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Fourth Standing Committee
on Delegated Legislation
Wednesday 7 May 2003
[Mrs. Marion Roe in the Chair]
Draft Value Added Tax (Supply of Services) (Amendment) Order 2003
9.55 am
The Economic Secretary to the Treasury (John Healey): I beg to move,
That the Committee has considered the Draft Value Added Tax (Supply of Services) (Amendment) Order 2003.
I am pleased to serve on the Committee for the first time under your chairmanship, Mrs. Roe. I am particularly pleased to introduce the order before us. It is a supplementary provision to changes being made to primary legislation in the Finance Bill, which counter a serious VAT avoidance scheme. It is part of our wider determination to clamp down on artificial avoidance schemes.
To protect indirect tax revenues, which the Government published alongside the 2002 pre-Budget report, we announced our strategy for tackling indirect tax losses caused by fraud, avoidance, and non-compliance. In line with that approach, and following the action taken at the pre-Budget report stage against schemes avoiding VAT on new freehold commercial buildings—and the simplification and strengthening of that measure in the Budget—we are tightening up further on a property scheme aimed at the same potential users. Those potential users are partly exempt businesses, such as financial institutions, charities, and certain educational bodies. Under the normal VAT rules, bodies such as those are limited in the amount of VAT that they can recover on their expenditure. We have evidence that the latest creative tax avoidance scheme on the market is already being heavily promoted by a leading group of tax advisers. Therefore, we are acting early in the Finance Bill, and with the order before us today, as part of a sustained push against such artificial avoidance schemes. We wish to head the scheme off, before it becomes firmly established.
The avoidance scheme that is being countered in the Finance Bill is based on the rules applying to business assets that are not put solely to business use. The scheme is particularly damaging because it could potentially be used by any partly exempt business through artificially manufacturing use that is not business use. The estimated revenue at risk from the scheme is at least as much—in our calculations—as from the property scheme that we closed at the time of the pre-Budget report, which was £165 million each year.
The scheme that we are concerned about is based on an approach known as Lennartz, named after a German case heard by the European Court of Justice. It is an approach in which a business purchase is not used wholly for business purposes. When that happens, VAT-registered traders are required to make an apportionment of the VAT that they incur
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between the business and the non-business element, at or around the time of purchase, so that only the VAT that relates to the business element is recoverable as input tax. Alternatively, they have the option of using the Lennartz approach as a way of paying VAT on the part that is not put to business use. Under the Lennartz approach, businesses are allowed full input tax on the purchases of an asset. That treatment of assets is allowed under schedule 4 of the Value Added Tax Act 1994. Businesses pay for any use that is not for the business by an output tax charge arising over the lifetime of the asset.
We are not calling into question the Lennartz approach, which usually works perfectly well. However, in the case of land and buildings, because the buildings depreciate only very slowly and can be disposed of exempt from VAT, it provides an opportunity to delay or avoid payment of VAT.
The changes that we are making in the Finance Bill will remove the Lennartz option from land, buildings and civil engineering works by excluding them from the output tax charge. The effect will be that in future, when land and buildings are not being used wholly for business purposes, there will have to be an up-front apportionment of the VAT incurred at the time of purchase, so that only the business element counts as input tax.
The order, which is a supplementary provision complementing the changes, has two limited objectives. First, it is designed to prevent a loophole arising from the Finance Bill changes. Where only business use is intended, no up-front apportionment is appropriate, and VAT on the purchase of land and buildings is treated in full as input tax. If, however, the assets subsequently change from business to non-business use, the order ensures that that will continue to give rise to a charge to output tax. Secondly, it will put beyond doubt that where services are to be used for non-business purposes, full input tax recovery is not available. A person is treated as making a supply of services leading to an output tax charge when he puts services that he has received to a private or non-business use. The changes that we are making will make it clear that that output tax charge cannot be used to recover VAT on purchases where it was not incurred for business purposes. That part of the order is a safeguard against future challenge.
The measure complements our continuing action to curb VAT avoidance in relation to land and buildings and it prevents a potential loophole; it represents Government acting before a new avoidance scheme becomes established.
10.1 am
Mr. Stephen O'Brien (Eddisbury): I, too, am pleased to have the opportunity to serve under your chairmanship, Mrs. Roe. This is an interesting statutory instrument. It links inextricably with clause 22 of the Finance Bill, which is before the House. The first question that has to be asked is why the Minister has chosen to debate it today, when the primary legislation to which it relates has not been considered. The Finance Bill received its Second Reading yesterday and this matter was touched
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upon, but it has not been through the usual constitutional processes. It would be highly arrogant and inappropriate for a Government to presume that all their measures will be accepted, without having submitted their proposals to the proper scrutiny of the House. Why is the secondary legislation being debated before the primary legislation has been properly considered?
Secondly, the order is retrospective. It takes effect from 10 April, nearly a month ago. There has been clear consideration by the Treasury and Customs and Excise because of their concerns about tax avoidance. All of us support the proper collection of taxes, and tax avoidance needs to be addressed, but it should not presume to take priority over the proper processes of legislation or the need for notice to create increased certainty rather than increasing uncertainty, which the measure does, not least because it is retrospective. It is clear from the issues that have been identified in the Finance Bill that the matter will be subject to considerable debate, providing that the Government do not allow their draconian and unnecessary programme motion to curtail or even stifle debate on the issue in the seven sitting days that the House has been permitted to consider the Finance Bill. On the assumption that the House will have an opportunity to consider the matter in detail, we seem to be putting the cart before the horse. This is a serious matter and the Government must give a full justification for something that must not be regarded as having been done through the normal and proper processes of the House.
On the background to the instrument, when a business purchases an asset that is to be used for both business and non-business purposes, EU law provides that the input tax incurred on the purchase of an asset is deductible. However, the business must account for an output tax charge arising over the lifetime of the asset. As the Minister mentioned, that treatment is known as the Lennartz approach—Lennartz was the name of the case in the European Court. There is an alternative approach, which is to apportion the VAT incurred and to treat that part relative to the non-business use as not being input tax and not deductible. There is then no output tax on the non-business use and there is also no VAT in the event of a sale of that part of the asset allocated to non-business use.
I believe that Customs and Excise takes the view that because buildings depreciate slowly—say, over 40 years—and can be disposed of exempt from VAT, the Lennartz approach provides an opportunity to delay and to avoid payment of VAT. That is probably what the Minister sought to highlight. Accordingly, the instrument and clause 22 of the Finance Bill, which is currently before the House, seek to prevent the Lennartz approach from being used for land and buildings where there is non-business use, which includes private use by an individual. More importantly, however, non-business use includes use by a charity, for instance, so the provisions will have an effect not only on particular individuals but on charities and other entities that have raised money for worthy purposes. For instance, some education and grant-funded research is regarded as non-business use.
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Under the terms of the instrument and clause 22 of the Finance Bill, private businesses will be obliged to use the second type of treatment to deal with non-business use of land and buildings.
Why is there a problem? The outline of the problem is simple and a number of issues arise. The principal taxpayers that the clause will hit will be educational establishments and charities, which are two of the biggest classes of taxpayers that have mixed business and non-business use. They suffer by taking all of the non-deduction for VAT up front, which adds significantly to their costs. I hope that my comments are in order, but I think that one must read the instrument in conjunction with clause 22 of the Finance Bill. The provisions of both, as read together and separately, are difficult to implement in practice.
If one assumes that buildings may have a life of 40 years, how can one be sure what the relevant proportions of that building will go to business and non-business over the whole of that period? Can the Minister therefore say whether one should instead use general projections—for instance, five years first—or the position on immediate use? If the projection is based on immediate use, will there be the option of making adjustments over the 40 years? That question is important, as there are no provisions that allow for the adjustment of the apportionment. If the proportion of non-business to business use changes downwards over the useful life of the building, it is conceivable that no deduction will be gained for significant taxable use, particularly in the event of the sale of the building.
Let use consider a charity that is deploying its hard-won assets, which have been acquired through donations and other charitable support from volunteers and the public over a period of years, for good public purposes. If such a charity needs to sell the building, will the provisions have a negative impact on its funds?
As a procedural point, I understand that Customs and Excise believe that it does not need to apply the reasoning in the Lennartz case, as there is provision to derogate in domestic law in England and Wales from the application of that article of the EU directive under which that case was decided. We all know that the different types of advice given on a subject can vary, depending on the number of advisers; that is especially so for economists. In law, however, although most things are arguable, it is probably clear to the Minister—it has certainly been made clear to me through the many representations that I have received on the issue—that many advisers agree on this issue.
It has become clear that a broad swathe of advisers, particularly those with a high reputation in this field of work, are now saying that they have considerable doubts whether the view that Customs and Excise seem to be taking is correct. The reason is that the UK provision derogates not only from the article under which Lennartz was decided but from another article that does not provide for derogation. It is also noted that the derogation can result in consequences that are disproportionate to the aims of the directive.
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It is understood that Customs and Excise have obtained counsel's advice on whether it can implement the statutory instrument—and, more importantly, clause 22 from which it derives its genesis. In the circumstances, and given the arguments that I have put forward and the arguments prayed in aid by the Minister when introducing the debate, it would be wholly appropriate and not without precedent for him to put a copy of counsel's opinion in the Library. We do not have the benefit of the opinion at today's proceedings, but it would have been exceptionally helpful. It is therefore critical, to enable proper scrutiny of the primary legislative provision, that a copy is put in the House of Commons Library before we consider clause 22 of the Finance Bill in a Committee of the whole House on 13 and 14 May. I hope that the Minister will give a direct response, and give an undertaking to put a copy of that opinion in the Library for the benefit of Members.
I realise, Mrs. Roe, that in order to make a proper exposition I may take a little longer than I might otherwise have taken. However, it is important that we debate the issue fully, because the Minister is seeking to make secondary legislation before the primary legislation is in place; he is doing so on advice that has apparently been received from Customs and Excise but which is now disputed by other lawyers. We do not have the benefit of that advice. It is important that Ministers of the Crown should try to ensure that we are as one, as we would seek to be, when making provision for proper anti-avoidance provisions. Because we are considering what Customs and Excise believes is an opportunity to delay or avoid paying VAT, I argue that we are contending with a serious issue.
In a number of situations, choices arise in the way in which transactions are structured, from which savings in VAT may be made. One example would be the refurbishment of buildings for use by a new tenant. The choice arises of whether the existing lease is assigned or the old lease surrendered and a new one entered into. The VAT treatment of refurbishment costs may differ, depending on the choice made. That may be another opportunity to delay or avoid paying VAT that is not being addressed.
That prompts another serious question. If the motivation behind the provision is truly as he has laid it out, the Minister will be familiar with a case that has received a lot of publicity in recent months in the context of alleged tax avoidance schemes in the property market. My right hon. and learned Friend the Member for Folkestone and Hythe (Mr. Howard), the shadow Chancellor of the Exchequer, says:
''People may find it suspicious that, a year after the Labour Party discovered how to avoid VAT for itself, the Labour Government closes the loophole for everyone else. Or, put the other way, it's certainly very convenient that they managed to buy their plush new offices in central London before Gordon Brown demanded more tax on such deals.''
Did the Minister know that his party had had to use that tax-avoidance scheme quickly for the lease of its Old Queen street headquarters, before it was too late? My right hon. and learned Friend wrote last month to
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the chairman of the Labour party, the Minister Without Portfolio. He set out in that letter why the provisions that we are considering today are so pertinent: the party of which the Minister is a member has gone to extraordinary lengths to avoid paying tax on the purchase of its prime office space.
It is important to have answers to my right hon. and learned Friend's questions. Is it true that an entirely new subsidiary called Labour Party Properties (Two) was set up to buy the Old Queen street building? If so, was that subsidiary able to reclaim VAT on property transactions? Would this statutory instrument have had an effect on that arrangement? Has the building subsequently been leased to the Labour party, which is unable to reclaim VAT on property transactions? When did the Minister discover that setting up an entirely new subsidiary meant that £1 million of VAT could be reclaimed on that purchase—was it before or after the Minister and his colleagues in the Treasury team were aware of such tax avoidance schemes? What will be the irrecoverable VAT liability of the Labour party on the lease from Labour Party Properties (Two)? How does that compare with the VAT already recovered by Labour Party Properties (Two)?
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