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Mr. Timms: I am grateful to the hon. Gentleman for his explanation and support for the clause. As he said, the schedule introduces legislation to counter avoidance involving the leasing of plant or machinery—avoidance that was disclosed to HMRC under the disclosure rules. The schedule also deals with a technical defect in the Capital Allowances Act 2001 that could lead to a loss of tax when a long funding lease ends.
The disclosed schemes involve sale or lease and leaseback that is designed to provide tax relief by way of capital allowances in excess of the net capital cost of the asset to the person entering into the arrangements. As the hon. Gentleman described, arrangements are used that result in the disposal value brought into account for capital allowance purposes being less than the capital allowance relief that can be claimed on reacquisition of the asset under the leaseback. The measure deals with that.
On the technical defect, under the long funding lease rules, a lessee is entitled to claim tax relief for the leased plant or machinery. When the lease ends, an adjustment may be needed to ensure that the total relief is limited to the lessee’s costs. It became apparent last autumn that if the lease is structured in certain ways, the lessee might obtain relief in excess of their expenditure. The measure ensures that at the end of a long-funding lease, a lessee obtains relief for no more and no less than the amount they paid.
The measure also corrects a minor flaw in the definition of sale and leaseback transactions. It makes small changes that ensure that initial payments under a lease are taxed in full and that ensure consistency with the taxation of chargeable gains.
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Mr. Hands: The Minister might already have explained this but what is the flaw that has been corrected?
Mr. Timms: I am glad to do so. As the law stands, the sale of plant or machinery followed by a leaseback to someone connected to the other seller who was already leasing the asset does not fall within the existing definitions. This arrangement, although not common, could be used to take sale and leaseback transactions outside the scope of the existing anti-avoidance rules.
The hon. Gentleman referred to the fact that draft legislation was published on 13 November last year. As is normal with anti-avoidance rules, the main provisions will have effect from the date of publication. The amended definitions, the change to the taxation of an initial payment and the amendments to the taxation of chargeable gains rules will apply from 22 April 2009, in line with the Budget date. As well as protecting the Exchequer, early publication allowed time for comments from businesses and their advisers. There has, however, been little comment on the measure; no concerns about any unintended effects have been expressed by businesses. I am grateful for hon. Members’ support and I ask that the clause and schedule stand part of the Bill.
Question put and agreed to.
Clause 63 accordingly ordered to stand part of the Bill.
Schedule 32 agreed to.

Clause 64

Long funding leases of films
Question proposed, That the clause stand part of the Bill.
The Chairman: With this it will be convenient to discuss the following: that schedule 33 be the Thirty-third schedule to the Bill.
Mr. Hands: The clause and schedule are the last in the series of anti-avoidance measures. The provisions relate to long funding leases of films and are designed to target a specific avoidance scheme. The scheme is apparently being used by film-makers who have already claimed capital allowances for the cost of making a film under section 42 of the Finance Act 1992, or section 48 of the Finance (No. 2) Act 1997, or sections 138 to 140 of the Income Tax (Trading and Other Income) Act 2005.
In essence, the scheme, the success of which is disputed by HMRC, appears to have been used in the case of films on existing leases for long periods of, it is generally said, 15 years, at rents which are subject to tax. By terminating the existing lease and replacing it with a long funding finance lease, the tax treatment of the rents is greatly mitigated. Not only that, but there is no recapture by the Revenue of the capital allowances already given. In effect, a film-maker could recover the cost of a film through capital allowances and still enjoy a low tax income.
The provisions of schedule 33 remove that treatment in respect of all long funding finance leases granted after 13 November 2008. There is a degree of retrospection, inasmuch as in the case of a long funding lease granted before that date, the rentals accruing due will receive the new tax treatment, but only for rents falling due after the 13 November cut-off.
Paragraphs 1 to 3 of the schedule exclude the income tax and corporation tax provisions normally applicable to long funding leases, when the subject of the lease is a film and the lease is granted after 13 November 2008. Paragraphs 4 and following exclude those treatments in the case of pre-existing leases that continue to subsist, but only in respect of rents falling due in periods of account commencing on or after 13 November 2008. They include transitional provisions based on time apportionment, where a rental period straddles two periods of account.
We have studied the schedule and find nothing to oppose, but I look forward to hearing whether the Minister agrees with my explanation.
Mr. Timms: The hon. Gentleman is right that the clause introduces schedule 33, which counters avoidance involving the leasing of films. It was introduced in response to information received by HMRC and was announced on 13 November 2008, with draft legislation published at the pre-Budget report. The schedule prevents avoidance that, if unchecked, would have led to a substantial loss of tax—perhaps as much as £1.5 billion over 10 or so years.
Mr. Hands: This intervention is similar to the one I made this morning. HMRC is rightly trying to recover money that should have been paid. However, the Minister gave some annual figures for two different schemes, then he cited, I think, prospective moneys to be recouped over two or three years, and he has just now given us a figure for a 10-year period—the significant sum of £1.5 billion. How much of that is likely to be recouped in year 1 of those 10 years?
Mr. Timms: Governments have supported the film industry for a long time. One way in which they have done so is through special reliefs, which have allowed the acquisition costs of a qualifying British film to be written off more quickly by the acquirers for tax purposes. The cost of the film was often recouped by investors through leasing out the film, so that over time the initial tax relief should have been recovered by taxing the rental received under the leases. In practice, most such investment took place via partnerships of wealthy individuals who were able to reduce their taxable income by using the losses generated by the write-off of the cost of the film. The investors received a timing advantage which they would share with the film producers, giving a benefit to the industry.
Those rules were abolished, and in 2007 they were replaced by a relief focused more directly at film producers but—this is the point that the hon. Gentleman has asked about—many film partnerships remain. They can last for up to 15 years, so the clause tackles the long-term impact of the avoidance. We estimate the tax at risk to be £90 million for 2009-10, £110 million for next year, £120 million for the following year and £140 million for the year after that. It all adds up, as I have said, to about £1.5 billion over 10 years.
Last November, HMRC became aware of a scheme that was intended to turn the taxable lease rental income into largely untaxed rental income. That would have been achieved by converting the leases into long funding leases—the hon. Gentleman mentioned that—the income from which, as a general rule, is largely not brought into account for tax purposes.
Mr. Hands: The film industry is extremely important in my constituency: Hammersmith is one of the bases of the UK film industry. The film industry has told me that probably the most important thing is certainty in the tax system. That £1.5 billion seems an awful lot of money to be recouped from anti-avoidance action on film schemes. Has the Minister assessed the likely impact on the UK film industry? How prevalent is the practice with which schedule 33 deals?
Mr. Timms: I think that I can reassure the hon. Gentleman. The special reliefs that gave the initial losses were abolished in 2006. They were replaced by a new relief, which has been in place since January 2007. The measure that we are debating now will therefore have no impact on the new relief, as it relates only to arrangements made before 2006. I reassure the hon. Gentleman on the important point about investment in the British film industry this year and in future years. The measure will have no effect either on previous investments, other than to ensure that the tax that should become payable over time does indeed remain payable. I do not think that there is a problem for the industry, although I take the hon. Gentleman’s point about the benefit of certainty.
I am glad that the hon. Gentleman sees nothing to object to, although it may be of interest to the Committee that HMRC has been advised informally that the announcement of the measure last November killed the scheme “stone dead” before it could be promoted.
Question put and agreed to.
Clause 64 accordingly ordered to stand part of the Bill.
Schedule 33 agreed to.

Clause 65

Real Estate Investment Trusts
Question proposed, That the clause stand part of the Bill.
The Chairman: With this it will be convenient to discuss the following: that schedule 34 be the Thirty-fourth schedule to the Bill.
Mr. David Gauke (South-West Hertfordshire) (Con): It is a pleasure to serve under your chairmanship once again, Mr. Hood.
Clause 65 and schedule 34 deal with real estate investment trusts—REITs. Those of us who served on the Committee that considered the Bill that became the Finance Act 2006—I do not know how many here today had the that pleasure, other than myself and my hon. Friend the Member for Fareham—will recall the legislation that introduced REITs, which came into force in January 2007. REITs were introduced with the intention of allowing investors to make indirect liquid and diversified investments in real estate in a way that attracted a similar tax treatment to direct investment. REITs were important in that they avoided the double taxation experienced by investors in other listed property companies.
Schedule 34 contains provisions relating to the REIT regime, and I have one or two questions for the Minister. If I may, Mr. Hood, I shall take the opportunity to ask about certain aspects of the reform of the REITs regime not included in the schedule, although I appreciate that that issue will be considered in the other place and, indeed, we may return to the REITs regime on Report.
Under paragraphs 3 and 4 of the schedule, REITs can offer convertible, non-voting preference shares in addition to the current categories of permitted investments, such as ordinary share, non-voting preference shares and convertible loan stock. It might help if the Minister were to explain the reasons for that extension.
The Government announced last year that they would stop property-rich groups such as operators of hotels, pubs and retail businesses restructuring and converting to REITs. I understand why the Government did that, but it is clear that the Government are not using schedule 34 to prevent conversion of landlords that let property to pubs, rather than operate them as tied houses. Rent from pubs is to be treated as rental income and not trading income. We have no objection to that liberalisation, but it would be helpful if the Minister explained what representations were made for the change, how many businesses the Government believe will be affected, and why the change has been made, given their steps to prevent property-rich groups from restructuring and converting to REITs.
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My main point is an issue on which the Government have received representations—the requirement for REITS to distribute at least 90 per cent. of their property income annually—and I know that the British Property Federation raised it. Given the current state of the economy, the housing market and the real estate market more widely, and at a time when credit is not easily available through banks, is it good stewardship to distribute 90 per cent. or more of property income annually, as REITS are required to do? Property companies need cash at the moment, first to strengthen their balance sheets, and secondly because, in the event of an upturn in the property market, which may or may not be imminent—I do not want to speculate—REITs will want to buy new properties and retaining cash would be helpful to them. In addition, the rental market is weakening, cash flows are under pressure, and REITs may need to build up cash reserves to persuade lenders of their ability to sustain borrowings.
In such circumstances, the Government could take steps, which they have not taken in schedule 34, to provide greater flexibility in the REIT regime. The British Property Federation has suggested three ways in which that could be done. First, distributions paid by a firm could be paid in the form of new shares—stock dividends—and they could count towards the mandatory distribution requirement. Secondly, the mandatory distribution could be deferred by, for example, three years from one year to four years. That would provide REITS with some current flexibility. Thirdly, and perhaps less radical, because breach of the 90 per cent. requirement results in a tax charge and the risk of expulsion from the regime—that is not automatic, but a REIT would be vulnerable—perhaps it would be possible, as a short term measure, to consider whether breach of the 90 per cent. requirement could simply result in a tax charge without the risk of expulsion from the regime. The Government have received representations on that, and perhaps the Minister will help by giving the reason for not going down that route. We will consider returning to the matter on Report.
I want to raise a second technical point about REITs—the anti-avoidance provisions relating to interest payments. Property income distributions may be liable to a withholding tax, depending on the recipient, but interest payments tend not to be liable to tax. For that reason, which is a perfectly good one, the PFCR—profit financing cost ratio—rule, which is an anti-avoidance provision, prevents REITS from restructuring their arrangements in such a way that distributions are made through interest. We fully understand the need for that, but two points have been raised by the BPF in the context of how that rule may act in a way that was not intended.
First, a REIT might hedge market value movements in debt with a derivative contract. There are perfectly good commercial reasons for doing so: so that a profit or loss involved in repaying debt is matched by a loss or profit in a derivative contract. However, the PFCR does not take account of any profit on debt, but does take account of matching loss on the derivative. Consequently, the loss is counted as a financing cost which may be considerable and cause the REIT to be in breach of the PFCR.
The second circumstance in which the same thing may happen is when market value movements in the debt and the derivatives used to hedge the debt are deferred—the costs involved are deferred until the debt or derivative is repaid or closed out. That can have a distorting effect because all the cost then occurs in one year. It could be that over a period of time a derivative is entered into but the cost all crystallises in one year, which may have a distorting effect in that year. The effect of such distortion is that the REIT may have a penalty charge as a consequence of entering into perfectly sensible hedging arrangements, or of market values moving in a particular way.
I would be grateful to know whether the Government have looked at the definition of financing costs and whether they would consider amending it to address those issues. I appreciate that the Minister has not had notice of all those points, but any light that he can shed on them would be of benefit to the Committee.
A more general question is about the Government’s strategic vision for REITs. When they were introduced, there were great hopes that they would take off as a product. That they have not is not to do with failures in the original drafting of the REIT legislation, which schedule 34 seeks to address. These nagging concerns are perfectly reasonable, but there is a concern that the Government are simply not addressing the REITs regime, that it is sitting on the back burner and has not received the focus that it might have.
REITs have clearly worked in encouraging conversion of existing listed commercial property companies. That has happened, but REITs have not attracted new entrants, as was once hoped would happen. I appreciate that this is a difficult time for the property market, but it is also an opportunity. For example, perhaps the best way of addressing banks’ holdings of unwanted exposure to properties and of finding equity investment would be to create REITs. Indeed, there is some evidence that in the period following a recession, which hopefully we will be in shortly, the equivalent of REITs in countries such as France and Japan tended to prosper. I ask whether we are prepared for that, and whether the Government are showing sufficient flexibility in respect of the REIT regime to benefit from what may be a considerable opportunity.
A point that has been made whenever we have debated REITs, certainly in 2006 and subsequently in various orders where we have amended the regime, is that there is a great opportunity for them to become significant players in the private residential rented sector, and that they could provide professional management that is not always available otherwise. There is an opportunity for greater liquidity for people who want to invest in the private rented market rather than go down the buy-to-let route, particularly given that the reputation of buy to let may well have taken significant damage in recent months. There is an opportunity there for REITs, but it may be necessary to take a more proactive view of the regime.
That is not a criticism of the original regime. However, organisations such as the British Property Federation feel that more could be done to ensure that we have an active and thriving REIT sector in the UK.
Stewart Hosie (Dundee, East) (SNP): The hon. Member for South-West Hertfordshire reminds us of 2006 when the REIT regime was introduced. He will also remember the very strict criteria for the creation of the real estate investment trust. There was a residential criterion, a minimum profit distribution criterion and a criterion that the REIT had to have a full stock exchange listing. The trust could not be a company traded on the alternative investment market or the off-exchange market, and it could not be a private company.
New section 136A(3)(a) states that the regulations may
“treat a specified person, or a person in specified circumstances, as forming part of a REIT group”.
New section 136A(3)(b) states that the regulations may
“provide for a specified provision which applies in respect of members of a REIT group also to apply”
Let me go a little wider and ask the Minister the same question that the hon. Gentleman just asked about the strategic vision for REITs. It was clear at the time, I think, that because there was a requirement for REITs to have a full listing on the stock exchange, they would tend to buy high-yield residential and commercial property and there was less incentive, or almost no incentive, for the small-scale investment trusts to build in the for-profit sector rented accommodation in local areas, which is something that I was very keen to see. I know that the Minister at the time said that that was an issue that would be kept under review.
Will the Minister tell us whether there is an intention to remove some of the restrictions, particularly the full stock exchange listing criterion, to allow smaller entrants into the REIT field? The reason for that would be to provide the core profit for housing in the private rented sector which is so desperately needed. Moreover, it will be very helpful if he can answer my specific question on paragraph 7 on connected persons so I can understand how someone connected to a REIT can be defined as part of a REIT group if they do not meet the original criteria.
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