Finance Bill

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Mr. Wilshire: I am listening ever so carefully to my hon. Friend and am trying to ensure that I fully understand his argument. We are discussing money on which tax has been paid and which would otherwise go to policyholders who have paid their premiums. They will now get less money because the Government want to tax them a second time. Is that what my hon. Friend is trying to get me to understand?

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Mr. Flight: Not quite, but nearly. My hon. Friend will recollect that both organisations were mutuals. As I commented when one was listed and the other sold, the members of those mutuals were entitled to the proceeds. What they have received is taxable, and tax has been paid. The point that I have tried to make at some length, because it is quite complicated, is that if the Bill goes through as drafted, the undistributed reserves due to go to shareholders would suffer double taxation. Therefore, we are talking here not about policyholders, but about the hundreds of thousands of people who were mutual members of Scottish Widows and Friends Provident.

Mr. Wilshire: I am beginning to grasp the situation. My hon. Friend refers to reserves. Am I right in understanding that those reserves have been accumulated after tax has been paid?

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Mr. Flight: Yes, historically. The element of double tax arises from the fact that the ex-mutual members have paid or will pay tax. To the extent that they have not had all their money yet, they will pay tax on it when they get it, but now an extra tax will be levied when the funds flow out of the reserve account.

The amendments would ensure that a proper amount of tax is paid by policyholders and companies on the surpluses and would prevent double taxation. Because of the double taxation, the Bill could result in capital being locked into the life funds of Friends Provident and Scottish Widows, which the groups may wish to utilise elsewhere in their business or for further acquisitions. If that were so, the practical impact of the provisions would be commercially damaging, as well as leading to double taxation.

Mr. Wilshire: This gets worse and worse. Can my hon. Friend tell me what the commercial damage would be? Again, not being a financier, I do not understand these things, but it would be helpful if my hon. Friend could enlighten me on the damage.

Mr. Flight: I had just endeavoured to explain that the funds would be locked into the respective life funds and could not be used by those two groups elsewhere in their business because of the tax penalties that would result. Therefore, in essence it would be dead capital that could not be constructively used.

There are other affected parties. The draft clauses would affect the ability of other companies to demutualise efficiently. The Scottish Widows transaction provided policyholders with immediate cash value for surplus assets, something that no other demutualisation has done. Other potential acquirers of mutual companies would not wish to pursue the same route, faced with a potential double tax charge. My understanding is that the Treasury and the Revenue have taken a more sympathetic approach to this matter, and I hope that the Economic Secretary will be able to make a useful comment on the Government possibly reconsidering these provisions.

I do not wish to speak to amendment No. 147, as it duplicates another amendment. Amendment No. 148 seeks to clarify the operations of one of the proposed provisions. Proposed new section 83(2C) provides that proposed new section 83(2B) will apply to the repayment of loans only if the loans were brought into account for the period of account but were not taxable for the period of account under section 83(2), but it is not clear to which period of account the measure refers. I understand that the intention is that the section will apply to the period of account in which the loan is made, rather than the period in which the repayment is made. It would be helpful if that could be clarified.

Mr. Wilshire: I understand what my hon. Friend says, but what would be the difference between the two periods? I am trying to get my mind around that, as I am not the expert that he is. Can he explain what the impact would be if one period were preferred to the other?

Mr. Flight: It is relatively self-evident that there are two crucial issues: when tax will eventually be paid,

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whether sooner or later; and how much tax will be assessed. There is an important matter of tax cost timing but also a need for clarity, which is a major part of what the amendment is about.

Kali Mountford (Colne Valley): I am at a loss to understand whether Opposition Front-Bench Members understand the clause or their amendments. It seems from the interventions that the Opposition have not consulted each other on them. Is that the case?

Mr. Flight: I thank the hon. Lady for that question. I am pleased to advise her that our amendments and briefing notes are regularly circulated to the members of our team, and we regularly meet for briefings and updates. However, she will be aware that the subject is very complex. Indeed, it is one that I do not claim to be on top of or about which I know as much as I could. Therefore, many hon. Members may not fully realise the implications of the Government's proposals or the Opposition amendments that have been tabled to ameliorate them.

Kali Mountford: I am grateful for and understand that explanation. However, I would understand it better had not all the Opposition Front-Bench Members put their name to the amendments. Is not it the case that the Opposition agree to amendments before tabling them?

Mr. Flight: Of course everyone agrees the amendments before they are tabled, but being refreshed as to their full implications is, with respect, quite another matter. However, I thank the hon. Lady for livening up our proceedings.

Let me rattle through the amendments as speedily as possible. Amendments Nos. 138 and 139 concern the proposed changes to section 83(6) and (9) of the Finance Act 1989, which are covered in paragraph 2 of schedule 33. The changes will have a significant impact on commercial reinsurance transactions undertaken by life insurance companies and could levy a significant tax cost on transactions for which there will be no tax motivation, while in effect denying relief for trading losses.

The legislation does not take account of the fact that reinsurance arrangements are central to the business of insurance and that companies enter into such arrangements for purely commercial reasons. The proposals apply only to reinsurance arrangements that could be viewed as alternatives to a transfer of business. However, the Bill could go further and have an impact on a wide range of commercial reinsurance arrangements.

Mr. Wilshire: Now I am on ground that I understand. The reference to trading losses is familiar to me. When I ran a business I knew all about trading losses. I also knew perfectly well that in the years in which I made a loss I could offset it against profit that I made. Are the Government trying to tax people when they make a profit and make them suffer when they make a loss?

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Mr. Flight: At the bottom of the heap, yes, but, as I will explain, the main impact is that the costs of reinsurance could be increased substantially and its availability could be limited. The latter effect, in a market in which there are already acute problems in obtaining professional indemnity cover and employer's liability cover, could be significantly damaging in a wider economic context.

It is quite common for only one life insurance company in an insurance group to write business directly to the public and then reinsure part of that business to a pension company or a linked company to manage the business more efficiently. Under the Bill, companies that suffer trading losses will be taxed on capital added to the long-term insurance fund in connection with such reinsurance arrangements. That effectively denies relief for trading losses on reinsured business and means that companies will be penalised for using reinsurance to assist in funding new business.

The amendment, which would bring pure reinsurance within section 83(3), would have a significant impact on all reinsurance groups. The requirement for additional capital to fund a loss is not uncommon for any company and the pure reinsurers are no exception. It is unjust for companies to be penalised by the proposed arrangements as a result of the nature of their trade. The proposals would make it extremely difficult for pure reinsurance companies to capitalise themselves without suffering adverse tax consequences.

Mr. Wilshire: I am listening carefully to my hon. Friend, and I heard him say that if things were to go ahead as the Government want, there would be a real risk that the cost of reinsurance would go up and its availability might decline. Is there any possibility that if the measures were to go ahead, businesses in this country would be forced to look abroad for the same sort of reinsurance cover that they might otherwise have got in London? If that were the case, would that not start to undermine the London insurance market and play into the hands of foreign competitors?

Mr. Flight: My hon. Friend will be aware that the London reinsurance market is already relatively uncompetitive and losing business as a result of past tax changes. The provisions could worsen that problem. As I commented, there are the dual effects of the failure of trading losses relating to reinsurance to be relieved and the knock-on effects on the reinsurance market.

I am focusing on amendments Nos. 138 and 139. Paragraph 2 will amend section 83 of the Finance Act 1989. It is an anti-avoidance provision that requires certain additions to the long-term fund of a life insurance company to be treated as taxable for the purpose of ascertaining whether the life insurance company has made a loss in a computation prepared on case 1 principles, for profit computations for pension business, individual savings account business, overseas life assurance business and life reinsurance business. The overall notional case 1 profit computations determine the element of the company's profits to be taxed at shareholder rates.

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For the provision to apply, the addition needs to have been made as part of, or in connection with, a transfer of business. Even under current law, the provision is widely drafted and capable of disallowing losses that are unconnected with the addition, for example, those that arise on new business. Paragraph 2(6) and (9) propose the widening of the definition of transfer of business. That definition already includes reinsurance as equivalent in practical terms to the transfer of a portfolio of contracts, but does not include reinsurance with a pure reinsurer, or reinsurance of new business. Those changes were not signalled in the press release of 23 December 2002, nor were they discussed with consultees prior to the release of the Finance Bill. The amendments are designed to prevent the widening of the definition of transfer of business.

Amendment No. 149 is essentially a probing amendment. Paragraph 3, which is key, introduces a provision in respect of contingent loans to life companies. It is a relieving provision and, as such, is welcome in principle. However, it does not go far enough and could accelerate tax in non-abusive situations. Amendment No. 149, like further detailed amendments that we may table later, seeks to deal with those situations. This amendment has been tabled as a probing amendment, in case it is not possible to pursue such additional amendments later.

The Revenue's aim has been stated in correspondence and in the explanatory notes as being to catch only abusive transactions, without penalising commercially motivated transactions. However, the legislation does not meet that aim and could affect the ability of insurance companies to achieve their required solvency positions. We believe that the legislation should be amended to allow the transfer of normal surplus to shareholders without penal tax costs. For those purposes, normal surplus should be surplus not funded out of or in connection with a contingent loan. The proposal to link allowed transfers to shareholders only to bonus payments is clearly inappropriate where a contingent loan is made to a non-profit fund, for which are no bonus payments.

Amendment No. 150 seeks to address the changes that paragraph 9 makes to section 432E of the Taxes Act 1988, which will tax mutual insurers on any surplus after allowance for the declaration of bonus. Although such a situation is unusual, it is not unheard of. The proposals could unjustly tax certain mutuals, for example when a mutual has two sub-funds and the Financial Services Authority allows one to declare surplus to support the other. In that situation, the mutual has no surplus overall, but the proposals will tax the surplus on the sub-fund that is providing support. The intent is to address a particular arrangement on the demutualisation of a business, so this relates to the points raised under amendments No. 133 and 134.

The Revenue is attempting to address a problem that it has seen as an abuse, but we feel that the provision should be amended to target only certain arrangements, such as a demutualisation within a

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certain period following the declaration of a surplus, or when the position of the long-term insurance fund as a whole is taken into account.

Amendment No. 151 is essentially a probing amendment.

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