Division No. 6]
Question accordingly negatived.
Clause 55 ordered to stand part of the Bill.
Clauses 56 and 57 ordered to stand part of the Bill.
Dr. Nick Palmer (Broxtowe) (Lab): On a point of order, Mr. Hood. Could we be updated on the health of the gentleman who had a problem on Tuesday? Will you consider sending him a card on behalf of the Committee saying that we look forward to seeing him again soon?
The Chairman: I appreciate the hon. Gentlemans concern. I expressed my concern and that of the Committee this morning. I am assured that the gentleman is recovering and resting, and that it will not be long before he is back at work.
Restriction on loss relief for non-active traders
(c) the trade is carried on with the intention of generating a loss for tax avoidance purposes..
I am sure that all hon. Members are delighted at the spurt of progress that we have just enjoyed and which I now intend to stop dead in its tracks. The schedule deals with restrictions on trade loss relief for individuals. That was not mentioned in the Budget speech, but was buried away in Budget note 63. It is effectively retrospective, not in quite the way that we have discussed in relation to previous clauses, but in the sense that it will impact on the treatment of decisions made before the measure was known about.
A significant step is being taken. The provision is being introduced under the guise of an anti-avoidance measure, so the Government, using their own principles, avoided extensive consultation on it. It removes what is in effect the oldest form of encouragement for enterprise in the tax code. I should be grateful if the Minister would tell us the scale of the mischiefI use the word againthat we are addressing. I understand that in conversation senior officials at HMRC indicated that HMRC has no idea of the extent of any avoidance through the use of sideways loss relief by individuals, no idea whether it is costing the Exchequer money, and thus no idea of what the relief is worth. That makes this look like a fishing expedition. We on these Benches are concerned that the Government are proposing legislation that will impact on not just the incentive to take business risks, but on individuals ability to take on risk, and that
Under current legislation, an individual who carries on a trade can offset losses arising in that trade against other income and gains. That is known as sideways loss relief. There is a provision, in section 66 of the Income Taxes Act 2007 in its most recent incarnation, which denies any such relief if the trade is not operated on a commercial basis. That is a perfectly reasonable restriction to impose and it ought to be sufficient to ensure that the measure cannot be used for the purposes of artificial avoidance.
A fundamental issue is at stake here; individuals are taxed overall on their total incomecertainly within any of the particular silos by which income is taxed. The Government are effectively seeking to introduce a sort of mini-scheduler approach within trading income, so that an individual is taxed separately on their income from different trades. That would have a significant effect. We are all aware that the Finance Act 2007 introduced provisions restricting the ability of partners in a partnership who were not actively engaged in the business of that partnership to obtain sideways loss relief. That was introduced to prevent artificial constructions that allowed individuals to take advantage of the losses generated in partnerships.
Schedule 21 provides for similar restrictions to be applied where an individual carries on a sole trade in a so-called non-active capacity. That raises different issues. Under the measure, where the trader is defined as a non-active trader, the amount of sideways loss relief is limited to £25,000 annually, unless the trade relates to film expenditure, in which case there will be no such restriction. Amendment No. 136 inserts a motive test into that through a provision that means section 74A will apply only if the trade has been carried on with the intention of generating a loss for tax avoidance purposes.
In my humble opinion, my amendment is redundantthat may sound like a slightly strange thing to saybecause section 66 of the Income Taxes Act 2007 already requires business be carried on for a commercial purpose, that is, for the purpose of making a profit. The amendment has been tabled to draw attention to that problem and to probe the Minister on the extent of the catchment of the clause by highlighting how a motive test would narrow it down.
What problems do we see in relation to the provision? According to schedule 21, an individual is thought to devote sufficient time to a trade for him to be considered an active participant, if he
spends an average of at least 10 hours a week personally engaged in activities of the trade and those activities are carried on...on a commercial basis, and...with a view to the realisation of profits.
The 10-hour rule is an arbitrary and unsatisfactory way of defining an individuals contribution to a business. It does not begin to address many of the real world situations in which people find themselves. It will also create a bureaucratic nightmare, which is the antithesis of the entrepreneurial spirit that the Government say they want to foster. Imagine an enthusiastic entrepreneur engaged in starting up a part-time business. When he
If we really want to foster a culture of entrepreneurship in this country, not only is that requirement patently absurd and unenforceable, but even the thought that entrepreneurs should be encouraged to think in that way about the hours that they put in to developing start-up businesses is depressing. There are many wholly commercial reasons why an individual might not spend 10 hours a week personally engaged in a trade. Having taken the risk of establishing a business and built it up by the sweat of his own labour, an individual might be in a position to employ others to run it while he is engaged on the next venture, and I would have thought that the Government would want to encourage such serial entrepreneurship. The hard-working entrepreneur who, having built up a restaurant, small guest house, pub or hotel business, wants to move on and devote his time and energy to building up another venture will fall foul of these rules unless he goes back and spends 10 hours a week pulling pints at the bar in order to qualify under the tests that the Government are imposing.
Many individuals start up businesses while still in employmenta point to which I have already alluded. That is a sensible way of probing the viability of a new business venture without sacrificing the security of a regular income. Many people work full time or part time for an employer while conducting a part-time business, and sometimes more than one. Indeed, I remember meeting a constituent of mine shortly after I was elected who was employed in the catering department in the House of CommonsI can tell this story because he no longer works hereand who very enterprisingly was conducting a business as well, manufacturing and distributing hand-cooked vegetable chips, and very delicious they were too. He eventually left the employment of the House of Commons and has, I am sure, prospered elsewhere. That is not an unusual case. Hon. Members will know of many people who have tested the water with a new business project while retaining the security of their existing employment.
Some businesses are seasonal, such as furnished lettings, and there are also smallholding agricultural businesses, which people might not be able to turn into a viable full-time occupation. That is less part of the culture of this country than it is of some of our European neighbours, where part-time agriculture is a common business occupation. We believe that there could be a serious impact on start-ups and on the fostering of entrepreneurship, especially in the wake of the Governments decision to abolish taper relief and the negative signals that that sent to those engaged in establishing new business enterprises.
I am afraid that it gets worse because new section 74A(6) provides that if an individual has received sideways loss relief in his capacity as a partner in a partnership, that amount has to be deducted from the cap that this measure proposes. That would be a further reduction in the capacity to absorb losses across the boundaries of different trades.
I have a number of other points to make on schedule 21. As I have gone this far, it might be better for me to complete my remarks, unless you indicate otherwise Mr. Hood. The Minister could then respond to the amendment and to the more general remarks, rather than have a separate debate on the schedule.
The Chairman: Order. I have no objection to the hon. Gentleman discussing other parts of the schedule, but we will not then have a separate debate on the schedule.
Mr. Hammond: That was exactly my thinking, Mr. Hood. It is precisely because I fear that I may already have strayed into some of the more general points that I suggested that I carry on.
The Government say that these measures are aimed at tackling contrived arrangements. We have no problem with that, but the legislation is very widely drafted. It is our contention that it will also catch some wholly commercial arrangements. A normal, industrious trader who seeks to establish a new business, or businesses, could be inadvertently caught in this trap. New section 74B(3) and (4) provides that no relief will be available where loss arises as a result of relevant tax avoidance arrangements. That is fine, but the relevant tax avoidance arrangements are widely defined. When claiming sideways loss relief, will an individual have to prove that he had no expectation at the outset that such a loss could be relieved? In other words, it appears that one can benefit from sideways loss relief only if one is not aware that one could benefit from it. Perhaps the Minister would clarify that point.
Could somebody be caught by these provisions as the result of a negative decision? I return to my earlier example of somebody who has established a business that is running quite successfully. He has employees who are running it for him and he wishes to devote his attention to his next business venture. He is a classic serial entrepreneur. Could HMRC treat his failure to incorporate that first business as an act that was seeking to exploit the possibility of the use of sideways loss relief?
We are in uncharted territory. It has always been understood that people with an established line of business that is generating profits can, with the security of that profit income, invest in a new business activity or trade, and that any losses in that new trade can be offset against their income from the existing trade. By definition, one might think that asking them not to devote their full energy to the new trade, and to take a chunk of their working time and attention and continue to focus it on existing trade, to satisfy HMRCs requirements in the test that is introduced by the legislation, would make the chance of incurring a loss in the early years of the new trade rather greater, because of the reduced attention and focus given to it.
The Budget day news release dealt with the purpose of the provisions, and said that the
Government made clear that avoiding tax through the use of sideways loss relief is unacceptable.
However, the provisions mean that genuine traders may not be able to claim statutory relief, which could lead to individuals being taxed on more than 100 per cent.
A particular case that could arise is one in which someone who was setting up a new business was taking advantage of the annual capital allowance to invest in it but, because that new business had no profits, they would seek to offset the value of the capital allowance against the existing profit stream from their established business or businesses. That will now no longer be allowed beyond the £25,000 limit. In discussions on the matter, it has been suggested that investment in plant and equipment up to the annual investment allowance could be exempt when calculating the loss for the purposes of applying the cap. Otherwise there is a danger of hindering investment in plant and equipment in the new business.
Perhaps the Minister could give the Committee some examples of the contrived arrangements that, presumably, she fears, so that we can distinguish them from the normal trading arrangements that we fear will be caught by the wide scope of the legislation, with all the damage that that will do. The effect of paragraph 6 of schedule 21 is to make the provisions retrospective. If a loss arises in a basis period ending after 12 March 2008, that loss will be time-apportioned between the periods before and after that date, and the proportion deemed to arise after 12 March will be subject to the loss restriction, even though the loss may have arisen before 12 March.
I should like to return to the definition of a non-active capacity. In the modern world, where many businesses of all descriptions are pushing the boundaries and frontiers in technology and the way in which business is done, simply to use a test of the number of hours of direct personal involvement is simplistic. An individual might have specialist knowledge, for example, or some unique reputational value to the business that would mean that his presenceeven his name on its letterheadhad a significant impact on its prospects. Someone might be absolutely essential to the functioning of the business, yet might not spend, or need to spend, 10 hours a week conducting that business. He might be the proprietor of the formula that the business is allowed to use without charge, for example. I urge the Minister to consider again whether the simple 10-hour test is really the message that the Government want to send about how they value individuals input into a business. We can anticipate, I think, the fact that the same argument will arise in relation to income shifting. Is it simply about how much time somebody commits to the business, or about the unique qualities and characteristics that they bring to it?
In conclusion, if there is abuse through artificial arrangements, we would support a targeted attack on that abuse, but that must not become an attack on risk taking, entrepreneurship, or start-up or spare-time businesses. The Opposition are deeply concerned that the Government are removing a fundamental part of the support system, particularly for new businesses, but also for serial entrepreneurs, which is absolutely not the direction in which the UK tax system should move, northis is perhaps more significantthe direction signalled in Government rhetoric.
HMRC appears to be saying in the proposals that individuals should not take risks; that, if they have an income from an established business or employment, they should not risk any of it. If they do take risks, that will be entirely at their own risk, and they will be taxed on the gross income from those other sources, rather than on the net income at the end of the process after taking into account losses incurred through investments made in genuine commercial ventures. I would differentiate between genuine commercial ventures and contrived arrangements. The Opposition believe that section 66 of the Income Tax Act 2007 already provides sufficient protection against contrived arrangements where HMRC can show that a business has been established for reasons other than generating a profit and running a commercial enterprise.
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