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

With this it will be convenient to discuss the following:

Clause 41 stand part.

New clause 2—Tax treatment of private equity fund managers’ pay—

‘(1) The Chancellor of the Exchequer shall, within six months of the passing of this Act, publish and lay before the House of Commons a report setting out proposals for amending the law to ensure that no element of the remuneration paid to an investment fund manager may be treated as a capital gain, and that such remuneration shall be treated for tax purposes wholly as income.

(2) For the purposes of this section, an “investment fund manager” is a person who performs investment management services directly or indirectly.’

Sir Roger, I will speak on clauses 40 and 41 and may remark on new clause 2 in anticipation of remarks we are likely to hear from the hon. Member for Kirkcaldy and Cowdenbeath.

Clause 40 makes changes to ensure that investment managers will pay at least 28% tax on the economic value of the carried interest they receive. Clause 41 makes a change to a definition of disguised management fees rules and supports the legislation in clause 40.

Investment fund managers are rewarded in a range of ways for their work in managing funds. One element of reward is straightforward income in the form of a fee. Hon. Members will recall that we took action in the spring 2015 Finance Act to ensure that fund managers could not disguise management fees as something else in order to pay less tax.

Another key element of the reward involves what is known as carried interest. Carried interest is the portion of the fund’s value that is allocated to the manager in return for their long-term services to the fund. The manager’s reward is therefore dependent on the performance of the fund. Aspects of the UK tax code meant it was possible for asset managers to reduce the effective tax rate payable by them on their carried interest awards; in particular, it was possible for fund managers to pay tax on amounts much lower than their actual economic gains.

The changes made by clause 40 mean that the full amount of carried interest will be charged to tax. Where the carried interest represents capital receipts, it will be taxed at 28% for higher rate and additional rate taxpayers. There will be no extra deduction on account of what is known as base cost shift, which would reduce the amount taxed in the hands of the manager. That will move the basis of the tax charge so that it is the economic gain that is subject to tax. Previously, the carried interest gain was calculated in accordance with the rules on capital gains tax for members of partnerships, but those rules could be interpreted and manipulated in such a way as to reduce significantly the amount of tax payable.

As part of their contract with a fund, an investment manager may be required to invest their own money on similar terms to those that apply to an external investor. To ensure that returns on those co-investments will not be impacted by the change, clause 41 redefines whether an amount is reasonably comparable to the return to external investors. The clause ensures that true arm’s length investments made by the fund manager will not be caught by the new rules.

The clause removes a quirk in the UK tax system that was being exploited in such a way that investment managers were not being taxed on their full economic gain. The changes ensure that capital gains tax will be payable at 28% on the capital element of carried interest received. I therefore hope that clauses 40 and 41 stand part of the Bill.

I would like to make one or two remarks about new clause 2 now, although I will of course respond to what the hon. Member for Kirkcaldy and Cowdenbeath says. New clause 2 proposes two measures: subsection (1) recommends a review after six months of what performance returns should be charged to income, and subsection (2) would define an investment fund manager for the purpose of the new clause.

I am sorry to disappoint Opposition Members, but we will not accept the new clause. It is not necessary to legislate for a review in six months, because the Government have already consulted in this area to ensure that awards will be charged to income tax when it is correct that they are, according to the activity of the fund. The consultation closed on 30 September and we will publish our response, along with any resulting draft legislation, in due course. I dare say that I will have more to say on new clause 2 later this morning, but I look forward to the debate on this group.

Before I call Mr Mullin, let me explain for the edification of not only new Members but some who are longer in the tooth that the lead amendment—the one that is first on the selection list—is always called first and moved after its introduction. No other amendment is moved at that time. It is not a question of saying, “I would like to move this.”

New clauses are always taken at the end of a Bill, so while they are debated in the context of the subject matter of the Bill, they are moved—if moved at all—at the end of the Bill. So there will be no occasion yet, as Mr Mullin will wish to know, to move the new clause. However, he is absolutely entitled to speak to it, as I am about to invite him to do.

Thank you very much, Sir Roger, for that clarification, which I am sure we all enjoyed. I wish I had fully understood it. [ Laughter. ]

“I was shocked to see that some of the very wealthiest people in the country have organised their tax affairs, and to be fair it’s within the tax laws, so that they were regularly paying virtually no income tax. And I don’t think that’s right.”

Those were the words of the Chancellor of the Exchequer in April 2012. He was right then, but he needs to do more about it now. We still find such loopholes continuing for the highest remunerated investment fund managers in the country. It may be a mere coincidence that some of them are significant donors to the Conservative party.

I recognise that the Government have moved a little way, but as is attested by page after page of technical explanation notes relating to these matters, we wait to see whether these modest proposals close or create further loopholes. I note the telling sentence in the explanatory notes, which says:

“HMRC will monitor the impact of these provisions”.

That is good. To ensure that we as legislators are fully informed, I am sure that our new clause, which calls for appropriate reporting, will be considered, notwithstanding the Minister’s recent comments.

The few thousand people who work in private equity firms are remarkably well remunerated. In the words of Stephen Feinberg, the head of PE firm Cerberus Capital in 2011:

“In general, I think that all of us are way overpaid in this business. It is almost embarrassing.”

The average European firm’s managing directors can expect to receive about £8 million in total personal compensation and the largest firms pay out even more. Even more junior directors and principals can expect to receive just over £1 million. Those figures will be relatively conservative for London, which has some of the highest paid private equity executives in London.

In some cases, executives have been able to bring tax rates on their carry-down even further by claiming entrepreneurs’ relief. As has been indicated already, private equity fund managers currently shrink their tax bills by arranging to pay 28% capital gains tax, rather than 45% income tax on their carried interest. Carried interest is in effect their remuneration for managing other people’s money and should therefore be taxed as income tax. The fund managers’ ability to pay capital gains tax instead of income tax also allows them to avoid paying national insurance contributions on a major part of their income.

Support for our measure comes from many quarters. Of particular interest to me is the fact that in May 2014 the OECD—not renowned for radical tax positions—released a raft of recommendations to tackle rising income inequality. Those include:

“Taxing as ordinary income all remuneration, including fringe benefits, carried interest arrangements, and stock options”.

The injustice in all this can be seen through a simple comparison. A senior matron in a local hospital or a middle manager in a local further education college on £47,000 a year will have an effective tax rate of about 32.2%, yet a senior private equity executive receiving about £8 million will pay, at most, 29.4%.

Does the hon. Gentleman agree that this is an excellent early opportunity for the Conservative party to put words into action by showing that it is, as it claims, the party of ordinary working people, as opposed to, for example, the political wing of the City of London?

I fully agree; indeed, I look forward to the Minister’s response in that regard. This may have been a missed opportunity that the Government now recognise and will want to correct.

Let me make another comparison. In my own constituency, my wonderful constituency manager, Lynda Holton, pays about the same effective tax rate as many fund managers who earn 100 to 200 times more than her. [Hon. Members: “Pay her more!”] When I was on the phone to her this morning, she did want me to say “my underpaid constituency manager”. And she is underpaid, but of course I am a devotee to the rules of the Independent Parliamentary Standards Authority in this regard. Surely it cannot be right that people on much more modest incomes have effective tax rates that are higher than those for some of the highest paid people in our society. I am prejudiced in favour of the simplification of tax as well as justice in tax. For both those reasons, I hope that the Government will respond positively to our new clause.

Sir Roger, I did understand your explanation. As you know, I am new and old—a retread—and I found it very helpful; thank you.

Clauses 40 and 41 are essentially anti-avoidance measures, so hon. Members on the Opposition Benches welcome them. I welcome the fact that there will be no base cost shifting—something that is discussed in the pubs and clubs of Wolverhampton every night of the week; we are very keen on that. However—there is on occasion a  “however”—we do not think that clauses 40 and 41 go far enough, because the carried interest is still treated as capital gains. It seems to us that treating carried interest as capital gains is a bad idea and the Government should not permit it. It certainly appears to be a tax loophole—again, not illegal, but immoral—and we think that it should be closed. I have considerable sympathy with the spirit and wording of new clause 2, which was spoken to very eloquently by the hon. Member for Kirkcaldy and Cowdenbeath.

Will the hon. Gentleman join me in welcoming the fact that the current Government have increased the tax rate on these kinds of capital gains from the 18% that it was at under the last Labour Government to 28% today? Would he also like to explain why, during its 13 years in office, the Labour party took no action in this area?

Looking round the room, I think that one hon. Member, the Minister, will remember that I was not a member of the last Labour Government when I was previously in the House—[ Interruption. ] I was “supportive” says an hon. Member from a sedentary position; we will get on to that—[Hon. Members : “Ah!”]. The Minister is well aware of this. I am aware that Alistair Darling, when Chancellor of the Exchequer, cut the capital gains tax rate to 18%. I said at the time that I thought that that was wrong and I have to say now that I think that it was wrong. Furthermore, I have to say, bearing in mind the time at which it took place, that it is shocking that I do not recall in the debate on that change any debate about how it would affect positively many right hon. and hon. Members who at that time, within the rules, owned second properties in London, on which they would accrue a capital gain, and on that capital gain, they would pay a lower rate of 18%. The hon. Member for Croydon South is absolutely right to say that it was the wrong thing to do. Putting it up to 28% is a step in the right direction, but on these measures and these activities of investment fund managers, they should pay income tax on what most people, including me, would regard as income.

As I have said, I have considerable sympathy with new clause 2. I shall listen with great interest when the Minister speaks at greater length about the new clause—he said he would and it would be helpful. Having heard his side, I and my hon. Friends will make up our own minds. We are not only swayed by the arguments for equity, equality and justice; we also bear in mind, as the hon. Member for Kirkcaldy and Cowdenbeath mentioned in speaking to new clause 2, the OECD’s recommendation that such incomes should be treated as incomes and be subject to income tax, not treated as capital gain and subject to capital gain tax. To those of us who are not taxation experts, it appears that calling it a chargeable gain is a manoeuvre to lessen the tax paid by those who benefit from that form of remuneration.

I will respond to the remarks, not necessarily at length. The comments from the hon. Members for Kirkcaldy and Cowdenbeath and for Wolverhampton South West were pithy.

I shall deal straight away with the question of carried interest. Carried interest is a reward for a manager that is linked to the long-term performance and growth of the funds they manage. It is therefore capital in nature  and should continue to be charged against capital gains tax. That has been the approach followed by Governments of both major parties for many years, and it is consistent with what happens in many other jurisdictions.

My hon. Friend the Member for Croydon South was right to say that capital gains tax was 18% when the Labour Government left office. If I remember correctly, it was possible for private equity managers to benefit from taper relief, so there was often an effective rate of 10% for many years under the Labour Government. There at least seems to be a consensus in the Committee that that was not the right approach. We believe we were right to take steps to change the capital gains tax rate, as we did at the beginning of the previous Parliament, but I would still argue that, as is the case in many jurisdictions, it is perfectly reasonable to treat carried interest as essentially a capital gain issue rather than an income issue. Of course, if any part of a manager’s rewards payments are properly regarded as income rather than capital, they should be charged to income tax. That is what drives the Government’s approach. We have launched a consultation to ensure that rewards that should be charged to income tax are always taxed in that way.

I will just pick up a couple of points made by the hon. Member for Kirkcaldy and Cowdenbeath. He is correct that national insurance is not chargeable on capital gains; it is payable only on earned income. However, it is not the case that entrepreneur’s relief can be accessed by investment managers, as the activity of the underlying fund is investing, not trading. Entrepreneur’s relief therefore does not apply in those circumstances.

If I were so inclined, I could quote extensive comments from the likes of Ed Balls, when he was a Treasury Minister, in support of the capital gains treatment of carried interest, and that was a period when the gap between income tax and capital gains tax was much greater, but I will spare the Committee that this morning. I am not sure that Ed Balls is a particular hero of the hon. Member for Wolverhampton South West, but our approach on carried interest is consistent with that of other countries and previous Governments.

We are determined to ensure that the rate at which private equity managers pay tax is never lower than their cleaners pay. That was the case under previous Governments, but it is not the case any more. Nor is it acceptable that what should be charged as income is in fact charged as capital gains. The Government have taken action on those points. I hope that provides reassurance to the Committee and I urge the hon. Member for Kirkcaldy and Cowdenbeath not to press new clause 2.

May I add a further consideration? Given that, as the Minister said, most other countries treat carried interest as capital gain, if we adopted new clause 2 and started taxing it as income, there would be a significant risk that the population of fund managers in London would simply relocate elsewhere and the UK Exchequer would end up receiving less cash instead of more, thus increasing the tax burden on the rest of us.

My hon. Friend makes a good and important point. In thinking through the impact of the policy advocated by some Opposition Members, we need to understand the international implications and the  implications for the UK’s competitiveness. Clearly, any assessment of the revenue effects would have to take account of what are likely to be significant behavioural responses. Claims of large revenue sums may be based on a static analysis, without an understanding that there is also a competitiveness point.

The Minister mentioned Ed Balls. I think the Minister was on a Committee in the position that I am now in when Ed Balls was trumpeting the fact that London had become the financial centre of the world and had surpassed New York because of light-touch regulation. Some of us on the Labour Back Benches pointed out to him that that was a bad move that might end in tears. Sadly, our warnings were more than fulfilled in 2008, with the Lehman Brothers meltdown and what happened in this country. I caution the Minister not to go along with the argument made by the hon. Member for Croydon South that people will go offshore and so on. We should not have had light-touch regulation and we should be careful about regulation now.

Again, I think we can find some consensus. I will not dwell on this, Sir Roger, because we will depart from the business before us if we start to discuss the failures of the regulatory system in the run-up to the financial crash in 2008. However, that is why we have undertaken substantial reform of financial regulation in the UK.

We should want a competitive and thriving financial sector in this country, but we must ensure that it does not pose systemic risks for the UK economy as a whole. That is the challenge that the Chancellor has referred to as the British dilemma in having a major financial centre, with many benefits to us. It is important that the City thrives. Some of my ministerial colleagues and I have visited the City—I do not know whether everyone can say that. However, we must ensure that we have a regulatory system that does not impose greater risks on the overall taxpayer. There is a question of judgment here, and ensuring that we have a thriving private equity industry is something we should welcome.

To clarify, we do not intend to press the new clause or any of our earlier measures to a vote at this stage, but we will return to them on Report, when we will also take account of the remarks the Minister just made, which I will want to challenge.

I very much look forward to debating this matter in future. I have said what I wanted to say. The Government are determined to ensure that income is taxed as income, and we have narrowed the gap between the rates of income tax and capital gains tax. I think that we are getting the balance right and we see that in the clauses we are considering today.

Question put and agreed to.

Clause 40 accordingly ordered to stand part of the Bill.

Clause 41 ordered to stand part of the Bill.

New clause 2 would have been taken at the end of the Bill, but Mr Mullin has indicated that he does not wish to move it, so that is now academic.