Schedule 12 - Tax relief for expenditure on research and development

Finance Bill – in a Public Bill Committee at 5:45 pm on 21st May 2002.

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Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs 5:45 pm, 21st May 2002

I beg to move amendment No. 25, in page 189, line 9, after 'enterprise', insert—

'or a small or medium-sized enterprise which makes an election pursuant to paragraph 16A below'.

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

With this it will be convenient to consider amendment No. 26, in page 194, line 35, at end insert—

'Regulatory simplification

16A. (1) In respect of any financial year any small or medium-sized enterprise may elect to forego the reliefs available to it under Schedule 20 to the Finance Act 2000 (tax relief for expenditure on research and development) and instead claim relief under this Schedule as if it were a large enterprise.

(2) Any election pursuant to this paragraph must be made in writing to the Inspector of Taxes prior to the end of the financial year in question.'.

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

The two amendments are straightforward and echo the brief remarks that I made at the beginning of the stand part debate on clause 50. It is entirely understood and correct that the reliefs available to SMEs are more favourable than those offered to large enterprises. However, comments that we have received from industry leaders lead us to believe that some of the conditions attached to the reliefs for small companies could be onerous and it might be simpler for small companies to claim a less restricted, albeit less generous, relief under this new measure. It would also, obviously, for those who chose to do that, render the transition from small to large much simpler. Both the IOD and the CIOT have suggested that it would be sensible to move to a simple, volume-based system in general.

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

The issues are complex and inter-related. As is my custom, I am perfectly prepared to allow a wide-ranging debate on the understanding that we do not then have a schedule stand part debate at the end. Insofar as Members find it convenient to discuss broader issues I am perfectly happy for that to happen.

Photo of Edward Davey Edward Davey Shadow Chief Secretary to the Treasury, Shadow Minister (Olympics and London), Liberal Democrat Spokesperson (Olympics and London), Liberal Democrat Spokesperson (Chief Secretary to the Treasury)

The principle behind the amendment needs applauding. If the Minister is not going to accept it, I hope that she can explain how she envisages companies growing and developing from one tax credit to the next.

The Minister was gracious to the Committee in the previous debate and explained the background and how the credits would work. That was a helpful reminder but I am still not clear whether, if a company grows over the period of the R and D investment and moves from one definition to the next, it will suffer penalties. How will the transition in its growth be managed within the tax system? That is an important issue. We should be grateful to the hon. Member for Arundel and South Downs for tabling the amendment because, if the R and D is successful, the company will grow. The Minister might argue that if the company is successful, the tax credit should be capped because the earnings that result from its growth will mean that it no longer needs the subsidy.

Investors will be putting in risk capital and expecting a certain return. Has the Minister analysed the relation between the two credits? Will she be able to reassure investors that their expected returns will not suddenly diminish because of the complex interrelations in the system?

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury) 6:00 pm, 21st May 2002

I am not attracted to amendments Nos. 25 and 26. In fact, they represent real danger for small and medium-sized companies with regard to the entitlement to the 50 per cent. addition. If there were an opt-out, they could come under pressure, because the 50 per cent. is given in return for what they undertake themselves. Subcontractors may be attached to a larger company, which will be entitled to the larger company benefits.

The hon. Member for Kingston and Surbiton referred to what happens when companies grow. The amendments would allow a small or medium-sized company to opt out of the tax credit for those sizes of company and be treated as a large company instead. It is far from clear why a company would want to opt out of receiving 50 per cent. in favour of receiving 25 per cent.

Under our proposals, a small or medium-sized company will be able to claim the existing credit for a company of that size on its own R and D and an extra deduction of 50 per cent., rather than the 25 per cent. that will go to the larger companies. There will be a possibility of a cash payment if the venture is loss making. If the company opts out, it will lose the cash payment option and its tax credit is reduced from 50 to 25 per cent. In addition, a small and medium-sized company, having protected its position vis-a-vis the 50 per cent., may still be able to claim the large company credit for expenditure on work financed by someone else—for example, subsidised work or work by a subcontractor for a large company.

The proposed new paragraph in schedule 12 is headed ''Regulatory simplification,'' but it is hard to see what the simplification is or what other benefits it would allow. It would add to the length of the Bill,

create new uncertainty over the status of the small and medium-sized company and could cause serious problems. Hon. Members may find it easy to imagine a contract being drawn up between a large company that wants access to a tax credit and a smaller company that would receive a tax credit at a greater rate, that would benefit to a greater extent and that might come under pressure for contract reasons to opt out of the better entitlement. Therefore, I am not at all attracted to the amendment.

The hon. Member for Kingston and Surbiton suggested that the Bill would make the rules for small and medium-sized businesses too complex. He asked how a business would move from one category to another and suggested that it would be simpler to allow them to choose. The Government and officials at the Inland Revenue and the Department of Trade and Industry have put a huge amount of effort into discussing with small and large companies how to make the rules as simple as possible, while allowing benefits to flow from that.

Photo of Michael Jack Michael Jack Conservative, Fylde

I am following the Paymaster General's argument carefully. Will she say what would happen if a large company took over an SME, whose R and D activity it found to be especially attractive, thereby giving the smaller company the enhanced credit that she mentioned a moment ago? Would the status quo of the smaller company remain, although it had become a wholly owned subsidiary of the larger company?

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

Perhaps I can answer that question in a slightly different way. It is not always possible to provide in legislation for such changes of status, and some discussion with the Inland Revenue will still be necessary. Of course, we hope that SMEs will grow into larger companies, and we want to encourage that. However, we should recognise that they will go through a transition. The effects of that transition will be eased by the definition of ''small or medium-sized enterprise'', which will allow a small company to continue qualifying as such in the year after it ceases to meet the criteria. None the less, at the end of the transition period, the company may fall within the definitions of ''large company'' and therefore fall within the tax credit regulations. We recognise that SMEs will be under a different pressure.

We have tried to keep the scheme as simple as possible but it must be able to operate. The precise definitions of ''R and D'' and how they will work in practice following the DTI guidelines are still being discussed with the CBI and other trade and accountancy bodies, as was referred to on the Floor of the House. The detail of many of those issues will need to be set out, but the essential point is to recognise that SMEs operate under different conditions and, therefore, if they are to be able to undertake R and D, will attract slightly different rules from large companies. The two sets of rules must co-exist as simply as possible to deal with the transition across boundaries. That is what the Government have tried to achieve, and that is why the consultation exercise opted for a volume-based rather than an incremental

scheme. The points that hon. Members are making about complexity would be writ large if we had an incremental scheme.

Both the Chartered Institute of Taxation and the Law Society of England and Wales are of the view that the way in which the credit will operate will provide for a clear system in terms of how companies claim. Until we see that in operation, I cannot say that all of the matters are settled and dealt with. However, we believe that companies and professional bodies should continue discussing with us the finer qualities of the provisions.

I return to a point made by the hon. Member for Kingston and Surbiton. This debate is not the final word on how the provision will operate or on how we should review it and make sure that it improves. Nor it is the final word on Government policy in continuing to encourage research and development, growth and productivity because of their clear benefits to the British economy in terms of jobs and skill levels.

I hope that Opposition Members realise that an opt-out for small and medium-sized companies would be bad, because they could come under pressure to give up what clearly are good benefits. We want the two credits to interact with a sufficiently light touch to ensure that SMEs do not find themselves squeezed, or having to operate under unreasonably complex rules. That is certainly what everybody is saying to us. Frankly, if it is good enough after all the consultation, we should give the legislation the opportunity to work before adding complexities to provide for things such as opt-outs.

I ask the hon. Member for Arundel and South Downs to wait and see how the tax credit operates. If people still have problems, I am sure that the Opposition will come back next year, if the Government do not, with suitable amendments. I ask the hon. Gentleman to withdraw the amendment.

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

The thinking behind the amendments was, first and self-evidently, that if an SME was nearly up to the limit, rather than getting caught with the problems caused by having one set of rules one year and another set the next, it might be more simple for them to go straight to the large company rules. The Minister has allayed that fear to some extent by saying that there will be a year's grace.

Another thought behind the amendments was that, as we were advised, some of the conditions attaching to the more generous SME reliefs are pretty onerous and demanding, and that that might act as a disincentive to SMEs to take them up. The Minister has not said anything specific about consultation with SMEs, but one of the attractions of the large company reliefs is that they are drafted in a simple and straightforward fashion, whereas existing reliefs for SMEs are quite complex. If an SME was not sure whether it would meet the requirements of the more generous provisions, but was sure that it would certainly meet the wider requirements, it might want to take them up.

The amendments are in essence probing amendments. As the Minister accepts, there is more work to be done in this area. However, I would like to hear a little more from her on whether the conditions attaching to existing SME reliefs are demanding and have therefore resulted in their underuse.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury) 6:15 pm, 21st May 2002

We have received no representations that the rules are too complex—quite the reverse. The SME tax credit is more generous and has a lighter touch than the large company tax credit. It should precisely recognise the slightly different circumstances of SMEs. I cannot understand the hon. Gentleman's logic. He says that the provision is too complex, so it should be made less complex by adding highly complex rules under which a company could give away all the extra benefits—Lord knows why it would want to—and pretend that it is a large company. A large company would be given less than a small or medium-sized company. Small and medium-sized companies that become large companies are protected in the transition, which is appropriate, given the planning.

The hon. Gentleman needs to understand that SME tax credit for R and D was provided for in the Finance Act 2000. There has not been a stampede to the Treasury's door from SMEs saying that they want the scheme for large companies instead, because it is less generous.

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

The Paymaster General has not answered the key question that lay behind the input that we perceived, which is about how much take-up there has been from provisions of the 2000 Act. We have been advised that many SMEs have found the arrangements too complex to bother with. The crude thinking was that, on the basis of the large company schemes being much simpler although not as good, it would be better for SMEs to take them up. Have the 2000 Act provisions been taken up?

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

My understanding is that they have, but I do not have the figures on take-up to hand. The hon. Gentleman will understand that investments in R and D require a long planning period before the tax credit comes in.

I find it incredible that the hon. Gentleman is asking me to believe that plenty of criticism has poured to him so that he can make his point in Committee, but not to the Government, who could have amended the legislation and ensured that there was no problem. The subject has not been reported to us as a problem by SMEs.

We have invested a great deal of time and taxpayers' money in the R and D credit. The policy is important to the Government, and I can assure the hon. Gentleman that if it was not working as well as it should and required amendment, we would take those considerations on board and do our best to amend it. The Inland Revenue is full of talented and able people, but mind readers they are not. Given that no one has pointed out why the scheme should be changed, it is

difficult for me to engage with the hon. Gentleman in a theoretical discussion on a complexity about which no one is complaining.

Indeed, the reverse is true: the scheme has been widely welcomed and is being used. People have had nearly two years to comment on it, and complaints are not coming through. If they do, I shall ensure that they are looked at, because I want the policy to be a success.

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

I am very glad to hear the Paymaster General's comments. She will find that the take-up has been extremely disappointing, and that there is something in the issue of complexity. However, I do not want to bang on about the matter. If my claim is substantiated, I am glad to hear that the Government will want to consider simplification. The amendments simply sought to offer a short cut to simplification, but the matter has had a valuable airing. They were probing amendments, and one or two interesting facts have come out of the discussion. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

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

I beg to move amendment No. 54, in page 189, line 24, at end insert—

'3A. A company's ''qualifying R and D expenditure'' shall not include any amount in respect of which, under the law of any territory outside the United Kingdom, the company is entitled to a deduction for the purposes of any foreign tax which exceeds the amount of such expenditure.'.

I had understood, when the main reliefs were announced, that they would relate only to R and D undertaken in the UK and there was an issue about the relative attractions of Canada and other such places. I was interested to hear the Paymaster General say that that was how the measures had been cast. As far as our adviser and I can see, clause 52 contains no restriction that any expenditure benefiting from enhanced tax relief should be incurred in the UK. Conceptually at least, the relief could be used to allow foreign groups to obtain additional tax relief for R and D expenditure routed through UK companies. The UK Exchequer could suffer without any additional R and D being carried out here.

The Paymaster General referred to the scope of the relief to R and D carried out in the UK being limited by European Union law. The amendment seeks both to limit the scope of any potential abuse by ensuring that no relief is given where another territory is giving a super-deduction for the same expenditure under its tax laws and to make it clear that double dipping is prohibited.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

I thank the hon. Member for Arundel and South Downs for his assistance in scrutinising the legislation to ensure both that companies do not use it in a way in which it is not supposed to be used and that expenditure is directed precisely to enrich the research and development capability in the UK.

The hon. Gentleman specifically raised the problem of tax incentives in other countries and how foreign multinationals that are not based here would operate. We raised that issue in last year's consultation. If a company is able to claim a tax incentive in another

country, why should we give another credit in the UK? However, we decided that such a restriction was not justified, and the problem that he has identified would not exist. Our new credit focuses on direct R and D costs—staff costs and consumable stores—of a company within the charge to UK tax, and the bulk of such costs would not be eligible for any foreign tax incentive. We are not giving credit, in general, for the costs of subcontracted work, including work subcontracted to a foreign business. That is another crucial difference between the tax credit for small and medium-sized companies, which would probably not have the ability to subcontract work to a foreign business, and the tax credit for large companies. Very little expenditure will actually qualify for an incentive in more than one country.

If we were to introduce a restriction, it could cause some multinational groups to locate outside the UK research and development activity that might otherwise have been conducted here, which is not the result that we want. The amendment is unnecessary in any case, because foreign R and D relief would almost certainly be cancelled through the operation of double taxation relief. Foreign tax relief will reduce the amount of double tax credit given against UK tax, allowing the UK Exchequer to benefit from foreign R and D credit. A company's overall tax liability will be reduced only by the UK tax credit, and not by a foreign tax credit as well. To go further than that and deny the UK tax credit would just be punitive and unnecessary.

Others have scrutinised that point, and the detailed views that we received in the consultation argued against such a restriction, which would inadvertently work against R and D. As well as large companies, a number of well-respected representative bodies, including the Chartered Institute of Taxation, the Institute of Chartered Accountants in England and Wales and the Law Society, criticised the idea. For those reasons, and after careful consideration of the design, the Government are satisfied that we can prevent such a restriction. However, if it turned out that something untoward was going on, and there was what we politely call ''tax leakage'', we would deal with it. We are trying to strike a balance throughout the Bill between protecting the Exchequer and recognising the commercial reality of the how companies operate.

Photo of Mr Iain Luke Mr Iain Luke Labour, Dundee East

The hon. Member for Arundel and South Downs made a valid point. I know from being involved in the all-party group on tyres, and from comments from the Chartered Institute of Taxation, that the tyre industry is wholly owned by companies outwith the UK, which is unfortunate given the UK's pioneering role. Given the complications of decisions on tax credits, the only thing that will save the industry is R and D credit. It will allow the industry to invest in high-quality techniques, which would beat off competition from the far east. The hon. Gentleman's points were pertinent. Will the Paymaster General bear in mind the tax credit issues that relate to the tyre industry?

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

Certainly. My hon. Friend raises an important point about how the tax credit operates. It will encourage research and development in the United Kingdom, particularly in industries that large multinational companies may be financing from outside the UK. My hon. Friend's example was of the tyre industry being financed from outside the UK when its R and D occurred here. Such an industry would qualify for tax credit.

The hon. Member for Arundel and South Downs made a slightly different point. He wanted to ensure that companies did not get double credit—from the United States and from the United Kingdom—for the same R and D. My response was that the operation of tax treaties, and the rules for calculating tax, would ensure that that did not happen. A multinational that accessed R and D tax credit in another part of the world could not access R and D tax credit in the UK—even if it tried to get it for different R and D—because that would make for complicated rules on distinguishing where research happened. We want our tax treaties and tax system to operate normally by ensuring that there is no double relief. I hope that I have reassured the hon. Gentleman that we are quietly confident that our rules will prevent behaviour that could cost the Exchequer money.

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

I am pleased to hear the Paymaster General's response, for which I thank her. The fundamental objective is to ensure that R and D happens here. I understood from discussions with CBI representatives last autumn that we are in a competitive game, particularly with Canada where there are attractive incentives—hence the argument in favour of the provision. The double dip is a secondary point. It strikes me that the schedule has been cleverly crafted, particularly within EU constraints, so that the net effect is that virtually all R and D takes place here. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Photo of Michael Jack Michael Jack Conservative, Fylde

I beg to move amendment No. 77, in page 189, line 30, after 'incurred', insert ', whether directly or indirectly'.

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

With this it will be convenient to take the following amendments: No. 78, in page 189, line 32, after 'stores', insert ', or

(c) on accommodation.'.

No. 79, in page 189, line 32, at end insert

', or

(c) on applicable direct overheads, such amount to be calculated on a just and reasonable basis.'.

Photo of Michael Jack Michael Jack Conservative, Fylde 6:30 pm, 21st May 2002

Amendments Nos. 77 and 79 are conveniently linked because they deal with aspects of staffing costs relating to the research and development tax credit. Amendment No. 78 deals with matters concerning accommodation. I would like to proceed carefully through this small series of amendments because their implications are quite technical.

Amendment No. 77 deals with the fact that many large companies and groups outsource certain expenditure. Indeed, many groups have a service company through which all their staff are employed, and where the costs are recharged to the relevant individual companies. As the Paymaster General will know, in terms of the R and D tax credit, matters connected with staffing costs that are allowable are provided for by paragraph 17(b) of the schedule, which states when read in conjunction with the first part of the paragraph that the provisions of paragraph 5 of schedule 20 to the Finance Act 2000 apply for the purposes of schedule 12 as they do for schedule 20. The definition of staffing costs of a company provided for by paragraph 5 of schedule 20 to the Finance Act 2000 is the one relevant to amendments Nos. 77 and 79.

As for amendment No. 77, the proposed legislation does not accommodate the fact that outsourcing costs or group recharges would qualify for relief even when expenditure relates to staffing costs, as the payroll is not undertaken by the company carrying out the research and development. I understand from those in the accountancy profession that that is likely to be a significant issue for large companies and groups. In their judgment, it does not seem to be in the spirit of the legislation, which is what the Paymaster General outlined in her earlier remarks: to encourage research and development in the United Kingdom. The amendment would ensure that relief would be given for outsourcing costs and intra-group recharges, where such expenditure would otherwise fall in paragraph 4(3).

Amendment No. 79 uses as its base the same analysis of the staffing costs, so I will not repeat that. Again, we have a situation in which many large companies calculate a fixed-cost rate when they apply to relevant projects being undertaken in order to provide suitable costing information for management accounting purposes. The cost rate typically includes employee costs and a measure of overhead, and I am sure that the Paymaster General will immediately appreciate that that is an important accounting point.

In order to comply with the proposed legislation, apart from determining which projects are qualifying research and development, many large companies will have to deconstruct the project cost rate to separate out the pure employment costs—hence the point I was making about the definition of allowable employment costs in the provision. To determine the qualifying staffing costs on that strict basis, as referred to in the previous amendment—paragraph 5 of schedule 20 to the Finance Act 2000—many companies will have to set up completely new systems of recording time and costings.

Although the basis of schedule 20 may be relatively simple to operate for SMEs with a small number of R and D staff, it is not appropriate for large companies that have several thousand employees engaged in research and development. Again, it is felt that that does not accord with the Government's objective of encouraging R and D in the United Kingdom. Therefore, the proposed solution as exemplified in the amendment is that qualifying expenditure for research

and development should include not only the staffing costs of those employees engaged in research and development but an appropriate element of direct overhead. It is felt that that would help large companies to continue with their current operating cost management systems and make it easier to apply and reduce compliance costs. That is complicit with what the Paymaster General said was the objection of the large companies.

I turn to amendment No. 78. Under the Finance Bill provisions, we are aware of what qualifies in terms of relief for R and D. However, the definition of qualifying expenditure does not include accommodation costs. Where a lease is entered into for the purposes of providing relevant accommodation for R and D, tax relief will be available only on 100 per cent. of the rental payments, rather than 125 per cent. of the new provisions. Given, for example, the unique conditions, such as sterile environments, that might be required for research and development in the electronics or aerospace industry, it is felt that it is inconsistent not to allow research and development relief for relevant accommodation costs. The proposal for that, therefore, is that qualifying expenditure for R and D should include not only the staffing costs, to which I referred in previous amendments, but the relevant accommodation costs.

Photo of Mark Hoban Mark Hoban Conservative, Fareham

I congratulate my right hon. Friend the Member for Fylde on the way in which he has introduced the series of amendments. He has picked up some important issues about what forms a cost base for R and D activity, and he has highlighted the Bill's narrow definition of the type of costs that will gain, in the words of the Paymaster General, super-plus relief.

We have to recognise that a lot of R and D takes place in very expensive premises. People who travel up the M1 regularly will have seen the research centre of GlaxoSmithKline in Hertfordshire. That is an obvious and powerful embodiment of the issue of whether we give the extra, enhanced relief to office costs and the costs of property that large companies incur when they engage in significant amounts of R and D. If we are to encourage and stimulate research and development in the United Kingdom, we must ensure that a broad base of costs is taken into account. I shall be intrigued—if the Paymaster General has the information—to know what representations have been received from pharmaceutical and electronics companies about the structure of costs that they incur. My concern is that if we give relief on a relatively small part of their cost base, it will not trigger the increase in R and D expenditure that we hope would arise from the introduction of this relief for large companies.

I support the amendments proposed by my right hon. Friend. He has raised some valid points that strike to the core of whether the relief will be attractive and will stimulate the growth in R and D expenditure that the Paymaster General hopes for.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

Unfortunately, I have to tell the right hon. Member for Fylde that I do not think that his amendments will be helpful. If it came to a vote, I

would have to ask my hon. Friends to vote against them. I hope that I shall be able to explain why. The hon. Member for Fareham (Mr. Hoban) touched on what industry might say to us. It would be inappropriate for me to name companies. However, to date with regard to, for instance, outsourcing IT, staffing or accommodation costs, we have received only one representation from one company. We are discussing that with that company, which is not in pharmaceuticals.

The response so far from all the companies involved, given that the matter has been in consultation for so long, has been very positive. Of course we accept, as do the companies, that it is difficult to draw lines, particularly in relation to staff costs where staff are involved in R and D to varying extents. However, the R and D guidelines on this issue attempt to make a reasonable distinction. In developing those guidelines we have been, and continue to be, in detailed discussions on the operation of the new tax credits with the very industries to which Opposition Members refer.

The amendments are designed to include as qualifying expenditure for large companies—interestingly enough, no equivalent measure is proposed for SMEs—''indirect expenditure'' and two new items of expenditure besides staffing costs and consumables, namely accommodation costs and overheads.

The inclusion of indirect costs by amendment No. 77 could give the principal credit for some element of subcontracted expenditure, which could effectively mean that a double credit would be awarded. The international situation, where a company could receive a credit from more than one country, which we were discussing in a previous debate, could occur here in the UK through the operation of those rules. The companies would receive a double credit, as the design of the large company scheme assumes that credit goes to the person carrying out the work. The amendment might not work, as paragraph 4(2) already requires a company to carry out R and D directly.

Including the amendment would mean that the Government might pay twice for the same research and development, perhaps raising our costs by as much as £100 million, which does not seem sensible. In addition, it would require complex rules to define the term ''indirect''. By widening the scope of the R and D tax credit, amendments Nos. 78 and 79 would also increase the cost. If the credit is to achieve its aims, it needs to remain focused. The more things that qualify, the lower the rate we can afford and the less the impact of giving that boost to R and D. That has to be part of the equation and of the balance in the Government's consideration of how much can be afforded and where that can be directed to greatest effect.

The amendments would add complexity. Companies would have to track a wider range of costs, for example making more apportionments for shared costs such as electricity.

Photo of Mark Hoban Mark Hoban Conservative, Fareham

The Paymaster General needs to reflect on the fact that many such costs are calculated and apportioned by companies anyway. Their own costing

systems for R and D for manufacturing will allocate costs among various activities. I am not sure that complying with the terms of the amendments moved by my right hon. Friend the Member for Fylde would require businesses to do much more than they do at the moment. There is a greater risk that they would have to deconstruct their existing cost bases to ensure that they comply with the schedule as drafted.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury) 6:45 pm, 21st May 2002

I want to come to the point about deconstruction because the hon. Gentleman is making that point with regard to one company only, as far as we know. It is a large and important company, but to make room for the difficulties of one company by making the rules for all companies complex is not a sensible approach and would risk adding distortions and increasing costs. For example, some companies would be able to claim a credit for a proportion of their rent but not for a proportion of the cost of a new building. That is clearly not right, especially given what the hon. Member for Fareham said about competing and contributory costs.

If R and D is outsourced, the company that carries out the work will qualify, so if we were to allow the principal contractor also to qualify, two payments would be made. That takes us back to the point that I was making about double credit and back to our discussion on a previous amendment about the pressure from large companies to make smaller companies opt out of their 50 per cent. to gain access to 25 per cent. Then there is the subcontracting issue, which is dealt with by virtue of the fact that the SMEs get access to the R and D work.

Work may be outsourced to a company resident in another country. It would be out of the question to allow that because it would be inconsistent with the focus of the tax credit on R and D undertaken in the United Kingdom. As I have said, it would be inappropriate for me to name the company that has recently raised several issues relating to deconstructing costs, the ratio of subcontracting and the huge importance of IT in research and development. At least one large company that has spoken to us will experience some difficulties because of the substantial contracting out of those costs.

I can tell the right hon. Member for Fylde that, although I am not attracted to amending the Bill to make room for one company, because it will make the provisions more complex for others, none the less some important issues are being discussed further with that company to try to ensure that the rules do not inadvertently exclude it from receiving R and D money to which it would have been entitled. Hon. Members must keep it firmly in their minds that the purpose of the tax credits for small and large companies is to recognise that there might be subcontracting, but to bring that R and D to the UK, so that we get the benefit. There would be no point in us funding, through a subcontracted chain, subcontractors outside the UK, because we would not get the benefit

of the R and D. The principal company will have to consider that, but in asking hon. Members to reject the amendment, I can tell the right hon. Member for Fylde that issues surrounding IT outsourcing and staff costs have been drawn to my attention by a particular company, and we will do our best to address those issues without compromising the underlying principles of the tax credits. I hope that, on that basis and having aired his points, the right hon. Gentleman will feel able to withdraw the amendment, at least for now. If he is not satisfied, I am sure that he will return to the issue in future.

Photo of Michael Jack Michael Jack Conservative, Fylde

I am most grateful for the way in which the Paymaster General dealt with the issue of tax credits. I am in the fortunate position of not knowing to which company she was referring, because those in the accounting profession who raised the matter with me also did not name it. In a way, I am delighted not to know, because she has implied that in relation to the IT outsourcing there may be wider issues.

Returning to the Paymaster General's wider comments, we shall have to see how we go, as we are in uncharted territories. I should say at the outset that it would be foolish to proceed to press to a Division amendments that would act in the context of untested legislation and might not deliver what was required. However, much of what the Paymaster General is saying could form the basis of future discussion. Perhaps in due course some guidance, a practice note or an appropriate publication could be produced to assist people in understanding the area covered by the amendments.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

I am grateful to the right hon. Member for Fylde for giving way immediately. I can assure him that we intend to produce guidance or practice notes, and that the discussions on that subject are taking place. Guidance would ensure that companies could navigate the more difficult points, be clear about their entitlement and receive it.

Photo of Michael Jack Michael Jack Conservative, Fylde

I am most grateful to the Paymaster General. I do not want to detain the Committee with having more forensic examinations and pursuing the cost aspects, but there are some complex matters in the part of the Finance Act 2000 from which I quoted. For example, some may find complex the issue of what percentage of a person's time counts towards R and D and ask whether a smaller percentage does not count towards it.

Amendment No. 78 deals with accommodation costs. I do not want to put words into the Paymaster General's mouth, but it seemed implicit that the subject might be reconsidered. The Government would surely not want to make it unnecessarily difficult for specialist facilities required for R and D to benefit from the provisions of the credit. I know from my constituency experience with BAE Systems that the company has had to construct a specialised facility to design the stealth characteristics of modern fighter aircraft. I would hate to think that the financing of such a facility could not benefit from credit relief because of a small technicality.

I take comfort from the way in which the Paymaster General responded, and look forward to reading the clarifying material. As she says, we may want to return to the matter when we all have more experience under our belts. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

I beg to move amendment No. 61, in page 192, line 24, leave out 'any' and insert 'that'.

The amendment corrects a deficiency in paragraph 11. As with the credit for small and medium-sized companies, our aim for the large company measure is to keep the concept of R and D in step with accounting definitions. Accounting principles allow a company in some circumstances not to reflect R and D expenditure in the profit-and-loss account but to defer it to a future year when it may be matched by some income from the activity. In line with that, we wanted to give the R and D tax credit when expenditure appears in the profit-and-loss account, but the Bill as drafted produced the opposite effect by using the word ''any'' in paragraph 11(2). I know that the Committee will accept the amendment as I have explained and apologised for the drafting error.

Amendment agreed to.

Photo of Michael Jack Michael Jack Conservative, Fylde

I beg to move amendment No. 80, in page 194, line 44, at end insert—

'17A (1) Paragraph 5(1) of Schedule 20 to the Finance Act 2000 shall be amended as follows.

(2) In paragraph (a) delete ''other than'' and insert ''including''.

(3) In paragraph (b) after ''company'' insert ''together with any Class 1A national insurance contributions paid by the company''.'.

The amendment again goes to the minutiae of the measure, but it is on an interesting detail. As I understand the proposals, when an employee takes a cash option instead of a company car, the cash option will qualify for R and D relief. However, the provision of a company car as a benefit in kind will not. The amendment addresses that issue, which is undoubtedly important to those to whom the company car matters.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury)

The amendment broadens the cost base of the credit and reduces the rate of the relief, which can be ill afforded in such a targeted measure. It would be distortive, because although we give R and D tax credits on current expenditure, the credit for benefits in kind and class 1A national insurance would not all be for current expenditure. The design of the scheme tries to avoid the complexity and distortion that are created by focusing on simple staff costs and consumable stores, which are the main extra costs of R and D. The scheme tries to stay clear of complex apportionments.

I believe that the right hon. Gentleman's amendment would give us much more complexity for no increase in R and D expenditure, so I ask my hon. Friends to reject it if it is put to the vote.

Photo of Michael Jack Michael Jack Conservative, Fylde

My amendment was very much a probing one, and in a way I felt that it was slightly mean to table it in the light of the bigger picture that the Paymaster General outlined. None the less, it is important to have heard the Government's view on the subject. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 12, as amended, agreed to.

Further consideration adjourned.—[Mr. Sutcliffe.]

Adjourned accordingly at three minutes to Seven o'clock till Thursday 23 May at half-past Nine o'clock.