Colin Breed (Shadow Minister, Treasury; South East Cornwall, Liberal Democrat)

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

Jimmy Hood (Lanark & Hamilton East, Labour)

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

‘shall have effect from 6th April 2008’.

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

Colin Breed (Shadow Minister, Treasury; South East Cornwall, Liberal Democrat)

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

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

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

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

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

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

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

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

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

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

David Gauke (Shadow Minister, Treasury; South West Hertfordshire, Conservative)

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

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

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

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

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

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

That spokesman—

Jane Kennedy (Financial Secretary, HM Treasury; Liverpool, Wavertree, Labour)

Who was it?

David Gauke (Shadow Minister, Treasury; South West Hertfordshire, Conservative)

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

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

Philip Hammond (Shadow Chief Secretary To the Treasury, Treasury; Runnymede & Weybridge, Conservative)

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

David Gauke (Shadow Minister, Treasury; South West Hertfordshire, Conservative)

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

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

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

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

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

Jane Kennedy (Financial Secretary, HM Treasury; Liverpool, Wavertree, Labour)

As always.

David Gauke (Shadow Minister, Treasury; South West Hertfordshire, Conservative)

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

Mark Field (Cities of London & Westminster, Conservative)

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

“are treated as always having had effect.”.

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

Jane Kennedy (Financial Secretary, HM Treasury; Liverpool, Wavertree, Labour)

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

Mark Field (Cities of London & Westminster, Conservative)

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

Peter Viggers (Gosport, Conservative)

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

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

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

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

“the legislation has always had that effect”

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

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

Jane Kennedy (Financial Secretary, HM Treasury; Liverpool, Wavertree, Labour)

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

Colin Breed (Shadow Minister, Treasury; South East Cornwall, Liberal Democrat)

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

Jane Kennedy (Financial Secretary, HM Treasury; Liverpool, Wavertree, Labour)

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

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

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

Mark Field (Cities of London & Westminster, Conservative)

Lerwick.

Jane Kennedy (Financial Secretary, HM Treasury; Liverpool, Wavertree, Labour)

I am grateful, Lord Lamont of Lerwick.

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

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

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