Finance Bill

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Ruth Kelly: I should begin by setting out the background to settlor-interested trust provisions. I shall then explain what the clause does, before dealing with why I believe that the amendment should be rejected.

People set up trusts for many and varied reasons. Some are purely tax-related; others are nothing to do with tax. The tax system respects the fact that there are trusts and that they are separate entities, but we must ensure that people cannot obtain an unfair tax advantage by putting assets into a trust. For that reason, we have long had special rules that charge the person who set up the trust—the settlor—tax in respect of gains realised by the trustees of a trust. The special rules apply when the settlor, or his or her close family, can benefit from the trust. The rules ensure that the right amount of tax is collected. The settlor may claim reimbursement from the trustees for the tax that he or she pays.

In broad terms, the clause restores the rules that applied before the introduction of the Finance Act 1998, so that settlors can set their available capital losses against gains that are attributed to them in that way. I readily admit that doing so will introduce complexity into the rules, because of the interaction with taper relief. It is because of that additional complication that we decided, when introducing taper relief in 1998, that it would be better to have a simple rule so that personal losses could not be offset against such attributed gains. However, we have come to the view that that can produce harsh results in certain cases and that it would be more equitable for people to set their personal losses against the attributed gains.

Amendments Nos. 52 and 53 and new schedule 1 would allow a settlor to obtain the benefit of losses realised by trustees and set them against all their gains. In effect, the amendments would set up a single pool for the gains and losses of a settlor from which they, or members of their close family, would benefit.

For settlors with genuine non-tax reasons for setting up trusts, the amendments would completely undermine the fact that they had transferred their property to them. For those settlors who set up trusts for tax reasons, it would make setting up trusts a one-way bet against the Exchequer. Indeed, those proposals would open up a real risk of tax avoidance, as people could use the election and juggle the timing

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of disposals to maximise the deduction of losses against gains. The amendments would cost about £25 million a year without taking into account any behavioural change caused by people exploiting them for the purpose of tax avoidance.

Mr. Flight: I do not understand the logic of permitting losses in a trust to be offset against personal gains, but not permitting gains in a trust to be offset against personal losses. As the Economic Secretary just said, tax legislation treats the situation as if a trust did not exist. I cannot see the logic of making a change one way but not the other.

Ruth Kelly: The trust rules on settlors and interest exist to ensure that the right amount of tax is paid. As I have explained, settlors have the power to claim reimbursement from trustees for any tax that they pay. Allowing settlors to set trust losses against personal gains would mean that a settlor would benefit at the expense of the beneficiaries of a trust. I shall explain that later.

At the moment, trustees' losses are set against their gains. That reduces the sum with which trustees have to reimburse a settlor where a settlor pays tax on an attributed gain, which leaves more for beneficiaries. Under the proposals, the losses would personally benefit a settlor, and more would have to be paid out of that trust's funds to reimburse a settlor for attributed gains, which would leave less money for beneficiaries. That cannot be right. In effect, the amendments would give a settlor the power to benefit from a trust in a way not envisaged by the original deed of settlement.

It will come as no surprise to the Committee that in this very complex area of the tax code, amendments Nos. 52 and 53 and new schedule 1 are not free of errors, some of which would open up new tax-avoidance possibilities. The proposals would, for example, allow untapered losses to be set off against amounts attributed in respect of tapered gains. It is quite unfair to obtain such an advantage just by involving a trust in the process. The amendments and new schedule are wrong in principle, would have a significant cost and would give rise to tax avoidance, and I therefore ask the Committee to reject them.

Mr. Flight: Will the Economic Secretary explain a point raised again by amendment No. 53? My understanding of clause 50 is that the quid pro quo of personal losses being offset against trust gains is the loss of taper relief on trust gains. What is the logic for that?

Ruth Kelly: I hope that I can reassure the hon. Gentleman on that particular point. I am advised that taper relief will not be lost under the clause. Trustees will not apply taper relief because the settlor will get it.

Mr. Flight: I thank the Economic Secretary for that answer, which concerns an unfairness that has not been addressed. Although I appreciate the issue about the position of the settlor versus that of the beneficiary, the logic of having the offset one way and not the other is strange, but it is not a huge issue. The Government considered the situation that resulted in clause 50 and

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I now request them to consider it the other way, because I cannot believe that they intended their reforms to produce a situation that is worse than if the assets were owned directly by the settlor.

I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 50 ordered to stand part of the Bill.

Schedule 11 agreed to.

Clauses 51 and 117 ordered to stand part of the Bill.

Clause 52

Tax relief for expenditure on research and development

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

5.30 pm

Mr. Flight: I think that everyone, particularly large companies, is pleased with the inclusion of the clause in the Bill and with the fact that a volume-based scheme is being introduced for large companies. However, the difference between the schemes for SMEs and large companies will lead to difficulties when small companies grow into large companies and vice versa. We believe in principle that there should be some integration between the two and our amendments to schedule 12 address that in part.

The complexity of the legislation and the continuing difficulty in determining whether expenditure falls within the definition of research and development will make it difficult for companies to decide in advance whether proposed expenditure will qualify for the new relief, and we have tabled amendments to schedule 12 to sharpen the definition. Those points of principle underlie the amendments that have been tabled to schedule 12.

Mr. Edward Davey (Kingston and Surbiton): I welcome you to the Chair, Mr. Gale. It is important to tease out some of the policy issues that lie behind the approach in the clause. It has been long heralded and there has been significant consultation on the new research and development tax credit. The Government listened to that consultation and changed their original proposals. However, it is worth having a short debate on whether that approach alone is sufficient to achieve the policy objectives.

There has been debate over a long period about the need for a research and development tax credit. Small allowances and support for research and development have been provided, but nothing as substantial as what is proposed now. Governments have said in the past that a tax credit would not do the job and have argued that most of the extra research and development that would gain the credit would have happened anyway, so there would be a high deadweight cost. The Government's proposal seeks to deal with that by trying to achieve extra research and development for

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taxpayers' expenditure, but there has always been a question in many people's minds about whether the provision would make a marked improvement.

The reason for that scepticism is that until recently the results of several studies on how other countries use such tax credits were equivocal. Evidence from some countries showed that their effect was limited and that large amounts of taxpayers' money was spent, with no major behaviour change in the private sector.

The Government have been fortunate in many ways because further studies have been carried out in recent years to discover the objective of tax credits. Today's Government policy has been instructed by lessons from other countries. The policy is undoubtedly needed because Britain's performance on research and development has been lamentable for a long period, particularly when military R and D is excluded from the overall figures. I am convinced that we need to pursue the route that we are on, because international evidence is overwhelming—I speak as someone who is generally reluctant to go down the route of extra tax credits and reliefs.

I hope that the general policy direction receives support from all hon. Members. Can the Paymaster General reassure us that the debate does not rest here and that the Government will deal with other aspects of R and D policy? It would be out of order for me to mention competition policy, regulation policy and so on, but a more imaginative use of the grant system is needed. For example, ideas are being developed for an old-fashioned way of promoting R and D, namely offering prizes. The Government, a research institute or a royal society could offer a prize for the first person or body to achieve a particular breakthrough. Emerging evidence from the past few years suggests that that is a cost-effective way to promote R and D. Only one sum of money would be offered, but if one ensured that it was the right amount and that it created the right incentive, an awful lot of extra research would be carried out in the private sector for a small amount of public money.

The international evidence suggests that the provisions in the clause are the right approach, but I hope that the Government have an open mind to alternative approaches so that we can turn Britain's performance on R and D to better effect for our economy's productivity performance over the longer term.

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