With this it will be convenient to take the following: Schedule 13—Capital Allowances on Long-Life Assets.
Amendment No. 3, in schedule 13, page 188, line 18, at end add—
11. The Treasury shall produce a report each year which—
The clause and the attached schedule, according to the Chancellor of the Exchequer in his Budget speech, are designed to ensure that the writing-down allowances that various Finance Acts provide for should be brought into line with normal accountancy practice. I think that, as a matter of principle, no one would argue with that. We have no objection in principle to the clause, but we would like to take the opportunity to raise a number of matters that arise from the operation of the clause and the attached schedule, and at the same time try to elicit from the Minister further clarification of what the Government intend.
The Committee will see, when examining the amendment, that it is intended, if agreed to, to allow the Government to bring forward, in effect, a report on the effect of the workings of the clause and the schedule. Whenever Parliament provides for allowances, or restricts or curtails allowances, it is important to be sure about the effect of what is proposed. There are many occasions when proposals are brought before the House of Commons and passed into law which turn out a year or two later not to have the intended consequence.
Perhaps it would be convenient to dispose of the principle of allowances, a principle on which I think there is broad agreement on both sides of the Chamber. The principle is that allowances should be designed to assist and encourage investment. They should be carefully worded so that they achieve the specific aim that lies behind them. They should not be allowed to distort investment decisions. Equally, the cost of the allowance should not be disproportionate to the gain. That has happened in the past. The Government's objective is to stop the cost of the allowance becoming disproportionate to the benefit gained. That is something that would generally be supported. Allowances should be in place to assist and encourage the investment process. At the same time, they should be fair. That is a point to which I shall return shortly.
It is my recollection that not so long ago the Opposition argued for enhanced capital allowances—indeed, a possible return to 100 per cent. first-year allowances. I certainly remember that in 1984, when we moved to a lower rate of income tax and lower capital allowances, there was opposition from the Labour party. Is it now the Opposition's policy to pursue what I would consider to be a more sensible approach, which is to follow accounting depreciation?
I suppose it was predictable that the hon. Gentleman would not be able to resist departing from a serious matter to make rather a silly point. If he cares to write, I shall look into what happened in 1984. I was not a Member of this place at the time and I do not remember what happened that year.
Successive Governments have accepted that capital allowances can be justified provided that there is a relationship between the cost of the allowance and the gain. That is the intention, which we want to support. It has always been the position that the Government of the day must review the working of allowances to ensure that they are cost effective and are achieving what was intended initially. Successive Governments have supported that principle.
It is clear that the level and rate of allowances will vary from time to time. I repeat, however, what I said at the outset of my remarks. I do not know whether the hon. Member for Beaconsfield (Mr. Smith) was listening at the time. I said that there is much to be said for ensuring that allowances do not distort investment decisions, and that there should in general be an alignment between what is normal accounting practice, normal business practice and the provisions of the appropriate Finance Act. There is no difference between us on that. Having established that principle—we do not need to waste time arguing the point—I shall deal with a number of points, some of which may interest the hon. Member for Beaconsfield, who tabled amendment No. 11, because he is on to the same point.
What immediately strikes anyone reading this provision is that although the intention is that the law will follow established accounting practice, that does not, I understand, happen. Let me give an example. The aeroplane manufacturing industry has drawn the Government's attention, and certainly our attention, to the fact that although aircraft are an asset and are capable of lasting more than 25 years, and therefore are caught by the provisions of the Bill, many operators in the United Kingdom do not use their aircraft for anything like 25 years; they sell them after 15 years. Therefore, they believe that they are discriminated against. Perhaps they have a point.
I can understand the Government's view that lines have to be drawn somewhere, but considering that railway rolling stock is exempt, I just wonder what the Government's rationale is. Although aeroplanes are caught by the provisions of the Bill, it is arguable that a great deal of an aeroplane that is still flying 25 years after its original manufacture may not be 25 years old, because parts will have been replaced during its working life. The same cannot be said of a railway carriage, a large part of which is the same railway carriage as left the workshop many years earlier.
Perhaps there is something of which we are not aware that has led the Government to exempt railways but to include aeroplanes. It will be interesting to hear from the Financial Secretary the Government's thinking on that point. If there is a rational explanation, I am sure that we will all accept it. Aeroplane manufacturers are concerned that they will be discriminated against. Perhaps I should return to one or two of those points later. It would be helpful to know why railways have been exempted.
I understand why ships have been exempted, because every year in Committee and in the proceedings relating to the Finance Bill we debate shipbuilding, and hon. Members on both sides of the House have been sympathetic to the plight of British shipbuilders. It will be interesting, however, to know why the Government want to exempt railways. Some people have unkindly suggested that it is a favour to those who have acquired the privatised railways, that they need these incentives to make ends meet, or perhaps they were promised this during the privatisation process. We are not all cynical, however, and it may be wrong to suggest such things, but it is difficult to see why so many other people have been included whereas railways have been exempted.
I notice in the explanatory memorandum that the Government issue to all members of the Committee that the rules will apply, in the words of the memorandum,
only to companies that invest heavily in long life assets.
The memorandum does not, obviously, have the force of law, but what Ministers say can be of help in interpreting what Parliament means, which brings me to my second point.
In regard to what is said in the memorandum, the terms and language of schedule 13 are vague. I understand that of necessity it may not be possible to have the precise language that one might like, but bearing in mind the fact that investment decisions may well turn on the allowances that are available, it would be helpful if the Minister could say what he believes the words "invest heavily" actually mean. Presumably an aircraft manufacturer, for example, will almost exclusively invest in assets that have a long life. What do we say to someone who makes the components of an aircraft that might or might not last 25 years? I do not know. Some parts may well last that long; others will not. That is clearly of some importance.
The same is true of the oil industry. It has been put to me by people involved in the oil industry that many of the decisions as to whether to invest in a new field are highly marginal. There are many considerations, of which capital allowances are only one, but it could be the critical factor. Some of the plant that is required will last more than 25 years; some will not. It will be helpful—I cannot find this in the schedule—to know in precise terms what the Government have in mind, and the definition of the assets that are to be caught.
Apparently, there is a further problem. Under the Bill, the test of the lifetime of an asset is whether it is capable of lasting for more than 25 years. I understand that it is normal business practice to write down plant according to the lifetime anticipated by the user or owner of the asset. Let us take the example of an aeroplane again. An aeroplane may be intended to operate for 15 or 20 years; the asset is then sold to someone else, who may use it for five or six years, and subsequently sold again and again, being used for progressively shorter periods. As the Bill stands, it is possible that people in possession of assets that are capable of being used for more than 25 years will find that, through no fault of their own, they will not receive the full allowances.
In view of what I said at the beginning of my speech, I should point out that I am not arguing that allowances should be granted indiscriminately when they may not always be justified; but there seems to be an anomaly in both the scope and the definition of the clause and schedule. Although the stated intention is to align accounting practice with the practice of the law, many individuals will find that their practice still bears no relation to the new law. We should not enact a measure that would distort decisions.
Aeroplanes are, by definition, very mobile. Unlike power stations or water pipelines, they do not have to be in this country. It has been said—although such threats should always be taken with a pinch of salt—that some operators might decamp and set up abroad in order to avoid these provisions and, in a global economy, we must of course be very aware of the tax competition issues that may arise.
I dare say that the Minister will have an answer to all those points, but it would help the Committee—and, perhaps more important, those who will have to put the measures into practice—to know what the Government intend, and how they propose to deal with the anomalies to which I have referred.
Some operators and owners, such as the utilities, have assets which, on any view, are likely to last for more than 25 years. In the case of others, such as the telecommunications industry, it is a moot point: there could be considerable argument about how long modern telecommunications equipment is supposed to last. Those who listened to the "Today" programme this morning will have heard an argument about the erection of telecommunications beacons in a park in Yorkshire. It was argued that they would last only another five years, but they are clearly capable of lasting for 25 or 30 years.
A theme that has recurred during debates on Finance Bills over the past few years is the desire not just to simplify the body of tax law, but to pass legislation that has some degree of clarity; but clarity is sadly lacking in clause 82. It is possible that the Government introduced the clause and schedule simply on cost grounds, but, if that is the case, let us hear it: let us not pretend that there was some other motive. If, on the other hand, the intention was to align accountancy practice with the practice of the law on allowances, will the Minister explain the apparent anomalies—as between railways and aeroplanes, for example—and will he explain what the taxpayer is supposed to do when he has an asset which he has no intention of operating, for any purpose, for anything like 25 years, although the law assumes that it will last for longer than that? That leads to a question that specifically concerns aeroplanes. What are people supposed to do when an asset that may be in the sky 25 years after its frame took to the airways is not the same asset as was originally built? I am sure that other Committee members wish to speak to clause 82 and to amendment No. 3. It would be helpful, however, if the Financial Secretary would explain what the Government have in mind with their provisions.
I listened very carefully to the remarks made by my hon. Friend the Member for Edinburgh, Central (Mr. Darling). Unsurprisingly, he dwelt on the example of aircraft, which is a good example for the reasons that he gave—its mobility and the possibilities of life extension and, although it will still be an aeroplane, of changing almost all its features. The latter feature of aeroplanes may be an argument against applying these provisions to them; I am unsure on that point. It is clear, however, that what is good for trains should be good for aeroplanes. Anyone who has travelled on the west coast main line will know that the life of those assets is considerably longer than 25 years. The railways provide some obvious examples for this debate.
It is always strange when Ministers suggest that legislation will be clarified by a comparatively modest amendment which, upon examination, only adds to the confusion. That is why we should like to have an annual report. If the Government's notional majority were to prevail and clause 82 were retained, it should be incumbent on the Government and on successive Governments to report on changes in the law. It is therefore desirable that we should receive an annual report on developments. Such a report would be to the advantage of the House, to potential investors and, not least, to the accounting profession.
My hon. Friend the Member for Edinburgh, Central mentioned the utilities and the oil industry; he also mentioned this morning's very interesting radio report about beacons for mobile telephones. We should also like to know the status of assets in the cable industry—which is busy digging up our country's roads and destroying trees. Asset life in that part of the telecommunications industry might be of considerable length, and I hope that it is. I do not want my street dug up again, and—given cable operators' tendency to drill holes through any wall they encounter—my wife does not want them anywhere near our house again.
In the utilities and telecommunications sectors, the burgeoning cable industry is entitled to receive some indication of how assets will be treated so that it can determine whether the provisions might frustrate development of exciting new technology. Interaction between home, office and shop, for example, could revolutionise the way in which we live and work.
My hon. Friend the Member for Edinburgh, Central also mentioned the oil industry. I am sure that he will recall that, some years ago, in Scotland, we attended a seminar hosted by a major oil company at which we heard a debate on investment intentions between senior executives of that company. It was clear that executives from the company's American headquarters were mesmerised by the "upstream" and "downstream" arguments on a proposed tax change. The headquarters executives were not interested in the somewhat refined debate on the relative importance of the Government's then proposed tax changes, and their patience was fairly short. If they had thought that tax advantages in the North sea were considerably less than those in south-east Asia or in Australia, they would have been quite happy to move their investment programme to a location that was more cost effective on tax. It is therefore important that the Minister gives an idea of the impact not only on the oil industry but on the petrochemical industry—the downstream industry in which the UK has assets.
I have a constituency interest in that many of my constituents work at the Grangemouth complex, which is on the edge of my constituency. It is one of the major facilities for harnessing and taking advantage of the products of the North sea oil industry. The investment programmes there are of considerable significance, and I do not think that the industry would wish to be disadvantaged by the changes that appear to be in train and which would be available to some industries and not others.
By the same token, we should consider the effect on power stations. Although this is not important at the moment, because the level of power station construction is not quite what it was in the early 1980s, it is clear that, come the end of this century and the beginning of the next—the date might coincide with 2010—a number of new plants will have to be constructed because the life of the existing ones will have been pretty well exhausted. New plants will have to be brought on line. If there is not to be a beneficial tax regime for companies that invest in this sphere, we might face a shortfall in generating capacity.
The construction of power stations involves petrochemicals and electricity generation. Even allowing for the new technologies involved in the generation of electricity, the construction of power stations is a major source of employment. The construction of the kit used in power stations is also a source of employment. It would be dangerous for the Government to highlight one industry—the railway industry—but discount the possible impact of those changes on others.
I am anxious for the Government to make their position clear. We are not happy with the vagueness of
investing heavily in long-life assets".
It could be open to all kinds of abuse and misinterpretation. It is therefore essential that the House has the opportunity to review at regular intervals the impact of the proposed changes. The best way to do that would be with an annual report.
The amendment is therefore sensible, easily operable and one from which the House, the accounting profession and industry would benefit. I see no reason why the Minister should not accept it. If he can tell us what
investing heavily in long-life assets
means with a degree of clarity and concision uncharacteristic of Ministers on most issues, we shall be pleasantly surprised and perhaps reassured. If we do not get that reassurance, I hope that the amendment is accepted. It has considerable merit and would certainly go some way to reassure the people on whom this country depends for employment and wealth creation.
I take the view that, as far as possible, the taxable profit of a business should, for the purpose of corporation tax, be as near as possible to the reported profit that appears in the accounts. Of course, it is not possible to achieve that in practice for very good reasons. In practice, one takes the reported profit in the accounts, adds the depreciation and then deducts the capital allowances to which the company is entitled. However, as far as possible the capital allowances should be roughly the amount of the depreciation that appears in the accounts. Clause 82 and schedule 13 take the capital allowances system a step further down that road.
For that reason, the proposed reform is sensible, but we should recognise that it is a reform that can be made only in an era of low inflation. The hon. Member for Edinburgh, Central (Mr. Darling) took exception to my question about the history of this matter, but it is significant that, 20 years ago, we could not have had the system that we have today. In fact, 20 years ago, when the rate of corporation tax was 52 per cent. and inflation fluctuated between 15 per cent. and 25 per cent., not only did we have to have 100 per cent. first year allowances for all capital investment, we had to have something for stock relief, recognising the fact that replacing stock costs a lot of extra cash in a high inflation era.
At that time, it was not good enough just to look at the reported profits of a company; the cash flow also had to be examined. In the 1970s, plenty of profitable companies had negative cash flow because of the effects of inflation on the need to maintain fixed capital and working capital.
The 1984 reform was important because it reduced the standard rate of corporation tax significantly, and reduced capital allowances. That was a welcome change, because it removed distortions from the system. As has rightly been said, having capital allowances significantly higher than the accounting depreciation introduces distortions into the system, which result in commercial decisions being taken for tax reasons rather than for good business reasons. I am glad that we have reached a stage at which the total capital allowances available to a business will be roughly equivalent to the accounting depreciation that appears in the accounts.
I should like to mention one or two issues that arise from the schedule. The first relates to aircraft, which the hon. Members for Edinburgh, Central and for Clackmannan (Mr. O'Neill) have mentioned. There are exceptions in the schedule for trains and ships. The best way to deal with aircraft seems to be to make an exception for them, too.
The determining factor in deciding how much depreciation will be charged in the accounts is not how long one owner expects to use an asset—so it is not open to an airline that expects to use an aircraft for 15 years to decide to depreciate it at 6 per cent. over 15 years—but the expected useful life of the asset, regardless of how long the current owner expects to use it. That is the problem for airlines. Although an airline may expect to use an asset for only 15 years, the life of an average aircraft these days may well be 25, 30 or even 35 years. United Kingdom airlines tend to buy new aircraft. A new 747, for example, might be owned by British Airways for 15 years and then be sold—probably abroad, although that is not particularly significant—to another operator, who operates it for another 10 or 15 years.
The problem needs to be tackled, and I hope that my hon. Friend the Financial Secretary to the Treasury will be able to do so. I do not understand why the Inland Revenue favours a reducing balance method. Why do we have 6 per cent. on a reducing balance? Would it not be more straightforward to allow 4 per cent. on a straight line basis over 25 years, and at the end of 25 years the asset could be written off? That is straightforward.
The Confederation of British Industry observes in its representations on the schedule that, at the end of 25 years, there is a substantial unrelieved cost. At the start, there is 6 per cent. relief, but that is 6 per cent. on the reducing balance. The CBI points out that, at the end of 25 years, a 6 per cent. reducing balance allowance leaves approximately 20 per cent. of the value unrelieved, whereas accounting depreciation over the same period would have written off the expenditure fully. I do not know how much longer it would take after 25 years at 6 per cent. on the balance for the expenditure to be written off completely. It could easily be another 15 years. It would be simpler to have a straight line basis of capital allowances. I wonder whether my hon. Friend the Financial Secretary could comment on that.
Another important detail relating to the transitional arrangements has been drawn to my attention. Proposed new paragraph 38H of schedule 13, at the top of page 187, provides:
This Chapter does not apply—
(a)to any expenditure incurred before 26th November 1996"—
(b) to any expenditure incurred before 1st January 2001 in pursuance of a contract entered into before 26th November 1996.
That sounds straightforward, but it has been pointed out to me that some large capital projects—the provisions are directed principally towards such projects—such as the construction of a large power station might be organised as a series of contracts. There might be five or six. Although the project would be agreed, the contracts might not all be signed at the start. On 26 November 1996, it is possible that a company might have agreed a project with a construction company but contracted only for the first or second stages. Will my hon. Friend the Financial Secretary consider whether that is a genuine point of practical concern? I do not know. I have raised it with him because it has been raised with me.
I am interested in the hon. Gentleman's point. There is another aspect to that problem. A power station can be built with different generating sets added over time. To get the show running and to generate some income, as well as electricity, the first set is put in and then funded out of the next one, which may come several years later. A continuing programme of expansion can be carried out under the umbrella of the original contract.
If it was clear that there was one contract and everything was carried out under that umbrella, there would not be a problem, as I understand the schedule. However, if there was something less than a contract—a commitment that was not contractually binding under which the project would not be viable if the whole undertaking was not proceeded with—there may he a problem. I do not know, but I hope that my hon. Friend will consider that.
Cable has been mentioned. I wrote to my hon. Friend the Financial Secretary in December about a problem that is of particular concern to Cable and Wireless, although it may be a problem for all cable companies. I shall not go into the detail, but I hope that my hon. Friend will be able to respond to that.
Having said all that, I think that the changes proposed in the schedule are sensible. They can be made only in a low inflation environment, but it is sensible to try to have the profit for the purposes of corporation tax as near as possible to the reported profit in a company's accounts. For that reason, I welcome the proposals.
The schedule adds a further eight and a half pages to the Capital Allowances Act 1990. No doubt it will also add substantially in due course to the voluminous case law on the issue.
It is clear from its size that the measure is not business-friendly. Capital allowances are complicated and present significant difficulties for small and medium-sized businesses in fathoming what allowances they can use for tax purposes.
The issue is of concern to many tax practitioners. In their book, "Practical Capital Allowances", Peter Newbold and Martin Wilson write about some of the practical difficulties. They say:
It is common practice to speak of 'preparing' a capital allowances claim. This pre-supposes that particular types of assets qualify automatically for particular types of allowances, and that a claim consists of no more than assembling and presenting self-evident facts.
In the 1990s, the process is much more complicated. Both tax law and building design have moved on to a new plane of complexity, and the 'grey areas' have grown—the facts are often less evident than they once were.…
A claim for capital allowances must be 'developed' before it can be developed and it must be 'planned'. This clearly involves a good deal of work, and the question is often asked whether the cost (in both time and money) is justified.
That is a very real concern for a number of United Kingdom businesses, especially small and medium-sized ones in the west midlands.
Does the hon. Gentleman agree that the exemption in the schedule for any business that spends less than £100,000 in one year on capital investment means that it is unlikely to apply to all small businesses and many medium-sized businesses?
No, I do not agree. The £100,000 limit will not exempt a significant number of medium-sized businesses—certainly companies that are still small but operate in a group structure. If the hon. Gentleman looks at the schedule, he will find that it places very severe restrictions on companies that operate group structures.
I would accept the principle behind the clause and the schedule if it really brought the tax treatment of long-life assets more closely in line with normal accountancy practice. The hon. Member for Beaconsfield (Mr. Smith) welcomed it, and like him I want taxable profit more closely to approximate accounting profit. In the same speech, however, he rightly made the point when referring to the CBI's submission, that, at the end of a 25-year period, as a result of the reducing balance system proposed in the schedule, about 20 to 21 per cent. of the value of the assets will not be relieved from tax. That does not seem to be getting close to mirroring tax treatment with accounting profit. The Government must be honest and give the real reason for the schedule. If it is a clever tax wheeze to raise £1 billion in two financial years, they ought to come clean and say so.
Following the point made by the hon. Member for Beaconsfield (Mr. Smith), I am prompted to ask my hon. Friend to look at section 38C of schedule 13, where he will see that there is a further problem concerning the £100,000 figure. Although it would catch a contract that spanned several accounting periods and treats them as being one accounting period, what would happen if concerns so arranged their affairs to have a series of separate contracts? In speaking in support of the amendment, my hon. Friend will know that we do not want to reach a point where we are creating a very healthy living for lawyers who argue such matters. Some certainty would be very helpful. Although I appreciate why the Government are trying to be helpful in exempting small firms, they could unwittingly be creating a gravy train for lawyers.
I thank my hon. Friend for his comments, which are not only valid but have independent support. Andrew Dilnot of the Institute of Fiscal Studies said when questioned by the Treasury Committee on the issue of capital allowances and long-life assets that the provision would indeed create a gravy train for tax lawyers and accountants. He was far from convinced that the projected yields of £325 million in 1998–99 and £675 million in 1999–2000 would be achieved. We should listen to what he says. Tax lawyers and accountants are already gearing up to offer companies advice on how they should organise their tax affairs. Some of the utilities with which I have discussed the issue certainly feel that there are ways around the system and that it will not affect their businesses to any substantial degree.
I turn to some of the detail of schedule 13, which raises fundamental issues that require scrutiny. It is unfortunate that, since this is the first clause and schedule to be discussed in Committee, it will not receive the level of detailed analysis that it deserves if we are to make good law in the area. I draw the Committee's attention to section 38A(2)(a) and (b), which revolve around who determines whether assets will have an economic life of at least 25 years and what we mean by a "useful economic life".
It seems clear that individuals and—probably—partnerships will decide themselves whether assets are caught by the legislation because, with the coming self-assessment regime, it will be up to them to determine such tax matters. Similarly, tax lawyers and accountants will advise companies, and undoubtedly some very interesting discussions will be held between companies and their firms of auditors as to how tax treatment of certain assets should be determined and accounted for.
The point is well made by the Institute of Directors in some of the concerns that it has been expressing about the Budget. It says that consultation with industry and tax advisers on how the rule can be implemented is desperately required. I very much endorse that. I will be interested to hear what plans the Financial Secretary to the Treasury has to consult those who will be affected by the legislation and whether further consideration should be given on Report to some of the problems that are likely to be associated with it.
Another key point to make about the section is that, although many major manufacturing companies will not keep assets for 25 years, they are nevertheless likely to be caught by the legislation because it may well be deemed that the asset has a "useful economic life" of 25 years. The most recent Government research that I have seen shows that the average age of plant and machinery in the United Kingdom is about 11 years.
Some of our leading manufacturers certainly have very clear investment programmes. I cite GKN plc as an example. It will clearly make significant capital investments in plant and machinery but will be upgrading and disposing of it well within a 25-year period. How will the section take account of obsolescence so that a machine that could last for 50 years can be replaced by a more advanced one within 15 or 20 years? What happens if everybody agrees in good faith that an asset will last for 30 years, but it lasts for only 20 years? Would the taxpayer be compensated for the loss of cash flow as a result of having only 6 per cent. allowances during this period?
Section 38A(4) and (5) deal with expenditure incurred on long-life assets in relation to composite assets, and state that apportionments should be "just and reasonable." This is peculiarly ill-defined, and it has some important knock-on consequences. Section 66 of the Capital Allowances Act refers to building alterations and states—in summary—that where a person carrying out trade incurs capital expenditure on alterations, it counts as plant and machinery. A company installing a major new manufacturing cell—which would be counted as plant and machinery, but may have a useful economic life of less than 25 years—may have to make substantial alterations to a building to install that cell. Those alterations would then be caught by the new regulations. At present, building alterations can qualify for the 25 per cent. writing-down allowances, but they will not in future. Companies that are likely to make alterations when investing in plant and machinery will be disadvantaged as a result of this part of the Bill.
Section 38B provides exemptions for dwelling houses, retail shops, showrooms, hotels and offices. I accept the point about dwelling houses, but it is not immediately obvious why it is right and fair to exempt retail shops, showrooms and hotels—or, indeed, offices. A number of large hotel groups and companies are making major investments in long-life assets, such as offices, and these will not be caught by the legislation. But a manufacturing company investing in plant and machinery to create wealth in the United Kingdom will be hit by the legislation. That does not seem to be a fair basis in law.
Section 38B(3) is welcome, as it provides exemptions to the shipbuilding industry. However, it is not immediately obvious why shipbuilding should be exempted, but dry docks—where ships go to be refurbished—are to be classified as long-life assets and caught by the Bill. If we intend to do something to help the shipbuilding industry—we have had discussions during debates on previous Finance Bills on the need to support shipbuilding—it is slightly anomalous that dry docks will not be relieved in the way that the shipbuilding industry is. In case law, I cite Inland Revenue Commissioners v. Barclay Curle and Co. as holding that dry docks are plant and machinery. Grain silos are also classed as plant and machinery and they will be similarly affected by the new legislation—even though they are used for the purposes of loading and unloading ships. We need clarification.
We also need details on the subject of investment in sports grounds. Section 70 of the Capital Allowances Act 1990 provides that investment in safety in sports grounds can be treated as plant, but there is no exemption in the legislation for such investment. In future, such investment is likely to get relief at the 6 per cent. rate rather than at the current 25 per cent. rate. Is that what the Government intend? Are they aware of the problem? Will they do something about it?
I also wish to highlight the potential problems in relation to the private finance initiative, and I will be very interested to hear the Minister's response. A number of PFI contracts for the hospital sector—which are being signed rather belatedly—are from major companies that will invest in long-life assets, and certainly in assets with an expected useful life of more than 25 years. Before this Budget there was an understanding that they would get capital allowances at the 25 per cent. rate. It seems to me—there is nothing in the schedule to suggest otherwise—that PFI projects in the health service could be damaged by the change in tax treatment proposed by the legislation. We need urgent clarification on this.
Perhaps the Minister will talk to his civil servants and respond in writing to the next few points that I wish to raise. Section 38C(3)(b) and (4)(b) of schedule 13 talk about expenditure incurred by an individual being subject to the relevant limit, which is set at £100,000. Section 38C(3)(b) says that this is subject to the individual devoting
substantially the whole of his time in that chargeable period to the carrying on of that trade and profession".
What happens if the individual—or partnership—does not devote
substantially the whole of his time in that chargeable period to the carrying on of that trade and profession"?
Section 38C(5)(a) talks about excluding expenditure
on the provision of a share in machinery or plant".
Why will expenditure on such shares be excluded? We could be talking about a 50 per cent. share of a £20 million capital investment. That does not seem to me to be obvious.
Finally, I wish to highlight the point that I made at the start of my speech in relation to groups of companies and associated companies. It seems to me that the legislation will affect company decisions about whether businesses should be part of groupings or not.
That could happen, because the legislation states that the £100,000 limit should be divided by the number of companies in the group, so for four businesses in a small group the maximum capital allowance in any one-year period would be £25,000. If that is so, it is fundamental, because small companies operating in group structures could be caught by the legislation. Will the Minister clarify whether my reading is correct and respond on whether that seems fair?
I am slightly concerned about the cliff edge of the de minimis limit, in that long-life expenditure of £100,000 will result in allowances of £25,000, but £100,001 will produce an allowance of only £6,000. Many companies will be concerned about contract values around the margin if they are considering investments of about £100,000, and that could have some serious tax consequences.
We need some clear answers about the real purpose of the clause and of the schedule to which the amendment refers. If it is to bring tax treatment more closely in line with normal accountancy practices, there are, as the hon. Member for Beaconsfield said, better ways of doing that than using a reducing balance method that leaves 20 to 21 per cent. of the asset value unrelieved after a 25-year period; if the real reason is that it is a nice little earner for the Treasury and a good tax wheeze, why does not the Minister say so?
Many probing points have been made, and I want to say at the outset how much I welcome the opening comments of the hon. Member for Edinburgh, Central (Mr. Darling). I was grateful for his remarks on the broad principles underlying the measure. He went to the heart of the matter when he rightly said that capital allowances should not be allowed to distort investment. I believe that he said that in the context of the previous reforms, and he certainly attached his remarks to the reform before us today.
One of the underlying themes of the debate has been, why we are doing this? The hon. Member for Dudley, West (Mr. Pearson) asked a moment ago whether it was a wizard wheeze to raise lots of money, and my hon. Friend the Member for Beaconsfield (Mr. Smith) suggested that it might be a timely reform to bring into line with accounting principles the way in which tax allowances treat long-life assets. It is very much that principle that has driven us in our considerations on the measure.
The current economic circumstances make it more propitious to advance that line of argument. It is important to refresh the Committee's memory about the rate of corporation tax. While we have been the Government, the mainstream rate has decreased from 52 per cent. to 35 per cent., and the small companies rate from 33 per cent. to 23 per cent.
For all those who express doubt or indeed dissent about aspects of the measure, however detailed, the acid test to which we return is whether enacting this reform in addition to our previous reforms to the tax allowance system allows us to sustain, and indeed—for small and medium-sized companies—to improve the corporation tax regime, to the extent that, by my assessment, we have the most generous small companies corporation tax regime and the most competitive mainstream corporation tax rate of the major economies.
When business people were asked where they prefer the balance to lie between allowances and a lower rate of corporation tax, by and large they preferred the lower tax. The measure allows us to sustain that position. There is no hiding from the fact that money will be raised, as that will clearly happen if we reduce an allowance—in this case to bring it, as far as the tax system is concerned, into conjunction with the accounting principles involved—and we make no apology for that result, because the corollary is a further improvement in the small companies corporation tax rate.
I hope that I have dealt with the points made by several hon. Members. The hon. Member for Edinburgh, Central said that whatever we did should be fair and should assist and encourage. I share that view: the tax regime on companies should be fair and it should assist and encourage investment. Everyone participating in the debate has expressed a genuine wish to remove distortion by virtue of tax allowances. As my hon. Friend the Member for Beaconsfield said, that is what the reform has done. On those points, I believe that the probing questions of the hon. Member for Edinburgh, Central have been answered.
The juxtaposition of aircraft and railways was mentioned, and there was some comment on ships, the oil industry and the cable industry. I shall try to deal in detail with the points raised on those issues. I was grateful for the supportive comments of the hon. Member for Edinburgh, Central, who acknowledged that it was appropriate to exclude shipping in this context. He has long experience in that area, and clearly recalls the changes that were made in response to representations from the shipping industry: in the previous Finance Bill we made changes in the roll-over relief arrangements, and it would clearly not be appropriate to undo by the current measures the good that we did on behalf of the industry at that time.
On railways, there is no fiendish plot artificially to favour those involved in rail franchising. First and foremost, circumstances in the railways are rather different from those in the mainstream industries affected by the proposal. The Committee will reflect on the fact that the railway industry has historically been a loss maker. However much we may have debated the rights or wrongs of privatisation, we set out with a genuine intention to try to improve our railway system through privatisation and the franchising operation.
I may have misunderstood the Government over the past three or four years, but I thought that the privatisation process was intended to ensure that profits, not losses, were made. I wonder, therefore, about the justification for excluding the railways, because I understood that they were to be in exactly the same position as, for example, an aircraft manufacturer or operator, and that they were to make profits. The hon. Gentleman seems to be acknowledging that they will never make profits and that they will have to be subsidised. That is a concession, is it not?
The hon. Gentleman has spent a great deal of time considering particular points of detail in the Bill, and indeed in the schedule, but perhaps it escaped his attention that the provisions last until 2010, when they are to be reviewed, and that is precisely because we see the potential of increasingly improved finances in the railways. The Government are providing grants, which are now paid through the franchising director for the provision of loss-making services. If these measures increase the costs of the railway industry, those costs will simply come back to us through the subsidies that will be paid to the franchises that are to be negotiated. That is a sensible move. I emphasise that we expect the railway system to move into profit in due course. To judge by some of the excellent commercial ventures that have already been started by various franchise winners, the process is well under way.
I listened carefully to the Financial Secretary. He seems to have made two fairly clear commitments. If I am wrong, perhaps he will clarify the matter. Is he saying that all the railway companies will be in profit by 2010? If he is, is he guaranteeing that when the matter is reviewed in 2010, they will be put on the same taxation basis as everyone else?
I refer the hon. Gentleman to paragraph 4 of the Inland Revenue press release of 26 November, which states:
Capital allowances will continue to be given at 25 per cent. a year on sea going ships and railway assets bought before the end of 2010, when this exclusion would fall to be reviewed by the Government of the day.
That was my point. I have expanded on the reasoning behind the shipping and railway exclusions.
If I understood him correctly, the hon. Member for Edinburgh, Central continued to probe the meaning of investing substantially in long-life assets. Those words are meant to make it clear that the sorts of enterprise concerned are exactly what the proposal says that they are: those that invest in long-life assets. In some trades, professions and activities, assets have a short life. We will discuss the question of life because many of his points revolved around the definition of long-life assets. That is why we recognised that there should be a cut-off—the de minimis exclusions—to try to take out the small and medium enterprises from the proposals.
Hon. Members have touched on how the proposals affect individual companies, and the hon. Member for Dudley, West mentioned groups of companies. Groups of companies that spend less than £100,000 a year on long-life assets, other than assets wholly excluded in the rules, are excluded. It would be to his advantage to examine the information in notes on clauses. The definition of the scope involved was "sizeable expenditure" on assets that are treated in accountancy terms as being long life. We are talking about industries that invest in substantial structures, such as heavy machinery and pipelines. The oil industry was mentioned, as were aircraft.
I hope that the answer to the question of the hon. Member for Edinburgh, Central suggests itself. In the real world, certain assets are deemed to have a life of 25 years or more, and it tends to be the bigger end of the investing spectrum that is affected.
May I seek clarification of that point, because it may help those who have to implement it? Does investing heavily refer to the value of the investment or to the nature of the business or individual? If the Minister personally decided to build a power station, would that be investing heavily? If a railway company that never bought any carriages suddenly bought one, would that be a light investment, even though it was a long-life asset? Is it the value of the investment or the practice and nature of the business that decides whether an investor is heavy?
There are two parts to the definition. It is determined, first, by the life of the asset, and, secondly, by the value. The point of the de minimis exclusion was that many small investments need not be caught by the provision. Serious sums above £100,000 a year would be regarded as starting on the trail of heavy monetary investment. However, to be caught, the life of the asset must be considered. If, in terms of accounting practice, it has a life of 25 years, it will be deemed to be a long-life asset and will therefore be caught. To answer the hon. Gentleman's point, if companies do not invest, they will not be caught.
I apologise for my absence from the start of the debate; I was chairing a Committee.
On the life of assets, is there not a strong case for differentiating between turboprop and jet aircraft, as the former tend to have a much longer life?
I shall pre-empt some more detailed remarks that I was going to make on that. For light aircraft, matters such as the number of flying hours can be taken into consideration. It is for the company to decide all such matters when it starts in its accounting principles to deal with long-life assets. If there is a dispute about assets being long life or short life, the discussions with the inspector of taxes come into play. If no agreement is reached between the inspector and the taxable entity, the matter can be referred to the commissioners for further adjudication.
At the start of the debate, we discussed bringing tax allowances into line with accounting principles: accountants will identify the asset at company level and decide whether it is appropriate to write it down in the company's accounts as a long-life asset. It is at that point that the tax treatment is triggered. We have brought the principles together as detailed in schedule 13.
I want to pick up a point made by the hon. Members for Edinburgh, Central and for Clackmannan (Mr. O'Neill). Major components of aircraft such as engines can be treated separately. When such significant components are replaced, they can be treated as any other replacement part would be under a tax regime different from the long-life tax regime. An oil rig or exploration device may be made up of a series of separate modules, and the test would apply to each part. The principles are fair in their practical application.
Is my hon. Friend saying that it would be open to airlines to break down an aircraft into its component modules? If the engines had a life of only 15 years, could they claim capital allowances at the current rate on the engines but claim for the fuselage under the new arrangements?
The engines and fuselage are treated as different parts because they are made by different companies. My limited knowledge of aircraft manufacture is almost wholly gleaned from a recent visit to Rolls-Royce. I am no aircraft engineer, but I know that many other parts of the aeroplane can be separated. Is the Minister saying that many other parts of the aeroplane can be separated? For example, I understand that the most important part of an aeroplane is its wings. Those who make the wings tell me that the wings affect how the aeroplane flies and performs. The bit in the middle that we all sit in is of lesser interest.
How can the Minister take the separation of the component parts of an aeroplane or anything else so lightly? Surely lawyers will have a field day arguing that the components of an aeroplane, a power station or anything else are separate assets and that the value of not one of them exceeds £100,000. The Minister can see what arguments might be open to accountants and lawyers. Will he be a little more helpful on what line the Revenue will take? We need some certainty.
Those of us who use aeroplanes—I think that the hon. Gentleman occasionally travels home in one—would regard the placing of the pilot as rather more important than he implied. My remarks were predicated on the Inland Revenue's current tax treatment of significant and separate components. If the hon. Gentleman knows anything about aircraft, he will know that engines are taken out and new ones are put in as part of maintenance operations. A wing is an integral part of the structure of the aircraft: people would not normally take one out and put another one in. He and I can debate that, but I have British Aerospace's military aircraft division headquarters in my constituency, so I perhaps have a shade more knowledge of aircraft maintenance procedures than he has. I do not want to get into such a debate, Dame Janet, or you will rightly call me to order.
The hon. Member for Edinburgh, Central spoke generally about the mobility of airline industry investment. My hon. Friend the Member for Beaconsfield (Mr. Smith) voiced a concern that has been expressed by the industry. The sum total of the effect of the proposal on the United Kingdom airline business on an annualised basis will be £25 million, against a total investment of some £2 billion. That represents an on-cost of £1 per passenger per year. Although the industry is bound to express concern, that figure puts it into perspective.
The financing of aircraft, which is also affected by the proposal, is an international activity. People go around the world with their various lease arrangements, almost collecting tax allowances as they go.
The hon. Member for Clackmannan drew the Committee's attention to the cable industry, and he expressed concern about how the proposal would affect it. It is important to put the matter into perspective. The annual capital expenditure of the cable industry runs at some £2 billion, and £6 billion is to be spent over the next three to five years. Given the current annual turnover of about £1 billion—which is growing—the effect of this tax proposal on the cable industry will be containable. It is not a showstopper, given the size of the investment.
We return to the question of non-distortion. It is fair to say that we have not tried to make artificial distinctions between one type of industry and another, apart from those of which I gave the Committee details a few moments ago. Given the size of the commitment, there is not a problem.
The hon. Member for Clackmannan also drew the Committee's attention to the effect of the proposal on the oil industry and asked whether any calculation had been done to measure it. I hope that my comments will reassure him. The tax effect is the equivalent of less than one third of 1 per cent. of the industry's turnover. Any industry is bound to mount an argument for special pleading, but I genuinely do not believe that the oil industry can argue that the effect of the proposal is such a serious matter.
There is, however, an important point of principle. The hon. Member for Edinburgh, Central was right to draw the Committee's attention to the need for an allowance regime that does not distort. It is important that decisions on major investments are not made by virtue of the tax allowances; sometimes, far bigger costs have to be taken into account. One of the biggest single costs to the airline industry is the amount of fuel used on a journey. One of the most important factors affecting profitability is—to use the colloquial expression—the number of bums on seats, which has a far greater effect on determining investment decisions. Airlines seek aircraft of a more modern design to save fuel, or with more capacity so that more passengers can be carried. Such considerations are more important than the effect of the tax allowance. It is important that decisions on investment should not be distorted by the allowance.
I am grateful to the Minister for trying at least to give some figures. The sums that he gave were somewhat vague. One does not know what would be the significance for investment in, for example, the North sea. We have to take account of the globalised character of that industry. At the margin, a project might be disadvantaged by even a fairly modest change in the tax regime. Such a project may be in competition with another in Alaska or the Gulf of Mexico, and it might be to the company's advantage to move there. Oil companies care not where they get their oil but about the money that they get from the projects in which they invest. That is the point that I was trying to make.
The Minister has not quite fiddled the statistics, but he has given a meaningless figure that needs either to be clarified or to be discarded as irrelevant.
I am not prone to deliberately misleading the Committee, but I have been informed that the hon. Gentleman was right when he said that my figure was meaningless: it referred to the airline industry, not to the oil industry. I take this opportunity to apologise to right hon. and hon. Members for my error. It adds to my argument about the airline industry and acknowledges the point that the hon. Gentleman made.
For a third of 1 per cent., that is going a bit far.
I am advised that the change mentioned by the hon. Member for Clackmannan is unlikely to cause any project, certainly in the North sea, to be dropped. I shall consider whether I can make any further points, with perhaps greater accuracy, to quantify the effect of the measure.
I have dealt with the points made by the hon. Member for Clackmannan about the cable industry. I was pleased to have the support of my hon. Friend the Member for Beaconsfield. He raised a number of issues on aircraft and I hope that I have dealt with them. I was also grateful for his assistance in answering the point made by the hon. Member for Edinburgh, Central about aircraft being sold on. He answered it with clarity and knowledge.
My hon. Friend also made some points about ships and railways, with which I hope I have dealt. He asked why we had chosen the figure of 6 per cent. Capital allowances on machinery and plant are calculated by pooling expenditure. That method is generally preferred by taxpayers as it is simple to operate, but it means that allowances are given on the reducing balance basis rather than on the straight line or any other basis that may be used in commercial accounts. It is misleading to look at the period over which the expenditure is written off on the reducing balance basis. In theory, it is infinite. In practice, it is not possible to determine because the identity of the expenditure is lost in the pool.
The better comparison is with the net present value of allowances. On that basis, 6 per cent. gives the best fit with commercial depreciation for an asset with a working life of 25 years or more. That is the technical explanation. I draw my hon. Friend's attention to the Inland Revenue press release, which explains the transitional rules. I suspect that he would also have liked to mention the effect of the proposals on theatres, but did not have the time. I acknowledge his interest. If he will be kind enough to inform me of his concerns, I will be delighted to write to him about them. To pick up on some of the other transitional points that he mentioned would add an undue complication to our proceedings. I know that he would like all the matters to be dealt with through a tax law rewrite, but that is complex.
Finally, the hon. Member for Dudley, West took us at some length through the central issue of how one determines the life of an asset. He read out a number of quotations. The straight question of who decides the useful economic life of an asset that needs to be determined when the accounts are drawn up. That is one for the accountants, who are used to it and understand it. As I said, if there is a disagreement, it is the role of the tax inspector and the commissioners to sort it out.
The hon. Member for Dudley, West asked whether inspectors would be bound by the expected economic life used in the accounts. That will be strong evidence of whether the 25-year test is made, but the inspector must be able to query the figure if he is not satisfied that it is reasonable. Those are fairly simple and straightforward statements.
I have been involved in industry, as has the hon. Member for Dudley, West (Mr. Pearson). How can my hon. Friend the Minister believe that in this modern age any asset lasts for 25 years? If we are to remain efficient in this competitive age, we need to replace machinery of almost any sort within 10 years. Writing off assets over 25 years is a total nonsense, and puts this country at a grave disadvantage with our competitors.
My hon. Friend is right. If he is drawing the Committee's attention to the fact that machinery may be built that has an obviously shorter operating life, to take account of technological advance, that clearly is a matter for the accountant. I remember this argument being used when I was involved with the glasshouse industry. It was made clear that some of the structures might not last all that long. The advice to that industry was clear—take it up with the tax inspector.
I hope that my hon. Friend will forgive me if I do not give way again, as I want to draw my remarks to a conclusion.
The life of an asset was a central part of the remarks of the hon. Member for Dudley, West. I shall certainly study carefully some of the further technical points that he made and, if he will excuse me, I shall write to him about them. I commend the clause and the schedule to the Committee.
I thank the Minister for his brief final comments and for explaining the meaning of life to the Committee. I appreciate that he will write to me about some of the technical issues, and so will not mention again building alterations, dry docks, grain silos and the treatment of groups of companies. Will he comment on how the Bill affects the private finance initiative, with particular reference to hospitals?
Has the Treasury taken into account in its estimates of cost savings the way in which contracts will be redesigned to take account of the new legislation? It seems clear that, when putting in a new production line or a manufacturing cell, whereas one might have awarded a £2 million contract for 10 different machines and all the links, one will now use 10 or 11 different contracts plus an assembly contract to get around the legislation and claim the allowances.
I am grateful to the hon. Gentleman for giving way when my hon. Friend the Minister would not. Is not one of the problems the fact that accountants make these decisions rather than production managers or engineers, who have more knowledge of the benefit of equipment than accountants, who merely look at the figures and the bottom line? Would the hon. Gentleman, whose interest and involvement in industry and in rugby football I have considerable respect for, comment on that matter before the Minister responds?
The hon. Gentleman is right, if he is making the general point that too many accountants run businesses and that too few people with a knowledge of production and manufacturing industry are on the boards of companies.
I should appreciate a response from the Minister on the PFI and hospitals, on the extent to which the Department has taken account of the real world and on how contracts will be redesigned as a result of the legislation. It is easy to draw a coach and horses through some of the Bill because of the way in which it is drafted.
We do not hide the fact that the Bill will affect the PFI and contracts where long-life investment exceeds £100,000. As the hon. Member for Edinburgh, Central said, the quality of the investment is what should see the thing through. The matter should not turn on the question of tax allowances, which is why we are removing this distortion. The underlying thesis is the fact that, in business terms, the highly competitive corporation tax regime is far more important to those who want to make quality investments than the tax allowance regime.
I know that the Committee anticipates a vote and I shall not speak for too long, but I must refer to a number of matters. The debate has shown the difficulties that we can get into when a straightforward proposition becomes complicated by exemptions, and where different reliefs apply, depending on different definitions. Indeed, it appears that, while the Government were trying to simplify the provision of allowances, the position has become rather more complicated and many of the gainers will be lawyers and accountants.
I will deal with one or two questions that the Minister did not completely answer. We should be grateful to him for clarifying the position on railways. We have a clear admission from the Government that the railways will be making losses for some years to come—certainly for 13 years. I understand the argument that there is not much point in giving a tax break to someone who has to be subsidised by the taxpayer. That admission undermines all the Government's claims about the railways. According to the Minister, they are loss making and therefore we cannot justify giving them a further tax break. I understand the logic of that, but it bears out what we have been saying—that the taxpayer will have to subsidise the privatised railways for many years to come. Thirteen years is a long time before any review.
I have never understood why aeroplanes are included in the measure and railways are not. The Minister did not deal with that central point.
It concerned me when the Minister, in effect, gave the industry tips on how to get around the provisions of the Bill, because it seems that the engines of an aeroplane can be removed and treated separately. Perhaps the example I gave, of wings, was not a good one, although the wings are a major part of an aeroplane. I should probably declare an interest, as I use aeroplanes at least twice a week. I have always—perhaps naively—thought of an aeroplane as being one body rather than the sum of a number of component parts, all of which can be treated differently for tax purposes and removed as appropriate.
That illustrates my point. If operators and manufacturers get round the problem by treating different parts of the aeroplane in different ways, it will lead to precisely the difficulty that was pointed out by the hon. Member for Macclesfield (Mr. Winterton)—accountants will instruct manufacturers to ensure that a part cannot reasonably have a life of 25 years and, therefore, obsolescence will be built in. When an engine or the electronics of an aeroplane is designed, the accountants will say that it must not last for more than 20 years, in case it gets caught. They can then claim the 25 per cent.
That shows the problems that arise when the law becomes, not simpler, as we all profess to want, but more complicated. I am worried that we are, in fact, creating great opportunities for lawyers and accountants. When describing the new concept—the meaning of economic life—the Minister referred to accountants, saying that they understand these matters. I was once a practising lawyer, so I know that accountants and lawyers understand these matters. In particular, they understand that a good and long argument is a lucrative way of spending their time, and we should not put together a tax system that guarantees them work for 25 years. Nevertheless, that appears to be what we are doing.
I have come to believe that the next Government will have to spend a substantial amount of time trying to sort out these difficulties, some of which will be immediately apparent, while others will only appear when the law starts to operate. It would be unreasonable to burden the next Government with having to report to Parliament in addition to that, as I suggested in my amendment.
Question put and agreed to.
Clause 82 ordered to stand part of the Bill.
Schedule 13 agreed to.