Finance Bill

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Clause 32

Small companies’ relief: associated companies
Question proposed, That the clause stand part of the Bill.
Mr. Hoban: The simplification has been broadly welcomed by industry groups because it deals with situations perhaps involving partners in firms of accountants. Under previous legislation, it would have been assumed that their companies were associated by virtue of the fact that they were partners rather than because there was commercial interdependence between the companies. The provision, particularly in the advent of large partnerships comprising several hundred partners, is to be welcomed. However, other situations are still caught by section 13 of the Income and Corporation Taxes Act 1988 when, because people are connected, it deems that their companies are associated even though there is no commercial interdependence.
For example, let us consider companies that are owned separately by relatives. Can the Minister clarify whether discussions are taking place on simplifying that aspect of the rules? There are other ways in which to deal with the same issue in respect of the annual investment allowance.
Angela Eagle: The clause deals with associated company rules, and I welcome the hon. Gentleman’s support for the simplification process. Associated company rules provide a range of anti-avoidance protection measures within the corporation tax regime. For the purposes of claims for small companies rate, they do that by preventing directors or shareholders from fragmenting business activities in order to qualify artificially in some ways for reliefs that were not intended, an issue that we have talked about before.
The clause amends associated company rules to make it easier to establish the number of other companies with which a company is associated, thus removing a potential cause of undue compliance burden. That is brought into effect, as the hon. Gentleman has rightly identified, by the changes to companies rules that allow for much larger partnerships—sometimes of more than 1,000. Clearly, it is not viable to expect a run-down on partnerships of 1,000 by one person and for that person to have detailed knowledge of all the holdings of the other partners in a way that perhaps happened in the past when partnerships were smaller.
The provision is the first of what we hope will be a series of simplifications. The hon. Gentleman referred to another area and further meetings will be scheduled to see how we can simplify the associated companies rules further. The matter is complicated. The stakeholders with whom we are engaging know and admit that it is complex. We are continuing to engage with them and we hope that further changes and simplifications in other areas, hopefully along the same lines, will come out of our discussions. With that reassurance, I hope that the Committee agrees that the clause should stand part of the Bill.
Question put and agreed to.
Clause 32 ordered to stand part of the Bill.
Clause 33 ordered to stand part of the Bill.
Schedule 13 agreed to.

Schedule 14

Company gains from successful investment life insurance contracts: consequential amendments etc
12.15 pm
Kitty Ussher: I beg to move amendment No. 98, in schedule 14, page 225, leave out line 7 and insert—
‘1A (1) Subsection (1C) of section 437 (general annuity business: income limit) is amended as follows.
(2) In paragraph (b)(ii), omit “capital elements and”.
(3) Omit paragraph (c).
(4) In paragraph (d), for the words after “2005” substitute “are so much of the payments under the new annuities as would be within the exemption in subsection (1) of that section if—
(i) section 718 of that Act were omitted, and
(ii) that exemption were an exemption applying in relation to companies as well as individuals.”
2 Omit sections 539 to 551A (corporation tax in respect of gains arising in connection with life policies etc).’.
The Chairman: With this it will be convenient to discuss Government amendments Nos. 99 to 104.
Kitty Ussher: Clause 33 and schedule 13, which we have just agreed, are simplification measures, when combined with schedule 14, which is before us. They are about profits on life insurance policies owned by companies. Together they turn some 60 pages of legislation into three, including some of the transitional provisions, leading to far lower compliance costs for industry. I trust that that too will be welcomed by the Opposition.
Government amendments Nos. 98 to 104 show that we can take the simplification in schedule 14 slightly further by also repealing some rules that apply to a purchased life annuity owned by a company. The rules set out how to calculate the non-exempt part of the annuity, which is the taxable income part. Amendment No. 99 repeals the relevant legislation on the special tax rules, which are no longer needed to identify separately a taxable part of the annuity. Amendment No. 98 ensures that, following the repeals, the tax treatment of an insurance company’s profits from its purchased life annuity business remains the same. An insurance company must continue to calculate a non-exempt amount for the purpose of its tax computations, where the annuity is owned by a company, in the same way as it does now. To do so, it must apply the rules that apply to purchased life annuities held by individuals; those rules continue in force. Amendments Nos. 100 to 104 repeal a number of provisions that are no longer needed or that inserted amendments into legislation that is being repealed.
I regret that we were not able to introduce the amendments with the original published Bill, but only once the possibility of simplifying further came to our attention. I hope that all sides of the Committee will agree that introducing the amendments is the right thing to do.
Amendment agreed to.
Amendments made: No. 99, in schedule 14, page 226, line 23, at end insert
‘(further provisions about corporation tax in respect of gains arising in connection with life policies etc).
6A Omit sections 656 to 658 (purchased life annuities).’.
No. 100, in schedule 14, page 227, line 7, at end insert—
‘(aa) in FA 1991, section 76(1),’.
No. 101, in schedule 14, page 227, line 13, after ‘1999,’ insert ‘section 80 and’.
No. 102, in schedule 14, page 227, line 18, leave out ‘paragraph 25’ and insert ‘paragraphs 25 and 27’.
No. 103, in schedule 14, page 227, line 19, after first ‘paragraph’ insert
‘(b) of section 473(2) and the “or” before it, paragraphs 268(1) and (2), 269 and’.
No. 104, in schedule 14, page 227, line 21, leave out ‘paragraph 111’ and insert ‘paragraphs 111 and 141’.—[Kitty Ussher.]
Schedule 14, as amended, agreed to.
Clause 34 ordered to stand part of the Bill.

Schedule 15

Changes in trading stock
Mr. Hoban: I beg to move amendment No. 75, in schedule 15, page 228, line 39, at end insert—
‘(4) This section shall not apply where an election under section 161(3) of the Taxation of Chargeable Gains Act 1992 is made, and instead the market value of the asset at the time of the appropriation shall, in computing the profits of the trade for the purposes of tax, be treated as reduced by the amount of the chargeable gain or increased by the amount of the loss referred to in subsection (1) of section 161 of the Taxation of Chargeable Gains Act 1992, and where that subsection and this section do not apply by reason of such an election, the profits of the trade shall be computed accordingly.’.
The Chairman: With this it will be convenient to discuss the following amendments: No. 76, in schedule 15, page 231, line 6, at end insert—
‘(4) This paragraph shall not apply where an election under section 161(3) of the Taxation of Chargeable Gains Act 1992 is made, and instead the market value of the asset at the time of the appropriation shall, in computing the profits of the trade for the purposes of tax, be treated as reduced by the amount of the chargeable gain or increased by the amount of the loss referred to in subsection (1) of section 161 of the Taxation of Chargeable Gains Act 1992, and where that subsection and this paragraph do not apply by reason of such an election, the profits of the trade shall be computed accordingly.’.
No. 77, in schedule 15, page 231, line 22, leave out ‘paragraph 7 does not apply’ and insert
‘neither paragraph 7 nor section 173 of the Taxation of Chargeable Gains Act 1992 applies’.
Mr. Hoban: I speak to amendment No. 75, which stands in my name and those of my hon. Friends. The change in this schedule is one of the more technical in this year’s Finance Bill. The change is slightly odd. It seeks to put on a statutory footing a tax treatment that dates back to 1955, raising the question of why that is needed for what seems to be an established part of tax law. I am sure that the Minister will address that in her remarks, but it might be helpful for the Committee if I give some background to the schedule.
The tax treatment stems from a case, Sharkey v. Wernher, that was heard in the House of Lords in 1995. The case held that a trader who had appropriated the stock from her business for private purposes should account for tax purposes for the profit that would have arisen had the stock been sold in the normal course of business, where the value of the asset sold was in excess of its cost. Lady Zia Wernher ran a stud farm, which was classified as a trading activity. She also ran a racehorse stable, which was not classified as a trading activity—in line with many people who have had experience of owning horses. It was deemed that when Lady Wernher transferred her horse from the stud farm to the stable, the stud farm accounts should show, as profit, the difference between the cost of the horse and its market value at the time of the transfer. Thus the notional profit on the horse should be taxed. That is different to the accounting treatment of taxable profit. Case law has extended that, to ensure that it applies to transfers within groups, or to when an asset has moved from being part of the trading stock of a business to being a fixed asset. Schedule 15 seeks to codify that longstanding treatment.
There are two schools of thought about the schedule. The first is that it is an unnecessary move—the practice has been long established so why do it now? That is reinforced by the fact that when the Income Tax (Trading and Other Income) Act 2005 was passed as a result of the tax rewrite process, it was decided not to enact the treatment in statute. The Rewrite Committee reported:
“We see no reason to doubt that the principles explained in Sharkey v Wernher continue to apply to the calculation of business profits. But it would be wrong to enact those principles while others doubt the position. The only way to preserve the law is to continue to rely on case law in this area.”
That hints at another school of thought, which is that the original 1955 ruling was flawed. Keith Gordon, a tax barrister, argued in an article entitled “Sharkey Revisited” in Taxation, on 24 July 2003, that
“the rule was susceptible to challenge on two broad bases. First because their Lordships had not had the advantage of evidence concerning the accounting treatment of such appropriations, and secondly, because (arguably) the importance of accounting principles became even more pronounced following the enactment of”
the Finance Act 1998, section 42. That principle is now reflected in the 2005 Act to which I referred. The Institute of Chartered Accountants stated:
“The proposal is that trading stock appropriated or otherwise ‘used’ by the trader for his own benefit should be treated as sold at market value. This treatment is contrary to the treatment under UK GAAP”
—generally accepted accounting practice—
“under which the transaction should be accounted for at either the cost price of the stock or at the price paid on disposal. FA 1998 section 42 states that taxable profits must be computed in accordance with GAAP unless an adjustment is required or authorised by law.”
The different treatment in the Sharkey v. Wernher case and UK GAAP shows a difference between accounting and tax profits. Schedule 15 emphasises that difference and, by having that difference between taxable profits and accounting profits, works against the Government’s stated desire to simplify the tax system. It would be useful if the Economic Secretary could clarify why the Government decided to add schedule 15 to the Bill. Is it, as Keith Gordon suggests in his article, that taxpayers have been much more assertive in questioning the continued applicability of the rule? There is also the wider point that the schedule enshrines in statute a further gap between the tax and accounting definitions of profits. One of the ways to make tax simpler is to align more closely the two definitions of profit. Why have the Government not chosen to go down that route?
Another issue that arises from the codification of Sharkey v. Wernher is that the rule—the 1955 judgment—has been relaxed in statement of practice A32. Let me quote again from Mr. Gordon’s article:
“Statement of Practice A32 gives rise to another interesting issue. The current draft of the new clauses makes no reference to the undoubted relaxation of the Sharkey v Wernher rule, assuming that the rule is valid. Consequently it would appear that property developers and other traders who appropriate stock which they have constructed, as a fixed asset of the business, together with other traders who receive (or whose family or household members receive) meals or other services from the business, will now find that they have to start paying tax on profits they have not made and that this will apply in respect of appropriations after 11 March.”
The statement of practice has allowed certain relaxations of the Sharkey v. Wernher rules. The concern that Keith Gordon outlined in his article is whether the statement of practice still holds and whether it is overruled by the schedule. It is customary in the restaurant trade for the manager or owner to take some bottles of wine from the cellar for personal consumption and not pay the full price for them. As I understand it, such appropriations have not been deemed to be subject to tax in the past.
Will the Economic Secretary clarify whether Mr. Gordon’s interpretation is correct that the schedule will overrule the statement of practice? Has she considered the administrative impact that that will have on small businesses, which will be required to compute the market value of the assets appropriately? Sometimes that is not entirely straightforward. For example, it could depend on the point that the asset has reached in its construction.
I understand that the VAT treatment of these appropriations is to tax them at cost rather than market value. It would appear that there is a very logical approach in the VAT system, which is entirely consistent with UK general accounting principles. A different approach is used for income tax and corporation tax.
Where an asset is transferred at market value from a company’s trading stock to its fixed assets under the Sharkey v. Wernher rule, it creates a notional profit on the trading account of a business, which would be subject to corporation tax. For CGT purposes, the base cost becomes the market value of the asset transferred. The principle also works in reverse. For example, a fixed asset is transferred into trading stock. To use Lady Wernher’s example, a racehorse becomes part of a stud.
Under current rules, an election can be made under section 161(3) of the Taxation of Chargeable Gains Act 1992 to transfer the asset into trading stock at its original cost rather than its market value. That means that any gain or loss on the transfer is taxed within the business’ trading profits rather than as capital gains. There is therefore no chargeable gain or loss on transfer, but they are dealt with as part of the trading activities of the business. It is not clear in the schedule whether election under section 161(3) of the 1992 Act can be made in respect of these transfers. Amendments Nos. 75 and 76 would make it clear that the election continues to be available for those businesses subject to income tax, by amending the 2005 Act, and corporation tax.
Amendment No. 77 deals with the transfer of assets between group companies. As drafted, paragraph 9 ignores the possibility that group companies might wish to make the election under section 161(3) of the 1992 Act to transfer the gain or loss to the trading account and be subject to tax through that route, rather than as a chargeable gain.
I would like some clarification from the Economic Secretary on why the Government have chosen to legislate for the Sharkey v. Wernher ruling. With the amendments, I am keen to ensure that there is clarity that the existing elections available to businesses and individuals will still be available under schedule 15.
Kitty Ussher: The hon. Gentleman raises a number of different questions and perhaps it will help the Committee if I first explain what we think the effects of the amendments will be. I believe that they are unnecessary, but perhaps they are probing amendments. I will then answer the specific points of substance before saying why we are legislating in this area.
The amendments seek to clarify how the market value rules introduced by clause 34 and schedule 15 intend to interact with similar rules for capital gains tax. They appear to be based on a concern that the legislation will override and affect the capital gains rules set out in sections 161 and 173 of the Taxation of Chargeable Gains Act 1992. I am sure that the hon. Gentleman will be relieved to know that that concern is unfounded. The schedule will have absolutely no impact on the operation of the capital gains legislation, and sections 161 and 173 of the 1992 Act will continue to apply in the same way as they do currently. Had our intention been to override those sections of the 1992 Act, we would have explicitly amended or repealed them. We have not done so because that is not our intention.
12.30 pm
I remind the Committee that schedule 15 will do nothing more than maintain the status quo, including the way in which the market value ruling in Sharkey v. Wernher interacts with capital gains tax rules, and I will explain why that is the case. Businesses will continue to be able to elect to disapply the market value rule for the purposes of capital gains tax under section 161 of the 1992 Act, in the same way as they have done in the past. That will include companies within the same group, which will be able to make such an election as they do currently under the provisions of section 161 as applied by section 173. Therefore, I do not feel in general that those amendments are necessary, but hope that my explanation has provided some background.
Turning to some of the wider points, the hon. Member for Fareham wanted to know where the new legislation will leave the statement of practice to which he referred. The statement of practice A32, as it is properly called, is part of HMRC’s published guidance. That sets out how HMRC applies the market value rule in Sharkey v. Wernher in practice. Once the rule is legislated in the Bill, as we propose to do today, there will be no need for a separate statement of practice, but there will be no practical effect on businesses, which will continue to operate the rule in the same way as they have always done.
Mr. Hoban: Is the Minister saying that statement A32 will continue to exist and form part of HMRC’s guidance, or will it be removed from that body of guidance?
Kitty Ussher: My understanding is that it will be removed, because it will no longer be necessary following the passage of this legislation.
Mr. Hoban rose—
Mr. Bone rose—
Kitty Ussher: That has provoked some excitement.
Mr. Hoban: I am not sure that I would go so far as to call it excitement, but the Opposition have raised in relation to previous Bills the problem about relying on guidance to articulate the meaning of legislation. In this case, the guidance softened or provided exemptions to the status quo—as the Minister mentioned earlier—that are based upon the Sharkey v. Wernher case. If that guidance does not form part of HMRC’s body of guidance, those exemptions are swept away. The schedule provides no exemptions to permit the existing relaxation of those rules to continue to apply, and that is the problem.
Kitty Ussher: It appears that I am about to be advised on that point. The purpose is to maintain the existing situation. I will take a little step back and diverge from what I was about to say to explain why we are doing this. We have been asked to legislate on this by the normal types of body that one would expect—the trade associations and the accountancy and legal professions—because although the case law has been operating happily for the best part of 50 years, it seems that there is now some uncertainty in the system.
Mr. Bone: Will the hon. Lady give way?
Kitty Ussher: I will give way, but I will first answer the question that was just asked. The statement of practice A32 will be obsolete, as I have just said, but there will be no effect on taxpayers. We do not believe that represents a softening of the case law, so perhaps that answers the hon. Member for Fareham. The exceptions, as he said, will remain, but statement A32 will be obsolete because it will be incorporated into law. I hope that clarifies the point.
Mr. Bone: I am grateful to the Minister for giving way, as my question is on that point. If we are creating new legislation so that the guidance is removed, HMRC will be forced to interpret the new law and catch people who previously were exempted. I do not think that is what the Government mean to do, so will they look at the provision again?
Kitty Ussher: I understand the hon. Gentleman’s point, but I have explained that it is absolutely our intention not to change the way that the process is carried out. It is simply a translation from guidance into legislation. Following the points that have been raised, I will take it upon myself to re-satisfy myself with my team that that is indeed the case. That is our explicit aim, so although the hon. Gentlemen are right to raise the issue, I hope that we can reassure them.
The effect of the provision on small businesses, including restaurants, which the hon. Member for Fareham mentioned, will not give rise to any additional administrative burdens. Its effect will be to maintain the existing treatment of movements of goods into and out of trading stock. No business will, as a result of this legislation, be required to do anything different from what they currently do. We are simply responding to concerns that it would be helpful to put the measure into law.
The hon. Member for Fareham asked whether the statement of practice is lawful, following the Wilkinson case. The decision of the House of Lords in Wilkinson concerned the proper authority of HMRC to make concessions from the strict application of tax law. That decision has no bearing on HMRC’s statement of practice, A32, or other published guidance, which, as I have already said, will now become obsolete; it will merely confirm that the market value applies only to goods, not to services, in line with tax case law subsequent to Sharkey v. Wernher.
Mr. Hoban: If the rule stands and has been decided by the highest court in the land, why does it need to be included in the Finance Bill? We do not seem to be changing anything by doing so.
Kitty Ussher: I hoped, innocently and naively, that I could deal with the substance and then with the timing issues. Perhaps I should deal with the timing now. Why is this measure being included in legislation? There is no evidence that the market value is not being applied in practice, but as modern accounting standards have developed in the past 50 years there has been a degree of uncertainty about whether the principles established by tax cases continue to override the relevant accounting standards, which of course they do. To put the matter beyond doubt, the Government are putting the principles arising from Sharkey v. Wernher on a statutory basis, because we want the tax system to be as clear as possible and to operate on the principle that areas of uncertainty should be addressed wherever possible. The measure supports that aim and puts the position beyond doubt.
The hon. Gentleman asked why we abandoned our plans to legislate on the market value principle as part of the tax law rewrite project in 2000. We intended to do so, but some respondents felt that as the rule was not previously contained in law, to include it in a law rewrite was inappropriate. That is a grey area, but we thought it best to err on the side of caution, so the relevant provisions are excluded from the tax law rewrite Bill. However, including such a thing in the Finance Bill enables us to debate the matter properly and get the issues on record. I hope that we have achieved that.
Mr. Hoban: I am grateful to the Minister for her remarks on the amendment and those covering the broader issues relating to the schedule. I am particularly grateful for her clarification about the availability of the election under section 161(3) of the Taxation of Chargeable Gains Act 1992, which was the main concern raised by one of the representative bodies. It was felt that it was not clear previously.
Kitty Ussher: I should like to make it crystal clear that we set out not the exemptions to the codes, but the operation of case law. But the point is the same.
Mr. Hoban: That is in relation to statement of practice, A32, rather than the availability of the election, which I was touching on. I am grateful for the Minister’s clarification that the election is still available. That is important.
We have a clear position on the statement of practice, A32, which the Minister just raised. However, although she was saying that A32 explained case law, surely that case law has been overridden by schedule 15. Although the Government were confident that the case was still the right one, the problem is that it was subject to greater challenge. Does that not have precedent over previous cases that have explored the measure? I think that in the past there was even a case over the cost of a bottle of wine.
I do not wish to detain the Committee for too much longer, but we need a clearer understanding of the status of the previous guidance and whether the schedule now applies to all cases where assets are appropriated from trading stock for personal consumption or are moved from fixed to trading assets. Another of the representative bodies has raised that point and it is important. It leads to an enshrining of the difference between profits as defined by UK GAAP—generally accepted accounting practice—and profits as defined by tax law. I suspect that will continue to be an issue as accounting practice develops to reflect changing circumstances. We are in danger of making a system more complex by maintaining the distinction between accounting profits and tax profits.
With the reassurances that the Minister has given on the section 161(3) election, I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
Schedule 15 agreed to.
Clause 35 ordered to stand part of the Bill .
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