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.
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.
The hon.
Gentleman mentioned the report in Taxation magazine, which said
that the House of Lords decision was not informed by evidence of
accounting
treatment and that the rule is therefore susceptible to challenge. We
believe that Sharkey v. Wernher is sound case law based on a
decision by the highest authority in the UK and that it has not been
overturned by any subsequent court decision. We have simply been asked
to include that result in legislation and I hope that we are doing so
uncontroversially.
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
.
| 
