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Public Bill Committee Debates

Value Added Tax (Supply of Services) (Amendment) Order 2007

The Committee consisted of the following Members:

Chairman: Mr. Eric Martlew
Alexander, Danny (Inverness, Nairn, Badenoch and Strathspey) (LD)
Battle, John (Leeds, West) (Lab)
Caborn, Mr. Richard (Sheffield, Central) (Lab)
Chapman, Ben (Wirral, South) (Lab)
Cunningham, Tony (Workington) (Lab)
Fraser, Mr. Christopher (South-West Norfolk) (Con)
Gauke, Mr. David (South-West Hertfordshire) (Con)
Goldsworthy, Julia (Falmouth and Camborne) (LD)
Hands, Mr. Greg (Hammersmith and Fulham) (Con)
Heathcoat-Amory, Mr. David (Wells) (Con)
Hoyle, Mr. Lindsay (Chorley) (Lab)
Kennedy, Jane (Financial Secretary to the Treasury)
Mitchell, Mr. Andrew (Sutton Coldfield) (Con)
Newmark, Mr. Brooks (Braintree) (Con)
Simon, Mr. Siôn (Birmingham, Erdington) (Lab)
Singh, Mr. Marsha (Bradford, West) (Lab)
Wright, David (Telford) (Lab)
John Benger, Committee Clerk
† attended the Committee

Fourth Delegated Legislation Committee

Monday 22 October 2007

[Mr. Eric Martlew in the Chair]

Value Added Tax (Supply of Services) (Amendment) Order 2007

4.30 pm
The Financial Secretary to the Treasury (Jane Kennedy): I beg to move,
That the Committee has considered the Value Added Tax (Supply of Services) (Amendment) Order 2007 (S.I. 2007, No. 2173).
It is a pleasure to be here, especially as there were problems on the west coast main line, as you also experienced, Mr. Martlew, and I did not know whether I would be here at all. However, we did struggle in, and it is a pleasure to be here and to serve under your chairmanship.
The order was laid on 25 July 2007 and came into force on 1 September. It amends the Value Added Tax (Supply of Services) Order 1993, statutory instrument 1993/1507. It removes two sections from that order, which are now ineffective following a ruling from the European Court of Justice. That legislation was introduced in 2003 to close a tax avoidance opportunity which arose following an earlier decision by the European Court of Justice in the case of Lennartz. The ruling concerned the VAT treatment of assets that are used by businesses and other organisations for both business and non-business activities. The court has consistently said that, under EC VAT law, the owner has the right to allocate such an asset
“wholly to its business purposes”.
That is often called Lennartz accounting, after the name of the leading case.
The benefit of Lennartz accounting is that the owner can recover from Her Majesty’s Revenue and Customs most, and often all, of the VAT charged in the purchase of the asset. At the same time, the owner must pay to HMRC VAT on the non-business use of the asset during its economic life. However, it is clear that that VAT treatment allows a significant cash-flow advantage, especially for high-value assets with a long life, such as buildings.
The 2003 legislation, which is now being repealed, was introduced to prevent Lennartz accounting on land and buildings, on the back of a provision of EC law that appeared to allow that. Other EC member states had similar legislation. However, in the summer of 2005, the European Court decided in the Dutch case of Charles and Charles-Tijmens that Lennartz accounting could not be prevented in that way and confirmed that it could be used for buildings. That decision made the UK’s earlier legislation ineffective.
4.33 pm
Mr. David Gauke (South-West Hertfordshire) (Con): It is a great pleasure to serve under your chairmanship, Mr. Martlew.
As the Financial Secretary anticipated, we do have some questions with regard to the legislation and the repeal of some of the 2003 measures. The measures were introduced in 2003 in anticipation of a scheme that was being marketed, which looked as if it might cost the Exchequer considerable sums of money. The figure that was quoted by the Economic Secretary at that time, the hon. Member for Wentworth (John Healey), was at least £165 million a year. I should be grateful if the Financial Secretary would outline any concerns that she might have, given that the legislation will no longer be on the statute book, as to the cost to the Exchequer.
The former Economic Secretary highlighted two particular areas where problems might arise. The first area involved the change in assets from business use to non-business use; the concern was that there may not be a rise in output tax, and the 2003 legislation was intended to prevent that from happening. The second point highlighted was that the intention behind the 2003 legislation was to put beyond doubt that, where services are to be used for non-business purposes, full input tax recovery is not available. The explanatory notes make it clear that there is a potential risk of revenue, but state that other measures may well be used to deal with this matter. I would be grateful for assurances from the Financial Secretary on whether she is confident that the ECJ judgment will not cause a loss to the Exchequer. Are steps being taken to mitigate that?
We know that regulations will be brought in under section 99 of the Finance Act 2007. Those were due to come into force by 1 September. I understand from the explanatory notes that that is not the case and that the regulations are due to come into force later in 2007. I should be grateful for an update on that situation. There are two concerns regarding losses to the Exchequer. One is about the interim between the ECJ judgment in Charles and Charles-Tijmens in 2005 and the new regulations being put in place and the other is about the cost going forward. An estimate from 2003 put the cost at £165 million if this area was not dealt with. I should be grateful for an update on that.
In the context of the Prime Minister having just sat down after his statement on the Lisbon discussions on the new constitutional treaty, I noticed that the Foreign and Commonwealth Office has produced 10 euro myths, which it has attempted to deal with. No. 1 states:
“The UK has maintained national control over key areas including ... tax”.
We are debating an area in which our tax law has been changed as a consequence of the European Court of Justice.
When the 2003 measures were debated, it was put to Ministers that the proposals might be in breach of European law. The former Economic Secretary made it clear that they had sought counsel’s opinion and believed that they were entitled to pass the proposal because there was a derogation under article 6(2) of the sixth VAT directive, which is now article 26(1)(a) of the 2006 VAT directive. Indeed, the Financial Secretary has said that the directive appeared to allow it. Of course, that was not the case.
When this matter was discussed in Committee, my hon. Friend the Member for Eddisbury (Mr. O’Brien) requested that the legal advice be made available. As far as I can see, that basis, on which the Government proceeded with the 2003 measures, was never made available. I should be grateful if it would be possible to make that legal advice available so that we can understand how the Government got this wrong or how the European Court of Justice reached a decision that was contrary to counsel’s advice. I say that because this sort of thing happens rather frequently within tax law: the Government maintain that they are entitled to do something, only to find that the ECJ says that they are not. If we were able to understand how that happens so frequently, it would be of great benefit to us all.
I do not intend to oppose these measures. They are necessary as a consequence of the judgment. However, Conservative Members were somewhat concerned about the proposals when originally introduced in 2003.
4.39 pm
Danny Alexander (Inverness, Nairn, Badenoch and Strathspey) (LD): It is a pleasure to serve under your chairmanship, Mr. Martlew. It is also a pleasure to follow the hon. Member for South-West Hertfordshire who is renowned for his knowledge on tax matters. However, his approach to matters European is slightly less sound. I had hoped that we might escape without any Eurosceptic pronouncements from the Conservative Front Bench. He will know that VAT matters have been part of the European Union for a very long time indeed. The measures included in this regulation are pretty essential to the operation of the single market. It is not his party’s official policy to get out of the single market, but perhaps it is his policy. Without wishing to stray too far, I thought that I would just make that point, Mr. Martlew.
The hon. Gentleman has drawn attention to some of the important questions about this matter, not least his first point about the cost to the Exchequer. He quoted the figure of £165 million, which I have seen quoted too. I should be grateful for the Minister’s assessment of that.
I should be grateful if the Minister would clarify a couple of points on the regulatory impact assessment of these regulations. It states:
“In view of the above”—
the analysis that the Minister has quite rightly given—
“the Government has decided to introduce three measures”.
The first, which is the purpose of today’s order, implements certain European Court of Justice decisions by repealing ineffective legislation. The second implements the ECJ decisions in Wollny. The third clarifies the legislation
“to resolve what is arguably a loophole.”
Will the Minister spell out in a little more detail what she means by clarify in this context? Are we to expect new legislation to follow in due course from the ineffective legislation that this instrument repeals? If so, what are her plans for doing that? What is the time scale? What will the nature of any changes that she seeks to make to replace this legislation be?
My second question relates to the small firms impact test. The regulatory impact assessment simply states:
“Small firms that use ‘Lennartz accounting’ will be affected by these changes.”
It does not give any further information. Given the importance that all sides attach to small businesses, will the Minister give us more detail on that point? Has she made any assessment of how many small firms might be affected and what the effect on their revenue incomes might be. Like the hon. Gentleman, I have no intention of opposing the regulations, which seem to be a sensible clarification, but having a better understanding of the impact they will have on smaller firms would be useful. With those few remarks, I look forward to the Minister’s reply.
4.42 pm
Jane Kennedy: I appreciate the thoughtful and probing approach that the hon. Members for South-West Hertfordshire and for Inverness, Nairn, Badenoch and Strathspey have both taken to this broadly welcome resolution.
The hon. Member for South-West Hertfordshire asked a number of questions, setting aside his broader comments about Europe, which are perhaps for a more robust debate on another day. On costs, I can tell him that I believe the estimates given earlier are right. The estimate for annual claims is around £75 million a year following the ECJ ruling in 2005. The Budget measures that were agreed this March prevent absolute tax loss arising from that ruling. We estimate that they will save the Government between £15 million and £25 million per annum, mitigating the cash flow advantage that businesses would have seen had we not taken the steps that we are proposing in later legislation.
That brings me to the hon. Gentleman’s final point. He asked me about costs. May I add one or two further points about mitigating the risks to the Exchequer? This is a genuine and proper concern to raise. Originally, there would have been two main avoidance opportunities. The first would have arisen where artificial, non-business use of an asset is created so that it becomes eligible for Lennartz accounting. This would have afforded organisations, which ordinarily would suffer significantly restricted VAT recovery, up-front recovery of most, if not all, of the VAT that they would incur. But by requiring non-business charges to be paid over fewer years, the Budget changes reduce the attractiveness of this form of avoidance.
Secondly, where the economic life of a building over which charges for non-business or private use must be paid is longer than the 10-year period prescribed by the new regulations, the taxpayer could previously have collapsed the Lennartz accounting mechanism after 10 years in such a way as to avoid any future charges. This would have provided an absolute tax saving, rather than just a revenue deferral advantage envisaged by Lennartz accounting. So the Budget changes proposed in March prevent this form of avoidance. Although the new regulations contain transitional provisions, which permit some taxpayers a longer economic life than 10 years, because they already operate the Lennartz mechanism, the amount of tax at risk is significantly reduced in such cases.
While we are on the point of what might be coming and the loophole changes that were effective from the Budget, which dealt with an omission in a related provision which failed to tax surrenders of leases, for example, I understand that we will consider two further orders later this year, but not too much later, as they have already been laid. They will be subject to the negative procedure.
In response to the hon. Gentleman, this order is one part of a wider package of measures that address the impact of the Lennartz accounting ruling from the Court. As part of this package of new regulations, which come into force on 1 November, the main change that the regulations introduce is that the time over which non-business use charges are to be paid has been set at 10 years for land and buildings.
Mr. Gauke: Did the Minister say 1 November?
Jane Kennedy: Yes, 1 November. The hon. Gentleman made comments about EU meddling. I would have put it more kindly and asked if this was another case of Brussels interference in UK tax laws. We will not get into a wider debate on that subject, Mr. Martlew.
The Chairman: We certainly will not.
Jane Kennedy: The European Court of Justice is responsible for ensuring that EU law is interpreted consistently across the EU. As I said, we framed our original tax law in the VAT proposal along similar lines to other countries to ensure that it was consistent but the court took a different view and we are legally obliged to give effect to the court’s judgments.
I think that I have covered all the points raised, but I will read Hansard to ensure that I have responded to all the questions asked by the hon. Gentleman, which he put very thoughtfully and in a proper spirit.
The hon. Member for Inverness, Nairn, Badenoch and Strathspey asked for clarification and I hope that much of what I have said has already clarified some of the matters that were causing him anxiety. I have talked about the further procedures that will come before the House.
The hon. Gentleman asked about small businesses. I do not have figures on the breakdown of responses but I can get them if they are of continuing interest. Some organisations complained that the changes introduced by this package of measures would cause them significant cash flow difficulties, so we considered whether additional transitional relief should have been offered. However, we formed the view that no additional transitional relief should be available outside that already contained in the regulations.
Those taxpayers who raised objections have enjoyed up-front recovery of VAT in respect of their non-business use of the asset and they will still have 10 years over which to repay that non-business and private use of the asset, which remains a considerable cash flow advantage. This approach, which is supported by the findings of the ECJ, also helps to mitigate the considerable avoidance risks associated with Lennartz accounting. When striking the balance between the two, 10 years is a fair period of time. To offer further relief would simply open the door to avoidance. Although that is a narrow response to the hon. Gentleman’s broader question, I will provide members of the Committee who may have an interest with the breakdown of responses.
The order forms part of a package of measures to mitigate the effect of Lennartz accounting and it implements the recent rulings of the ECJ. The repeal of ineffective legislation that is the subject of this order has been welcomed by business and the wider community and I hope that Committee members of all parties will give it a fair wind.
Question put and agreed to.
That the Committee has considered the Value Added Tax (Supply of Services) (Amendment) Order 2007 (S.I. 2007, No. 2173).
Committee rose at eleven minutes to Five o’clock.

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