Schedule 4

Finance Bill – in a Public Bill Committee at 6:30 pm on 15th May 2007.

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Restrictions on trade loss relief for partners

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury

I beg to move amendment No. 62, in schedule 4, page 98, line 34, leave out from beginning to end of line 34 on page 100.

Photo of Eric Illsley Eric Illsley Labour, Barnsley Central

With this it will be convenient to discuss amendment No. 63, in schedule 4, page 99,line 11, leave out ‘£25,000’ and insert ‘£100,000’.

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury

As I have just said, we have grave concerns about schedule 4. The amendment would delete proposed new section 103C of the IncomeTax Act 2007, which is proposed in paragraph 1 of schedule 4. In so doing, the amendment would remove the Government’s restriction on sideways loss relief for non-active partners, as proposed in the schedule. Sideways loss relief allows a partner to set off partnership losses against other income. I understand that it has been part of our tax system for more than50 years. Sideways loss relief is designed to give relief in the early years of a partnership, when losses might be high, as they often are with a start-up business.

In schedule 4, the Government propose a two-stage restriction on sideways loss relief. Proposed newsection 113A of the 2007 Act would disallow any sideways loss relief for arrangements, where one of the main purposes of entering the transaction was tax avoidance. That might not have caused an enormous amount of controversy. There would have been issues to explore around the purpose test and the scope of the proposals, but they would not have caused huge concerns. However, the Treasury proposes to go much further with new section 103C. That will impose significant restrictions on ordinary commercial ventures that are not motivated by tax avoidance. To obtain full sideways loss relief under the proposals in schedule 4, a partner will have to spend 10 hours a week working personally on the partnership’s business. For those partners who do not devote 10 hours a week to the venture, the sideways loss relief that they can claim is limited by the schedule to £25,000.

As the Institute of Chartered Accountants has pointed out:

“The measure is not targeted solely at tax avoidance schemes...The result is that the measure will impact upon many small businesses being set up with substantial investment in the early years.”

The London Society of Chartered Accountants has expressed concern that schedule 4 means that many deserving investment projects will now never see the light of day. It urges the Government to reconsider, and so do the Opposition.

That is why I tabled amendment No. 62 to delete the 10-hour condition and the £25,000 cap. Amendment No. 63, to which I shall come at the end of my remarks, is proposed as a compromise alternative to raise the cap from £25,000 to £100,000, although in our view it would be preferable to opt for amendment No. 62 and the complete deletion of proposed new section 103C.

I point out also that the Committee will soon have the opportunity to consider amendments Nos. 64 and 65, which form a key part of a package of proposals that the Opposition suggest in relation to schedule 4. They would restrict sideways loss relief to those ventures that can pass a demanding threshold designed to show that they are commercially motivated ventures, not artificial tax-avoidance schemes. We recognise that some of the schemes that have utilised sideways loss relief have caused problems in terms of revenue leakage from the Treasury. We do not oppose efforts by the Government to shut down abusive and artificial  schemes that are motivated only by tax avoidance and that do not involve genuine commercial risk. However, we are worried that vital commercial ventures will be hammered by the Government’s attempts to shut down problematic tax-avoidance schemes.

The package comprising amendments Nos. 62,64 and 65 is aimed at giving Her Majesty’s Revenue and Customs the power to shut down abusive schemes, but without clobbering genuine enterprise and investment. The Opposition fear that, unless those amendments are adopted, schedule 4 will have a very damaging effect on high-risk investment and small business start-ups.

The first point to make about schedule 4 centres on the way in which the changes were announced on Friday 2 March this year. They were rushed out right at the end of the financial year, when many people had made their plans on the basis that the reliefs would be available. The changes will impact on many ventures in respect of which investments have already been committed on the basis of the existing tax system. Now, investors have had the rug pulled from under their feet, and they find themselves at risk for large amounts of money with no prospect of relieving potential losses in the way in which they had envisaged.

I have received protests on that point from many people, including Mr. Wood of Morgans Independent Advisers, Jeff Moores of Moores Warren, and Richard Grant of Pantheon Financial Management. They point out that the legislation impacts unfairly in treating partners in the same arrangement differently according to whether they contributed earlier or later in the tax year, even if both investments were made before these provisions came into effect. That might not be such a huge problem if the only arrangements hit by the changes were dubious and artificial tax-avoidance schemes, but as I have said, that is not the case. The retroactive nature of schedule 4 adds to the concern of the Opposition about the measures and their impact on ventures and contracts agreed on the basis that sideways loss relief was available.

The Committee may be aware that there was a rapid U-turn when the proposals were initially announced. They were initially due to cover film tax reliefsunder section 42 of the Finance (No. 2) Act 1992 and section 48 of the Finance (No. 2) Act 1997. Within, I think, three working days, there was a rapid about-turn, and the Treasury decided that section 42 and section 48 reliefs would not be restricted. That certainly seemed to make sense, because only a few weeks before that the Treasury had announced a temporary extension of those reliefs. The assumption seems to be that, the section 42 and section 48 problem having been solved, this sorts out the film industry, but that is not the case.

No doubt the Minister will quote back at me statements that suggest that not everyone in the film industry is worried about the remaining provisions in the Bill on sideways loss relief, but I have received a number of very concerned representations on that issue. The film industry has found sideways loss relief so important because of the high degree of risk involved in a film project. It is very difficult to predict in advance whether a film will be successful. Hence, investment proposals are often based around investing  in a number of films. The assumption is that, if one backs 20 films, there is a chance that one of them might make money and offset some of the losses from the others. That becomes impossible with the abolition of sideways loss relief.

Sebastian Speight of Ingenious Media has told me that two high-profile UK films, “St. Trinian’s” and “Brideshead Revisited”, had seen their private investment withdrawn as a result of the announcement in schedule 4. These films were relying for up to a third of their funds on investors expecting to be able to reduce the risk of the investment by using sideways relief. Those films were rescued by the Film Council, but it remains a concern as to how other films will find funding in the absence of sideways relief. Mr. Speight put the problem as follows:

“The new film tax credit will provide 20 per cent. of the cost of making a film. However, for larger projects, it is difficult to see where the remaining finance will come from beyond a few national and local grants. Big films need a critical mass of investment before they can be undertaken and this restriction makes it much harder to get.”

The issue here is that part of film funding which is not covered by the film tax credit. Sideways loss relief reduces the high risks for investors who are asked to provide the 80 per cent. of funds that are not covered by the tax credit. The Government’s film tax credit will not work if projects find it impossible to raise the other 80 per cent. of funds that they need. Restricting sideways relief makes that much more difficult.

Variety magazine said that scrapping sideways loss relief would “gut British film production”. Patrick McKenna, a film investment expert, has pointed out that films such as “Vera Drake” or “Girl with a Pearl Earring” would not have been made without sideways loss relief. He told me that many films that are already in production or about to go into production may not now be made. He said:

“The Revenue have taken a very blunt instrument to deal with this. It has not discriminated between bona fide investment and tax abuse.”

Photo of Stephen Timms Stephen Timms The Chief Secretary to the Treasury

I have listened to the hon. Lady’s argument with interest. She has acknowledged that the new film tax relief will provide 20 per cent. of funding for films, but she is saying that that is not enough. I presume that she is saying that the public purse should provide a still higher proportion. What proportion does she think should come from the public purse towards the cost of producing a film?

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury

I am saying that the Government should not abolish sideways loss relief, because that relief is reducing the risk that investors face when they go into a film project.

Coupled with restrictions on venture capital trusts, these measures could cause significant problems for the film industry, and the problems for the film sector are replicated in other areas of the creative industries. As with a film project, predicting how the public will respond to a new computer game, for example, is much more difficult than, say, developing a new soap powder or shampoo. Again, sideways relief allowed investors to take a punt on risky proposals for new games,  knowing that at least they had the protection of being able to set losses off against other income. I would like to ask the Minister if the Treasury has conducted any research whatsoever on the impact that schedule 4 would have on the hugely important computer games industry.

It would be wrong, however, to think of this issue as a film tax issue, or to think that the creative industries are the only ones that will be affected. The Chancellor has often referred to the “funding gap”, in other words the difficulty that many start-ups have with raising finance. We have always been a nation of inventors and innovators, but far too often we have had difficulty turning those ideas into commercial reality. Sideways loss relief has been one of the few useful mechanisms for bridging that funding gap, and now the Treasury wants to scrap it.

A number of distinguished academics have indicated serious concern about the impact of schedule 4 on scientific research, which is also something that the Chancellor has repeatedly said that he wants to encourage. Professor Ian Swingland, founder of the Durrell Institute of Conservation and Ecology and Emeritus Chair in Conservation Biology at the University of Kent, has said:

“At least 10 per cent. of high-risk research will be destroyed by this aggressive move against collective investment, and probably more. Many investors will be dissuaded from funding key environmental projects rather than use other existing highly bureaucratic mechanisms. If environmental research and development is to grow in the UK, it is essential that sideways loss relief continues to be available for high-risk and innovative ventures.”

He expanded on those concerns in a letter published in the Financial Times this morning.

The impact of schedule 4 on crucial emerging markets for environmental technology has been raised with me by a number of people. Martin King, who leads the Silver Planet consortium of investors in environmental technology, told me:

“I and a number of colleagues have organised high risk venture funding via Business Angels using the sideways relief that was available to offset failed investments...The changes proposed...in the draft Finance Bill mean that partnerships will not now invest in high risk ventures and in particular research which has been particularly targeted by Treasury. Already we have had to turn down over 20 projects that were of a very high risk nature...Obviously we have informed all those organisations that they cannot be funded in this traditional way and I assume they will have to look overseas for their funding...HMRC have suggested that funding could be switched to State approved schemes such as EIS and VCT but most business angels find the bureaucracy and severe limitations these schemes have to be a real deterrent... Equally the HMRC suggestion that Banks will replace this kind of funding is ludicrous.”

Tony Blakey, founder of Ethical Trading and Marketing, contacted me to express his grave concern about the impact of schedule 4 on projects to develop technology that is effective in tackling climate change. He is involved with a number of revolutionary projects in areas such as tidal energy, applied accelerated tree-growth technology, accelerated community biomass technology and environmentally-friendly biodiesel production. He believes that if such projects prove successful, the technology that they harness could produce low-cost renewable ways to cover a significant proportion of the world’s energy needs. He tells me that up until 2 March, the UK had a very significant share of that developing market,  but now all the projects are likely to go offshore as a result of schedule 4 to Germany, Pakistan, Brazil and other countries. Funds dried up as soon as the 2 March announcement on sideways relief was made.

Mr Blakey told me:

“The abolition of sideways loss relief has significantly reduced the number of investors willing to risk early stage research funding...Partnerships currently fund vital environmental projects like tidal energy, biodiesel, and accelerated tree growth...These projects cannot now be completed using partnership funding...Foreign investors will benefit as the projects will no longer be controlled or owned by the UK.”

The problem is that no one knows which research will yield results. Of 50 projects to accelerate tree growth to produce cheap environmentally-friendly energy, 49 might fail. Before now, investors at least had the cushion of sideways relief to soften the impact of the losses. The Government propose to remove that cushion, so the risk becomes higher and the funds more difficult to obtain.

Chris Dodson of Torftech Ltd has also written to me about a range of environmental energy projects that are being shifted overseas as a result of the changes proposed in the Bill. The Chartered Institute of Taxation has told me that schedule 4 is jeopardising projects to make use of the special capital allowances introduced by the Chancellor himself in 2003 to encourage environmental technology.

Rupert Lywood, to whom I referred on Second Reading, is an investor in a partnership pursuing research and development work on lung and bowel cancer vaccines. He is concerned about the impact of schedule 4 on existing and future medical research projects. He commented:

“Investment in private medical research is very high risk, projects such as cancer vaccines research and development couldn’t be contemplated without the availability sideways loss relief...These proposals have a retroactive effect on existing projects and will undoubtedly jeopardise potentially life-saving medical research and the opportunity for UK businesses to lead in important fields of research and profit from international exploitation of newly developed technologies.”

Mr. Lywood tells me that important existing projects on cancer, HIV and multiple sclerosis have already been put in jeopardy by schedule 4.

The proposed 10-hour limit is fundamentally unsuited to this kind of project. Many of the business angels hit by schedule 4 will have investments in a wide spread of high-risk projects. They need to take that approach to spread their risk, and they cannot possibly find 10 hours in every week to devote to each project. The restriction simply misunderstands how such investment projects work.

Nor can HMRC’s approved investment schemes plug the gap left by the abolition of sideways loss relief. HMRC’s response to the concerns expressed about schedule 4 is that those affected should use one of the Government’s state-approved arrangements, such as the enterprise investment scheme or venture capital trusts. Such schemes simply will not take up the slack, because the amounts that can be put into them are limited and, in many ways, they can be bureaucratic, inflexible and expensive to run.

Rupert Lywood has said:

“Everyone supports measures to counteract tax avoidance, but that’s not what these proposals do. What they do, is to create  powerful disincentives for individuals wishing to invest in bona fide commercial enterprises which would enhance the UK’s competitiveness and wealth-creation. The Government has reneged on its promise not to use these provisions to disadvantage business. The incentives delivered through the Enterprise Investment Schemes and Venture Capital Trusts have been steadily eroded over recent years to the point where they are now, in practical terms, almost irrelevant as a source of serious capital for new or developing businesses. Sideways loss relief was the last real practical incentive available to encourage private investment is growing enterprises, its removal is completelyat odds with the Government’s objective to encourageenterprise”

The Institute of Chartered Accountants has expressed concern about the impact of schedule 4 on start-up businesses that source finance from family and friends who become non-active or sleeping partners, and it has given a number of examples of micro-business start-ups involving family members that could be hit. Those micro-businesses already face increasing corporation tax rates and possibly problems with the MSC regime, and they are thumped again by the loss of sideways relief that would have provided assistance in the difficult early years of any enterprise.

Amendment No. 63 would increase the cap on sideways relief from £25,000 to £100,000. Of course, if amendment No. 62 were adopted, the need for that change would fall away with the deletion of the cap. I tabled amendment No. 63 for two reasons. First, it is a compromise. If the Government were not able to accept the complete deletion, they might mitigate the damage of section 103 by raising the cap. Secondly, it allows the Committee to probe the Government’s rationale for the £25,000 cap. In making a similar request, the Institute of Chartered Accountants points out that no justification has been given for the imposition of the £25,000 limit—the figure seems to have been plucked out of the air, so I should like the Minister to explain why that figure was chosen.

In conclusion, the Chancellor says that he wants to plug the funding gap, but he is ripping away one of the few measures that helped to do that. In his Budget statement, he said that he wanted the UK to be a world leader in the discovery and development of new energy technologies, yet in the very same Budget, he was proposing to abolish a key tool in driving forward that discovery and development. Schedule 4 would damage the film industry, damage enterprise and investment and damage many projects vital to tackling climate change. I urge the Chief Secretary to think again about schedule 4 and to consider accepting the amendments that I have put forward.

Photo of Philip Dunne Philip Dunne Conservative, Ludlow

At the risk of trying your patience, Mr. Ilsley, and that of other members of the Committee, I wish to contribute at this late hour to the debate on this amendment, because of all the aspects of the Bill, this schedule is the one that will cause most damage to the structure of enterprise in this country and to innovative investment. It is the measure on which I have received the most comments from outside this place, and the one on which I urge the Chief Secretary, whom I know to be a reasonable man, to take note of the arguments that have been so well put by my hon. Friend the Member for Chipping Barnet. He should think again about its impact and what it will do to the  growing entrepreneurial and innovative investment climate that has been cultivated in part under his Government—let me give credit where it is due.

The measure will have a major impact in driving investment offshore and shutting down a large proportion of high-risk investment in this country. I should remind the Committee that I am a partner in two partnerships, a farming partnership and an investment partnership. Although they have been going for a long time—they are not new partnerships, so the measure would not directly apply to them—I have experience of investing in partnerships. I know that they provide a valuable structure, not for tax avoidance but for suitable flexible equity involvement in a business by both active partners and those who retire or become less active, as I did when I came into this place. We are at risk of diverting investment activity out of a good structure that exists for positive reasons into sole trading or individual investment, or into a corporate structure in which the ability to offset losses against other kinds of income is not currently threatened. The measure will divert business activity in an entirely unintended way.

The ministerial statement of 2 March from the Paymaster General sought to clarify why the clause was being introduced. She stated:

“The capital contributions to be excluded will be those paid by non-active partners on or after 2 March 2007 where the main purpose, or one of the main purposes, for contributing the capital to the partnership is for the partner to obtain a reduction in tax liability by means of sideways loss relief.”—[Official Report, 2 March 2007; Vol. 457, c. 105WS.]

That is an appropriate measure to deal with tax avoidance, and the Conservative amendments seek to achieve the Government’s precise objective. Their measures will restrict all sorts of other bona fide commercial activity.

Let me pick up on one other point. Thought has clearly been given to what types of activity will be affected. The ministerial statement specifically carved out high-risk underwriting at Lloyds as an activity that should be exempted from the clause, and it is exempt under proposed new section 103C(8). As my hon. Friend said, there was a U-turn over the film industry, as a special exemption was sought for qualifying expenditure for films, which can now be found in proposed new section 103C(6). However, the ministerial statement referred to professional firms as exempt, but that does not appear in the Bill. Why has the Chief Secretary had a change of heart? Where is the logic behind that decision? If special pleading by a particular industry has found favour in the Treasury and in the Chief Secretary’s deliberations, will he think too about the special pleading on behalf of investors—business angels of the type described by my hon. Friend?

Time is pressing and hon. Members will wish to move on, but I have two more questions. The measure is designed to get at losses generated from the early stages of a partnership. When the Chief Secretary sums up, will he confirm that the provisions will not apply to partnerships that have existed for some time but where losses might legitimately arise as a result of the business getting into difficulty a year or two later? That is not clear from the explanatory notes.

As far as the two limits on working hours and the amount of money that can be invested are concerned, it seems extraordinary that the drafting should apply in such a way that in order to qualify for sideways relief, individuals will be compelled to spend 10 hours a week—presumably the Government will not encourage them to breach the working time directive, so that is25 per cent. of their working time—committed to a project. Most people who invest in high-risk projects and wish to benefit from sideways loss relief are doing so because they are entrepreneurial investors with other activities. They do not necessarily have the relevant skills to work for 10 hours a week in the business.

My hon. Friend referred to individuals who had engaged in biotech research. They might well be entrepreneurs with a commitment to developing new vaccines or environmental energy projects, but they might not necessarily be scientific boffins who could spend the time doing so, and, because of their other activities, they might not have the time to promote the business. There is a lack of logic to the 10-hour limit and an equal lack of logic to the £25,000 limit. If the amendment is put to a vote and not accepted, I urge the Chief Secretary to go away and come back on Report with a more considered clause.

Photo of David Gauke David Gauke Conservative, South West Hertfordshire 7:00 pm, 15th May 2007

I should like briefly to pursue one of the points that my hon. Friend the Member for Chipping Barnet made about film tax relief. She described how the Treasury’s original proposals appeared to rule out section 42 and section 48 film tax relief.

From my limited experience of the Committee this year and last year, as well as from my experience of a Committee on a statutory instrument, the Treasury devotes a fair amount of attention to film tax. In passing a lot of legislation in such an important and sensitive area, it has no doubt developed a highly skilled team, with much expertise in the field. I should therefore be grateful if the Chief Secretary could tell the Committee whether the Treasury’s film tax experts were consulted on the original proposals on sideways loss relief, and if not, why not. If they were, did they spot the difficulties that became apparent after the original proposals were announced? The Treasury appeared to do a U-turn in three working days, which is fairly quick. I have some experience of seeing the Treasury do U-turns on film tax, but they usually take a matter of months, not days.

The Treasury seems to be particularly sensitive to film tax and to ensuring that the burden does not drive films offshore. I assume that the reason for that is that the film industry is highly mobile, as well as highly innovative and high risk, as my hon. Friend mentioned. If the tax burden were greater, fewer films would be made and the Treasury’s tax revenue would therefore be reduced. I suspect that my hon. Friend the Member for Braintree would describe that as a perfect example of the Laffer curve in operation.

However, could the same principle apply to other sectors? My hon. Friend the Member for Chipping Barnet gave some examples of sectors that perhaps do not have such a well-developed lobbying capability and to which the Government are perhaps not always as sympathetic as they appear to be to the film industry. In the light of the difficulties that emerged with the film  industry, as a consequence of the abolition of sideways loss relief, has the Treasury given any consideration to whether any other sectors would be adversely affected by the proposals?

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

Once again, we seek through tax avoidance schemes to distinguish between organisations that are genuine commercial enterprises and those that are set up purely to avoid tax. The Chartered Institute of Taxation suggested that the Government consider introducing a motive test, which might have made a contribution, so I should be grateful if the Minister could say whether that proposal was feasible or not.

Photo of Adam Afriyie Adam Afriyie Conservative, Windsor

The schedule seems to reflect a fundamental misunderstanding of the investment environment. It confuses working for an enterprise for 10 hours a week with providing finance for risky ventures, and thereby plugging what is clearly a seedcorn finance problem for many creative industries. I therefore urge the Government to rethink the schedule.

Photo of Stephen Timms Stephen Timms The Chief Secretary to the Treasury

I do not want to try to the Committee’s patience unduly, but I certainly do want to respond to some of the points that Opposition Members have made.

The schedule changes the rules for offsetting the trading loss of a non-active or limited partner in a trading partnership against their other income and capital gains, which is known as sideways loss relief, as we have heard. The Exchequer has incurred significant and growing losses from the misuse of sideways loss relief by wealthy people who participate in partnerships not in anticipation of an investment gain, but purely to access losses—frequently highly contrived in nature rather than real—to reduce their tax on income or capital gains.

The new rules have been targeted specifically to halt that form of avoidance while preserving access to a significant degree of sideways loss relief for people who are not seeking to avoid tax. On a number of occasions, Opposition Members talked about the abolition or removal of sideways loss relief, but that is not correct. There is a limit in the schedule to the amount of sideways loss relief available, and the vast majority of sideways loss relief that is not motivated by tax avoidance falls within that limit. We are not withdrawing it.

Photo of Stephen Timms Stephen Timms The Chief Secretary to the Treasury

In a minute.

I want to make very clear the Government’s position in response to the points that have been made. We have a responsibility to block schemes for tax avoidance. The argument that some ancillary benefit arises from the scheme is not a justification for retaining the ability to establish such schemes. We have introduced a number of measures to encourage productive investment, such as the new film relief measures, and the research and development tax credit, which if I remember rightly, Opposition Members want to abolish. Ours is the proper way to encourage investment.

The claim that some tax avoidance schemes may lead to investment that would not otherwise have occurred is not a justification for leaving tax loopholes in place,  and the claims for the amount of investment that may take place are often grossly exaggerated. At the very least, tax avoidance schemes are a deeply inefficient use of public money. Sideways loss relief is not an efficient use of taxpayer funds for promoting the investment that we have heard about; it is deeply inefficient.

Committee members are perfectly entitled to believe that there is a need to use taxpayers’ money to promote investment in a part of the economy, and they are at liberty to propose measures to help, along the lines of the film relief or research and development tax credits. However, let us reject the argument that scams should be left in place because this or that incidental benefit arises from them.

It is very important that we are not naive about what is going on. FT.com on 10 March explained that the schemes

“work by generating trading losses in the first year which high net worth individuals have been able to offset against their earned income for tax purposes using sideways loss relief.”

It quoted Martin Churchill, editor of “Tax Efficient Review”, who said:

“Snipping the sideways loss relief has really choked up these schemes.”

The piece went on:

“He believes that £2 billion would have been poured into those schemes between now”—

10 March—

“and April 5”.

Mr. Churchill was quoted further:

“Everyone was gearing up to put significant amounts of money into these schemes. Bonuses gets paid in February and people don’t tend to do anything until the run up to the end of the tax year”.

We can get an idea of the impact of the change resulting from the announcement through published data on limited liability partnerships. In 2005-06, about 40 per cent. of the total number of partners in avoidance partnerships, which are set up for an avoidance purpose, were recruited after 1 March and before 6 April—just in time for the end of the tax year. In 2006-07, the most recent financial year, only 1.1 per cent. were recruited following the announcement.

The hon. Member for Chipping Barnet explained that amendment No. 62 would completely remove the proposed annual limit on sideways loss relief while amendment No. 63 would increase it to £100,000. We are dealing with a particularly aggressive form of avoidance whereby schemes consistently adapt their arrangements to get around the rules. It has become very clear that a purpose test alone will not deter it.

In response to the hon. Member for South-East Cornwall, there is a purpose test in the Bill, but there is also a limit. We need an annual limit to provide an additional deterrent to the purpose test and to make it uneconomic to challenge the intention of the legislation. An annual limit of £25,000 will achieve that deterrent, comparing the relief gained with the fees required to set up a scheme. A limit of £100,000 would not do so. It would provide a significant incentive to continue to use those schemes to avoid tax, even after allowing for the quite considerable promoters’ fees and for other costs.

In practice, more than 90 per cent. of losses incurred by people in the partnership population who are not motivated by tax avoidance are lower than £25,000. The vast majority of losses that arise to those who are motivated by tax avoidance exceed £25,000. An annual limit of £25,000 strikes the right balance between allowing non-avoiders access to sideways loss relief, while preventing avoiders from abusing it.

The cost of the more modest of these two amendments—raising the limit to £100,000—would be at least £150 million per year. Given behaviour changes on the part of the avoiders, in due course it would quite likely reach the full £400 million score against this measure in the Red Book. It could be more, but we have scored it at £400 million. Of course if the limit were £100,000, and it was economic to avoid tax still by this route, people would set up a whole string of these arrangements so they could continue to avoid tax in this way. I hope that I have explained the purpose of the annual limit and the reason that it is set at £25,000. I hope that the hon. Lady will agree to withdraw her amendments. If not, I shall certainly urge ask my hon. Friends to oppose them.

I should finally like to make a couple of points on films. The hon. Lady quoted a couple of remarks by people in the film industry. Let me just quote Andrew Eaton, co-founder of Revolution Films, who said:

“Everyone has been aware that there have been funds that have been able to make quite a lot of money out of tax schemes and haven’t always been putting money back into the business. There was a very strong sense across the industry that at some point those funds were going to be stopped.”

Indeed, a number of people in the film industry have made the point that what they want is a sustainable industry. It is ludicrous for the hon. Lady to say that the taxpayer must provide not only the 20 per cent. that the tax relief now pays, but the rest of the 80 per cent. cost of producing films too. The film industry is a commercial business like every other. It is in the interests of the industry that it should be viable and commercial.

Finally, I do not accept for a moment——and I did see the letter in the Financial Times this morning——that there will be a huge impact on investment in research and development companies. Since the announcement at the beginning of March, we have received just two specific responses from research and development interests to that publication of the technical note. We considered both those representations carefully, and we are confident that the rationale for the change remains sound. If hon. Members have evidence of actual loss of bona fide investment not motivated by tax avoidance, I invite them to submit it and I will look at it with great interest.

As I said, more than 90 per cent. of the sideways loss relief claims in the past couple of years that have not been motivated by avoidance have been below £25,000, so they will not be affected by the change. I urge the Committee to reject the amendment.

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury 7:15 pm, 15th May 2007

The Chief Secretary seems deliberately to have misunderstood what I was saying and failed to read the amendments. We are not concerned about the scams as the amendments are deliberately designed to  allow HMRC to shut down those scams. What we are concerned about are the genuine, bona fide commercial arrangements that will be shut down by schedule 4.

Photo of Stephen Timms Stephen Timms The Chief Secretary to the Treasury

I put it to the hon. Lady that her amendments under-estimate the ingenuity of the people responsible for these schemes, who would quickly get round the arrangements that she suggests should be left in place.

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury

The very demanding tests set out in the amendment in the next group would enable HMRC to shut down those schemes. No matter how ingenious the efforts to use sideways loss relief for an abusive purpose, there is a way to ensure that the genuine commercial enterprises are not hit by schedule 4 while at the same time giving the Government the power to shut down the abusive schemes.

I would like to correct the Chief Secretary. I was not saying that the taxpayer should stump up the extra80 per cent. of film funding. I was saying that withdrawal of an important way of reducing the risk of investing would have a significant negative impact on the film industry. The Chief Secretary also said that he would be willing to look at evidence that research projects are being damaged. I believe that I presented such evidence to the Committee and would be only too happy to provide further details of those projects that are going to the wall or going overseas as a result of his proposed changes. I would like to press amendment No. 62 to the vote.

Question put, That the amendment be made:—

The Committee divided: Ayes 8, Noes 18.

Division number 5 Nimrod Review — Statement — Schedule 4

Aye: 8 MPs

No: 18 MPs

Ayes: A-Z by last name

Nos: A-Z by last name

Question accordingly negatived.

Photo of Eric Illsley Eric Illsley Labour, Barnsley Central

Before we come to the next group of amendments, I have to tell the Committee that I am prepared to go on for a little longer if we can achieve a suitable point in the Government’s programme before adjourning, otherwise we have to adjourn for a dinner break and come back afterwards.

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury

I beg to move amendment No. 64, in schedule 4, page 101, line 12, leave out from ‘if’ to the end of line 14 and insert

‘it is made in connection with any arrangement which is not a qualifying arrangement under section 103E.’.

Photo of Eric Illsley Eric Illsley Labour, Barnsley Central

With this it will be convenient to discuss amendment No. 65, in schedule 4, page 104, line 23, at end insert—

‘103E Meaning of “qualifying arrangement”

(1) For the purposes of this chapter, an arrangement is a qualifying arrangement if—

(a) the individual as a partner in a firm or as member of an LLP carries on a trade which is conducted on a commercial basis and with a view to the realisation of profits and involves genuine financial risk; and

(b) before the individual commences carrying on such trade, the Commissioners for Her Majesty’s Revenue and Customs have on the application of the firmor LLP notified the firm or LLP that the Commissioners are satisfied that the arrangement is being entered into for genuine commercial reasons and not as part of a scheme or arrangement of which the sole or main expected benefit is the obtaining of a reduction in tax liability by means of sideways relief or capital gains relief.

(2) An application under subsection (1) shall be in writing and shall contain particulars of the arrangements.

(3) If the Commissioners for Her Majesty’s Revenue and Customs consider that the particulars or any further information provided under subsection (1) of this subsection are insufficient for the purposes of this section, they must notify the applicant as to what further information they require for those purposes within 30 days of receiving the particulars or information.

(4) If any such further information is not provided within30 days from the notification, or such further time as the Commissioners allow, they need not proceed further on the application.

(5) The Commissioners for Her Majesty’s Revenue and Customs shall notify their decision to the applicant within30 days of receiving the application under subsection (1)(b) or, if they give notice under subsection (3) above, within 30 days of the notice being complied with.

(6) If the Commissioners for Her Majesty’s Revenue and Customs notify the applicant that they are not satisfied as mentioned in subsection (1)(b) above or do not notifytheir decision to the applicant within the time required by subsection (3) above, the applicant may within 30 days of the notification of that time require the Commissioners to transmit the application, together with any notice given and further particulars furnished under subsection (3) above, to the Special Commissioners; and in that event any notification by the Special Commissioners shall have effect for the purposes of subsection (1) above as if it were a notification by the Commissioners.

(7) If any particulars furnished under this section do not fully and accurately disclose all facts and considerations material for the decision of the Commissioners for Her Majesty’s Revenue and Customs or the Special Commissioners, any resulting notification that the Commissioners or Special Commissioners are satisfied as mentioned in subsection (1)(b) above shall be void.

(8) The Commissioners for Her Majesty’s Revenue and Customs may by regulations provide that any activities of a specified description shall be precluded from being qualifying arrangements for the purpose of this section, where specified means specified in the regulations.

(9) The regulations under subsection (8) above may—

(a) make provision having retrospective effect,

(b) contain incidental, supplemental, consequential and transitional provisions and savings, and

(c) make different provisions for different cases or purposes.

(10) No regulations may be made under this section unless a draft of them has been laid before and approved by a resolution of the House of Commons.’.

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury

I can be very brief on amendmentNo. 64.

The amendments put into practice the entirely responsible approach that the Opposition has taken on sideways loss relief to ensure that the dire consequences predicted by the Chief Secretary would not happen. The conditions set out in the amendments would enable abusive schemes to be shut down while ensuring that genuine commercial enterprise could continue. Critical to our proposal is that schemes and transactions should qualify for sideways relief only where the venture involves genuine financial risk. Tax-motivated schemes generally do not involve that risk, so this is a key divider.

Proposed section 103E would add to the safeguards by providing that an arrangement would not qualify for sideways relief where the sole or main expected benefit was the reduction of tax. There is even a further safeguard in that only HMRC-approved schemes could obtain relief from the package that the Opposition is putting forward, which gives HMRC ample scope to crack down on those ingenious avoiders that the Chief Secretary is so worried about. Proposed subsection (8) would provide yet more protection in that it would allow HMRC to prohibit the use of sideways relief in sectors in which there are significant concerns. Such concerns have arisen in areas such as property development, hotels and residential care homes, which are not generally associated with the high-risk sectors that we have been discussing.

Lastly, I come to proposed subsection (9), which I was not sure whether to include, because it is quite draconian. It would give the Treasury the power to adopt regulations with retrospective effect to close down abusive and problematic schemes. Retrospective legislation must always be approached with extreme care and should be used only when there are genuinely special circumstances to justify that approach. In this case, I would use it to give the Chief Secretary the reassurance that he needs. I regret that the Government do not accept the Opposition’s entirely cautious and responsible approach, which would help to save the high-risk enterprises that are, sadly, being put in jeopardy by the schedule.

Photo of Stephen Timms Stephen Timms The Chief Secretary to the Treasury

I certainly agree that what the hon. Lady proposes is draconian. The amendment would ensure that in every case in which an individual partner proposed to commence business in a trading partnership or, indeed, enter into an arrangement in connection with the business, that partner would have to seek advance clearance from Revenue and Customs. If HMRC was not satisfied or did not notify its decision within 30 days, the case would be referred to the special commissioner.

That would mean that if an individual partner did not seek advance clearance from HMRC before starting a partnership, they would never be able to claim sideways loss relief or capital gains relief for any losses that they made as a limited partner or non-active partner in that partnership. I simply cannot believe that  the hon. Lady really intends to impose such an enormous bureaucratic burden on potential investors. It would simply be unworkable.

It is also worth considering who would want to seek a clearance and why. The avoidance arrangements that are caught by the measure are not entered into accidentally. People who use a scheme to create a contrived loss will know that a main purpose of the scheme is to create a loss and gain a tax advantage. It could certainly be expected that avoiders would, as they have frequently done, attempt to dress up avoidance schemes as commercial transactions and would seek clearance through the procedure that the hon. Lady proposes before investing in a scheme.

Conversely, a genuine investor would not anticipate making a loss, or, at least, the existence of sideways loss relief would not be the decisive factor in the investment, so they would have no reason to seek pre-transaction clearance. It is, therefore, clear that a clearance regime would not be appropriate. It would not provide any benefit to the non-avoiding population, but would impose disproportionate and unworkable administrative burdens on them. I hope that with that explanation the hon. Lady will withdraw the amendment. If not, I ask my hon. Friends to oppose it.

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury

I shall not press the amendment, as the Committee has had ample opportunity to vote on this issue already. I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Question put, That this schedule be the Fourth schedule to the Bill.

The Committee divided: Ayes 18, Noes 6.

Division number 6 Nimrod Review — Statement — Schedule 4

Aye: 18 MPs

No: 6 MPs

Ayes: A-Z by last name

Nos: A-Z by last name

Question accordingly agreed to.

Schedule 4 agreed to.

Further consideration adjourned.—[Kevin Brennan.]

Adjourned accordingly twenty-eight minutes toEight o’clock till Thursday 17 May at Nine o’clock.