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Rob Marris: As the hon. Gentleman knows, I served on the Standing Committee that considered the Bill. My recollection—he will correct me if I am wrong—is that under these provisions the taxpayer is put to an election as to whether they go into the new regime or, so to speak, have the house back and do not pay a rent or quasi-income tax on it. The taxpayer is not forced into one position or the other, but has a choice.

Mr. Flight: Again, the hon. Gentleman anticipates me, because one of my subsequent points deals with what would be a fair transitional relief. The whole principle underlying British law in this territory is that in such circumstances transitional relief is fair; for reasons that I will deal with later, in this case it is not fair.

Mr. John Burnett (Torridge and West Devon) (LD): Does the hon. Gentleman agree that the choice is not as simple as that, but is more like Hobson's choice in certain circumstances? For example, to avoid French inheritance tax laws, shares may be owned by a company that owns property in France. In those circumstances, the shares might attract relief but the property does not. That has most unfortunate consequences.

Mr. Flight: I thank the hon. Gentleman for his intervention; again, I will come to that in due course.

Amendments Nos. 9 and 7 would exclude from a pre-owned assets charge those interests in trusts that have never been treated as gifts with reservation, or may not be gifts with reservation depending on the facts. Where the settlor has settled property in a trust for a limited period after which the property reverts to him, the inheritance rules have always included a settlor's future right—his reversionary interest—as part of his estate, valuing it on an actuarial basis. That is, if the settlor recovers the property in a month's time, his interest is more valuable than if he recovers it in 25 years' time; that is perfectly rational. As a result, the gifts with reservation rules have never needed to apply.
 
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Under the pre-owned asset rules, however, the settlor effectively gets a credit for the value of the reversionary interest, but is nevertheless subject to income tax on the property in the trust, notwithstanding that he cannot benefit for another 25 years. Surely that is perverse.

Rob Marris: I venture to the hon. Gentleman that he is confusing a gift with a reservation of benefit—a concept that was introduced by his Government in the late 1980s—with a reversionary interest of a settlor. Those are two separate things, but he is eliding them.

Mr. Flight: Gifts with reservation of whatever kind have all been subject to the existing rules. The application of inheritance tax in relation to all the different situations involving gifts with reservation is covered by one territory. The hon. Gentleman says that these provisions date from when the Conservatives were in power, but I do not see why that makes much difference.

Mr. Burnett: I fail to perceive the relevance of the previous intervention. My understanding is that gifts of reversionary interest do not attract inheritance tax.

Mr. Flight: That is precisely the point—we are considering something that previously did not attract inheritance tax. I look forward to an engaging debate between the hon. Member for Torridge and West Devon (Mr. Burnett) and the hon. Member for Wolverhampton, South-West (Rob Marris) on the subject.

When a settlement is badly drafted, the settlor frequently retains no interest in it while it subsists. However, if it comes to an end and there are no living beneficiaries, the settled assets revert to the settlor by operation of law, by way of what is known as a resulting trust. In all likelihood, the settlor will never benefit from the settled assets but the possibility of benefits means that section 660A of the Taxes Act 1988 applies. If it is accepted that such circumstances do not constitute gifts with reservation, the amendment would ensure that such arrangements escaped the pre-owned assets charge.

It could be argued that a person who is not a beneficiary of a discretionary settlement but can be added as a beneficiary does not reserve a benefit in the settled property for gifts with reservation purposes, notwithstanding that section 660A would apply. Again, the amendment would keep settlors who are not currently beneficiaries out of a pre-owned assets charge. Of course, they would be covered by the charge if and when they were added as beneficiaries.

Amendment No. 10 would tackle the most ridiculous aspect of the pre-owned assets rules: that sales of part interest in property for full consideration are caught by the rules. If a child moves in with a parent, who gives the child half a share in the property, there is currently no pre-owned assets charge. However, if the child pays full consideration for the half share, there is such a charge. The Paymaster General suggested that she was worried about opening the door to possible avoidance but it appears that she is far more concerned about the possibility of catching innocent parties. She has failed to identify the mischief that she claims she intends to counter.
 
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As matters stand, the arrangements have a serious impact on equity release schemes, which are a growing source of revenue for the elderly in the light of the disastrous effect of the Government's policies on pensions saving. The Paymaster General promised to come back to me about that matter, which I raised in Committee, but the Government have tabled no amendment to paragraph 10(1)(a). That means that someone who has an equity release scheme either with a member of the family or a commercial provider will be caught by income tax. That is ridiculous. I have been told confidentially that the Government's view is that not many people have yet prepared equity release schemes and therefore the schemes do not matter. However, many more, in ignorance of the extraordinary tax trap, will take them up. Even if the numbers are not great, new laws should be fair and reasonable.

The problem is that the pre-owned assets legislation merely requires a disposal, not necessarily a gift, and occupation of the property. The paragraph 10 exemption lets people off pre-owned asset income tax only if there is a sale of their entire interest in the property, except for any right expressly reserved over it. That would not cover sales of, for example, a half share in the freehold, which is part of the typical equity release scheme contract.

The reference to non-exempt sales that was made in Committee does not deal with the problem because a sale of the entire interest in the land is required and we are referring to sales below value. The contrary aspect is that someone who had arranged to retain a lease and sell the freehold, subject to that lease, for full consideration, would not be affected by the pre-owned assets charge. The result would be essentially the same but via a different legal route. By contrast, selling half the unencumbered freehold in the property—a more typical transaction for the ordinary elderly citizen—is not covered.

2.45 pm

In the past, the Financial Times has discussed equity release schemes and the pros and cons in some detail. The Government have supported measures to get equity release schemes satisfactorily regulated by the Financial Services Authority. They are a growing fact of life today. However, many people who have done equity release schemes will not realise that there is an income tax, pre-owned assets charge in those circumstances.

Amendment No. 11 deals with the transition that the hon. Member for Wolverhampton, South-West raised. It would allow arrangements for those who are caught by the pre-owned assets rules to be unwound without incurring any tax charges and with any potential capital gains in the assets intact. That means that there would be no capital gains tax disadvantage in the process and that the basis of unwinding would be fair.

The Government's current policy of expecting people who are caught by the new rules to elect into a gifts with reservation charge is penal because the property would be back in the estate for inheritance tax purposes but would continue to belong to the donee. There is therefore an element of double inheritance taxation. As I argued at great length in Committee, there would be no
 
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capital gains tax uplift for the asset on death. Historically, only the ignorant or badly advised got into gifts with reservation positions. The amendment would introduce fairness into the transitional arrangements by giving people a genuine opportunity to unwind the clock. The Paymaster General complained that only those who wanted to effect new planning would want to do that, but that is unreasonable. People who have to unwind their arrangements will be reluctant to embark on new planning, unless it is specifically endorsed as acceptable. Indeed, that is the Government's intention with the pre-owned assets charge penalty.

I come now to amendment No. 225. As drafted, the schedule charges tax on the notional annual value after deducting the tax already paid. Surely the deduction should be based on the value on which the tax is paid so that there is no double charge to tax. In other words, 40 per cent. of 100 per cent. net of tax already paid produces a tax charge of 64 per cent., not the intended 40 per cent.

Amendment No. 226 relates to paragraph 2(b) of schedule 6 of the Inheritance Tax Act 1984, which provides that the reserved gift-tracing provisions do not apply to a gift that is a sum of money in sterling or another currency. That provision follows the former estate duty tracing provisions in section 38 of the Finance Act 1957. The purchase of a property from a benefit may be reserved with a cash gift, which is chargeable only if the purchase and the gift can be regarded as associated operations.

The problem of tracing cash gifts was discussed in Committee but the pre-owned assets charge should not be used to rewrite schedule 20 of the Finance Act 1986. A gift of cash that is unconnected with a subsequent purchase by a donor from which the donee may benefit is not and never has been a gift with reservation.

I want to consider problems with the interpretation of section 102C(3) of the Finance Act 1986. It deals with disposals of land after March 1999 and states that there is no reservation of benefit when a donor reverts to occupation due to unforeseen hardship. Paragraph 6 to schedule 20 of the 1986 Act deals with all disposals since March 1986, and states that there is no reservation of benefit where the donor occupies land or chattels for full consideration or reoccupies land due to hardship.

Paragraph 11(3)(d) to schedule 15 states that the provisions

"would fall to be so treated but for section 102C(3) of, and paragraph 6 of Schedule 20 to, the 1986 Act".

The intention is to ensure that, in those circumstances, there is also no income tax charge, but there has been confusion about the use of the word "and" in the above sentence. The effect of the word "and", inserted by amendment No. 141, appears to require both the reliefs covered to apply together to avoid the income tax charge, which most legal specialists believe is not the Government's intention. Does this mean that the conditions of section 102C(3) and paragraph 6 have to be satisfied? If so, the relief from income tax is confusing because it would apply in extremely limited circumstances. Or does it mean that if either section 102C(3) or any of the paragraph 6 conditions are satisfied, there is no income tax charge? This is an important point, because people frequently make gifts
 
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of chattels or land, and pay a full market value for their use and occupation, and they need to know whether they are in the income tax charge or not.

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