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Session 1999-2000
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Standing Committee Debates
Finance Bill

Finance Bill

Standing Committee H

Thursday 8 June 2000

(Morning)

[Mr. Frank Cook in the Chair]

Finance Bill

(except clauses 1, 12, 30, 31, 59, 102 and 113)

Schedule 14

Enterprise management incentives

9 am

Mr. Howard Flight (Arundel and South Downs): I beg to move amendment No. 198, in page 312, leave out lines 15 to 18 and insert

    `a dependent subsidiary within the meaning of section 86 of the Finance Act 1988'.

The Chairman: With this it will be convenient to take the following amendments: No. 199, in page 325, leave out lines 28 to 31 and insert

    `becoming a dependent subsidiary within the meaning of section 86 of the Finance Act 1988'.

No. 235, in Schedule 15, page 341, leave out lines 11 to 14 and insert

    `a dependent subsidiary within the meaning of section 86 of the Finance Act 1988'.

Mr. Flight: As we continue our discussions, many matters will arise under schedules 14, 15 and 16. In the main, we support the enterprise initiatives and our amendments are designed to make the scheme more workable. At present, it contains many unnecessary and niggling catches that are likely to cause legal disputes or result in people being disqualified from participating. The initiatives are to little end, in terms of tax revenue or fairness. Amendments Nos. 198, 199 and 235 deal with qualifying companies. We believe that the present list is too restrictive, as it would exclude an unlisted company with a majority shareholder such as a venture capital house or other strategic investor. Surely, they are the businesses in which employee share ownership is key and at which the scheme is aiming.

The object of the exclusion is to ensure that enterprise management initiatives are operated only by independent companies. There is already a test for that in the employee share legislation, which is that a dependent subsidiary is a subsidiary that is operated on a non-independent basis, with most of its business on a non-arm's-length basis with the root companies and, hence, does not create an artificial share price. There is a requirement that a company escapes dependent subsidiary status only if the parent company auditors are willing to certify that it is independent. That gives a valuable third party control that the Revenue can rely on. Although we understand the thinking behind the provision, we consider that it is not necessary. It undermines a key category of company at which the scheme is aimed. Amendment No. 199 would change the qualifying company definition and amendment No. 235 deals with the corporate venturing scheme.

The Economic Secretary to the Treasury (Miss Melanie Johnson): The amendments are grouped together because they propose changes to the rules for identifying the independent companies at which the enterprise management incentive scheme and the corporate venturing scheme are aimed. EMI is being introduced to provide tax-advantaged share incentives to help small, independent, higher risk trading companies attract and retain key personnel. Those companies will often be at an early stage or just beyond their initial stages of development. The CVS is aimed at encouraging equity investment in the same types of company and it is hoped that it will also help to promote corporate venturing relationships involving small, independent, higher risk companies.

Both schemes target small independent companies and the parent groups of small independent groups, because such companies have greater difficulties in attracting key staff and finance than do companies that form part of or are controlled by larger groups. We do not intend shareholdings of subsidiaries to be directly involved in either scheme. In the case of CVS, we doubt that equity investment in a subsidiary of a small trading company will be more attractive to, or, indeed, more practical for, a potential investing company than investment in the parent. EMI is aimed at small companies and groups of small companies in cases in which improvements to the value of a subsidiary company brought about by the efforts of a key employee will be reflected in the share price of the parent. That intention is reflected in the targeting rule, which excludes 51 per cent. subsidiaries and companies controlled by another company in which they are not 51 per cent. subsidiaries.

The amendment would allow subsidiaries and controlled companies to qualify as issuing and qualifying companies for the purposes of the CVS and the EMI respectively, with the exception of dependent subsidiaries-a narrow category. It would also impose a regulatory burden on the company's directors. The result would be to add unwelcome and unnecessary complexity and uncertainty and would be a burden for companies to operate. As the test can be applied only at the end of a period of account, in the case of EMI, for example, a company would not know at the time of granting an option whether the option qualified for EMI. The directors of the parent company would be required to certify that the relevant requirements had been satisfied, and an auditor's report would need to be obtained.

There is no need to amend the Bill to allow employees of subsidiaries to benefit from EMI. Nothing will prevent EMI options from being granted to employees who work in a subsidiary; they, too, can take part, as long as the options relate to shares in the parent company. In the case of the type of group that will qualify for EMI, the increase in the value of the subsidiary will be reflected in the value of the parent.

Taking the approach suggested in the amendment might identify independent subsidiaries when the opportunity for value shifting by the parent is minimal. However, it would not ensure that EMI relief is targeted at companies that are less likely to have the resources to recruit and retain key employees.

We understand the anxieties expressed on one aspect of the matter-that companies controlled by venture capitalists will not qualify for EMI because the company that wants to offer options to its employees is not independent. The anxieties expressed about companies that will not be able to use EMI because of venture capital funding were considered during the consultation period, but no practical suggestions emerged-not even the solution suggested in the amendment, which, as I hope that I have explained, is not practical.

Even if we were to accept that we wanted to allow companies controlled by venture capitalists to qualify for EMI, it would be difficult to provide a test that identified venture capital backing as opposed to any other kind of financial backing. It would also be difficult to distinguish or identify which venture capitalist companies should be allowed to control an EMI company. We would also need to provide a new definition of control, which would in itself introduce complexity and possible avoidance opportunities.

The solution proposed in the amendment would not solve the venture capital problem. Although the use of the dependent subsidiary rules would in theory deal with the anxiety expressed about value shifting and tax avoidance, it would not meet the policy aim of ensuring that EMI relief is targeted on companies that are less likely to have the financial resources to recruit and retain key employees.

Many companies will experience no difficulties with the EMI legislation. When several separate and unconnected venture capital funds own in aggregate more than 50 per cent. of the target company, it may well qualify for EMI. It is only in the unlikely event that a single venture capital company holds more than half the ordinary shares that the target company will be a subsidiary of a venture capital company and therefore will not qualify for EMI. It will therefore be possible for a company that has received a large amount of venture capital backing-up to 50 per cent.-to qualify for EMI.

The amendment would also allow subsidiaries of quoted companies to be included in the CVS. However, that is not the purpose of the scheme. In the case of both schemes, nothing would prevent the tax benefits from being obtained in cases in which the issuing or qualifying company is controlled by a large group by means other than share ownership. The scheme is not aimed at such companies because they will generally have access to the resources of the controlling group, and nothing would prevent share price manipulation.

Although we sympathise with one aspect of the argument advanced by the hon. Member for Arundel and South Downs (Mr. Flight), I hope that the amendment will be withdrawn. If not, I urge the Committee to oppose it.

Mr. Flight: As the Economics Secretary commented, and as I made clear, the amendment relates to small businesses that are backed by venture capital houses or strategic investors. As I said, we understand that the logic applies more widely. In a normal mature group the subsidiaries can-although not always-be covered by participating under the current rules. The dependent subsidiary definition route is operative although, as I pointed out, accountant certification support is needed. Although it would not be the norm for a venture capital house promoting a company to have 50 per cent. or more of it, it is not that unusual, especially for a strategic investor. If the matter is not addressed, the scheme has a hole in it. Representatives of the venture capital industry have said to me, ``It's a great scheme, but it won't work in about a third of situations.''

I am not quite sure what the Economic Secretary is saying. If she is saying that the Government are looking for a method of addressing the problem, I shall withdraw the amendment. However, if she is saying that the Government cannot be bothered, I shall want to press the matter to a vote, as a highly important principle is at stake.

Miss Johnson: I thank the hon. Gentleman for his remarks.

In January this year, the British Venture Capital Association commented:

    We want to commend HM Treasury and the Inland Revenue for the manner in which the consultation process was established and taken forward We are particularly pleased to note that the consultation has resulted in the acceptance of a number of improvements to the original proposals.

I therefore hope that the hon. Gentleman does not doubt our bona fides in terms of the way in which the consultation has been conducted and its results. We have not been able to find a route through the problem that he has identified because, as I said, it has consequences elsewhere. For all those reasons, there is no answer on the cards. That is not due to a lack of willpower in the Treasury; it is a result of the difficulties that the issue presents, and the fact that it was not raised during the earlier consultation.

 
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