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Paragraph 245 of that report states:
“It is difficult to conclude that this partial failure is wholly due to the economic circumstances and not also in part to structural defects in the system. Moreover there has been little attempt to respond flexibly or significantly in their design to the difficult economic context.”
The group of amendments that we are considering is an attempt to encourage the Government to respond flexibly and significantly. Indeed, the Government have made some progress on that front. In Committee, I raised possible ways of providing some flexibility in design, based on proposals made by the British Property Federation. Since that date, the House of Lords Select Committee has recommended that the Government
“look again with greater sympathy at the proposals by the representative bodies.”
To assist, we have today tabled four amendments, which, as I say, are based on the British Property Federation proposals. We are pleased to see that in one case the Government have followed suit, at least partially, and tabled an amendment seeking to address one of the concerns that we identified.
Broadly, we seek in our amendments to address two issues. The first issue relates to the current requirement that REITs distribute 90 per cent. or more of property income, because in the current economic circumstances it is very helpful if companies can retain cash. Credit is clearly difficult to access, and companies need to build up balance sheets—in particular, to keep banks lending to them. If and when the property market picks up, a REIT with sufficient cash might be able to make several acquisitions.
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Amendment 17 seeks to address the issue of a mandatory distribution of 90 per cent., which has to be done in one year, by deferring it for four years. It would be only a temporary measure, and any profits arising in accounting periods ending after 31 March 2010 would be subject to the current distribution rules, but it would provide REITs with flexibility.
Amendment 18 would provide for distributions to be paid by new shares rather than by cash, and there should not be a revenue implication: shareholders receiving a stock dividend, which is a distribution for these purposes, would be automatically subject to tax, as they would be with a normal property income distribution in cash. We therefore press the Government to look sympathetically at the amendment.
Amendment 16 is a less radical proposal, but it addresses the same area and would retain the 90 per cent. test. Any breach of it would not result in the risk of expulsion from the REIT regime, as that would be expensive for the REIT, but would involve corporation tax being paid on the undistributed profits. The argument that the Government tend to make against all such proposals is that there is an issue of investor protection, but when institutions are looking for investors to invest in a REIT, there is strong commercial pressure to make use of such provisions only when necessary. It is a commercial judgment that, one might strongly argue, could be left to the REITs rather than to the regulations, so we would be grateful for the Government’s response to those points.
The second issue relates to the profit-financing cost ratio. Property income distributions are subject to a withholding tax of 20 per cent., unless the recipient is a UK charity, pension fund or corporate. Payments of interest by a REIT, however, may not be subject to withholding tax, and there is therefore the clear possibility of a REIT distributing income through interest payments as an avoidance measure. The profit-financing cost ratio is an attempt to address that. It is an anti-avoidance provision aimed at preventing REIT investors from structuring their investment as a loan.
Broadly, the PFCR rule provides that the amount of a REIT’s tax-exempt profits must be at least 1.25 times the size of the financing costs that are related to the REIT’s tax-exempt business. There are, however, a couple of problems with that. First, a REIT might hedge market value movements in a debt with a derivative contract. The PFCR rule does not take into account any profit on debt, but it does take into account a matching loss on the derivative. The loss is counted as a financing cost so the REIT might breach the ratio as a consequence of market movements.
Secondly, the aggregate of all movements in a derivative contract is deferred until closing out occurs, and that could lead to a distortion of the ratio in one particular year. Amendment 15 seeks to address those specific problems.
As I mentioned earlier, Government amendment 47 addresses the issue of the profit-financing cost ratio by allowing HMRC to waive rules in particular circumstances—when a REIT is in severe financial difficulties, the circumstances arose unexpectedly and the company could not reasonably have taken avoidance action. I have communicated with the British Property Federation, which welcomes movement on the issue but is concerned that the particular circumstances that I have mentioned are somewhat restrictive, difficult to interpret and vague.
As a consequence, Government amendment 47 may not be effective enough in addressing what both sides of the House agree is a potential problem. I would welcome comments from the Minister on that, because we think that amendment 15 would provide REITs with greater certainty and clarity and address the specific problems raised by the British Property Federation, rather than having the apparently broader flexibility involved in HMRC’s waiving the ratio, although in restricted circumstances that would be difficult for the REIT to understand. The Minister may well be able to provide guidance and clarity on the issue; as it stands, however, we are not sure that Government amendment 47 is as successful as amendment 15.
Ian Pearson: We believe that Government amendment 47 will be effective, and I shall explain why in a moment. As the hon. Gentleman will know, the British Property Federation and others have welcomed the amendment, which has arisen as a result of continued discussion with the industry in the post-Budget period. It makes a further change to the regime to ensure that its rules on financing costs achieve their original objectives without creating any unintended effects.
Government amendment 47 will allow the charge to tax to be waived when the commissioners of Her Majesty’s Revenue and Customs think that a company is in severe financial difficulties and that it could not reasonably
have avoided breaching the profit-financing cost ratio owing to unexpected circumstances. That ensures that the tax charge can be waived if a REIT that has not borrowed excessively breaches the profit-financing cost ratio because of a fall in its profits and/or an increase in its financing costs that have led it into severe financial difficulties.
The amendment does not seek to define “severe financial difficulties”. However, in case extra clarity should be needed, it provides HMRC with a power that may be used to specify in regulations criteria to be applied by commissioners in determining whether to waive the charge. The hon. Gentleman will be aware that currently there are 21 companies in the REITs regime. We believe that that number is manageable. However, if “severe financial difficulties” needs to be defined, the powers are there. We believe, however, that the phrase is pretty broadly understood.
Opposition amendment 15 would relax the requirements of the profit-financing cost ratio by bringing in credits in respect of debtor relationships and by excluding financing costs that are considered
“exceptional due to their size or incidence.”
However, it is not clear to the Government why the size or incidence of a financing cost should be considered to make it exceptional and why that would make it an appropriate item to exclude from the profit-financing cost ratio. We also believe that the Government amendment, by seeking to protect the ratio while ensuring that it does not lead to any unintended consequences for companies in severe financial difficulties, is a more targeted and preferred measure.
Amendment 16 concerns the requirement of the REIT to distribute 90 per cent. of its profits from the property rental business to shareholders by way of a dividend. That helps to protect the investor and the Exchequer by ensuring that profits are distributed to shareholders who pay tax on them. The amendment seeks to ensure that if a company in financial difficulty fails to meet this distribution requirement it would not be treated as a “serious breach” of REITs rules. REITs legislation states that the consequences of multiple serious breaches of the rules are that REIT may be given notice by HMC to leave the regime. In the context of the distribution requirements, “serious” is not defined. However, if a company is in financial difficulties there is scope under the legislation for that to be taken into account in deciding whether to issue a termination notice. We therefore believe that there is no need for the amendment.
Amendment 17 also relates to the 90 per cent. distribution requirement. Its purpose would be to allow a REIT to issue stock, instead of cash, in order to meet the 90 per cent. requirement. Allowing a REIT to issue stock, rather than cash, as part of this requirement could risk harming the investor, particularly if stock is issued to shareholders on a mandatory basis. A mandatory issue of stock as part of the distribution requirement would reduce the size of the cash dividend received by each shareholder without increasing the value of their shareholding. There would also be a risk of imposing a tax charge on shareholders that could not be covered by the cash part of the distribution. If stock is issued on an optional basis, those electing to receive cash could still see their shareholding diluted by those electing to receive stock. However, I understand the point that the
hon. Gentleman makes, and I can say in response that officials will continue to meet those in the industry to discuss this issue.
Amendment 18 is intended to provide REITs with an extra three years to distribute the profits from their property rental business. We cannot accept the amendment because we believe that allowing REITs an extra three years to make these distributions would harm the Exchequer and investors, many of whom have invested in REITs because of the expectation that they will receive frequent distributions.
Government amendment 47 takes a targeted approach, and it has been welcomed by the property industry. We cannot accept the Opposition amendments, but we will continue to keep the regime under review and remain in dialogue with the industry on these issues.
Mr. Gauke: I am grateful to the Minister for his comments about continuing to look at the stock dividend issue. I am still not entirely convinced by his view that his amendment is better than ours, but we should be grateful that we at least have an amendment. I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
Amendment made: 47, page 290, line 24, at end insert—
‘Profit: financing-cost ratio5A (1) In section 115 (profit: financing-cost ratio), after subsection (3) insert—
“(3A) The Commissioners for Her Majesty’s Revenue and Customs may waive a charge in respect of an accounting period where they think that—
(a) the company was in severe financial difficulties at a time in the accounting period,
(b) the result of the sum specified in subsection (2) is less than 1.25 in respect of the accounting period because of circumstances that arose unexpectedly, and
(c) in those circumstances, the company could not reasonably have taken action to avoid the result being less than 1.25.
(3B) The regulations may specify criteria to be applied by the Commissioners in determining whether to waive a charge.”
(2) The Commissioners may waive a charge in respect of accounting periods ending before the day on which this Act is passed.’.— (Ian Pearson.)
Mr. Timms: I beg to move amendment 48, page 291, line 28, at end insert ‘(but subject to paragraph 16A).’.
Mr. Deputy Speaker: With this it will be convenient to discuss the following: Amendment 29, page 293, line 4, leave out subsection (2).
Amendment 30, page 295, line 46, at end insert—
‘(3) When an individual establishes a protected pension input amount in respect of any of the schemes listed in paragraphs 8 to 13 below and their arrangements change, the protected input amount applies to the new arrangement.’.
Amendment 25, page 296, line 25, at end insert—
‘(3A) Where contributions are not paid in accordance with subsection 3(c) above, the protected pension input amount is the lower of £50,000 or the average of contributions made over the last three years.’.
Amendment 26, line 297, line 23, at end insert—
‘(3A) Where contributions are not paid in accordance with subsection 3(c) above, the protected pension input amount is the lower of £50,000 or the average of contributions made over the last three years.’.
Amendment 27, page 298, line 25, at end insert—
‘(3A) Where contributions are not paid in accordance with subsection 3(c) above, the protected pension input amount is the lower of £50,000 or the average of contributions made over the last three years.’.
Amendment 28, page 299, line 15, at end insert—
‘(2A) Where contributions are not paid in accordance with subsection 2(b) above, the protected pension input amount is the lower of £50,000 or the average of contributions made over the last three years.’.
Government amendments 49 and 50.
Mr. Timms: In the Budget, we announced a restriction of higher rate tax relief for the pension contributions of people with the highest incomes from April 2011. The House well understands why we had to introduce anti-forestalling rules in the meantime to protect an estimated £2 billion of tax that could have been at risk otherwise. The arrangements were designed to be fiscally neutral in the interim period between Budget day and April 2011. The principle that we adopted was to maintain higher-rate relief for continuing regular pension contributions over this interim period but to restrict the relief when contributions were additional to the regular pattern.
We have defined regular contributions as those made quarterly or more frequently—an established pattern of pension savings where it is readily possible to identify the typical level of contributions. The level is also likely to be consistent, as part of a contract with an employer or with a pension scheme direct, so it is relatively easy to isolate forestalling as distinct from normal pension saving. It is harder to identify as “normal” contributions that are made less frequently, particularly when that requires looking back over previous years, not least because the A-day changes made three years ago have altered pension saving habits. Irregular contributors have a much more limited track record on which to base judgments on typical levels of contributions, and the payments tend to vary more in size.
Many self-employed people and others, particularly those with personal pensions, make annual contributions or contribute on a more ad hoc basis as their circumstances allow, and we did not want to damage their interests. The regime includes an annual savings limit of £20,000 on which people are entitled to receive higher-rate relief. For some people—a relatively small group—£20,000 will be less than they have tended to contribute to their pension in the years since A-day. Incidentally, it will often be more than they could have contributed before A-day, but not since.
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In my written ministerial statement on Budget day and in our debate in Committee, I acknowledged that difficulty and made it clear that I wanted to consider how best to protect annual contributors alongside more frequent contributors, without risking large additional Exchequer losses. So we have Government amendments 48, 49 and 50, providing that if irregular contributions
have been made over the past three years, the special annual allowance will be increased to the average of those contributions, but with an upper limit of £30,000.
The approach in the Government amendments is similar to that in Opposition amendments 25 to 28, which likewise refer to average contributions from the past three years and would set an upper limit. I welcome the Opposition’s support for that approach. The difference between us, not surprisingly, is what the limit should be. The Government amendments set it at £30,000 while the Opposition amendments suggest £50,000.
The majority of people contributing on a non-regular basis had average contributions below the £20,000 level and so will be fully protected. Of those whose average contributions exceed that level, many are not far above it. We estimate that setting the limit at £30,000 will extend full protection to many annual contributors and to more than three quarters of all those affected. Only the highest quarter of contributors will be constrained at all, and they will see their limit for higher-rate pensions tax relief increased by half as much again, so they, too, will benefit.
I suggest to the House that the £30,000 level is sensible and will bring the costs of the anti-forestalling regime down to an additional £70 million over the next two years—more than would have been the case without the relaxation, but an affordable level. Setting the level at £50,000, on the other hand, would raise costs by £130 million, nearly twice as much. The Opposition amendments would also potentially, though I imagine unintentionally, open a loophole for people with several pensions to have an annual limit of £50,000 on each. This is a difficult area, but I hope that Opposition Members will feel able not to press their amendments and to support ours instead.
I wish to say a word about the other Opposition amendments, which have not yet been spoken to. On amendment 30, I have received representations on the subject of flexibility for those who change provider. I have thought about it, and I accept that we can be more flexible so that if somebody changes pension provider and carries forward exactly the same pension arrangements, they can retain their protected pension contributions. There is a risk, though, of inadvertently opening up significant avoidance. I would therefore like to take the matter forward through regulations, after consulting the industry on draft regulations. I accept the argument that lies behind the amendment, but I hope that on the understanding that I want to deliver that aim, the Opposition will not press it.
One matter not covered by the amendments has been raised with me, which is that the rules on the commencement dates for the anti-forestalling regime are too stringent with regard to the treatment of those who set up new pension arrangements on or just before Budget day. There is scope there, too, to be helpful, and we will discuss the matter with providers and make any change necessary through regulations.
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