George Young (North West Hampshire, Conservative)

I just wanted to press the Paymaster General on what appears in schedule 7 regarding conditions A and B.

The schedule deals with the transfer of assets abroad. I have no time for those who transfer their assets abroad with a view to avoiding tax and I welcome the initiatives that the Government are taking in the Bill to stop that practice. However, there are legitimate reasons why assets might be transferred abroad—the establishment of a business, for example. The bit that caught my eye is in paragraph 3, where we come across conditions A and B. The provision is referred to in the explanatory notes as a revised purpose test, designed to discover the motive behind the transaction. I would be grateful if the Paymaster General would let me know whether the conditions appear in other tests of tax avoidance.

As I understand it, if there is a dispute between the Revenue and an individual as to whether a certain activity is taxable, it goes before the courts at the end of the day, and they would consider all the circumstances of the case and come down on one side or the other. If one goes down the condition A and condition B route, the taxpayer would not just have to show that, on balance, his interpretation was correct, but that the interpretation the Inland Revenue had put on it was unreasonable. It would be interesting if the Revenue planned to introduce this test in schedule 7, but extended it broadly to apply to other cases in which there was a dispute between the individual and the Revenue. If it did, the terms of trade between the Revenue and the individual would be tilted towards the Revenue.

I have some questions for the Paymaster General when she winds up the debate. Is there any precedent for the conditions; why do not they apply, as I understand they do not, in other tests of tax avoidance; and are they the beginning of a series of new tests designed to shift the balance away from the individual and towards the Revenue?

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

I shall raise several concerns, particularly from the Law Society, about the operation of schedule 7. Some of them touch on the points that my right hon. Friend the Member for North-West Hampshire (Sir George Young) made. The Institute of Chartered Accountants in England and Wales has also expressed some concerns about the operation of schedule 7.

Schedule 7 amends the exemptions for bona fide transactions from sections 739 and 740 of the Income and Corporation Taxes Act 1988. However, representations from the Law Society suggest that in several respects the schedule goes too far, narrowing unnecessarily the scope of the exemption and imputing on to the taxpayer the motives of the tax adviser.

My right hon. Friend referred to the two tests—conditions A and B. The Institute of Chartered Accountants in England and Wales would welcome some guidance on the circumstances in which HM Revenue andCustoms believes that condition A would be satisfied. Paragraph 60 of the consultation document, “Transfer of Assets Abroad—Technical Notes on Draft Clause”, sets out the Revenue’s view that the new provisions will require all relevant circumstances of the case to be considered, including the

“actual objective outcome of the transactions”.

The purpose of the amendments is to move away from a subjective test of what happens when assets are transferred abroad, to a more objective test of the motives behind it.

If the objective outcome of the transactions is no reduction in the amount of UK tax payable, arguably there will be no need for the Revenue to invokethe provisions in section 739 of the 1988 Act, thus rendering the exemption of proposed new section 741A redundant. The ICAEW requests clarification about whether the Revenue envisages any scenarios in which the objective outcome of the transaction results inthe reduction of UK tax, but the exemption under proposed new section 741A(1)(a) is still allowed, by virtue of condition A being satisfied.

Condition B is a broader test of the transactions. It requires all transactions to be commercially valid, and requires that the steps in the transaction are no more than incidentally designed to avoid the liability for tax. Subsections (5) and (6) of this schedule then give further details of the definition of commercial transactions.

The Law Society believes that transactions by individuals are unlikely to benefit from the exemption in condition B. In a clear example, it shows that if a transferor transfers assets into a trust for investment, the transfer will not be at arm’s length, and it will therefore fall outside the exemption. Indeed, that would be true if an individual invested directly into an overseas fund, since although the fund would meet the conditions of subsection (5), the personal investor would not.

Furthermore, the Law Society is concerned that subsection (6) is overly focused on the structure of the transaction. It provides that

“the making and managing of investments...is not a trade or business except to the extent that—

(a) the person by whom it is done, and

(b) the person for whom it is done,

are independent”.

For that purpose, independent means that the persons concerned are not connected within the meaning of section 839 of the 1988 Act. The provision puts to one side whether transactions are done on an arm’s length basis, and it focuses on whether the people involved are connected.

The person for whom the investment is done can be the transferor or the person who receives the benefit of the investment, or the offshore entity, or the fund itself, because the investment manager will often be contracted by or on behalf of the fund rather than the investment. One can imagine a situation, particularly in a corporate structure, in which the investment manager could be connected with the offshore fund.

The Law Society believes that it would be difficult for a transaction to satisfy the independence element of subsection (6) of this schedule. It suggests that the real test should not be about the structure of the transaction, because that is likely to result in subsection (6) not applying in a huge range of circumstances. Instead, it suggests asking whether the transaction between investor and manager is at arm’s length. Will the Paymaster General comment on that? Because if the criterion is one of structure rather than an arm’s length test, the exemption may be redundant.

Philip Dunne (Ludlow, Conservative)

I should like to give an example to elaborate on that point. It would be helpful if the Paymaster General would clarify whether the provision is intended to catch investment managers who seed a hedge fund offshore. Somebody may set up a hedge fund based in the UK that seeks to have its centre of operations in a jurisdiction such as the Cayman Islands, or another offshore jurisdiction attractive to other foreign investors who are looking to invest in that fund and who would not be subject to UK taxation. To get the fund off the ground the individual—possibly a sole trader—could make an investment in a special-purpose vehicle that would be set up in an offshore jurisdiction. That might be classified as a connected  trade, because there would be no third party and it might take some time for the individual to establish the business—it often takes months if not years to get such investment vehicles running. It surely cannot be intended that such a situation be caught.

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

My hon. Friend’s point leads me to a similar one made by the Institute of Chartered Accountants about setting up a new business. An individual resident in the UK may establish a foreign company to trade outside the UK—possibly in a country with higher corporation tax rates than the UK—and he may decide that it is commercially sound to provide finance or assets to the company on favourable terms from his own resources, because he may consider it worthwhile to subsidise his company to enable it to generate revenue. The institute is concerned that that situation might be caught.

Those situations concern different types of business, but the issue remains how to demonstrate the value of assets that have been transferred overseas, and whether they were transferred at a commercial rate, and in both situations there could be an impact on the business economics. A more equitable approach in both situations may therefore be to consider the commerciality of a transaction as a factor to be taken into account in determining whether it was more than incidentally designed for the purpose of avoiding tax liability.

Subsection (4) of the schedule concerns the imputation of tax advisers’ motives to their clients. It says:

“The intentions and purposes of any person who, whether or not for consideration,—

(a) designs or effects the relevant transactions or any of them, or

(b) provides advice in relation to the relevant transactions or any of them

are to be taken into account in determining the purposes for which those transactions or any of them were effected.”

I am concerned that a tax adviser may decide to structure a particular transaction in a way that minimises tax but the taxpayer might not be aware of that. The clause would mean that taxpayers, even if they did not know, ought to have borne in mind the fact that the tax adviser may have tried to structure the transaction in a particular way.

I suspect that the Paymaster General will say—as she did on an earlier clause when we were debating an amendment tabled by my hon. Friend the Member for Wycombe—that we are talking about legislation targeted at particular schemes that have been marketed to individuals in an aggressive fashion, and cases in which both the taxpayer and the adviser know the exact purpose of the scheme, which is to reduce tax. Could the Paymaster General comment a little further on subsection (4), and say whether she thinks thatthe terms have been drawn so widely that there may be situations in which innocent taxpayers—someone setting up a business overseas, for example—are inadvertently caught by that subsection?

Rob Marris (Wolverhampton South West, Labour)

I do have some sympathy with thehon. Gentleman’s point, and I think that it has also been made by the Law Society of England and Wales, of which I am a member, but I caution him about picking up other people’s briefs, because I am almost  certain from what he has read that he is referring to subsection (4) of proposed new section 741A, which is to be inserted into the Act. That is at the bottom of page 193. It is not a subsection (4) to the schedule. If I have got it wrong, and he is not referring to the final two lines on page 193 and the first lines on page 194, perhaps he will tell us so, but if he is referring to those lines, I caution him about the way in which he takes his briefs.

Andy Reed (PPS (John Healey, Financial Secretary), HM Treasury; Loughborough, Labour)

There is no answer to that.

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

There is indeed no answer to that, and it is indeed proposed new section 741A that relates to subsection (4) on line 39, page 193. One of the issues in dealing with a Bill such as this one is that outside bodies are interested in it, and raise concerns about the scope of the changes and their impact on lawyers, accountants, taxpayers and so on.

The Law Society also has concerns about whether the provisions would allow inquiries into the purposes of the adviser, and it also raises issues around legal privilege and the confidentiality of clients’ information. I am not a member of the Law Society of England and Wales—and I am, at times, profoundly grateful for that. My hon. Friends and the hon. Member for Wolverhampton, South-West may wish to comment on that aspect of the Law Society’s brief, but that is a concern that it has, and it is important that the issues that it raises are aired on its behalf, as there are so few solicitors in this House who can speak up in its defence.

May I just comment on subsection (9) on page 194? It says:

“The jurisdiction of the Special Commissioners on any appeal includes jurisdiction to review any decision taken by an officer of the Board in exercise of the officer’s functions under this section.”

I should be grateful to hear from the Paymaster General whether that gives the special commissioners the power to amend or vary the decisions taken; I suspect that it probably does, but I should be grateful for that clarification.

I also want to raise the thorny issue of clearance, which has popped up in debates along the way. As I understand it, any application for exemption under section 741 is dealt with under a self-assessment system, so that a company entering into a transaction such as establishing a foreign company—something that my hon. Friend the Member for Ludlow (Mr. Dunne) referred to—would claim the exemption in its 2007 tax return. Assuming that the taxpayer were to submit his return before the 31 January 2008 deadline and full disclosure were made, HMRC would have until 31 January 2009 to open an inquiry into the tax return. In effect, the taxpayer would not know for certain whether he has a UK tax liability in respect of the company’s income until almost three years after the company was established. That will create uncertainty in the minds of taxpayers.

We discussed how exemptions could put into question some transactions. One solution that would deal with the uncertainty and provide a clearer picture  for the taxpayer earlier than up to three years after he establishes the business would be a formal clearance procedure. An alternative is the informal route that the Paymaster General referred to under clause 78, whereby a taxpayer could seek guidance from HMRC which would then be binding.

I understand that advisers and professional bodies have been in discussion with HMRC about the issue and that at present the Government are not proposing a clearance system but are prepared to consider, in the light of further evidence, whether such assistance might be necessary. I understand that people are trying to determine whether there is sufficient evidence to justify taking the matter back to the Treasury. I should be grateful for the Paymaster General’s views on whether any informal clearance will be offered to people who wish to set up such transactions.

This is not a straightforward schedule—I have ploughed through it—and people outside this House are interested in following through some important issues around the extent of the exemptions. Theywant to ensure that bona fide, genuine commercial transactions will not inadvertently fall within the scope of the Bill, and they are particularly concerned about how conditions A and B and subsections (5) and (6) will operate.

Jeremy Wright (Rugby & Kenilworth, Conservative)

I have three concerns about what is proposed in subsection (4) of proposed new section 741A of the Income and Corporation Taxes Act 1988. As we have already discussed, the proposed new subsection deals with the intentions and purposes of the designers of transactions, and of tax advisers.

The first concern arises because of a potential difficulty with legal privilege. I should make it clear that I am a lawyer but not a member of the Law Society. It is right, of course, that some of the advisers that the schedule refers to will be tax lawyers—any member of the Gauke family, for example—and under such circumstances a difficulty with legal privilege may arise. I wonder whether the Paymaster General can comment on that.

The second difficulty is a practical one. Transactions will be permissible although they avoid tax liability if they were incidentally designed to avoid tax. It is difficult to envisage circumstances in which it will be possible clearly to establish how an adviser explained to his client that a particular transaction would only incidentally avoid tax, rather than primarily avoid it.

My hon. Friend the Member for Fareham referred to the third difficulty, which seems to be the key problem. Surely it is the intention of the taxpayer, not the adviser, that the Government are keen to explore. Those two things are not necessarily the same. It is right and logical that the client—the taxpayer—goes to an adviser because the adviser has more knowledge of such matters than the client does; otherwise, the advice would scarcely be necessary. It is therefore conceivable that the adviser understands far more about the avoidance of tax than the client does, and only if that intention to avoid tax is communicated to a client does a problem arise.

Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

Is the hon. Gentleman seriously suggesting that if a professional adviser knowingly advises on tax avoidance and the client simply does not ask because they are happy to take the money, there is no responsibility?

Jeremy Wright (Rugby & Kenilworth, Conservative)

No. I am suggesting that a tax adviser might advise a client on a sensible measure to take to order his financial affairs, which that tax adviser understands far better than the client. If that measure were taken incidentally to avoid tax, it would be perfectly acceptable under the Government’s proposed legislation, but if it were taken primarily to avoid tax, it would not be. That distinction might in some circumstances cause clients difficulty.

The measures are entirely superfluous. If the Government are seeking to penalise those taxpayers who understand that they are avoiding tax, surely the taxpayer’s intention and not the tax adviser’s is significant. If a taxpayer came to understand from his tax adviser that what he was going to sign off on was tax avoidance, he would rightly be penalised for it. But why is it necessary to include in consideration the intention of the tax adviser rather than what he has communicated to his client? That seems to be the difficulty created by the clause.

Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

Clause 79 and schedule 7 will amend legislation on the transfer of assets abroad. They are important anti-avoidance provisions that were enacted in 1936, an important date in our understanding of how the rules should operate.

The rules introduced in 1936 aimed to prevent UK-resident individuals from avoiding UK income tax by putting assets in offshore structures in such a way that they retain control of the income arising from those assets. The changes announced in the pre-Budget report closed a loophole exploited by tax planners to avoid tax.

The provisions in schedule 7 will recast the exemption test for post-PBR transactions. All relevant circumstances, including the objective outcome of the transaction, must be taken into account when deciding whether there was a tax avoidance purpose. The intention of advisers must also be considered. I shall return to that point.

The right hon. Member for North-West Hampshire asked whether the question of purpose and reasonableness was new. The straightforward answer is no. It is elsewhere in the legislation—in section 741 of the Income and Corporation Taxes Act 1988, for example. Will the proposed measures shift the balance toward HMRC? No. That is how HMRC operates currently.

Perhaps I should give a slightly longer answer. The provisions are based on the existing purpose test in section 741 of the 1998 Act. The Government’s view is that section 741A strikes a fair balance. Its aim is a reasonable conclusion test to ensure that all circumstances are taken into account when deciding whether an individual had avoidance purpose. It is right to take all relevant factors into account and draw a reasonable conclusion.

The courts and commissioners have full power to consider HMRC decisions and replace them if they decide that the taxpayer met the terms for exemption under the reasonableness test. There is no doubt that  special commissioners’ jurisdiction under the provisions will necessarily include a power to vary or set aside HMRC’s decisions, not just to review them. That has always been the case under current legislation, which has virtually the same wording.

On the question of legal professional privilege, I disagree with the point that the hon. Member for Rugby and Kenilworth (Jeremy Wright) made. The aim of subsection (4) is to ensure that the professional advice obtained is taken into account as one of the circumstances of the case and not disregarded as irrelevant. If an individual asserts that they did not have the subjective purpose of avoiding tax, it is reasonable to see whether the advice they were acting on was consistent with that claim. That is all that is being required.

The new provision does not override advisers’ legal privilege. There is no compulsion under subsection (4) to disclose advice given to clients. However, in practice, using the example that the hon. Gentleman gave, it may be in the taxpayer’s interest if advisers do provide advice and waive that privilege, assuming that the advice given is consistent with the claim that there is no subjective purpose of avoiding tax. Otherwise, there is a complete mismatch; people would say, “I didn’t have the knowledge, they just happened to get a good deal for me.” That is ridiculous and that connection has to be made.

There is no reason why transactions involving innocent offshore structures, such as family trusts, could not qualify under condition A; likewise for ordinary investment transactions on arm’s length terms in commercially run offshore entities. In such cases, conditions for a section 739 charge might apply. However, the taxpayer could potentially show that an exemption was due.

The approach for condition B mirrors that of the old purpose test in section 741. It strikes a reasonable balance in allowing some element of avoidance in commercial cases, provided that they are no more than incidental, but that is an essential part of the test and the case must be genuinely commercial and not driven by tax avoidance.

I disagree with the idea that subsection (5) is too restrictive. It is needed to prevent the abuse of non-resident personal trusts for avoidance purposes by UK residents. Generally, in cases where individuals make ordinary investment transactions in entities independently managed by commercial concerns on arm’s length terms, condition A in section 741A will be satisfied. There may be exceptional cases in which it is appropriate to use section 739 against particular marketed retail investment projects.

I shall not even attempt to answer the point made by the hon. Member for Ludlow; what he says shows the complexity of the issues. Given that the legislation has been in place for rather a long time—over 70 years—it would be foolish to respond specifically to his point. I am sure that he would not expect me to, without the full facts before me, and a summary of what might happen to hedge funds is not sufficient. Nor—before the hon. Gentleman rises to repeat his question—shall I indulge in giving tax advice. I am not a solicitor. I am not an accountant. There is a vast Department called HMRC that provides that advice, and it is the appropriate point for advice.

Philip Dunne (Ludlow, Conservative)

Will the right hon. Lady give way?

Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

No, I shall conclude my points; then the hon. Gentleman can make his.

On the guidance that HMRC could give on the operation of the legislation and in response to the issues raised by the hon. Gentleman, I should say that a drafting of guidance is in hand. HMRC aims to show that guidance to representative bodies so that the agreed version can be published at about the time of Royal Assent. The guidance will have examples of how the rules will work in a number of different cases.

The final point was about the pre-transaction clearance system. I shall make clear what is going on in discussions with HMRC. HMRC has already written to the representative bodies explaining Government decisions in respect of the schedule and why it thinks that a clearance is not necessary. Nevertheless, as one would expect, the Department has indicated a willingness to consider, without commitment, any further supporting evidence showing why a clearance system is necessary.

Section 739 has existed for 70 years without clearance. The changes under the Bill should make the law clearer and remove doubt about how the purpose test is intended to apply. There is now potentially less, not more, need for a clearance system. As I said, HMRC will provide guidance on the new provision. The representative bodies will need to get over a rather high hurdle, given that something that has existed for 70 years and did not need clearance apparently cannot be understood now and needs it. As I said, there is no commitment, but if those bodies come forward to say why the system should change, the Department will be prepared to consider that.

Jeremy Wright (Rugby & Kenilworth, Conservative)

Will the Paymaster General deal with my point about intention? I did not hear her deal with that. My point was that, on section 741A(4), I would entirely understand if the Government’s case was that it is important to know what advice a taxpayer has received in deciding whether that taxpayer intended to avoid tax. The difficulty is that subsection (4) does not say that; it deals with the “intentions and purposes” of the adviser, not the advice given.

Helen Goodman (Bishop Auckland, Labour)

I am interested in the hon. Gentleman’s argument. Will he try to reconcile this? Many of us have listened to the shadow Attorney-General use up hours of time on the Floor of the House discussing intention in respect of terrorism legislation. He said that maintaining intention in that legislation was vital.

Jeremy Wright (Rugby & Kenilworth, Conservative)

I shall try to assist the hon. Lady. I am worried not about the fact of intention, but whose intention we are talking about. I am talking about the intention of the taxpayer. When it comes to the avoidance of tax, the Government ought at the very least be concerned about whether the taxpayer intends to avoid tax. My concern is that, although I understand the logic of wanting to know what advice a taxpayer  has received, I am not clear about why the legislation deals with the “intentions and purposes” of the adviser rather than with the advice given. I invite the Paymaster General to deal with that specific point.

Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

I dealt with that point. I made it clear that if an individual asserted in their defence that they did not have the subjective purpose of avoiding tax—that their intention was not to avoid tax—the Government would not consider it unreasonable, if the specific avoidance that HMRC seeks to close off was indicated, to see whether the advice on which the individual was acting was consistent with that claim. This is a responsibility of the taxpayer.

Therefore, as I have said, I do not believe that any taxpayer would not understand their intention or the type of advice they had been given, or that their legal advice or professional advice in any other way would have left them ignorant of the purpose. This is another test to discover whether the claim made by a taxpayer is sustained by the professional advice that they then acted on—they signed forms, they acted on it.

Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)

I thank the Paymaster General for what she has said in response to the points I and my colleagues made on this schedule. She has set out clearly the Government’s position on a range of issues, and she has added some welcome clarity, particularly on the operations of condition A and condition B, for which we are grateful. Given that this legislation seems to have remained relatively untouched for 70 years, I would like to think that we will not revisit it in the next 70 years, but I fear that our hopes and aspirations of not doing so will be dashed as I am sure we will examine it again at some point in the future.

The Paymaster General referred to the ongoing consultations on the guidance. They are welcome, and the guidance should flesh out some issues; it might not go so far as to address Cayman Islands hedge funds, but I hope it might address matters such as businesses being set up overseas where a transfer of assets has taken place at less than commercial value with a view to setting up the business.

Finally, I am grateful for the confirmation that the power to review includes set aside and vary. The Paymaster General confirmed that in such a way that it seemed an obvious point, but it was not obvious to some of the people who have commented on this measure.