Finance Bill

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Schedule 3

Entrepreneurs’ relief
Mr. Hammond: I beg to move amendment No. 14, in schedule 3, page 120, line 20, leave out from ‘use’ to ‘for’ in line 21.
The Chairman: With this it will be convenient to discuss the following amendments: No. 15, in schedule 3, page 120, line 22, after ‘business’, insert
‘where such assets have been in such use for a period of not less than two years at the time of the disposal’.
No. 17, in schedule 3, page 120, line 26, leave out from ‘throughout’ to first ‘the’ in line 27 and insert
‘a 12-month period beginning not more than two years before’.
No. 18, in schedule 3, page 120, line 30, leave out from ‘throughout’ to first ‘the’ in line 31 and insert
‘a 12-month period beginning not more than two years before’.
No. 16, in schedule 3, page 120, line 31, leave out from ‘which’ to end of line 34 and insert
‘the disposal of the asset takes place’.
No. 19, in schedule 3, page 120, line 37, leave out from ‘throughout’ to second ‘the’ and insert
‘a 12-month period beginning not more than two years before’.
No. 23, in schedule 3, page 120, line 41, leave out from ‘group’ to end of line 44.
No. 24, in schedule 3, page 121, line 1, leave out from ‘the’ to end and insert ‘condition in’.
No. 25, in schedule 3, page 121, line 2, leave out ‘are’ and insert ‘is’.
No. 20, in schedule 3, page 121, line 2, leave out from ‘throughout’ to end and insert
‘a 12-month period beginning not more than two years before’.
Mr. Hammond: Schedule 3 is one of the critical measures of the Bill. It is very complex, contains lots of technical issues and is lengthy. There will be a series of debates about it and inevitably there will be some overlap between issues that arise in one debate and those that arise in another. If I may, bearing in mind your reluctance to allow a stand part debate in relation to the previous clause, Mr. Cook, perhaps I could just say this—
The Chairman: Correction. I cannot allow that to go unchallenged on the record. I allowed the hon. Gentleman to make the points, almost ad nauseum, that he had already made on the amendments, so there was a stand part debate, a response to it, and it was put to a vote, so let us have the record straight, please.
Mr. Hammond: Okay, and the record will record the phrase “ad nauseum” as well, Mr. Cook. I apologise if I erred, but I gained the impression that there was an element of reluctance. That is my error.
I was seeking to make the point that a large number of amendments have been tabled to the schedule and a large number of outside bodies have raised further issues with it—all members of the Committee will be aware of that because they will have received the briefings. A number of issues have not been covered by the amendments tabled so far, because the observations from professional outside bodies arrived too late for amendments to be tabled. It might be possible, depending on the progress of today’s debate, for further amendments to be tabled. If it is not, it would be helpful to the Committee if we were able to cover some of the areas raised by the Law Society, in particular, in a stand part debate at the end. My point is that I will resist the temptation to go wider than the amendments to try to sweep up some of the other issues in the hope that we will be able to come to them in a stand part debate.
The Chairman: Eminently sensible.
Mr. Hammond: Thank you, Mr. Cook.
This large group of amendments deals with the scope of disposals eligible for entrepreneurs relief. As we have already said—perhaps ad nauseum—it is much narrower than the scope of taper relief. In principle, we are seeking to establish why the scope of taper relief is not being applied within the £1 million limit that the entrepreneurs relief regime proposes. All the amendments in the group relate to new section 169I. As the Committee will understand, schedule 3 inserts a number of new sections into the Taxation of Chargeable Gains Act 1992, so the structure of the schedule is a series of new sections to that Act. Section 169I deals with the disposal of shares or of assets used in an unincorporated business.
Three separate issues are raised by the amendments. Amendments Nos. 14, 15 and 16 seek to redefine a disposal of business assets under new section 169I(2)(b), which deals with the disposal of assets that are used for the business but that are not owned by it. An example would be the disposal of a factory building at the time the business operating that building is closed down. There may be various circumstances in which that structure is used in the financing of a small business, and where the individuals involved may personally own assets that are deployed in that business. That may be because there is difficulty in raising capital for the business, or because capital can be raised only by giving personal guarantees or security over personal property—typically residential property—and it is thought to be safer for the individual to own the asset personally and allow it to be used in the business. The subsection seeks to deal with the situation where an asset is disposed of at the same time as the disposal of the business.
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As drafted, the Bill only allows eligibility for entrepreneurs relief in the disposal of an asset used in a business, if that business ceases to be carried on by the individual. The broader issue is the contrast between the treatment of sole traders—individuals who carry on businesses—and the treatment of partnerships. As many of the professional bodies have pointed out, one of the effects of picking up the old retirement relief regime and using it as the skeleton for the model of entrepreneurs relief, is that it does not seem well fitted to the world of limited liability partnerships as a new business form that is becoming increasingly used. Because of that, we have a situation where partners in limited liability partnerships will receive different treatment from individuals who are sole traders. By virtue of new section 169I(8), assets disposed of by partnerships where the business does not cease to be carried on, will be eligible for entrepreneurs relief. That seems somewhat iniquitous. If someone sells a factory while continuing the business, they will have no eligibility for entrepreneurs relief in respect of the gain on the sale of the factory.
Once again, that is economic nonsense. It discourages people from renewing assets and it encourages them to hold on to assets used in conjunction with the business until such time as the business is disposed of. They do that rather than renewing those assets on a timely basis that is dictated by normal economic considerations rather than driven by tax considerations. That is generally not the best way to plan and run a business and, from the point of view of the economy, it is not the way to achieve the optimum outcome.
The amendments seek to inject into the structure of the Bill the characteristics of the taper relief regime, where all disposals of business assets were eligible. That was one of the key characteristics of the taper relief regime as far as smaller businesses were concerned, and it was very helpful to them. The amendment deletes the words on page 120, line 20, so that there would be no reference to the business ceasing. Instead, it inserts a requirement for the asset to have been in use for the purposes of the business for at least two years at the date of disposal. Two years was picked to represent what would have been the qualifying period for full taper relief under the previous taper relief regime.
The Government’s drafting creates what I would call an artificial concept of ceasing the business as a qualification. We will return to the question of what cessation of carrying on the business actually means—it is very woolly drafting and we will come back to it in about 300 amendments’ time. It is a term borrowed from the retirement relief legislation, where there was clearly an unambiguous intention that retirement was to take place. Reading this schedule, it is not clear whether there is an intention for retirement to take place. In some places it looks as though that is what is in the draftsman’s mind, and in other places it looks as though that interpretation has been modified. There is a lack of clarity about what is intended. Given the lifetime cap of £1 million, we suggest that there is no need for the restriction on the disposal of assets used in a business at any time as it would simply mean that somebody got to their lifetime cap more quickly. By introducing that additional hurdle, the Government are creating a complex and potentially damaging restriction that could actually be removed without any significant consequences. That is what amendments Nos. 14 and 15 address; amendment No. 16 is purely consequential.
Each of these little clusters or sub-groups of amendments stand separately. What I am about to say in relation to amendments Nos. 17 to 20 does not assume that amendments Nos. 14, 15 and 16 have been accepted. Amendments Nos. 17 to 20 assume as their context the continuation of a requirement for cessation of involvement in the business and they relate to the restriction concerning the time of ownership of the business. The amendments come principally from the Institute of Chartered Accountants in England and Wales, although others have made similar observations. Nobody has any problem with the one-year period of ownership, but as the current wording of the Bill is restrictive it is suggested that the qualifying period should be defined in the same way as the qualifying period for the substantial shareholding exemption—any 12-month period in the previous 24 months.
The amendment paper contains four identical amendments and I have explained the concept behind them. On reflection, substituting
“a 12 month period beginning not more than two years before”
for the words in the Bill, which refer to a period of one year ending with the date of disposal, does not have any material effect and is arguably unworkable in relation to new sections 169I(3) and (4). I accept, before the Minister gets there, that amendments Nos. 17 and 18 are inappropriate. In other words, the suggested changes have been inserted in four places where they should have been inserted only in two places. Amendments Nos. 19 and 20 are the substantive proposals that I want to speak to and I will accept a slap on the wrist in respect of amendments Nos. 17 and 18.
Amendments Nos. 19 and 20 would create greater flexibility around the time at which it is necessary for an individual to comply with the requirements, first, to own 5 per cent. of the shares in the company and, secondly, to be an officer or employee of the company. Amendment No. 19 would allow a qualification for entrepreneurs relief where the shareholding fell below 5 per cent. at the point of disposal, or where the individual ceased to be an employee or officer of the company, so long as he held the 5 per cent. and was an officer or employee for a period of 12 months in the last 24 months.
That aims to give some flexibility to accommodate real-world scenarios of managed exits from small businesses. It is quite possible, for example, that the exit of an individual from a business might involve a structured reduction in his holding, such that he disposed of some of his shares, leaving him with 2.5 or 3 per cent. at one point in the process, and he then disposed of the remainder at his final exit. It is also likely that he may cease to be an employee or officer of the company before finally disposing of his shareholding. The tax regime in the Bill will drive structures for exits from businesses and that is undesirable. We think that the tax regime should not drive behaviour that otherwise would optimise the smooth transition of a business from one ownership to another.
Mr. Mark Field (Cities of London and Westminster) (Con): I rise briefly to clarify my hon. Friend’s comments. Would the 12-month period out of the previous 24 months have to be unbroken to avoid the sleight of hand and other concerns that he has rightly raised about the tax tail wagging the corporate dog?
Mr. Hammond: My hon. Friend raises a good point. The intention, as I said earlier, is to replicate the requirements of the substantial shareholding exemption. My understanding is that that requires an unbroken 12-month period beginning not earlier than the period of 24 months from the date of the disposal in question.
Amendment No. 20 allows the same flexibility around the timing of the qualifying period where a company has ceased to be a trading company prior to disposal. That will quite often happen, such as when a business is being run down and is being turned into a cash and asset-holding shell and the balance between the holding of assets and the trading activity becomes such that the company is no longer treated as a trading company by HMRC. That is not an atypical situation in the winding up of a small business when someone is seeking to retire.
Subsection (7) of the new section signals that the draftsman understood that sometimes an exit will be structured so as to wind a business down and turn it into a non-trading shell, but did not understand the possibility of a managed exit by the individual, where the company will continue trading as he reduces and finally relinquishes his shareholding and at some point ceases to hold office. Our challenge to the Government is whether these arrangements are economically sensible and whether they encourage a degree of tax planning in the management of small businesses which will be detrimental to the most efficient functioning of those businesses and thus of the economy overall.
Amendments Nos. 23 to 25 address a slightly different issue. Amendment No. 23 challenges the requirement for an individual to be an officer or an employee of the company in question. That was not a requirement under the taper relief regime and it is not obvious why that requirement has been inserted now. The Minister earlier said that the relief was targeted at owner-managers: I think she used that phrase, but she certainly talked about active involvement. I urge the Government not to slip back into the pre-1994 Labour party thinking that only the people who work on the shop floor are contributing. The investors who risk their capital are also a vital part of the equation.
The Minister may say that that is not a problem because it is perfectly possible for the business angel investor to become a director of the company. Then he will qualify, but more and more responsibilities and liabilities are being placed on directors of companies, for example, in relation to health and safety with corporate manslaughter provisions coming in. We should not encourage phantom directorships where for tax purposes people who have no control or involvement in the day-to-day running of a business become directors simply so that they qualify for a certain tax treatment. That would be a detrimental move. We should aim for an environment in which the directors of a company are the people who are in control of that business and can therefore be properly held to account for the conduct of that business on a day-to-day basis. That requirement will encourage people who are not actively involved in the business to seek nominal directorships, while having no engagement in the running of the business. I would be interested to hear the Minister’s take on that scenario and whether she believes that there is an issue of concern there. That concludes the group of amendments. Amendments Nos. 24 and 25 are consequential to amendment No. 23.
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Jane Kennedy: I will take on board your comments, Mr. Cook, about the volume of my speech. You will be pleased to hear that you are in good company. The first time I spoke in a Standing Committee—on the National Lottery Bill—our dear hon. Friend Gwyneth Dunwoody was in the Chair. Within my first three sentences she had leaned across the lectern and, as only she could do, whispered loud enough for the whole of the Committee to hear, “For goodness sake, Jane, speak up”. I hear what you say and I will do my best to remember it.
Under the taper relief rules, business asset taper relief was potentially available on the disposal of any business assets, provided that there was a qualifying period of ownership of at least one year. Entrepreneurs relief, on the other hand, is available where disposal of assets is part of the disposal of all or part of the business, or where disposal takes place of assets used up to the time the business ceased. I confess that I missed which of his amendments the hon. Gentleman felt were unnecessary, but I heard him say that amendments Nos. 19 and 20 were the two key amendments.
Mr. Hammond: Amendments Nos. 17 and 18.
Jane Kennedy: Amendments Nos. 17 and 18. Some business asset taper relief was available in respect of disposals of shares, if the company had been a trading company or a holding company of a trading group at any time in the 10 years preceding the disposal. Entrepreneurs relief is available only if conditions are satisfied throughout the year immediately preceding the disposal, or the cessation of the company’s business, if earlier.
I will take first one of the last points that the hon. Gentleman made. He invited us to consider seriously whether it is sensible to create what he believed might be described as phantom directorships for tax purposes. That is not a partisan point; it is a sensible point and I will consider whether that is one of the matters arising from this set of reforms that we need to keep closely under review. We will listen to representations on that point.
The differences that I have described between the taper relief rules and those for entrepreneurs relief mean that entrepreneurs relief is not available on many disposals that would have qualified for taper relief. That is an effect of the different targeting of the two reliefs. The effect of amendments Nos. 14 to 16 would be that an asset that had been used for business purposes for two years would qualify for entrepreneurs relief, without the requirement that it be a disposal on cessation of business.
Amendments Nos. 17 to 20 would make it possible for assets that had changed use before disposal to be eligible for entrepreneurs relief, and shares could qualify even if the conditions of connection to the claimant and the activities of the company had ceased to be satisfied before the disposal. That group of amendments comes out of representations made by the Institute of Chartered Accountants in England and Wales, an organisation with which I have—I hope—a healthy and lively relationship. The amendments suggest that the change in the qualifying period would be consistent with the conditions for the exemption from tax on gains realised by companies on disposals of substantial shareholdings. However, the effect of the amendments would be a significant relaxation in the targeting of entrepreneurs relief on people withdrawing from business.
The hon. Member for Runnymede and Weybridge asked whether the lack of entrepreneurs relief discouraged renewal of business assets. Where a continuing business replaces business assets, rollover relief is available, and that has not changed. We do not believe, therefore, that entrepreneurs relief is needed in those circumstances. It is aimed at disposals of business and includes closing a business down.
Mr. Hammond: Does the Financial Secretary accept that in the absence of amendments Nos. 19 and 20, there is an artificial restriction? She is right in what she says, but can she not envisage a situation in which, in the course of winding down or selling a business, the qualifying requirements that one holds a minimum of 5 per cent. of the shares and is an office holder or employee will cease before the final disposal is made? What she is doing is denying relief in those cases. It seems to us from a common-sense point of view that in such cases the Government would not want to deny relief, other than for money-saving considerations. The measure will invite people to structure deals and transactions purely for tax purposes. Her predecessor, with whom I used to have interesting discussions, felt very strongly that that was not the way to go forward.
Jane Kennedy: I hope that we have interesting conversations about these subjects. I want to respond to the hon. Gentleman in the spirit in which he is probing on this matter. I do not believe that this measure will have the effect that he has described, but it is another of those areas on which I will keep the impact of the reforms that he is drawing to my attention under review. I do not believe that his concern is justified.
Mr. Field: One of the biggest concerns with any artificial tax-driven deal that is created as a result of these proposals is that in 12 or 24 months’ time we will face another Finance Bill and it will contain clause upon clause of anti-avoidance measures. That is what has happened in the past because the Treasury has constantly and understandably been playing catch-up with professional advisers who are able to create artificial mechanisms. We are concerned that a future Finance Bill Committee will have to consider such measures to alleviate, from the Treasury’s point of view, problems that arise with artificial creations that come as a result of ill-thought-through measures such as this. All that we are asking the Financial Secretary is that, for once, we be wise before the event.
Jane Kennedy: The hon. Gentleman is right. There are many occasions when behaviour changes as a result of changes in the tax regime. That was the point made by the hon. Member for Runnymede and Weybridge on the way in which decisions relating to the disposal of assets might be influenced by the application of entrepreneurs relief. With even the best structured tax regime for capital gains tax and given the most detailed thought, there will still be tax advisers whose whole purpose is to advise businesses on how to manage their investment decisions and their decisions on the disposal of assets to their advantage in tax terms.
We are talking not about people evading tax but about businesses making decisions based on the tax regime within which they function. I accept the point that the hon. Gentleman is making, but we believe that, by introducing much-desired simplicity by making changes to capital gains tax, we will reap benefits for businesses in the coming months and years. Even if we had changed the regime as suggested by the Conservative party in its amendments, tax advisers would still be working hard to find ways of minimising the tax liabilities for their clients. While the hon. Gentleman has made a point worth making, it is not relevant. I suspect that we shall be doing what he suggests that we shall be doing anyway. [Laughter.]
Businesses will continue to be set up for a variety of commercial reasons. The hon. Member for Runnymede and Weybridge asked why there were differences for sole traders and partnerships. Tax, including the possible availability of entrepreneurs relief, will be just one factor that people might want to take into account when deciding the business structure that is right for them. I acknowledge that the tax regime does influence decision making, but it is not the only factor.
Mr. Hammond: Of course, the Minister is right, but let us suppose that I am a sole trader setting up a new small business. I expect to have business assets that I might like to sell and on which I shall receive entrepreneurs relief. Why would I not set up the business as a limited liability partnership with my wife rather than as a sole trader, knowing that if I just take the simple step of establishing it as a limited liability partnership—or even an ordinary partnership—I would be able to sell business assets and gain the benefit of entrepreneurs relief without having to cease the business? That seems a perverse signal to send; it would cause people to structure their businesses in an unnatural way simply for tax advantages.
Jane Kennedy: Any tax relief will have pressure around its edges. I accepted the point about how the regime might influence behaviour, and the hon. Gentleman has now described more than one way in which it may be perverse. We believe that the rules, as drafted, strike a reasonable balance with clear conditions, but I have said that I shall keep the relief under close review.
Amendments Nos. 14 to 16 would have the effect that I have described. They would allow disposals to qualify for relief, even if the individual was not withdrawing from business. Amendment Nos. 17 to 20 would allow the assets to be switched away from businesses, but to continue to qualify for relief. Amendment No. 15, perhaps unintentionally, would prevent some disposals following the cessation of a business from qualifying for relief as, in certain cases, assets would not meet the new test of having been in business use up until the point of disposal.
Mr. Hammond: I am grateful to the Minister. She is reading out the answer to the points that have been made, but will she think about what she is saying? Let us consider the example of the factory and its disposal. The right hon. Lady said that, if an asset becomes used for a non-business purpose, it ceases to be eligible for entrepreneurs relief. In the course of disposing of a business, it would be unsafe to switch the business to new premises and then dispose of the old premises that were held outside the business as assets of the individual because they would then be disqualified from eligibility for entrepreneurs relief. It is that sort of micro-management and how the decision process is taken that we consider will be so debilitating, unnatural and inhibitive of the way in which people would normally handle such matters.
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Jane Kennedy: The hon. Gentleman has described a further example of the way in which behaviour might be affected by the relief, as provided. We do not expect that that would be the effect. However, for those reasons, as I have said, I will keep the matter under close and active review.
All the amendments are unnecessary. In constructing schedule 3, we have deliberately focused entrepreneurs relief on individuals disposing of all or part of their business. It is the people who have built up a successful business whom we want to reward, and the benefit of the 10 per cent. effective tax rate will be of most value for business owners and material investors at the point of disposal. Broadening the scope of the relief in the way proposed, to allow a wider range of assets or looser connections to the business activity to qualify, would necessarily dilute this focus.
Having heard my response to his opening speech to the amendments, I hope that the Member for Runnymede and Weybridge will accept the further detail, which I hope I have provided, and not press his amendments to a vote. We are in his hands. If he chooses to press them, I will invite my hon. Friends to resist.
Mr. Hammond: I am disappointed by the right hon. Lady’s response because I do not feel that she has engaged with the specific issues raised. She talked about simplification; surely it must be obvious to anyone on the Committee listening to the debate and reading schedule 3 that this is not a simplifying measure. This late amendment, the entrepreneurs relief, has hugely complicated the Government’s proposals on capital gains tax. In fact, it has removed the only benefit of the original package, which was so abruptly introduced but, in its favour, did simplify the system. Grafting entrepreneurs relief on top of the proposals makes them hugely complex.
The Financial Secretary talked about the incentive for tax advisers to develop all sorts of planning scenarios. In the real world, where the maximum tax savings will be £80,000, only the simplest planning strategies will be implementable. People will not be able to go to large firms of accountants and have them establish very complex tax planning strategies, because the amount of tax to be saved simply will not justify it. I am pleased, but alarmed, by the number of matters that she has agreed to keep under review. I can see that the Government are going to have to appoint a new person to the Treasury Front-Bench team—the under-secretary for reviews of the Finance Act 2008. If the hon. Lady keeps all these matters under review, she is going to be very busy.
We have tabled these amendments to be helpful and to probe the Government’s intentions. There is still a lot of uncertainly out there about what this regime will mean in practice. I had hoped that the Financial Secretary would clarify at least the Government’s intention today. Our fear and our belief is that this was done in a great hurry in response to pressure from business organisations and particularly from the Federation of Small Businesses, which should get a mention for its success in getting this huge climbdown for small businesses.
Some of the consequences that I have spelt out and will be spelling out in future debates were not intended. They were not the result of some great Government plan to deprive this or that person. They have fallen through the cracks of hastily drafted legislation. We were hoping that the Minister would do more than undertake to keep under review some of these issues, particularly the requirement for employment or office holding. Later we shall come to the requirement for a 5 per cent. share holding. I had hoped that she would undertake to review such issues before Report. I sense that the mood of the Committee is that we have a great deal to get through and we want to discuss many other areas in schedule 3. Therefore, in the interests of time, I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
Mr . Hammond: I beg to move amendment No. 21, in schedule 3, page 120, line 39, leave out ‘the individual’s personal company’ and insert ‘unlisted’.
The Chairman: With this it will be convenient to discuss the following amendments: No. 22, in schedule 3, page 127, leave out lines 37 to 42.
No. 38, in schedule 3, page 127, line 37, leave out from ‘company”’ to end of line 42 and insert
‘has the same meaning as in section 165(8).’.
No. 39, in schedule 3, page 127, line 39, leave out ‘5%’ and insert ‘1%’.
No. 40, in schedule 3, page 127, line 41, leave out ‘5%’ and insert ‘1%’.
No. 41, in schedule 3, page 127, line 42, at end insert ‘, or
(c) in which he holds shares under an approved HMRC share scheme.’.
No. 42, in schedule 3, page 127, line 42, at end insert ‘, or
(c) in respect of shares in which he holds EMI qualifying options.’.
No. 5, in schedule 3, page 127, line 42, at end insert—
‘(3A) Shares held by an individual through an employee profit sharing scheme or a share-ownership scheme shall be exempt from the requirements of subsection (3).’.
No. 43, in schedule 3, page 128, line 9, at end insert—
‘“EMI qualifying options” has the meaning given in section 527(4) of the Income Tax (Earnings and Pensions) Act 2003,’.
Mr. Hammond: Again, I intend to address the issues raised in this group separately, but they all deal with the circumstances in which a sale of shares is a qualifying disposal for entrepreneurs relief. Amendments Nos. 21 and 22 challenge the requirement for a 5 per cent. holding of shares. There was no such requirement in relation to taper relief or in relation to the share in a limited liability partnership. Limited liability partnerships are an alternative form of business structure and are comparable to incorporation for a smaller business. That rule seems to have been lifted from retirement relief and not updated to reflect the emergence of limited liability partnerships, as I said earlier. That is onerous for those in high-tech industries, for example.
The hon. Member for Dundee, East raised some points raised by the BioIndustry Association. It has drawn attention to the fact that in capital-intensive start-up areas to which highly skilled employees need to be attracted, it is not unusual to give employees shares or share options in the business. It would be unlikely that anyone but the most lucky employee or one of a group of founders—perhaps those who came out of a university and set up a high-tech business—would hold more than 5 per cent. of the shares each after they had suffered a number of dilutions during the capital-raising process of taking their business forward. That is a function of the fact that significant equity needs to be released in order to attract the capital.
Therefore, I invite the Financial Secretary to think about the example of five brilliant bioscientists leaving a university and setting up a business on the Cambridge University science park. Over the years, they first raise £500,000, and then another £500,000, but on each occasion they will have to give away part of the equity in the business until they come to the point at which they are reasonably successful. They would be ready to dispose of their company by perhaps floating it on the stock market or selling out to a much larger company, but by that stage the five of them would have between them only 24 per cent. of the original equity. They will not qualify for entrepreneurs relief, and to me that is a bizarre situation.
With the greatest respect to small businesses, many people go into business and establish small companies, not with the intention of creating a large business, employing lots of people, floating it on the stock market and creating millions of pounds of wealth, but simply with a view to having a comfortable lifestyle and engaging in useful and remunerative activity, which is very worthy. Such small businesses are the backbone of our society, and I applaud them. However, in economic terms, we should focus on those who start businesses with a view to turning them into the Googles, the Microsofts and the major biotech companies of the future. It is on those businesses that the Government should focus their attention.
Stewart Hosie: I think that I have just discovered a double whammy. I had not considered the dilution of shares at the back end in the way that the hon. Gentleman has. The dilution of shares will be intensified by this measure precisely because the outside investor, if they want the same cash return with the new tax regime, might demand more from the pot. Therefore, the scenario described is now more likely under the new rules than it was before.
Mr. Hammond: The hon. Gentleman is giving me more credit than I deserve, because I had not discovered that, but the logic of what he says is absolutely right. I am sure that risk-taking investors, faced with alternative asset classes with similar tax treatment and perhaps with other opportunities elsewhere in the world, will certainly look for compensation for the reduction in post-tax return that they will receive. Why should high-tech, high-capital requirement business be disadvantaged as compared to low-tech, low-capital requirement business? That does not look like the forward-looking, technological focus that I would expect from a Government who were thinking about this country’s future.
Emily Thornberry: Will the hon. Gentleman help with this point? Would not amendment No. 21 simply allow the tax relief that the Government wish to give to entrepreneurs to be given to the stock exchange? That tax relief would therefore be available only to investors, not to entrepreneurs. It turns the whole idea of the tax relief on its head.
Mr. Hammond: The relief would be available to investors in unlisted shares. The hon. Lady used the term stock exchange. It would not be available to investors in stocks quoted on a stock exchange. That is the point of inserting the term “unlisted”. It reflects the taper relief regime where unlisted shares—and under the terms of that regime, also shares quoted on the alternative investment market—were, in most cases, treated as unlisted investments. Unlisted investments were eligible for taper relief.
I would be delighted if the Minister said that she could not accept the amendment in the terms in which it is phrased, but that she accepted the point behind it and would address it in another way. The point we are trying to get to is about the 5 per cent. threshold. Let me be frank with her. I have a vision of the person drafting the measure. In his mind, he has a small factory—perhaps in Birmingham, Erdington—that is bashing something out. There are boxes going out the door and there is a hard-working entrepreneur who owns 100, 50 or 33 per cent. of the business. That is the business that the draftsman has in mind, and when thinking about that type of relatively low-capital business, I can understand his insertion of the 5 per cent. limit. However, when we look at the kind of high-tech, high-capital businesses—perhaps those growing up around our universities—which we so desperately need to promote and foster, the 5 per cent. threshold starts to look like wishful thinking and an absurdly high bar that we are asking people to clear.
As I said on Second Reading, it seems bizarre for the Government to reward investors in buy-to-let properties and owners of second homes with a lower tax rate, to give owners of small, low-capital lifestyle businesses a lower tax rate, but to say to those who risk their capital and earning potential by working, founding and investing in high-tech, potential high-growth businesses, which form the British winners of tomorrow, that they must pay a relatively high rate of tax. It is a bizarre signal to send, and I cannot believe that the Government wanted to send that message to those people. That is why I would be delighted were the Minister to accept, or at least recognise, our concerns, even if she cannot accept the amendments in the precise terms in which they are drafted.
Amendments Nos. 21 and 22 replace the definition of a personal company with the phrase “unlisted” company. I have deliberately not defined unlisted company. There are various ways in which it could be done. As I said earlier, under taper relief it included companies listed on the alternative investment market, although that is not essential. Why should the relief be more restrictive than it was under taper relief, when everything under the entrepreneurs relief is subject to the overall £1 million cap?
Before I sit down, I want to return to a specific point relating to enterprise management initiative options, which was raised earlier by the hon. Member for Dundee, East. In high-tech industries, such measures will almost always result in holdings of less than 1 per cent. on exercise. I have a question for the Minister. The enterprise management initiative was created by the Government to encourage these people. They are now going to be penalised. They make a conscious choice to take risk and to be remunerated by capital gain rather than going to work for a big company and being remunerated through income.
A concern being expressed by professional bodies is that the way in which EMI options are treated by the schedule suggests that the Government have lost interest in them, have had a change of heart and are signalling that they should no longer be used as the preferred route to incentivise employees in these businesses. I should be grateful if the Minister answered that challenge and, if I have got it wrong, gave a categorical assurance that the Government remain committed to the EMI regime.
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Stewart Hosie: The way in which it has worked historically is that the banks would facilitate the purchase of the shares for a day or so to allow them to be sold. Given that they now need to be sold for a year, given that there is a very tight credit squeeze and given the market uncertainty, far from being an incentive, it might be that someone simply cannot raise the money to crystallise and make the profit and they would be landed with a liability.
Mr. Hammond: The hon. Gentleman is right and I wonder whether the Minister and her colleagues have thought this through. The point about an option is optionality. One sits on it and hopes that it will have value but it does not have a downside. If it does not have any value, one has not lost anything. One turns around and walks away from it. As soon as anyone exercises that option, as they will be required to do to gain the benefit of entrepreneurs relief, and acquire the underlying shares, they will be exposed to risk. They could collapse in value. The company could become insolvent. They could reduce to zero in value. It is not about a bank lending for a couple of days. It is about a bank lending for a year and being prepared to take the full risk of something happening to that business during that time. Options and shares are not interchangeable in that way. Shares represent a capital risk. Options represent an opportunity with no downside risk.
That was amendments Nos. 21 and 22. There are lots more amendments in the group. Amendment No. 38 explores a different approach to the same problem and one which would simplify and introduce consistency within the Taxation of Chargeable Gains Act 1992, which this schedule amends. Amendment No. 38 substitutes in new section 169S at page 127 line 37 for the existing definition of a personal company as a trading company in which an individual holds at least 5 per cent. and is an officer or employee, a definition that is already in section 165(8) of the Taxation of Chargeable Gains Act. That definition is 5 per cent. of the voting rights. It is not as loose as I would like, but it is a looser definition than the one which has been imported from the old retirement relief into the entrepreneurs relief schedule.
If the Bill is enacted we will have a situation where the Taxation of Chargeable Gains Act will define a personal company in two different ways. It will define it at section 165(8), as amended, as being a company in which an individual holds 5 per cent. of the voting rights, with no obligation whatsoever to own 5 per cent. of the ordinary shares, and it will define it in respect of new section 169S as a requirement to hold both 5 per cent. of the ordinary share capital and 5 per cent. of the voting rights. It is a reduction in flexibility, an unhelpful complication in the Act and an additional impediment in the raising of capital having to have 5 per cent. both of the ordinary share capital—that is to say the beneficial economic interest in the business—as well as 5 per cent. of the voting rights.
Amendments Nos. 39 and 40 represent yet another approach, which I hope will tempt the Minister. The point here is to show her that there are a number of ways of tackling the problem. Amendments Nos. 39 and 40 would accept the Government’s architecture of a minimum percentage requirement for voting and ordinary shareholding, but make it less of a threshold by replacing 5 per cent. with 1 per cent. If the Government insist on having a threshold, we can at least make it a level that is unlikely to trip up entrepreneurs.
So far, we have heard no explanation whatsoever of the purpose of a 5 per cent. threshold. We have not heard any rationale for it being set at 5 per cent. We know very well that there is no rationale. It was just lifted from the provisions on retirement relief. Whether the threshold is abolished, reduced to 1 per cent. or limited to voting rights only and made consistent with the rest of the TCGA, will the Minister explain why the requirement is in the Bill and why it has been set at that level?
Amendment No. 41 takes us back to the debate that we had in relation to schedule 2. One group of losers from the restructuring of capital gains tax is holders of shares in approved employee share schemes. I heard the Minister say earlier that she doubts the figures provided by ifs ProShare, which suggest that 270,000 employee shareholders—quite a small percentage of the total; I think that it is 16 per cent. or a little less—would have gains that exceeded the annual exemption limit. Of course, the vast majority of them will not. Most people who are members of the Tesco employee share plan will have a relatively small holding and will make gains that are comfortably within the annual exemption limit. I accept that.
With the greatest of respect to the right hon. Lady, while I think that we all welcome employee share ownership in large and small companies, I do not think any of us would argue that employee share owners in Tesco are as necessary and vital a driving force to the future expansion of business as employee shareholders in small start-up high-tech businesses, where the incentive of owning shares is a key part of the package that drives the business forward. Those are the kind of businesses that double in size every year. Although it may sometimes seem to us—[ Interruption. ] I am concerned, Mr. Cook, at the possibility of another by-election. I hope that the hon. Member for Ealing, North will recover his composure in a moment.
It may seem to us sometimes when we read the newspapers that Tesco doubles in size every year, but I can assure members of the Committee that on closer inspection they will find that it does not. The Minister said last week in the Chamber, in response to something that I said about employee share ownership:
“Our figures show that the average amount of gain that a typical employee makes from save-as-you-earn options is well under the annual exempt amount of £9,600 a year, but”—
she said presciently—
“I have no doubt that we will return to that point in Committee.”—[Official Report, 28 April 2008; Vol. 475, c. 66.]
Well, here we are.
As I am sure has been discussed under the previous schedule, the old CGT regime meant that basic rate taxpayers who held shares in their employer for at least two years were subject to only a 5 per cent. CGT charge, or 10 per cent. for higher-rate taxpayers. They face an additional 13 per cent. tax on any gain above £9,600 because they are not eligible for entrepreneurs relief. It does not seem likely that the Government would wish to argue for that.
In the quotation that I gave from the Chamber last week, the Minister said:
“Our figures show that the average amount of gain that a typical employee makes ... is well under the annual exempt amount”.—[Official Report, 28 April 2008; Vol. 475, c. 66.]
But in an answer to the hon. Member for Edmonton (Mr. Love) on 12 December, when he asked for an estimate of the number of individual members of save-as-you-earn schemes that would be affected by the changes introduced by the recent Budget, she said:
“The information requested is not available.”—[Official Report, 12 December 2007; Vol. 469, c. 620W.]
I would be grateful if she could tell the Committee when the information that she was apparently quoting last week in the Chamber became available, and in what form that information was collected.
The amendment extends the definition of a personal company to include a company in which the individual holds shares under an HMRC-approved share scheme, regardless of the percentage of shares held. Surely the Government have to send a consistent message. If they no longer wish to encourage employee shareholding in companies that will grow, and in which that shareholding will therefore become worth significantly more than the annual exemption limit, let them say so clearly. I would hope that that is not the Government’s position and not the case that the right hon. Lady wishes to argue.
Amendments Nos. 42 and 43 take us back to EMI options, the importance of which we have discussed. EMI options were introduced in the Income Tax (Earnings and Pensions) Act 2003, but it is no good introducing these things as an incentive to people and then snuffing out the signals that they are meant to send with subsequent legislation. That not only erodes the value of the initiative, but undermines confidence in future initiatives and weakens the signal that the Government seek to send with similar initiatives in the future.
Amendment No. 42 adds a company in which the individual holds EMI options to the definition of a personal company, again without a percentage requirement. That allows for sale of the options, rather than having to exercise them, addressing the point that the hon. Member for Dundee, East made in an intervention. Allowing the options to be realised with eligibility for entrepreneurs relief, avoids the need to raise the finance and to take the risk of holding a capital asset and possibly seeing it depreciate over a year—getting the timing wrong. That would send a powerful signal in favour of the EMI regime.
The Minister should not underestimate the concern among professional bodies that the Government’s apparent abandonment of EMI in the set of provisions is sending a signal that the Government are no longer committed to it. I am not an expert in those areas, but I understand that professional bodies have already picked up signals from the Government that they may no longer be as keen on the EMI scheme. If that is not the case, it would be helpful if the Minister could make an unambiguous statement of the Government’s commitment to the EMI scheme. The amendment adds a provision that options under EMI qualify the individual under the entrepreneurs relief regime, and it inserts into the relevant section the definition of EMI taken from the Income Tax (Earnings and Pensions) Act. I look forward to her comments.
Jane Kennedy: The group of amendments seeks in one way or another to relax the conditions under which disposals of shares and securities can qualify for entrepreneurs relief. Amendments Nos. 21 and 22 would remove the 5 per cent. shareholding requirement and extend the relief to any holding of shares or securities in an unlisted company. Amendment No. 38 also seeks to remove the 5 per cent. shareholding requirement. Amendments Nos. 39 and 40 seek to dilute the 5 per cent. shareholding and voting rights requirements to 1 per cent. Amendments Nos. 5 and 41 to 43 seek to extend relief to shares acquired under employee share schemes or the enterprise management incentive scheme. Again, all those amendments are unnecessary.
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In constructing schedule 3, we have deliberately focused entrepreneurs relief on individuals who own their own business or a material stake in a company. The relief is designed to promote and reward substantial investment and involvement in a business. We consider the 5 per cent. shareholding test to be a suitable benchmark for that purpose. The hon. Gentleman has spoken at length about why he thinks that we arrived at 5 per cent. However, entrepreneurs relief is targeted at those with a material stake in a company and those who play an active role in it. The right to vote is an important part of defining that activity. The rules, therefore, require the qualifying 5 per cent. material stake in the company to be accompanied by the same minimum percentage of voting rights. We are striking a balance between focusing relief on material investors and allowing many people to benefit from the relief and the cost of the relief. The hon. Gentleman has heard explanations for the 5 per cent. He just does not agree with the explanations that have been offered.
I shall turn now to the EMI question. May I offer him an absolute commitment to the EMI as a valuable aid to help small companies in riskier areas to recruit and retain the staff that they need to grow? Our commitment to EMI is shown by the increase in the individual limit from £100,000 to £120,000, which took effect from 6 April 2008. The impact on individual investors will depend on their personal circumstances.
Mr. Hammond: I am grateful to the Minister for that clarification, which will be heard beyond this room. I am sure that it will be a welcome statement of the Government’s intentions.
I want to return to the question of the Government’s apparent obsession with the idea that they want entrepreneurs relief to be available only to people who have a material interest in the business. [Interruption.]
The Chairman: Order. May I ask Members seeking to hold a conversation to do it outside or to desist?
Mr. Hammond: I want to ask the Minister if it is her view that a 4 per cent. interest in a company that has grown to be worth £10 million is less material than a 40 per cent. interest in a company that is only worth £1 million? That is not how I think about the growth of companies and the development of the economy.
Jane Kennedy: In defining what we mean by interest and a material stake in the business, we drew the line at 5 per cent. We believe that that was the right balance to strike. I accept the example that the hon. Gentleman gave of five young students coming out of university and investing in the way in which he described. If the capital gain were split between the five equally, they would not receive the relief. In seeking to define what we meant, we have arrived at the definition that I have described. We believe that it strikes the right balance.
Some of the amendments in this group make reference to employee share schemes. Some of the schemes, such as the share incentive plans, and capital gains tax relief, remain in place, while the vast majority of participants, including the save-as-you earn schemes, have capital gains well below the tax-free annual exempt amount. In all cases, the income tax and national insurance benefits of scheme membership remain in place. We do not believe that it is—
Mr. Browne: I did not mean to stop the Minister mid-sentence. What assessment has she made of the additional cost to the Exchequer if the Government were to accept the amendment tabled by the Conservative spokesman to reduce the threshold from 5 per cent. to 1 per cent. ownership of the company?
Jane Kennedy: I do not have that figure immediately in front of me. If we have a figure for it, I will supply it to the Committee. It is not material to the consideration of the amendments themselves. We do not believe that the amendments are necessary in principle. It is not necessary or desirable to connect the shareholdings described in some of the amendments—that is the share incentive plans and the save-as-you-earn schemes—to the entrepreneurs relief.
Having heard my remarks in response to the amendments, I hope that the hon. Member for Runnymede and Weybridge will not press them to a vote, but if he does choose to do so, I hope that my hon. Friends will resist.
Mr. Hammond: I am, once again, disappointed. I do not get the impression from the Minister’s response to that group of amendments, as I did from her response to the previous group of amendments, that she was even listening to the issues. There was no sense of a thoughtful response or even a concession that there might be a grain of something that needs to be “kept under review”—to use her phrase.
I do not want to labour the point, but I sometimes wonder whether Ministers and those who advise them understand at all how small and medium businesses work and what motivates the people who get involved in them. The message going out from here is very negative. It is sending the wrong signal to all sorts of people. We have heard that the Government are now in “listening mode”—they switched to listening mode on Sunday morning. I would have thought that in the spirit of that listening mode the Minister would have wanted to look at some of these issues again because the 5 per cent. limit is a problem; it will exclude people who should not be excluded and it will preferentially treat lifestyle businesses while penalising those in high-capital-requirement, high-growth businesses that really are important to the economy.
I noted the result of the last Division, and because of the arithmetic in the room I am not going to detain the Committee by pressing the amendment to the vote. Those outside will have heard that we have made the case, they will have heard that the Minister has failed to respond to it and that the listening Government are not listening as far as entrepreneurs, high-growth businesses, holders of share options in those businesses and holders of employee shareholdings are concerned. They will draw their own conclusions. I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
Further consideration adjourned.—[Mr. Blizzard.]
Adjourned accordingly at eight minutes past Four o’clock till Tuesday 13 May at half-past Ten o’clock.
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