Schedule 19 - Venture capital trusts

Finance Bill – in a Public Bill Committee at 2:45 pm on 20th 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 2:45 pm, 20th May 2004

I beg to move amendment No. 27, in

schedule 19, page 369, line 23, leave out from beginning to end of line 7 on page 370.

Photo of John Butterfill John Butterfill Conservative, Bournemouth West

With this it will be convenient to discuss the following amendments:

No. 28, in

schedule 19, page 374, line 23, at end insert—

'17 (1) Schedule 33 to the Finance Act 2002 (Venture Capital Trusts) is amended as follows.

(2) After paragraph 7 insert—

''7A Without prejudice to the generality of the foregoing of this Part of this Schedule, a VCT-in-liquidation or a VCT-in-liquidation that has been wound up shall be deemed to remain a VCT (that is to say, a company whose shares are deemed to be shares whose approval as a venture capital trust is not withdrawn) for the purposes of Schedule 5C of the Taxation of Chargeable Gains Act 1992''.'.

No. 29, in

schedule 19, page 374, line 23, at end insert—

'17{**th**}(1) Section 151A of the Taxation of Chargeable Gains Act 1992 (Venture Capital Trusts: Reliefs) is amended as follows.

(2) At the end of sub-section (1) of that section, insert—

''save that a loss arising on the disposal of such ordinary shares shall be an allowable loss in the case where and to the extent that a claim was previously made under paragraph (2) of Schedule 5C to this Act and the expenditure on such ordinary shares was treated for the purposes of that schedule as qualifying expenditure.''.'.

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

I should welcome you to the chair this afternoon, Sir John, and I apologise for not doing so earlier.

All three amendments are probing. The first is designed to tease out whether the Government statement means the deferment of CGT relief is to be abolished for ever. I repeat the point that I had understood in discussion with others that in nearly two years' time the regime would be up for grabs—all things being equal—and a decision could be made to revert to the present regime. What the Economic Secretary has just said confirmed that the Government are not thinking of leaving that option open for the future. That is a mistake; very different circumstances may prevail in future.

When I was going through amendments Nos. 28 and 29 last night, I thought that they were not very good. The tax position on venture capital projects that go bust, be they VCTs or enterprise investment schemes, is complex, and one forgets what the rules are.

Circumstances have arisen in which venture capital investments that have had the income tax shelter and that of CGT deferral go bust and, at best, the investor is left to refund the 20 per cent. income tax allowance. The previous Conservative Government introduced the measure, and although its logic is clear, the other side of the coin is that people would have been better off never having risked their money in the first place, paying their capital gains tax and leaving the money in the bank. Well, fair dice—take a risk and hard luck if it does not work—but that has seriously damaged the perceived attractions of venture capital investment. Money has dried up not just because people have had less capital gains tax to defer, but because they have had the unpleasant experience of finding that a lot of their investment has gone bust and that they have a tax refund bill at the end.

The rules are incredibly complex. From my own experience, finding out when something has gone bust and precisely what the tax rules are has burned up hours. I corresponded with Sir Nick Montagu about that and he admitted the problem but said that it was too difficult to address. It is a very complex and tedious aspect of taxation. Ultimately when businesses go bust the tax situation is relatively harsh.

I stray a little in talking about EIS investments, which are a little more specific and cut and dried than VCT investments. It is unusual for VCTs to go bust because of their spread of investments, but in market value terms many have done extremely badly and stand at one third of their start-off value.

We are also moving to a time of possible enforced realisations. Although the five-year rule has been changed to three years for income tax, it has happened only latterly. For the great majority of venture capital money, if the loss crystallises in five years, the income tax charge must be fully refunded.

The rules about how one can take capital losses were complex. In some cases, it was a 100 per cent. loss and one could take it against income if one had enough to take; in others, and I have forgotten the

technicalities, one could obtain a capital gains tax offset.

The point of the amendments is to highlight the fact that when things go completely bust or pretty badly for historic venture capital and VCT investment, the tax situation is complex and harsh. That is one reason why people are jaundiced by it; if nothing else they did not expect the situation to arise. I freely admit that the previous Conservative Government introduced the regime, but as with the changes today no one thinks about the future. People's knowledge of their tax position and its tax consequences is unsatisfactory.

The amendments are rather crude and do not work particularly well because they would either add no advantage or create too generous an advantage. However, they highlight a problem that underpins one reason why people are less keen on venture capital trusts. The Economic Secretary will say, ''We are not interested in the past, so hard luck on those poor devils, but changing to an income tax regime means a new regime that will have its own attractions.'' However, it has its own potential weaknesses as well. Does the Economic Secretary have any thoughts about addressing the complexities of the tax situation and its relative harshness for venture capital investments that go back for years? Do the Government have any proposals to address those problems?

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

The hon. Gentleman describes his amendments as probing. I hope that he feels that, on the first of his concerns, which is raised in amendment No. 27, he probed sufficiently during the debate on clause 89. I simply say to him that venture capital is a dynamic industry; it constantly strives to alter its attractiveness to investors. We want the flexibility—as a Government, I think it right that we claim it—to ensure that we can respond accordingly and play our part in ensuring that VCTs remain attractive. We will consider how to do that during the next two years.

Amendment No. 27 seeks to reverse the abolition of the CGT deferral relief for investors. I hope that I have explained why that would be a backward step and given the hon. Gentleman the information—if not the reassurance—for which he was probing.

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

Thinking back, I heard the Economic Secretary say that there would be no consideration of a changed regime that might bring back CGT deferral. He then talked, slightly more generally, about the situation being open. I want to know whether the Government's position is that there is a clear understanding, as per the original announcement, that this is the end of CGT deferral.

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

If the hon. Gentleman consults the Official Report for the Committee, he will see that I did not, at any point, say that. I explained why we have taken the view that CGT deferral relief exacerbates some of the cyclical problems of VCT fund flows. He will have heard me say that the majority of respondents to our consultation were of a similar view and wanted reforms such as those in clause 89 and this schedule. At no time will he have heard me say that anything is ruled out as we take stock during the next two years and consider what we should put in place to try to maintain the attractiveness, and

maximise the volume, of investment funds through VCTs.

On amendment No. 28, I remember the proposal that the hon. Gentleman made during the proceedings on the Finance Bill in 2000. I also remember the discussion that we had in Committee during the scrutiny of the Finance Bill in 2002 when, as a Government, we provided for VCTs to merge or, as relevant here, to wind up in an orderly fashion without risking the loss of VCT tax reliefs, about which the hon. Gentleman was consistently concerned.

It may be more appropriate to discuss this point in the debate on the next group of amendments, but I just say that, although the hon. Gentleman talks of VCTs going bust, I am not aware of any doing so, and nor are my advisors. If the amendment's purpose, apart from probing, is, as I think, to ensure that a VCT in liquidation—what, in draft regulations, would be termed a VCT that is winding up—would be treated as continuing as a VCT so that CGT deferral relief was not revived solely on account of the winding up, I can reassure the hon. Gentleman that the provisions in schedule 33 of the Finance Act 2002 are already adequate.

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

I thank the Economic Secretary for that response. As I said, the amendments were tabled to air some issues. I shall just comment on his last point. What I was trying to get at was slightly wider. In situations in which a gross investment in a VCT of £100 ends up being worth £10 or £20, which is not at all uncommon, or—this is really more relevant to EIS investments—in which individual venture capital investments go bust, as a large proportion do, investors generally find themselves in a rather more unpleasant situation tax-wise than they had anticipated. The CGT deferral comes back into play, and, if the period is less than five years, the income tax bill is restored. There are certain circumstances in which capital losses can be offset against income and others—I have forgotten how they work—in which one can actually claim a capital loss, but there is generally pretty bad news tax-wise when venture capital investments fail.

Both amendments were designed to raise the point that situations of total failure, which I grant are more suitable for EISs than VCTs, or of substantial loss have been a significant turn-off to VCT investment. There is probably no pragmatic argument for doing anything about that—there is a case for looking to the future—but the Revenue might look at the issue in more detail.

Finally, something that is not in the amendments at all but is relevant is the administration, which is a complete nightmare. It is difficult to define when something has gone bust, and the hassle for people filing tax returns when venture capital investments fail is formidable. That also is a big deterrent. What looks nice up front turns out to be a nightmare when it goes sour. I was simply asking whether the Government were at least considering the matter. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

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

I beg to move amendment No. 32, in

schedule 19, page 374, line 23, at end add—

'17 (1) Schedule 33 to the Finance Act 2002 (Venture Capital Trusts) is amended as follows.

(2) After ''Obtained'' in sub-paragraph (2) of paragraph 8 (Power to facilitate mergers of VCTs) insert ''but not subject to any condition that would prevent a merger of two or more companies in the case where one company makes an unsolicited offer for the shares of one or more other companies (or otherwise makes an offer for such shares that has not been agreed by such other companies).''.'.

Photo of John Butterfill John Butterfill Conservative, Bournemouth West

With this it will be convenient to discuss amendment No. 33, in

schedule 19, page 374, line 23, at end add—

'17 (1) Schedule 33 to the Finance Act 2002 (Venture Capital Trusts) is amended as follows.

(2) In paragraph 10—

(i) subparagraph (1)(b)(i), after ''company'', insert ''such that company A comes to possess voting power in excess of 50 per cent. of the shares in the other merging company''.

(ii) in subparagraph (2)(b)(i), after ''company'', insert ''such that company B comes to possess voting power in excess of 50 per cent. of the shares of each of the merging companies''.'.

Photo of Mr Howard Flight Mr Howard Flight Shadow Chief Secretary To the Treasury, Economic Affairs, Shadow Chief Secretary to the Treasury 3:00 pm, 20th May 2004

The amendments are not probing amendments but endeavour to be explicit. The Economic Secretary was kind enough to refer to my proposal in 2000 and to the Finance Act 2002. I had raised the need for mechanisms to sort out venture capital trusts. Some are done well, some are done badly, takeovers are required and so on. Rationalisation was, in essence, blocked by the rules governing VCT investment because if trusts did not invest in a security that met the definitions, they disqualified themselves. The point was taken by all sides and provisions were introduced in the 2002 Act to implement it. However, nothing has happened yet. There have been several consultations, but we still do not have secondary legislation to implement the principles in the 2002 Act. First, on a practical point, when will that happen? We are two years later on.

Secondly, the amendments address two practical issues, and from my knowledge of where the Revenue has got to I do not understand the problem. The Revenue has insisted within the regulations that mergers should be agreed, but that will never be achieved unless there are common fund managers. The fund manager of a VCT will probably resist it because they lose the business of running it and the number of voters in such situations is never an overwhelming majority. It would be entirely healthy to permit hostile bids, as they would shake out the market. In producing the regulations, is the Revenue still insisting on agreed mergers? If so, that is inappropriate.

The Revenue proposes that where there is a share-for-share offer by one VCT for another, more than 90 per cent. of shareholders should be required to accept it in order for a merger to qualify for VCT relief. Given the average size of VCT investments, which round up to £25,000, if that, the chances of getting 90 per cent. of shareholders to vote at an AGM are remote to say the least. That is why the amendment

suggests a 50 per cent. target, but even that will not be easily achieved.

We are two years down the line from the measure in the 2002 Act. There have been nine drafts of the regulations and still nothing has happened. I do not know whether I have got this right, but if the two issues that I have mentioned are the sticking points, I cannot see why the latter cannot be resolved by a 50 per cent. vote and the former by removing any requirement for agreed mergers.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

I understand what the hon. Gentleman means when he talks about 50 per cent. of the voting power, but he also referred to 90 per cent., which in the Bill is

''90 per cent. of the issued share capital . . . and not less than 90 per cent. of the voting power''.

Why in amendment No. 33 has he not referred his 50 per cent. to the issued share capital as well as to the voting power?

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

I thank the learned hon. Gentleman for his comment. The answer is that it should be there, for which I apologise.

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

The hon. Gentleman made three points: he contested the idea that mergers must be agreed; he argued that in this field hostile takeovers are a good thing; and he stated that 90 per cent. of the votes is too high a merger-acceptance figure. I hope that I can be helpful as I explain our position and the approach that we plan to adopt.

As the hon. Gentleman says, amendments Nos. 32 and 33 attempt to change the primary legislation that introduces regulations allowing VCTs to merge with each other or wind up in an orderly fashion without jeopardising the generous VCT tax relief. Far from nothing happening, the next draft—he may be right that it is the 10th draft—of the regulations that provide for the merger and takeover of VCTs is imminent. The Inland Revenue and the VCT industry have been working very closely and hard on the issue. It has proved to be a highly complex area, which has been quite resource intensive for both sides, not least in terms of the paper that has been used for the drafts. We aim to have the next draft of the regulations available about the end of next month.

The hon. Gentleman will be pleased to have confirmation that amendment No. 32, which aims to prevent the VCT merger regulations from imposing conditions that prevent the VCT tax reliefs from being available in circumstances where there is a hostile takeover by one VCT of another, mirrors the point put to us by the industry following the last exposure of the draft regulations. Having considered his arguments and suggestions carefully, we agree and accept that the amendment has merit, and the next draft of the regulations will reflect that accordingly.

Similarly, amendment No. 33 reflects a point that has been made to us by the industry following the exposure of the previous draft of the regulations, which rather underlines the value of the process of drafting, exposing and re-drafting regulations in order to get them as right as we can. The draft stipulated that the acceptance figure needed for a VCT merger to fall within the regulations would be set at 90 per cent.

of the vote. We recognise and accept that to achieve 90 per cent. acceptance before a merger can proceed might create practical difficulties. I assure the hon. Gentleman that the next draft of the regulations will deal with that point and set the level of acceptance for proposed mergers at 50 per cent., as he proposes in amendment No. 33. With those assurances, I hope that he will consider withdrawing the amendment.

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

I am delighted to hear those confirmations from the Economic Secretary. Can I just ask him please to get it done by the time of the next election, which as he well knows may well be in the autumn? Two years is enough, and the industry needs a lot of sorting out as soon as possible. On the basis of his remarks, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Schedule 19 agreed to.