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Mr. Flight: We welcome this amendment. In fact, in Committee, it was our error to have missed one of the references to 60 days. We are glad that the Government have picked up that omission, so that the Bill will refer to 92 days throughout.
Mr. Burnett: We also welcome this amendment. We supported the amendments in Committee. The date for notification and payment will now be 92 days, not 60 days, as in the proposals as originally drafted. This worthwhile amendment is welcomed throughout the business community.
The Bill, as hon. Members know, responds to the concerns of a number of companies about the effects of paying national insurance on employee share option gains. Following that change, some companies said that the uncapped secondary national insurance charge had led to accounting difficulties for them.
Following a period of consultation, measures were introduced last year, enabling companies to remove the accounting problems and uncertainty that the NIC charge presented. The earlier measure allowed companies to ask the employee to bear the secondary national insurance charge on the share option gain. That was announced on
Although last year's legislation was drafted to cover all the options that had already been granted, it has, not surprisingly, been difficult for employers to negotiate with employees terms that change options already granted to them, so the uncertainty remained for some of the companies that granted options before 19 May 2000.
The Bill responds by giving companies the chance to settle their national insurance liabilities on the options granted between 6 April 1999 and 19 May 2000 early, in advance of the date when the actual gain is made by the employee. Companies that choose to take advantage of this measure will be able to cap their national insurance liability by calculating the amount of national insurance due by reference to the accrued gain up to 7 November 2000.
Mr. Andrew Tyrie (Chichester): Will the Financial Secretary clarify a basic point about the legislation? We are trying to redress an anomaly, which was created as a consequence of earlier legislation designed to prevent tax avoidance of the NIC charge by the use of share options. How much revenue do the Government reckon was at stake in the beginning, and how much revenue is at stake now? We have just heard the most extraordinary labyrinthine story of complex legislation being added to the statute book, and that has resulted in huge compliance costs for industry and a bonanza for lawyers. How much money will the Government get in return for that?
Mr. Timms: The Bill does not correct an anomaly; it completes the arrangements to ensure that companies will not face the uncertainties about which some of them have been concerned. On the hon. Gentleman's question about the cost, because payments in the first year will have to be made within 92 days of Royal Assent there will be a gain to the Exchequer. Money will be paid earlier than it would be if it were paid only when the options were exercised. Over a five-year period, there will be a loss to the Exchequer and we estimate that to be about £160 million.
Mr. Tyrie: I am sure that the Minister has given the correct answer about the cost of the Bill, but my question was about the problem that was generated by the decision taken in 1996. I want to know how much revenue was at stake when that decision was taken. Clearly, the Government must have gone back to consider the original legislation to see whether it was worth while closing all these loopholes.
Mr. Timms: I do not have a figure for how much was at stake when the previous Government made the changes in 1996. I have no doubt that they published figures at the time, and I shall certainly try to dig them out. Perhaps I can write to the hon. Gentleman about that.
As I have explained, companies that choose to take advantage of the measure will be able to cap their national insurance liability by calculating the amount of national insurance due by reference to the gain accrued up to 7 November 2000. They will be required to notify the Inland Revenue and pay the appropriate amount within 92 days of Royal Assent.
Our consideration of the Bill has been brief, but it has been fruitful. Several worthwhile improvements to it have been made and I am grateful to hon. Members for that. I take pleasure in commending the Bill to the House.
Mr. Flight: As the House is aware, the Bill is the Government's second attempt to correct the problems of their own making when, with inadequate consultation, they introduced in April 1999 a charge to national insurance on unapproved option gains. As has been pointed out, this attempt has resulted in excessive technical detail and it still has not got the corrections entirely right in the objectives for takeovers, under this relieving Bill.
We have welcomed, in principle, the relieving measures in the Bill and we welcome the fact that the Government accepted most of the points that we raised in Committee. They will make the operation of the relieving measures more practical by allowing a sensible period of 92 days in which to elect to pay this one-off national insurance charge.
However, as we said at some length on Second Reading and in Committee, we continue to oppose the principle of making companies gamble on their potential tax liabilities. The only comfort for most listed companies that issued options between April 1999 and May 2000 is that the options would likely have been significantly under water on 7 November 2000, given what happened to stock markets over that period. Therefore, the great majority of companies will not have any difficult decisions to make, because they will not have a special NIC liability.
I stress that we do not think it is correct for Governments to play with tax policy and offer quid pro quos, or gambles, on shareholders' funds. Let the Government never forget that the overwhelming majority of shareholders are pension funds.
The Government have not entirely understood the principles relating to market abuse on which they themselves insisted in the Financial Services and Markets Act 2000. At that time, we urged them to accept the principle of intent, but they resisted that. As a result, under the Bill, giving misleading price information--whether intended or not--will be an offence.
As we have previously pointed out, if companies do not exercise the option to make the special NIC payment, the markets will perceive them as sending a negative signal about their share price prospects. However, as the Minister agreed, the reasons for that might be quite different: companies might not exercise the right because of a shortage of cash or because of intended staff changes. The only comfort is that the latest draft of the Financial Services Authority's code of conduct on market abuse makes it clear that it has included the concept of intent in virtually every provision, as we recommended at the outset.
As we pointed out last summer in the debates on the Finance Act 2000, our main criticism is directed towards the whole approach of treating options in the same way as remuneration and the argument that gains on unapproved options should be subject to national insurance charges. Such thinking is misplaced. It is absolutely clear that if someone's remunerations arrangements involve a lower salary than he might receive at a mature company but
In reality, the Government's proposals were an excuse for more stealth taxation. On 4 September last year, the Minister wrote to me advising that the Treasury viewed the cost of not having national insurance on unapproved options as £1 billion per annum. I think it is extremely unlikely that the Government will obtain anything like that revenue from national insurance on options. To the extent that the Government argue that the proposals are designed to close avoidance loopholes, I point out that I have never encountered arrangements whereby one can have a share option scheme with a certain return. If the Government and Revenue have encountered such an arrangement, that problem could have been dealt with specifically. The much wider measure of treating option gains as the same as earned income is the wrong path down which to go.
The issue is important because unapproved options have become central to entrepreneurial motivation in this country. The tax regime for approved options is attractive but they are limited to £30,000 in value. Sadly, the Government's new executive management incentive scheme is extremely restrictive. Therefore, unapproved options are used overwhelmingly to offer incentives to management, particularly in new businesses in the new technology and new economy sectors.
In Committee, the Minister admitted that only 100 companies of the 20,000 or so suitable have taken up the new executive management scheme incentive scheme. Although it looks very generous, it is difficult to qualify for and any company that started to achieve success would quickly disqualify itself. I am tempted to observe that the Government knew that because the amount of tax cost provided in the Red Book was modest.
Let us come to the heart of the matter. I am assuming that the Government are not disingenuous in their desire to see a much more vital economy and a much higher level of venture capital investment. We should not be complacent. The United Kingdom is doing poorly against America. Per pound or dollar of national income, America is achieving about four times the level of venture capital investment of the United Kingdom. We may be doing well against Europe, but we are certainly doing poorly against America. That has been central to the growth rates of the two economies. America has grown at about 4.6 per cent. per annum for the past three years and the United Kingdom at only about 2.3 per cent. Our under- performance is material. The huge US economy has done so well largely because of the tremendously positive level of investment and activity in new ventures in high-tech, new economy and so forth.
This is central to the Bill. When people in the venture capital industry in the United Kingdom are asked what are the key issues, interestingly they say that right now it is not about there not being enough money, but about a shortage of talented management wanting to come forward. There is a shortage of people willing to leave the more comfortable employment terms and security with large, established businesses and risk joining a new business. Often there is also a shortage of new business projects that those people might otherwise bring to the table.
When the venture capital industry is asked what is central to this issue, it says that the tax regime on share options in the United Kingdom is extremely unattractive compared with that in the United States. In the United States for the equivalent of UK approved schemes, known as ISOs, people can have $100,000 of options per annum; the employee is not taxed on exercise but only on the sale of shares following the exercise of those options; the tax rate, provided that he has held the shares for a year, is 20 per cent.; and there is no equivalent to national insurance charge because social security charges are capped for both employer and employee at incomes of $74,000.
In the United States, the new business sector which is not hugely profitable--it is building businesses where cash flow is tight--uses predominantly ISO options to pull in and motivate talented management and, inevitably, pays them lower salaries than they would get in mature businesses. That is what options are all about.
While US unapproved options have a tax of 39.6 per cent. on exercise, the issuing companies get a tax credit equal to the tax which the employee pays, so the net tax situation between employer and employee is tax paid at about 10 per cent. and, again, there is no equivalent to our national insurance charge.
If the Government genuinely want to get a higher level of venture capital activity in the United Kingdom, it is crucial that they accept and understand the message from the industry that we are going wrong on option incentives. The Computing Services and Software Association said to the Chancellor in the lead-up to the discussions behind the Bill:
The staff needed in the new business areas are international. They are people who will move about the world readily. This is not necessarily about a brain drain from here to the United States; it is also about whether we attract the talent from all over the world to the UK that we need to get our high-tech sector going.
The chairman of the UK small business investment taskforce, appointed by the Government, commented in a letter two weeks ago on how restrictive the executive management incentive option schemes were and on how punitive the national insurance charge arrangements on options are. The chief executive of QXL Internet Auction company commented that the NIC situation in this country would force talented staff out of the United Kingdom.
The message from the high-tech industry is loud and clear. This relieving Bill is welcome in terms of the specifics, but it does not address the fundamental issue--namely, that the Government have hit the venture capital and new tech industries by applying a 47.3 per cent. tax
Last May the Government realised and accepted the threat to the cash flows of new companies by imposing NICs on options. It is the companies that are the problem with a 12.2 per cent. national insurance charge. The Government thought that they could be clever and that by a wheeze they could keep the stealth tax that they had imposed by changing the rules so that the employer's NIC could be transferred to the employee. As the Government have confirmed, that gives a 47.32 per cent. tax charge to employees on unapproved share options.
It is palpably nonsense that a risky form of remuneration--whether options are worth anything depends on the particular success or failure of an individual business, whether new high-tech areas prosper and the general economic climate and where the risk-to-reward ratio is skewed heavily to risk--should attract higher tax than a safe salary. That is theoretical nonsense. It is reducing the use of options. The reaction of talented people who are willing to work for new ventures is to want better salaries and a safer income, as well as some options. Instead of the trade-off of lower salaries and more options, they are demanding higher salaries, and that is just what new businesses cannot afford.
Behind the Bill still lies the great misfortune that just when the Government have been claiming that they want to help new ventures, venture capital and entrepreneurship, they have hit at the centre and made the key element--namely, option incentivisation--punitive and unattractive tax-wise. If the Minister goes out and about in the venture capital industry and talks to people other than the Government's cronies, he will find that the Government are not seen as bona fide friends to entrepreneurship and venture capital, and are believed not to understand how crucial the taxation of options is to entrepreneurial endeavour.
When the relieving measures that we are discussing were announced shortly before Christmas, the press reaction summed them up. It was that the proposals received one cheer from high-tech entrepreneurs, who said that they did not go far enough and did not address the fundamental issue. Others commented that the problem is of the Government's own making, with constant tinkering and a failure to sort out the fundamental issue of what the tax regime should be for share options, if we want to be able to attract many more talented people into new ventures.
The Bill is a relieving measure and we are not opposing it. We hope that the Government will correct what we believe are outstanding technical errors as the Bill passes through another place. We appreciate that the Government have accepted our proposals to make arrangements simpler and to avoid potential for unfairness in this Bill. We say to the Government, "If you are genuine about wanting to encourage entrepreneurship, go back to first principles and consider the taxation of options in the United States. Do what those who are at the centre of, and who are trying to create, more new venture capital and more new business recommend, and look to have option taxation regimes that are broadly similar to those of the US and that are not punitive, as the mainstream unapproved option regime now is."