Gilts and Bonds (Taxation)

Prayers – in the House of Commons at 1:30 pm on 12th July 1995.

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Photo of Mr Tim Smith Mr Tim Smith , Beaconsfield 1:30 pm, 12th July 1995

I welcome my hon. Friend the Financial Secretary to the Treasury, who now has one of the most fascinating jobs in Government. There is no doubt about the importance of taxation. My hon. Friend has probably already discovered the difficulty of reconciling the various principles: we all want simplification, but we also want fairness. The subject of taxation of gilts and bonds illustrates that difficulty very well.

This may seem a somewhat technical subject, but it is important. A surprising number of private investors have holdings in gilts—three quarters of a million, I understand. Many others have holdings in zero-dividend preference shares, and use both gilts and those other instruments for the purposes of legitimate financial planning arrangements.

When my hon. Friend's predecessor published a consultative document on the subject on 25 May, it provoked considerable interest. I entirely support the twin objectives contained in its proposals. The first was to simplify taxes by sweeping away 100 pages of legislation dealing with the taxation of different financial instruments, and stating that no distinction would be made between capital and revenue in regard to gilts and bonds: the whole lot would be taxed as one.

That was clearly straightforward, but it involved a major extension of tax. I rather agree with The Daily Telegraph, which said yesterday that, if matters were to be simplified, it was probably better to abolish taxes than to extend them. Nevertheless, I support the objective.

My right hon. Friend the Member for Ealing, Acton (Sir G. Young) said: The current tax rules for gilts and bonds originate in the 19th century. As the financial markets and the tax system have evolved, more and more special rules have been added. If that is the case, the whole thing had become very complex.

The second objective was to support the establishment of a gilt strips market, and to facilitate the development of new varieties of bond in the market, to ensure that London remained a leading financial centre. You may not know what "strip" means in this context, Mr. Deputy Speaker. There is a helpful definition at the bottom of page 3 of the Bank of England's consultative document: Originally 'stripping' referred to the practice of physically stripping coupons from a bearer bond certificate. As the US market developed, the term 'STRIPS' was employed to stand for Separate Trading of Registered Interest and Principal of Securities. You are now fully au fait with the term, Mr. Deputy Speaker.

A serious point is embodied in that objective, quite apart from the wish to ensure that London remains a successful financial centre. The hon. Member for Edinburgh, Central (Mr. Darling) will recall much discussion in the Standing Committee on the Finance Bill earlier in the year about the gilts repo market. All the changes involved the laudable aim of reducing the Government's funding costs by trying to ensure that the instruments available to investors matched their needs as far as possible.

The reform was simple. The idea was, and still is, that all profits should be treated as income and all losses should be relievable. What caused concern was the extension of the proposals to cover private investors. Professional investors can cope with complex financial instruments and, indeed, complex taxation; it is much more difficult for private investors to do so. The document proposed the extension of the proposals to all private investors, subject only to a fairly low threshold: a nominal value of about £20,000-worth of gilts was suggested.

That prompted two sets of concerns, about the substance and about the timetable. I would not say that lower coupon gilts designed for the private sector had been marketed by the Government, but there is no doubt that they were introduced for the benefit of the private investor and, in particular, for higher rate taxpayers, on the understanding that they would not be subject to capital gains tax. There was a problem for those who held gilts individually, and a major problem for collective investment schemes. Many people prefer to invest through either a unit trust or an investment trust.

The second concern related to the fact that people had been asked to respond by 30 June to a consultative document published on 25 May. I believe that, notwithstanding the timetable, some 400 people have responded. My right hon. Friend the Member for Acton said that he would make a decision soon after that date, which prompted a worry about parliamentary consideration: it was clear that, by the time the Finance Bill went into Committee in January next year, all would be signed, sealed and delivered, and we would be considering it retrospectively. We ought to have the opportunity to consider such a major change before its full implementation.

I do not particularly like legislation by press release. It is fair enough if the Inland Revenue discovers some major source of tax avoidance and wants to clamp down on it quickly, but a major change such as this should not be introduced in a press release. Another important consideration is the operative date: when such changes are made, taxpayers should be allowed a reasonable period in which to reorganise their affairs.

On Monday afternoon, my hon. Friend the Financial Secretary and my right hon. and learned Friend the Chancellor of the Exchequer announced major alterations to the proposals. I congratulate my hon. Friend on the speed with which he has moved since his appointment to deal with the matter; however, it could be said that, after having to deal with the problems of Cornish fishermen, he finds dealing with the men from the Inland Revenue a doddle.

In Monday's press release, the Chancellor dealt with most of the major concerns expressed by those who commented on the consultative document. The vast majority of private investors will now have to pay income tax on interest only, as a £200,000 threshold is to be introduced. That will leave only 4,000 private investors subject to the new regime. Why, however, does my hon. Friend consider a threshold necessary? Why can there not be a separate regime for private investors generally?

I have received a number of letters from constituents about that. One, who had chosen to invest in gilts the wealth that he had created during a lifetime in business, told me that he had an investment of £1.5 million. I think that we should welcome the fact that people are prepared to support the Government's funding requirement in that way, and I am not sure why my constituent should be subject to the new regime simply because he has a large holding.

None the less, the change is extremely welcome, exempting as it does the vast majority of taxpayers, and so is the proposal—this could be the answer to my constituent, who has such a large holding—to exempt two particular low coupon gilts: the 3.5 per cent. 1999–2004 and 5.5 per cent. 2008–12 because they are held by private investors in particular. I suppose that one could say to my constituent that he could choose to switch into those two, although some cost would be involved.

Unit trusts that are wholly dedicated to gilt and bond investment are also to be excluded from the new regime. That, too, is extremely welcome, as is the fact that zero-coupon preference shares will be excluded. Some details are to be sorted out in relation to the transition. I am sure that my hon. Friend will now be familiar with what is known as the kink test. That will have to be considered. As with all these things, we shall have to ensure that we do not have a regime that is subject to abuse. That is extremely important.

I should like to mention the position of investment trusts, because, unless I have missed something, I do not think that Monday's announcement referred to them. Of course, a number of them also invest in gilts and bonds, and it is therefore not surprising that the Association of Investment Trust Companies is still concerned. A letter that it has sent me today states: under the proposed rules investment trusts will be subject to taxation on capital gains on holdings of gilts and bonds.The key principle underpinning the taxation of investment trusts has always been that, wherever possible, investors should not be any worse off should they choose to invest indirectly through an investment trust, than if they had chosen to invest directly in the underlying investments. As they presently stand, however: The government's proposals would run counter to this principle as investors would be exposed to double taxation". They would be paying capital gains tax inside the trust, and then capital gains when they sold their shares in the trust. I hope that the Minister will consider that point, because a strong case exists for putting investment trusts on the same footing as unit trusts.

Of course, there is a difficulty when one gets collective investment vehicles that invest partly in gilts and bonds and partly in equities. It is for that reason, and also because it is important that Parliament should have an opportunity to consider the proposals in detail, that the change in the implementation date, which was announced on Monday afternoon, is most welcome.

The proposals will not come into force until 1 April next year for institutions and 6 April for individuals. That will both provide an opportunity for some of the detailed technical matters relating to collective investment vehicles and other matters to be sorted out, and ensure that we have full parliamentary debate on all the details. That is a much more sensible way to proceed.

First, I welcome the change, because the objectives are entirely laudable: secondly, I welcome the amendments that the Chancellor of the Exchequer has proposed, because we will have a sensible system that will allow some simplification—although, inevitably, there will be more legislation than there would have been. As I said, however, that is the problem if one wants to have equity. The proposal will encourage the development of the strips market in the City, and reduce the cost of borrowing to the Government.

Photo of Michael Jack Michael Jack , Fylde 1:43 pm, 12th July 1995

I thank my hon. Friend the Member for Beaconsfield (Mr. Smith) for his kind warm words of welcome. He is entirely right that this is my first appearance in my new role at the Dispatch Box. May I also say how pleased I am that the hon. Member for Edinburgh, Central (Mr. Darling) is here as well? I am sure that we will debate matters across the Dispatch Box in perhaps more combative terms than today.

This is not, however, my first parliamentary outing since joining the Treasury, as, within but a few hours of my appointment, I was debating a double taxation agreement on the subject of Bolivia and Belarus. I think that, at that point, I realised, in the nicest sense, what I had let myself in for in transferring my responsibilities from Cornish fishermen, who showed their dissent by throwing things at me, to this more esoteric world. I have yet to find out what angry taxpayers do.

I congratulate my hon. Friend on securing this Adjournment debate on this important subject. In considering his correspondence in the Treasury, I am conscious of the substantial amount of campaigning that he has done on this issue on behalf of private investors in gilts and bonds. I also acknowledge his particular interest in tax matters in general, which his opening remarks attested to, and in the special subject of tax simplification.

As my hon. Friend said, not only does this proposal offer us a way forward in that subject, but Monday's announcement shows that my right hon. and learned Friend the Chancellor of the Exchequer, my right hon. Friend who preceded me in my job and I listened carefully to all the views expressed on this important matter.

Before responding to my hon. Friend's sage remarks on this subject, I hope that the House will allow me to explain briefly what the Treasury hopes to achieve by the reforms outlined in this sector.

There were two main objectives. The first was to simplify the tax rules in this sector to provide a more straightforward and coherent regime. At present, taxpayers must grapple with, as I am discovering, many arcane mysteries: deep gain securities, deep discount securities, qualifying convertible securities, the accrued income scheme, and much, much more. When each set of rules was introduced, there was good reason for it, but the overall effect is now a mountain of complexity, full of anomalies, tax traps for the unwary, and scope for avoidance.

With our announcement on Monday, we see the prospect of major deregulatory gains sweeping away the hundreds of pages of legislation that my hon. Friend referred to, and having a much simpler, shorter and more intelligible tax code as a result.

The second objective is, as my hon. Friend said, to free up the financial markets for new developments. There is a clear demand, from both issuers and investors, for new types of financial investment.

To give just one example, some people have said that they would like to see the issue of "limited price index bonds". Those are bonds where the maturity value is indexed within a pre-set limit. They could be of value in financing large capital projects and in meeting the needs of long-term institutional investors, but at present the tax rules get in the way. My hon. Friend also put his finger on another important point—the potential for the Government to reduce the cost of their borrowing.

Another example is an official market in gilt strips, which again my hon. Friend mentioned. I must admit that I too worried when I first came across that piece of terminology, but he provided us with an extremely good explanation of it. As he said, that is an official facility to trade separately in both the right to capital associated with a gilt, and in the rights to receive interest. Other countries, notably the United States of America and France, have introduced an official strips market with considerable success, but the United Kingdom's current tax rules get in the way of such developments.

There is a clear demand for such innovations, and we need to allow them to take place if the UK is to stay competitive in world financial markets, but it is difficult to cater for them without having some radical tax reform.

Under the proposals, both the Government and private companies can benefit. Companies issuing debt would receive full relief for their borrowing costs. The present obscure distinction between different types of bond will largely disappear, and income and profits received by lenders will be treated as income, with the additional benefit that any capital losses made by lenders will be relieved.

Thus the distinction between capital and income will be removed for bonds. That distinction makes good sense for shares and for real property; it is doubtful whether it makes much sense for bond-type lending, where the likely returns are more predictable from the outset. The result will be a simpler system in which tax factors interfere much less with normal commercial decisions, and in which market innovations such as those I have mentioned can take place.

All that is for companies as issuers and holders of such investments, but we were always clear that something much less sophisticated would be necessary for private investors, and that, for the great majority of them with relatively modest holdings, it would be sensible to continue taxing them, in general, only on interest income, much as now.

To test reactions to the proposals in my hon. Friend's speech, the Inland Revenue and the Bank of England issued consultative papers on 25 May. In response, companies and tax practitioners strongly endorsed the reform in principle for professional investors, but two reservations came through very clearly.

First, there were widespread calls for implementation to be deferred to give a further opportunity for consultation on matters of important detail, and to give the House full scope to examine the results. I am grateful to my hon. Friend the Member for Beaconsfield for his comments on that. Deferral will also allow firms and individuals to approach the start date with reasonable certainty about what they are taking on.

Secondly, while the ideas were welcomed by business and the financial markets, concern was expressed by private investors who felt that the proposals might adversely affect them. They were particularly concerned that their investment expectations could be disrupted, as they had planned their existing portfolios against the background of the tax rules that have applied to date. Some called for a higher threshold than the one that was mentioned in the consultation document, while others pressed the particular claims of investors in low-coupon gilts. Others urged us not to disturb the debt/equity borderline, and to leave the current taxation of shares, including zero-coupon preference shares, unchanged.

Those concerns were carefully considered by my predecessor, my right hon. Friend the Member for Ealing, Acton (Sir G. Young), who is now Secretary of State for Transport, and my right hon. and learned Friend the Chancellor. I hope that my hon. Friend the Member for Beaconsfield agrees that those concerns were addressed by the Chancellor's announcement on Monday. I hope that it will be helpful to the House to set out the details of his announcement.

There will be a generous threshold of £200,000 for private investors. That will ensure that probably no more than 4,000 private investors will fall within the scope of the changes. I shall develop that point later in answering my hon. Friend's question about why there should be a line at all above which some private investors will be included.

Two gilts with a particularly low coupon are to be excluded altogether. Those have long been held by private investors, and assurances about their tax treatment were given by a previous Administration. There will be no change in the debt/equity border line. Therefore, there will be no change in the present treatment of zero-coupon preference shares or, indeed, any other type of share. I hope that that underlines the reassurance that my hon. Friend derived from Monday's announcement.

The start date for all these changes has been deferred until April next year. Consultations on the details of the proposals will continue until that date, giving people more opportunity to prepare for the changes and to voice any remaining concerns. I hope that my hon. Friend, who has considerable expertise and interest in these matters, will participate in that exercise. Where valuations are needed, they will be carried out in April 1996.

Some hon. Members have expressed concern about the impact of the changes on collective investment vehicles—in particular on the need to avoid the double taxation of gilts and bonds that are held by such vehicles. My hon. Friend spoke about that. We envisage that unit trusts that are invested predominantly in gilts and bonds will, as taxpayers, be wholly outside the new rules. They will be treated in the hands of investors as a sort of synthetic bond that is subject to the new rules, but included, in the case of private investors, in the generous threshold provisions that we propose.

That ensures that collective schemes will continue to offer efficient access to the full range of PEP opportunities, including corporate bond PEPs which are deservedly attracting so much attention. It also gives bond funds equivalent treatment in competing with direct investment in gilts and bonds outside PEPs.

I appreciate that there are some further concerns in the unit trust and investment trust sectors. That is one reason why we are deferring the start date until April next year. As I have said, that will allow additional consultation on the details of the proposals to continue. Given a constructive approach in future discussions, I am confident that we can find whatever further detailed adaptations may be necessary.

The end result of the Chancellor's proposals is that, essentially, there will be no change in the way in which the overwhelming majority of private investors are presently treated. I trust that the House welcomes the proposals. The outcome has been widely welcomed outside. My hon. Friend quoted from a well-known national newspaper, so I shall reciprocate by quoting from another.

The view of the Financial Times was: Most private investors have been given everything they wanted from the changes to the gilt tax proposals". The paper said that it was a victory for private clients and common sense". Many professionals have welcomed the further opportunity for consultation on details and the prospects for progress—now confirmed—towards the gilt strip facility which I and my hon. Friend the Member for Beaconsfield have described. I am glad to hear that my hon. Friend's main concerns have been met.

In the context of valuations, he asked whether the so-called kink test fits well with gilt strips—we must leave others to judge the terminology. The issue is of some interest to my hon. Friend, but I hope that he will forgive me if I do not give a precise answer now. I am aware of some questions about the issue.

The fate of the so-called kink test is tied up with wider questions about the handling of the transition that the Revenue will need to develop and discuss further. It is our firm priority that the transitional rules should be seen to be fair and workable. I am sure that my hon. Friend will contribute to that debate.

He also asked about the drawing of the line, and whether any private investors should be included in the reform. As I think he understands, some 4,000 people will be above the threshold. In setting any line, there is always an element of judgment, but a high threshold has two results. It protects the Exchequer, while retaining the bare minimum of detailed provision to deter tax-driven investment strategies.

With no threshold at all, we would face an unattractive choice between open-ended Exchequer costs and retaining or even increasing the full and sometimes ugly apparatus that we all want to get rid of. We think that the threshold that we have chosen for private investors strikes the right balance between cost and complexity and the concerns of private investors.

My hon. Friend said that, for those above the threshold, the larger investors, there will be an additional gain, in that any capital losses that they may have incurred will be eligible for relief under the proposals. That may appeal to his friend who has a large holding.

We have set out the basic principles. There are many matters to discuss and much detail to fill in, as the ideas are worked up into their full legislative form. Many of those ideas are outlined in the Revenue's press release that was issued at the beginning of the week, and the Revenue will approach them all in a constructive spirit.

This is a valuable reform. It will improve the competitiveness of the City and make life simpler and easier for companies. At the same time, it must respect the concerns of private investors, and I think that our package achieves that proper balance. I am grateful to my hon. Friend for continuing to press this matter in debate, and for giving me the opportunity to put on record the current position on this important matter.