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Session 2005 - 06
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Standing Committee Debates

Twelfth Standing Committee on Delegated Legislation

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Twelfth Standing Committee on Delegated Legislation

The Committee consisted of the following Members:


Mrs. Joan Humble

Cable, Dr. Vincent (Twickenham) (LD)
†Fabricant, Michael (Lichfield) (Con)
†Fallon, Mr. Michael (Sevenoaks) (Con)
Green, Damian (Ashford) (Con)
Kramer, Susan (Richmond Park) (LD)
†Liddell-Grainger, Mr. Ian (Bridgwater) (Con)
†Primarolo, Dawn (Paymaster General)
†Reed, Mr. Andy (Loughborough) (Lab/Co-op)
†Simpson, Alan (Nottingham, South) (Lab)
†Slaughter, Mr. Andrew (Ealing, Acton and Shepherd’s Bush) (Lab)
†Spring, Mr. Richard (West Suffolk) (Con)
†Starkey, Dr. Phyllis (Milton Keynes, South-West) (Lab)
†Tami, Mark (Alyn and Deeside) (Lab)
†Thornberry, Emily (Islington, South and Finsbury) (Lab)
†Walley, Joan (Stoke-on-Trent, North) (Lab)
†Watson, Mr. Tom (Lord Commissioner of Her Majesty’s Treasury)
Jenny McCullough, Committee Clerk

† attended the Committee

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Wednesday 13 July 2005

[Mrs. Joan Humble in the Chair]

Draft Partnerships (Restrictions on Contributions to a Trade) Regulations 2005

2.30 pm

The Paymaster General (Dawn Primarolo): I beg to move,

    That the Committee has considered the draft Partnerships (Restrictions on Contributions to a Trade) Regulations 2005.

This is the first time that I have had the pleasure of serving under your chairmanship, Mrs. Humble. I welcome you to the Committee, and I look forward to the debate this afternoon.

The regulations are made under powers that were introduced under the Finance Act 2005, and provide the detailed rules to tackle tax-avoidance schemes used by wealthy individuals investing in partnerships. The schemes sought to inflate a partner’s trading losses by overstating the true value of their investment, thereby reducing the tax that they would otherwise have to pay on their other income. That was an outright abuse of the loss relief rules. The regulations and the Finance Act 2005 put an end to that abuse. They make it clear that certain amounts are to be excluded when calculating an individual’s contribution to a partnership. In particular, they exclude contributions financed by loans that the partner does not have to pay back.

I shall briefly explain the mischief that the Government seek to tackle. Generally, individuals in partnerships can set trading losses against their other income and gains, reducing the total tax that they must pay. That encourages and supports genuine investment in business activities, but this loss relief is limited to the amount of the actual investment that they have made in the partnership. That condition is entirely reasonable. However, some wealthy individuals, acting through partnerships, sought to sidestep that restriction by inflating the amount of their investment with the aim of obtaining loss relief for money that they never actually lost or had any risk of losing.

Michael Fabricant (Lichfield) (Con): It is quite clear that the Paymaster General views this practice as an abuse of the system. Will she say whether any institutions, such as the Institute of Chartered Accountants of England and Wales or any other authority, have written to her in defence of the practice?

Dawn Primarolo: I am not aware of any submissions in defence of the practice, but I am sure that there will have been comment, as there always is when the Government introduce legislation, as well as a request for clarification. I recall, however, that the response was very muted and that things were said privately
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when the measure was announced in the pre-Budget report. Representations are always made about the detail, which is important. Perhaps it will put the practice into perspective for the hon. Gentleman if I explain more fully how it was being used.

As I was saying, this mechanism sought to inflate the amount of investment with the aim of obtaining loss relief for money that was never lost or at risk of being lost. Regrettably, this is not the first time that the Government have had to take action to counter tax avoidance using the rules for loss relief. In the Finance Act 2004, the Government took action to make it clear that inactive partners could not claim loss relief in excess of the amount that they had actually put into the business. However, some investors continued to look for other ways of obtaining relief for money that was never at commercial risk. They adopted schemes in which the investment was boosted by loans from third parties—loans that the investor was under no obligation to repay. That is not the Government’s idea of a genuine commercial arrangement of the sort that should attract loss relief. I shall explain how the schemes work.

For every £100, an investor would put up £20 of his own money, borrow £80 from a third party and then claim tax relief at the higher rate of 40 per cent. on the full £100 loss of the partnership. The investor would get an immediate cash advantage, funded entirely by the Exchequer. As the tax relief claimed would be greater than the amount invested, they would be granted a tax free gain whether or not the trade generated any income. That is a totally unacceptable use of the relief.

Mr. Michael Fallon (Sevenoaks) (Con): The Paymaster General has explained so clearly what seems to be an unacceptable abuse that I wonder why it was not foreseen in the Act to which she referred. Surely the definition of capital should have been extended to loans in the first place.

Dawn Primarolo: Regrettably it is a matter of finding a balance, but those of us who have just completed another Finance Bill will know how important is the balance that is sought by Ministers, Opposition Members and the House. When anti-avoidance legislation is taken, it closes down specific schemes; it should not affect or inhibit normal commercial practice. It is difficult to anticipate what might be done by those who seek to avoid the rules in order to create unintended relief. It could result in huge amounts of legislation going through the House that is never used. When moving to close down an avoidance, it is my practice as it was the practice of Ministers in previous Governments to issue warnings; people are told not to try and get around the rules in other ways. However, it would be intolerable for all concerned if the Government, advised by officials, tried to anticipate what might happen next.

The question is not directly affected by these regulations, but the Government try to anticipate the problem of avoiders turning to new schemes by the use of the disclosure rules, which the House has fully discussed, and by the statement that I attached to last
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year’s pre-Budget report with regard to a particular type of avoidance scheme. The Government put down a marker and say, “If you try and get round it in any other way, we will backdate legislation to that point.” The hon. Gentleman raises an important point. The challenge for all Governments is to find a reasonable balance between closing down avoidance schemes, which necessitates complex legislation—the schemes are often complex—and protecting the Exchequer.

On 2 December, the Government announced that they would stop those schemes with immediate effect. We were right to do so. It is important to point out to the hon. Gentleman that Her Majesty’s Revenue and Customs does not accept that the schemes are based on existing legislation. Such schemes can be challenged under existing legislation. The Department has challenged, and will continue to challenge, any that it comes across in the course of its normal inquiry work. In the view of HMRC, they are challengeable, but the Finance Act and the regulations put the matter entirely beyond doubt.

The regulations explicitly exclude any loan that the investor is not liable to repay, thereby ensuring that they can get loss relief only for money that is at genuine commercial risk. The regulations have no impact on legitimate investors who make, or wish to make, a real financial contribution to any business venture. Nor do they have any effect in cases where the cost of a loan is met by another person in the normal course of personal relationships—where, for instance, an individual becomes unable to repay a loan or is taxed when someone else repays the loan.

Unfortunately, the schemes that we are discussing have been very common, particularly in the film industry. Films are highly speculative ventures, which some investors find attractive because of the potentially high rates of return if the film turns out to be the next blockbuster. The investors who use these schemes, however, profit whether or not the film is a success at the box office. The schemes have nothing to do with encouraging genuine investment in British films and everything to do with avoiding the responsibility to pay tax where it is due.

The Government have said repeatedly that we are determined to tackle tax avoidance. We are committed to supporting the British film industry and we have been extremely generous in doing so on behalf of taxpayers over recent years. However, that commitment does not extend to allowing deliberate and aggressive abuse of the tax system, and we are right to put an end to these schemes. I commend the regulations to the Committee, and I look forward to responding to hon. Member’s points.

2.42 pm

Mr. Richard Spring (West Suffolk) (Con): May I say what a pleasure it is to have you chairing our proceedings, Mrs. Humble? I thank the Paymaster General for her explanatory comments on the regulations.

As we heard a few minutes ago, the regulations reflect changes to the taxation of the film industry that were introduced in the Finance Act 2004, and the
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power given to Revenue and Customs commissioners in the Finance Act 2005 to supplement those changes. Those are, of course, not the only changes to the taxation of the film industry in the past few years, which will be of interest to my hon. Friend the Member for Sevenoaks (Mr. Fallon). Given the changes in the Finance Acts of 2002, 2001 and 1997, there have been no fewer than five lots of changes in eight years.

Although we strongly welcome any measure to clamp down on tax avoidance, the Government should appreciate that the British film industry needs a consistent tax regime. Such frequent changes and the uncertainty that they breed are not conducive to consistency. In September 2003, even before the most recent changes, the Select Committee on Culture, Media and Sport said:

    “the Government must end the current uncertainty plaguing the industry.”

In passing, I simply add that the number of British films produced in the United Kingdom fell by 40 per cent. in 2004.

As I said, the most recent changes to the taxation of the film industry came in the Finance Act 2005, which was enacted before the election. As such, they were never debated in the House. They end the practice of “double-dipping”, whereby tax relief is secured more than once, and limit relief to the cost of production. They also prevent the potential for abuse where film partnerships purchase films and subsequently lease them back to their producers, giving rise to an immediate tax rebate. Investors then exit the scheme early, of course, avoiding the proper clawback of the rebate over 15 years.

Alongside those reforms came sections 73 and 79 of the Finance Act 2005, which provide for the regulations. They give HMRC the power to set out in regulations details of the contributions that should be excluded when calculating an individual’s contribution to trade. I should like to flag up that it is not always desirable for powers to be given to HMRC to determine people’s tax liabilities through secondary legislation, as with the regulations before us. Can the Minister explain what pre-clearance regime was put in place, so that investors were made aware of their potential tax liabilities on investments made since December 2004, when the regulations have effect?

Furthermore, in what other circumstances are sections 73 and 79 of the Finance Act 2005 likely to be used? If they were passed simply in order to make the regulations possible, why were the regulations not included in the Finance Act? The regulations build on section 119 of the Finance Act 2004, which introduced an income tax charge where investors claimed film-related losses in excess of their contribution to a partnership. When section 119 of the Act was discussed in Committee, my party tabled an amendment to try to ensure that the new provision affected only schemes motivated by tax avoidance, rather than legitimate commercial trades. It was feared that the new legislation would ensnare legitimate operations. The amendment was, of course, rejected by the Government. However, will the Minister state
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what studies have been carried out in order to ascertain whether any of the industry’s fears were realised before the regulations have retrospective effect?

What assessment has the Minister made of the revenue implications of the regulations? The explanatory notes state that the regulations

    “are part of anti-avoidance rules which simply ensure legislation is applied in the way that it was intended by Parliament.”

Of course, I take that at face value, which is why we are not challenging the regulations. We support any sensible measures to prevent tax avoidance. It is also why the Government have not published a regulatory impact assessment of the regulations. However, although they may not impose new burdens on taxpayers, they will presumably force some taxpayers to re-arrange their affairs or to pay an additional income tax charge. What additional revenue does the Minister expect to gain from them? Given the state of the public finances, and the Chancellor’s apparent need to squeeze every last penny from taxpayers, it is important that we know the full implications of the regulations before us.

2.47 pm

Dawn Primarolo: On the question of new burdens on business, as the hon. Gentleman put it, there are none. The regulations are quite straightforward, as I explained in my opening remarks. The vast amount of taxpayers know how to use this relief correctly. As I said, regrettably, despite the clarity of the current legislation, there are those who seek to get around it and use the loss relief in a way that was never intended. The regulations are specifically targeted at that. When we discussed the Finance Bill in Committee, the matter arose briefly. I explained to the Committee that targeted and—I am sure that members of this Committee can see—detailed regulations are more appropriately contained in statutory instruments, but following the affirmative procedure, so that hon. Members can consider them.

On the loss of revenue, if the Government had not taken swift action at the time of the PBR, I am advised by my officials that the tax-avoidance schemes could, if unchallenged, have cost the Exchequer an estimated £250 million in 2004–05 alone. There are two ways in which that will be challenged. Under the previous law, schemes were not seen as challengeable. However, the regulations send a clear message—picking up on the point made by the hon. Member for Sevenoaks—that it is beyond doubt that such schemes should not be used.

The hon. Member for West Suffolk (Mr. Spring) asked about the uncertainty facing the film industry. It became clear, over several years, that, regrettably, avoidance schemes were being used in that sector. The Government have a duty to close those down. That is widely accepted in both Houses. None the less, the Government continue to support the film industry in many ways. The reliefs helped to make 2003 a record year for production in the UK with £1.17 billion worth of expenditure on production, and British involvement
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in 177 films. The second most successful year on record for films was 2004, in which total production expenditure was £807 million and the UK was involved in 132 films.

The Select Committee on Culture, Media and Sport concluded that the tax reliefs were vital in securing inward investment in the UK and maintaining that critical mass of indigenous film making, but we cannot allow something of such great value to the film industry to be misused, as that undermines the industry. People who invest in the industry should, like the vast majority, do so because they are interested in it and want it to grow and to develop, not because they can use it as a vehicle to get more money than they are entitled to. If the film industry unwittingly becomes a haven for such schemes, its existence and future will inevitably be undermined.

Michael Fabricant: The Paymaster General may know that I was a member of the Culture, Media and Sport Committee for some years. In fact, the right hon. Member for Manchester, Gorton (Sir Gerald Kaufman) credited me with some of the wording of the Finance Bill that became an Act under the present Chancellor in 1997, which made many changes that I welcomed because they were recommended by the Select Committee on National Heritage. Sadly, they were rejected by our Chancellor, but we will not go into that in too much detail.

I am keen on the film industry and have many friends who work in it. Further to my earlier question, I ask the Paymaster General whether she can reassure me that no one from the film industry has said that the changes will damage the industry. Do they say that the changes will damage only the people who misuse the legislation?

Dawn Primarolo: There may be mixed messages. Those who use the schemes and who purport to speak on behalf of the industry will not be happy. I credit the hon. Gentleman for his involvement with the industry in a previous life. I should like to reassure him that HMRC and I, as the Minister overseeing this issue, keep up a regular dialogue with the industry to explain, further than the published guidance, measures such as the regulations, to monitor activity and to ensure that the compliance rules are clear. As he might expect, we are committed to working with the industry to create the certainty and security that are required by any industry, but particularly the film industry, to be able to plan for future years regarding income.

The Government have been clear, as has the Select Committee on Culture, Media and Sport, about the help that they want to give to the industry. They want to help those who are making films and to ensure that the money goes directly to that, not to others—for example, financiers or these partnerships—who would attach themselves to any industry, not just the film industry, if it offered them such a vehicle.

The hon. Gentleman will know from his contacts in the industry that the Government have confirmed that the new reliefs will be structured along the lines announced last September. The reliefs—the tax credit—will be released next year following a period of
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consultation, which will include an opportunity for the industry to look directly at the draft legislation and to comment on it. Many of the representations that I have received have come from those working in the film industry and its representatives, who want to move beyond what has been a difficult period and to rid themselves of the opportunity to be used in such a way. They want to be on a firm footing, with Government money going directly into the production of films and towards the developments that we want to see, using the fantastic resources and expertise that we have in Britain.

The hon. Member for West Suffolk mentioned clearance procedures. We do not provide clearance procedures for avoidance; there is no question about that. We do not say to avoiders, “Come and ask us whether we think your avoidance works.” We have clear regulations, as well as discussions with the industry, to make sure that procedures are fair and proportionate. Wherever we can, we ensure that the reliefs are used in the way in which they should be.

Forgive me, Mrs. Humble, if I move slightly beyond the regulations. As we move to the consultation on the tax credits, we will, by working with the film industry, be able to give a firm and secure base on which it can continue to develop and to flourish. There cannot be a secure base if individuals who are not committed to the industry are attached to it only because it gives them the opportunity to reduce their tax liability or to gain reliefs to which they are not entitled. Such behaviour adds complexity and confusion in the industry and gives a false view about what resources are available for investment. The regulations make sure that that will not happen when it comes to such schemes.

I look forward to the consultation and the comments on the draft legislation. I am sure that the hon. Member for Lichfield (Michael Fabricant) will want to be involved. I hope that when we agree the
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legislation he will stand up and praise the Government for opening a new era for the flourishing of the film industry.

2.58 pm

Mr. Spring: First, may I acknowledge the comments of the Paymaster General? I am not sure that she answered a number of my questions, but perhaps she will reflect on some of them and write me a note.

On pre-clearance procedures, of course, no Member of Parliament could ever subscribe to a tax-avoidance scheme that led down the road of illegality. That would be wholly unacceptable. My point is that the film industry has been affected by a huge number of tax changes over the years. That is symptomatic of the micro-management that now occurs in the tax system. It affects many industries, has spawned vast numbers of accountants, actuaries, tax planners and advisers and involved a lot of cost. As people have to grapple with it, it is hugely important that there should be clarity from HMRC and the Government. The idea that that has been a clear aspect of the governance of this country would be an absurd proposition.

Having said that, we are happy to support the closure of tax-avoidance schemes. Having now engaged with her on a number of occasions, I think that the Paymaster General must have been a thespian in a previous life. Her parliamentary performances are always very engaging.

In conclusion, we do not wish to divide the Committee, so all I can say is carry on filming.

Question put and agreed to.


    That the Committee has considered the draft Partnerships (Restrictions on Contributions to a Trade) Regulations 2005.

Committee rose at Three o’clock.


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