Clause 54 - Trading profits etc. from securities: taxation of amounts taken to reserves

Finance Bill (except clauses 4, 5, 20, 28, 57 to 77, 86, 111 and 282 to 289, and schedules 1, 3, 11, 12, 21 and 37 to 39) – in a Public Bill Committee at 3:00 pm on 13th May 2004.

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

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury

The CIOT has expressed concern that the clause does not appear to have been discussed in earlier consultations and that there is an assumption that where items are marked ''to market'' on the balance sheet with any revaluation surplus taken to reserves, the revaluation surplus should, none the less, be taxable. The CIOT's concern is that that rule will introduce an unwanted element of volatility into the computation of taxable profits. Although it may be that few companies are likely to be affected, it suggests that that is an unwarrantedly hasty implementation of a somewhat dubious principle. I think that we appreciate the points that it makes. This is essentially a matter of tax policy, but I would welcome the Minister's comments thereon.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

The clause reflects the two points that I made this morning, which seem to run through the Bill as a theme. One is that the Revenue's intention is to have its cake and eat it. If there is a change in accounting rules, as there is with the introduction of IAS, and that change provides a benefit for the taxpayer, as it would were it not for this clause, the Revenue and the Government are proposing to make sure that the taxable profit is still judged on the previous GAAP basis. Once again, the position is ''heads you lose, tails I win''.

The other principle to which I referred this morning, and which I think is a bad principle that runs through the Bill, is that as accounting principles progress and better reflect economic reality—I think that we all agree that not only is that the purpose of IAS, but it is one that is largely achieved—the gap between that reality and the view of reality taken by tax law increases, because tax law gets left behind and we still

have tax applied on the previous GAAP basis. That will be the effect of the clause; it is retrograde and problematic.

I wish to ask a few practical questions. Again, we should be concerned with the theory, coherence, fairness and justice of tax—I make no apology for raising such issues—but we should also be concerned with the immediate practical impact of it. The Economic Secretary may tell me that I have misunderstood the proposal, but from henceforth and despite the introduction of IAS, if a company as defined in subsection (1) has assets that are available for sale, even if they are not regarded by the company as there for the purpose of trading, any profit on them will be taxed as if they were trading assets. The Economic Secretary indicates through his body language that I have misunderstood the effect of the proposal.

A question arises as to the possible perverse impact of such a definition of assets available for sale. I can think of all sorts of examples in which a company as defined in subsection (1) may have assets available for sale that are significant in relation to its net worth, or at least to its profits. Any taxation of changes in the value of such assets would be a major contributor to the volatility of the company's profits, as my hon. Friend the shadow Chief Secretary explained.

Let me give the Economic Secretary some examples. I hope that he will tell me that my concerns are unfounded. If a bank takes a strategic stake in another bank—a quotable security, an asset that would be marked ''to market'' or held at the lowest of cost or market—and there is a profit, would that profit be taxed? The profit would be considerable if the strategic stake were in a bank with which the tax-paying bank had a strong relationship. Perhaps the strategic stake is accumulated for the purpose of a long-term relationship that is relatively stable; however, the value of the shares is not stable at all. Perhaps the stake is accumulated for the purpose of making an eventual acquisition. The taxpayer would not regard it as a trading asset. Would a strategic stake of that kind be caught? If so, the effect that my hon. Friend outlined would undoubtedly occur. There would be considerable volatility of profits and exposure of the tax-paying bank to substantial amounts of tax as a result of a structural investment. That seems completely contrary to the traditions of our tax law and certainly very bad for business generally.

Let us say that a bank were faced with the prospect of making a debt-equity swap. Should we discourage banks from making such swaps? Suppose the bank had a customer that ran into considerable trouble and the only way of saving it, rather than throwing it into bankruptcy and putting thousands of people out of work—I do not suppose that the Government would really want that to happen—would be to take over part of the equity of the company through a debt-equity swap. Is it the Government's intention that the tax law should prevent such a transaction from taking place?

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury 3:15 pm, 13th May 2004

The thought crosses my mind that the same would be true in reverse. Selling an asset sold when the booking to reserve is negative may result in an entirely questionable loss to be offset.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

My hon. Friend shows what a good Chief Secretary he will be. He is already concerned about the revenues of the Inland Revenue and, with his usual expertise and insight, immediately puts his finger on a potential loss of revenue that the Government apparently have not even considered. That was a very valuable contribution to our debate. I hope that his question will be subsumed in mine and we shall get an answer to that from the Economic Secretary if we get an answer to nothing else.

Debt equities concern Governments, too; they have been a feature of the restructuring of the debt of third-world countries. I thought that there was a consensus in the House in favour of restructuring the debt of over-indebted, poor and developing countries. If bank X holds several billion dollars' worth of the loans of a highly indebted country and is prepared to swap them into shares in privatised utilities in those countries, why should we introduce into our tax system a disincentive or barrier to that? We should be told whether the clause introduces such a disincentive.

Another aspect of the matter is securitisation. Subsection (4)(b) makes it clear that loan relationships are excluded. Therefore, if a bank has advanced a loan, that has nothing to do with this issue. However, it might decide to securitise the loan, and to hold some of the resulting loan in the form of debt securities and sell others of those debt securities to other institutions. Would it, by dint of that transformation, change against its interests or, as my hon. Friend suggested, in its interests and against the interests of the Inland Revenue? Would it change the tax nature, the tax treatment or the taxability of what is actually the same economic reality—an underlying debt asset, a debt instrument held by a bank? That would be perverse, and certainly contrary to any economic rationality. I should like an assurance that that is not the effect of the clause.

Perhaps my last two points are connected. There is often a considerable secondary market in the debt of countries that have a dubious credit rating, the value of whose debt is volatile. Take Argentina or Brazil: it is amazing how the value of their debt goes up and down. Sometimes it is quoted at a discount of 50 per cent. or 30 per cent., and sometimes it is 20 per cent. It can go all over the place. Substantial amounts of apparent trading profit could be created if there were to be the slightly perverse implementation of the clause which I fear, and in such circumstances considerable differences could be made to the tax position of a bank as a result of securitisation.

Those are some of the questions that arise from the clause, and I should be grateful for a sober, calm, reasoned, informative and helpful response.

Photo of John Healey John Healey The Economic Secretary to the Treasury

May I say at the outset, just to reassure hon. Members, that before it was brought to the Committee the clause was consulted on extensively, particularly through the Inland Revenue website. Generally, it has been accepted.

It applies to companies and others who deal in shares either as their main business—such as stock exchange market makers—or as part of a larger financial business, say banking or insurance. Under UK GAAP the profit from such share dealing appears in the company's profit and loss account. That means that it is included in the computation of profits from the company's business. Under IAS 39 and the proposed UK standard based on it, that treatment is likely to continue. However, it might be possible for some companies to put such profits in what is called the statement of changes in equity. Under current tax law, those profits might escape taxation or be deferred. The clause ensures that it does not matter whether the profits—or losses—are shown in the profit and loss or another account. The profits will still be taxed, and any losses allowed, when they are shown in the accounts.

The hon. Member for Grantham and Stamford raised three points. The first concerned available-for-sale assets. Under both IAS and revised UK GAAP, such assets will be subject to fair value. That means that unrealised changes in value will be shown in the accounts, and will be taxed or relieved as they arise.

In general there is no reason to stop that happening. Fluctuations in profit can be ironed out by the ability of a company to carry back and carry forward losses. The question whether something should be done when companies move to fair value accounting can really be answered only when we see, come 1 January 2005, whether the transitional adjustment is significant.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

Am I right in summarising the answer that the Minister is giving me thus: the danger that I have outlined exists; a strategic stake such as I described would indeed be taxable on the relevant basis; but he intends to wait to see how great the effect will be in practice before deciding whether he needs to do something about it?

Photo of John Healey John Healey The Economic Secretary to the Treasury

That is basically a fair summary. I was making the point about being able to make a clearer judgment after 1 January. I remind the Committee that the schedule contains a power to make regulations with respect to the case in question, if they are needed. We shall monitor the situation closely.

The hon. Members for Grantham and Stamford and for Arundel and South Downs suggested, as I believe the Chartered Institute of Taxation did, that what is happening might introduce an unwarranted and unwanted element of volatility into the computation of taxable profits. In our judgment that is not so. The rule ensures that a company dealing in shares will not be able to escape taxation by designating its portfolio as available-for-sale assets under international accounting standards or the revised UK GAAP. It applies only to those companies

that are already taxed on a fair-value or mark-to-market basis in respect of their portfolios of shares. It is difficult to see how it introduces a new element of volatility.

Clause 54 does not cover or relate to debt equity swaps, securitisations or other loans.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

It is reassuring, in a sense, to hear that the second and third of my examples—debt equity swaps and securitisation—will not result in any difference in the taxation regime applied to the relevant institutions. However, I must ask why not. It seems to me that they are assets available for sale. What assurance do we have that there will indeed not be a change in the taxable profit?

Photo of John Healey John Healey The Economic Secretary to the Treasury

The short answer is that the clause is drafted in such a way that it is not relevant.

Question put and agreed to.

Clause 54 ordered to stand part of the Bill.