Mr. Timms: The origins of the UK real estate investment trust model go back to Kate Barkers review of the housing market, which recommended that there was merit in considering a vehicle that was based on the US REIT model. Such a model has been introduced elsewhere, as the hon. Member for South-West Hertfordshire rightly mentioned, to encourage increased institutional investment in housing. We implemented that proposal and extended its scope to include commercial property. The main objectives of the model, which was launched at the beginning of 2007, was to promote greater efficiency in property investment and to provide smaller-scale investors with access to commercial property returns.
We have seen that the model works well. Some 21 companies so far have announced that they have become UK REITs, including most of the big listed UK property companies. The scheme is still less than three years old, and we expect other companies to join in the future, as investors become more confident in the UK REIT market.
Effectively, the regime removes the tax distortion between investing in property directly and investing in property indirectly by exempting both income and gains made on property from corporation tax provided that the company or the group meets some specified conditions.
We announced in the pre-Budget report that the Bill would amend the conditions to be met by a company or group in the UK real estate investment trust regime to ensure that those conditions could not be circumvented by the artificial creation of new group structures. The conditions include the requirement that at least 75 per cent. of total profits must come from the rental of property to tenants. We confirmed our intention to legislate in the Budget.
Schedule 34, which is introduced by clause 65, amends part 4 of the Finance Act 2006 to introduce a power for the Treasury to make regulations concerning the use of artificial structures to circumvent the existing UK REITs legislation. The regulations, which are available in draft form alongside the clause, are to be made by the affirmative procedure. Regulations to exclude owner-occupied properties from the REITs regime have also been made using existing powers under schedule 6 to the 2006 Act.
Schedule 34 also amends the 2006 Act so that section 98 of the Income and Corporation Taxes Act 1988 is disqualified for companies or groups of companies seeking to join the REITs regime. That will allow a business with tied premisesa pub business, for exampleto treat the rental income from those premises as part of the property rental business of a REIT. Tied premises are those where a company supplies goods to a third party for sale on a premise that the company rents to the third party. Before the amendment, such income would not have been treated as rental income. That created an arbitrary barrier to the REITs regime, which schedule 34 removes.
In addition, following discussions with the industry, schedule 34 makes minor amendments to UK REITs legislation that will have effect on and after 22 April 2009. They address some of the points raised by the British Property Federation, although there are other points that it wishes to promote, a number of which have been mentioned by the hon. Member for South-West Hertfordshire. The minor amendments allow UK REITs to issue an additional type of share; provide a consistent definition of asset; clarify how apportionment of funds between the tax-exempt and non-tax-exempt part of the business should operate; and ensure that the regimes requirements do not create unnecessary barriers to entry.
The hon. Gentleman asked about the extension to convertible preference shares. The extension allows REITs to use such shares where they previously could not, and is made in response to a consultation with the industry. On the general question whether we can do more to help REITs, it is certainly true that UK REITs, along with other parts of the economy, are struggling in the current economic climate. We have announced a wide range of policies to support businesses through what is a difficult period for them and, indeed, for households. The measures will provide help to all parts of the UK economy, and I expect UK REITs to benefit as well. I am less certain that there is a need for very targeted help for UK REITs beyond what we have done to support businesses in general, but we are very happy to listen to representations that people may wish to make to us.
Mr. Gauke: One of the BPFs proposals that I have outlined may involve the deferral of tax revenue, but the other two are likely to be fiscally neutral. Indeed, one of them may raise some revenue. The Government may therefore be able to address the issue without a cost, so I urge the Minister to look at the matter very closely.
Mr. Timms: We will certainly be happy to look at those representations. No amendments have been tabled, but we will, of course, look at proposals.
The hon. Gentleman also asked why we had not relaxed the profit financing cost ratio restriction. The restriction on gearing helps to ensure that profits are
Mr. Gauke: I acknowledge the Financial Secretarys point, but does he not accept that REITs will have their own incentives to keep investors happy and that the management of a REIT would be careful about pursuing a route that could cause them disadvantage with an investor, because of commercial pressures if nothing else? I acknowledge his concern, but that flexibility would probably not result in the management of a REIT acting recklessly, as far as the interests of investors are concerned.
Mr. Timms: I take the hon. Gentlemans point. My point was simply that there are issues to be weighed when considering a change of that kind, and the effect on investors is one of them. It is not necessarily a showstopper, but it needs to be taken into account.
The hon. Gentleman asked why the Government had not allowed deferral of part of the distribution requirement. It is important to note that each of the conditions of the regime is in place for good reasons. The requirement to distribute 90 per cent. of the profits from the property rental business within 12 months of the end of each accounting period helps to ensure that profits are distributed to shareholders who then pay tax on them, and it also helps to ensure that the investor gets a good deal.
We touched on the use of REITs for residential property investment, but there are difficulties with that in the current economic environment. Doing much about that problem would require significant changes to the regime, and we could then run into some EU state aid difficulties, which is another factor to be borne in mind.
Stewart Hosie: All of the criteria for being a real estate investment trust, such as the profit distribution and the residential qualification, are met, so what EU state aid barrier could there be that would be different for residential property than exists for commercial REITs?
Mr. Timms: The current difficulty is the cost of setting up a REIT for investment in residential property. The model currently works fine for commercial REITs, but there is a cost problem for setting up a REIT for residential investment, and changing that so that is was more attractive for residential investment could lead us into difficulties with EU state aid. The barrier is a cost barrier, but fixing it could cause problems with state aid. Certainly, there would have to be some work to address that.
The hon. Member for Dundee, East asked whether other connected persons would be obliged to follow the REITs conditions. We want the connected person to be part of the existing REIT, rather than a separate REIT, so they would not need to meet all the conditions of the regime. The purpose of that legislation is to prevent a group artificially meeting the requirements of the regime by bringing into the REIT any part of the group that has been artificially removed. I hope that that is helpful and commend the clause and schedule to the Committee.
Question put and agreed to.
Clause 65 accordingly ordered to stand part of the Bill.
Schedule 34 agreed to.
Deductions for employee liabilities
Question proposed, That the clause stand part of the Bill.
Mr. Gauke: I have one brief question on clause 66. It has something in common with clause 67, and our debate will focus on that clause. Both clauses relate to anti-avoidance provisions. The test that is inserted for arrangements that fall foul of those provisions is that
the main purpose... is the avoidance of tax.
Most new avoidance legislation seems to include in its main purpose test the phrase obtaining a tax advantage or something similar. What is the reason for the change in terminology? Is this the terminology that we can expect to see in future in these anti-avoidance provisions and is there not a danger of some complexity or confusion here? The phrase the avoidance of tax seems narrower. I do not know whether that is the intention.
Mr. Timms: Clauses 66 and 67 are an interesting case. Early in the new year, HMRC received information about a particularly abusive avoidance scheme, which relied on deliberate default to generate artificial liabilities, which are then set against the otherwise taxable income of the individual concerned at a potential cost to the Exchequer of about £200 million in the first instance. So on 12 January, to head off this threat to the public finances, I issued a ministerial statement announcing the closure of this scheme with effect from that date.
Following that announcement, HMRC received further information that a variant of the schemethis time involving the legislation on employment-related losseswas being used to similar effect at a potential loss to the public purse of at least £200 million in the first instance. So I took further action on 1 April, but also effective from 12 January, to close this down. We will come to that in the debate on the next clause.
Clause 66 gives effect to the original 12 January statement. It works by amending sections 346 and 555 of the Income Tax (Earnings and Pensions) Act 2003. As they stand, these sections allow relief to employees where either they, or their employer on their behalf, meet the costs of insuring against employment-related liabilities, or the actual cost of those liabilities, such as damages relating to their jobs or legal costs to defend against such damages.
The particular scheme that clause 66 addresses took a rather tortuous route to exploit these provisions and make sure there was no real loss to the scheme users. The arrangements would have involved the use of a number of both companies and trusts, some of them offshore. A key element was the creation of a contrived employment, the duties of which included entering into financial arrangements with another party. During the course of the contrived employment, the individual would deliberately default on some aspects of the financial arrangements. Under the terms of the arrangement, this would trigger automatic damages payable by the individual. The individual would borrow the money to pay the damages, through a loan made by another entity in this rather complex structure, and in reality the individual would not need to repay the loan.
I have gone into that in detail so the Committee has a sense of what we are dealing with and of the degree of contrivance and artificiality.
It is a highly abusive, completely contrived arrangement, with the sole aim of avoiding paying the tax due to the Exchequer. We are providing that that relief be allowed only where there are not arrangements in place designed to avoid tax. Any real employment-related liabilities will still be eligible for relief in the normal way.
The hon. Member for South-West Hertfordshire asked why the main purpose test in the clause uses the phrase
the main purpose...of which is the avoidance of tax.
when most new avoidance legislation uses the tax advantage test, as he rightly said. The main goal is to ensure that all wording is effective in achieving its primary purpose, which we are satisfied that the wording achieves. The words used are in keeping with those used elsewhere, such as the Income Tax (Earnings and Pensions) Act 2003, so they are not novel.
By taking swift action, we are preventing exploitation of the tax system by the schemes of a small number of wealthy people. Honest taxpayers rightly expect the Government to identify such schemes quickly and block them effectively. That is what we have done.
Question put and agreed to.
Clause 66 accordingly ordered to stand part of the Bill.
Employment loss relief
Mr. Gauke: I beg to move amendment 73, in clause 67, page 32, line 6, leave out 12 January and insert 1 April.
The Chairman: With this it will be convenient to discuss amendment 74, in clause 67, page 32, line 7, leave out subsections (3) and (4).
Mr. Gauke: I thank the Financial Secretary for setting out details of the arrangements. He describes them as particularly abusive, which is perfectly accurate given that it is a deliberate default in relation to arrangements entered into during employment to create employment income offsets that can reduce tax on personal income.
This is not the first time that the some of us have debated retrospective taxation. On 22 May last year, I debated the issue with the Financial Secretarys predecessor, the right hon. Member for Liverpool, Wavertree (Jane Kennedy)may I say on behalf of the Opposition that we hope that she is safe and well? A similar point was raised in the context of double taxation treaties and retrospective provisions on Isle of Man partnerships. It would be fair to say that the case against the Government then was stronger than it is today, because then we looked at retrospection going back 21 years for something that HMRC had known about for a long time and not sought to address. One could argue that the arrangements that we debated last year were less abusive then the arrangements that we have today. None the less, there is a principle to do with the nature of retrospective legislation in this field. Last year, the right hon. Member for Liverpool, Wavertree said:
The Government understand some of the concerns about retrospectivity. It is right to be concerned about the use of that, and it is right for the Government to justify every case.[Official Report, Finance Public Bill Committee, 22 May 2008; c. 371-372.]
I therefore make no apology for raising this issue, notwithstanding the aggressive and abusive nature of the loophole that the Government are closing. The point is whether the announcement of 12 January 2009 to which the Financial Secretary referred was sufficient to close the loophole or whether this matter was not addressed effectively until 1 April 2009.
When debating the retrospective nature of taxation, it is customary to refer to the Rees rules, which date back to the Finance Act 1978. The shadow Chief Secretary of the time stated that it is important that clear and specific warning is given prior to a Finance Act implementing any such legislation. My right hon. Friend the Member for Charnwood (Mr. Dorrell) went on in the early 1990s to argue that in addition to those clear and specific warnings being given in advance, there must be exceptional circumstances for legislation to be retrospective. It may well be that the abusive nature of these arrangements and the considerable potential cost to the Exchequer are exceptional circumstances.
I will turn to what the Government said in considering whether the Rees rule was met. In the press release of 12 January 2009, HMRC stated:
The specific avoidance arrangements of which the government is aware aim to exploit the provisions of sections 346 to 348 and 555 to 559 Income Tax (Earnings and Pensions) Act 2003, (ITEPA).
Those references are picked up in clause 66, which we debated earlier. Paragraph 9 of the press release states:
The specific avoidance arrangements being countered are outlined above but the government is aware that it might be possible to use different structures to achieve a similar outcome. As a result the proposed legislation will deny any deduction under section 346 or section 555 ITEPA where the liability in respect of
The press release, which reflects the Financial Secretarys written statement, highlights certain specific arrangements and broadens it further. However, it does not broaden the identification of the scheme used in the loophole as widely as the subsequent press release and technical note of 1 April 2009, to which the Minister referred.
That press release announced further action and was entitled Government taking further action to prevent artificial avoidance schemes. Having outlined the contents of the January provisions, in paragraph 5 the technical note goes on to state:
The Government is aware of a similar scheme or schemes that seek to exploit S11 ITEPA 2003 and S128 ITA 2007.
The essential point is that we are concerned about backdating those anti-avoidance provisions to 12 January, when that announcement addressed certain specific arrangements; indeed it slightly broadened it out to beyond the arrangements of which it was aware, but was not as broad as the 1 April arrangements. We consider that the risks of retrospective legislation are very considerable. That is important as it damages stability and certainty in the UK tax system. If we have a tax system that is unpredictable, it undermines confidence. We are therefore concerned that by backdating the effect of clause 67 to 12 January as opposed to 1 April, the Government are going beyond what we accept as allowable under the Rees rules, the Dorrell doctrine and, indeed, by the statement made by the former Paymaster General, the right hon. Member for Bristol, South (Dawn Primarolo). In December 2004, she referred to remuneration planning, an area where there has been retrospective legislation for some time. This would appear to be broader than that and my attention has been drawn to comments made by the right hon. Lady on 6 June 2006. I interpret her remarks to mean that the approach to remuneration planning applied merely to the extraction from a company of income otherwise taxable in the form that was rendered free of national insurance, PAYE and income tax. I do not think that this is quite what we have here, so we are concerned about these provisions.
Perhaps I can take this opportunity to ask the Minister where the Government stand on retrospectivity in general. In what circumstances do the Government consider that a retrospective provision is justified? Does the Minister recognise that there is a risk that HMRC may use this as a fallback against its mistakes? That was very much the nature of our case last year on partnership income and Isle of Man partnerships. HMRC should have addressed that matter much earlier and it sought to address it through retrospective legislation. What constraints are there on the use of retrospective legislation and do the Government recognise that there are problems caused to the UK tax system if it is overused? It may well be that the Ministers remarks today can provide some reassurance, but it would be a damaging attribute to our tax system if there was frequent use of retrospective legislation in this area.
More specifically, on clause 67 and amendments 73 and 74, may I ask the Minister why the announcement on 12 January was thought to cover more than that
Mr. Brian Binley (Northampton, South) (Con): May I say what a pleasure it is to serve under your chairmanship, Mr. Hood? I am grateful to have the opportunity to speak on the clause, and I congratulate my Front Bench colleagues on emphasising its importance. It seems to me to be one of the most disturbing clauses in the Bill, not least for the wider reasons. My hon. Friend the Member for South-West Hertfordshire made the point that an announcement on certain issues was made on 12 January 2009indeed, I am told that it was made clear that the rules would not apply to payments made after the date of the announcementand the industry ceased to use the scheme. That is the information that I have received.
The crime comes when we consider the announcement of 1 April 2009, when the Government widened the scope of the provision, and did so retrospectively and without notice. It is said that the measure will impact upon only 600 people, but retrospective legislation that impacts upon one person, particularly in such an activity, is not good enough. For 600 people, of course it is not good enough. However, it is the wider questions of perception and the breaking of what many businesses see as a genuine understanding between business and the Department that is the real danger inherent in the provisions.
I understand that the hard-working people of the Treasury are keen to protect the interests of the Government and the nation by stopping tax avoidance. To most people, tax avoidance is unacceptable. I would love to get certain people who live on certain islands and then, through their own newspaper organs, make their own moral judgments, and many Members of the House would agree. In this instance, however, we are not talking about the normal practice of announcing a measure and giving people due warning. We are talking about the Department making an announcement, with no warning, of a measure that would be used retrospectively. Therein lies our concern.
To date, it has been generally accepted practice to apply retrospective tax legislation only when HMRC has announced that it will do so. It is that element that has been broken in the clause. I do not need to tell the Committee that retrospective legislation is bad legislation, no matter what the issue, as it is a fundamental requirement that legal frameworks should provide certainty for individual behaviour at the point when that behaviour takes place and not retrospectively. That is generally accepted as good, fair and proper government. It is the undermining of that concept that is so damaging in the wider sense.
It is the question of perspective that concerns me immensely. I come from a world where certainty is vitalthe business world. I come from a world that believes that treatment between business and the Department is fair and proper. Action of this sort undermines that concept. If it happens more and more, business will begin to think that it cannot trust the Department, and therein lies the real danger. The perception of HMRC itself is under threat when the Government decide to act retrospectively in such a fashion. I recognise that accountants rarely take perception into account, but business men do, because the perception of their business is vital to the well-being of their customers. That is the point that I fear the Treasury is unable to grasp, and which I would particularly like the Minister to address.
The Government tell us that the measure will prevent a loss to the economy of some £200 million. That is pure accountancy talk; it fails to take into account the image of this country doing good and fair business. It is another little brick in that wall that will prevent more and more people from wanting to do business here. What assessment has there been of the impact on people who might want to come to the UK to do business, but might be put off by the thought that they could be taxed retrospectively without their knowledge? That also needs to be taken into account.
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