New Clause 2 - Shares in employee-controlled companies and unconnected companies

Finance Bill – in a Public Bill Committee at 10:15 am on 24th June 2004.

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'(1) Each of the provisions of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (c.1) (employment income: securities) specified in subsection (2) (exception from charges for certain company shares) is amended in accordance with subsections (3) to (5).

(2) The provisions are—

(a) section 429 (restricted securities),

(b) section 443 (convertible securities),

(c) section 446R (securities acquired for less than market value), and

(d) section 449 (post-acquisition benefits from securities).

(3) In subsection (1) of each of those sections, after paragraph (b) (but before the word ''and'' where that word features at the end) insert—

''(ba) subsection (1A) is satisfied,''.

(4) After subsection (1) of each of those sections insert—

''(1A) This subsection is satisfied if the avoidance of tax or national insurance contributions was not the main purpose, or one of the main purposes, of the arrangements under which the right or opportunity to acquire the employment-related securities was made available.''

(5) In subsection (4) of sections 429, 443 and 446R, and in subsection (3) of section 449, for the words after ''are not'' substitute ''employment-related securities.''; and accordingly omit section 429(5), 443(5), 446R(5) and 449(4).

(6) In Chapter 3A of that Part of that Act (securities with artificially depressed market value), after section 446I insert—

''446IA Disapplication of exceptions from charges

(1) Section 429 (exception from charge under section 426 for certain company shares) does not prevent section 426 (restricted securities: chargeable events) applying in relation to an event if section 446E or 446I(1)(a) would have effect in relation to the event.

(2) Section 443 (exception from charge under section 438 for certain company shares) does not prevent section 438 (convertible securities: chargeable events) applying in relation to an event if section 446G, 446H or 446I(1)(b) would have effect in relation to the event.

(3) Section 446R (exception from charge under Chapter 3C for certain company shares) does not prevent that Chapter (securities acquired for less than market value) applying in relation to employment-related securities if section 446B would have effect in relation to them.

(4) Section 449 (exception from charge under Chapter 4 for certain company shares) does not prevent that Chapter (benefits from securities) applying in relation to a benefit if section 446I(1)(e) would have effect in relation to the benefit.''

(7) In Chapter 3B of that Part of that Act (securities with artificially enhanced market value), after section 446N insert—

''446NA Disapplication of exceptions from charges

(1) None of the provisions specified in subsection (2) (exceptions from charges for certain company shares) apply in relation to employment-related securities if the market value of the employment-related securities at the time of the acquisition has been increased by at least 10% by non-commercial increases within the period of 7 years ending with the acquisition.

(2) The provisions are—

(a) section 429 (restricted securities),

(b) section 443 (convertible securities),

(c) section 446R (securities acquired for less than market value), and

(d) section 449 (post-acquisition benefits from securities).

(3) If section 446L (market value on valuation date increased by more than 10% by non-commercial increases during relevant period) applies in relation to employment-related securities, section 429 does not subsequently apply in relation to the employment-related securities.''

(8) This section applies on and after 7th May 2004.'.

—[Ruth Kelly.]

Brought up, and read the First time.

Motion made and Question proposed, That the clause be now read a Second time.

Photo of John Butterfill John Butterfill Conservative, Bournemouth West

With this it will be convenient to consider the following:

Amendment (a),

in subsection (5) after 'securities', insert

'that have been acquired within the previous seven years'.

Government new clause 3—Restricted securities with artificially depressed value.

Government new clause 19—Approved plans and schemes.

Government new clause 20—Shares acquired on public offer.

Government new clause 21—Associated persons etc.

Government amendment No. 553.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs

I want to address a point on new clause 2 to which amendment (a) relates. The new clause introduces anti-avoidance measures about which there is no disagreement on either side of the House or in the marketplace. I understand that it has an unintended effect that will impact on arrangements for long-term saving available to companies by means of which they can provide a method for their employees to invest in a spread of equities or other securities held in authorised open-ended investment companies where tax avoidance is not an issue or a motive.

Those plans have been developed to encourage long-term saving together with the Financial Services Authority. The problem is that subsection (5) will bring any investment gains arising from an employee's savings into charge to income tax with corresponding reductions required under pay as you earn, and indeed

a national insurance charge. That is in circumstances where any such gains result purely from stock market appreciation, rather than any action by the employee or the employer, regardless of the fact that the employee may have left the employment some years ago.

That is because the shares in question were originally acquired by reason of employment—in other words the action of the employing company in sponsoring the savings plan—even though the individuals concerned are not employees of the open-ended investment company, and because the requirement under the savings plan for employees to keep the OEIC shares for the long term—typically a minimum of 10 years—means that they fall within the definition of restricted securities. The solution in amendment (a) is to exclude from the charge shares that have been held for more than seven years. That would not limit the effect of the clause in preventing the abuse at which it is aimed.

I understand that there was a not dissimilar issue in connection with the original legislation on restricted securities back in 1972. That issue concerned employee savings plans sponsored by companies. Under the arrangement, the company purchased units, in authorised unit trusts, for its staff. Such plans were strictly caught by section 79 of the Finance Act 1972. When that position became apparent, the then Government introduced an amendment to the legislation by way of section 40 of the Finance Act 1984. That broadly provided that, in the case of any investment by the unit trust in the employer's shares that did not exceed 10 per cent. by value, the acquisition of such units by employees through the savings plan was to be excluded from the growth-in-value charge that would otherwise have arisen under section 79. In other words, it was accepted that any gain on the employees' savings should properly be subject to capital gains tax and not to income tax.

I trust that the Paymaster General and the Revenue are already aware of this unintended problem. If the Government do not like the amendment that we have come up with to solve it, I hope that she will tell the Committee by what other means it will be solved.

Photo of David Laws David Laws Shadow Chief Secretary to the Treasury

As I understand it, and as the hon. Gentleman has just set out, the new clause is intended to deal with avoidance problems that have arisen recently, particularly in relation to remuneration schemes. As such, we strongly support it. However, I hope that when the Paymaster General responds she can tell us whether tax revenues have already been lost as a consequence of those avoidance schemes. If they have, I hope that she can quantify that loss.

It is depressing that we continue to have to deal with such avoidance schemes. When I was working in the City of London more than 10 years ago, I used to receive my annual bonus payments in all sorts of bizarre forms—they were entirely legal, I might add. Each year it changed. I was given shares that never seemed to go up or down in value, and fine wine. Before I was there, people were given gold bullion. All sorts of items were used to evade paying national insurance contributions.

As soon as I transferred from the City to advising the Liberal Democrat Treasury team on such matters, I was able to give them the benefit of my experience. I suggested that there should not be one-off solutions to closing down the loopholes, and that instead the Government should legislate in a way that would deal with them once and for all. One of the proposals was to extend employers' national insurance contributions to all benefits in kind, which were the benefits that were being abused at that time. The then Chancellor, the right hon. and learned Member for Rushcliffe (Mr. Clarke), rejected that proposal out of hand in his emergency Budget, when he had to fill the hole left by VAT on fuel.

I am pleased that the current Chancellor extended employers' national insurance contributions to all benefits in kind, rather than dealing with each and every scheme as it came up. However, now we are back to having to deal with remuneration-related avoidance schemes. The question is not only how much money has been lost—how much tax avoidance there has been—but why we continue to have to legislate year after year to deal with such avoidance schemes.

I am not clear from the explanatory note whether the problem has arisen because the Government have introduced new measures to encourage employee share ownership, which have been abused, and whether it results from too many new tax reliefs and allowances that open up opportunities for abuse. If that is the case, the question is whether the Government should be more careful in introducing such reliefs in the future. I shall not revisit old arguments about film industry tax relief, but there are similarities.

If that is not the problem in this case, surely we must consider whether we can introduce legislation specifically to address avoidance of income tax and national insurance contributions on remuneration in a way that will deal with the matter once and for all, rather than requiring new legislation every year while, in the meantime, the Exchequer loses tax. I hope that the Paymaster General will be able to comment on that.

Photo of John Butterfill John Butterfill Conservative, Bournemouth West 10:30 am, 24th June 2004

Before the Minister replies, let me say that I hope that this will not develop into a debate on all the historic avoidance devices that have been engineered by individuals in the City. Having spent many years there myself, I am well aware that there is no end to their ingenuity.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

I sigh. I want to say, ''Oh, dear.'' Where has the hon. Member for Yeovil (Mr. Laws) been since the Committee began diligently scrutinising the Finance Bill in May? Indeed, why was he not here on Tuesday, when we discussed disclosure? Why has he not read the Hansard for that sitting, which, again, he could not attend? If he had, he would know the answer. He would be aware of the Government's proposals to tackle the issues that his experience—as opposed to his knowledge—tells him must be

addressed. I shall share with the Committee only briefly how the Government became aware of avoidance in this area.

Last year, we had a long discussion on schedule 22, which rewrote the criteria for Government-approved tax-relieved employee share plans. Indeed, I seem to remember that at that time the Government were told that they were being too tight—both with taxpayers' money and in the drafting of the legislation—in the matter of allowing reliefs.

Two of the avoidance schemes that are being closed by the new clauses were drawn to our attention by professionals blowing the whistle on fellow practitioners. I can do no better than to quote one of the people who provided such information:

''I have noticed increasingly that whenever specific anti-avoidance provision is enacted, unscrupulous and highly paid accountants and lawyers will come up with some new scheme to get round it so their wealthier clients''—

apparently the hon. Member for Yeovil used to be one—

''can pay less tax, leaving those with less money no choice but to pay the full tax due on their income.''

My discussion on Tuesday with the hon. Members for Arundel and South Downs and for Torridge and West Devon (Mr. Burnett), who was here, on the disclosure clauses addressed precisely that point. How can the Government get ahead of the game? What must we do to encourage people to behave in a more acceptable fashion?

Let me turn specifically to amendment (a). I understand the position of the hon. Member for Arundel and South Downs, but let me assure him that there are no unintended effects. He made the point himself that the new clause is about employee share schemes and he referred to individuals not employed by the company that provides the scheme. He said it himself: the tax relief arises if one is working for the company and if it is an employee share ownership scheme. Therefore, income invested in the savings plan should not come from taxed income after the restrictive regime has applied. Unfortunately, it is clear that the amendment would result in before-tax income being available for the employee to invest.

I understand that the amendment relates to an arrangement promoted last year as a long-term savings scheme by a firm of accountants. The scheme provides for employees to put their gross pre-tax salary aside into stock market investment through a special purpose fund vehicle. The scheme is designed to take advantage of a relieving provision in part 7 of the Income Tax (Earnings and Pensions) Act 2003 to enable the value to pass free of tax and national insurance.The relieving provision is intended to cover limited circumstances in which the benefit to the employee is incidental to a wider reorganisation in the company, where the majority of the shareholders are not employees, so the benefit does not pass to the employees by reason of employment. That is not the case where a special purpose vehicle is used to promote employee savings.

The hon. Member for Yeovil told the Committee of his own experience of receiving pay in interesting and creative forms. The ingenuity of those who design

these schemes apparently knows no bounds, even when they know what the provisions entitle them to. This goes back to our discussions on disclosure. Obtaining a tax advantage in certain prescribed circumstances, and this is one, is clearly not avoidance; obtaining a tax advantage in a way that is not prescribed is avoidance. That is what we are talking about here and what we will deal with.

I share the disappointment of the hon. Member for Yeovil that people continue to use such schemes. He asked how much revenue we had already lost. I can only report to the Committee what the Inland Revenue has been told: about £300 million in remuneration has already been put through the gilts scheme, and £20 million in one company alone. Tax and national insurance forgone alone amount to £150 million each year.

We are not mind readers, but as the legislation went through this Committee as well and was fully consulted on, and although it is regrettable that we must rely on information about other professionals being passed to the Revenue in this case, I sincerely hope that, once the disclosure procedure is working, the frustration voiced by the hon. Gentleman and other members of the Committee about the constant need for anti-avoidance measures will have been relieved. He must also say whether his party would do away with tax relief for employee share schemes. I doubt it. I am sure he will agree that, given the choices before the Government and the powers that we have, we should defend that revenue now that the information is available.

If the hon. Member for Arundel and South Downs presses the amendment to a Division, I shall ask the Committee to reject it.

Photo of David Laws David Laws Shadow Chief Secretary to the Treasury

I resent the Paymaster General's tone. We are talking about the 10 years ago since I left the City of London, time during which she has been serving in Finance Bill Committees. My point was designed to be helpful to the Treasury.

For a prolonged period, under Conservative and Labour Governments, the Treasury has consistently failed to close such loopholes. It has failed for two reasons. First, it has been consistently unimaginative in introducing legislation to anticipate loopholes. Instead, the loopholes have to be closed afterwards. The proposal that was eventually introduced to extend employers' national insurance contributions to all benefits in kind is a model of that type. Secondly, the Paymaster General has not recognised the fact that if the Government continue to introduce tax breaks that allow innovative individuals in the tax avoidance industry to exploit such loopholes, we shall no doubt return to the same debate year after year.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

The hon. Gentleman is quite right that I have served on Finance Bill Committees under two Governments—a total of 10 Finance Bills, yet I cannot recollect one occasion when the Liberal Democrats advanced a solution. Indeed, I can remember the party voting against anti-avoidance

proposals. If the hon. Gentleman has a proposal, we would like to hear about it. It is not a matter of party politics. It is about the defence of revenue for the good of all taxpayers.

Photo of David Laws David Laws Shadow Chief Secretary to the Treasury

I shall not steer too far away from the subject of the debate, Sir John, but the Paymaster General is entirely wrong in suggesting that we have not proposed measures to close avoidance opportunities. I refer to 1994—four or five years before a Labour Government eventually decided to close the avoidance on national insurance contributions and benefits in kind—when the Treasury kept on closing down individual schemes, rather than dealing with the whole problem. I refer also to our comments about avoidance opportunities in film industry tax relief—comments that were made at the time, not later.

Finally, in relation to the Paymaster General's somewhat intemperate comments—you can always tell when the right hon. Lady is in trouble, Sir John, because she speaks intemperately—the record will show that I have attended at least as many sittings over the past month and a half as she has done.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs

I am clearly a rather dull creature; never in my 30 years in the City have I participated in one of those benefits in kind bonuses. I used to hear about them, though.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

I am not at all surprised to hear that, because the hon. Gentleman is thoroughly genuine, honest and straightforward. I know that he would tell the Revenue if he had received one.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs

Yes, I would probably sneak on a competitor.

I observe that there are two highly important factors in the game of avoidance and anti-avoidance. The first is the level of taxation. When I worked in Hong Kong, where taxes were much lower, there was broad consent about paying a modest level of tax. All Governments have to realise that if taxes are substantial, people will do their best to limit their tax liabilities.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

Is the hon. Gentleman seriously suggesting that our higher rate of tax of 40 per cent. is not modest, and that it is too high?

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs

I think that the Paymaster General is deliberately misinterpreting me. I am saying that tax avoidance is not an issue in areas that have low taxation. Obviously, 40 per cent. is a favourable rate of tax in comparison with many of our inefficient EU-economy partners. It is high relative to Hong Kong.

The key point is that the Paymaster General said that the savings schemes that the measures impact on—which are separate from remuneration anti-avoidance measures—are, in the Government's view, taking advantage of measures in the last Finance Bill that the Government do not want to encourage. Therefore, far from being unintended, it is intended that the measures in new clause 2 affect those savings schemes. I think that that was not understood by the organisations that put in place those schemes, so it is important that it be cleared up.

There is no point in the amendment if it is the deliberate intention thus to tax those saving schemes. What strikes me as somewhat strange is that the schemes have, generally, been put in place with the knowledge of the authorities and of the Financial Services Authority. It might have been helpful if it had been communicated earlier, right up front if possible, that the schemes were not intended.

Question put and agreed to.

Clause read a Second time, and added to the Bill.