Column Number: 377
Standing Committee A
Tuesday 25 May 2004
[Mr. John McWilliam in the Chair]
(except clauses 4, 5, 20, 28, 57 to 77, 86, 111 and 282 to 289, and schedules 1, 3, 11, 12, 21 and 37 to 39)
Restriction of relief: non-active partners
Amendment proposed [this day]: No. 183, in
Question again proposed, That the amendment be made.
The Chairman: I remind the Committee that with this we are taking amendment No. 182, in
clause 119, page 100, line 11, leave out subsections (7) and (8) and insert—
'(7) In subsection (1) ''a trade'' does not include—
(a) underwriting business within the meaning of section 184 of the Finance Act 1993 (Lloyd's underwriters), or
(b) a trade where the Board have, on the application of a partnership of which an individual is a general partner or member of a limited liability partnership, notified the partnership that the Board is satisfied that the trade will be effected for bona fide commercial reasons and will not form part of any scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability of tax.
(8) Any application under subsection (7)(b) above shall be in writing and shall contain particulars of the operations that are to be effected and the Board may, within 30 days of the receipt of the application or of any further particulars previously required under this subsection, by notice require the applicant to furnish further particulars for the purpose of enabling the Board to make their decision; and if any such notice is not complied with within 30 days or such longer period as the Board may allow, the Board need not proceed further on the application.
(9) The Board shall notify their decision to the applicant within 30 days of receiving the application or, if they give a notice under subsection (8) above, within 30 days of the notice being complied with.
(10) If the Board notify the applicant that they are not satisfied as mentioned in subsection (7)(b) above or do not notify their decision to the applicant within the time required by subsection (9) above, the applicant may within 30 days of the notification or of that time require the Board to transmit the application, together with any notice given and further particulars furnished under subsection (8) above, to the Special Commissioners; and in that event any notification by the Special Commissioners shall have effect for the purposes of subsection (7)(b) above as if it were a notification by the Board.
(11) If any particulars, furnished under this section do not fully and accurately disclose all facts and considerations material for the decision of the Board or the Special Commissioners, any resulting notification that the Board or Commissioners are satisfied as mentioned in subsection (7)(b) above shall be void.
(12) This section has effect subject to sections 118ZJ and 118ZK (transitional provision).
118ZEA Application to particular trades
(1) Section 118ZE(7)(b) shall not apply to any trade unless—
(a) It can be shown that in respect of any period where a loss was sustained, the trade was carried on throughout that period on a commercial basis and in such a way that profits in the trade
Column Number: 378
could reasonably be expected to be realised in that period or within a reasonable time thereafter;
(b) The profits of the trade are taxed on the general partners or members of a limited liability partnership who claimed the reliefs referred to in subsection 118ZE(1) in the same proportions that the partnership's loss was claimed.
(c) The partnership's expenditure is not applied, directly or indirectly, to provide security for repayment of any borrowings of the partnership or of any of its general partners or members of a limited liability partnership, including without limitation, by means of a cash deposit;
(d) The receipts from the trade are entirely contingent on the performance of the products or services comprising the trade; and
(e) The trade is carried on for bona fide commercial reasons and does not form part of a scheme or arrangements of which the main purpose, or one of the main purposes, is avoidance of liability of tax.
(2) The Board may make regulations with respect to the application of section 118ZEA(1) above to particular trades.'.
The Financial Secretary to the Treasury (Ruth Kelly): I am delighted to see you in the Chair again this afternoon, Mr. McWilliam, because I rise with a little trepidation, as the Treasury's resident tax expert, the Paymaster General, is undergoing an emergency dental procedure. Nevertheless, I am delighted to be able to address the subject of film tax relief, and in particular the amendments tabled by the hon. Member for Hertford and Stortford (Mr. Prisk). I believe that the amendments would seriously undermine the effect of the legislation and open the door to continued avoidance on a wide scale.
Clause 119 tackles tax avoidance and deals with schemes that offer a risk-free tax gain to wealthy individuals acting in partnership through misuse of loss relief intended to benefit people who risk their capital trying to make a living from a trade. The abuse consists of the misuse of sideways trading loss relief so that wealthy individuals receive tax relief that is greater than their financial contribution to the partnership. It follows that the partnership must be trading if there is to be a trading loss on which the scheme depends. I would argue that to exclude partnerships from the provision simply on the basis that they were trading would miss the abuse entirely. I want to make it absolutely clear that the clause does not enforce a specific commercial structure on partnerships. It simply restricts the way in which losses can be used for tax purposes.
The schemes that the clause targets effectively allow a business to transfer the benefit of its trading losses to a partnership of individuals by allocating more losses to the individuals than the amount they put into the partnership. The individuals can then cash in the loss by setting it against their general income and gains. Because they claim 100 per cent. of the losses, the wealthy individuals get back 40 per cent. as a tax rebate. That is more than the 25 to 35 per cent. that they typically put in, so they receive an immediate cash gain at the expense of the Exchequer.
The partners using the scheme have not, in effect, invested any of their own money: their investment was funded by the honest taxpaying public. In practice, the individuals are guaranteed to make a tax-free gain, even if the trade generates no income whatever, as the tax relief is greater than the amount they have put in,
Column Number: 379
and they have a chance of increasing their gain if the trade generates future income. They are on a one-way bet, underwritten by the Exchequer.
Mr. Mark Prisk (Hertford and Stortford) (Con): Does the Financial Secretary accept that, as was inferred from the Paymaster General during our previous debate, the clause as drafted casts the net wider than simply the illegal activity to which she has rightly referred, and which it is right to block in the clause? Does she accept that the danger is that, contrary to what was said previously, the provision will affect legitimate commercial trades, even if only a small number?
Ruth Kelly: This turns on the point of certainty, which the hon. Gentleman talked about this morning. The new rules ensure that individuals cannot claim more loss relief against their general income than they have put into the partnership. To claim the rest of the loss, they must either stay in the trade and claim it against future profits or make a further contribution. The changes apply only to someone who is not active in running the trade and only to losses in the first four years that the trade carries on. They have no effect on someone who actively starts up and runs their own business.
I do not accept the hon. Gentleman's point. The legislation as drafted carries an objective test and people will know where they stand.
Mr. Prisk: What future, then, would business angels have in this environment?
Ruth Kelly: Well, business angels, just like any other investor through a partnership model, will know exactly where they stand. An objective test is applied, and they know under what circumstances they can claim options against future profits, and indeed they understand exactly how the contributions are treated, both in the initial year and in future years.
Mr. Prisk: I am not entirely sure that that is clear, because many business angels do not take an ''active role'' as defined in this clause. Can the Financial Secretary clarify what that means, and what that will therefore mean to business angels, whether in film or, frankly, in any other partnership?
Ruth Kelly: This is a narrowly drawn definition, for the reasons that I have set out already. Turning to business angels, one has to ask the question: why should they attain more relief than they have invested through a partnership in the film industry? It is a fairly common-sense proposition that relief should be constrained in the way that the new rules set out.
On amendment No. 182, an important part of the new rules is the change for limited liability partnerships. Under the current rules, as the hon. Gentleman pointed out this morning, a member of a limited liability partnership can base their claim to loss relief on the amount of their liability in a winding up. However, this liability can be no more than notional, and has been exploited aggressively to allow individuals to claim far more in loss relief than they have actually contributed. That is why we are changing the rules, so that only the actual amounts
Column Number: 380
contributed, either in the course of the trade or during a winding up, can rank as contributions for deciding the amount of loss relief against general income. However, we are making those changes only for people who are not actively engaged in the trade of a limited liability partnership, which draws a clear line between people who are actively running their own businesses and people who use these vehicles as schemes to claim large amounts of tax relief when they have no active role in the trade.
I can confirm that the existing provision under section 118ZC, which the hon. Gentleman raised this morning, has not been repealed, because this provision is still required to apply to partners who are not affected by the new rules—for example, active partners. If amendment No. 183 were accepted, it would mean that all members of limited liability partnerships could carry on as if nothing had changed, which would completely undermine the effect of this measure.
I also ask the Committee to reject the amendment No. 182, on two grounds. First, there is the question of certainty. I can confirm that it would create uncertainty over how and when the legislation will apply. The new rules that we have introduced are simple and objective, as I have already set out. If you are not an active trader, you can claim losses against general income only up to the amount of your contribution. It is easy to apply, and easy to understand. The amendment would introduce a whole layer of subjective tests that would make the position uncertain, as well as being a burdensome administrative procedure.
Secondly, the amendment is founded on a completely flawed view of profits and commerciality. These schemes involve creating a very large loss in year one by selling a film, say, with the right to future income, and estimating that future income at a fraction of the production cost.