We have not tabled any amendments to the clause, but I want to make several points. The clause is a positive step, as it reduces the holding period necessary for business assets to obtain maximum taper relief. It has been broadly welcomed, but it does not address certain anomalies. For example, the holder of a business asset can never reduce his taxable gain to nil, whereas the holder of a non-business asset can do so, if indexation is greater than the gain.
That situation arises because the maximum taper relief is 75 per cent. of the gain and 25 per cent. is taxed. Indexation allowance, which applies to non-business assets provides an inflationary allowance such that the index cost of the asset is effectively what someone would pay today for the same asset, if it had risen in value by the rate of inflation. That means that only the real increase in value is taxed.
If an individual held a business asset since January 1985, with an original cost of £100,000, and sold it this year for £200,000, the unindexed gain would be £100,000. Taper relief would be £75,000, leaving £25,000 charged to tax, so he would have to pay tax of £10,000, if he was a 40 per cent. taxpayer. However, if the asset was a non-business asset, the individual would be able to claim indexation allowance of some £91,000, and pay tax at 40 per cent. of £3,460. That anomaly arises because the retail prices index increased by 91.34 per cent. from January 1985 to April 2002, which is the proportion that can be attributed to inflation. In that case, the holder of the non-business asset would be better off than the holder
of the business asset. Perhaps the Government would address that to allow the holder of an asset on which taper relief can be claimed to elect for indexation allowance to apply and for the asset to be treated as if it were not a business asset, if that would benefit him.
We will come to another anomaly in subsequent clauses, which has been pointed out by the Chartered Institute of Taxation. That is the unfairness of the situation that applies to someone who acquired shares in the company for which they work before September 2000. Supposing an employee, who was made redundant last month, sells his shares later this year and, through no fault of his own, finds that 25 per cent. of his gain is deemed to be a non-business asset. Assuming that he is a higher rate taxpayer, the marginal rate of tax will be 70.5 per cent. For every £1,000 gain, £250 will be taxed in full at 40 per cent., so £750 will be subject to 75 per cent. taper relief. Therefore, the total tax burden on each £1,000 gain will be £175, which is 70.5 per cent.
We have tabled an amendment to clause 46, a starred amendment, which would allow individuals, in calculating the length of ownership, to discount the time when the asset was used for non-business purposes. That would not help in the particular examples of retirement or redundancy, but it would deal with the unfairness between pre-2000 and post-2000 business assets.
I rise to address a couple of points, the first of which follows on from the comments made by my hon. Friend the Member for Arundel and South Downs.
On business and non-business assets and potential changes of status in relation to an organisation, Ministers need to be mindful of the situation that can often exist in the early stages of the formation of a business, and in particular the stages in its development when it is backed by venture capital. It is often the case that a person who sets up a business does not end up leading it further down the track. It is very common for somebody to take a business through its first, and possibly its second, round of financing, and then discover that as the business becomes established and developed the investors who are supporting it bring in an additional group of managers to add new experience to it. Very often the person or persons who founded the business may find themselves moving on, retaining shareholdings and no longer working for the company. It is important to tackle that anomaly because it could have an adverse effect that we would not want on entrepreneurial groups in our society and I hope that the Economic Secretary will give that due consideration.
Secondly—I refer hon. Members to my declaration in the Register of Members' Interests—I want to probe the status of property assets with the Economic Secretary. In which cases will property assets become business assets? In relation to the burgeoning residential property market and people's involvement as investors in that marketplace, what is the status of property under clause 45? In which circumstances, if any, will it be classified as a business asset?
I rise to underscore the remarks made by my hon. Friends. The Economic Secretary will have had the very helpful briefing, which deals with some of those matters, from the Chartered Institute of Taxation drawn to her attention. It is probably as well to point out that all such matters are drawn to the attention of Treasury Ministers, who have copious briefings on how to deal with them. I look forward with great interest to what she has to say on those points.
I should like to take our discussion of clause 45 a little further. Although I welcome the fact that the tapered arrangements for the lowest rate of capital gains tax now apply after two years rather than after four, as they did previously—it is a pleasure to see when a sinner repenteth—I should like the Economy Secretary to spend a few moments explaining the rationale for that move.
When tapered tax was introduced, the Government told us that it was good and virtuous. They told us that it would aid investment in British industry. They told us that short-termism was a bad thing, and therefore a taper over a much longer period was entirely to be applauded irrespective of the questions about complexity that Conservative Members raised. On page 49 of the Red Book, clause 45 is justified by reference to
''simplification of the CGT regime to reduce compliance costs, in particular for those who invest in business and for employees.''
What a turnaround by the Government. They introduced the complexity that capital gains tax represents and we now have to unpick it. I should be interested to know the reasoning behind that gradual move.
Will the Economic Secretary tell us why tapered tax has to be applied at two years, rather than at three years, one year or zero years? She is shrugging her shoulders and smiling in her delightful way, but there must be a reason why the Government took that decision, about which it would be helpful for both Parliament and the world of business to know more. She is well versed in economic analysis and is a highly intelligent person who should have no difficulty in providing information on economic gains under the previous regime of longer tapered arrangements. Can she say how much more investment took place as a result of the arrangements that the clause will reverse? How did British productivity gain from such complexity, and what will be the gains from the change to a two-year regime? Can she expand on the Government's policy, philosophy and approach to capital gains tax?
The clause makes a clear distinction between business and non-business assets. Discussions on previous clauses have illustrated that an economic effect can be achieved in the economy through investment in non-business assets. It is about time that the Government outlined their philosophy on capital gains tax, because in successive Finance Bills we have seen a piecemeal unpicking of tapered tax arrangements. The Economic Secretary and the
Government owe it to the House and the country to lift the lid a little on their approach to that tax.
I endorse the point made by Conservative Members about people owning disqualifying business assets pre-April 2000. It is preposterous that they must wait until April 2010 to receive full capital gains tax relief, whereas those who acquired an asset after the change in rules receive that relief significantly earlier.
During the Finance Bill a year ago, the right hon. Member for Fylde and I took that up with the Economic Secretary, but we were never given a satisfactory explanation for that preposterous state of affairs. I am indebted to the Chartered Institute of Taxation for its remarkably lucid parable about Fred and Jim, who both worked for Successful plc. Because poor old Fred held shares prior to April 2000, he would qualify for the 10 per cent. rate of tax only if he were to sell them in April 2010; Jim would get the tax advantage because he held shares after April 2000. That is unsatisfactory because it will not reward individuals who have worked hard, and risked their assets and money, for longer. Those people need rewarding. I look forward to the Economic Secretary's endeavour to defend what many people consider to be indefensible.
I, too, am indebted to the Chartered Institute of Taxation for providing the Opposition Benches with such valuable ammunition, amusing anecdotes and illuminating examples. I intend to deal with them all in my response.
First, I shall address the point of principle raised by the right hon. Member for Fylde. He referred to what we have said about previous Finance Bills, such as that introducing greater relief for business assets was good and virtuous, and that short-termism was bad. What we did then, and are continuing to do, is introduce a taper relief that means that a tax bill diminishes the longer an asset is held. That is the fundamental principle; it is key to our agenda to reward enterprise, encourage work and increase productivity. I do not accept that our fundamental motive in making the changes has changed in any respect.
Fred would disagree with what the Economic Secretary has said because he has held the asset for a long time and is not getting the reward to which she rightly said he is entitled.
I hope that, in dealing with the point about what the relief is designed to do, I shall also answer the point raised by the hon. Gentleman.
Why do we have the taper relief? What is its purpose and what is it designed for? I would argue strongly that the Government are not in the business of cutting taxes for no purpose. We are in the business of promoting enterprise and rewarding entrepreneurship, to make commercial decisions more valuable and, hopefully, to promote the direction of investment.
Surely the Government are also in the business of increasing productivity and economic
growth, which require the most efficient use of capital. The argument on tapering rates is about locking money into assets that are not ideally allocated. We are all in full agreement on enterprise, motherhood and apple pie, but there is a much bigger second issue relating to capital taxation, which is the efficient use of capital.
I completely agree with the hon. Gentleman, but as he and other hon. Members will understand, we believe that there is actually a market failure concerning start-up and growth companies. We can take action and encourage productivity by the use of the tax system and other policy levers at our disposal. We continue to use the tax system to promote long-term investment and to discourage short-termism.
The Economic Secretary is about to launch into a discussion on why long-term investment is good. If long-term investment is good and short-term bad, why are the Government shortening the taper?
The hon. Gentleman interrupted me in mid-flow. If only he had waited, he might have heard the answer. The change that we are making this year will specifically build on the success of earlier reforms and, in particular, encourage investment in start-up and growing companies. For such companies, equity investments are a vital source of finance. However, venture capitalists and other early-stage investors frequently invest with a view to realising their capital in less than two years, so we have designed the taper specifically to take into account the natural mode of operation and interests of venture capitalists, and their investments in start-up businesses. We are doing that to promote the productive potential of this country, to encourage business start-ups and to encourage the right sort of investment to take place.
Several hon. Members rose—
Surely we want the venture capital industry to consider the long-term support of businesses, rather than making a short-term buck. A tax system that encourages them to get in and out within two years does nothing to encourage the long-term support of businesses by venture capital firms.
I do not think that the hon. Gentleman's point is realistic. We have a system in which investment in entrepreneurs and start-up companies is usually short term. We do not want to cut out from all the potential gains that we are offering all the companies that make a very valuable investment in start-up companies. It is only right to recognise that their period of investment is usually shorter than that of other companies where investment is held for long periods.
I am happy to give the Economic Secretary the benefit of the doubt in this matter. I suspect that it is just unintended consequences rather than anything malign that she has in mind. I must confess, as someone who benefited from the old system
of taper relief when it came to selling my business on entering the House, that I should tread carefully in this regard.
I am concerned that the two-year arrangements effectively make it easier for hit-and-run merchants constantly to set up businesses during a short period of time. Instead of encouraging enterprise and entrepreneurship, they will encourage the worst aspects of the process. Companies will be set up quickly and individuals will move from company to company to take advantage of the very favourable regime for capital gains tax taper relief.
I do not accept that. Holding an asset for 12 months or two years by investing in a company for 12 months or two years is a very valuable benefit to start-up companies, which is what we are specifically trying to encourage. A 12-month or two-year period will not encourage a hit-and-run exercise by investors. The measure will have a huge beneficial effect.
The chart speaks for itself and hon. Members can refer to it at their leisure.
The right hon. Member for Fylde asked about publishing an economic analysis of the impact of the provision. The Inland Revenue is committed to evaluating the impact of the taper relief reforms, but time has been too short to obtain concrete information to analyse. The Revenue continues to draw on the experience of a standing consultative review group of outside interests. It is consulted whenever practical on reforms to taper relief and other suggested changes.
On some of the more specific points raised, the hon. Member for Arundel and South Downs suggested that we should consider reducing capital gains relief to zero. The effective tax rate on gains for higher rate taxpayers is now 10 per cent. after two years. I would argue strongly that that not only provides a real incentive to invest in business and encourage share ownership by employees, but it is not clear that making the taper more generous would promote additional cost-effective activity and improved investment performance. I also believe that individuals who make and realise substantial gains should be liable to some tax on those gains.
The hon. Gentleman suggested that non-business assets can be contrived to have a gain of zero, but the indexation allowance applies only to April 1998, which is a matter of contention in the Committee. After that, it does not apply to business assets or non-business assets, so his point is neither practical nor significant.
I was simply saying that the issue is arbitrary. The arithmetic was correct. I was not proposing a zero rate in principle, but asking whether the Government had thought about giving people the option in the rare circumstances in which a long-standing business asset might be banished by the business taper relief.
The appropriate answer is that it would be very complex to have a system of election into indexation or taper relief as circumstances dictate. We are trying to incentivise behaviour, so we are looking to the future rather than the past.
That brings me to the argument that apportionment is wrong in principle. The hon. Member for Epsom and Ewell (Chris Grayling) referred to apportionment that follows from the need to have two tapers to distinguish productive investment from passive wealth. Time apportionment produces an accurate result when the value of an asset increases uniformly over time, and for many assets that will be a reasonable approximation. Apportionment is a simpler and cheaper system than a valuation-based approach. It is perfectly fair that an asset that has not been a business asset throughout the relevant period of ownership should be treated less generously than one that has. The whole point of a more generous business asset taper is to provide for a lower charge on the gain that accrued while the asset was indeed a business asset. Therefore, it would be unfair to make other poorer taxpayers pay an extra £200 million in tax to end apportionment for no obvious economic or social benefit.
The hon. Member for Arundel and South Downs suggested that employee shareholdings should remain business assets after retirement. We give employees business asset taper relief on their shareholdings because they align their interests with those of the company and have an incentive to work more productively. We cannot benefit from increased productivity if they have left work. It is neither unfair nor contrary to the aim of business asset taper relief to give it only for the time that the relevant conditions of a business asset taper are satisfied.
It would be unfair to other taxpayers who hold shares that are non-business assets to give relief to ex-employees for periods when the relevant conditions of a business asset taper were not satisfied, simply because those people had satisfied them at some point. Employees who retire would benefit from business asset taper relief on any disposal within 10 years of retirement. It is right that a relief should dwindle the longer they hold the shares as non-employee investments.
The hon. Member for Epsom and Ewell asked whether residential property qualified as a business asset. As I understand it, residential property does not normally qualify and is defined as a non-business asset for taper relief. However, there are exceptions to that general rule. Property that is let to a qualifying company and used for trade can qualify as a business asset. I hope that we are interpreting the issue reasonably.
I shall have to write to the hon. Gentleman on that issue to clear it up for him.
I think that I have clearly set out our rationale on the tax. We want to encourage appropriate and
valuable economic activity. We do not want to distort the market for start-up finance. The regime is simple and appropriate, and will encourage investment in shares and productive activity.
I am grateful to the Economic Secretary for those words. I am delighted to hear that the Inland Revenue will produce some analysis to explain how tapered tax operates and, I hope, what its economic effect is. I eagerly anticipate that.
I also thank the Economic Secretary for agreeing that economic activity was turned off and start-ups were damaged as a result of the original proposals. She said that the purpose of the clause was to address a market failure. The failure would not have been there in the first place had the Government not introduced the original tapered tax regime. If they now say that there is time to change it and put forward an economic rationale, there must have been something wrong with the original proposals. I am grateful to her for confirming that on the record.
Question put and agreed to.
Clause 45 ordered to stand part of the Bill.
Clause 46 ordered to stand part of the Bill.