House of Commons Hansard Debates for 5 Jul 1999 (pt 29)

The Paymaster General (Dawn Primarolo): I beg to move, That the clause be read a Second time.

The new clause is intended to prevent avoidance of capital gains tax through the purchase of losses realised in trusts. We are introducing it now because it is only in the past six weeks or so that the Inland Revenue has gathered evidence of significant exploitation. When we announced the measure on 16 June, our assessment of the potential loss of revenue, if the schemes of which we had evidence were to succeed, was about £500 million. Since then, further schemes have come to light, and the estimate has now risen to £750 million. That is exploitation on a grand scale, and it is entirely unacceptable. We have made it clear that we shall take prompt action to stamp out

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avoidance of this kind. That is why we are taking action now, and why we shall continue to take such action whenever the need arises.

Capital losses realised by trustees on assets in a trust can normally only be set against capital gains of the trust. The losses cannot be transferred to beneficiaries of the trust, except in one situation: when a beneficiary becomes absolutely entitled to settled property under the terms of the trust--in other words, when the property of the trust becomes the property of the beneficiary. Any capital loss arising on that occasion that cannot be used by the trustees is transferred to the beneficiary.

Those rules, which have applied since 1965, are being exploited in the following way. Trustees of trusts with large losses that cannot be used to offset gains within the trust create an interest in the trust property in favour of a beneficiary. That interest is contingent on a certain event occurring--an event that is almost bound to occur--after a short period.

Steps are then taken for appropriate portions of the interest to be sold to individuals and companies that have gains to shelter. Those individuals and companies become new beneficiaries of the trust. When the appointed day arrives--usually after a very short time--the appropriate amounts of losses pass to them. In such cases, huge losses are available. The Revenue is aware of one scheme where a manufactured loss of £1 billion is involved. The effect is that people with gains can use losses that they have not incurred to eliminate their tax liability. That is wholly contrary to the purpose of the legislation.

8.30 pm

The mischief is not confined to cases where new beneficiaries purchase an interest in the trust. The beneficiaries could be appointed by the trustees, or the interest could be transferred to the ultimate beneficiary via an intermediary. It is because of those difficulties that confining action to the purchase of interests in trusts would not solve the problem.

The Revenue has been aware of the possibility of loss buying in those circumstances for some time, but there has been no evidence of a widespread problem until very recently. However, as I have said, in the past few weeks, evidence has emerged of very large losses being manufactured in trusts purely to take advantage of those rules by profiting from their sale. The scheme takes a number of forms, but all involve the creation of losses within UK trusts, or the use of UK trusts with existing losses, so that the trust loss can be sold to prospective purchasers.

Although the Revenue will challenge the validity of those schemes under existing law, the scale of the problem is so large that we are not prepared to stake the potential loss of so much tax on the possibility of a favourable outcome in the courts. The only sure way to stop the sale of all future trust losses is to attack the source of the problem; I am sure that hon. Members agree.

The new clause provides for losses on trust assets sold by the trustees to be allowed within the trust under the normal rules. If a beneficiary becomes absolutely entitled to an asset in the trust and a loss is deemed to accrue on that occasion, and if the trustees cannot offset that loss against gains arising at that time, or earlier in the year, the loss will be transferred to the beneficiary, but the beneficiary can then use that loss only against subsequent gain arising on that asset.

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That is how the legislation should work and that is how it will work from now on. The new clause not only stops a serious potential loss of tax, but puts right an anomaly in current legislation, which should have been corrected a long time ago. I commend the new clause.

Mr. Quentin Davies: I have some sympathy for the Paymaster General's approach to the problem. She has set out her thinking clearly, for which we are grateful. However, several points concern me. I shall ask her some questions. I hope that I receive clear and sensible answers, so that we can have a serious dialogue across the Dispatch Box. I hope that she does not follow the example of the Financial Secretary to the Treasury, who tried to avoid all my questions although, finally, she made the declaration that I wanted all along, so I suppose that we must be grateful to her for that.

Two things concern me most about the new clause. It seems to run counter to, and potentially to damage, two principles that should characterise our tax law, or any rational and fair tax law. I fear that the new clause moves our law on capital gains tax away from those two principles .

The first, which is terribly important, is even- handedness between losses and gains. If trustees can distribute gains and if those gains are subject to tax in the hands of the recipient and beneficiary, it should be axiomatic that trustees can distribute losses and that those losses can be used freely by the beneficiary, to be set against gains for which he or she might otherwise be liable elsewhere on his or her portfolio of investments. We seem to be moving away from that principle of equivalence of treatment between gains and losses.

Secondly, the new clause poses the danger of moving us away from the principle that an individual should be taxed on the basis of his or her income or capital gains to the greatest extent possible, irrespective of whether those assets are held, those incomes or gains derive from a beneficial interest in a trust, or whether they are held directly.

We know very well that, for many years--although it is not always the case--trusts were established deliberately to avoid tax legally. However, the previous Government's reforms, which have been implemented in the past few years, to modernise our tax system have all attempted to remove that anomaly in tax law, and to ensure that people are taxed on their real financial position--on losses or gains for capital gains tax; on income for income tax--regardless of whether income was channelled through, or assets held, in a trust. Now, we are moving away from trying to make such a reform.

There may be very good reasons for establishing a trust, and I do not want anyone to get the impression that Conservative Members are against establishing one. There are extremely respectable--indeed, valuable--reasons for establishing a trust, such as to promote a particular cause or objective, to protect the interests of minors, or to protect family property down the generations by preventing one generation from squandering it all. Those are all sensible and responsible uses of a trust. However, so far as possible--this was the thrust of the previous Conservative Government's reform of trust taxation--trusts should not be established simply to shelter a given income flow or potential capital gains from tax to which the beneficiary, without a trust, would be liable.

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New clause 4 moves against the previous Government's reforms, and in the direction of creating a situation in which it is less advantageous to have losses credited to one in a trust, as it would not be possible to offset those losses against gains that might arise elsewhere in one's portfolio. Such an offset should be allowed if gains distributed to the beneficiary are similarly taxable.

Those are my general concerns, and those principles certainly inform the Opposition's thinking and the way in which we consider tax. I should like the hon. Lady to tell us, very frankly and seriously, whether she generally shares our principles in the matter; and, if she does, how she justifies moving the proposals in new clause 4 and, regrettably, taking the Taxation of Chargeable Gains Act 1992 away from those principles. If she does not share our principles, perhaps she will tell us why she does not.

The hon. Lady justified the Government's proposals entirely on the ground that they would deal with potential tax avoidance, and she gave some alarming figures on that. I am, again, grateful to her for her extremely intelligent and sensible exposition of the Government's thinking on the matter. She explained why the Government feel that there would not be sufficient protection if we legislated that gains could be enjoyed for purposes of setting against losses only when the beneficiary to which the gains were distributed had not purchased his or her interest in the trust--as other mechanisms would be available that could lead to the same abuse that she described. An existing beneficiary could, for example, nominate another beneficiary, or the trustees could nominate another beneficiary.

My initial reaction to those examples is that, presumably, without some financial consideration, no one would nominate someone else to benefit from gains or useful losses that were attributable to him or her. I should think, therefore, that the approach that the hon. Lady rejected might be more promising than, at first sight, she believed they were. I am quite certain that, in practice, any trustee or beneficiary who is giving away his or her rights is receiving some form of compensation. Therefore, if we legislated to ensure that such ultimate beneficiaries could not enjoy the benefits of losses they had thus acquired, we might solve the problem. I hope that she thinks a little further about whether there might be some other way to approach the issue which would not do violence to the key principles that I have just enunciated.

Another approach that is worth exploring and on which I should like a response from the Paymaster General would be to protect those who are beneficiaries by virtue of the original trust deed. They might not be named in the trust deed because they might be a subsequent generation, but they would be of a category provided for in the original trust deed rather than secondary or tertiary beneficiaries who had been nominated or who had purchased their interest in the trust through the avenues that the hon. Lady set out. I make my suggestions in a constructive spirit, because I share the Minister's concern about the potential loss of tax revenue and I am grateful to her for the extent to which she has taken us into her thinking.

I do not doubt the hon. Lady's personal sincerity, but the new clause aroused my suspicions. Eliminating the risk of tax avoidance is not a full and credible explanation