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. 4.45
pm
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
64Long
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
65Real
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. 5
pm
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” to
others. I want to ask the Minister whether those others, who have been
deemed to form part of a REIT group, would also be obliged to follow
the same conditions
that have been set up for a REIT proper? I am talking about the size of
the company, the stock exchange listing, and so on and so forth. I just
want to understand for myself how someone can be deemed to be a REIT or
part of a REIT if they do not meet the other conditions that were set
out in
2006. 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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