Clause 47 - Use of trading losses against chargeable gains

Finance Bill – in a Public Bill Committee at 4:30 pm on 21st May 2002.

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Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs 4:30 pm, 21st May 2002

I beg to move amendment No. 12, in page 32, line 19, leave out from 'relief)' to end of line 21 and insert—

'for ''disregarding section 3(1) of the Taxation of Chargeable Gains Act 1992 and the effect of this section'' substitute ''disregarding the effect of this section and either section 2A (taper relief) or section 3(1) (annual exempt amount) of the Taxation of Chargeable Gains Act 1992 as the person elects for the year of assessment in question.''.'.

The clause is intended to allow individuals to benefit from both taper relief and trading losses in the same year. The points that I shall make may be slightly convoluted.

As we understand the clause, the choice that will be presented to people for the early-stage operations of disposing of business assets could, unintentionally, be unattractive. Under section 2 of the Taxation of Chargeable Gains Act 1992, taper relief is given to reduce capital gains on business assets. It works to reduce taxable gains through a taper that depends on the length of the ownership of the business asset. It is available if the total chargeable gains for the year exceed current-year and brought-forward capital losses and the taper is applied to the net gain after deducting those capital losses. Section 72 of the Finance Act 1991 allows individuals to set trading losses against capital gains by treating the maximum amount of loss as a capital loss. The maximum amount is currently the net capital gain after taper relief but before the annual exemption. It should be noted that

as section 72 of the 1991 Act treats a trading loss as a capital loss, taper relief is applied to the net gain after setting off the trading loss.

The interaction of the two measures seems to mean that an individual could have trading losses in excess of their gross capital gains but, because of the way in which the taper works, could not reduce their capital gains to nil. The Bill increases the maximum amount of trading loss that can be set against the capital gain to the gross gain before taper relief. That in turn allows individuals with trading losses in excess of their capital gains to reduce the gains to nil. It also means that the benefit of taper relief is lost. That could penalise sole traders who need to realise funds by selling a business asset and use the cash raised to turn the unprofitable business around. The tax saved by each £10,000 of trading loss used in this way is £1,000 for assets held for more than two years, but £4,000 of tax could be saved if the loss were used against trading income.

The amendment would give taxpayers the option to elect to lose either taper relief or the annual allowance. That may sound an odd idea, but it might force the Government to explain why taxpayers must lose both. Although it would be relevant only in specific circumstances, the provision is a stealth tax nasty, although I believe that it was intended to be helpful. The Institute of Directors and the Chartered Institute of Taxation have also noted the anomaly.

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

We have accepted that, under existing rules, the determination of the amount of trading losses that can be deducted from a gain is not as generous as it should be. The maximum amount is restricted to an amount equal to the gain that would be chargeable to tax after taking taper relief into account. The purpose of the provision is to correct that anomaly. It introduces a modest change that will increase the amount of trading losses that can be set against capital gains. As a result, trading losses can be deducted from a gain if they do not in total exceed it. We have been encouraged to make the change by representative groups and we would, rightly, be criticised if we allowed the anomaly to be perpetuated.

Amendment No. 12 would introduce a change that was neither simple nor appropriate. It would allow a person to elect that trading losses be set against gains up to an amount equal to their total gains before the annual exempt amount was deducted. If such an election were made, the amount of the losses set off would be restricted to the total gains after taper relief had been applied, thus negating the effect of the clause.

The amendment would also provide taxpayers with the choice of making an alternative election: to set trading losses against gains up to an amount equal to the total gains before they are tapered. If such an election were made, the total amount of losses set off would be restricted to the total gains after the annual exempt amount had been deducted. The purpose of that alternative election is to allow a claimant to elect that their trading losses be used to reduce gains only to the level of the annual exempt amount and not, as now, to nil.

We believe that it is right in principle that the amount of trading losses capable of being set against gains is not restricted by reference to the tapered gain or to the gain after the annual exempt amount has been deducted. Allowing trading losses to reduce capital gains down to the level of the annual exempt amount would also be inconsistent with the treatment of capital losses that arise in the same year as chargeable gains. The rule is that such losses are set off against gains to arrive at a net figure, without taking the annual exempt amount into account. The general principle that the amount of losses that can be deducted is not restricted by allowances applies equally to the taxation of income. Reliefs for trading losses, management expenses and so on are given by way of deduction from total income. There is no case for making an exception for setting off trading losses against capital gains.

Amendment No. 12 would have a further effect: most, if not all, claimants would have to make an election to ensure that they did not lose out as a result of the anomaly in the current rules. Therefore, the amendment would not be a simplification; instead, it would add significant complexity to the system.The elective element in clause 47 is merely transitional. If the new method of deduction is of benefit to people incurring trading losses in the tax years 2002-03 or 2003-04, they may elect for it to apply. However, from the tax year 2004-05 onwards, the new rules will apply to all relevant claims. Clause 47 makes the rules for trading loss relief operate in a simpler and fairer way.

Photo of Michael Jack Michael Jack Conservative, Fylde 4:45 pm, 21st May 2002

I ask this out of a genuine wish for information. The Economic Secretary is arguing that the proposal in the substantive clause should be accepted instead of the amendment of my hon. Friend the Member for Arundel and South Downs. Are the carry-forward provisions for unused trading losses and capital losses in the substantive clause or in the amendment?

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

Obviously, I have been discussing the general clause, because it is necessary to understand it in order to understand the complexity that would be introduced by the proposal of the hon. Member for Arundel and South Downs. However, the substance is clearly in the clause rather than the amendment. Amendment No. 12 would complicate the process and run counter to the way in which relief is given for losses in other contexts. Therefore, I urge the Committee not to accept the amendment.

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

I do not think that the Economic Secretary has answered the pertinent question raised by my right hon. Friend the Member for Fylde (Mr. Jack). To try to explain the matter in simple language, clause 47 corrects one anomaly but creates another one. In essence, a sole trading business in need of cash may be forced to surrender valuable tax losses for the future in order to save on the capital gains tax in the year in question. The Government are not happy with our amendment. Although the issue is specific, I cannot believe that the clause accords with

Government policy, which is supposed to be about endeavouring to help small new businesses. The Chartered Institute of Taxation suggested that the implementation of the rule in clause 47 might be put back a year or two and that the treatment should be available by election, so that the individual can choose to sit on a small loss instead of obtaining taper relief to preserve losses to carry forward.

One anomaly has been addressed but another situation has opened up. I do not think that that is the intention of the policy. The issue is quite technical, but I ask the Government to consider further the point that has been raised. On full digestion, I believe that they will agree that clause 47 is not exactly what they want.

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

The change is essentially one that will reduce tax charges. People will be able to set a greater amount of trading losses against their capital gains and, by doing so, generally reduce the charge to tax. If it is helpful to the Committee, the carry-forward provisions are not changed by the clause. Unused trading losses carried forward can be set against future trading profits. I do not think that the concerns of the hon. Member for Arundel and South Downs are valid.

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

What the Economic Secretary has just said is extremely important. For the sake of clarity, is she arguing that, if there are greater trading losses than are needed to take advantage of the taper relief, those that are not used can definitely be carried forward against future profits? Clause 47 does not quite say that. I would be interested to know how it works—not now, but in a letter perhaps. That is the exact point that we are endeavouring to get at; if it is covered, we are happy.

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

I will write to the hon. Gentleman explaining the technicalities behind the interpretation of the clause. If there is anything there, we will certainly consider it.

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

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 47 ordered to stand part of the Bill.