Transfers of income streams

I beg to move amendment 178, in schedule 25, page 247, line 6, after ‘taxed),’ insert—

‘(aa) section 809AZCA (certain annuities),’.

With this it will be convenient to discuss Government amendments 179 and 180.

The second example in the Bill of the use of principles-based legislation, the schedule secures that receipts that derive from a transfer of a right to income are treated as income for the purposes of income tax and corporation tax. Like the measure on disguised interest, it is the result of consultation on principles-based legislation.

Case law shows that it is possible for companies and individuals to convert income into capital for tax purposes by selling the right to income streams. For individuals, such schemes are particularly attractive as a result of the capital gains tax increase to 18 per cent. Avoidance in this area has led to a wide range of piecemeal measures that treat sales of income as giving rise to amounts charged to tax as income. The schedule replaces the various targeted anti-avoidance rules with a comprehensive rule that ensures that a company or individual cannot avoid tax by selling income for a lump sum that is taxed more favourably than the income would have been—for example, a capital gain covered by losses.

As a result of the consultation, schedule 25, like the preceding schedule, contains specific exceptions—in this case, for transfers of income that are the consequences of the transfer of the asset from which the income arises, or where a transfer of income is the consequence of the grant or surrender of a lease over land. There are also exceptions for disposals of rights in respect of oil licences. The new legislation saves 15 pages of anti-avoidance legislation, using only eight pages, and is another example of the principles-based approach being made to work.

The Government amendments correct an error in the schedule, which replaces a number of enactments. Among the repealed provisions is a rule that currently taxes the sale of the right to annual payments as income—that is, recurring payments of an income nature that are paid under a legal obligation. That repealed provision contains a number of exceptions for sales of annual payments that are already subject to appropriate tax treatment. Owing to an oversight, the new transfers of income rules do not replicate those exclusions, but they should have done. Without the amendments, the new rules could impose an additional and inappropriate tax charge  on transactions of that kind, so they simply restore the exclusions and make sure that they continue to apply under the new legislation.

Is not the Financial Secretary making the case against principles-based legislation? Instead of laying down things that one knows are wrong and saying that they must not be done, the principles-based approach sets out a principle that is thought to say what things are wrong, but can catch things that are perfectly acceptable. Is not the Minister outlining that in this exemption? Is not that the problem that principles-based legislation creates?

No, I do not think it is necessarily a problem. It is perfectly possible, with the new approach, to set out clearly things that are excluded, and that is what we are doing. The hon. Gentleman’s description highlights the difficulty with the old approach. If one sets out in legislation things that people are not allowed to do, it is not difficult for them to come up with a slight variation that they will do instead. The disguised interest rules that we were talking about a moment ago were introduced in 2005, but it has been necessary every year to amend them to capture the new things that people have come up with. I hope that annual amendments will not be required under the new approach.

But again, I think the Minister is making my point for me. Yes, the approach favours the Revenue in catching more avoidance, but it is catching innocent taxpayers as well. Under the previous approach, we said that something was definitely wrong and, yes, it had to be updated every year, but taxpayers who were acting innocently were not caught by it, whereas the new approach will capture people whom the Minister has not realised should be exempted, so he will have to introduce more and more exemptions each year.

I do not agree. It is important that we get the exceptions right and set them out clearly and correctly, which the amendments will help us to do. However, I do not agree that the approach we are adopting needs to catch people who are doing perfectly proper and innocent things. Of course, if an exception is subsequently drawn to our attention, it will be perfectly possible to include it, but I do not think we will be in the position of having to make annual changes, which was the position under the old approach.

There is an obvious analogy with the Green Book on Members’ expenses. That had to be rewritten every year, but we have now moved to a principles-based decision-making procedure. The only problem with that is that it will lead to some post-hoc judgments being made that might not be favourable.

The hon. Gentleman draws an interesting and perhaps illuminating analogy to assist the Committee in its deliberations.

I think that the approach we have chosen is right. This is something of a pilot and we will need to see how it goes, but the work has so far shown that it is a promising approach that we can perhaps make more of in the future. I commend the amendments to the Committee.

Given that the Financial Secretary made some broader remarks about the schedule, perhaps it is appropriate for me to make some comments about the schedule and ask one or two questions.

On the principles-based approach and the breadth of the schedule, I understand the problem that the Minister wants to avoid of having to make annual changes to legislation and introduce more exceptions to capture different types of transaction. However, my hon. Friend the Member for Wellingborough put the alternative case on the breadth of the schedule and what sort of transactions it actually covers. Are we certain that swapping narrow rules for a broader-based approach is the right way to go?

An example has been raised with me that illustrates the problem that the Government are facing and the issue that my hon. Friend has discussed. Throughout the consultation process, the policy focus of this part of the Bill was on the corporate sector. There was no suggestion that the rules in the Bill would be applied to individuals to any appreciable extent. However, in the drafting, it is necessary to include in part 2 the words

“a person within the charge to income tax”, in contrast with

“a company within the charge to income tax”, which is referred to in part 1. The wording in part 2 captures non-resident companies that are not carrying on a trade in the UK through a branch or an agency. I understand the point of having that, but the suggestion has been made that for individuals, arrangements that divert income to another party are likely to be caught by settlement legislation. IR35—the managed service company’s rules—also apply where income from personal services is concerned.

Although the Government have said that, as a consequence of the Arctic Systems ruling, there has been some consultation on income shifting, in the Budget it was suggested that such measures would be deferred. There is concern about whether the provisions of schedule 25 are drafted widely enough to be capable of catching transactions or arrangements under which turnover generated by an individual’s personal activities can be passed to another person and caught by the income shifting rules that, so far, the Government have not sought to introduce. That goes back to the question of breadth. Although it is not the intention or the policy objective to capture individual arrangements, the breadth of the schedule allows them to be caught.

The Financial Secretary might say, by way of clarification, that the schedule is not intended to capture individual arrangements, and such a statement would be welcome. However, the concern is that any statement to that effect made in this Committee would not have the weight in court that it should have, because there is no ambiguity in the schedule. I would be grateful if he clarified whether the schedule is intended to capture income shifting between individuals. If it is not, how can it be amended on Report to put it beyond doubt that it is not a backdoor way of introducing the rules on income shifting that the Government decided to put on hold?

I also want to discuss how the rules will interact with other parts of tax law and what the priority should be. For example, the CIOT representation states that rules on loan relationships, derivative contracts and intangible fixed asset regimes should take priority over the transfer of income rules. There is also no specific provision on the interaction of these rules with capital gains tax rules. Clarity on that would be helpful.

However, the main issue that the Financial Secretary must tackle is whether the transfer of income streams between individuals will be caught by these provisions. If they are not intended to be caught, he should say how we can clarify that through amendment on Report.

It certainly is possible for individual transfers of income to be caught by the provisions, and deliberately so. Under the new arrangements that the Committee has debated, people could obtain a tax rate of 18 per cent. rather than 50 per cent., which is the new higher rate of income tax. Therefore, individuals do come within the schedule. However, on income shifting, I reassure the hon. Gentleman that the provisions will not be applied in situations such as the Arctic Systems case. That case involves a different type of transaction whereby income is allocated tax efficiently between two or more parties. As a result of the ownership of the asset from which the income arises, that case does not involve the transfer of a right to income. Therefore, the legislation will not apply in that case. What the schedule deals with does not happen in cases such as Arctic Systems, because there is no transfer of a right to income.

Clearly there is some disagreement between the Treasury’s interpretation of the schedule and that of the Law Society and others. Is it not possible to put the matter beyond doubt by introducing an explicit exclusion for income that is transferred as a consequence of a performance of personal services, for example?

I think that the matter is beyond doubt, but I will happily look at it again and reflect on the hon. Gentleman’s point.

The hon. Gentleman’s second point was about capital gains tax. If the consideration is charged as income under the transfer of income rules and the transferor realises neither a capital loss nor gain on the part disposal of the asset, but is able to carry forward the whole pool of capital expenditure to deduct on a subsequent disposal of the asset, that outcome is reasonable because the whole amount of capital expenditure remains available when the asset is sold. If the asset is subsequently sold for a capital loss, that loss cannot be set off against the taxable income that previously arose, but that outcome is not unreasonable, given that it is within the transferor’s power to avoid that outcome by selling the asset rather than just the income.

I have been reminded, Mr. Hood, that the guidance on Arctic Systems and income shifting cases of that kind does make the position clear.

Amendment 178 agreed to.

Amendments made: 179, in schedule 25, page 248, line 15, at end insert—

‘809AZCA Exception: certain annuities

This Chapter does not apply to a transfer of a right to—

(a) annual payments under a life annuity as defined in section 473(2) of ITTOIA 2005, or

(b) annual payments under an annuity which is pension income within the meaning of Part 9 of ITEPA 2003 (see section 566(2) of that Act).’.

Amendment 180, in schedule 25, page 250, line 32, at end insert ‘and

(i) in CTA 2009, in Schedule 1, paragraphs 214 and 230.’.—(Mr. Timms.)

Schedule 25, as amended, agreed to.

Clause 50 ordered to stand part of the Bill.

Schedule 26 agreed to.

Clause 51 ordered to stand part of the Bill.