Finance (No. 2) Bill
Mr. Hoban: I thank the Economic Secretary for his remarks. I would have been much more nervous had my hon. Friend the Member for South-West Hertfordshire (Mr. Gauke) been here, because he would have questioned my use of the ECHR rather than the Economic Secretarys breathtaking irony. I am delighted that he is sure of the penalty regimes correctness and confident that it will withstand all challenges. We look forward to that proving to be the case.
On the transitional reliefs, I note the Economic Secretarys remarks on property being bought off-plan, pre-A-day. I am sure that they will have been noted. On borrowing, I welcome the fact that he talked about the consultation process that had gone on prior to this legislation and the support for the existing borrowing limits.
On the unquoted shares, according to the Economic Secretarys explanation, it seems that the problem started when the rules were relaxed in the Finance Act 2004 and we had investment in the pension Picasso, the pension Porsche, the pension penthouse and so on. He said that he will consider representations from the industry on that. In trying to stamp out one particular set of abuses, we must be careful that we do not deprive SIPPs of the opportunity to invest in other assets where they might feel it to be in their interest. I hope that the industry takes up his offer of consultation.
Question put and agreed to.
Schedule 21, as amended, agreed to.
Recycling of lump sums
Mr. Hoban: I beg to move amendment No. 141, in clause 160, page 134, line 39 [Vol I], leave out because' and insert following the receipt'.
The Chairman: With this it will be convenient to discuss the following amendments: No. 142, in clause 160, page 135, line 1 [Vol I], leave out envisaged' and insert intended'.
No. 143, in clause 160, page 135, line 7 [Vol I], leave out 1' and insert 10'.
Mr. Hoban: The Economic Secretary alluded to the clause in his remarks in the schedule 21 stand part debate. The clause is interesting and perhaps I should explain a little of the background. It appears to be quite a sweeping clause as it lays a charge of 55 per cent. on the pension commencement lump sum of people who make a significant increase in their pension contribution having already received the lump sum or in the knowledge that they will receive a high lump sum in the future.
The provision could capture a great deal of pre-retirement pension planning, as anyone who makes a significant contribution to their pension prior to retirement will do so envisaging that it will lead to a higher pension commencement lump sum. A pension
That is, in a nutshell, how the clause works. Having said that its effects are quite sweeping, its broad effects are mitigated by 28 pages of non-statutory guidance notes that act to restrict it. Take away those guidance notes and many people could be swept within its scope.
It has been possible for people to recycle lump sums as contributions to pension schemes since at least 1988 and possibly as far back as 1956. All that they must do is take the benefit and reinvest the tax-free lump sum as a pension contribution if they have unused allowable pension contributions. Historically, it was not much of an issue, as the limits on pension contributions as a percentage of earnings were relatively low and based on age, although there was a nuance whereby people could carry forward six years of unused contribution relief for retirement annuities.
By lifting the cap on contributions and making it much easier to withdraw lump sums from pension funds, the A-day regime has created an opportunity for people to reinvest those lump sums in pensions. They can effectively invest 100 per cent. of their salary in a pension fund in any particular year, and the unsecured income option allows them to take the cash and still draw no income at all. They do not need to take their pension benefit when they withdraw the cash and reinvest it in a lump sum. It does not take a genius to realise that there is a big potential for tax loss.
For example, if someone has a £400,000 scheme, they could withdraw £100,000 and invest it in a new scheme, gaining tax relief for £40,000. From thatnew £100,000 pension fund, they could extract a further 25 per cent., or £25,000, invest that in a new pension fund and receive tax relief at 40 per cent.a further allowance increase of £10,000. The process can go on iteratively until the money is exhausted.
Clause 160 and the 28 pages of guidance seek to tighten up the rules to prevent the alleged potential for widespread abuse of recycling by preventing people from withdrawing lump sums from their pension funds and reinvesting them. The change was heralded in the 2005 pre-Budget report, which stated:
action will also be taken to prevent abuse of the rules for tax-free lump sums from 6 April 2006. The legislation will remove tax advantages where lump sums are recycled back into funds in order to generate artificial levels of tax relief.
The draft legislation has put that into effect. The pre-Budget report announcement suggested that we should tackle those abuses.
According to the details of the rules, a scheme can make an unauthorised payment if several conditions are satisfied. The pension commencement lump sum received must exceed 1 per cent. of the standard lifetime allowance, which is currently £1.5 millionin other words, the lump sum must be £15,000 or more. The additional pension contribution must exceed 30 per cent. of the
From looking at the pre-Budget report announcement, I would assume that the sequence envisaged was the receipt of a lump sum followed by the payment of a significantly increased pension contribution. However, the Bills definition of relevant time means that an individual can make the significantly increased pension contribution and then receive the pension commencement lump sum.
The sequence works both ways. A person can either receive a lump sum and reinvest it to get the tax relief or make significant contributions now in the knowledge that they could receive a significantly enhanced pre-commencement lump sum later. It is the latter sequence that causes a problem, because it captures what people might think is legitimate pre-retirement tax planning.
Revenue and Customs has recognised that that could have an impact on ordinary retirement planning. Its guidance notes include four paragraphs on pre-planningless than one page out of 28 to tackle an issue that is difficult to identify. It says in paragraph 4.4:
There must be pre-planning for the recycling rule to be triggered, an individual will know that a conscious decision has been taken to use a pension commencement lump sum as a direct or indirect means to pay significantly greater contributions to a registered pension scheme.
That seems quite clear, but let us consider three examples to help illustrate the divergence of the broader circumstances.
Let us consider Mr. B of Westminster, who is planning to retire shortly. He might decide to increase his pension contributions, knowing that that will lead to an increased lump sum. The language of the 2004 Act suggests that he envisaged that that would be caught, but the meaning of the guidance notes is clear: it would restrict the application of the provision, because although he knew about it, he did it and nothing seemed to happen deliberately.
If the same Mr. B took out a pension commencement lump sum and reinvested it in another pension fund, assuming all the other conditions were met, in terms of the amount withdrawn and the change to the contribution package, HMRC would say that it was recycling and would levy the additional charge. But what if Mr. B decided to sell a flat and put the proceeds in his pension fund, rather than topping up his savings, knowing that he would, as a consequence of investing that money in his pension fund, receive a higher pension commencement lump sum to replenish his savings? He knew that the investment would lead to a higher pension commencement lump sum and that he did not need to put the proceeds of the sale in his savings, because he would be able to withdraw that lump sum later and replenish his savings that way. There is a relationship: he knew that he would draw a lump sum out in future, so why should he tap into the savings now? Why should he not use the proceeds from the sale of the flat to top up his pension scheme? He would have entered into an arrangement apparently in the knowledge that it would lead to an increase in his contributions. I am not sure how that would be treated. It seems to be a legitimate approach, but it does not
Rob Marris: The hon. Gentleman mentioned the relevant time, which is defined in the clause. It refers to
paragraph (a) of sub-paragraph (2).
It does not refer to paragraph (2)(b), which deals with the envisaged point that the hon. Gentleman is making.
Mr. Hoban: The hon. Gentleman makes an interesting point and it illustrates the complexity of the rules: a relatively straightforward, short clause needs to be explained by 28 pages of guidance notes. It is a sweeping clause that causes a problem with the sequencing of events.
The amendment would restrict the clause so that it only tackled circumstances where the lump sum is received and recycled. It does not take into account situations where contributions are increased with the intention that a higher lump sum will be received in future; it considers recycling as set out in the PBR measure, which proposed that there would be a clear sequencereceive lump sum and investrather than any other relationship.
Amendment No. 143 would restrict the scope of the clause by lifting the threshold for investigation from1 per cent. of standard lifetime allowance to 10Â per cent. This is a probing amendment. The £15,000 threshold is potentially quite low and could lead to a significant burden on administrators and others who are trying to identify contributions that have been made. I wonder whether that is too low and does not focus on wide scale abuses, and whether it will pick up a wide range of pre-retirement planning in a grey area. We need to recognise that the taxation consequence of breaching the clause is a 55 per cent. charge on the pension commencement lump sum and is not based on the additional contribution that a member might make to the scheme.
I do not know whether 10 per cent. is the right level or whether it should be varied between 1 and 10 per cent., but I would like the Government to explain why1 per cent. has been chosen as the right level. Is there a better a level that would not pick up a relatively low level of transactions that were not directed towards abusing the recycling regime?
I have a broader concern. This is a short clause with extensive guidance notes attached to it that do not have statutory status. They could be changed and amended. My concern is that the breadth of this clause is so great that there need to be stricter and more tightly defined regulations underpinning it that the House can discuss. Otherwise the Government could at some stage in the future withdraw the guidance notes and allow the clause to have its full effect.
Finally, could the Economic Secretary guarantee that the provision does not affect the tax-free status of the lump sum? This is one of the first times in which that status has not been used in legislation and there is reference to a pension commencement lump sum. The
Ed Balls: The answer on that last point is no; of course, that is not the intention and that has been made clear in the pensions White Paper and by me today. The new pensions tax regime, which we have put in place since 6 April, will make it easier for people to invest for their retirement using tax relief by lifting the limit on contributions. Individuals can save as much as they like, where they like in registered pension schemes, with annual tax relief on contributions limited to the lower of 100 per cent. of earnings or £215, 000.
We became aware of the potential within these new, generous and less restrictive rules for a systematic exploitation that could lead to potentially generous and substantial amounts of tax relief being diverted through a device known as recycling or turbo-charging. Under this device, an individuals tax-free lump sum is put back into a pension scheme as a further tax relief contribution.
To explain how turbo-charging occurs, let us consider an individual with a pension pot of £100,000 who takes a tax-free lump sum of £25,000, leaving £75,000 in his pension pot. He then puts the lump sum back into the pension scheme as a contribution, and this picks up a basic rate relief of £7,051 on the way back in. He also gets a further £5,769 in higher relief in his pocket. If he stops there, he has inflated his pension pot from £100,000 to more than £107,000 and has got a further £5,769 in his pension pot, all from the same money going round in a circle and picking up Exchequer relief funds on the way. He can go further if he wishes by putting his higher-rate relief back into the pension pot as well, and he could also repeat that cycle to get further relief and inflate his pot even more. I am not sure whether there is a technical term for that. It may be called repeated reverse turbo-charging. [Interruption.] Or reheated turbo-charging, perhaps.
What I need to clarify is that we believe that very few lump sum payments will be affected by the rules that we are putting in place to deal with this issue. I am grateful to the hon. Gentleman for allowing me to correct a fundamental misconception. Some people have wrongly assumed that our aim is to prevent individuals from putting additional contributions into their pension schemes late in their working lives to fulfil a shortfall in their fund and ensure that their pension benefits pay out as much as they have been hoping for. That is something that we want to encourage. We are happy for individuals to put genuine additional money into their pension funds, including lump sums.
The recycling measure does not aim to catch or prevent that behaviour. It aims to catch individuals who deliberately take their tax-free lump sum in order to put it back into a registered pension scheme and generate additional tax reliefs through an artificial circulation of the same money, and it will catch them only if that happens in a structured and pre-planned way. We were keen to deal with the misconception, and that is why we produced a substantial amount
The guidance, however, does not seek to add to, amend or change the intent of the clause. It aims to make it clear that the cases that some people have feared might get caught inadvertently will not be caught. The intent of the legislation is absolutely clear. That is why the Chartered Institute of Taxation concluded:
HMRC have consulted effectively on these changes; the resulting rules
that, I think, means both the clauses and the guidance
seek to separate structured tax avoidance from accidental or insignificant increases to pension fund payments, while the guidance includes a lot of excellent worked examples.
The fact that there are 28 pages of guidance is evidence of the fullness as well as the excellence of those worked examples. They are there to make clear what we are attempting to do, which is to stop recycled turbo-charging or reverse and multiple turbo-charging, without trying to disadvantage people genuinely trying to top up their pension funds.
We have had to act in that way with the legislation and guidance because the simplification and shift in more generous limits, as a result of the A-day reforms, means that, although in the previous regime past restrictions made it difficult for deliberate tax avoidance through turbo-charging and reverse multiple turbo-charging to occur, the matter could conceivably arise in our new more light-touch and deregulated pension tax regime. Through the use of guidance in the clause, we wanted to make clear that that tax avoidance would not be allowed.
The hon. Gentleman spoke to three different amendments. Amendment No. 141 would effectively allow individuals to step around the anti-recycling provisions quite easily. As drafted, the provision ensures that it is not possible to get round the anti-recycling rule by making additional contributions before taking the lump sumfor example, by funding them with short-term borrowing to be repaid when a lump sum is received. That potential means of sidestepping the rule was touted around in the specialist press even before the draft legislation was published. Such pre-emptive multiple turbo-charging is something that we are not minded to allow to occur, but the amendment would allow it to happen. That is why I urge the hon. Gentleman not to press it.
Amendment No. 142 seeks to replace the word envisaged with intended. The hon. Gentleman explained why. Twenty years ago, in studies on the philosophy of mind, which were part of my degree, I read an interesting book by Professor Davidson from the University of California, called Actions, Reasons and Causes. It is an excellent and forward-thinking book in which almost the entire text of 300 to 400 pages focuses on the use of terms such as action, reason and intention. As those who have studied those terms will know, they have quite different meanings.
A desire to do something is different from an intention to do something. An intention is a narrower and more purposeful word. I might like, desire or hope to do something, but to intend to do somethingimplies a degree of pre-planning and foresight, and of
When drafting the Bill, we considered the issue and consulted with lawyersbut not philosophers. However, we have seen in this Committee that it is possible to be a Member of Parliament and a lawyer; presumably it is possible to be a Member of Parliament and a philosopher, or even a lawyer and a philosopher, and therefore to have a philosophical, as well as a merely legal, discussion about the use of intention. In the case of recycling, in which a lump sum is taken, the term intended is used andI go back to my earlier remarks about the philosophy of mindthat suggests that the individual must actively plan the recycling on the date that they receive the lump sum. If I intend to go to the zoo, one would assume that I know the date on which I am going; I may have even made a plan. A desire to go to the zoo would mean that I will perhaps go at some point over the summer.
An intention would normally imply a degree of active planning around the receipt of the lump sum, and that means that a case where the recycling had been planned and set up before that date so that no further action was necessary on the part of the individual on the date itself, might not be caught. Similarly, a case where an individual had made arrangements for someone else, such as an employer, to make additional contributions might not be caught. However, in such a case, the individual may not be intending. Envisaging is a broader term; it might be an intention on behalf of someone else, rather than a personal intention. Envisaging may mean opening up the possibility that someone else may use the provisionin this case, to recycle the lump sum on that date. If envisaging were used, that case would be caught. The difference between envisaged and intended is subtle but essential. Envisage will cover the concept of intention, as sought by the amendment, and will go a little wider, so as to ensure that we catch all necessary cases.
I am sure that the hon. Gentleman will have reflected on those issues when drafting the amendment, but I urge him to reflect further and agree that we cannot risk a change that might render the legislation ineffective against some of the most offensive pre-planned cases of recycling. In some of those cases, the word intention may not be the most appropriate way of catching the action, reason and cause in question.
Finally, turning to amendment No. 143, the recycling legislation has been carefully framed to strike a balance between deterring recycling activity, catching the more blatant and artificial cases and leaving unaffected those smaller pensions savers and those going about the normal business of retirement planning. To achieve that balance, we have included a threshold of 1 per cent. of standard lifetime allowance, or £15,000 in a tax year. Individuals taking total lump sums of no more than that amount in a 12-month period will not be
Given the generosity and flexibility of the A-day regime, introducing that further substantial increase in the threshold would be unnecessary and would make the legislation ineffective in all but the most exceptionally large cases. It would not provide an effective deterrent against recycling activity, because the majority of people using deliberate and planned recycling and tax avoidance schemes would know that they could safely do so within the ambit of the legislation as a result of the hon. Gentlemans amendment.
The proposed threshold of £15,000 already carves out the majority of pension savers. To go further,from £15,000 to £150,000, would be grossly disproportionate. We think that we have struck the right balance, allowing small pensions savers not to trigger recycling rules, but catching the medium and larger potential multiple and turbo-charging recyclers. On that basis, we urge the hon. Gentleman to withdraw the amendment.
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