Clause 50 - Deduction of personal losses from gains treated as accruing to settlors

Finance Bill – in a Public Bill Committee at 5:15 pm on 21st May 2002.

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Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs 5:15 pm, 21st May 2002

I beg to move amendment No. 52, in page 37, line 15, leave out 'has' and insert

'and Schedule (set off of losses treated as accruing to settlors) to this Act have'.

Photo of Roger Gale Roger Gale Vice-Chair, Conservative Party

With this it will be convenient to discuss the following: Amendment No. 53, in schedule 11, page 185, line 22, leave out from beginning to end of line 44 on page 187 and insert—

'(2) After subsection (5) (computation of tax in cases where gains treated as accruing to settlor etc in respect of trust gains) insert—

''(6) Subsections (4) and (5) above shall cease to have effect for the year 2003-04 and subsequent years of assessment.''.'.

New schedule 1—Chargeable gains: set off of losses treated as accruing to settlors—

Introduction

1 The Taxation of Chargeable Gains Act 1992 (c. 12) is amended in accordance with paragraphs 2 to 6.

Section 2

2(1) Section 2 (persons and gains chargeable to capital gains tax, and allowable losses) is amended as follows.

(2) In subsection (2) (computation of capital gains tax), for the word ''and'' at the end of paragraph (a) substitute—

''(aa) any attributed loss accruing to that person, and''.

(3) After that subsection insert—

''(2A) Where on a disposal a loss accrues to trustees of a settlement in circumstances where, had it been a gain that gain would have been attributed to another person by virtue of sections 77 or 86, then that person may elect for that loss to be an attributed loss accruing to that person for the purposes of subsection (2) above for the year of assessment in which the disposal occurs.

(2B) Attributed losses must be deducted first from any gains accruing to a person by virtue of sections 77 and 86 chargeable for the year in question before they may be deducted from any other chargeable gain.''.

Section 77

3 In section 77 (charge on settlor with interest in settlement), in subsection (1) at the end insert ''No deduction of any loss shall be made by the trustees in respect of any disposal which gives rise to a loss which the settlor informs them is to be regarded as an attributed loss for the purposes of section 2(2).''.

Section 86

4 In section 86 (attribution of gains to settlors with interest in non-resident or dual resident settlements), after subsection (1), insert—

''(1A) For the purposes of subsection (1)(e) above no account shall be taken of any disposal which gives rise to a loss which the settlor informs the trustees is to be regarded as an attributed loss for the purposes of section 2(2).''.

Section 86A

5 In section 86A (attribution of gains to settlor in section 10A cases), after subsection (8) insert—

''(8A) For the purposes of this section, no account shall be taken of any disposal which gives rise to a loss which the settlor informs the trustees is to be regarded as an attributed loss for the purpose of section 2(2).''.

Section 87

6 In section 87 (attribution of gains to beneficiaries), before subsection (4) insert—

''(3Z) In making any computations under this section, no account shall be taken of any disposal which gives rise to a loss which the settlor informs the trustees shall be regarded as an attributed loss for the purpose of section 2(2).''.

Commencement

7 This Schedule applies to persons and gains chargeable to capital gains tax and allowable losses in the year 2003-04 and subsequent years of assessment.

Election for Schedule to apply for years earlier than 2003-04

8(1) This Schedule also applies, if the person so elects, in relation to chargeable gains and attributed losses accruing to a person in any of the years of assessment 2000-01, 2001-02 and 2002-03.

(2) An election under this paragraph—

(a) must be made by notice given to an officer of the Board no later than 31st January 2005;

(b) where attributed losses may be regarded as arising in respect of two or more settlements, may be restricted to those regarded as arising in respect of the settlement or settlements specified in the election.

(3) All such adjustments shall be made, whether by way of discharge or repayment of tax, the making of assessments or otherwise, as are required to give effect to an election under this paragraph.

(4) Where—

(a) a person makes an election under this paragraph for any one or more of the years of assessment 2000-01, 2001-02 and 2002-03, and

(b) the effect of the election, or (as the case may be) both or all of them taken together, is to increase the total amount of tax that the person is entitled to recover from the trustees of a particular settlement for those three years under section 78(1)(a) of the Taxation of Chargeable Gains Act 1992 (c. 12) or paragraph 6 of Schedule 5 to that Act,

the trustees of that settlement must join in the election, or (as the case may be) each of them that has that effect or contributes to it.'.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

By way of background, when the rules on settlor trusts were changed, it was the Government's objective to render the settlor liable to the gains of income of such trusts as if they accrued to him directly. The provisions of clause 50 have been generally welcomed, but they raise two questions.

If the clause is to apply to the deduction of losses from gains treated as accruing to persons, why should someone elect for it to apply the other way round, to deem losses to accrue and be deducted from gains realised by him? Given that the Government's main intention was to look through the trust, why does the provision work one way and not the other? Extensive legislation provides that settlors recognise trust gains as their own. As it stands, losses remain with the trustee and are netted off against gains within the trust before they are attributed to the settlor.

The amendment would extend the intended changes to trust taxation, to permit settlors to offset their losses against their direct gains. It would allow the taxpayer to choose between accelerating the benefit of losses in trust by taking the risk of higher taxable gains from the trust in future, and leaving the position as it stands.

The changes that we propose are designed to be compatible with schedule 11, irrespective of whether our amendments to that schedule are accepted.

Amendment No. 53 deals with a different issue, and I hope that the Economic Secretary will tell me that it is not necessary. As we understand it, the clause would also remove taper relief to settlors if they opted for the choice provided in it. We cannot see the logic for doing so when the trust's gains and losses are to be viewed as exactly pari passu, as if the settlor owned them directly.

I apologise for the length of new schedule 1, but we understood from the Bill Office that there was no alternative way to address the issues. It is necessary to achieve the transfer of losses and gains both ways, which requires a complete amendment to schedule 11.

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

I should begin by setting out the background to settlor-interested trust provisions. I shall then explain what the clause does, before dealing with why I believe that the amendment should be rejected.

People set up trusts for many and varied reasons. Some are purely tax-related; others are nothing to do with tax. The tax system respects the fact that there are trusts and that they are separate entities, but we must ensure that people cannot obtain an unfair tax advantage by putting assets into a trust. For that reason, we have long had special rules that charge the person who set up the trust—the settlor—tax in respect of gains realised by the trustees of a trust. The special rules apply when the settlor, or his or her close family, can benefit from the trust. The rules ensure that the right amount of tax is collected. The settlor may claim reimbursement from the trustees for the tax that he or she pays.

In broad terms, the clause restores the rules that applied before the introduction of the Finance Act 1998, so that settlors can set their available capital losses against gains that are attributed to them in that way. I readily admit that doing so will introduce complexity into the rules, because of the interaction with taper relief. It is because of that additional complication that we decided, when introducing taper relief in 1998, that it would be better to have a simple rule so that personal losses could not be offset against such attributed gains. However, we have come to the view that that can produce harsh results in certain cases and that it would be more equitable for people to set their personal losses against the attributed gains.

Amendments Nos. 52 and 53 and new schedule 1 would allow a settlor to obtain the benefit of losses realised by trustees and set them against all their gains. In effect, the amendments would set up a single pool for the gains and losses of a settlor from which they, or members of their close family, would benefit.

For settlors with genuine non-tax reasons for setting up trusts, the amendments would completely undermine the fact that they had transferred their property to them. For those settlors who set up trusts for tax reasons, it would make setting up trusts a one-way bet against the Exchequer. Indeed, those proposals would open up a real risk of tax avoidance, as people could use the election and juggle the timing

of disposals to maximise the deduction of losses against gains. The amendments would cost about £25 million a year without taking into account any behavioural change caused by people exploiting them for the purpose of tax avoidance.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I do not understand the logic of permitting losses in a trust to be offset against personal gains, but not permitting gains in a trust to be offset against personal losses. As the Economic Secretary just said, tax legislation treats the situation as if a trust did not exist. I cannot see the logic of making a change one way but not the other.

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

The trust rules on settlors and interest exist to ensure that the right amount of tax is paid. As I have explained, settlors have the power to claim reimbursement from trustees for any tax that they pay. Allowing settlors to set trust losses against personal gains would mean that a settlor would benefit at the expense of the beneficiaries of a trust. I shall explain that later.

At the moment, trustees' losses are set against their gains. That reduces the sum with which trustees have to reimburse a settlor where a settlor pays tax on an attributed gain, which leaves more for beneficiaries. Under the proposals, the losses would personally benefit a settlor, and more would have to be paid out of that trust's funds to reimburse a settlor for attributed gains, which would leave less money for beneficiaries. That cannot be right. In effect, the amendments would give a settlor the power to benefit from a trust in a way not envisaged by the original deed of settlement.

It will come as no surprise to the Committee that in this very complex area of the tax code, amendments Nos. 52 and 53 and new schedule 1 are not free of errors, some of which would open up new tax-avoidance possibilities. The proposals would, for example, allow untapered losses to be set off against amounts attributed in respect of tapered gains. It is quite unfair to obtain such an advantage just by involving a trust in the process. The amendments and new schedule are wrong in principle, would have a significant cost and would give rise to tax avoidance, and I therefore ask the Committee to reject them.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

Will the Economic Secretary explain a point raised again by amendment No. 53? My understanding of clause 50 is that the quid pro quo of personal losses being offset against trust gains is the loss of taper relief on trust gains. What is the logic for that?

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

I hope that I can reassure the hon. Gentleman on that particular point. I am advised that taper relief will not be lost under the clause. Trustees will not apply taper relief because the settlor will get it.

Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs

I thank the Economic Secretary for that answer, which concerns an unfairness that has not been addressed. Although I appreciate the issue about the position of the settlor versus that of the beneficiary, the logic of having the offset one way and not the other is strange, but it is not a huge issue. The Government considered the situation that resulted in clause 50 and

I now request them to consider it the other way, because I cannot believe that they intended their reforms to produce a situation that is worse than if the assets were owned directly by the settlor.

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 50 ordered to stand part of the Bill.

Schedule 11 agreed to.

Clauses 51 and 117 ordered to stand part of the Bill.