Finance Bill

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Mr. Flight: Our amendments and the next two cover crucial issues under the schedule. With your permission, Sir John, I shall include in my comments on these amendments any minor comment that I might have made in a debate on the whole schedule.

The amendments to the bad debt relief rules for debts between companies that were connected but became unconnected as a result of insolvency proceedings are the third part of the territory covered by the schedule. If companies are connected, the bad debt write-off is non-deductible on one side and non-taxable on the other. However, that is not the case when companies are unconnected. There is a gap in the existing rules that means that it is possible for a one-sided tax effect to arise because of a lack of clarity on which arrangements left companies unconnected. Schedule 8 clarifies in detail the rules governing connection. We have no perceived problem with the rules. Indeed, because they clarify the conditions under which release of a debt can be made without a taxable credit arising on the debtor in certain insolvency proceedings, we view them as helpful.

Amendments Nos. 53 to 55 relate to the late interest rules, which are highly technical. The Government's changes are split into two parts. According to the boasts of the Inland Revenue briefing note, the first makes changes to put beyond doubt a point of concern for the venture capital industry. Many believe that the Government's proposals in paragraph 2 will not achieve the desired objective in relation to investments by private equity funds that are not collective investment schemes. They are bodies corporate even though they are limited partnerships.

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The point of concern revolves around whether companies owned by private equity partnerships could deduct interest on their loans from those partnerships on an accruals basis, even if the interest were rolled up or not paid within 12 months from the end of the accounting period, and arose because the rule affects interest paid by a close company.

Most private equity investments are treated as close companies, because each private equity investor must attribute all the partnership interest to itself to work it out. The Bill introduces a measure that exempts a partnership from the need to attribute interest, which the industry greatly welcomes, but concern remains that the general partner of the private equity partnership could still make the partnership close because of the control that it exercises on behalf of the other partners. Amendments Nos. 52 and 53 would extend the definition of the collective investment scheme-based close company to cover that point.

Another concern relates to the same provisions. Customarily, private equity groups used a two-tier structure, which ensured that private equity investment could deduct interest on an accruals basis. Following the Finance Act 2003, the view was that that was no longer effective unless the creditor was a collective investment scheme, as defined in the Financial Services and Markets Act 2000. That carve-out has been helpfully supplemented by the Bill, with another small exception.

The Government's proposed exemptions may remove the CIS-based companies when the creditor is a participator, but they do not seem to do that when the creditor has control of the company or a major interest in it. I am told that there is a common circumstance in which a general partner receives a substantial amount of the income from investments in periods during which there is no capital realisation and when the partner could be deemed to control, or have a major interest in the investment. We therefore propose that the exemption for CIS limited partnerships should be extended to situations in which the partnership controls the major interest, and not only where it is a participator. Amendment No. 55 seeks to address that issue.

The Paymaster General (Dawn Primarolo): Good morning, Sir John.

I shall respond to the amendments tabled by the hon. Member for Arundel and South Downs (Mr. Flight) by putting into context schedule 8, which makes changes to legislation on loan relationships and derivative contracts that have been identified in the post-implementation consultative group, of which the hon. Gentleman is aware. It deals with some loopholes that have emerged since 2002, covers areas such as the treatment of certain venture capital limited partnerships by relaxing further an anti-avoidance rule that had an unintended effect on those partnerships, and deals with companies in insolvency proceedings by extending the circumstances in which they can avoid being taxed on imaginary profits. It also covers companies that emigrate or move assets from a permanent establishment by ensuring that tax is charged on profits accruing up to the date of the move, and covers the major interest test for

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deciding if companies are connected and so receive special tax treatment. As the hon. Gentleman said, this is a highly complex area of tax law.

It is the Government's view that, together, amendments Nos. 53 and 54 create an unjustifiable new category of loans that can be exempted from the late interest anti-avoidance rules. The late interest rules prevent a tax deduction for interest that has not been paid within 12 months of the end of the accounting period, and they apply where the lender and borrower are connected or under common control.

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Amendments Nos. 53 and 54 add a completely new category of venture category funds whose loans would be exempt from the late interest rule. That new category covers limited partnerships funds, where the late interest rule applies because the general partner is the only partner who can manage the partnership. By excluding loans from those funds from the late interest rules, the amendments seek to disregard the central role of the general partner.

The Government are proposing changes that do no more than put beyond doubt the circumstances in which the late interest rules are set aside for loans made under limited partnership venture capital funds. One change makes sure that the existing exemption covers some of the foreign partnerships that the industry argued are otherwise excluded because they have some corporate characteristics. The other change stops some loans made by venture capital funds from coming under the late interest rules as a result of an individual being a partner in the fund. We consider that those changes go as far as is needed to address the difficult areas of foreign legal concepts, and cases where individuals are partners in such funds. As the hon. Gentleman said, the changes have been welcomed by the industry.

I recognise the point that the hon. Gentleman and the industry have been trying to make, but I am trying to explain the difficulties to the Committee. The amendments represent a significant step beyond the clarification of the existing exemptions from the late interest rules that is proposed by the Government. They go to the heart of the concept of control, which is used widely in the Taxes Act 1988 as a trigger for anti-avoidance rules. I am not minded to take this step because of the risk of weakening the rules; to do so would carry significant and unjustifiable risks for the Exchequer. I entirely accept that it is a complex area, but as a Minister I am clearly making the judgment on advice from my officials. Although we listen carefully to what the venture capital industry is saying, we cannot allow the breach of wider rules.

Mr. Flight: I want to go back to something that the Minister said a few minutes ago, about the general partner having a lot of control over the private equity companies that they manage. They have that control as the investment manager on behalf of the other investors, and not in the normal context of controlling a close company. I trust that she would agree that it is inappropriate for the requirements to apply in that situation. If she does not like our amendments and

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thinks that they go too far, how else does she hope to deal with the issue?

Dawn Primarolo: As I tried to explain, the rules that were set in 2002 were widely welcomed and are working well. Discussions with the venture capital trust industry are continuing and a number of issues are being raised. The role of the general partner is at the heart of a number of issues in the tax system. It is one thing to identify an issue for a particular industry. However, I have to ensure that we do not allow a particular industry or sector to operate in a way that we did not allow anywhere else, for good reason, under the Taxes Act and other legislation. Amending the control tests, even narrowly as suggested in amendments Nos. 53 and 54, is not appropriate, because it would risk weakening existing legislation that applies elsewhere.

It is not within the gift of Government—we would be challenged—to say that a particular industry could work in one way but that everyone else could not. I have to pay attention to the general rules. The hon. Gentleman will understand that a relaxation of the control test in one part of the system will cause significant problems across the board. I think that he is well aware that dialogue between the Inland Revenue and the venture capital trust industry continues. It has raised the matter with us, but what he suggests is not appropriate and cannot be done. He asks how else I would do it. Frankly, I cannot give him an answer. The fundamental point is what happens elsewhere in the tax system.

I turn to amendment No. 55, on which I might be a little more helpful, although I do not want to raise the hon. Gentleman's hopes—I am not going to accept it; I thought it best to give that caveat, just in case. It seeks to extend the application of the new definition of a collective investment scheme limited partnership to areas of legislation beyond the application of the late interest rules.

As I said earlier, when outlining the provisions of schedule 8, the Government propose a change that puts beyond doubt the circumstances in which the late interest rules are set aside when a limited partnership venture capital fund has invested in a close company. We consider that the changes go far enough to address difficult definitional areas, and they are welcomed by the industry.

To the extent that there remain areas of difficulty, the Revenue will continue discussions with the British Venture Capital Association , with a view to resolving the difficulties through revised guidance. I confirm that the existing clarification in Revenue guidance will not be withdrawn. Concern was expressed by the industry that that guidance would be withdrawn as a consequence of schedule 8, but it will not be.

I hope that the hon. Gentleman agrees that we are doing our best to respond to the particular issues raised by the industry, but we clearly have to draw a line. We are not going to allow, nor should we, the breach of other legislation. I hope, at least for now, that the hon. Gentleman considers the matter to have

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had a good airing and that he will withdraw the amendment. If he presses it to a Division, I shall ask the Committee to reject it.

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