Clause 53 - Treatment of expenditure on research and development

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 2:55 pm on 13th May 2004.

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Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury 2:55 pm, 13th May 2004

I beg to move amendment No. 98, in

clause 53, page 59, line 15, at end insert

'such that deductions are available as and when the expenditure is incurred.'.

Mr. McWilliam, I welcome you to the Chair this afternoon. It has been assumed that the purpose of clause 53 is to put relief for research and development on an incurred basis, which was contemplated and referred to in the Budget press release. However, it is not entirely apparent that that purpose is achieved by the clause, which disapplies intangible fixed assets legislation. There seems to be an underlying assumption in the clause that, in the absence of that legislation, a deduction is obtained on an incurred

basis, which is not necessarily always the case. The Minister will be aware of the case of Gallagher v. Jones.

Outside the intangible fixed asset rules, generally accepted accepting practice is imposed, as distinct from the incurred basis. As a result of clause 50, which we debated earlier, GAAP will be in respect of IAS in companies that prepare accounts in accordance with IAS. It seems that clause 53 will not achieve anything. Our amendment is designed to address that problem and is consistent with some of the points raised by the Chartered Institute of Taxation. It goes further, and states that it is unsatisfactory to reintroduce the traditional tax capital revenue distinction, which is well known to be imprecise in its effects, in clause 53. While that may be the case, the distinction is currently ingrained in British tax law, and the Economic Secretary may comment on the difficulties faced in applying the test, but we still feel that an amendment is necessary.

The related point has been made as to whether the intention is to preserve existing UK GAAP in the timing of deductions for research and development expenditure, or whether such deductions should be made on an incurred basis, the effects of which would not be the same, but are not that different.

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

In trying to deal with the points that the hon. Gentleman raised, I shall, for the benefit of the Committee, briefly discuss the aim of the clause.

The current tax rules for research and development allow relief only when expenditure is taken to the profit and loss account. When it is added to the cost of an asset, relief is given over a period of years only as the expenditure is written off. The clause permits an immediate deduction to revenue expenditure on research and development where the expenditure is added to the cost of an asset and not taken to the profit and loss account. By ''immediate deduction'', I mean a deduction that is given when the expenditure has occurred. That is the effect of clause 53, and it needs no extra words.

The extra words proposed in the amendment may cut across some of the necessary conditions for a research and development deduction. By turning what is a permissive rule into a mandatory one, the amendment would bypass the conditions for obtaining relief: the expenditure must be related to a trade, must be directly undertaken by the trader or be on his behalf, and should not include payments for R and D rights.

The arguments advanced by the CIOT are based on a complete misunderstanding of the clause. The intangibles asset regime is not supplied in the clause. We are introducing the change because companies adopting international accounting standards will find that some expenditure that they could have taken to the profit and loss account under UK accounting rules would have to be added to the cost of the asset instead. That would delay the deduction and any consequent claim for enhanced expenditure under the R and D tax relief regimes.

Photo of Mr John Burnett Mr John Burnett Shadow Minister, Home Affairs, Shadow Solicitor General, Law Officers (Constitutional Affairs) 3:00 pm, 13th May 2004

I am quite interested in what the Economic Secretary says. Is he saying that there is considerable flexibility about the relief, and it will either be available against the profit and loss account or, at the taxpayer's election, the expenditure, including past expenditure, can be added to the cost of the asset, so that the taxpayer, whether corporate or unincorporated, can take whatever suits them best?

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

Essentially, the answer is yes—either but not both. We could have considered changing the tax rules only for those companies using IAS, but we have taken a broad, simplifying approach instead to allow all companies the deduction when the expenditure is incurred.

In answer to the point made by the hon. Member for Arundel and South Downs also, that approach allows companies using UK GAAP to choose whether to add expenditure to an asset or take it to profit and loss on the basis of what is best for their accounting purposes. They will not be driven to account in one way because of the tax treatment. In no case will there be a delay in granting R and D tax relief, including the payable credits, to companies carrying out R and D. That is one of several improvements to the R and D rules in the Bill. It supports our aim of increasing productivity through the growth of the knowledge economy, and I hope that it commends itself to the Committee.

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

I find it slightly strange that the accountancy profession and not just the CIOT did not understand the clause as cleanly as the Economic Secretary has described it. I was concerned that seeking always to put relief on an incurred basis would always apply. I think that he is saying that that will be the case and that the worries pertaining to Gallagher v. Jones are redundant, even if the drafting of the clause is not hugely clear. On the basis of what he has said, and our point having been addressed and put into the record, 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 Quentin Davies Quentin Davies Conservative, Grantham and Stamford

I make two brief points. I ask for clarification from the Economic Secretary, and I hope that the culture of reasonable answers to reasonable questions has returned. The first question relates to the phrase,

''if not of a capital nature'' in the first line of the clause, which begins:

''Expenditure by a company on research and development, if not of a capital nature''—

I now summarise—does not prevent it from being the subject of a tax offset by virtue of the fact that it is expended in connection with the creation of an intangible asset. Surely, if the expenditure is part of the creation of an intangible asset, it is being capitalised. It does not matter if the asset that is being created is fixed or intangible, it is still an asset, so it is capitalised. So, what is the meaning of the phrase,

''if not of a capital nature''?

It seems to be a contradiction in terms. No doubt there is a simple explanation, but we should have it before we proceed.

I am a little concerned about the phrase, ''writing down'', in subsection (3). I suspect that it is absolutely fine and that the Minister will say that everything is all right, but we know that tax cases can turn on the use of language in a context such as this. I am concerned about a situation in which a company spends money on R and D and creates an intangible asset; for example, a patent or a piece of software that it capitalises.

I welcome the thrust and the purpose of the clause, which is an excellent tax reform. It means that it does not matter whether the expenditure is used to create an intangible asset or written off as a current expense in the year—the tax treatment is the same. That is splendid; it is the way it should be. If the intangible asset is then depreciated over its useful life, as would be the normal situation, it is clear that one cannot get a double deduction, which is also a purpose of the clause, and I agree with that, too.

However, what happens if the intangible asset being created is not written off in the normal way and depreciated over its useful life but written off immediately—in other words, written off rather than written down? For example, the company may spend the money, create the patent or the software, decide the next year that the technology is useless and have to write the whole thing off, so it is not depreciated in the normal way; it is written off in the following financial period. In such circumstances, I take it that the purpose of the clause is that equally there would then be a full offset, but for tax purposes the amount already written off in terms of the expenditure as part of the creation of the asset would not be deductible; only the balance would be deductible, which is perfectly reasonable. However, I want to ensure that the balance would be fully deductible in that year in which the asset is written off and I would like the Minister's assurance that that would indeed take place, in case the point subsequently arises in the courts.

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

I welcome the hon. Gentleman's description of this as an excellent tax reform. He is right: in general, the tax relief for R and D has been a significant success. It is very popular and has played an increasingly important role in helping to support the competitiveness and development of British business. It is costing the Government about £500 million a year, but it is money that we are ready and well prepared to invest in the development of a much greater R and D capacity, particularly in the private sector. The measure is of particular value to manufacturing because 80 per cent. of private sector R and D is carried out in this country by the manufacturing sector. Some of my hon. Friends who represent traditional manufacturing areas strongly support the measure and are interested in the reform.

The reform that we are considering is part of a process: if we can make the operation of the R and D tax credits work more effectively, and respond to suggestions from industry about how it works, we will. It is an example of the sort of reform that has been urged on us by British manufacturing companies. Rolls-Royce, in particular, has an interest in the clause.

I will answer the two specific points raised by the hon. Member for Grantham and Stamford. First, on the question whether something is not of a capital nature, for tax purposes the expenditure is not capital, even if it is capitalised. [Interruption.] As the hon. Member for Arundel and South Downs acknowledges from a sedentary position, it is an instance where tax and accounting have a different concept of capital. That is probably the explanation that the hon. Member for Grantham and Stamford was looking for.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

The Minister has given me the explanation that I was anticipating. Does he agree that it is one more example of the principle that I set out this morning: that unfortunately tax law and tax lore, the whole culture of tax, diverge more and more from economic reality, and that that is a worrying state of affairs? Should not it be the concern of responsible Ministers, whichever party is in power—it should not be a matter of party politics—to try to do something about it and bridge that gap, or narrow it?

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

The hon. Gentleman tempts me, but there is no great difference between us on the matter. In general, the Government are committed to the principle of trying to harmonise the definitions and operation of accounting practices and to make them as suitable as possible for tax purposes. There are instances in the Bill, some of which we have already discussed, that take us in that direction. There may be occasions and purposes where, for tax reasons, that is not possible, but the general principle is one that I agree with.

Photo of Mr John Burnett Mr John Burnett Shadow Minister, Home Affairs, Shadow Solicitor General, Law Officers (Constitutional Affairs)

It may be the case that the tax accounting system—this may be the case under the clause, too—is more generous to taxpayers than the strict accounting system that the hon. Member for Grantham and Stamford is referring to. The relief provides flexibility, giving the opportunity to see exactly what the value of the asset is going to be—whether it will be worthless or otherwise—and, in subsequent years, it gives the taxpayer an opportunity to choose whether to capitalise the expenditure or write it off. That is not a bad thing.

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

The hon. Gentleman re-emphasises a point that I made earlier, which is that the provisions give taxpayers greater choice, allowing them to decide how to act according to what is best for their accounting purposes.

The hon. Member for Grantham and Stamford raised a concern about writing down. He asked whether in-year write-off would be allowed. If write-off is allowed when it is incurred, then it may not again

be written off. I hope that that is the answer that he was looking for. On that basis, I commend the clause to the Committee.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

The Economic Secretary said that if it is allowed at all, it is obvious that the amount that has already been allowed is deducted. We accept that. I want to make it absolutely clear that the tax affected is exactly the same regardless of whether the subsequent deduction takes place as a total write-off of the asset—because the asset is deemed to be worthless—or as a normal depreciation. That is the assurance that I want.

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

Indeed, yes.

Question put and agreed to.

Clause 53 ordered to stand part of the Bill.

Photo of Mr John McWilliam Mr John McWilliam Labour, Blaydon

I noticed the secretary of a Member passing a piece of paper to that Member a few minutes ago. As the Member did not leave the Committee, that is not allowed and should not happen.Clause 54 Trading profits etc. from securities: taxation of amounts taken to reserves