---

Mr. Burnett: I am extremely grateful to the Paymaster General for giving way. I should like to put to her a set of circumstances. Let us imagine that Mr. and Mrs. A form a company. Mr. A has 99 shares; Mrs. A has one share. The company's income is taxed accordingly, with Mrs. A taking one hundredth and Mr. A 99 hundredths. Three years down the line, Mr. A gives 49 of his shares—I hope that I have still got my maths right—to Mrs. A. Will they thereafter be taxed 50:50 or, because of the settlement provisions, will Mr. A be taxed 99 per cent. and Mrs. A 1 per cent.?

Dawn Primarolo: The hon. Gentleman should focus on the declaration. If there is no declaration, the settlement provisions in section 660A will run and section 282A will kick in on the 50:50 split. A legal declaration is provided by the spouses to tell us that the ratio is not 50:50, but some other proportion. We need to follow that for tax purposes. If there is no declaration, the two provisions operate in the way that was always intended. It is not necessary to think up "what ifs". The only "what if" is if there is no declaration to the contrary, how do the two sections in the Income and Corporation Taxes Act operate? That is what I have explained.

The final question that the hon. Member for Torridge and West Devon asked was why the words "equal to" appear. Those words are needed because the clause must include any case in which couples have entered into a legal declaration—we do not require them to enter into such a declaration, but they have decided to do it—in respect of close company shares held in their joint names. If shares are held half and half, income will be taxed half and half. The effect of the clause is that couples will be taxed on their proper share of income, as they declare it to the tax authorities.

I do not see why the Commitee should object to income being taxed fairly, on the basis of information given to the authorities about the close company. The legal declaration seeks to neutralise the working of the two sections. Clause 86 ensures that if there is a declaration, it is followed. If there is no declaration, section 282A will apply, as normal. With that clarification, I hope that the Committee will agree that the clause is appropriate, proportionate and right to close a loophole whereby legal declarations have been used to get round the clear intent of Parliament since independent taxation was introduced in 1990.
 
28 Apr 2004 : Column 897
 

Mr. Flight: I apologise for taking the Committee's time but, with respect to the Paymaster General's comments, the clear intent in 1990 was not as she described. She agreed—I thank her—that clause 86 was introduced because if the Revenue is successful in its new interpretation of section 660A, which we object to, the clause removes the section 282A alternative defence. The two are entirely interlinked, in that the essential motive for clause 86 is to support the new initiative under section 660A.

Mr. Burnett: I do not know whether the hon. Gentleman is minded to answer my last intervention on the Paymaster General. What effect will an alteration of equitable interests have? Will it invoke the settlement provisions—income deemed to be that of settlor provisions—in which case the allocation of shares will be altered by declaration of trust or otherwise, but the married couple will still suffer tax as to the ownership prior to the alteration, and the change will not be reflected?

Mr. Flight: I thank the hon. Gentleman. That is precisely the point. My understanding is that, if the Revenue succeeds with its new interpretation of section 660A, the couple, in spite of having transferred to 50:50, will go on being taxed as though the split were 99:1.

Let me elaborate on the areas of dispute in relation to section 660A. By the way, the case comes up on 14 June and I know a little about it, as it concerns a constituent. Perhaps the Paymaster General should be aware that all the bodies whose names I listed have come together to disagree with the Inland Revenue on that case. It is therefore the first test case, which will resolve the matter one way or the other.

The area of dispute in relation to section 660A concerns the application of the settlements legislation where a husband and wife set up a company together, each subscribing for the shares. One party—say, the husband—earns money in the market place, and the wife may play a supportive role, giving advice or organising appointments. After paying employees and the husband's salary, there are sufficient funds in the company for a dividend to be paid to the shareholders.

The Revenue view in its new interpretation of section 660A is that that combination of factors is a settlement, and the necessary bounty is created when the husband takes a salary that might be deemed to be less than market value, so to leave distributable profits. The dividends received by the wife should thus be re-allocated to the husband. That is the specific case that the Revenue made in its 64th tax bulletin. The Revenue holds that the mischief in such situations is that the shareholdings adopted and the dividends paid lead to the diversion of income from a spouse who may be liable to tax at the higher rate to the spouse with a more favourable tax situation.

1.15 pm

The contrary argument that all those professional bodies have advanced is as follows: there is a clear exemption in section 660A(6) for outright gifts between husband and wife unless the gift does not carry a right to the whole of that income, or the property given is
 
28 Apr 2004 : Column 898
 
wholly or substantially a right to income. In a partnership where both the wife and the husband assume the risk of unlimited liability, it is surprising to see the Revenue arguing that the partnership share is wholly or mainly a right to income. In a company, the income comes to the wife by reason of her shareholding, and ordinary shares cannot represent a right to income. They are a bundle of rights, including a right to a share in the underlying capital of the company. The ownership of a share does not represent a right to income. At best, there may be an expectation. There may, in fact, be no income, or the directors may decide not to distribute the income. The wife is contributing to the business, even though she is not the person active in the external marketplace.

At the time of the 1990 Budget and Finance Bill, the Budget press release stated that although the settlements legislation was introduced in the 1930s, the exemption for gifts between spouses was introduced in the 1990 Finance Bill as clause 109. That subsequently became section 108 of the Finance Act 1990, and then section 660A(6) of the Income and Corporation Taxes Act 1988. The purpose of the clause was set out in the relevant Inland Revenue Budget press release:

"The Chancellor proposes in his budget to make changes in the income tax rules for gifts between husband and wife and for some other settlements. These follow the personal tax reforms in last year's budget. They will make the rules for settlement operate in a way which is consistent with the Government's objective for independent taxation . . . the changes will ensure that when independent taxation begins in April 1990 income from simple outright gifts of assets between husband and wife and certain pensions allocated between them will be taxed as the income of the recipient and not as the income of the person making the gift."

That was further elaborated in the detailed sections of the release:

"Under independent taxation the income arising from a gift of an asset between husband and wife will be treated as the recipient's for tax purposes only if it is an unconditional gift of both the asset and the income arising from it. The income will generally be treated as the donor's for tax purposes . . . if the donor has the right to get back the asset in the future, or to decide what the recipient should do with it",

or if

"the donor uses a trust to give the income to his or her partner while retaining control over the capital or passing the capital to a third party."

It should thus be noted that there is no mention of the sort of situation to which the Inland Revenue now refers in its new interpretation of section 660A, which was set out in examples 3 to 5 of its tax bulletin. Indeed, the press release indicated the opposite, by saying that unless the donor retains the underlying asset, the transfer will be effective for tax purposes.

The parliamentary debate on clause 109 of the Finance Bill back in 1990 makes interesting reading. It centred around an amendment tabled by the right hon. Member for Islington, South and Finsbury (Mr. Smith)—I apologise for not knowing his constituency at the time—to rewrite what is now section 660A(6) by adding a subsection that sought to achieve what the Government are currently seeking to achieve. The provision would have applied when the gift did not carry
 
28 Apr 2004 : Column 899
 
a right to the whole of that income, when the property given was wholly or substantially a right to income, or when the gift was undertaken with the sole or main objective of achieving a tax advantage. The amendment was tabled because the Labour party was concerned that it would be possible to make a gift producing income that was taxed at a lower rate than in other circumstances, especially when one household member was in a higher tax bracket, while the other paid tax at the basic rate.

The Chief Secretary of the time said that the amendment would undermine the very basis of independent taxation and that, if it were carried, there would be no independence for married couples and people would not be free to arrange their affairs as they wished. He added that independent taxation was bound to mean that some couples transferred assets between them, with the result that their total tax bill would be reduced. He stated that that was an inevitable and acceptable consequence of taxing husbands and wives separately. Even more explicitly, he said that the Government had made it clear that they expected that income splitting would occur, and the amendment was withdrawn.

The reallocation of assets between spouses to take advantage of one spouse's personal allowance and lower rates of tax was thus not only contemplated, but accepted by the Government of the time as part of the price for independent taxation. There is no reason why such transfer of assets should not include shareholdings and partnership shares.

I apologise for putting all that on record, but the bottom line is that if the Government wished to reinterpret section 660A, they would have been better off doing it by legislation. Instead, it is being done by Inland Revenue initiative. As has been pointed out, and as the Paymaster General conceded, that matter has an acute relationship with clause 86 and the defence usage of section 282. We therefore oppose clause 86 in principle, and we will certainly do so until the special commissioner's findings emerge in June to resolve the underlying section 660A issue one way or the other.

---