Clause 89 - Venture capital trusts

Finance Bill – in a Public Bill Committee at 11:00 am on 20th 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

We have some amendments to schedule 19. Although clause 89 only introduces the provisions of schedule 19, I should like to make some general comments on the arrangements before dealing with the schedule and our specific amendments.

As Committee members will aware, the arrangements make a number of changes to the operation of venture capital trusts, some of which are in line with the amendments that we have just discussed with regard to EIS companies. The maximum amount on which relief can be claimed is likewise increased to £200,000. The main point is that the nature of the tax has been changed. Capital gains tax deferral relief is abolished and income tax relief is increased to give relief at the higher 40 per cent. rate of tax; the previous rate was 20 per cent. There are a number of other amendments in respect of what companies qualify for investments and how they carry on their trade. Again, that is broadly in line with the changes that we have discussed.

There are some points of principle that I would like to raise, and some background I should like to discuss. I presume that the shift to a more generous income tax relief and the abolition of the capital gains tax shelter largely reflect the fact that there have been very few capital gains to shelter during the past few years. I presume that the industry has therefore told the Government that there is not much incentive provided by the capital gains tax deferral for the present.

It would be helpful if the Minister made clear what the Government really mean by limiting the extra income tax shelter to a two-year period, and what they meant in announcements about the abolition of the capital gains tax deferral all together. I understood that the Government intended to review the situation in two years' time and that—if they were still in power, and we had not come in and changed things—in principle they might switch back to the existing arrangements and stimulate venture capital investment, if they felt that capital gains deferral was likely.

However, from the way in which the announcements were made, it has come across to many that capital gains tax deferral is dead and gone for ever, that the higher rate of income tax is only for two years and that this is really about the Government looking to phase out the VCT altogether. Clarification on that central issue would be helpful.

A venture capital management company, which I regard as among the most professional and conscientious, wrote me a long letter saying that it

was pretty uncomfortable about the changes, although they looked attractive on the surface. It said that the changes could have some undesirable effects, and that they had not been thought through.

The company's argument was that capital gains tax deferral was a suitable tax incentive for long-term venture capital investments, and that, typically, a period of 10 years or so should be allowed for a normal venture capital investment to fructify. With a VCT, the expected process is that some investments will go bust, some will do nothing and some will do well. The company said that that should not be thought of as an income tax avoidance vehicle, and that the focus should be on the long term.

There is a danger of bringing in a 40 per cent. income tax incentive similar to that which operated under the old business expansion scheme under the last Conservative Government, and which started to get structured and designed as a tax shelter vehicle rather than as a long-term venture capital vehicle. I think that there is something in those concerns, and I would be interested to hear what the Minister has to say about them.

When one makes a VCT investment to shelter capital gains tax, there is a clear message that one is in it for the long term. In the marketplace, there will be considerable temptation to structure VCTs to attract shorter-term savings of income tax, and doing that would affect the sort of investments that VCTs make. For example, it might be more attractive and safer to invest in companies that are in essence off-balance-sheet financing vehicles for larger companies and give a safer type of return, than to make genuine early stage long-term venture capital investment, which of its nature is very uncertain. There is some possibility that it could make VCTs that really are long-term early stage investment vehicles more difficult to market above those that address the income tax shelter market.

To go back to my earlier comments, that is why it is important for the Government to get across their message very clearly. My understanding is that the provisions in clause 89 and schedule 19 are a short-term, palliative measure to retain some incentive for the venture capital industry because, with the fall in the securities markets, very few people have capital gains to shelter, and that, in a couple of years, the decision might be taken to revert to the regime that is now being left behind. I hope that that is the case, because that might reduce the risk of the increased income tax advantage slightly distorting what venture capital trusts invest in and the way in which they are used. Our amendment No. 27 is a probing amendment dealing with just that issue.

The provision is generally sensible, welcome and understood, but we would appreciate the Minister's response to those concerns and thoughts.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West 11:15 am, 20th May 2004

I have a brief question for the Minister. Does ''issued'' in subsection (1) in line 22 on page 79

mean the same as ''allotted''? If not, is it really the Government's intention to use ''issued'' or ''allotted''?

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

The hon. Member for Arundel and South Downs made several general comments on the clause and raised two points of principle. I shall do the same and deal with some of the more detailed aspects when we come to the schedule.

The clause and the schedule make a number of improvements to the incentives to individuals to invest in the venture capital trust scheme and relax the rules relating to companies that are invested in. Taken together, they mark a significant change in the attractiveness of VCTs to investors and to smaller companies seeking finance from them.

For shares issued by a venture capital trust between 6 April 2004 and 5 April 2006, the rate of income tax relief available to investors is doubled from 20 per cent. to 40 per cent. The maximum amount of the investment on which that relief can be claimed is also doubled to £200,000 a year. Those measures should greatly stimulate investment in VCTs.

The hon. Gentleman asked me about removal of capital gains tax deferral. That is a longer-term structural measure, not something with a temporary rationale. That provision is one of the tax aspects that has contributed to unsustainable fluctuations in VCT funding year on year. By removing it, we believe that we will make this less susceptible to the peaks and troughs of VCT funding. An unreliable or unstable investment flow through VCTs can hamper both the investment fund industry and smaller companies that are looking for investment and relying on it through that route. The facility for deferring capital gains tax by reinvesting a gain in VCT shares is being abolished for shares issued after 5 April 2004.

To link the two principal points made by the hon. Gentleman, we believe that the temporary increase in income tax relief more than compensates for that. The increase in the income tax relief is aimed at a temporary stimulus to increase investment in VCTs. No longer-term decisions have been taken, but we will look at the position in detail before the two years have passed.

I hope that I have been able at least to make clear the rationale and our thinking behind the changes. We are also relaxing the rules for companies in which VCTs invest, but the details are largely in the schedule, so I shall not dwell on them now.

In summary, the changes constitute a response to the many representations made to us and have been warmly welcomed by the venture capital industry. For example, the European Venture Capital Journal reported that the

''UK Chancellor of The Exchequer Gordon Brown gave a potential shot in the arm to the fund raising efforts of Venture Capital Trusts''

in his Budget.

It being twenty-five minutes past Eleven o'clock, The Chairman adjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Two o'clock.