The Chairman: Order. I have to point out that the clause is about the year 2005 only and not about any other year.
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Question put and agreed to.
Clause 25 ordered to stand part of the Bill.
Small companies' rate and fraction
for financial year 2004
Question proposed, That the clause stand part of the Bill.
The Chairman: This clause is about 2004.
Mr. Flight: The clause sets the starting rate of tax for small companies for this year. The key point is that, under the new corporate distribution rate, the starting rate for the overwhelming majority of small companies will be 19 per cent. and not zero per cent.
Question put and agreed to.
Clause 26 ordered to stand part of the Bill.
Clause 27 ordered to stand part of the Bill.
Special rates of tax applicable to trusts
Mr. Flight: I beg to move amendment No. 57, in
clause 29, page 23, line 35, leave out subsection (4).
The Chairman: With this it will be convenient to discuss the following:
Schedule 4—Amendments relating to the rate applicable to trusts
New clause 1—Repeal of section 677 of Taxes Act 1988
'Section 677 of the Taxes Act 1988 (sums paid to settlor otherwise than as income) is hereby repealed.'.
I suggest to hon. Members that it is probably useful if they include anything that they would like to say on clause 29 stand part now.
Mr. Flight: I thank you, Mr. McWilliam, for the comments that you have just made, because the territory is very much interrelated. In the course of my remarks, I want to make a point about amendment No. 31, which, for technical reasons, has not been selected, but is a central part of the point here.
Both clause 29 and schedule 4 increase the income tax rates for non-interest in possession trusts—discretionary and accumulation trusts—from 25 per cent. to 32.5 per cent. and for UK company dividend income from 34 per cent. to 40 per cent. That opens up what we perceive as an unfair imbalance in the treatment of UK company dividends. Whereas higher-rate taxpayers are taxed at 25 per cent., the income received by the beneficiary in a non-interest in possession trust will be taxed at 40 per cent. I think that that will also apply to pension-saving arrangements that fall under the funded unapproved retirement benefit scheme, or FURBS.
Next year, the Government are proposing sensible measures for streaming that I describe as automatic look-through. At the least, I ask why the tax is being put up a year ahead of that, which will result in a year of unfairness, and why it would not be more sensible to combine the two in the same tax year and to delay the tax increase for another year.
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I had an extraordinary constituency case, where a little girl's father died at 35, leaving her £10,000. Her grandfather put that into a discretionary trust. He was going up the wall because he was already having tax estopped on it and could not get it back from the Revenue. He said, ''I hear that the rate is now going up to 40 per cent. What sort of justice is that? The amount involved is tiny.'' I said to him, ''As I understand it, in another year you would be alright because it would be a straightforward look-through situation, but I am afraid that this year, for some half-baked reason, you will have to pay even more tax, unless we can persuade the Government to coincide the two measures.''
New clause 1 would abolish section 677. We see no need for schedule 4, which introduces consequential amendments arising from the increases to the schedule F trusts rate and the rate applicable to trusts. Moreover, it complicates an already over-complex situation. The essence of the point is that, if we deal with the whole lot together, once we move to stream the higher tax rates, we do not need section 677 or schedule 4.
Certain capital sums paid to a settlor are taxed as income by section 677 when there is undistributed income in the trust. Schedule 4 introduces yet more complex first-in and first-out matching rules to relate the tax credit received by the settlor to the tax paid by the trustees. We would welcome an explanation of the provision, which appears to be a little capricious. Already the problems with sections 677 and 678 are made worse by schedule 4. The explanatory notes have turned up in the past day or two but, when I and others focused on this area, we did not have the explanatory notes to sort out some of the problems.
Section 677 could be repealed given that UK trust income is increasing to the new 40 per cent. rate. The key point is that, once the tax rate has been increased, you do not need all the clutter that section 677 and schedule 4 bring. There will be virtually no accompanying tax revenues once the rate has been upped to 40 per cent. The amount of tax at stake will diminish over the years as the amount of undistributed income that has suffered tax at rates of less than 40 per cent. reduces over that time. The related rules of section 678—capital sums paid by a body connected with the settlement—will become similarly redundant over time.
To sum up, it seems extraordinary that the Government are not dealing with the new tax rate and streaming at the same time. If both were dealt with at the same time, you could simplify an area of taxation that is ludicrously complex, and made more complex by the provisions of schedule 4, for little or no loss of revenue.
The Chairman: Just to remind members of the Committee, it is 30 years since I have been the trustee of anything. The word ''you'' is being used too often.
Mr. Burnett: I want to address my comments to amendment No. 31. It is a popular misconception that all beneficiaries of non-interest in possession trusts are—
The Chairman: Order. That amendment has not been selected. However, the argument can be made.
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Mr. Burnett: All I can say is that I am anxious to speak to that amendment. I am not moving it.
The Chairman: Order. For the sake of clarity, it is not possible to move the amendment, because the amendment is out of order. I accept that it is out of order on a technicality, but I suggested to hon. Members that they should take the group of amendments and clause stand part together. The argument is in order.
Mr. Burnett: I shall therefore proceed to make the argument—[Interruption.] I am willing to give way to the hon. Member for Ealing, North (Mr. Pound), who, if we are very fortunate, might regale us with details of his naval career.
It is a popular misconception that only the very rich are beneficiaries of non-interest in possession trusts. That idea is wrong for various reasons. Often, for example, simple mitigation of tax, with property prices being so high, will involve, on the death of a first spouse, the creation for at least two years of a non-interest in possession trust—a nil rate inheritance tax trust. There could be 10 beneficiaries of that trust, including the surviving spouse, and many of those beneficiaries could be extremely badly off. I do not understand why the Government have a fair system in place for the next tax year and a patently unfair system for this tax year.
Mr. Flight: It is not just patently unfair, but made more unfair by the increase in the rate to 40 per cent.
Mr. Burnett: That is absolutely right. For that reason I hope that the amendment will be pressed to a Division, unless the Government accept it, because we support it. It is patently unfair to discriminate doubly for one year against many individuals who are low-rate taxpayers, thus ensuring that they pay considerably more tax.
Mr. Flight: Tragically, we cannot specifically vote on the measure as the amendment has not been selected. Therefore, unless the Government can satisfy us that they will deal with the issue, the only possibility is to vote against the clause.
Mr. Burnett: I understand that, but we have to be very careful in the Committee because we might want to keep our powder dry until Report. Nevertheless, I hope that we shall receive from the Paymaster General, who is invariably generous and courteous, some words of compromise and sense.
Dawn Primarolo: I hope that in explaining clause 29 and schedule 4 to the Committee, and responding to the amendments, I will also be able to address the specific point about the future changes to trusts, about which the Government are currently consulting, and how they will interact with the clause. I hope that hon. Members will then be satisfied that the calamitous situation that they believe possible will not come to pass.
Clause 29 changes the applicable rate for trusts from 34 per cent. to 40 per cent., and the corresponding schedule F trust rate from 25 per cent. to 32.5 per cent. The rate applicable to trusts has traditionally been set above the basic rate, which
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reflects the fact that many—but, as the hon. Member for Arundel and South Downs said, not necessarily all—of the ultimate beneficiaries are liable to the higher rate tax. Higher rate taxpayers still can, and do, achieve an unfair tax saving by channelling their income through trusts. Increasing the rate applicable to trusts ensures that the right amount of tax is paid by the higher rate taxpayer.
The ultimate tax liability of the beneficiaries who receive income from a trust will not be affected by the increase in the rate applicable to trusts. Beneficiaries will continue to get a credit for the tax paid by the trustees so that higher rate taxpayers will not have to pay any more tax when trust income is paid to them. Beneficiaries who are not liable for income tax, or are liable at the starting or basic rate, will be able to claim the repayment, as is the case at the moment.
Clause 29 and schedule 4 are part of a wider package of changes that will modernise the way that we tax trusts.
Mr. Flight: Will the Paymaster General give way?
Dawn Primarolo: If the hon. Gentleman will let me finish this point, I shall give way to him. The changes will reduce the compliance burdens faced by smaller trusts. From the tax year 2005–06, there will be a £500 basic rate band for trusts that pay tax at the rate applicable to trusts. Trusts established for the most vulnerable will benefit from the new rules; the trustees will be taxed only at the vulnerable beneficiaries tax rate.
This is a complex area. The Inland Revenue has consulted widely on it, which has been welcome. That consultation continues, and it is designed to ensure that all the details are correct. The provisions will ensure that trusts for the vulnerable do not pay more tax. In many cases, they will pay less, and it will be backdated.