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Mr. Field: To paraphrase a discussion that took place this morning, I will be a hedger rather than a
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ditcher. Much as I should like to be a ditcher in relation to the insurance industry, I shall not press the amendment to a vote I take some comfort in what the right hon. Lady has said.
The Paymaster General was guilty of some contrivance in her example, which was an almost ludicrously exaggerated case of a contrived means of bonus payments being harboured for the purposes of an investment bank.
Dawn Primarolo: I hope that when the hon. Gentleman uses the word ''exaggerated'' he is referring to the exaggerated attempts of those who designed that real, functioning scheme. I merely told him about it. Perhaps it will instruct him of the lengths to which a few very well paid people will go in order not to pay their tax and national insurance.
Mr. Field: Sir Nicholas, you will be glad to know that contrivance is a two-way street. If the Minister is telling us that only companies that could be subject to the provision would be investment banks with equally contrived schemes, I would be entirely satisfied and there would be little point in debating the matter further. However, the Paymaster General will understand that we are trying to tease out the grey area. The example she gave is clearly from that grey area and was contrived wholly as a way of avoiding tax, but I suspect that that loophole was filled in some years ago with previous bits of legislation. It is not an example that anyone can be proud of it.
The reality is, of course, that smaller companies are not able to take complex tax advice and are often set up with an exit route in mind. In my experience, many entrepreneurs and small business men are, from the outset, looking to sell within three, five, seven or ten years; on that basis, they consider structuring their business in such a way as to minimise tax. There is concern that that would be deemed contrivance. Clearly, on one level it is contrivance in the ordinary use of the word, but it is obviously not contrivance along the lines of the investment banking example that the Minister quoted.
Dawn Primarolo: Would the hon. Gentleman concede that that course is still open if a business is planning an exit strategy and is using efficiently all the reliefs available to it through the legislative process that is clearly laid down? Is he seriously suggesting that businesses should use contrived schemes to avoid tax and national insurance in designing an exit strategy? Surely that is different. That is the point I am making. It is an important line not to cross.
Mr. Field: It is indeed, however, we need a clear idea of exactly where that line falls. That is the core of the concerns expressed in this group of amendments and others. More clarity is needed. That is the main concern that has been voiced time and again from the various bodies that we have spoken to. The hon. Member for Bristol, West (Stephen Williams) will be happy to know that we have been in touch with a number of professional bodies—and I hope that I will not be speaking entirely verbatim from their notes at a later stage.
There is a great concern about the lack of clarity. Smaller businesses will suffer most from the risk that
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the measure will be applied in an arbitrary fashion. Large organisations will be in a position to take detailed advice to ensure that whatever programmes they set up are unlikely to fall foul of even the most senior Inland Revenue inspectors. Smaller businesses may find that a relatively innocuous—indeed, uncontrived—scheme falls foul of the regulations.
Dawn Primarolo: I direct the hon. Gentleman to my statement to the House on 2 December 2004, which has been widely publicised and which ensures that there are no grey areas. It is absolutely clear in laying down the principles and what is expected. It should not be said that there is a grey area and that people will not understand. How can people not understand that if they receive employment-related income, it is subject to income tax and national insurance?
Mr. Field: I am grateful that we have had at least some comfort in that regard.
Mr. Newmark: The Paymaster General makes an excellent point on contrivance and gave an excellent example of a riskless transaction. I followed what you said verbatim and whoever gave that example to you, it was an excellent one. However, my hon. Friend's point is that entrepreneurs who tax plan do so with risk capital, and it is risk capital that he is trying to discuss. The unintended consequences of your legislation might draw true entrepreneurs and people who take risks with their capital into it. I ask you to address that concern.
The Chairman: Before I call the hon. Member for Cities of London and Westminster, I must say that as much as occasionally I would like it to be, it is not my legislation. It is the Government's legislation.
Mr. Newmark: I am sorry, Sir Nicholas.
Mr. Field: I hope that my hon. Friend the Member for Braintree will make further contributions in the correct form during the course of these debates. Without any further ado, I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn
Mr. Field: I beg to move amendment No. 4, in schedule 2, page 64, line 19, leave out from 'acquired' to end of line 24 and insert 'after that date.'.
The Chairman: With this it will be convenient to discuss the following amendments: No. 5, in schedule 2, page 64, line 25, leave out paragraphs 5 and 6.
No. 6, in schedule 2, page 65, line 1, leave out paragraph 7.
No. 7, in schedule 2, page 65, line 9, at end insert—
'431C Procedure for clearance in advance
Section 431B shall not apply so as to treat an election as having been made for the purposes of section 431 if, before the issue of securities is made, the Board have, on the application of either the employer or the employee notified either the employer or the employee that the Board are satisfied that the issue of the securities is for bona fide commercial reasons and will not form part of any such arrangements as are referred to in section 431B.''.'.
Mr. Field: We now turn our attention to a series of amendments relating to the category of restricted securities. The first pair of amendments, Nos. 4 and 5, would defer the time when the new legislation comes into operation. Many companies issue redeemable
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shares for commercial purposes and have done so for many years. Redeemable shares are advantageous in that they can be repurchased and cancelled by the company with minimum formality, as the Paymaster General is aware. The retrospective changes to make them restricted securities will seem unfair to many employers and employees.
Employers currently have an obligation to pay PAYE and national insurance contributions but are likely to face difficulties in recovering them when a tax charge arises. That might be because, for example, the employer does not have contractual right to recover either PAYE or national insurance contributions from an employee. A particular difficulty arises in relation to former employees, some of whom may have moved away and be uncontactable.
The retrospective nature of the change means that employees have now lost the opportunity under ITEPA to make a section 431 restricted securities election in respect of the shares. If that opportunity existed at the time of acquisition, many employees would, as they currently do, make that election. As was the case when the 2003 Act was introduced, we believe that the Bill should allow a late section 431 election to be made following the changes. Any PAYE or national insurance contributions to the general employment remuneration tax would then be paid in the year in which the legislation received Royal Assent without any further interest.
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As paragraph 4(4) is currently drafted, it would appear that chapter 2 could be interpreted to apply to redeemable securities acquired before and after 16 April 2003, the normal cut-off date to which chapter 2 applies. I hope that the Paymaster General can give us some assurances on that, and will either say that this is intentional or clarify the situation.
Paragraph 7 causes an election to be made at the time that the securities are issued. The result of leaving out that paragraph will be that the impact of taxing an employee at the time that the securities are issued will be similar to that of the US system, which has led to some perverse outcomes.
The Government need to recognise that companies may wish to issue securities with restrictions for valid commercial reasons. There will not be an issue of contrivance in that, as we have discussed, but that might be dependent on the quality of service as a ratchet to highly incentivise management, and continued employment is not necessarily a condition that could cause a security to be a restricted security.
I know that there was a discussion about the large international investment banks during the last debate on the previous group of amendments, but for many privately owned companies there is a great problem of valuing securities that are subject to a restriction at the time of issue.
There is also the risk that restrictions may never be lifted—for example, if they are based on profit targets that are not met. That will leave the employee with a charge to tax on income that they never got. Similarly, if the securities were to decrease in value, there is a risk
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that an employee will be taxed ''as income'' and pay tax, but then suffer a potentially large capital loss on the subsequent fall in value—a loss that the vast majority of ordinary taxpayers would not be able to obtain value for, given that they already have an £8,000 annual exemption from capital gains.
There is no mechanism in the Bill to deal with the potentially ruinous effect on employees of a precipitate fall in the share price, leading to a capital loss and a disproportionately high income tax liability, rather than capital tax liability. Therefore, amendment No. 6 seeks to limit the application of the new clauses to those circumstances where tax avoidance is intended, and to make it possible for taxpayers to obtain advance tax clearance so that they have the comfort of knowing that the Inland Revenue will not examine such transactions retrospectively—and, hopefully, for practices, to provide clarity on the operations of these provisions.
In our view, general anti-avoidance rules only work when we have a transparent and general clearance procedure via the Inland Revenue. Commercial certainty demands that the Inland Revenue should be in a position to give detailed and accurate guidance to each class of taxpayer, corporate or otherwise, likely to be affected by a proposed change. That does not appear to have happened, which is why we have tabled our amendments.
I turn to amendment No. 6. If the main purpose test is satisfied, proposed new section 431B of the Income Tax (Earnings and Pensions) Act 2003 deems that a restricted securities election is made. The main purpose test applies in relation to the avoidance of tax, which is defined as income tax and corporation tax, as well as national insurance. It is possible to see circumstances in which the main purpose test could catch situations—for example, where an employer structures a share plan with a view to obtaining a corporation tax deduction. I hope that we will get some guidance and satisfaction from the Paymaster General on this, because the deeming of a section 431 election could adversely affect innocent employees who had received no, or marginal, tax benefit.
A number of examples have been given by some of the relevant professional associations, and I would like to highlight one of them. An employer has previously issued redeemable shares to employees. The employee will now automatically fall within the restricted securities legislation, and so be subject to income tax on a chargeable event, but the employer will not be entitled to a tax deduction under schedule 23 of the Finance Act 2003. To take advantage of the symmetry introduced under schedule 23 between the employee's tax position and the employer's tax position, the employer issues non-redeemable shares. Does that now fail the main purpose test? Surely the main purpose of the arrangement would be to incentivise employees. However, the use of non-redeemable shares in that instance would clearly be to obtain a tax advantage, to give the employer the symmetry to which I referred. If that were to fail the main purpose test, it would mean that the employee would then be
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potentially liable to tax on the acquisition of the shares, which he or she would not otherwise have been. We believe that an exemption should be made in such a situation or an assurance be given by the Paymaster General for the record.
One of the hallmarks of the Bill has been the uncertainty posed for businesses in their planning by the retrospectivity of so many provisions, and that applies in particular to several complex issues under schedule 2. That may have been unintentional, so it is all the more important that we can deal with such matters in Committee. The Government will argue that their provisions are not retrospective. However, certainty is key. People and businesses need to be able to plan in a stable environment. Changing the basis on which a transaction is organised will make it harder to plan.
Several companies and employees could end up having to pay additional PAYE and NICs unexpectedly due to the change being made under the Bill. If taxation legislation is to change, it should be effected by a change of policy going forward. That is acceptable as long as the transactions that were undertaken in the past are protected. Such grandfathering procedure is seen as the norm. It is all too easy to be discouraged by measures being labelled as ''tax avoidance'' measures and it is easy to point a finger of blame at large investment banks with visible tax avoidance plans, as the Paymaster General has done in the debate. We fear that that would sell the pass on certainty and the stability that is provided by the rule of law.
Our amendments would make the Bill prospective, not retrospective. In detailed comments that were submitted to the Inland Revenue as recently as 18 March, the Chartered Institute of Taxation expressed concern that the Bill would be retrospective. The measure is billed as having effect from 2 December last year, but the way in which the Bill is drafted shows that the measure will apply to all employment-related securities even if acquired before the date of the announcement.
The definition of securities under part 7 of the Income Tax (Earnings and Pensions) Act is widened under section 424 of the Act to include certain instruments to prevent it from being used to pay tax-free bonuses. Among the instruments are redeemable shares. That is done by taking redeemable shares that were previously exempt out of exemption under paragraph 4(2) of schedule 2. We understand that such action is controversial, given that there are many occasions when redeemable shares are not used for the purposes of tax avoidance and what it amounts to is a blanket ban. The question to probe is why redeemable shares should not be subject to the same motive test as the conditions that are set out.
The phrase ''something has been done'' is extremely broad language. It has been much criticised by not only the Chartered Institute of Taxation, but others. It seems to be taxation by feel. The measure is going down the road of arbitrary taxation. For example, is the decision not to declare a dividend in any one year something that has been done with the effect of increasing the value of the securities in question? I can
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understand that many of the bond securities regulations proposed are based on a worry that, all too often, the tax tail is wagging the dog. We run the risk of falling into that precise trap and too many corporate decisions will be made that will hinge on whether activity can be defined as ''something being done''. We hope that this new term will be clarified in the frequently asked questions and the guidance, but to go back to an earlier point, that means that too many tax inspectors will be guided by the questions and answers drawn up by policy officers. In our view, it is inherently undesirable to have a system governed by Government guidance, which can change without warning and carries little weight in court.
There is a real problem with uncertainty under this schedule, and I will be interested to hear what the Paymaster General has to say to pacify the concerns that we are addressing, which were raised by a number of interest groups. Setting boundaries by administrative guidance, rather than by law, is less than ideal at the best of times. We believe that the provision also potentially opens the door to the imposition of double taxation.
I shall summarise our objections, which give rise to all four of the amendments in this grouping. Section 422 of the ITEPA introduces the restricted securities regime. Where employment-related securities, subject to restrictions, are required, income tax and national insurance charges can arise on the removal of the restrictions or on the disposal of those securities. The charge is linked, in broad terms, to the proportion in which the amount paid, or treated as paid for the restricted security, is less than the value of the security, had it not been restricted. This proportion on a later chargeable event is subject to income tax and national insurance. The purpose of the provision is to prevent the value of securities being depressed on acquisition, thus reducing the initial tax charge on the acquisition at an undervalue of securities obtained by reason of employment, and the restrictions being lifted subsequently without a charge arising.
The provisions reduce the analysis of whether a profit from a share derives from employment to a numerical test based entirely on valuations. The lower the value by virtue of the restrictions, the greater the income tax charge. The taxpayer can, under section 431, elect that, in valuing the securities for the purpose of the initial acquisition, all or some of those restrictions be ignored. That increases the acquisition value for tax purposes, increasing the initial tax charge. It thus reduces the proportion subject to charge at a later event. We believe that the taxpayer should have that choice of election. It may be that the chances of a chargeable event arising are small. For example, the individual may hold shares subject to restrictions, and it may be that he or she is unlikely to dispose of his or her shares, and it may be unlikely that the restrictions will be removed. Therefore the election may not be made.
Before 2 December last year, the taxpayer could be certain of his or her position. The numerical and value-based formula would indicate a likely tax charge. Now, if there is avoidance, no such certainty
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exists; we fear that the taxpayer may face an unanticipated up-front tax charge on the value of the securities. It is all the more important that the taxpayer can receive tax clearance in those circumstances. The provision has been introduced to prevent avoidance, and that is fine, but now there really must be clarity for all taxpayers.
I am sorry, Sir Nicholas; we have gone into some detail on this rather complex and technical subject, but I hope that I have been able to articulate my relatively straightforward concerns about the sheer uncertainty of the system and the concern that there will be taxation by feel. It is of key importance, particularly when we are trying to incentivise employees, that there should be certainty. I hope that we can have a meaningful debate on these amendments; they are key, and go to the core of many of our concerns about schedule 2.
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