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Mr. Howard Flight (Arundel and South Downs) (Con): To revert to the point that the Economic Secretary was making in leading up to this, will joint venture company situations, where it may be administratively appropriate to be part of a group, be possible under the new measures? My understanding is that they would effectively be ruled out as a result of where the lines are being drawn, although there may be a perfectly good practical and non-tax avoidance case for them.

John Healey: It will depend on the nature and application of the test that we will devise and implement in secondary legislation. Principally, it will turn on who draws the principal benefit from the joint venture company. I shall explain further as I make progress.

The measure that we propose does two things. First, it amends the law on VAT grouping to make it clear that a company or other corporate body cannot be in two VAT groups at the same time. That clarifies the position but does not change anything in practice for existing VAT groups. Secondly, the measure will stop abusive grouping arrangements by changing the rules for VAT grouping eligibility. Currently, a company is able to join a VAT group even though it is run by, and for the benefit of, a company that is not part of that VAT group. Those are the criteria that we want to tighten up.

Mr. Flight: That reply leads on to the second related point. Can the Economic Secretary assure the House that there will be sufficient clarity in the secondary legislation in relation to this territory? Many in the business community are concerned that there will be greyness. Can he assure us that, without it being too extensive, it will be as clear as possible?

John Healey: If the hon. Gentleman will bear with me, I will come on to that point. I am confident that I can provide that degree of assurance in relation to clarity. There will also be consultation, which will also answer the point made by the hon. Member for Yeovil about concerns over complexity.

The arrangements that we want to tackle result in a substantial revenue loss to the public purse, which is estimated this year, if we took no action, at £75 million.
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Alongside those losses to the Exchequer, the companies concerned obtain a significant advantage over their competitors.

Since 2001, Customs has used its "protection of the revenue" powers to stop such abuses when it finds them. This has been well known, and Customs has published business briefs on its actions and activities. Nevertheless, the abuse has not stopped. The reason is that Customs can take action only once it has found a company using the scheme, which could be some years after the event. Even then, Customs cannot recover the VAT that has already been lost, so there is a limited downside risk to entering one of these schemes at present.

A further concern that has been raised about the current position is that, with the ability to challenge and close such schemes resting on Customs' revenue protection powers, businesses have complained that there is a degree of uncertainty about what is and is not unacceptable. The legislative solution proposed in clause 20 resolves those concerns.

These schemes create unfair competition, which should be rectified without the delay that the hon. Member for Hertford and Stortford urges. The revenue saved by such action against these schemes this year is estimated at £50 million. The change is not being sprung on business without notice or without dealing with their concerns. Most respondents to the consultation accepted the need to act on the abuse to get, as one person put it, a level playing field. However, they said that the proposed changes would impose extra costs on VAT groups generally, in order to tackle a small minority of abusers. We responded to those concerns. The clause that we are examining today does not change group eligibility criteria for the vast majority of VAT groups who are not involved in this abuse. Instead, it gives the Treasury power to make an order that can change the eligibility criteria in limited circumstances, targeted at the situations in which abuse can arise.

I can confirm that the order will be subject to parliamentary scrutiny under the affirmative statutory instrument procedure. I can also confirm that I will ensure that it is published in draft in advance. I hope that that helps to deal with the anxieties expressed by the hon. Member for Yeovil, and will give the hon. Member for Arundel and South Downs (Mr. Flight) an opportunity to scrutinise the provisions for the "greyness" that is worrying him.

The clause is not about outsourcing; it is intended to prevent abuse of the VAT grouping eligibility rules, to level the playing field for compliant businesses—particularly small businesses—and to give businesses in general more legal certainty. It constitutes an effective response to aggressive VAT avoidance. It is what is needed, and what is needed now. It is a proportionate and timely response, and I commend it to the Committee.

Question put and agreed to.

Clause 20 ordered to stand part of the Bill.

Clause 28

The Non-Corporate Distribution Rate

Mr. Flight: I beg to move amendment No. 3, in page 22, line 26, insert 'and—
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(c) the company does not retain at least £10,000 of its distributable profits for the period.'.

The amendment seeks to deal with a specific aspect of the problems caused by the clause and the related schedule. I think there is a general view that the clause and the whole territory constitute an unfortunate example of the Government's incompetence, and their tendency to meddle for spin reasons without fully appreciating where their measures will lead. As we all know, the Finance Act 2002 introduced a zero per cent. rate on the first £10,000 of profits. During the debate on that, the Government were well warned that it would cause massive incorporation by small businesses. We have already heard much quoting of the Paymaster General's "gift horse" comment—that she realised that it was a big fiscal inducement to incorporation. Now the volume of lost revenue appears to be significantly greater than the Government anticipated, and we have been presented with a rather hasty and not fully thought out measure to deal with the problem.

In his Budget speech, the Chancellor claimed that he expected small businesses to retain £10,000 worth of profits. That was, I think, a somewhat disingenuous excuse for these measures, which present a variety of problems. For one thing, an unfair arrangement will operate when companies that have paid tax on past profits want to distribute those profits in a subsequent year. Our understanding is that they will be liable to the new 19 per cent. tax. In the past they could have borne tax of between 19 and 30 per cent., so there could well be an element of double taxation. Companies that are currently not profitable but are distributing earlier years' profits will also be penalised for past investment, as they too will pay 19 per cent. on the profits distributed.

We think it should be made clear that paragraph 9 applies only when companies continue to be under the control of those who had control immediately before the degrouping. The definition of a group for the purposes of new section 13AB and schedule 3 is very wide, and will treat companies with little economic interest in one another as being grouped. Surely what is needed is an amended version of the definition that applies for the purposes of corporation tax on chargeable gains, in order to go on applying the definition of a group to companies likely to have a significant common interest.

6 pm

The proposals are particularly harsh on small businesses with modest profits where the owners need to withdraw profits in order to live. In a sense, the only people who can benefit from the zero per cent. band are now those who have profits below £50,000 and do not need to withdraw more than £10,000 as a dividend. The tax relief thus ends up particularly benefiting the passive type of income-generating businesses, hobby businesses or businesses with spouses.

The 19 per cent. rule sounds simple, but in practice, because it makes dividends payable out of after-tax income, the calculations that it leads to are quite complex. Let us look at the calculation of profits available to be paid out as dividends where taxable profits are, say, between £10,000 and £50,000. If P is taken as the algebra for the profit for a full year, the calculation for distribution is P x 0.7625 x P + £2,375 ÷ 0.9525 x P + £2,375. It is not at all straightforward.

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If dividends paid in one year exceed current taxable profits, the excess is carried forward and treated as paid in the following period, so again small businesses need to record the carry-forward, or they may be caught out by an unexpected tax bill. Double taxation credit relief where it may be relevant is ignored in applying the new 19 per cent. rule. The new rule is worked out first and any double taxation could reduce it afterwards.

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