days relief. They are therefore liable to pay UK tax only on any amounts of foreign income and gains that are subsequently remitted to the UK:

“brought into, used in, or enjoyed in the UK”.

To establish tax liability, there needs to be an established way of distinguishing income attributable to overseas duties from income attributable to UK duties. If the remittance to the UK is made from an account containing a single source of income for a single year, it is easier to identify what has been remitted and therefore what is liable to UK tax. However, as individual types of income and gains are taxed differently, statutory rules are therefore needed to determine how remittances to the UK should be taxed. Known as “mixed fund rules”, they work by determining, for every offshore transfer or remittance to the UK, what kinds of income and gains make up that transfer or remittance. The mixed fund rules therefore operate on a transaction by transaction basis, effectively requiring people to establish their UK tax liability on the basis of each individual payment into the account over the course of a tax year. It can be administratively complicated to apply to employment income, as each payment of salary would need to be apportioned in relation to the work done in each pay period.

SP1/09 provided a simpler tax treatment for qualifying individuals as it removed the obligation to operate the mixed fund rules on the main overseas account into which their salary was paid on a transaction by transaction basis. It enabled affected employees to apportion their annual earnings from their single contract of employment between UK and non-UK earnings on a “just and reasonable” basis, taking, for example, the number of days that they worked in the UK compared with the number of days they worked overseas during the whole year, and by reference to the value of deposits in, and transfers out, of the account in any given tax year.

SP1/09 was introduced following changes to the remittance basis of taxation in the Finance Act 2008, and it came into effect on 6 April 2009. It replaced the earlier statement of practice, which had been broadly in place for the same purpose and effect. However, in June 2011 the Government announced a consultation about the reform of the taxation of non-domiciled individuals, and they also announced their intention to put SP1/09 on a statutory basis via the Finance Bill 2012, as part of a series of measures to simplify or formalise the existing remittance basis rules.

However, a number of concerns were raised in the submissions to the 2011 consultation, which led the Government to announce in December 2011 that

“it is important to ensure that the legislation does not depart significantly from the way in which SP1/09 currently works. It—”

That is, the Government—

“will therefore give further consideration to these issues and take forward legislation of SP1/09 in Finance Bill 2013 to take effect from April 2013.”

Here we are in 2013. The Government also said in December 2011 that the deferral to 2013 was

“to co-ordinate with the parallel deferral of the abolition of Ordinary Residence for tax purposes”,

which is something the Committee will deliberate on a little later, in our consideration of clause 215, which deals with the “statutory residence test”, and clause 216, which deals with “ordinary residence”.

Subsequently, a further consultation was published alongside draft legislation in October 2012, which again prompted further concerns, resulting in a second summary of responses and a second draft of legislation being published for consultation in February 2013. In response to suggestions made to all of these consultations, the Government have agreed that the simplified treatment previously offered by SP1/09 should be extended to provide further administrative easements or further simplification of the process, so that the simplification offered by clause 19 and schedule 6 will also apply, with effect from last month, to: existing bank accounts, where previously only completely new accounts were eligible for the simplified treatment; accounts held jointly by a spouse, where the spouse makes no economic contribution to the account; and accounts containing funds from more than one employment, which have duties both in the UK and overseas, where previously only funds from a single contract of employment were eligible.

Those changes, which were made as a result of the consultations that were undertaken, are of course welcome, particularly the decision that people will not be required to “nominate” their qualifying bank account before arriving in the UK, as was originally suggested by the Government. That suggestion would quite clearly have created practical difficulties for employees arriving in Britain who would not necessarily have known until after they had arrived here that they needed to “nominate” an account, and in many cases they would have needed to discuss matters with a tax adviser here in the UK before nominating an account.

However, as I have been unable to locate the Government’s response to the most recent consultation on these changes, perhaps the Minister could enlighten me as to where I could find that information. Will he also confirm whether any further concerns about the proposals were raised in response to the February 2013 consultation and, if so, whether any steps have been taken to iron out any of the most recent concerns that have been expressed?

The large majority of people impacted by the clause due to the nature of their employment and likely salary will be in a position to seek and pay for tax advice to get to grips with what remains a complex issue, regardless of the simplification measures that the Government have taken. However, for those few who are not in that position, will the Minister outline what steps HMRC is taking to ensure that people previously affected by SP 1/09, which is now clause 19, are aware of, and understand, their tax liabilities? It would be useful to know what initial cost HMRC expects to incur in providing further guidance to individuals and employers on these changes.

David Gauke (Conservative, South West Hertfordshire)

I thank the hon. Lady, both for her support for the measures and for setting out some of the issues involved in this area, which as she rightly says is one of the more technical, complex areas.

The clause introduces schedule 6, which puts statement of practice 1/09 on a statutory basis. SP 1/09 simplifies the tax rules that apply to certain employees who are taxed on the remittance basis. This gives certainty for key employees who normally come to the UK to work for a relatively short period of time.

At the risk of repeating what has already been said, I should like briefly to outline the rules incorporated in SP1/09. The rules were introduced in 2008, when the remittance basis of taxation was reformed. The remittance basis is an alternative basis of taxation available to individuals who are resident but not domiciled in the UK. The rules incorporated in SP1/09 apply where an individual brings money to the UK from an overseas bank account that contains a mixture of different types of income, or a mixture of income from different tax years, or both. The purpose of the rules is to determine the amount of tax that is due when money is brought to the UK from a mixed fund. They do this on the basis of each transaction made throughout the tax year.

Employees who perform duties both in the UK and overseas will typically have their salary paid into a single overseas account. If they do so, that account will be a mixed fund. They will typically use that account to fund their day-to-day living expenses in the UK and elsewhere. Under a strict application of the mixed fund rules, they would have to examine hundreds or even thousands of transactions to determine their UK tax liability at the end of the tax year. Such employees may also have difficulty determining how much of their total employment income relates to duties in the UK and how much relates to duties outside the UK until the end of the year. SP1/09 was introduced to address both these issues and it provides such employees with simplified mixed-fund rules to eliminate the need to look at every transaction made through a bank account. It also allows them to apportion their earnings on an annual basis between UK and overseas duties based on the proportion of their total work days that were spent in the UK.

The schedule puts SP1/09 on a statutory basis. It introduces rules for individuals who are taxed on the remittance basis and who have duties in both the UK and overseas as part of the same employment. The schedule also introduces a number of easements, including allowing the use of joint bank accounts and pre-existing accounts, neither of which are permitted under SP1/09.

The changes will affect approximately 15,000 individuals, who are typically expatriate employees who come to work in the UK for a relatively short period of time. These changes are designed to be revenue neutral. They remove what would otherwise be an administrative burden for these individuals, their employers and HMRC.

On the question whether these measures may be too complex for taxpayers, and while acknowledging that many of those who are likely to be affected will be in a position to take professional advice, it is worth pointing out that these rules provide a significant simplification over the existing remittance basis, mixed fund rules for internationally mobile employees coming to work in the UK. For the vast majority of that group the rules will be straightforward to operate. In practice, most taxpayers using SP1/09 are already represented by advisers, but we are providing extensive guidance to help anyone using the new rules. HMRC has already produced a frequently asked questions page on its website that will provide some assistance. We do not believe that there is any significant cost to HMRC for providing this guidance.

I will deal, if I may, with the question about the consultation document response. We have not published a response document to the last round of consultation, but HMRC has discussed the changes with external representatives who broadly welcomed these changes. The legislation in this schedule reflects a number of very small technical changes as a result of the February 2013 consultation. We are not aware that significant concerns about the Bill remain. I hope that that answers the hon. Lady’s question. Clause 19 and schedule 6 are a further step towards our objective of creating a more efficient and simpler tax system by removing the need for certain individuals to carry out potentially hundreds of computations during a year to calculate a UK tax liability.

Clause 20 - Remittance basis: exempt property

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss that schedule 7 be the Seventh schedule to the Bill.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Thank you, Mr Crausby, for giving me the opportunity to come back to the Minister, who replied to all of the concerns raised in relation to clause 19. We now move on to clause 20 which introduces schedule 7. Like the previous clause and schedule, it deals with the taxation of remittances to the UK. As I am sure Committee members will know, section 47 and schedule 12 of the Finance Act 2012 saw a number of changes to the remittance basis of taxation provided by chapter A1 of part 14 of the Income Tax Act 2007. I see Government Members nodding enthusiastically.

Schedule 7 effectively serves to tidy up those changes in relation to inadvertent remittances arising in certain circumstances. It is designed to ensure that property acquired overseas, using foreign income and gains and therefore not constituting a taxable remittance under last year’s changes, will also not trigger a taxable remittance to the UK if any compensation payment relating to the loss, theft or destruction of the property is received, provided that such payments are either taken offshore or used to make a qualifying investment in the UK within 45 days of receipt.

Schedule 7 also makes changes to the public access rule, which currently sees property exempted from UK taxation if it is remitted to the UK and meets four conditions. The first condition is that it is defined as a work of art, a collectors item, or an antique, as defined in annex IX of Council directive 2006/112/EC. The second is that it is available for public access at an approved establishment, or is in transit to or from or in storage at an approved establishment. An approved establishment is an approved museum, gallery or other institution within the meaning of group 9 of schedule 2 to the Value Added Tax (Imported Goods) Relief Order 1984.

“Available for public access” is an important definition. It means that it must be on display at the establishment, or held at the establishment and made available to the public on request, or held by the establishment for public exhibition in connection with the property’s sale. I recall many interesting discussions last year on tax avoidance schemes that had been identified by the press in relation to some works of art.

The third condition is that the property is available for public access for no more than two years, or such longer period as the HMRC commissioners may specify. The fourth is whether the property attracts a relevant VAT relief.

Schedule 7 will still require property remitted to the UK to fulfil three of the above conditions if it is to be exempted from UK taxation, but the public access rule will include all property, and not just works of art, collectors items and antiques.

On the first issue dealt with by clause 20 and schedule 7—the tidying up legislation made last year—can the Minister confirm that he is confident about how the 2012 changes to the remittance basis of taxation are working? Does he envisage further legislative changes having to be made in future finance Bills?

On changes to the eligibility for exemptions under the public access rule, I am keen, in light of my earlier points, to hear why these changes have been introduced. It would be helpful if the Minister elaborated on and clarified the matter. What sort of items does the Minister expect to be included, beyond those currently defined as works of art, collectors items or antiques? How many items of property and individual owners does he expect the change to impact on each year? The tax information and impact note suggests that the change will be made at no cost to the Exchequer, but what specific measures or checks does HMRC have in place to ensure that the exemption, and the extension to it, will not be used as an avoidance loophole? That is a key concern of Members of this House and, in particular, of members of the public.

David Gauke (Conservative, South West Hertfordshire)

As we have heard, clause 20 introduces schedule 7, which makes changes to the remittance basis rules as they apply to exempt property. The changes reflect concerns expressed about the rules during consultation on the remittance basis. As I outlined in the debate on clause 19, the remittance basis is an alternative basis of taxation. It is available to individuals who are resident but not domiciled in the UK.

The current remittance basis rules were legislated for in the Finance Act 2008 and significantly amended in 2012, as the hon. Member for Newcastle upon Tyne North said. Most notably, a new incentive was introduced to encourage those who are taxed on the remittance basis to bring their money from overseas to invest in UK businesses. At that time, the Government also made a commitment to consider extending the existing rules for exempt property to cover situations where such property is lost, stolen or destroyed. The clause and schedule deliver on that commitment; the exempt property rules apply to any property that an individual who is taxed on a remittance basis has acquired overseas by using their foreign income and gains that is subsequently brought to the UK. In the absence of those rules, bringing such property here would trigger a taxable remittance in the UK.

The rules allow property to be brought to the UK without creating tax liability, provided that certain conditions are met. Examples include cases in which the property in question is a work of art that has been imported to be displayed at a public gallery or museum, or where the property has been brought here temporarily for repair or renovation.

It has been pointed out that the exempt property rules do not cater for situations in which exempt property is lost, stolen or destroyed while in the UK. That means that if someone has brought to the UK a painting that they acquired overseas to lend to a gallery for public display, they could become liable for tax should it be destroyed.

The same consequence would arise if the property in question was brought to the UK for repair but was stolen before the repair was completed. As the hon. Lady pointed out, clearly that would not be reasonable and it was never the intention to make people liable for UK tax in respect of property that they could not enjoy because it had been lost, stolen or destroyed. The clause and schedule ensure that that is no longer the case by providing rules that remove any tax charge that would otherwise arise when exempt property was lost, stolen or destroyed while in the UK. They also go further than that by making a series of other changes to the exempt property rules, which reflect concerns expressed by external stakeholders. They remove the restrictions that currently apply to the types of property that can be brought to the UK for public display and correct some minor technical defects in the rules. Those changes reflect concerns raised in consultation and have been broadly welcomed.

To respond to the questions raised, first, on the impacts, we do not expect an Exchequer impact. The proposals affect only resident non-domiciled individuals who are taxed on the remittance basis; in 2009-10, approximately 45,000 individuals elected to pay on that basis. The proposals’ objective is to reduce the complexity of the calculations that individuals and their advisers have to make to comply with those rules.

The hon. Lady asked what items were included under exempt property. As I said, under the current rules, that applies to works of art or antiques, but not other items that might be displayed in public such as sporting memorabilia or theatrical costumes. This measure will remove that restriction and allow any property to benefit from the public access rules, although the condition will remain that such property needs to be displayed at an HMRC-approved establishment, such as a gallery or museum.

John Cryer (Labour, Leyton and Wanstead)

The Minister may not have this information to hand, so he may want to write to me at a later date, but what is the definition of public access? Many years ago there was some controversy over this matter. Would the definition of what constitutes public access, so that people can take advantage of the scheme, be 10 days or 20 days, for example?

David Gauke (Conservative, South West Hertfordshire)

I am very happy to answer the hon. Gentleman’s question. The public access rule allows exempt property to be brought to the UK without creating a taxable remittance where the property in question is brought to the UK for the purpose of being displayed in a recognised establishment, such as a museum or gallery. Specifically, the public access rules allow exempt properties to be on display in the UK for up to two years.

It is quite difficult to say how many items will be affected. We do not have any data on the number of items of exempt property in general, nor on the effect of the clause on that number. By their nature, exempt items do not need to be reported to HMRC, so HMRC does not have data on that.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

The Minister’s response about the length of time that an item may be on display did not deal specifically with the question raised by my hon. Friend the Member for Leyton and Wanstead. How accessible an item has to be is an interesting and key question for many members of the public. How open to members of the public do the approved premises need to be to qualify for the tax exemption? Does the Minister have that information readily to hand? If not, will he write to my hon. Friend and me?

David Gauke (Conservative, South West Hertfordshire)

The exemption is designed for where a property is displayed at a recognised establishment, such as a museum or gallery. I suspect that part of the concern is that it should not apply to, for example, a private home that is open to the public for a small number of days a year. We are talking about recognised establishments such as museums and galleries. For example, if a painting is lent to the National Gallery, that clearly would be on public display. HMRC has to give its approval, so the exemption is not designed for private locations that are open for only a small number of days.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

I thank the Minister for that clarification, but are there potential loopholes, whereby a wealthy individual could set up a small establishment and receive HMRC approval? It would be interesting and useful for hon. Members to have clarity on exactly what the requirements are to gain approval from HMRC to become approved premises.

David Gauke (Conservative, South West Hertfordshire)

Let me write to hon. Members to set out further details about HMRC’s policy on approving particular institutions. I hope that that will be helpful to the Committee.

The hon. Lady asked whether the changes that were made—she will remember them well from last year’s Finance Bill—are working. We are confident that the reforms will ensure that some minor anomalies in the remittance basis rules are removed.

We are also confident that the remittance basis rules are appropriate. The complexity of the rules is unavoidable and flows from the need to ensure that the rules are not abused. However, we do not anticipate further changes. We made a commitment in 2012 not to make any further changes to the remittance basis for the lifetime of this Parliament other than tidy-up measures, such as those before us today, and that commitment remains in place.

Taken together, the changes made by clause 20 and schedule 7 ensure that the exempt property rules work properly, while removing an unintended tax charge.

(Except clauses 1, 3, 16, 183, 184 and 200 to 212, schedules 3 and 41 and certain new clauses and new schedules) - Clause 21 - Payments on account

Catherine McKinnell (Labour, Newcastle upon Tyne North)

It is a pleasure to be back, Mr Crausby.

Clause 21, like the previous two clauses that we discussed, would tidy up existing legislation in section 47 and schedule 12 of the Finance Act 2012 on taxation of remittances to the UK. Again, the clause deals with inadvertent remittances in certain circumstances. Long-term UK non-domiciled residents who elect to be taxed on the remittance basis are subject to an annual charge of £30,000 or £50,000, depending on whether the individual meets the seven-year residence test, if UK resident for at least seven of the nine tax years preceding that year, or the 12-year residence test, if UK resident in at least 12 of the 14 tax years immediately prior to that tax year. Under section 809V of the Income Tax Act 2007, the payments of this annual charge made in respect of foreignincome and gains do not constitute a taxable remittance. However, if for whatever reason the charge is repaid in part or in full by HMRC, this repayment is currently not exempted from being regarded as a taxable remittance.

Let me put a little bit of colour on what may seem a rather dry clause. Individuals who elect to be taxed on the remittance basis and make payments for a non-domiciled charge on account to HMRC and then, in a later year, decide no longer to be taxed on the remittance basis, could find that the repayment of the annual charge by HMRC would constitute a taxable remittance. The clause would amend that situation, provided that any repayment made in the circumstances described is taken offshore by 15 March in the end of the tax year in which that amount is repaid.

The tax information and impact note provided on non-domiciled taxation does not mention the minor change made by the clause, so it would help if the Minister clarified exactly how many people will feel the impact of the clause, or have been affected by this situation, and for whom the change is being made.

The clause raises the same issues as clause 20, in relation to whether the Minister is confident about how the 2012 changes to the remittance basis of taxation are working and whether he envisages that any further changes are required to legislation, in addition to the clause and the change that we are considering.

David Gauke (Conservative, South West Hertfordshire)

I welcome you back to the Chair, Mr Crausby.

Before speaking about the clause, it might help if I provided some further information to the Committee on a couple of points raised this morning about related issues to do with remittances, particularly the requirements that an establishment must meet to secure status as an approved establishment for the purposes of the viewing public. As I said this morning, the rules relating to exempt property require that the property in question is placed on public display in an approved establishment in order to be treated as exempt.

I assure the Committee that there is a long-standing and well-understood process by which HMRC grants approved establishment status. This process pre-dates the introduction of the current remittance basis rules. It was set up to allow museums and galleries to import items from countries outside the EU customs union, for exhibition in the UK, without incurring the VAT and customs duties that would otherwise arise. To take advantage of this concession, the museum or gallery must seek HMRC’s approval to be an approved establishment. Approved establishment status is given by HMRC’s national import reliefs unit according to a range of criteria, which will depend upon the facts in each case.

The hon. Member for Newcastle upon Tyne North also asked about how HMRC polices the process for granting approved establishment status. Again, I can assure the Committee that HMRC has a comprehensive compliance regime for this process, informed by a national risk assessment, as it does for other rules for which it is responsible. I should also add that, in order to ensure that the rules for approved establishment status are not abused, an establishment generally needs to have its approval renewed on an annual basis. If the hon. Lady wants further information on this matter, I direct her to public notice 361, which is published on HMRC’s website.

The hon. Lady also asked this morning what was meant by public access for the purposes of the exempt property rules. I direct her to the legislation introduced by the previous Government in Finance Act 2008, which makes it clear that the property in question, throughout the period in which the property is held by the approved establishment, needs to be on display to the general public; available for viewing on request by the public; held for educational purposes; or on public exhibition in connection with the sale of that property. I think the hon. Lady was concerned that these rules could be open to abuse and used as a means of tax avoidance. I can inform the Committee that since they were introduced in 2008, HMRC has not seen any evidence that the exempt property rules have been used for the purposes of tax avoidance, and we do not anticipate that the changes made by schedule 7 will alter that position. I hope that is helpful to the hon. Lady and I thank you, Mr Crausby, for allowing me just a moment’s digression before turning to clause 21.

Clause 21 makes a minor change to the remittance basis rules in response to concerns expressed during consultation, in the same way as clause 20 and schedule 7, which we have just discussed. Specifically, it prevents a taxable remittance from occurring when an individual is liable to pay the annual remittance basis and is required to make payments on account, under the self-assessment system.

As you will be aware, Mr Crausby, payments on account are an advance payment of a current year’s income tax liability, based on the individual’s liability in the previous tax year. When an individual has paid the annual charge of either £30,000 or £50,000 in a previous year, their payments will automatically include an amount in respect of the annual charge due in the current year.

However, if an individual decides at the end of the tax year that they do not want to elect to pay tax on a remittance basis, the payments relating to the annual charge will be refunded to them by HMRC. If the initial payment was made using foreign income and gains, the person will be treated as having made a remittance and taxed accordingly. It does not matter that the individual had the intention to bring money to the UK in the first place. Under current rules, they do not have the option to take the money back offshore. That is clearly unreasonable.

The clause prevents that inadvertent remittance from arising where an overpayment of the annual remittance basis charge is refunded by HMRC. However, to take advantage of this new rule, the individual will be required to take the amount repaid back offshore, in order to avoid being taxed. I am sure that hon. Members will agree that this is a far more reasonable position.

I was asked how many people will be affected by the clause. In all honesty, it is not always possible to say how many people will be affected. Theoretically, however, everyone paying the remittance basis charge could be affected. In 2010-11, that was 5,600 people. However, in practice we expect there to be a much smaller number.

Will further changes to the rules be needed? We are confident that no further changes to the remittance basis rules will be needed. The clause corrects a very minor anomaly in the remittance basis rules and it does not represent a fundamental flaw being corrected. As I said this morning, the Chancellor made the point in Budget 2011 that we have no intention of making any further substantive changes to the remittance basis rules for the remainder of this Parliament, and I am happy to reiterate that. We believe that a stable set of rules for non-domiciled individuals will provide certainty and increase the international attractiveness of the UK as a place to live and work. I hope that that is helpful to the Committee and that the clause can stand part of the Bill.

Clause 22 - Arrangements made by intermediaries

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Clause 22 amends chapter 8 of part 2 of the Income Tax (Earnings and Pensions) Act 2003, or the intermediaries legislation commonly known as IR35. I would like to state for the record, in the event that it is relevant, that I am a member of the all-party group on the freelance sector.

At present, as office holders are not considered to be employees, any office holders engaged via intermediaries would not fall within the IR35 legislation for tax purposes. Clause 22 seeks to amend that so that the application of IR35 extends to office holders with effect from this tax year. Members of the Committee will probably know that IR35 was introduced by the previous Government in April 2000 after being announced in the 1999 Budget and subsequently being consulted on. The IR35 legislation was then updated by the Income Tax (Earnings and Pensions) Act 2003. The aim of the legislation was to eliminate the avoidance of tax and national insurance contributions through the use of intermediaries such as personal service companies or partnerships in circumstances in which an individual worker would, for tax purposes, otherwise be regarded as an employee of the client, and for national insurance purposes be regarded as in employed earner’s employment by the client.

Prior to the legislation taking effect, an individual could use this disguised employment to avoid being taxed as an employee on payments for services, and to avoid paying class 1 national insurance contributions by providing those services through an intermediary. The worker could take money out of the intermediary, normally a personal service company, in the form of dividends instead of a salary. As dividends are not liable for national insurance contributions, that would result in the worker paying less in such contributions than either a conventional employee or a self-employed person. Of course, PAYE taxation would also not apply to the dividends.

IR35 sought to consider the underlying nature of the relationship between the worker and the engager such that if the relationship would be considered to be employment were it not for the interposition of the intermediary, the IR35 legislation would apply. Where it applies, the income received by the intermediary is deemed to be employment earnings of the worker and the worker is liable to pay income tax on it, in accordance with chapter 8 of the Income Tax (Earnings and Pensions) Act 2003.

Currently, office holders engaged via intermediaries fall under the relevant national insurance legislation so that they are in the same national insurance contributions position as those who fall within the IR35 legislation. Clause 22 seeks to equalise the tax treatment of office holders engaged through intermediaries in the same way, but what is an office holder? The explanatory notes to the clause suggest that it is impossible to provide an exhaustive list or definition of the term. However, the notes suggest that the term “office” includes

“in particular any position which has an existence independent of the person who holds it and may be filled by successive holders.”

An office

“is a separate and independent position to which duties are attached; and office does not owe its existence to the incumbent or the discretion of an organisation”.

Therefore, an office holder might include, for example, a non-executive director, but according to the explanatory notes, but according to the explanatory notes, it would not include the post of manager or head of division, as such roles will only exist as long as the organisation wishes them to.

However, the attempt to define “office holder”, which is clearly critical if the legislation is to function, has already been criticised for its lack of clarity. For example, Qdos Consulting stated:

“The lack of clear and concise guidance as to what an office-holder looks like is disappointing and will only add another layer of doubt to the IR35 legislation, something that HMRC were at pains to avoid when they overhauled the administration of IR35 last May.”

I would be grateful if the Minister could address some of those clearly critical concerns, when he responds on clause 22.

The overhaul of the administration of IR35 in May 2012 took place after the coalition agreement stated, back in May 2010, that it would

“review IR 35, as part of a wholesale review of all small business taxation”.

The Chancellor’s first Budget in June 2010 stated:

“The Government remains committed to a review of IR35 and small business tax”.

In July 2010, it was announced that the review would be undertaken by the recently established Office of Tax Simplification.

The OTS’s review, published just ahead of Budget 2011, made a number of recommendations, including that the Government should look at the wholesale integration of income tax and national insurance contributions, or that IR35 should be abolished. However, Budget 2011 announced that IR35 would be retained

“as abolition would put substantial revenue at risk”,

but the Government were committed to

“making clear improvements in the way IR35 is administered”.

Shortly after the Budget announced that IR35 would be retained, the Exchequer Secretary asked HMRC

“to undertake a thorough overhaul of the administration of this area of the tax system”.

That would include HMRC providing pre-transaction clarity and certainty and restoring trust, and the changes would

“include setting up a dedicated helpline…publishing…guidance on those types of cases HMRC view as outside the scope of IR35, targeting compliance activity by restricting reviews to high risk cases and setting up an IR35 Forum which will monitor HMRC’s new approach.”

Almost 50 pages of new IR35 guidance were subsequently published by HMRC in May 2012, which outlined the new, risk-based approach, monitoring IR35 compliance through a set of 12 business entity tests to help individuals work out the risk of HMRC checking whether IR35 applies to them.

As we know, the use of personal service companies by individuals became a particularly hot potato for the coalition when details of the pay arrangements for the chief executive of the Student Loans Company emerged at the beginning of last year. Mr Lester took up his position permanently in February 2011 and it was discovered that he was being paid off-payroll—that is, via a personal service company. That revelation led the Chief Secretary to the Treasury to announce, in February 2012, an internal audit of such appointments across all Government Departments to ensure “good value for money” and the unwinding of arrangements where necessary and “as quickly as possible”.

In May 2012, the Chief Secretary reported the findings of the review, which uncovered more than 2,400 such appointments. He declared that

“That lack of transparency cannot continue”

and that there would be

“new tighter rules on off-payroll appointments.”—[Official Report, 23 May 2012; Vol. 545, c. 1159-60.],

which would be implemented by September 2012.

On the same day, the Chief Secretary also announced plans to change the application of IR35 to individuals given a controlling function in a client’s organisation. The Government proposed to change the law so that controlling persons would be required to be on the payroll of that organisation and not engaged by an intermediary. However, this proposal was dropped in the autumn statement 2012 with the Government apparently concluding that their changes to the administration of IR35, along with changes to public sector recruitment practices, would be sufficient to prevent tax avoidance through disguised employment.

This fairly minor change to clause 22 is designed to ensure that office holders engaged via intermediaries will fall into IR35 in terms of their tax treatment as well as for national insurance contributions. That is part of the Government’s limited attempts to reform this thorny area. I would be grateful if, as well as addressing the concerns about the definition of the term “office holder”, the Minister could outline how many people the clause is likely to affect. In light of recent media reports, could he provide the Committee with an update on the employment of people off payroll in Government Departments and how the Chief Secretary’s plans to ensure greater transparency and tighter rules have been implemented to date?

The Minister might wish to comment on the Department for Education’s apparent continued employment of 24 academy brokers, whose role is to convince head teachers to join the academies programme, through personal service companies, reportedly on contracts of up to £1,080 a day, with some of these contracts running for up to 10 years. Is that what the Chief Secretary meant by

“new, tighter rules for off-payroll appointments”?

John Cryer (Labour, Leyton and Wanstead)

I am interested in the definition of personal services. It could have numerous connotations. Could my hon. Friend be more specific about that?

Catherine McKinnell (Labour, Newcastle upon Tyne North)

It is obviously a complex and thorny area of the law. I, too, would be interested to hear the Minister give a clearer definition of personal services.

There is another important area of false self-employment which the Bill and, disappointingly, the clause do little to address. According to the Union of Construction, Allied Trades and Technicians and its excellent report, “The Great Payroll Scandal”, bogus self-employment in the construction industry, from misuse of the construction industry scheme to enforced use of payroll companies, has been described as the biggest employment rights challenge in the industry. UCATT estimates that over 50% of those working in the construction sector are falsely designated as self-employed subcontractors, even though many are permanently employed by a single firm. Those “employed” in this way are, of course, missing out on rights such as paid sick leave; holiday pay; overtime rates; redundancy pay; travel allowances; pension contributions; and employment protections. Many are forced to sign a contract stating that they are self-employed. Many are also expected to shell out £15 to £25 a week, which is deducted from their wages, to pay for these payroll services.

It should be of particular concern to the Minister that the problem is estimated to cost the Exchequer £1.9 billion a year. It is disappointing, when considering clause 22 and the Government’s actions in making a small change in this particularity difficult area, that there does not appear to be a commitment to tackle that scandal in the Finance Bill or in other legislation. I would be grateful if the Minister would comment on that matter and reassure the Committee that the Government are considering these issues, in particular, from their perspective, the loss to the Exchequer that results from it.

As I am sure the Minister is aware, the Labour party is currently undertaking a policy review on this issue, led by my hon. Friend the Member for Leeds West (Rachel Reeves). We are speaking to employers, employees, trade unions and other organisations about what action we can take to stamp out false self-employment for good without stifling genuine self-employment, which is vital to our growing economy. I would be grateful if the Minister could comment on all the issues that have been raised. Clearly it is an issue of workers’ rights and fairness in the system, but it is also about protecting revenue to the Exchequer, which is clearly vital at this time.

David Gauke (Conservative, South West Hertfordshire)

I am grateful to the hon. Member for Newcastle upon Tyne North for setting out very thoroughly the background to the clause and IR35 more generally. As she said, the clause is a relatively minor matter. It aligns the tax and national insurance treatment of office holders under the intermediaries legislation more commonly known as IR35. Historically, IR35 has applied to office holders for national insurance purposes but not for tax. That means that office holders engaged via intermediaries currently pay national insurance contributions on the same basis as office holders who are engaged directly, but they are taxed differently. This small change rectifies the situation and creates parity between the tax and national insurance treatment.

Where an office holder is engaged directly by an organisation, income tax and national insurance have to be deducted at source by the engaging organisation, in the same way as they do for an employee. We expect this to be the case for the vast majority of office holders. Indeed, HMRC may still argue in the first instance that the office holder should have income tax and national insurance deducted at source by the engager, notwithstanding the terms of the clause. This small change to IR35 ensures that, where an office holder is personally required to provide the service of that office but is working through a limited company or other intermediary, HMRC is able to collect the tax that is due. The Government welcome the contribution that personal service companies make to the economy, and realise that in the vast majority of cases they are there for legitimate commercial reasons. This change creates a level playing field for office holders, and ensures that tax cannot be avoided by putting in place contrived arrangements.

Concern has been raised that this change will be used to apply IR35 to all those working through an intermediary. I would like to assure the Committee that that is not the case. This change does not extend the definition of an office holder. The term “office holder” is not defined in statute; it relies on case law. It is worth pointing out that HMRC publishes guidance on what constitutes an office holder, and it is used widely to determine who is an office holder for PAYE purposes. It does not apply solely to IR35 matters.

An office is a separate and independent position to which duties are attached. It does not owe its existence to the incumbent or the discretion of an organisation. Examples of office holders include returning officers and clergymen. Case law recognises that a succession of individuals to a post or job title is not enough to establish an office. If, for example, the role and responsibilities can change or the engager can decide that the post is no longer needed, the individual is not an office holder. HMRC has published guidance on what constitutes an office holder; it has also published guidance on how the change applies.

I come now to definitions, and personal service companies. Personal services are provided by an individual when they must undertake the work rather than be able to provide a substitute. As for how many people will be affected by the clause, I cannot provide that information today, but I shall write to the hon. Member for Newcastle upon Tyne North about it. She asked about false self-employment in the construction industry. Several issues relate to that, including the loss of revenue. As announced at the Budget, HMRC is continuing to examine issues arising in the intermediaries market as part of wider avoidance work. That includes false self-employment in the construction industry, and it is a matter on which we continue to focus. The hon. Lady will be aware of our announcement in the Budget about offshore intermediaries. It demonstrates a willingness by the Government to act in related areas where we believe that there is a strong case.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Will the Minister comment further on the steps being taken by Departments engaged in off-payroll personal service company contractual arrangements because, clearly, that goes to the very heart of the public’s concern and to the very heart of the Government in many respects? I should be grateful if the hon. Gentleman would put on record what steps are being taken to deal with such worries.

David Gauke (Conservative, South West Hertfordshire)

The hon. Lady raises a significant issue, albeit one that is much broader than the clause. She will be aware that the process of providing services to Government public sector workers being paid through intermediaries was not new, and one that emerged from the case involving Mr Lester. The system was used widely, particularly under the previous Government. My right hon. Friend the Chief Secretary made several announcements about such matters, and we believe that there is a need for much greater transparency.

I cannot specifically answer the hon. Lady’s question about the Department for Education and academy brokers but, in short, I say that, as a Government, we have been much more willing to deal with the matter than was the case in the past. The Departments are reviewing their work force and reporting the results to the Treasury, as part of the review of the way in which public bodies are working on such issues. I think that the Government will be saying more on that matter in due course.

The clause involves a relatively small change; none the less it will ensure that people pay the correct amount of tax. It will also ensure that there is a level playing field for office holders, and that working through contrived arrangements does not result in a tax advantage. I hope that it will stand part of the Bill.

John Cryer (Labour, Leyton and Wanstead)

I want to speak at slightly greater length on one point that was raised by my hon. Friend the Member for Newcastle upon Tyne North and answered by the Minister—bogus self-employment, especially in the construction industry. The construction industry has been highlighted, but bogus self-employment now seems to be creeping into other industries such as hotel and catering. We are essentially talking about the distinction between employed and self-employed. Traditionally, that was a hard and fast distinction, but it has become blurred over the past 20 or 30 years. To some extent, that is due to change in work practices. Many on the Committee have probably been self-employed freelance in the past, and that is completely legitimate.

However, ruses and scams—some legal and some floating on the edge of illegality—are used by unscrupulous employers. I use the term “unscrupulous employers” advisedly because respectable, law-abiding employers would not get up to that sort of thing. Unscrupulous employers use certain ruses to transfer people who are clearly employees to self-employed status on a bogus basis. If employers transfer employees to self-employment, they avoid a number of obligations, including sick pay, holiday pay, overtime rates, redundancy pay, travel allowances, pension contributions and certain employment protections, as well as employer’s national insurance.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

I am grateful to my hon. Friend for highlighting a major concern, in terms of not just Exchequer return but employment rights. Does he share my concern at discovering that many teachers are paid through off-shore payroll service companies? Some of the teachers engaged were not even aware that they did not have those employment rights until they found themselves in the position, for example, of having to take maternity leave and realising at that stage that they were not entitled to it.

John Cryer (Labour, Leyton and Wanstead)

My hon. Friend is right. There is a notorious example; I was going to refer to it later but will do so now. International Subcontracting Solutions Ltd employs 24,000 supply teachers across the UK. Because the company is based in the Channel Islands and is a payroll company, it is not liable to pay employer’s NI, although technically it does employ the teachers. That is a strange anomaly which in the past Ministers would not have had to grapple with. However, with the changing nature of the economy, it is a problem that has become apparent in the past couple of years.

Returning to the practices prevalent in the construction industry, we have seen the advent of payroll companies, of which I expect the Minister is aware. Payroll companies say to employers, “Give us the contract and responsibility for your payroll duties, and we will get HMRC off your back.” They will get rid of all the duties and obligations that I previously mentioned. In addition to promising to get HMRC off the backs of employers, in the worst cases they can use tax relief claimed against workers’ expenses to fund employer’s NI. That seems to be flirting on the edges of legality.

My hon. Friend referred to a report produced by UCATT, written by freelance journalist Jamie Elliott. He invented a company called Fairbrother Builders and asked payroll companies how they could help him out with HMRC and divest him of his obligations and responsibilities. I should point out that some of the payroll companies said that that was not appropriate, that he was employing people and should continue to employ them and that they were not in the business of helping him transfer people to bogus self-employment to avoid responsibilities. However, the majority of payroll companies said, “That’s fine. We will help you out.” When Mr Elliott approached Hudson Contract, the biggest payroll company, it responded by writing a letter, which stated:

“We can save you money, 20% of your labour costs, by reclassifying PAYE staff, paying them through CIS.”

That seems to me to be, at the very least, a questionable sort of practice. The letter went on:

“Self Employed operatives, paid under CIS deduction through Hudson are not entitled to holiday pay, redundancy or notice. We are helping companies to move their PAYE labour over to CIS…Last year this saved our clients over £25M in Employers NIC, placing tax and employment law liabilities with us.”

That seems pretty disreputable to me. It also diverts a lot of money that should go to the Treasury into the pockets of the employers who engage in such practices deliberately to avoid obligations.

Ian Mearns (Labour, Gateshead)

My hon. Friend is making important points indeed. There are vital facets to this discussion. The employment rights aspect is of great importance. Government Members should be concerned about employment rights as well as the cost to the Exchequer. Such practices must be costing the Exchequer hundreds of millions of pounds annually. If the profits that were not being paid in taxes were being spent on something useful, such as training the future work force, we could make an argument for those practices, but I am afraid to say that the construction industry is notorious for not doing so.

John Cryer (Labour, Leyton and Wanstead)

I agree with my hon. Friend.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Both my hon. Friends have raised very important issues. Another facet that is often overlooked is the fact that such practices not only cause a loss to the Exchequer but are unfair on and exploit workers. It also creates an unlevel playing field for the many businesses that do the right thing. We have an obligation to speak up on behalf of those businesses. They pay a price by not winning contracts, because they cannot compete with such exploitative practices.

John Cryer (Labour, Leyton and Wanstead)

That is absolutely right. Winston Churchill laid the path for the Agricultural Wages Board when he became Home Secretary in 1910. He said that the best employers would be undercut by bad employers, or something along those lines. I cannot remember the quote, but I think the Committee gets the gist. We are seeing perfectly reputable employers who want to do their duty, pay decent wages and make their contributions being undercut by the worst.

When people are transferred to what I would regard as bogus self-employment, they are often given a sweetener—a slight increase in pay—but very often that comes nowhere near compensating them for what they lose in sick pay, holiday pay and so on. I will quote the standard sort of contract used by Hudson. It sounds as though I am picking on Hudson Contract. The reason why Hudson is used so extensively in the report is simply that it is the largest of the payroll firms, not because it is particularly untypical. The contract used by Hudson states that the worker

“has no contract of any type whatsoever with the client”,

and

“he neither has nor shall make any contractual claim of any type against the client”.

In the vast majority of cases that I know about, the employees carry on doing exactly the same job. They are instructed by the same foreman and the same manager, and yet they are suddenly self-employed and supposedly have no relationship with their former employer. That is fantasy. It is fantasy economics and it is a con.

The Hudson website states:

“Say goodbye to HMRC status issues and employment tribunal challenges.”

That is a bold statement, but, to a large extent, Hudson is justified in making that claim. HMRC challenged Hudson in 2007 on the basis that Hudson was transferring people to bogus self-employment. Strangely, HMRC lost the case in the High Court. HMRC argued that there was an implied relationship between the construction company and the freelance operative due to the reality of the relationship between them. That would make sense to most people, I would have thought, but the High Court, bizarrely—I do not know what planet the High Court was on that day, but it is not unusual for it to make bizarre decisions—said, “No, there is no such relationship”, despite the fact that there was one. HMRC lost, and since then, there has been a rapid expansion in the activities at the dodgy end of the market. In the past three years, the number of employer compliance reviews conducted by HMRC has fallen substantially.

Perhaps when the Minister responds he will tell us that the number of compliance reviews of companies is starting to rise. I hope that he will be able to say that, because that would go some way to addressing the problem, which is increasingly prominent in construction and other industries.

In the three years up to the UCATT report, published a few months ago, the number of compliance reviews and inspections had been falling consistently. That of course says to employers who want to engage in bogus self-employment, “You are going to get away with it, because HMRC is not going to come round to talk to you, look at your books or check that you are following the letter of the law.” They will have more confidence in trying to keep cash away from the Treasury, where it should be going.

As I said at the beginning, my worry is that, while at the moment the practice is prominent in construction, it is spreading, particularly to the hotel industry; I say that from some experience in that industry. We are starting to see such bogus self-employment creep into hotels and catering. After that, it will spread to other industries. At some point, the Treasury and HMRC will have to take the issue seriously, because it clearly will have an effect on the flow of cash coming into the Treasury, which will of course have all sorts of implications.

David Gauke (Conservative, South West Hertfordshire)

I am grateful for the opportunity to return to the subject. Although the debate has broadened out from clause 22, the area is an important one.

To respond to the points raised by the hon. Member for Leyton and Wanstead, I reiterate that the Government announced in the last Budget their proposals to deal with offshore employment through intermediaries. The consultation document on that will be issued this summer. It will look to address all the abuses referred to and ensure that offshore employers pay the full amount of tax and national insurance contributions.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

The Minister mentioned the consultation. My understanding was that it would be published in May 2013—this month. He now says that it will be published in the summer. Will he clarify when precisely the consultation will be published?

David Gauke (Conservative, South West Hertfordshire)

At this point, I am not going to be more precise than to say this summer. Obviously, I will let the hon. Lady know if I can be more precise.

Regarding compliance, I assure the Committee that HMRC has increased the number of compliance teams dealing with employment avoidance. A number of further teams are due to come online soon, in a directed compliance programme in this area. I am sure that hon. Members will be aware of the Government’s efforts to support HMRC so that compliance activity can be stepped up across the board.

It is also worth saying that the offshore employment through intermediaries consultation document is the first part of an HMRC project into the avoidance of tax and national insurance contributions through intermediaries. HMRC will continue to gather evidence about the other forms of employment tax avoidance referred to today.

In a spirit of generosity to the hon. Member for Newcastle upon Tyne North, I will now be more precise on when the consultation document will be published: I can reveal for the first time that it is due to be published on 30 May.

Clause 23 - Taxable benefit of cars: the appropriate percentage

Catherine McKinnell (Labour, Newcastle upon Tyne North)

The clause relates to the taxable benefits on company cars that are made available for private use, known as company car tax. The company car tax calculation, which previously had been calculated purely on the basis of business mileage, was rightly reformed in 2002 by the previous Government to be based on CO2 emissions.

Sections 121 to 148 of the Income Tax (Earnings and Pensions) Act 2003 provide for calculating the cash equivalent of the benefit of a company car that is made available for private use. In broad terms, the calculation depends on the list price of the car multiplied by the level of carbon dioxide emissions that that car produces. The outcome of the calculation is expressed as the appropriate percentage, which means that the lower the cars emissions are, the lower the percentage.

The appropriate percentage for such cars was an area on which we had a lengthy discussion during last year’s Finance Bill Committee. We do not want to replay that unnecessarily this year, but many concerns were raised by Opposition Members about the impact that increasing by 1 percentage point the tax rate on company cars emitting carbon in excess of 75g per kilometre would have on people’s pockets—particularly those on modest incomes, such as district nurses, midwives and carers, who often have little choice about whether they use a company car. [Interruption.] I hear reassuring noises from my hon. Friend the Member for Gateshead, who contributed passionately to last year’s debate.

This year’s clause on the appropriate percentage for such cars deals specifically with ultra-low-emission vehicles. That is, in the words of the tax information and impact note, part of the Government’s package

“to incentivise the purchase and manufacture of ultra low emission vehicles in the UK.”

I am keen to return to that wider issue when we consider clause 67, which looks at the capital allowances for cars with low carbon dioxide emissions, as supporting the growth of this industry is of particular interest to me and a number of my colleagues as north-east MPs.

As members of the Committee may know, the 2002 reforms to the company car tax regime mean that changes to rates are announced at least two Budgets in advance; that practice is intended to provide a level of stability and certainty in the company car market. Indeed, it is particularly helpful for fleet operators when making vehicle purchasing decisions, as the average length of company car ownership is between three and four years. The clause therefore legislates for changes that will not be made until April 2015, and relates to the decision, confirmed in Budget 2013, that the five-year company car tax exemption for zero and low-carbon vehicles will come to an end in April 2015, as originally legislated for in the Finance Act 2010.

I do not wish to confuse members of the Committee about the various dates involved, but they are key to discussions on this provision. The Minister will no doubt be aware of the impending ending of the exemption and the significant concern that that has caused to all involved in the burgeoning zero and low-carbon-emission vehicle industry. Consumer choice is absolutely critical to that industry, not least because fleet purchases—that is, company cars—accounted for the vast majority of the UK’s first 1,000 electric car and van sales.

Indeed, the proposed ending of the exemption led John Lewis—not the department store, but the chief executive of the British Vehicle Rental and Leasing Association—to express this concern just last year:

“By eliminating their company car tax exemption from April 2015, the Chancellor is getting rid of one of the main incentives for fleets to operate”

electric vehicles. He concluded:

“This measure could kill the electric car market stone dead.”

Dr Ben Lane, the managing editor of Next Green Car—I am sure we all read that publication—suggested that the changes presented

“a serious challenge to the UK electric vehicle market”.

He said:

“At a stroke, this will remove one of the key fiscal drivers of the new market for plug-in electric vehicles.”

He went on:

“While fiscal incentives should be time-limited, 2015 is far too early to expect electric vehicles to compete with much lower priced petrol-hybrids and clean diesels. With battery and plug-in hybrid development still ongoing, and sales volumes still low, the playing field isn’t yet level enough for a fair fight. If this goes ahead, the electric vehicle market will be killed off before it’s even started.”

The measures in the clause to mitigate the ending of that exemption from company car tax are therefore a hugely welcome improvement. Also announced in Budget 2013, they mean that from April 2015 there will be two new company car tax bands for ultra-low-emission vehicles, a 5% band for cars with emissions of 0g to 50g of CO2 per km, which will rise to 7% by 2016-17, and a 9% band for cars with emissions of 51g to 75g of CO2 per km, which will rise to 11% in 2016-17.

Those rates are, for the record, lower than the 13% rate suggested by Budget 2012 for all zero-emission and low-carbon cars emitting less than 95g of CO2 per km in 2015-16, which was to rise to 15% by 2016-17. According to HMRC’s tax information and impact note, the clause will see a basic rate taxpayer who drives a zero-emission car with a list price of approximately £28,500 paying £450 less company car tax in 2015-16 than they would have done at the 13% rate.

A rate of 5%, however, is clearly higher than paying nothing at all. Will the Minister outline exactly what company car taxation the aforementioned basic rate taxpayer will be paying in 2015-16 compared with what they pay at present—which is, as far as I understand it, nothing? I would also like to hear what specific assessment has been made of the impact of these changes on the growth of the ultra-low-emission vehicle industry, particularly given the importance of company car purchases in supporting growth in that industry, and the critical role the industry plays in supporting apprenticeships and high-skilled jobs in regions such as mine, through the excellent Gateshead college, which is in the constituency of my hon. Friend the Member for Gateshead, and also through Nissan, with its significant local supply chain.

It is a positive development that after 2013 company car tax rates will be announced three years in advance to give the automotive and company car sector a level of certainty that will boost confidence and, hopefully, stimulate greater demand. It is also welcome that Budget 2013 stated that the Government will review these incentives for ultra-low-emission vehicles in the light of market developments at Budget 2016 to inform decisions on company car tax from 2020-21 onwards. However, I urge the Minister to make a commitment that this matter will be kept under constant review, and that the Government take steps to act accordingly for the reasons I have outlined. My hon. Friends may also put forward similar arguments, given that it such a crucial sector to support in these early days of its development.

Ian Mearns (Labour, Gateshead)

I echo my hon. Friend’s concerns, particularly about the future of the developing electric vehicle market. As my hon. Friend pointed out, Nissan is producing the Leaf at its Washington plant, and I am very glad that on a recent visit I had the opportunity to buy one—[ Interruption. ] Not to buy one, to drive one; I could not afford one. I have to declare an interest. I do not own a car, and I occasionally hire vehicles when I have to use one. I am greenish, because I do a lot of walking in my constituency. It is neat and tidy, my constituency, in terms of overall size.

The problem with developing the electric car market is first and foremost that the vehicles are, on the face of it, quite expensive. There is a high capital outlay at the beginning, but there is an immense saving on fuel as the vehicle is used. We therefore need to incentivise the market to get more of these types of cars on the road. If the Government are to be the greenest Government ever, one would think that incentives for electric vehicles such as the ones being produced by Nissan are crucial in terms of making sure we all collectively reduce our CO2 emissions.

In my area, the 6,000 jobs at the Nissan plant do not automatically rely on the production of the Leaf, but the growth of the Leaf product is crucial to the plant’s place in the European market in particular. An awful lot of vehicles from the Washington plant, as I mentioned last week, are exported directly to Europe via the dock at Jarrow. But in addition to the 6,000 jobs at the Nissan plant, something like 25,000 to 30,000 jobs in the supply chain industries working directly for Nissan are affected by what we do.

In developing the electric car market, we have to remember that we do not yet have an adequate network of charging points around the country. On top of that, it is a developing technology, in which we are hoping to see some breakthroughs in battery life and the mileage that cars can achieve in a day without recharging. One of the developments that has taken place is the updating of charging points. A rapid charging point can give a vehicle something like an 80% charge in the space of 20 to 30 minutes, which is vital for making sure people can carry on using their vehicles.

If incentives are withdrawn in the way that has been outlined, and company fleets shy away from purchasing electric vehicles because of the erosion of the tax relief, that will be a matter of grave concern. I am reflecting the opinions of people in the market itself. We could see something that is vital for our green investment future being strangled at birth, particularly through the fleet markets being eroded.

We need to get more of these vehicles on to our roads so that people can see what their performance is. Their performance is high but the capital outlay often makes buying an electric vehicle seem prohibitive. We need to demonstrate that they are the technology for the future.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

My hon. Friend makes a powerful case for electric vehicles. I visited Nissan with him and drove one of the new Leaf vehicles. I would love to be able to purchase one. One of the issues in a region such as ours that hampers the development and roll-out of electric vehicles is confidence. It boils down to confidence in the market, confidence in Government support for these new technologies and, as my hon. Friend eloquently puts it, confidence that they will not be strangled at birth. They will obviously multiply immediately once we start seeing more electric vehicles on the road; there will be that confidence for more people to buy into the technology.

Ian Mearns (Labour, Gateshead)

My hon. Friend makes a powerful point. I will listen with interest to the Minister’s response. Nissan is a fundamental industry for the north-east of England but it is also a fundamental industry for our future in terms of how it develops this technology to try to reduce our overall CO2 emissions from vehicular traffic. If we are not careful, a lot of our collective aims and objectives could be thwarted by something that might be regarded as a tad careless.

David Gauke (Conservative, South West Hertfordshire)

Clause 23 makes changes that affect the level of tax payable on the private use of a company car. Company car tax was reformed in 2002 to reduce the carbon dioxide emission levels of cars. The amount of tax paid on a company car is now based primarily on the amount of carbon dioxide it emits. The changes made by the clause develop that reform and are in line with a wider £100 million package to support the purchase and manufacture of ultra-low-emission vehicles, also known as ULEVs, in the UK. At Budget 2013, we guaranteed reduced rates of company car tax for ULEVs until at least 2020. We announced a three-year extension of the 100% first-year allowance for ULEVs from 2015-16 and committed to reviewing both the company car tax and capital allowance incentives for ULEVs in light of market developments at Budget 2016.

We also said when we would announce company car tax rates. As we have heard, since 2002 they have been announced at least two years in advance. In future, company car tax changes will be announced three years ahead and I welcome the support for that policy. This will continue to provide stability and certainty in the company car market. It will allow employers and company car drivers to plan changes to their fleets well ahead of any tax changes.

The clause introduces two new company car tax bands for ULEVs which are effective from 2015-16. The detail of the bands is set out in the legislation but they effectively ensure that ULEVs will be taxed at a lower rate than conventionally fuelled cars. In 2015, ULEVs will also be taxed less than planned by the previous Government.

Let me provide an example. In 2015-16, a basic rate taxpayer driving a zero-emission car with a list price of £28,500 will pay £470 less company car tax than on a typical conventionally fuelled car. A higher rate taxpayer will pay £940 less. Those new bands support the purchase and development of ULEVs in the United Kingdom.

The clause also sets out the 2015-16 company car tax rates for non-ULEVs. The appropriate percentage of the list price subject to tax for the cars will increase by two percentage points, with effect from 6 April 2015. That ensures that company car tax continues to reflect changes in fuel efficiency and supports the sustainability of public finances. A basic rate taxpayer with a popular conventionally fuelled car with a list price of £18,000 will pay approximately £72 more in 2015-16. The higher rate taxpayer will pay £144 more.

Employees can pay less by choosing a less polluting company car. The increase should be seen in the context of the larger extent of tax increase of £1,335 in the first allowance, which took place last month. Budget 2013 also announced a further increase of £560, which means that the personal allowance will increase to £10,000 in 2014-15 and, from April 2014, the cumulative effect of the Government’s personal allowance increases will have taken 2.7 million people out of income tax. A typical basic rate taxpayer will see a cash gain of £705 per year.

I was asked specifically about the impact of the CCT measures on ULEV sales.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Will the Minister give way?

David Gauke (Conservative, South West Hertfordshire)

Shall I just continue responding to the question?

Catherine McKinnell (Labour, Newcastle upon Tyne North)

I was going back to a previous point.

David Gauke (Conservative, South West Hertfordshire)

I give way to the hon. Lady.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

I could not let this opportunity pass. While the personal allowance will decrease the tax burden on certain taxpayers, the increase in VAT to 20% and other changes to the tax and benefit system have been shown clearly to increase the tax burden on the very families that the Minister claimed in his statement the Government want to support. Ultimately, families will be worse off in 2015 than they would otherwise have been.

David Gauke (Conservative, South West Hertfordshire)

I am tempted to broaden out my remarks and argue about the fact that we inherited such a large deficit and to say that, had we not taken the steps that we had, we would not have reduced the deficit by a third, while the Opposition favour increasing borrowing. But I will not make those points. I shall turn instead to the questions asked about the clause.

Given that the market is at an early stage of development, it is not possible to estimate precisely the impact on ULEV sales. It is fair to take into account the wider support that the Government provide to ULEVs. We are taking steps to encourage their purchase and, hence, contribute to our objectives to reduce greenhouse gas emissions from road transport, while supporting the manufacture of ULEVs in the United Kingdom. It is worth pointing out, in that context, that we have listened to the views of car manufacturers, and that we have announced a £100 million package to support the purchase and manufacture of ULEVs. It is also worth saying that some of our improvements to R and D tax credits are helpful. In its response to the Budget on 20 March, the Society of Motor Manufacturers and Traders stated:

“The Chancellor’s actions to improve R&D tax credits will help trigger extra business investment, and the change to the Company Car Tax rules for ultra-low emission vehicles will be welcomed by many in the UK automotive sector”.

It goes on to say that

“SMMT is ‘delighted’ with the introduction, from April 2015, of two new bands at 0-50 g/km of carbon dioxide…and 51-75 g/km CO2”.

Of course, we will continue to monitor the ULEV market.

3.15 pm

Perhaps I should also turn to the point made by the hon. Member for Gateshead about recharging infrastructure. The Government have committed £74 million to recharging infrastructure. In February 2013, the Department for Transport announced a £37 million package to pay 75% of the cost of installing charge points in houses, on streets and at railway stations, and 2,800 charge points have been installed via the plugged-in places scheme since 2010.

Concerns have been raised about why we did not keep the zero rate for the lowest emission cars. I reiterate that the previous Government legislated that the rate for zero-emission cars would end in 2015. It is also worth pointing out that, under our plans, electric cars will be taxed at 5% in 2015 and 7% in 2016; the previous Government would have taxed electric cars at 9%, which is obviously more. I hope that that is helpful to the Committee.

Ian Mearns (Labour, Gateshead)

Will the Minister give way?

David Gauke (Conservative, South West Hertfordshire)

I give way on the controversial point that 9% is more than 5%.

Ian Mearns (Labour, Gateshead)

Does the Minister accept that in the three years since the 2010 election, a notional Labour Government might actually have changed their mind?

David Gauke (Conservative, South West Hertfordshire)

I certainly do accept that. In fact, I notice that there is a tendency by the Labour party to place great weight on its own plans to reduce the deficit, and yet on any specific element of such plans—most notably on the fuel duty escalator—when pressed, it makes clear, as it did this morning, that it would not have stuck to the plans anyway. So I certainly do accept that any efforts to reduce the deficit would probably have been abandoned by the Labour party.

Chris Leslie (Labour, Nottingham East)

You are not reducing it.

Brooks Newmark (Conservative, Braintree)

Will my hon. Friend the Minister give way?

David Gauke (Conservative, South West Hertfordshire)

Before I get drawn into debates about how this Government have reduced the deficit by a third, I will give way to my hon. Friend.

Brooks Newmark (Conservative, Braintree)

I want to help my hon. Friend the Minister. I appreciate that maths is not the greatest strength of the Opposition Front-Bench spokesman, as he once again demonstrates, but £120 billion is a lesser number than £180 billion, is it not? There has been a decline in the deficit from £180 billion to £120 billion, so the deficit has fallen by a third. It may help the Front-Bench spokesman if my hon. Friend reiterates that point.

David Crausby (Labour, Bolton North East)

Order. Minister, I think we should get back to clause 23.

David Gauke (Conservative, South West Hertfordshire)

I will, in moving seamlessly towards clause 23, say that my hon. Friend is right that the deficit has indeed been reduced.

Clause 23 strikes a balance between supporting the UK’s ULEV market and ensuring that all company cars are subject to a fair level of tax. Together with the wider support that the Government are providing to ULEVs, particularly on recharging infrastructure, the measure will encourage the purchase and manufacture of ULEVs in the UK. Indeed, Nissan recently launched its zero-emission car, the Leaf, in Sunderland, as we have heard.

Mike Thornton (Liberal Democrat, Eastleigh)

I have a technical question. I understand from people who are knowledgeable about electricity generation in this country that a significant take-up of electric cars—for example, to 20% to 25% of motor vehicles—would severely affect our ability to produce enough electricity. Has that been taken into account?

David Gauke (Conservative, South West Hertfordshire)

Just as I was concluding my remarks I was thinking, “Should I give way to my hon. Friend?” I am pleased I did, because he raises an interesting query that I am sure all members of the Committee would like to mull over. I am not going to prevent members of the Committee considering that point but, if he will forgive me, I am not able to provide an answer straight away.

This is a sensible approach; we are striking the right balance; this is a more supportive approach to ultra-low emission vehicles than the one we inherited. I am pleased that we have cross-party support and hope that the clause will stand part of the Bill.

Clause 24 - Gains from contracts for life insurance etc

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss that schedule 8 be the Eighth schedule to the Bill.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Clause 24 introduces schedule 8, which amends the rules for time-apportioned reductions from gains made on life insurance policies for periods where the policyholder is resident outside the UK. The rules are known as the chargeable event gain regime.

Under chapter 9 of part 4 of the Income Tax (Trading and Other Income) Act 2005, time-apportioned reductions are provided only for life insurance policies issued by a foreign insurer. Clause 24 and schedule 8 would change that so that time-apportioned reductions were extended to life insurance policies issued by UK insurers.

Chargeable event gains arise if a policyholder makes withdrawals or receives cash or other benefits on a full surrender, part surrender, maturity or death, from a life insurance policy, life annuity or capital redemption policy; or if he sells or assigns the whole or part of a life insurance policy, life annuity or capital redemption policy, including as part of arrangements on divorce or separation; or if the ownership of a policy or part of a policy changes hands for money or money’s worth; or if the policyholder holds a Personal Portfolio Bond with an insurer in the year; or if any of the other things have been done by a trustee of a trust that the policyholder created or contributed to, the trustees of a bare trust of which the policyholder is a beneficiary, anybody holding a policy in their own name as the policyholder’s nominee or a lender to whom the policyholder’s policy was previously assigned as security for a debt.

Those gains are taxable as income and included in income for all purposes, including entitlement to personal allowances and tax credits. Provision is made within the chargeable event gain regime to ensure that chargeable event gains arising on policies issued by foreign insurers are reduced in proportion to the policyholder’s period of residence outside the UK at any time during the life of the policy. These are known as time-apportioned reductions and broadly mean that gains accruing during an individual’s period of residence outside the UK are excluded from the charge to UK tax.

Time-apportioned reductions are currently not available to policies issued by UK insurers, even though individuals with such policies may also have periods of residence outside the UK. The tax information and impact note states that the change is expected

“to impact on a relatively small number of individuals who have periods of residence outside the UK during their ownership of a life insurance policy”.

Obviously, schedule 8 relates to taxable gains arising on the life insurance policies held by individuals who are non-UK resident for some of the time during the prescribed period. Currently, certain life insurance policies or capital redemption policies issued by a UK non-resident company or forming part of an overseas life insurance business of a UK insurer, are defined as foreign policies and some aspects of the tax treatment are therefore different from policies issued by UK insurers.

One example of different treatment is that the gain on a foreign policy would be reduced if the policyholder was not UK-resident throughout the entire prescribed period. As I understand it, and as I am sure the Minister will confirm, the clause is intended to apply to new UK policies or variations of existing UK policies where the owner of the policy is resident outside the UK during the policy ownership period.

I would be grateful if the Minister would confirm my understanding of the change that is being introduced. Would it have been desirable for the change to have applied to all existing UK policies? How many policyholders who reside abroad are likely to be impacted by the change? What is the typical period for relevant policyholders who are affected by the change? What will be the cost or yield to the Exchequer of schedule 8? The Exchequer impact is assessed as being negligible, but it would be useful if the Minister could confirm that there would be no additional yield to the Exchequer.

David Gauke (Conservative, South West Hertfordshire)

Clause 24 introduces schedule 8, which makes changes to ensure that there is greater alignment between the treatment of policies issued by insurers inside and outside the UK, and that the rules on time-apportioned reductions provide a more appropriate reduction to chargeable event gains.

It might be helpful if I set out a little bit of background to the measure, which was announced at Budget 2012. Special rules, which are referred to as the chargeable event gain regime, apply income tax to investment profits that individuals realise from life insurance policies. Under the current regime, chargeable event gains arising on policies issued by foreign insurers are reduced in proportion to a policyholder’s period of residence outside the UK at any time during the life of the policy, a process known as a time-apportioned reduction. Broadly, that means that gains accruing during an individual’s period of residence outside the UK are excluded from the charge to UK tax. Time-apportioned reductions are currently not available to policies issued by UK, as opposed to foreign, insurers, even though individuals with such policies may also have periods of residence outside the United Kingdom. In addition, the amount of the reduction under the current rules may be inappropriate in some circumstances. For example, relief is given by reference to the residence history of the legal owner of the policy rather than to that of the person liable to income tax on the gains, who is generally the beneficial owner.

Clause 24 and schedule 8 extend time-apportioned reductions to life insurance policies issued by UK insurers. The clause and schedule provide that time-apportioned reductions will be calculated by reference to the residence history of the person liable to income tax on the gains, not by reference to the residence history of the legal owner of the policy.

A formal consultation was launched in the summer of 2012, and the possibility of amending the simple formula currently used to calculate the allowable reductions for periods of non-residence was discussed. The aim of those discussions was to tie the calculation more closely to the dates of premium payments and the values of sums invested at particular dates. A number of different methodologies were considered, but the improved accuracy was far outweighed by the complexity of the calculation that the taxpayer would be required to carry out, so the existing simple formula remains in place.

The hon. Member for Newcastle upon Tyne North asked about the impact. As she correctly said, the tax information impact note states that there is a negligible impact on the Exchequer, which means that the measure will result in neither a significant cost nor a significant yield. She also asked about the number of people who are likely to be affected. She will be aware that the proposed changes are expected to impact on a relatively small number of individuals who have periods of residence outside the UK during their ownership of a life insurance policy. It is difficult to be specific about that and go beyond what the TIIN states, but we are probably talking about a few thousand.

The hon. Lady also made the point that it is desirable for the change to apply to all UK policyholders. I would agree with that; the measure supports the Government’s objective of ensuring that our tax system is fair by aligning the treatment of policies issued by UK and non-UK insurers. I hope that that is helpful to her.

This measure is about promoting fairness in the tax system by levelling the playing field so that UK insurers and those insurers outside the UK are treated in the same way. It provides a more appropriate calculation methodology, based on the residence history of the person paying tax on the life insurance policy gain. I hope that the clause will have the support of the Committee and may stand part of the Bill.

Clause 25 - Qualifying insurance policies

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss that schedule 9 be the Ninth schedule to the Bill.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

As far as I understand it, the clause introduces schedule 9, which provides for the implementation of a new annual premium limit on qualifying life insurance policies, which I shall refer to as QPs—I am sure that the Minister will be grateful for that abbreviation. The QP regime was introduced in 1968 to preserve pre-existing tax treatment for traditional moderate-value, long-term, regular premium savings policies that contain a significant element of life insurance. No upper limit was set for the investment premiums that could be paid into a QP, which allowed individuals to obtain unlimited relief from higher rates of income tax.

QPs are essentially regular premium life policies that run for 10 years or more and have an investment, such as endowments or whole life with profits. Term policies that pay a fixed sum if a person dies within a fixed period of years, but have no investment value, also usually qualify.

In Budget 2012, the Government announced their intention to restrict the tax relief available for QPs from 6 April 2013, limiting to £3,600 the premium for new QPs taken out by any individual if the maturity proceeds are to qualify for tax-free status. Policies taken out before 21 March 2012 are not affected, but some transitional arrangements have been put in place for policies taken out from that date to forestall people who might have tried to take advantage of the old rules before the new rules became clear.

The measure was consulted on in June 2012 and the summary of the responses published suggested that the following key concerns had been raised:

“There are likely to be significant implementation costs to industry from a reporting system both for policies taken out before 21 March 2012 and those taken out on or after that date, disproportionate to the protection of Exchequer receipts being sought by the Government. There are concerns about the extent to which policies taken out before 21 March 2012 are brought into the new annual premium limit regime”

and

“The proposed changes add complexity to an already complicated area of tax law.”

Further concerns about the impact of the changes on inheritance tax planning have been raised:

“Since the special tax regime for qualifying policies was introduced in 1968, it has given them important advantages for tax planning, and IHT in particular when written in Trust. This may have a significant effect on some traditional IHT planning arrangements. For example many policies were taken out in the 1970s -1990s and placed in Trust to build up a fund to meet IHT on the death of the survivor of a married couple. Back to back annuities were another example. These may be less popular nowadays as investment returns on traditional policies have declined with interest rates, but they still have a place in tax planning.”

The tax information and impact note states that the measure is expected to have a negligible impact on the Exchequer, and will

“impact a relatively small number of individuals and households who would have used such arrangements for higher value investment. It is expected that there will be no impact on individuals making regular moderate value investments for which premiums payable will not exceed the limit.”

In 2010, 30 life insurers and 12 friendly societies were known to sell QPs.

I have a general point to make. That reference to a relatively small number of individuals is relative to what? Some clarification would be helpful. I also have a few queries that arise not only from the concerns raised in the consultation but from some of the statements in the impact note. It would be helpful if the Minister could explain in layman’s terms how the annual premium limit will work in practice and which life insurance policies will be deemed qualifying life insurance policies. It was helpful that the Minister sought to quantify the relatively small number of households that will be affected in his comments on the previous clause. If he could do the same here, it would provide some reassurance.

Does the Minister think these changes will have an impact on the propensity of individuals to save in their policies on a regular basis? Are life insurance policies becoming a less fashionable form of savings these days? Could he also explain the rationale for the difference between the ISA tax-free allowance, which is around £5,800, and the tax relief on premium limits set in this schedule, which is £3,600? I have one final comment on the impact on business, including civil society organisations, which are mentioned in the impact note. The measure is expected to have an impact on those 30 life insurers and 12 friendly societies which the Government were aware of in 2010. It says that the final number of businesses affected and the impact of this change on them cannot be quantified at this stage and that it is expected that there will be an increase in administrative burdens and a one-off cost to businesses as they familiarise themselves with this policy change. Greater clarity on those impacts and associated costs would be helpful.

David Gauke (Conservative, South West Hertfordshire)

The clause introduces schedule 9, which makes changes to introduce an annual premium limit of £3,600 for qualifying insurance policies from 6 April 2013. That will improve fairness in the tax system by ending unlimited relief from higher and additional rates of tax being granted on premiums to life insurance policies.

The qualifying policy regime was introduced in 1968 to preserve pre-existing tax treatment for traditional, moderate-value, long-term, regular premium savings policies that contain a significant element of life insurance. No upper limit was set for the investment premiums that could be paid into a QP, which allowed individuals to obtain unlimited relief from higher rates of income tax. The Government announced in Budget 2012 a restriction to the tax relief available for QPs, which supports our objective of promoting fairness in the tax system by ensuring that tax reliefs for QPs are correctly targeted.

The clause and schedule provide for the implementation of a new annual premium limit on QPs. For policies issued on or after 6 April 2013, the amount of premiums payable into QPs for an individual will be limited to no more than £3,600 in any 12-month period. For policies issued on or after 21 March 2012, but before 6 April 2013, transitional rules will apply. Relief for policies issued in that period will be restricted. Full relief is available in relation to premiums payable or treated as payable in the transitional period; however, for those policies the £3,600 annual limit will apply to premiums payable on or after 6 April 2013.

Mike Thornton (Liberal Democrat, Eastleigh)

Will the Minister give way?

David Gauke (Conservative, South West Hertfordshire)

I will, but with some trepidation.

Mike Thornton (Liberal Democrat, Eastleigh)

This is a purely technical question—[Hon. Members: “So was the last one.”] I am a Lib Dem—what can I say?

Do these measures apply to single premium policies, commonly called bonds? A lot of those policies are used to supply money for people for their old-age care, an issue that we are all concerned about on both sides of the House, and to fund care home fees later in life. I have no objection to any of these measures for most policies, but for those particular policies it might restrict people’s ability to save money for care home fees.

David Gauke (Conservative, South West Hertfordshire)

I am always nervous when someone stands up and says that they will make a purely technical point, but the point is perfectly fair. It is worth mentioning that there are some exclusions to the rules: for example, pure protection policies are excluded, unless they are varied so that they are no longer pure protection policies; that covers those policies that have no surrender value or are not capable of acquiring a surrender value, or under which the benefits payable cannot exceed the amount of premiums payable except on death or disability. I will come back to the specific cases that the hon. Gentleman raised later in my remarks.

Policies issued before the transitional rules came into effect will be affected by the new rules only where on or after 21 March 2012 there is a substitution of a new policy for an existing policy or a variation of an existing policy, or the exercise of an option within an existing policy, that results in a major change—such as, for example, the extension of the premium-paying term or an increase in premiums payable. The tax treatment of policies issued before 21 March 2012 that are not altered on or after 21 March will remain unchanged.

A formal consultation was launched in summer 2012, to which 19 responses were received, including from representative bodies for insurance companies, friendly societies and mutual societies; HMRC also held a number of meetings with businesses, representative bodies and professional firms.

During the consultation, industry suggested that existing policies issued before 21 March 2012, often referred to as the back book, should be excluded from the new rules. The Government have listened to those representations and agreed that back book policies will be brought within the new annual premium limit only if they are altered in a substantial way. Additionally, to lessen any administrative burden on the industry arising from the introduction of the annual premium limit, insurers will not be required to provide reports on back book or transitional period policies to HMRC.

Industry also suggested a number of different types of policy that should be excluded from the new annual premium limit. The Government have excluded pure protection policies, and I have run through that issue. We have excluded mortgage endowment policies issued before 21 March 2012, when the alterations to the policy are made only to ensure that the policy enables repayment of the relevant mortgage capital. Exempting those policies will avoid unduly harsh repercussions for policy holders whose investments had not performed as expected and who will either have to increase premiums above the cap to meet the target of repaying their mortgage or run the risk of losing their property.

The schedule grants powers to HMRC to make regulations providing for statements from individuals to support qualifying policy status for new or continuing policies issued or amended on or after 6 April 2013, and reporting requirements for insurance providers in respect of qualifying policies issued on or after 6 April 2013. Draft regulations were published for consultation on 31 January 2013, and the consultation closed on 28 February 2013. The detail of the regulations is still under discussion with the working group drawn from the industry and the accountancy profession, the aims for the regulations to be made when Royal Assent is given to the Finance (No. 2) Bill 2013.

Let me deal with some of the issues raised in the debate. The QP relief applies to all individuals, in addition to existing savings vehicles. The majority of policyholders will be unaffected by the £3,600 premium limit. I was asked how many will be affected. The impact assessment says that relatively few will be affected, and the hon. Member for Newcastle upon Tyne North asked “relative to what?” I could say that it was relative to the 2.7 million people who have been taken out of income tax by the Government or the 25 million people who have seen a reduction in their basic rate of income tax but, to be more precise and using FSA statistics, in 2010, of the 420,922 QPs that were issued, only 7,907 policies will be affected by the limit.

Concern was expressed about whether there would be an increased administrative burden for industry. The Government acknowledge that there is an increased administrative burden, but we believe that it is commensurate with the overall aim of the measure, which is to increase fairness in the tax system. We have done our utmost to limit the impact of the burden. For example, there has been wide consultation with the industry.

As for friendly societies, again we have consulted closely.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Will the Minister give way?

David Gauke (Conservative, South West Hertfordshire)

Let me finish my point about friendly societies. The measure does include additional information obligations for providers when policies are first issued. Broadly, discussions with the industry suggest that the additional requirements are unlikely to be burdensome, although we acknowledge that they might have a greater impact on a small number of friendly societies that do not routinely provide information to HMRC on life policies.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

My question relates to an earlier point that the Minister made. Unfortunately, I do not have my Red Book immediately to hand. However, bearing in mind the doubts expressed in the consultation about whether the proposed change would bring in sufficient revenue to justify the complexity of the change, can the hon. Gentleman clarify what the yield is expected to be from the change, which obviously needs to be offset against the cost of implementing it and the allegation of its being disproportionate, one of the issues raised in the consultation?

David Gauke (Conservative, South West Hertfordshire)

The hon. Lady will be aware that the tax information impact note again says that the Exchequer impact is negligible None the less, we think that the measure supports our objective of promoting fairness in the tax system by ensuring that the reliefs are correctly targeted. The current regime has no upper limit on the investment premiums payable into a QP, allowing individuals to obtain unlimited relief from higher and additional rates of income tax. The measure will restrict the amount of premiums that can be paid into a QP.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

I apologise if I am not following the argument fully. If there is no impact—no cost and no yield—can the Minister explain how that will work in practice and whether any actual change in behaviour will result from the measure being put in place? In terms of economic impact, I cannot see how it can possibly be measured.

David Gauke (Conservative, South West Hertfordshire)

If the hon. Lady is making the point that she would not support a tax measure that did not bring any yield in, I welcome her presumed support for reducing the 50p rate of income tax to 45p, so that is an interesting principle.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Will the Minister give way?

David Gauke (Conservative, South West Hertfordshire)

In a moment. It is an interesting principle for her to have accepted.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

That is not what I was saying. If he gives way, I will clarify.

David Gauke (Conservative, South West Hertfordshire)

That is why I am not giving way. We believe that the measure is a matter of fairness. Although we cannot identify an immediate yield as a consequence of the measure, it does protect revenue. It prevents the QP system from being abused in a way that may have an implication for lost revenue, and we think it is a matter of fairness that a £3,600 limit in the circumstances is the right thing to do.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

I thank the Minister for giving way and for giving me the opportunity to clarify my point. If there is no economic benefit or detriment that is recognisable in behavioural change as a result of the policy, I would question whether the Government’s aims are being fulfilled in terms of ensuring fairness, as the policy and the figures that have been laid before the Committee today do not appear to have any economic impact on the individuals affected.

David Gauke (Conservative, South West Hertfordshire)

All I can say is that we have worked closely with the industry to ensure that burdens are minimised. There are no reporting requirements in respect of policies issued before 6 April 2013. The form of statement from customers is not prescriptive and industry can modify existing statements that are completed in this area. The burdens will not prove substantial in the vast majority of cases. Without the measure, there is the opportunity for it to be used in a way that does not target the tax relief.

On the issue raised by my hon. Friend the Member for Eastleigh about how QPs can be used to supply money to pay care home fees, it is worth pointing out that policies existing on 5 April 2013 will not come into the new regime unless the amounts saved are increased above the limit, so they can continue to save provided they do not go over that limit. As I said, the limit is there to ensure fairness in the tax system.

A point was raised about the comparison with the ISA. The ISA is the primary savings product available to individuals. The limit on QPs is designed to reflect the fact that it is a supplementary savings product, and it is consequently set at a lower level. A question was asked about how the premium limit will work in practice. The annual premium limit of £3,600 applies from 6 April 2013 for premiums payable under QPs in a 12-month period. As I said earlier, prior to 21 March 2012, policies are unaffected unless amended on or after 6 April 2013.

With those points of clarification, I want to reiterate that this measure supports the Government’s objective of promoting fairness in the tax system by ensuring that tax reliefs for QPs are correctly targeted. It will restrict the amount of premiums that can be paid into a QP, thereby ending unlimited relief in higher and additional rates of income tax. It is one of a number of measures in the Bill to ensure that wealthy individuals pay their fair share of tax, and I hope the clause will stand part of the Bill.

Clause 26 - Transfer of assets abroad

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss the following:

Government amendments 21 and 22.

That schedule 10 be the Tenth schedule to the Bill.

David Gauke (Conservative, South West Hertfordshire)

Schedule 10 makes changes to the transfer of assets abroad provisions. The provisions are designed to prevent UK resident individuals from avoiding tax by transferring assets of any kind, so that income arises to a person abroad while the UK individual is still able to enjoy the benefit of the income, directly or as a capital sum. The legislation may also apply where the arrangements result in someone in the UK other than the actual transferor being able to benefit as a result of the transfer.

This is essentially anti-avoidance legislation which will deter people from sheltering income from UK tax by artificially arranging for it to arise to a person offshore. However, there are, quite rightly, exemptions from the rules. These are where tax avoidance is not a main purpose, and also where it is no more than an incidental purpose and the arrangements are commercial. Both of the existing exemptions depend on an element of tax avoidance purpose being identified.

The Government consider that the way in which the existing exemptions are applied in practice is consistent with EU law. But in order to be more clearly compatible with EU law, the legislation introduces a new and alternative objective exemption. Rather than looking at the purpose of the arrangements and whether they were put in place to avoid tax, as the existing exemptions do, the additional exemption focuses, in accordance with EU law, on objective features of the transactions. It will ensure that income attributable to transactions that are genuine and serve the single market—for instance, by contributing to real economic activity in another member state—are not subject to a transfer of assets charge.

The legislation gives particular illustrations of what is accepted as genuine, based on past cases in the European courts. A genuine transaction is one that is on arm’s-length terms, or forms part of the activities of a foreign business establishment which meets specified commercial pointers aimed at excluding artificial, so-called brass plate, arrangements.

The new exemption excludes gifts made for personal reasons which are inherently not at arm’s length but which are only of personal benefit to the recipient. In order to ensure that the legislation is proportionate, and does no more than exclude the artificial aspects of the arrangements, there is provision to apportion income between the part of a transaction that is genuine and the part of the transaction that is artificial. Similarly, the legislation allows that where an asset is used for genuine commercial purposes the transaction may fall within the exemption.

The Government do not consider that the exemption’s introduction will reduce the effectiveness of the legislation, given the way it is already applied in practice. The new exemption is more objective, as EU law requires. It remains targeted at artificial arrangements that avoid tax. The cost of introducing the new exemption is estimated at £10 million per annum, compared with the £340 million per annum that we believe the legislation protects from Exchequer loss due to abusive arrangements.

The measure was formally consulted on between 30 July and 22 October 2012. A further version of the draft legislation was published in December for consultation. In response to suggestions from stakeholders on the existing legislation, further amendments were proposed as part of the consultation, with the aim of clarifying rather than changing the way in which certain aspects of the provisions operate. In the light of the responses, the schedule introduces additional rules to provide greater clarity about the prevention of double charging, which may arise as a result of income being subject to income tax under both the transfer of asset rules and another part of the Taxes Acts. A further change will clear up any misunderstanding over the interaction of the transfer of asset rules with double taxation agreements and thus stop claims for what is tantamount to double non-taxation.

A third change proposed in the consultation, to recast the matching rules, has been deferred until the Finance Bill 2014. The matching rules are used to calculate the amount of income that is chargeable where someone other than the transferor receives a benefit caught by the transfer of assets rules. The postponement of that change is to allow for further consultation over the summer in order to ensure that the amended rules are clear, workable and fair.

Amendments 21 and 22 to the schedule are minor and technical. One of the changes introduced by the schedule is that companies incorporated outside the United Kingdom but nevertheless resident in the United Kingdom for tax purposes will no longer be automatically treated as a “person abroad” for transfer of asset purposes. The amendments will ensure that schedule 10 fully delivers that outcome. Currently, the legislation specifically provides that companies incorporated abroad but UK resident are persons abroad, and the schedule omits that specific provision with effect from 6 April 2012. However, for this change to be effective, the legislation also needs to be clear that a company’s domicile is not relevant in deciding whether the company is a person abroad. The amendments are to achieve that result and ensure that the announced policy change, which was welcomed by stakeholders, is delivered. A company will be a person abroad only when it is resident outside the United Kingdom.

Schedule 10 introduces changes that are aimed at improving the operation of the existing anti-avoidance provision, either by adding clarity for interested parties or maintaining their compatibility with EU law.

Nigel Mills (Conservative, Amber Valley)

At the risk of inviting the Minister to come over all swivel-eyed, does the Minister agree that the provisions have always been perfectly sensible anti-avoidance rules, and that the European Court’s decision that they somehow contravene the treaties is utterly ridiculous and trespasses into areas of tax policy that were never meant to be in the EU’s sphere of influence? It has forced us to give away £10 million a year to tax avoiders who have no commercial purpose for what they are doing.

David Gauke (Conservative, South West Hertfordshire)

My hon. Friend makes his point forcefully. Were he to look back at one or two Finance Bill debates in previous years, he may find that I have made similar points. I note his objections, which he put across well. From the position that we are in, it is worth pointing out that the vast bulk of the revenue that we are protecting continues to be protected—our intention to prevent avoidance in this area has not been undermined, and the legislation is an attempt to meet the concerns raised by the EU in a measured and proportionate way.

The regime remains robust against abuse, and schedule 10 is one of a number of measures in the Bill designed to ensure that individuals cannot exploit loopholes in tax legislation to avoid paying their fair share of tax. With those comments, and in anticipation of any queries that Members may want to raise, I commend the clause and the schedule to the Committee.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

I wish to comment on clause 26 in its entirety, and briefly on the Government amendments tabled by the Minister at a late stage, despite being warned about the issue to which the amendments relate by the Chartered Institute of Taxation as early as 1 May. I will return to that later in my remarks.

Amid the Government’s current swivel-eyed difficulties on Europe, and as the Minister alluded to, clause 26 has been introduced in an attempt to satisfy the European Commission. That is probably vexing many Government Members in the Committee, and perhaps some in the Opposition.

As the Minister explained, the clause introduces schedule 10 to make changes to the transfer of assets anti-avoidance legislation in chapter 2, part 13 of the Income Tax Act 2007. As the explanatory notes make clear, the legislation applies to UK-resident individuals who have transferred assets so that income has become payable to an overseas person, while the UK-resident individual continues to be able to enjoy the income of the person abroad, or receive a capital sum directly or indirectly from that income.

The legislation also applies to UK-resident individuals who have not made the transfer that results in the income arising to the person abroad, but who can benefit directly or indirectly from the income arising. Generally, the transfer of assets rules impose a charge to income tax on individuals who find themselves in such circumstances.

However, on 16 February 2011, the European Commission formally requested the UK Government to amend the anti-abuse legislation on the grounds that it was discriminatory, stating:

“Under this legislation, if a UK resident individual invests in a company by transferring assets to it, and if this company is incorporated and managed in another Member State, then the investor is subject to tax on the income generated by the company to which he/she contributed the assets. However, if the same individual invested the same assets in a UK company, only the company itself would be liable for tax…the Commission considers there to be discrimination, seeing as investments outside the UK are taxed more heavily than domestic investments. The difference in tax treatment between domestic and cross-border transactions restricts two fundamental principles of the EU’s Single Market, namely of the freedom of establishment and the free movement of capital”.

The formal request by the Commission took the form of a reasoned opinion—the second step of the infringement procedure—and incorporated similar concerns about the compliance of the legislation on the regime on the attribution of gains to members of non-UK-resident companies, which we will deal with under clause 61. Clause 26 aims to reform the transfer of assets legislation to ensure compatibility with the Commission’s request.

The Government responded to the situation by announcing in December 2011, through a written ministerial statement, that there would be a consultation on the proposed amendments to the provisions, and the position was confirmed at Budget 2012. The consultation was published in July 2012, and the response to it was published alongside draft legislation in December 2012.

Exemptions to the transfer of assets rules already exist where there is no tax avoidance purpose or where the transactions are genuine commercial transactions and any tax avoidance purpose was incidental. That is defined by the Government as meaning that business transactions are not regarded as genuine unless they are on arm’s-length terms and, in the case of transactions for the purposes of a business establishment, give rise to income attributable to economically significant activity that takes place overseas.

The Government’s remedy to the European Commission’s request is to add a new exemption to the legislation through clause 26 and schedule 10, which operate where the EU treaty freedoms are engaged. It focuses on whether the nature of the transactions is genuine and whether they serve the purpose of the freedoms. An exemption will provide for genuine commercial business activities overseas, and also for transactions that do not involve commercial activities but that are, nevertheless, genuine transactions protected by the single market.

As I have said, the Government have consulted widely on the matter, but several serious concerns remain about their attempts to make the transfer of asset rules EU-compliant. On 1 May, the Chartered Institute of Taxation wrote to HMRC to express three main concerns about clause 26 and schedule 10. Two of those concerns were technical; the CIT believed that a flaw in the drafting of the Bill—specifically, confusion about the definition of the term “person abroad”—meant that it would not deliver the Government’s stated purpose. Government amendments 21 and 22 are designed to resolve that uncertainty, although they have been introduced rather late in the day, given the importance of that definition to the outcome of clause 26.

I understand, however, that the CIT also seeks further clarity on the phrase

“provision…of goods or services”

in proposed new section 742A(8) of the Income Tax Act 2007, because it is not clear whether goods and services are meant in the VAT sense or in the everyday sense. If the Minister is aware of those concerns, will he provide additional clarity in his concluding remarks?

During the consultation, the CIT voiced the more general concern that

“these provisions do not achieve the objective of ensuring that UK law complies with EU law...the changes to the transfer of asset abroad provisions are strange because they purport to create a welcome exception when a transfer contravenes EU law, but then seek to impose additional conditions before reliance can be placed on this exception.”

The Institute of Chartered Accountants agreed:

“It is our view that the amendments made to the draft legislation as published on 11 December 2012 do not increase the likelihood of the UK law being EU compliant; if anything the position is worse than previously...EU law makes no distinction between trading and investment activities. It is the actual substance of an activity that is relevant and should determine whether s13 and/or the transfer of assets abroad (TOAA) provisions apply. There is concern that active investment companies may not fall within the definition of economically significant activities; the definition should expressly include the letting of property and dealing in property and dealing in shares and other investments...There is no de minimis for the TOAA provisions. In theory, the transfer of only £1 could result in a potential charge on the transferor on income of an offshore structure.”

KPMG has highlighted the complexity of the issue:

“The new exemption relies upon knowledge of provisions of the Treaty on the Functioning of the European Union. By making reference to EU law, which itself is subject to decisions in the European Court of Justice, it will be difficult for taxpayers or their advisers to ascertain with certainty whether or not they fall within the new exemption.”

Many organisations have expressed their disappointment that the Government appear to have ignored the concerns expressed in consultation about the proposed change, and I would be grateful if the Minister could address those concerns. It is vital that the Government get the proposals right, or further legislation will be required. The CIT has asked on what basis the Government

“rejects our EU law analysis of the provisions. Is it willing to share its analysis/legal advice on which it is basing the contention that the amended rules will ensure compliance with EU law?”

An answer from him on that would be helpful.

Finally, the tax information and impact note indicates that this move will cost the Exchequer £10 million a year from 2015-16 to 2017-18 and it would be useful to understand the basis on which those figures were reached. Does the Minister expect avoidance activity to increase as a result of the changes, or does this measure simply incorporate tax charges that should not have been made in the spirit of the single market? I would be grateful if he would respond to those concerns.

Nigel Mills (Conservative, Amber Valley)

I do not want to speak for long. I have great sympathy for the Government, who have ended up in the ludicrous situation of having some perfectly reasonable anti-avoidance provisions being threatened by a rather perverse EU judgment that says that they have gone too far. The crime that the Government allegedly committed is that if someone, in an attempt to avoid tax, transfers assets overseas from which they still get some benefit in the UK, such as use of income, we subject them to income tax on that benefit, whereas if they had just transferred those assets within the UK we would not have done that because we would have been taxing them where they were transferred to. What are the Government expected to do in that situation? Are they expected not to do anything?

We have ended up in a perverse situation and we have had a few of these over the years. We now have the ridiculous situation that if a UK company’s subsidiary makes a trading loss in another EU jurisdiction, it can have that loss set against its UK profits. I thought that we all agreed now that multinationals should be taxed on the profits that they make in the UK, so it seems bizarre that we have been forced into that situation as well.

It is worth stressing that within the provisions we already have exemptions for where tax avoidance was not the main purpose; where, viewed objectively, the transaction can be considered to be genuine. We also had a provision for where the transaction was not more than incidentally designed for purposes of avoiding liability for taxation. Therefore, we already had the exemptions for purely commercial transactions; it is not as though we had a general blanket rule that provided a disadvantage to people transferring things around the EU with us taxing them regardless. Those measures only kicked in if transactions were not commercial.

We have been forced to add another exemption, in bafflingly complex language, which effectively says, “This does not apply if it would contravene EU law.” We have ended up with an EU Court telling us that we cannot take this action because it contravenes EU law, and now we are saying, “Okay, we will not do it if it contravenes EU law.” For anyone conducting a transaction, it will be interesting to try to work their way through that, because rather than it being clear where our domestic law applies with various fundamental freedoms of the EU that might disapply those UK rules, we now have a UK rule that brings in those EU rules—whatever they are, and whatever they might become in the future—and overrides UK legislation without us actually knowing exactly what they are or how they are to be applied.

We have ended up in a perverse situation with an exemption that I cannot imagine any taxpayer will be able to rely on with any kind of certainty. That may well be the idea: we can go back to the European Court and say, “Look, we have made our rules comply with what you wanted.” What we have done is probably utterly pointless, but it complies with the letter of what the EU is stupidly saying to us. If that is the case, I wholeheartedly congratulate the Government on doing that. I would not recommend that they admitted that, as it probably would not help their case, but, as a principle, we should set out that taxation is a matter for member states, not the EU, and unless we are doing something that is wholly unreasonable or wholly uncommercial, or that clearly infringes on sensible things that people do, we should be saying, to put it into layman’s language, “This is not for you to be getting involved in. There is no risk here to an ordinary commercial transaction. This is for us to decide. Keep your nose out.”

Our tax system will end up in an unfortunate situation if we let the EU keep creeping into these matters. EU directives were not meant to encourage tax abuse and the Government are allowed to impinge on freedoms if they are trying to tackle that. Somehow, the system has gone wrong. I have no objection to what the Government have to do here as this measure is probably to fix rules that protect a valuable amount of income and stop some heinous tax avoidance. I will support the measure, but we have been forced into a wholly unnecessary situation.

David Gauke (Conservative, South West Hertfordshire)

Let me see whether I can deal with the various points raised in the debate. First, let me deal with why the amendment was tabled when it was. It would be fair to say that the issue that the amendment deals with came to light relatively recently, and it required technical analysis. It was necessary for Her Majesty’s Revenue and Customs and the Treasury to ensure that the points that had been raised were technically correct and delivered the intended policy, and that is why the amendment was tabled when it was.

Those of us who served on Finance Bill Committees during the previous Parliament—I look at my hon. Friends the Members for Braintree and for Chelsea and Fulham—will be aware that in the past it was customary for the Government to come forward with lots of amendments as a consequence of points that had been raised by the likes of the Chartered Institute of Taxation. The fact that we publish legislation first in draft form means that many such points can be addressed, but from time to time it is necessary to respond to submissions, fully investigate and analyse concerns, and amend legislation where necessary.

Regarding whether the amended legislation will be wholly compliant with EU rules, we believe that we fully address the European Commission’s concern that the legislation as it stands might not comply fully with EU law. Nevertheless, EU law on that matter is not well defined and is still developing. The European Commission might wish to test the application of EU law and decide to take forward proceedings in the European Court of Justice with that aim in mind. The Government, however, believe that we are complying.

I was asked whether the Government would share the legal advice they have received on the matter, and I will give the customary response that Ministers have given through the ages, which is that legal advice will not be published. It is worth pointing out that we have consulted widely, met with interested parties and listened to concerns in the evolution of the legislation. Our position is that the provisions comply with our European obligations, even though that might be subsequently tested.

I shall deal with some of the technical points that were raised by the hon. Member for Newcastle upon Tyne North, many of which were brought to her attention by the Chartered Institute of Taxation. Regarding the concern that the definition of “goods and services” might be unclear, the term will have its everyday usage applied in the circumstances, but HMRC will also publish guidance for consultation, which I hope will provide greater clarity.

I was asked why the legislation makes a distinction between trading and investment activities when the EU does not. The legislation does not distinguish between trading and investment activities as such. It specifies that if there is an overseas business establishment the activities must consist of the provisions of goods or services on a commercial basis. The threshold for commercial activity can be met by an investment or holding company that provides services, as well as a trading entity. If unusually an investment or holding company does not carry out its activities though an overseas business establishment, a transaction may still be genuine, and the activities will not be subject to the test in subsections (7) and (8) of proposed new section 742A, but will be subject to the rest of the proposed new section and will be exempted if genuine. That means that it will always be possible for an investment or holding company to be exempt in accordance with EU law, if the overall arrangements are genuine and serve EU treaty aims.

I was asked why we do not introduce a de minimis exemption. We do not believe that one is needed. This is anti-avoidance legislation and genuine transactions are not subject to a tax charge. I was also asked why there is a £10 million cost each year as a consequence of the changes. The estimated £10 million reduction in tax receipts does not represent the tax loss from tax avoidance schemes, but the tax on income attributable to transactions with genuine economic substance that have been structured so as to result in a lower tax bill. The legislation will help to ensure that the rules operate as has always been intended by the exemption of genuine business transactions.

It is not necessary for the legislation to specify that property letting and active investment transactions may be genuine. It has been drafted so that it is entirely open to a taxpayer to show that any transaction is genuine in relation to treaty freedoms. As is reflected in the legislation, all relevant circumstances and objective features of the arrangements will be taken into account in deciding whether a transaction is genuine.

Finally, my hon. Friend the Member for Amber Valley, who expresses his views firmly, made an interesting point about where the jurisdiction of European institutions should lie in direct tax matters, and has opened up a much larger debate. I shall attempt to resist entering it, but I am sure that we will return to it. I hope that clause 26 can stand part of the Bill.

Schedule 10 - Transfer of assets abroad

Clause 27 - Payments of interest

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss that schedule 11 be the Eleventh schedule to the Bill.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Clause 27 introduces schedule 11, which will make changes to the rules on deduction of income tax from yearly interest relating to compensation payments, specialty debt and interest in kind. The changes were announced at Budget 2012, and were consulted on in March 2012 as part of a wider consultation on possible changes to income tax rules on interest. The provision amends section 874 of the Income Tax Act 2007, so that interest in respect of compensation payments is subject to the deduction of income tax at source.

As outlined in the Government’s December 2012 response to the consultation, they intend to make it clear that the requirement in chapter 3 of part 15 of the 2007 Act to deduct income tax from interest applies to compensation payments made to individuals, including payments made by banks in the ordinary course of their business. The provision will apply regardless of whether the interest is paid yearly. The explanatory notes explain:

“The application of the current rules on deducting income tax from interest can be unclear and inconsistent in certain situations. For example, tax is required to be deducted from interest on compensation payments if it is ‘yearly interest’, but not if it is ‘short interest’; and, even if it is yearly interest, no tax is required to be deducted if the institution paying it is a building society or a bank paying it in the ordinary course of its business. A common example of interest paid on such compensation is that paid by financial institutions in cases of financial mis-selling.”

It is obviously a hot issue, given the number of claims that members of the public are currently pursuing, particularly in relation to payment protection insurance. The explanatory notes continue:

“The changes clarify the application of the legislation and ensure that the rules on deduction of income tax operate in a consistent manner.”

However, HMRC’s tax information and impact note makes a rather curious reference to “a secondary legislative power” that

“will allow this requirement to be disapplied where necessary.”

The Low Incomes Tax Reform Group raised a number concerns about this proposal. It stated:

“Without a wider review of the basic principles, we are disappointed”—

that the clause and schedule—

“treat ‘interest’ which is received as part of a one-off payment of compensation as ‘yearly interest’; and for this ‘interest’ element to be consequently taxed at source...We believe many payments of compensation wrongly have elements of them categorised as ‘interest’ and that the rules (as set out in HMRC guidance rather than legislation, with that guidance not being consistent with case law) are not clear. Compensation payments might be calculated using an assumed rate of ‘interest’ as a proxy to recompense the claimant for their loss. Under the proposed legislation, this ‘interest’ calculation could then be used by HMRC as an actual interest payment which is then taxed at source. We therefore reiterate our concerns from our original consultation response, which used the recent payments of compensation on Payment Protection Insurance policies as an example.”

The group went on to express its concerns about the secondary legislative power, saying:

“The draft legislation gives HMRC the ability to make regulations not to apply tax deduction in prescribed circumstances, but we are not clear what those circumstances are and the Explanatory Note gives no indication of what that regulation-making power might be used for. If the purpose of the new rules is, as stated, to ‘clarify the application of the legislation and ensure that the rules on deduction of income tax operate in a consistent manner’, we query why a regulation-making power to disapply the rules is considered necessary or even desirable.”

Importantly, it raised concerns about how this change will affect non-taxpayers.

“If the assumed ‘interest’ is to be treated as taxable, we would also expect that the individual should have the option to elect for gross payment if they are a non-taxpayer, ie applying the Form R85 procedure to these payments. Our January 2013 report ‘Banks, building societies, HMRC and their non-taxpaying customers: a plea for better service’ highlighted that many people on low incomes overpay tax on their savings as they are not provided with the correct Form R85 and the relevant guidance. Clear guidance is needed for when the R85 can and cannot be used in relation to payments of interest of whatever kind from financial institutions and we would be willing to engage in discussions with HMRC about what is needed.”

On the back of that, I have a few questions for the Minister. I would be grateful if he addressed the concerns of the Low Incomes Tax Reform Group in his reply. Will he confirm that HMRC is already working closely with the Low Incomes Tax Reform Group, and whether it is willing to work with the group to ensure that people on low incomes are provided with the relevant advice and guidance to ensure they are not paying an unnecessary amount of tax?

Will the Minister illustrate for the Committee what impact that change is likely to have on individuals? Do the Government acknowledge its impact on low income groups? If the Minister would respond to the concerns of the Low Incomes Tax Reform Group, that would provide some reassurance to the Committee.

David Gauke (Conservative, South West Hertfordshire)

Clause 27 and schedule 11, like clause 28 and schedule 12 which follow, arise out of a consultation on aspects of the income tax treatment of interest, which HMRC conducted following last year’s Budget. The consultation brought together in one document a number of features relating to the taxation of interest.

The legislation follows up a number of strands of the consultation relating to deduction of income tax from interest paid. Deduction of income tax from interest payments is a long-standing feature of the income tax system. The schedule makes three changes to the rules to update them in response to developments in recent years to ensure that the deduction of tax rules operate more sensibly for the majority of taxpayers.

The first change is that income tax will henceforth have to be deducted from interest included in compensation payments. Very large sums have been paid out by financial institutions in recent years as compensation for financial mis-selling. Compensation payments often include an element of interest to reflect delay in payment and that is taxable as income like any other receipt of interest. At present the rules on whether tax should be deducted from such interest are confusing and depend on what kind of financial institution makes the payment.

Broadly, banks and building societies pay without deduction of tax. Other companies, such as insurers and credit providers, have to deduct tax. That is confusing for both the institutions and taxpayers—most of whom will be basic rate taxpayers, and therefore find themselves having to declare this income and complete tax returns only because the interest has been paid to them gross.

The change therefore requires all interest included in compensation payments to be paid under deduction of tax. That applies the deduction of tax rules in a consistent manner, in much the same way that they apply to other interest paid—for example, by banks and building societies on deposit accounts. I emphasise that the change does not affect the tax treatment of the compensation itself. Payments that are capital in nature remain capital. It is concerned only with the deduction of income tax from interest on the compensation, which is already taxable.

The second change deals with an aspect of the application of the deduction of tax rules on speciality debt—that is, a contract signed under a seal. It is sometimes argued that interest on such debt does not arise in the UK, and hence the duty to deduct tax does not arise if the document is signed outside the UK. That is an arcane point based on archaic law, and HMRC has never accepted that interest on speciality debt is exempt from the duty to deduct, but the point continues to be a source of contention. It is long overdue that that anomaly was swept away, and the change puts it beyond doubt that speciality debt is subject to the same deduction of tax rules that apply to any other type of debt.

Finally, the schedule deals with so-called interest in kind. Increasingly, retailers and financial institutions have begun to offer customers interest in the form of goods, services or vouchers. Such interest is taxable as interest on first principles, but the tax rules provide no clear principles on how it is to be treated for the purposes of valuing it and deducting tax from it.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

The Minister raised the issue of vouchers. There does not seem to be any information within the explanatory note or the legislation about what happens to existing vouchers and how individuals who are in receipt of them may be impacted. Will the Minister clarify that? Also, will he comment on the practicality of the measure for employers who are equally impacted by the changes?

David Gauke (Conservative, South West Hertfordshire)

The hon. Lady raises an interesting point. I will turn to that in my remarks later or I will write to her. I will try to address the matter shortly. Before I do so, I will conclude my remarks on the measure.

The change with regard to vouchers provides a clear rule for the first time, ensuring that the recipient of interest in kind will receive a statement from the retailer or the institution showing the value of what they have received, and can therefore complete their own self-assessment returns correctly.

I will try to address the points raised by the hon. Lady. Compensation should not be taxable and there is a concern that we are extending the definition of what constitutes interest for tax purposes. This change does not extend the definition of what constitutes interest for tax purposes in any way; nor does it affect the long-term established manner in which the taxation of compensation operates. Many compensation payments, for example for mis-sold personal pensions, benefit from statutory exemptions, but in other cases compensation includes interest for the period that the investor did not have the use of the funds or where there is a delay in making the payment.

These amounts have always been taxable interest and remain so. This measure ensures that tax is deducted at source from that interest and will be of benefit to the vast majority of taxpayers who will not have to complete self-assessment returns just because they have received a one-off compensation payment that includes some interest.

The Low Incomes Tax Reform Group has expressed concern about a power to disapply the rule on deduction of tax from interest on compensation payments. The calculation of compensation payments and the interest on it in cases involving financial mis-selling can be complicated. The power is there in reserve to enable the rules to be adapted quickly in response to particular situations where it might be appropriate not to tax the payment in question without needing to wait until the next Finance Bill to address the problem.

The LITRG was also concerned that the deduction of tax from interest in compensation was unfair to non-taxpayers. It has raised the point about using the R85 system, which is designed for regular payments of interest by banks and building societies through the tax deduction scheme for interest. Most of the payments to which the rule applies will be one-off payments. Some will be paid by banks and building societies. Some will be paid by other institutions that are not within the TDSI system. The majority of people receiving interest on compensation payments are likely to be basic-rate taxpayers. For such taxpayers, the new arrangements will be a big improvement as they will no longer have to complete tax returns just because they have received a one-off payment of this sort. Non-taxpayers receiving interest as part of compensation payments can reclaim the tax, as they can if they receive any other payment under deduction of tax, but it would be disproportionate to design a system equivalent to the R85 system for these one-off payments. HMRC would be very happy to continue to work with the LITRG on the R85 or other matters in this area.

The position on vouchers, cashback and non-cash incentives is that cashback on purchases is a discount on that purchase, such as a fuel card that earns a rebate in points towards fuel or cash. This is a long-standing position, and nothing in the Bill will change that. In terms of how interest in kind will affect companies, if a company pays interest it must deduct tax now. Nothing has changed as a consequence of these measures. Interest in kind has always been taxable. Now, essentially, we have the same rules to clarify how to value it and to require deduction at source. This measure provides some useful clarification. I hope that those points are helpful to the Committee.

Clause 28 - Disguised interest

David Crausby (Labour, Bolton North East)

With this it will be convenient to discuss that schedule 12 be the Twelfth schedule to the Bill.

Catherine McKinnell (Labour, Newcastle upon Tyne North)

Finally, in the grouping of clauses headed “Other provisions”, we turn to clause 28, which introduces schedule 12 as an anti-tax avoidance measure. That ensures that a person who receives an amount that is economically equivalent to interest will be charged income tax on that amount, thereby introducing a comprehensive income tax charge on disguised interest. The measure also enables the repeal of anti-avoidance legislation on guaranteed returns from futures and options, which is a form of disguised interest arrangement, and allows for the simplification of income tax rules that treat certain amounts arising on stock lending and repos as payments of interest. Under the measure, a return will be considered economically equivalent to interest if it arises by reference to the time value of money, at a rate comparable to a commercial rate of interest, and is practically certain to be produced.

I shall briefly explain the background to the measure to put my concerns in context. It was first announced at Budget 2012, and was consulted on last year. The tax information and impact note states:

“This measure will support fairness in the tax system by reinforcing the protection already afforded to the Exchequer against potential loss of tax as a result of avoidance arrangements intended to secure that interest-like returns escape income tax.”

The Opposition wholeheartedly back supporting fairness in the tax system and clamping down on avoidance activity, although it is inevitably frustrating that these measures are counterbalanced by the tax cuts being given to those earning the highest incomes. The reason why I raise that is that the concerns raised about this measure have again come from the Low Incomes Tax Reform Group, which has commented:

“We do not think there is a strong case for importing a similar ‘disguised interest’ rule for individuals as has been introduced for Corporate Finance…We note that HMRC current guidance on the legal concept of interest is as follows:

‘In common law the general rule is that interest is not payable on a debt or a loan; except where there is an express agreement to pay interest…an agreement to pay interest can be implied from a course of dealing between the parties, or from the nature of the transaction, or custom or usage of the trade or the profession concerned, or…in certain cases by way of damages for breach of a contract (other than a contract merely to pay money) where the contract, if performed, would to the knowledge of the parties have entitled the parties to receive interest.’

We think that the above, particularly the second bullet, gives HMRC room to contend that individuals have engaged in an arrangement in which interest is effectively changing hands, either in cash or in kind, without adding further anti-avoidance legislation along the lines of that for Corporate Finance…We fear that the above would extend HMRC’s powers too far, if one considers for example loan arrangements between family members which may not pay interest but may not be made on any clear legal footing. The unrepresented could find themselves open to challenge by HMRC officers that interest should be applied on monies lent between family, for example, even if there is no ‘legally enforceable’ arrangement in place or intention that interest should be paid…The idea of introducing such a rule is to counter schemes involving ‘highly structured products involving derivative contacts, warrants and other types of financial arrangement’…We therefore think that a better means of targeting such avoidance could be through the General Anti-Abuse Rule…without the need to add a further layer of specific anti-avoidance legislation here which carries the risk of unintended consequences.”

As ever, I would appreciate hearing the Minister’s comments in response to those concerns, particularly given the decision to legislate for this area separately from the general anti-abuse rule, which the Government seem confident will combat many forms of avoidance—certainly they have given that level of reassurance to members of the public.

David Gauke (Conservative, South West Hertfordshire)

Clause 28 and schedule 12, like clause 27 and schedule 11, arise out of a consultation on aspects of the income tax treatment of interest, which HMRC conducted following last year’s Budget. The consultation brought together in one document a number of features relating to the taxation of interest. The clause follows from one particular strand of the consultation and establishes a general principle that a return that is economically equivalent to interest, regardless of its legal form, will be taxed as income. Income tax rules have, for many years, ensured that that is the case in certain instances, for example in the case of the return from deeply discounted securities or the amount of accrued interest included in the sale price of securities.

There is also a limited number of now rather dated anti-avoidance rules in the area. They address, for example, schemes under which a number of derivatives are used in a structured and highly artificial way to produce a specific return. The effect is essentially the same as if the investor had put the money on deposit.

In keeping with Government’s overarching approach of simplifying tax rules and adopting a principles-based approach where practicable, the measure introduces for the first time a general rule on disguised interest for income tax purposes. The rule will provide a robust replacement for existing anti-avoidance rules and enable other existing income tax rules on matters such as manufactured interest and price differences on sale and repurchase agreements—known as repos—to be simplified.

The form of the legislation echoes the successful corporation tax legislation on disguised interest introduced in previous Finance Acts. In response to representations made after the publication of the draft legislation last December, the legislation contains an exemption for certain types of share, so that genuine investment returns will be taxed as capital gains.

The introduction of the rule will enable the immediate repeal of 12 pages of statute. Once the new rule has bedded in, HMRC will review other lengthy and complicated tax rules that concern the boundary between interest and capital gains, such as the rules on deeply discounted securities and the accrued income scheme, to determine whether those rules may be simplified.

A move away from prescriptive and mechanistic legislation towards a more principles-based approach necessarily requires more extensive guidance from HMRC, which has recently published draft guidance on the interpretation of the new rules. HMRC will work with interested parties to refine the guidance to ensure that both financial institutions and their customers have as much certainty as possible on how the legislation will apply to the sometimes genuinely difficult distinction between interest-like returns and capital gains in the area of complex financial instruments. At the same time, the legislation will provide robust defences against avoidance that seeks to exploit the boundary, and is a genuine simplification of the statute.

The hon. Member for Newcastle upon Tyne North was concerned that the legislation goes too far in extending what is taxable as interest. I do not accept that. For example, investments that are taxable as capital gains will remain taxed as such. The real issue in disguised interest is, first, the risk of avoidance where arrangements are dressed up to provide an interest-like return in a non-income form and, secondly, normal commercial but complex arrangements such as repair and stock lending arrangements that provide a return that is economically but not legally interest.

The measure provides better safeguards against avoidance and allows for a significant simplification of current legislation. A point was made that that should apply only to avoidance purposes and that the rule is too wide-ranging, but a general avoidance test for all types of disguised interest would limit the application of the legislation only to avoidance cases, so it can never be used to simplify legislation, which currently applies to interest-like returns that are not intrinsically avoidance. That is why we have taken the broader point. I wanted to say that in response to the argument that the issue should be dealt with by the general anti-abuse rule, which will tackle abusive avoidance schemes. Disguised interest arrangements are sometimes, but not necessarily, abusive avoidance. The GAAR will not typically apply to them. The Bill is complementary to the GAAR and the GAAR will ensure that there is no easy way of walking around the disguised interest rule. As the Aaronson report made clear, it will work most effectively where the principle behind the legislation is clearly set out.

Again, there is a similar point in relation to loans between family members. This is not just an anti-avoidance measure, but it will not catch loans between family members unless it is clear from the outset that an interest equivalent return will be paid. With those points, I want to underline the fact that these are sensible changes that will ensure that the income tax rules work more effectively for the majority of taxpayers.