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Mr. John Gummer (Suffolk, Coastal) (Con): Does my hon. Friend therefore agree that, when the Government tried to block what it was perfectly reasonable to block, it was not acceptable that they did it retrospectively and then pretended that it was not retrospective? Its retrospectiveness lay in the fact that people who had done what was perfectly legal and what had been shown in the courts to be legal were then told that it would have to be undone, in circumstances that, by their nature,
 
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would be wholly different from the circumstances in which they had made the decision in the first place. Had they known that that was going to happen, they would not have made the same decision. That was blatant retrospectiveness.

Mr. Hammond: My right hon. Friend is right. Those of my hon. Friends who have had the opportunity of serving on the Finance Bill Committee, and those who served on previous Finance Bills, will know that the Paymaster General will make a great case for the distinction between retrospectivity and retroactivity. She will say that the measure was not retrospective, although it was retroactive. I am afraid that the effect on the taxpayer is exactly the same.

In the Finance Act 2005, the Government called time on this particular scheme, not by attacking inheritance tax planning directly but by levying an income tax charge on the value of the benefit from the retained interest in the house sold at arm's length to the first trust. That caused considerable anguish and anger because of the retroactive nature of the legislation—imposing a new tax on a series of difficult-to-reverse transactions, some of which had been in place for nearly two decades when the measure was introduced. There was a large-scale gnashing of teeth at the time. Now that the dust has settled, most taxpayers accept that the game is up, and that the schemes that they have expensively set up have failed for the purpose that they set them up, and that those schemes should now be dismantled. That is what most taxpayers confronted with this new income tax charge want to do. Therein lies the problem that we seek to address with new clause 5.

The Government action under the Finance Act 2004 was devastatingly effective. It completely removed the economic benefit of the schemes, and the Government's objective would be achieved by the dismantling of the schemes. Unfortunately, in doing so, the taxpayer is subject to a huge risk of a double taxation charge. The Government have provided a protected exit route from such schemes. Regulations under the Finance Act 1986 provide some protection against double charging, and regulations that were made earlier this year, under schedule 15 to the Finance Act 2005—a measure targeted to deal with a problem that had already been recognised—provide for those who have set up such a scheme to avoid the income tax charge by making an election, which essentially makes the whole establishment of the double trust transparent for inheritance tax purposes. The trusts therefore remain in place, but the house, notwithstanding its sale, is treated as a chargeable asset, and the relief is given on the lesser in value of either the house or the debt due from the children's trust on death. No double charge to tax would therefore arise.

That is a de facto unwinding of the situation from an economic, not a legal, standpoint. It has been an effective way out of the mess for many ordinary middle-income families, leaving them bruised by the expense and stress of setting up and then unravelling the scheme but otherwise intact, while protecting the Exchequer at the same time by ensuring that the same inheritance tax is payable as would have arisen in the absence of the scheme.

There are good reasons, however, why the election route under regulation 6 of the snappily named Charge to Income Tax by Reference to Enjoyment of Property
 
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Previously Owned Regulations 2005 is not an appropriate route for most people. First, the ownership of the property is left unchanged—the economics of the scheme are addressed but ownership is not, so that while the house will be charged to inheritance tax in the donor's estate, the debt, which has been gifted to the children's trust, remains in existence and will eventually give rise to a tax charge on the children who are the beneficiaries of the children's trust.

Secondly, most people not unnaturally feel that, if they have come out with their hands up, unravelled the arrangements that they have made and accepted that they will remain liable to inheritance tax on their house—the asset originally intended to be protected—there should not then remain in existence what is effectively a debt due from them to the children's trust that they have established.

Thirdly, and perhaps most importantly, for technical reasons, an election under regulation 6 by a married couple will give rise to an inheritance tax charge on the first death rather than, as is normally the case with a married couple, on the second death. That does not alter the total inheritance tax due on the house, but it can cause serious cash-flow problems for the surviving spouse, and may possibly even require the sale of the house on the first death.

That cannot—at least, I hope it cannot—have been the Government's intention. Given the problems that I have outlined, the obvious route for such people is to unwind the scheme rather than take advantage of the right to make an election under regulation 6. Unwinding the scheme would involve the trustees of the children's trust advancing the debt to the beneficiaries and the beneficiaries then releasing or writing off the debt due to them, so the position would revert to what it had been before. Mr. and Mrs. A would no longer hold the house subject to a debt but would be fully liable to inheritance tax on its value, while escaping the income tax charged on pre-owned assets.

The difficulty is that, if either Mr. or Mrs. A, or both of them, die within seven years of the original gift of the debt to the children's trust, they face two lots of inheritance tax, one on the failed potentially exempt transfer represented by the gift of the debt and one on their share of the full value of the house. Two inheritance tax charges will be made on what is essentially the same economic value.

Before this year's regulations were made, that problem also arose if people made an election under the Inheritance Tax (Double Charges Relief) Regulations 1987. However, regulation 6 of the 2005 regulations now relieves from a double taxation charge the estates of people who die within seven years of the original gift of the debt having made the election under regulation 7.

Unfortunately, the same treatment does not extend to people who unwind arrangements completely. Our purpose is to seek a commitment to close that unintended trap—at least, I hope it was unintended—for unwary people seeking to comply with the changed rules by unravelling the schemes that they set up before the Finance Act 2004.

New clause 5 seeks to amend the underlying primary legislation—the Finance Act 1986, under which the original relief was available—to address the circumstances that I have identified, by inserting new section 104A. In
 
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practice, that would extend to people who die within seven years of unwinding a scheme by writing off or releasing the debt, the same relief as applies to those making an election. It would do that by requiring two separate calculations of the tax due—in respect of the debt and in respect of the house—and requiring the lower valuation to be reduced to nil, and the higher amount to be payable. Essentially, that is the same procedure as required under regulation 6 of the 2005 regulations for people who have made an election.

Subsection (2)(d) of proposed new subsection 104A, providing that the double taxation relief would be available only if the release of the debt was being made other than for full-value consideration, would ensure that the new clause could not become a tax avoidance mechanism in itself. The relief would operate whoever released the debt. In the example that I have used, it would be the children who were the beneficiaries under the children's trust. The debt would have to be advanced to the beneficiaries, because only they could readily give a discharge of the debt from the settlor. The trustees cannot write off the debt, because to do so would confer a benefit on the settlor, who would have been excluded by the terms of the original trust deed when it was set up for the original purpose.

3.15 pm

For whatever reason—I suspect it is largely because of the pressure of the growing net of inheritance tax—ordinary people have been lured into complex tax planning by the iniquitous tax drift that has turned IHT into the biggest stealth tax. Retroactive legislation has been imposed on them, and most of them have now accepted that the schemes into which they entered are ineffective, and they want to unwind them, thus giving effect to the Government's intentions. However, they find that they cannot do so without incurring a real risk of double taxation which, even without taking into account the costs of setting up and dismantling the scheme, would leave them significantly worse off.

We must not forget that, as my right hon. Friend the Member for Suffolk, Coastal (Mr. Gummer) said, those schemes were perfectly legal tax planning when they were set up. Indeed, they remain so, although they have been economically neutered. Ordinary people seeking to comply with the changed rules should not be penalised by modest estates being put at risk of a potential 80 per cent. tax charge on the surplus value of the estate over the IHT threshold if both the debt and the house are charged to IHT.

Even with the proposal for relief that we suggest in new clause 5, there would still be considerable downside risk for the taxpayer seeking to unwind such a scheme. First, a beneficiary of the children's trust will suffer inheritance tax if he dies within seven years of the debt being written off. Secondly the position for married couples who leave their property to each other on the first death, within seven years of the original gift, will remain unsatisfactory. For example, if Mr. A dies within seven years of the original gift of the debt, the potentially exempt transfer will become chargeable, even with double charge relief. On Mrs. A's death later, the full value of the house would become chargeable, so in effect, Mr. A's share will be taxed twice.
 
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Perhaps that will be sufficient to satisfy the Paymaster General's well-known penchant for putting into the tax system deterrents to legal tax planning. However, even with those remaining penalties, new clause 5 would greatly improve the position of the group of taxpayers who seek to unwind schemes and get on with the rest of their lives. I therefore appeal to her sense of compassion. Many thousands of people, the vast majority of whom will never have indulged in any form of serious planning before, and the vast majority of whom will have no wish to go near any form of tax planning ever again, have been caught in this trap.

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