Clause 48 - Election to forego roll-over relief on transfer of business

Finance Bill – in a Public Bill Committee at 4:45 pm on 21st May 2002.

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Photo of Mr Howard Flight Mr Howard Flight Conservative, Arundel and South Downs 4:45 pm, 21st May 2002

I beg to move amendment No. 65, in page 33, line 11, after 'apply', insert

'to the full gain arising on the incorporation of the business or a proportion thereof as specified in the election'.

We have tabled the amendment to make the election apply only to part of the gain, as suggested by the Institute of Directors. The purpose is to allow people who incorporate their business and then dispose only of some of the shares in a two-year period to disapply incorporation relief on the proportion of the gain arising on the shares disposed, and not on the whole gain. The Chartered Institute of Taxation suggests a

full review of the reliefs available on incorporation, particularly if lots of unincorporated businesses arise; we discussed earlier the issue relating to people choosing to incorporate as a result of the tax advantages of incorporation. If that happens as we anticipate, the whole territory may need more consideration.

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

The amendment would introduce an unwelcome complexity to the way in which capital gains tax incorporation relief applies. First, to give a little background to the Committee, I think that it would be useful to explain incorporation relief.

Such relief enables the owners of an unincorporated business to transfer it to a company as a going concern without facing an immediate capital gains tax charge on the disposal of the assets transferred. The relief prevents capital gains tax acting as a disincentive for a growing business to incorporate. It works by rolling over the gains on the assets of the business into the shares acquired in the company. The gain comes into charge when the shares are eventually disposed of.

Incorporation relief does not always work to the taxpayer's advantage because any capital gains tax taper relief that has accrued on the transferred assets will not be inherited by the shares. That means that, if the shares are disposed of two years after the transfer, the business owner might have been better off if he or she had not received the benefit of incorporation relief.

The clause deals with that concern. It will allow the business owner to opt out of incorporation relief after the event, and incur the capital gains tax charge on the transfer of assets to the company with the appropriate taper relief intact. The rules proposed in the clause for an election to opt out of the relief are straightforward and simple. The change will reduce tax charges in the majority of cases where shares in the company are sold within two years of the transfer.

Amendment No. 65 would introduce a special provision for cases in which only some of the shares are sold in that period. That would introduce some significant additional complications, which I fear are not addressed by the amendment. For example, it would be necessary to cater for circumstances in which more than one class of share was involved and the different classes carried different rights to the assets that had been transferred. Furthermore, rules would be needed to deal with situations in which the assets transferred did not all qualify for the same rate of taper relief.

Clause 48 introduces a modest but worthwhile change that will reduce some of the stress of the incorporation decision. We are introducing it in response to specific representations that we have received. I am not attracted to the idea that we could tinker with it in order to deal with the points made by the hon. Member for Arundel and South Downs. The amendment would introduce additional significant complexity, and it is not clear how people would benefit from it.

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

For simplification, I think that the Minister is saying that the Government do not agree in principle that it should be possible to make the election in respect of a proportion of a business corresponding to which shares are disposed of within two years of incorporation and to receive incorporation relief on the remaining part of the business. Why does she not feel that that ought to be addressed?

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

This is a question not of principle but of pragmatism. Every taxpayer who made a disposal of shares soon after incorporation would, under the hon. Gentleman's proposal, feel compelled to work through every possible combination of full and partial elections to see which gave the best results. The legislation would have to be considerably expanded to cater for the different circumstances that needed to be addressed by a partial election.

I do not dispute the fact that the amendment would benefit some people. However, I do not believe that it would be worth while to include the amendment because of the additional complexity that it would introduce, which would be to the disadvantage of the majority of owners who incorporate their businesses. What we hear from businesses is that they would like the tax system to be simpler. The proposals in clause 48 would help many people in a simple, straightforward way. It is the inherent complexity, not the principle, of the amendment that I cannot accept.

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

This is not a huge issue, but it is one that was raised by the Institute of Directors, so some elements of business do have concerns about it. I understand the Minister's logic and do not think that the matter is sufficiently material to put it to a vote. However, the Government might, in the interests of fairness, think about whether there is a simpler way to address the point. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question proposed, That the clause stand part of the Bill.

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

With this, it will be convenient to take new clause 5—Taper relief: holding period for business assets when roll-over relief on transfer of business assets applies—

'.—(1) After section 162(3) of the Taxation of Chargeable Gains Act 1992 (roll-over relief on the transfer of business) insert—

''(3A) For the purpose of computing any chargeable gain accruing on the disposal of any new asset that is eligible for taper relief under subsection (3) above the qualifying holding period for taper relief shall be deemed to have commenced on the period after 5th April 1998 when the business so transferred under subsection (1) above was held and to have ceased upon the disposal of the new asset.''.'.

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

In effect, our re-jigging of clause 48 by new clause 5 is in order to ensure that the taper relief clock is not stopped and then restarted under the election that is proposed in the Bill, the effect of which would be to waste the number of days during which the business was being incorporated because they were insufficient to contribute to a whole year to qualify for taper relief at the time of incorporation. If, at the time

of incorporation, the business had been held for one year and 11 months, the 11 months would be lost if the election were made, and there would be one whole qualifying year for taper relief; that would make 50 per cent. of the gain chargeable under the taper relief provisions. However, if our re-jigging were accepted, the new shareholder would be able to sell the shares only one month after incorporating the business, and would then qualify for two complete holding years. In turn, that would mean only 25 per cent. of the gain being chargeable.

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury 5:00 pm, 21st May 2002

I have already spelled out how clause 48 improves the way in which capital gains tax and corporation relief work. The clause is being introduced in response to representations, and it is simple and straightforward to understand. On those grounds, I have to say that I am not attracted to new clause 5.

First, the clause aims to assign the taper history of the business assets to the shares received on the transfer, thus removing the need to opt out of incorporation relief. I would argue, however, that the assets of the business—for example, the buildings and goodwill—are not the same as the shares issued in exchange for them. It is right in principle that the taper clock on the shares should start when they are issued.

Secondly, the assets might in practice have several different histories for taper purposes. They might have been acquired at different times or be classified as a mixture of business and non-business assets. It would be extremely complex to translate accurately and fairly the different taper histories of the business assets into one value that could be applied to the shares received. New clause 5 deals with that neatly by ignoring the assets altogether and focusing instead on the earliest time after 5 April 1998 when the business was held by the person claiming incorporation relief. That is certainly a simple way of dealing with the issue, but it is also entirely inappropriate. It would, in effect, enable gains on all assets transferred to the company to benefit from a taper history extending back several years, irrespective of how long they had been assets of the business.

Clause 48 will allow a business owner to elect to opt out of incorporation relief and incur the immediate capital gains tax charge on the transfer of the assets to the company, but with the appropriate taper relief intact. That straightforward and simple change, which has been sought by representative bodies, will reduce tax charges in the majority of cases when the shares in the company are sold within two years after the transfer. On those grounds, I have no hesitation in recommending that the Committee reject new clause 5 and agree to clause 48 standing part of the Bill.

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

In simple terms, the Minister is saying that the clause is an improvement on the present situation, which is the case. In new clause 5, we raise the potential unfairness that, in the example, 11 months could be lost if the election were made. The Minister says that it is not worth the complication of trying to deal with that. It is not a fundamental issue of the new regime, but it is worth thinking about.

As we are debating clause stand part as well as new clause 5, I also raise the fact that the time limits imposed might be relaxed by a year. The limits proposed in the Bill are meant to tie in with deadlines for filing returns. The Institute of Directors has suggested more relaxed limits in order to correspond to the normal patterns for other claims such as trading loss relief, so that taxpayers can finalise all their elections together to optimise their tax positions.

Photo of Ruth Kelly Ruth Kelly Economic Secretary, HM Treasury

I believe that the deadline is long enough to enable people to make elections in time to obtain the most favourable tax treatment that could apply to their circumstances. That is the critical point. The longer the election period, the more complicated the record keeping and tax calculations will be and, in the end, the higher the interest payments become. The time limit is reasonable and representative bodies seem to be content with it.

Question put and agreed to.

Clause 48 ordered to stand part of the Bill.