Clause 156 - Life insurance policies and deferred annuity contracts

Finance Bill – in a Public Bill Committee at 8:55 am on 17th June 2003.

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Photo of Nicholas Winterton Nicholas Winterton Conservative, Macclesfield 8:55 am, 17th June 2003

The question is that clause 156 stand part of the Bill. I apologise to the Committee. I am keen that we should make progress, but I am slightly overstepping the mark, as I have selected an amendment to this clause.

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury

I beg to move amendment No. 245, in

clause 156, page 93, line 25, after 'other', insert

'(whether or not section 58(1) applies to the disposal).'.

Photo of Nicholas Winterton Nicholas Winterton Conservative, Macclesfield

The hon. Member for Eddisbury took me by surprise by not rising on the previous clause.

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury

We should be grateful for small mercies, Sir Nicholas. Your pronouncement reminds me of ''Just a Minute''.

We come to a new part of the Bill dealing with chargeable gains. The amendment would provide clarity and avoid any inference that the reference to a disposal from one spouse to the other might be intended to link with the conditions in a technical provision in section 58(1) of the Taxation of

Chargeable Gains Act 1992. That section restricts the no-gain, no-loss treatment of disposals from one spouse to another while they are living together and during the residue of the current tax year after they separate, which could be as short as one day. It has been pointed out many times that that causes problems with financial arrangements on divorce, and proceedings are commonly not concluded for some time after that.

The Law Society and others have argued for an additional two years of assessments to be allowed, especially in view of recent trends in high-value divorce cases. Subsections (5) and (6) of the clause recognise, for the first time, the significance of post-marriage transfers in the limited context covered by the clause, and protects the spouse who receives a life or deferred annuity policy as part of the financial arrangements from being taxed on maturity of the policy. Were it not for subsection (5)(a), a negotiated divorce package would involve the actual consideration of whatever either party was disposing of. The actual disposal from one spouse to the other would generally not involve a chargeable gain on the disposal as a result of the revised section 210(2) and (3) of the 1992 Act. In those circumstances, section 58(1) and its question on whether they were living together or had been doing so within the tax year of the disposal would be immaterial.

The policy intention seems to be that the question is not intended to be relevant in the revised section 210, and that actual consideration given between spouses should be disregarded if the disposal is made at any time prior to the final dissolution of the marriage, irrespective of how recent or otherwise the separation is, and after then if the conditions in subsection (6) are satisfied. Subsection (5)(a) should, however, put it beyond doubt that that is how the provision is meant to work. That is the purpose behind amendment No. 245.

Photo of Dawn Primarolo Dawn Primarolo Paymaster General (HM Treasury) 9:15 am, 17th June 2003

The clause corrects two separate defects in the rules for taxing capital gains on second-hand life insurance policies. People have been exploiting the defects to avoid paying tax on their gains, and we are correcting those defects as part of our commitment to fairness in taxation.

The first defect in the current rules allows people to generate capital losses for tax purposes that could far exceed any economic loss that they have suffered. There is increasing evidence of schemes in which the whole purpose is to exploit that loophole.

The second defect allows capital gains to escape a charged tax simply because the person making the disposal received the policy as a gift. A classic example is when a husband buys a second-hand life insurance policy as an investment. In his hands, any capital gains on the policy would be liable to tax, but if he gives the policy to his wife, all capital gains that she realises are free of tax. The clause closes both loopholes and puts an end to the avoidance.

I have no quarrel with the intention behind amendment No. 245, but in my view it is entirely unnecessary, and I hope that when the hon.

Gentleman has heard my explanation, he will consider withdrawing it. As he said, the concern that prompts the amendment is that the provision that it is intended to clarify may apply only in cases in which the husband and wife are living together at some stage in the tax year in which one transfers the insurance policy to the other. I assure the Committee that that is not so. The provision applies to any transfer between husband and wife, irrespective of whether the couple are living together as man and wife, or have separated. The additional words that the amendment would insert are unnecessary and, as they add nothing to the legislation, it is better to omit them. There is no danger that people will misunderstand the scope of the provision. Its meaning is clear.

Having given that assurance, I hope that the hon. Gentleman will consider that his point has been answered and will withdraw his amendment, but if he does not, I ask my hon. Friends to oppose it.

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury

It will be helpful to have that exchange on the record. I am sure that those who have been concerned about the matter will find the Paymaster General's comments helpful when it comes to clarification. On the basis that the last thing that I would ever want to do is add otiose words, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury

I beg to move amendment No. 298, in

clause 156, page 93, line 41, leave out from beginning to end of line 10 on page 94.

Photo of Nicholas Winterton Nicholas Winterton Conservative, Macclesfield

With this it will be convenient to discuss amendment No. 299, in

clause 156, page 94, line 43, at end insert—

'(1A) For each of sections 541(1)(a)(i), 541(1)(b)(i) and 541(1)(c)(i) of the Income and Corporation Taxes Act 1988 substitute—

''(i) in any case where, immediately before the chargeable event in question, the rights conferred by the policy or contract were vested in a person (other than the original policyholder) who had acquired those rights for a consideration in money or money's worth, the sums which would be allowable as a deduction for the purposes of computing a gain pursuant to Section 38 of the Taxation of Chargeable Gains Act 1992 and, in any other case, the total amount previously paid under the policy by way of premiums; and''.

(1B) For section 543(1)(a)(i) of the Income and Corporation Taxes Act 1988 substitute—

''(i) in any case where, immediately before the chargeable event in question, the rights conferred by the contract were vested in a person (other than the original policyholder) who had acquired those rights for a consideration in money or money's worth, the sums which would be allowable as a deduction for the purposes of computing a gain pursuant to Section 38 of the Taxation of Chargeable Gains Act 1992 and, in any other case, the total amount previously paid under the contract, whether by way of premiums or as a lump sum consideration, reduced in either case, if before the happening of the event one or more payments have been made on account of the annuity, by the capital element in that payment or payments, determined in accordance with Section 656; and''.'.

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury

This matter requires some concentration and is complex. Amendments Nos. 298 and 299 go together and are intended to deal with a

problem that I will now describe. I am indebted to the Association of Policy Market Makers, which has been in touch with the Treasury and the Inland Revenue about the point. I hope that members of the Committee will understand that we are discussing the active trade that has grown up over the past 15 years in second-hand life insurance policies. When the legislation to which clause 156 relates was framed, the growth of the market had not been anticipated. The amendments identify and, we hope, address that problem of legislation predating the growth of the secondary market.

The Association of Policy Market Makers, which represents the interests of the majority of companies that buy and sell second-hand life insurance policies, says that clause 156 proposes revisions to section 210 of the Taxation of Chargeable Gains Act 1992 to counter tax avoidance schemes that have exploited anomalies in the current rules. As the Paymaster General knows, all Members seek to ensure that the Revenue secures its due receipts. None of us seeks to promote tax avoidance schemes.

Subsection (3) of proposed new section 210 seeks to correct a defect in the current legislation, which allows a husband and wife to avoid capital gains tax on the disposal of a life insurance policy acquired in the secondary market as an investment—some of those issues were raised by the previous amendment. Subsections (7), (8) and (9) of proposed new section 210 seek to counteract an anomalous consequence of the application of sections 37 and 39 of the Taxation of Chargeable Gains Act 1992 on the disposal of certain types of life insurance policies under certain circumstances, which currently enables the creation of artificial capital losses by the acquisition and disposal of life insurance policies.

The problem does not, however, lie with sections 37 and 39, which are properly aimed at avoiding the double taxation of gains and the duplicated deduction of allowable expenditure. The chargeable event legislation, with which I am sure Members will be familiar—in particular, sections 541 and 543 of the Income and Corporation Taxes Act 1988—applies to purchases of second-hand or traded policies. The anomaly lies in the fact that the chargeable event legislation seeks to levy income tax on the disposal by an investor of a traded policy on an amount that is unrelated to the gain made by the investor. That mismatch should be corrected.

The APMM takes the view that the prevention of the creation of such artificial capital losses could be achieved more simply and effectively by amending sections 541(1) and 543(1) of the Income and Corporation Taxes Act 1988, which would treat the cause rather than the symptom. It therefore recommends that clause 156 should be amended by amendment No. 299.

If I can crave the Committee's indulgence, it might be helpful if I go through a worked example. I dare say that the Paymaster General will agree that the old situation was nonsense. The proposal in the Bill is also nonsense, but it is unquestionably in the Inland Revenue's favour. The alternative proposal contained in the amendments is not only better but reflects the

true position on tax and economic gain—we are, after all, dealing with chargeable gains.

Let us imagine a policy with a full market value of £100,000 that has been bought in the secondary market. To find out the gain for income tax one would, under the old system, take into account not only the premiums paid by the previous policyholder, but the premiums paid by the person who had subsequently bought it. If the lifetime premiums were £25,000, the gain for income tax purposes would be £75,000. If one keeps the £75,000 income gain in one's mind, one can examine the capital gains tax treatment.

If the market value of the policy were £100,000 and the premiums paid by the person who bought it second hand were £5,000, the investment price would be £70,000 because the £20,000 of premiums paid by the previous holder would not be computed. A loss of £70,000, which is the investment price, would therefore be computed for the capital gain. The allowable CGT loss under the old system was £70,000, which was patently nonsense because a loss would be created although there had been no genuine economic gain or loss.

Considering the same example under the proposal in the Bill, a policy with a market value of £100,000 would have the £25,000 of premiums paid deducted from it leaving a gain for income tax of £75,000—so far, there is no difference. On the capital gains tax treatment, however, the £100,000 of the market value and the £5,000 of premiums paid by the new secondary owner would be disregarded. The investment price of £70,000 would be deducted to show a capital gain of a loss of £70,000, which would leave an economic gain of £25,000. The Revenue would suddenly have an economic gain, which would not be the true gain, while the allowable CGT loss would, of course, have been reduced to nil.

The APMM proposal is an easier way to understand the problem and is therefore more elegant. Under it, the market value would be £100,000 and the investment price—what somebody paid for the policy—would be £70,000. Knocking off the investment price and the £5,000 of premiums paid by the secondary owner would leave a gain for income tax purposes of £25,000. For income tax purposes, the figure would be £25,000 under the APMM proposal and £75,000 under the previous two examples.

For the purposes of CGT, the £100,000 market value would be disregarded under the APMM proposal. The £5,000 premiums paid by the current owner would be knocked off the income, which we have dealt with. The investment price of £70,000 would also be disregarded leaving a capital gain of zero, which is exactly where the proposal in the Bill ends up. Those examples may bear further study by reading the record, because words are the currency of Hansard; it would have been easier if I could have put up a slide and gone through a presentation. The amendments are not only a genuine attempt to establish the true economic gain, but are a more elegant and simple way to achieve the same result. I admit that it was difficult to present the example, but I hope that the amendments will elicit a favourable response from the Paymaster General.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

Can the hon. Gentleman explain how his example materially differs from that given in the explanatory notes?

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury 9:30 am, 17th June 2003

I could if I put the two documents together side by side. Example 2 in the explanatory notes shows what happens under the old system, and I described it in my first example. I described three columns of figures, and example 2 in the explanatory notes was my starting point. My second example concerned the proposal in the Bill. The old system would leave an allowable CGT loss of £70,000, which we all accept is not logically defensible. The proposal in the Bill would leave an economic gain of £25,000, which equally bears no relation to the true position underlying the transaction. The APMM proposal, in what is for various reasons an increasingly important and growing market, would reduce the gain to the true economic position. That would be a nil gain, with the normal things netted off, and the income tax would again be caught on the true income tax position. The Revenue would then achieve its aim of removing the artificial loss created in the original proposal, but would also have found a logical way of producing a calculation related to the true economic gain while not losing sight of the normal charging for income tax.

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

I shall briefly refer to the example that the hon. Member for Eddisbury gave, then respond specifically to the group of amendments. In moving the amendment, he flagged up that this is a sophisticated and somewhat complex market.

On the hon. Gentleman's example, it should not be possible for someone to lose money on a second-hand life insurance policy but still have income tax to pay on a gain, as shown in a recent edition of Taxation. It is theoretically possible for an income tax charge to arise when no profit has been made, although the amendment does not satisfactorily address that. However, in practice, such cases do not arise in any great number. The commercial market is almost always a market for policies on which income charges do not arise. It is a sophisticated market, as the hon. Gentleman has acknowledged, and those involved in it are well aware of the tax rules. If an income tax charge might exceed the real profit, the financially astute investor will not lose out because he or she will adjust the purchase price accordingly.

As I have already said, the amendment does not work properly. It has long been recognised that the sale of life policies does not sit well in the regime for taxing life policy gains. That has been the case since those transactions were brought into charge in 1983. The amendment seeks to deal with some of the difficulties but would cover only assignments for consideration of all the rights under a policy. To work properly, it would also have to cover assignments for consideration of part of the rights under a policy. Getting the rules right for such transactions would involve changing the way in which all part withdrawals and assignments are dealt with.

Those rules are very complex and changes would only add to the complexity. They would probably involve getting rid of the present facility that allows withdrawals of up to 5 per cent. of premium without immediate tax consequences. Such a change would affect the hundreds of thousands of policyholders who make regular withdrawals from their life policies. It would be wrong to make such a change unless there were very good reasons for doing so.

So far, we have seen no compelling evidence that the accepted weaknesses caused by the 1983 change to the regime are causing serious difficulties, either by way of double tax charges or to the professional market in second-hand policies. However, if the hon. Gentleman has evidence that there are serious difficulties, I should be pleased to see it. That statement has also been made to those who have made representations on this matter. We would then need to consider whether and what changes might be necessary.

These are difficult and wide-ranging issues, and careful consideration of the impact of change would be needed. There is no question of changes this year, but if there is real evidence of difficulty, as opposed to the explaining of a theoretical possibility, I will examine it to see whether it would be appropriate to introduce some suitable measure next year. However, in the absence of real evidence, when only theoretical possibilities are being advanced, I see no grounds for accepting the amendment.

In summary, the case for change by showing the real effect has not been made. The amendment would not be effective to cover part assignments. We would need more fundamental change than the hon. Gentleman suggests. Insurers would not meet their obligations to the policyholders and, in the absence of a problem having been demonstrated in practice, change is not justified at this stage. I hope that the hon. Gentleman will therefore accept my offer—which is to him and to those who read the record—that if there are real examples of significant damage, I will happily consider them and review the position. What I will not do today is accept the amendment, because of the further implications for a complex market. Should he press it, I shall ask my hon. Friends to oppose it.

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury

I am grateful to the Paymaster General for taking my points on an admittedly complex matter seriously. I have listened carefully as she has progressed through her arguments. I am cognisant that the old situation is nonsense—as I think we all accept—and the new proposals in the Bill therefore reflect the need for change. I think that we are at one that change is required. It would be unfair of me to say that the Paymaster General actually said this, but I felt that implicit in her remarks was the admission that the measure is the Revenue's and the Treasury's best attempt to put the situation right. There has been an admission that this matter is very complex, and an attempt to call on those who might have evidence of anything that needs to be further considered to produce that evidence.

In going through this complex market, it has been recognised that many matters can be worked out theoretically, and that has been addressed. I think that the APMM made a fair representation in giving worked examples to show why the measure in the Bill might not necessarily be a perfect and logical way of arriving at an economic gain, when that does not necessarily relate to the real world. That is the current position, a change from the previous nonsense position.

Having listened carefully, and accepted that the double taxation point has already been addressed, I shall not ask my right hon. and hon. Friends to vote on the amendments, as I think it important not to engage in gestures. The offer to keep the matter under review, listen to anyone who can produce evidence on the operation of the new proposals and address further issues, is constructive. What has been put on the record will be helpful to all concerned and, on that basis, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury

I beg to move amendment No. 246, in

clause 156, page 94, line 44, leave out '9th' and insert '16th'.

This is a simple matter. It is clear why the Government have felt it necessary to make the changes. My only concern is that the clause does not take account of the fact that, whereas some second-hand policies of assurance have been acquired for tax planning purposes, many more have been acquired as perfectly ordinary investments. The application of the provisions might, therefore, be considered too wide.

In particular, we are concerned that if a second-hand life assurance policy is used as security for a loan, and a lender takes a charge over it, it would be treated as a disposal of an interest in the life assurance policy, notwithstanding an important, related part of tax law, section 26 of the Taxation of Chargeable Gains Act 1992. It is wrong in principle that the changes should apply from Budget day rather than the publication of the Finance Bill.

As Committee members will spot, the amendment would simply change the date from 9 to 16 April. The Budget day press release did not state with sufficient precision the manner in which the computational rules were to be altered to allow a taxpayer who made the disposable policy between Budget day and the publication of the Finance Bill to know how a loss on the disposable policy would be calculated. We propose to change the date to 16 April, which was the date of the publication of the Finance Bill. I am happy to be corrected if that was not the actual date. This is a point of detail and clarification. I hope that it would not have a major impact; I do not believe that it would, so I hope that it will find favour with the Paymaster General.

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

I shall ask the Committee to reject amendment No. 246, which as the hon. Gentleman explained puts back by a week the date when clause 156 has effect. There are two grounds why I cannot agree to the delay that the amendment would create. First, I do not accept that the Budget note published by the Inland Revenue gave insufficient details of the proposed change. It contains simple but clear

statements of the two defects in the current rules and how each loophole is stopped by clause 156. It also explains the other changes that the clause makes.

The level of detail in the Budget note is standard for changes that are relatively straightforward, such as those in clause 156. There is no evidence that the information provided by the Inland Revenue was inadequate. It is quite usual for draft legislation relating to anti-avoidance measures that take effect from Budget day to be published for the first time in the Finance Bill.

The second reason for rejecting the amendment is that the people who have most to gain from any delay are those seeking to avoid tax by exploiting the loopholes that are closed by the clause. A delay could also cause some people to lose the benefit of the provision that prevents certain policies from becoming liable to a capital gains tax charge.

The hon. Gentleman went on to make two points. He said that clause 156 was too widely drafted, which was the point made by the Chartered Institute of Taxation. It is entirely right that capital gains made on ordinary investments should be liable to tax. Equally, there is no reason to allow losses for tax purposes that are greater than any economic loss. The clause does not deny relief for all losses. It has been drafted carefully to restrict tax losses to the amounts that people genuinely suffer. His second point regarded security for a loan. There is no disposal for capital gains tax purposes when someone uses an asset as security for a loan. No liability can arise because the second-hand life insurance policy is used as security in that way.

In short, there is no evidence that delaying the change made by clause 156 would help ordinary investors in second-hand life insurance policies. A delay could have the undesirable effect that I have mentioned of making certain policies liable. Therefore, I hope that the hon. Gentleman will consider withdrawing the amendment, but if he presses it to a vote, I shall ask my hon. Friend's to oppose it.

Photo of Stephen O'Brien Stephen O'Brien Conservative, Eddisbury 9:45 am, 17th June 2003

This point of clarification is clearly being made for the sake of good order, and it would be wrong to detain the Committee by pressing the amendment to a vote. I have put the matter on the record, and the Paymaster General sought to defend the clarity of Revenue Budget note 30. I hope that those who have a need to refer to our proceedings will find the clarification that resulted from the exchange helpful. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 156 ordered to stand part of the Bill.