Clause 5

Finance (No. 2) Bill – in a Public Bill Committee at 4:30 pm on 19th October 2010.

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Question proposed, That the clause stand part of the Bill.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

Many members of the Committee will no doubt wish to comment on what are quite technical matters, and your forbearance in the Chair would be most appreciated, Mr Caton. I know that you will be fair and reasonable at all times and in all your rulings.

Clause 5 facilitates the introduction of schedule 2 on venture capital schemes. As hon. Members know, venture capital trusts give tax breaks to individuals investing in small unlisted trading companies. They offer a set of tax advantages, including, for instance, 30% income tax relief on the costs of investment up to about £200,000, a capital gains tax exemption on disposals and tax-free dividend payments. The typical venture capital trust involves a group of between 20 and 40 companies.

Currently, all venture capital trusts are companies listed on the main market of the London stock exchange. Government Members will be particularly pleased to hear that the provisions in the Bill appear to be largely driven by the need to align UK legislation with wider European Union regulations on venture capital trusts. No doubt Government Members are all good pro-Europeans, and it is healthy to see that they are taking a harmonising approach in their legislation. In particular, the regulations concern shares in venture capital trusts and the markets in which they are listed.

At present, regulations under the Income Tax Act 2007 require that the ordinary share capital be included in the official UK list. Clearly, and quite rightly, that can, to a degree, be construed as a barrier to the free movement of capital. Accordingly, the clause changes arrangements so that shares can instead be admitted for trading on any European Union regulated market. As I said, that is commendably pro-European. By allowing listing on any European Union market, and indeed any European economic area market, as set out in the Official Journal of the European Union notices annually, the new rules will, I hope, ensure the greater transparency and interoperability of schemes across national boundaries.

The schedule makes a number of other technical changes to venture capital schemes. It includes changes that regulate the composition of venture capital trusts’ eligible shareholdings and it redefines the minimum criteria required. In particular, the clause introduces a  financial health check to ensure that tax reliefs would be granted only if there was a good prospect of the business remaining a going concern. That applies to shares in companies that it would be reasonable to classify as being in difficulty, which would exclude them from qualifying. That is quite an interesting innovation in policy and tax law. Obviously, it will probably be the focus of much comment and debate today.

The Opposition agree that it is necessary to align and harmonise the regulatory arrangements for venture capital trusts and enterprise incentive schemes in the wider European Union context. We also concede that it is a sensible and rational change to have a financial health check; that is certainly worth while. However, I want to probe the Minister on several aspects of the operation of the clause.

First, the Bill states:

“The issuing company is ‘in difficulty’ if it is reasonable to assume that it would be regarded as a firm in difficulty for the purposes of the Community Guidelines on State Aid”,

which were listed under the reference 2004/C 244/02. However, I am told that the Institute of Chartered Accountants pointed out that those guidelines appear no longer to have effect—a point that I think came up on Second Reading. Therefore, there could be an anomaly in the Bill, in that the particular reference to the community guidelines on state aids may be otiose and create a situation in which the guidelines have lapsed. I would be grateful if the Minister clarified whether those guidelines are still effective.

Will the Minister also precisely define the financial health check? Will it be applied, for instance, to a group of companies, and perhaps a newly created subsidiary of firms? Many hon. Members will know that corporate law is complicated. Many companies and firms are quite creative in how they can spur a series of enterprises and roll operations within various groupings of undertakings. I am concerned; if one part of a firm or group does not pass the financial “firm in difficulty” test but the larger part does, or vice versa, how will the operation of the test work? It is not clearly defined in the legislation.

In particular, I am intrigued by the steps in the Bill that allow Her Majesty’s Revenue and Customs to apply the financial health check rule retrospectively, or at least in hindsight to withdraw the relief, possibly after a difficulty has occurred, potentially compounding the problems of small and medium-sized enterprises that otherwise might well have been able to make ends meet and continue as a going concern. I am anxious that the rules should not magnify the financial difficulties of a company if it is just getting by on or above the border line, especially if there is retrospective operation of the rules. I would be grateful if the Minister walked the Committee through the process of the judgment taken by regulators, companies and investors in applying that financial health check.

A recent guide by Chancery chartered accountants stated that, as is self-evident, within the cluster of 20, 30 or 40 companies often grouped in venture capital trusts, one or two selected by that venture capital trust manager will typically fold, while others will prosper. If it is part and parcel of the normal chain of events in venture capital trusts for firms to be in difficulty, I would like to learn a little more from the Minister about how the whole tax relief arrangements for that venture capital trust might be treated.

As a subsidiary to a set of technical questions, I am also interested to know whether the Minister can say how the rules will apply to overseas holding companies—for instance, companies resident in tax havens. In those circumstances, how will information about the financial health and viability of those firms be discerned, gathered and communicated? Clearly, there is often less transparency in those overseas holding arrangements than in the UK.

I refer the Minister to paragraph 2 of schedule 2, where a set of threshold changes is suggested, with a 70% threshold for eligible shareholders. As the current arrangement provides a regulated level at 30%, I want to understand from where that ratio derived. That is, obviously, a significant change to make in one go.

I am sorry to fire so many questions at the Minister in quick succession. There are several other points that I would like to address, but if he thinks about the questions that I have asked, I will be grateful.

Photo of David Gauke David Gauke The Exchequer Secretary

It is a great pleasure to serve under your chairmanship once again, Mr Caton. I am grateful to the hon. Member for Nottingham East for setting out some of the background to the clause, and I hope to respond to his questions.

As we heard, clause 5 introduces schedule 2, which makes changes to the enterprise investment scheme and venture capital trusts, the two taxpayers’ venture capital schemes. The previous Administration agreed the changes with the European Commission in order to obtain state aid approval for the schemes.

It might be helpful to provide some background to the schemes. They were introduced in 1994 and 1995 respectively to give investors a range of tax reliefs in return for investing in small, higher-risk companies, and they have been successful, supporting investment of £10 billion or so to date. The schemes help such companies, which face particular difficulties in raising finance, to start up and grow by encouraging investment in them. Such companies have never been more essential to the UK’s growth and jobs than they are now.

To make the schemes comply with new state aid rules, various changes have already been made. The previous Government engaged in a two-year process to ensure compatibility with the new rules. Clause 2 introduces four final changes to the conditions that companies must meet. Those changes are set out in the schedule in detail, but briefly, they are as follows: companies benefiting from the reliefs will no longer have to carry on their trade wholly or mainly in the UK, they will have to meet an “in difficulty” test, venture capital trusts may be listed elsewhere in Europe and, although VCTs will have to hold higher amounts of equity, the definition of what constitutes equity will be slightly wider.

The hon. Gentleman asked several questions, including whether the “in difficulty” test for enterprises had expired, rendering the provisions otiose. I can inform the Committee that the guidelines were extended for a further three years by a Commission communication of 9 July 2009. Therefore, the “in difficulty” test for companies continues to apply.

In the context of enterprises in difficulty, he also asked what happens in relation to the other group companies if a company in a group is in difficulties. Essentially, the company to which the rule applies is the  company issuing the shares. The position of other group companies will not generally be relevant. I hope that that provides clarification.

The hon. Gentleman also asked whether a retrospective change could be made, as it might exacerbate the position of a company moving into difficulty if the test were applied. The test applies when the shares are issued. HMRC will not seek to withdraw relief where formal approval has been given and a company subsequently moves into difficulty.

The hon. Gentleman asked about companies resident abroad, in particular those in tax havens. The schemes have always allowed money to be used overseas to some degree. The UK should still get a return on its investment when a UK company reaps the benefit of its overseas investment and, within EU rules restricting foreign investment, is liable to run into problems with the fundamental freedoms. That is why some of the provisions had to be relaxed. HMRC will still look at cases where companies are in difficulty, and at the rules that apply to companies resident abroad and how we get the information. I believe that guidance has been published on how that will be done.

The hon. Gentleman also asked about the threshold change from 30% to 70%, and where the ratio came from. That is required under EU state aid rules, and it was discussed with the European Commission as part of the approval process. The figure of 70% is an EU requirement in such circumstances. I hope that that is helpful and provides the hon. Gentleman with some clarification on the fair questions that he raised.

The clause was put out for consultation and a number of comments were received. As a result, changes have been made to some points of detail. Clause 5 provides certainty for business by ensuring compliance with venture capitalist schemes while allowing flexibility within the rules.

Photo of Alison McGovern Alison McGovern Labour, Wirral South 4:45 pm, 19th October 2010

It is a pleasure to serve for the first time on this Committee under your chairmanship, Mr Caton. I wanted to ask the Minister a couple of additional questions about the clause. The enterprise investment scheme was designed to help smaller, high-risk trading companies to offer relief to investors and it is a measure that could be particularly crucial at this time.

Creative and high-tech companies, especially smaller creative or high-tech science-led companies, could be crucial to our future. That is especially true in my part of the world in Merseyside and the north-west, where we have particular expertise and a creative, science-led economy. I wanted to ask more about proposed new section 180A, which introduces the requirement that was referred to and concerns companies based

“wholly or mainly in the United Kingdom,” rather than those that have “permanent establishment” in the UK.

Does the Minister have an estimate for the volume of companies that will be affected? Is there any sense of what the trend might be? Will he say more about the representations that he mentioned and whether any of them covered that point? It would be helpful for the Committee to be made aware of the scale of the companies that we are dealing with, and to know how far that has been tracked by the Department.

The Minister also mentioned negotiations with the European Commission. Have any discussions involved the expertise of colleagues in the Department for Business, Innovation and Skills? They have particular responsibility for the kind of companies that I am concerned about. Will the Minister clarify for the Committee what discussions have taken place?

On firms in difficulty, we are obviously at a time when that definition will be apposite to the position that companies find themselves in. Will the Minister indicate the number of companies in the UK that could be affected by the measure? It would be helpful to have a sense of size and scale, and to know what discussions have taken place so far on how the provisions might impact on those specific companies.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I want to follow up on a point made by the Minister, and I echo many of the reasonable questions asked by my hon. Friend the Member for Wirral South. The Minister answered my point about whether the reference to the community guidelines on state aid had expired, and he said that there was an extension for a further three years. I am always concerned that legislation should be as permanent and everlasting as we can frame it to be, but if there is a continual need for the updating of references, I presume that the Minister will have the power to bring forward reference changes in the consequential supplemental clause at the end of the Bill, if necessary. Alternatively, is there a risk that the clause will be in force for only three years, and that we shall then have to return to the matter in a future Finance Bill? That is, again, a minor drafting issue.

The Minister mentioned that the financial health check applies only to the parent company, which issues the shares. I am still not quite clear in my mind about how often a parent company can be essentially a shell vehicle for a number of other activities within it. Clearly, the test is—or I presume it is—more of a voluntary requirement on all the participants, either in the company or in the purchase of the shares, and not just a requirement on the investigators and regulators in Her Majesty’s Revenue and Customs to impose the test. Therefore the disclosure burden must surely rest on those involved in the company; that might be the way of getting round the problem of disclosure, where there is a difficulty. If I am wrong, perhaps the Minister will tell me.

It is good to hear that guidance is to be issued about the overseas holding company arrangements and, I think the Minister was implying, on the operation of the scheme and the financial assets generally. If he gave the Committee a sense of when the guidance is likely to be forthcoming from HMRC, that would be useful. If it is to be in the near future, it would be a useful insight if he could circulate it, or a draft of it, to the Committee.

I wonder whether the Minister’s officials know—again, this is more for context—the cost to the Exchequer of providing the tax relief arrangements for venture capital trusts more generally. We would like to get a sense of what amounts of money—what flows—we are talking about, even if it is a broad estimate figure. A sense of the revenue implications would give us a flavour of whether the change is massively significant or quite technical. It would be useful to know the scale.

I gather that in tomorrow’s spending review, issues about the green investment bank may crop up. I know  that the Minister has various individuals scaling the walls of the Treasury as we speak; I do not know whether they have been peeled off. There are questions about the trend of availability of venture capital generally to small and medium-sized enterprises, and particularly those firms that are forging away on innovations in low-carbon technologies and so forth. If the Minister shares any insight he has into whether the green investment bank will provide some of the capital that perhaps would otherwise have come from venture capital schemes, that may give us a sense of what we are talking about.

Finally, perhaps the Minister can also provide some illumination for the Committee as to a commitment that I understand the Lord Chancellor and Secretary of State for Justice gave when he was shadow Business Secretary, before the general election. He indicated that the Conservatives wanted to reform venture capital trusts to encourage investment in technology-based manufacturing, specifically. Yet I have not seen any of those commitments in the schedule or the Bill. If not now, when will the Government bring forward the changes that would fulfil the commitment made by the right hon. and learned Gentleman?

Photo of David Gauke David Gauke The Exchequer Secretary

I am grateful to hon. Members for those further questions and shall try to deal with them all. The point was raised about how many companies will be affected, in particular by the relaxation of the definition in relation to a permanent establishment test. It is not possible to give an exact number, but we believe that a relatively small number of companies will benefit from that, largely because, under the enterprise investment scheme, investors often want to invest in businesses close to them. It is not therefore likely to have a big impact.

It might help the Committee, and partly respond to some of the other questions, if I highlight the impact of the clause as a whole. The cost is £20 million in 2011-12, rising to £30 million in 2012-13, and £40 million in 2013-14 and 2014-15. That gives an idea of the scale involved. That relates to all aspects of the clause, and I hope that it provides a useful idea of the overall cost of the measures. We should consider it in the context of the cost of the EIS to the Exchequer of £180 million, and the cost of the VCT scheme of £80 million in 2009-10. [Interruption.]

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

How much did the Minister say? Will he repeat that figure?

Photo of David Gauke David Gauke The Exchequer Secretary

The overall cost of the EIS is £180 million for 2007-08, and the Exchequer cost of the VCT regime in 2009-10 is £80 million. I hope that that is useful. On the overall position on venture capital funding and the relationship with the Department for Business, Innovation and Skills, BIS produced a Green Paper, “Financing a private sector recovery”, which raised questions about how we can be most effective in supporting venture capital investments, including EIS and VCT. I therefore reassure the Committee that BIS is heavily involved in the discussions, and that the Treasury and HMRC work closely with it.

On the green investment bank, the hon. Member for Nottingham East will not be surprised to hear that the Government will make an announcement in due course, so I do not intend to say anything further on that subject this afternoon. He also asked about the guidance  and I am grateful for the opportunity to clarify my earlier remarks. The guidance was made available to the Committee last night, so he should receive it shortly. If he does not, I would be grateful if he would let me know and I will ensure that that is addressed.

The issue of how tax relief for a group will operate in practice when one company is in difficulty was also raised. As I said earlier, the rules apply only to the company issuing shares, not to other group companies. If the company issuing shares can raise equity capital from existing shareholders or the market—that is to say, new shareholders—the company will qualify for the regime.

The hon. Gentleman asked about the drafting of the European Union guidelines on state aid. All EU guidelines on state aid are time limited. The Government will feed into any review or renewal of those guidelines and we will take into account any changes when and if necessary. If it is necessary to update legislation, we will have to look at that. We do not, however, envisage that it is necessary given the current extension which occurred last year.

I hope that those answers are helpful. We have had a good discussion and useful information has been given to the Committee. I think that the clause will be welcomed by various groups. It is an important area and we want to do what we can to encourage equity investment, particularly at times when credit has not always been easy. I hope that the clause is useful and constructive and will assist our position in that area.

Question put and agreed to.

Clause 5 accordingly ordered to stand part of the Bill.