Select Committee on Economic Affairs Second Report

CHAPTER 6: CONCLUSIONS AND RECOMMENDATIONS

General Issues

THE CONSULTATION ON CAPITAL GAINS TAX AND RESIDENCE AND DOMICILE

285.  We are firmly in favour of consultation and, although we have considered carefully what officials said to us, we have little doubt, given the strength of feeling of our private sector witnesses, that something went wrong in the development of these initiatives. We see no reason why there could not have been earlier, better and more open consultation on both CGT and residence and domicile. We are particularly disappointed that the progress on consultation, which we welcomed in last year's report, has not been maintained. (para 25)

286.  If clarity and certainty are to be achieved, consultation should in principle take place as early as possible whenever there is any significant technical content. Even if it were necessary to keep back certain aspects— such as the £30,000 charge or the level of the single rate of CGT—we think consultation on many aspects could have taken place on a "what if" basis before announcements. If the argument were—and it was not put by officials—that consultation was not possible in the time available, our response would be that the proposals should not have been announced without that consultation. (para 26)

287.  We therefore recommend that HMT and HMRC should critically consider these consultative processes. Officials should analyse why the private sector bodies are so unhappy with what took place and why those bodies thought that what they were saying was not getting through to Ministers. Officials should learn the lessons. (para 27)

288.  We also recommend that HMT and HMRC should look at their record of consultation as a whole, learning from well-handled examples and striving to apply uniformly the points of best practice. (para 28)

FURTHER ASPECTS OF THE CONSULTATION ON CAPITAL GAINS TAX

289.  We are at a loss to explain the difference in views as to how open the consultation on capital gains tax was in the period after the PBR announcement. Whatever the position, the important general point is that consultation has to be, and be seen to be, as even-handed as possible. Limited, secretive consultation breeds suspicion and mistrust. (para 32)

290.  We recommend that consultation should be even-handed and open, involving as many as possible of the professional bodies and other parties which have a valid interest. (para 33)

FURTHER ASPECTS OF THE CONSULTATION ON RESIDENCE AND DOMICILE

291.  Although we accept there can be tension between early certainty and full appraisal, we doubt if it applies to the consultation on residence and domicile. A high degree of certainty may not always be attainable in formulation of tax policy. But a review which starts with consultation, continues in a desultory way and appears to have petered out, only to be followed by the announcement of wide-ranging proposals which bear little relation to the matters previously under discussion, tends to devalue consultation. (para 38)

292.  We recommend that consultation should be genuine and meaningful and must be active on an appropriate timescale. Subject to limited exceptions, for example rates of tax, it should cover the issues on which Ministers will make decisions. If it is not leading anywhere, Ministers should decide to close down the consultation to provide the certainty that everyone agrees is desirable. (para 39)

HOW SHOULD THE CONSULTATION PROCESS BE CARRIED OUT?

293.  We recommend that the professional bodies should send their ideas to HMT and HMRC. And we recommend that HMT and HMRC should come forward with their own ideas on how consultation processes should be handled. There should then be a dialogue between HMT/HMRC and the professional bodies and other interested parties to bring out the essential elements of good and timely consultation on a tax policy initiative and to identify the limited circumstances when consultation would not be possible. (para 43)

294.  We further recommend that any agreement reached should be developed into a Code of Practice governing consultation on tax changes, extending and amending as necessary the Cabinet Office Code of Practice on Consultation. The onus would then be on the Government/HMT/HMRC to consult in all circumstances outside recognised exceptions. (para 44)

HMT AND HMRC WORKING TOGETHER

295.  We cannot tell whether there is any substance in the point put to us by our private sector witnesses that the policy partnership between HMT and HMRC is not working well. We note the forceful rebuttal by officials. We recommend that the review of the consultative processes (which we recommended previously) should include consideration of how well HMT and HMRC are working together. (para 48)

INTERNATIONAL COMPETITIVENESS: CAPITAL GAINS TAX

296.  It is difficult to reach a definitive conclusion as to the competitiveness of the UK in relation to capital gains tax, given that the Government has not published its economic case for the new regime. However, in the light of developments both here and in other countries, the overall impression being given today is of a less competitive tax environment. We also think that announcing unexpected tax changes adds to the perception of reduced competitiveness. (para 60)

297.  We recommend that the Government and HMT should publish the economic case for the new regime, justifying the single rate of 18% as internationally competitive. We also recommend that they should work now towards reassuring investors and potential investors of the advantages of investing in the United Kingdom; and that further unexpected tax changes should be avoided wherever possible. (para 61)

INTERNATIONAL COMPETITIVENESS: RESIDENCE AND DOMICILE

298.  We are very concerned by the weight of evidence coming from our private sector witnesses that these proposals seem likely to have a negative effect on the UK's competitiveness. We think it vital that everything that can be done is done to retrieve the position. (para 70)

299.  It is clear to us that the Government has failed to communicate successfully the message that these changes are not intended to discourage non-domiciles from coming to the UK and that non-domiciles are important to the health of the UK economy. We therefore recommend that the Government does all it can to communicate this message and to maintain the UK's competitiveness by ensuring that the UK remains an attractive place for workers with key skills. (para 71)

300.  We also think it important that those outside Government have the opportunity to see HMT's assessment of the economic impact of these changes so that they might form their own judgment. (para 72)

301.  We therefore recommend that HMT should publish its economic impact analysis of these changes to residence and domicile so that everyone can share their thinking on this matter. We also recommend that HMT should update this analysis in 12 months' time in the light of events. (para 73)

302.  More generally, we recommend that, in future, economic impact analyses should be published at the same time as any significant tax changes are announced; such analyses are clearly a vital element in the decision on whether any tax changes should go ahead. (para 74)

Capital Gains Tax and Entrepreneurs' Relief

SUSTAINABILITY

303.  In our view it will take time for the certainty and predictability which investors need to be restored, given the shock to which the changes gave rise. Matters have not been helped by the manner in which the changes were introduced, and the legitimate expectations which—rightly or wrongly—investors believed that they had been denied. It may also not help investment that long term gains are no longer treated better than speculative gains: indeed as inflation picks up they are arguably less well treated. It will therefore take time for confidence in the system to be restored and for it to be seen as sustainable. (para 91)

304.  We recommend that the Government/HMT should persist in explaining the reasoning behind, and the advantages of, the changes, with a view to restoring confidence in the system, its sustainability and predictability. (para 92)

FORESTALLING

305.  While we understand the reasoning of officials and are very mindful of the arguments for simplification, we nevertheless think it unfair if some people were in a better position to retain the benefits of the old regime than others because, for example, either they were married or in civil partnership rather than single, or the assets were held in trust. (para 98)

306.  We recommend that, in any future changes of this kind, particular thought is given to the opportunities for forestalling and that either those opportunities are made available to all or denied to everyone. (para 99)

INDEXATION

307.  The abolition of frozen indexation relief has enabled very considerable simplification to take place, and many holders of assets where indexation was significant will have been able to crystallise their gains before 6 April by one means or another. In addition the rate of tax has been reduced. (para 106)

308.  Although we recognise the arguments for retaining frozen indexation, on balance we are inclined to the view that its abolition was a reasonable step to take, notwithstanding the disquiet which remains around this issue. (para 107)

SIMPLIFICATION

309.  The addition to the changes of the entrepreneurs' relief added a measure of complication especially as it was not, in our view, framed as simply as might have been possible. Nonetheless in general the overall effect of the changes has been a measure of simplification, which we certainly welcome. (para 115)

310.  The tax remains complex, however, in particular in relation to establishing what is allowable expenditure and in consequence the size of the gain or the loss. While there is a good argument for letting the dust settle on the changes now being made, at the same time the case for continuing the process of simplifying the tax remains strong, provided that it can be done without importing unfairness. (para 116)

311.  We recommend that HMT/HMRC should open up a dialogue with professional bodies and other interested parties to discuss further opportunities for simplification within the new regime so that there can be legislation at an appropriate time. (para 117)

FORECASTS AND THE CONTEXT FOR SIMPLIFICATION

312.  In our view the possibility of simplifying a tax in the course of a major change should certainly be pursued even when, as in this instance, the overall impact of the change is to raise revenue. However, where revenue is raised, there will be more losers than winners or the amount the losers lose will be larger than the amount the winners win. To that extent therefore the simplification may be less easy to achieve. (para 122)

313.  We remain surprised at the confidence in the current forecast of the yield from Capital Gains Tax including the entrepreneurs' relief and recommend that a fuller explanation should be given. (para 126)

AVOIDANCE

314.  Even though avoidance in this area may no longer be a major issue, the possibility of its re-emergence should be carefully watched. It could be that, depending on the outcome of consultation on the use of principles-based anti-avoidance legislation in the area of financial products, a new approach along these lines might also be useful here. (para 132)

315.  We recommend that, notwithstanding the general optimism that there would not be significant avoidance, HMRC should monitor closely what is happening in this area. We hope that it will not be possible to devise ways of turning income into gains which are not notifiable under the disclosure provisions, but this possibility should be kept in mind. (para 133)

ENTREPRENEURS' RELIEF

316.  We note and understand, both from the debate in the Commons Public Bill Committee and from what officials told us, that the policy of the Government is to focus the relief on entrepreneurs. Nonetheless, within that, we think that there is a strong case for widening the relief, by way of amendments to the Finance Bill at its Report Stage in the Commons, to include the particular areas brought to our attention:

• employee shareholdings;
• trustees doing business;
• assets held outside a business;
• withdrawal from a business in stages, particularly retirement as a director before a sale of shares.

There is also a good case for aligning the treatment of disposals of interests in businesses whatever the form of business structure. (para 145)

317.  We accept that any widening of the relief would require a measure of further complexity, but, given that we cannot now go back to a provision closer to the business assets taper relief which would have been simpler in both structure and operation, this is a price that may have to be paid. (para 146)

SERIAL ENTREPRENEURS AND THE LIFETIME LIMIT

318.  We recognise that the Government has said that it will keep under review the size of the limit to the entrepreneurs' relief and we have seen the assurances which the Financial Secretary to the Treasury gave to the Public Bill Committee. Nonetheless, given the shocks to which these changes to capital gains tax and other events have given rise, we are concerned whether an assurance is in practice sufficient to provide the certainty which entrepreneurs need to see in the tax system. (para 153)

319.  Accordingly we recommend that there should be a means of ensuring that the limit keeps pace with events, for example, though not necessarily, through indexation. (para 154)

Residence and Domicile

GENERAL HANDLING

320.  Whilst we hear what officials said to us, we cannot accept that there would be the strength of feeling on the handling of this initiative relating to residence and domicile if everything had proceeded as smoothly as they seek to suggest. (para 175)

321.  We recommend that, if they have not already done so, HMT and HMRC should carry out a full review of the reasons why there were so many difficulties in the development of this policy initiative. They should ensure that the lessons are learned so that these problems do not emerge in other initiatives. (para 176)

322.  We also recommend that if another policy initiative gets to the point where the legislation cannot be finalised for inclusion in the Finance Bill, that initiative should not be included in the Bill, or, if feasible, the part which is not finalised should not be included. We cannot support the approach of the Finance Bill's still being subject to much amendment at the time it is published, particularly when the proposals come into effect from the beginning of the tax year, as in this case. (para 177)

COMPLIANCE ISSUES: HIGH NET WORTH INDIVIDUALS

323.  For high net worth individuals there are additional complexities in these provisions. These complexities are undesirable, even though these individuals will have access to the best professional advice. (para 182)

COMPLIANCE ISSUES: MIDDLE INCOME EXECUTIVES

324.  We remain concerned that there might be significant compliance burdens on those employers who have a large number of overseas executives working for them. If there are, they will be in sharp contrast to HMRC's programme to cut compliance costs which we commended in last year's report. (para 188)

325.  We therefore recommend that HMRC should monitor closely the effect of these proposals on UK employers over the next couple of years and take all possible steps, with the operation of PAYE for example, to ensure that their compliance burdens are minimised. (para 189)

COMPLIANCE ISSUES: THOSE OF MODEST MEANS

326.  In our view HMRC are greatly underestimating the compliance difficulties for people of more modest means. We are firmly of the view that something further has to be done to make these provisions workable. (para 200)

327.  In our view the provisions as drafted with a de minimis level of £2,000 are essentially unworkable in practice. To address this, we prefer the approach of increasing the de minimis limit. However, so far as we are aware, there is no detailed work on what the de minimis level should be to ensure that the great majority of these people are not troubled by these provisions and that HMRC is not burdened by compliance problems. Unless HMT/HMRC has some work of which we are unaware, or can produce some on a very short timescale, any increase will be a stab in the dark. (para 206)

328.  We recommend that the de minimis limit should be increased to a level to take a big majority of the lower paid non-domiciles out of the scope of these provisions. The Government should introduce an amendment to achieve this. If there is no better basis for estimating what that level should be, we recommend that in this year's Bill the de minimis level should be increased to the amount of the individual's personal allowance (which this year is to be £6,035). (para 207)

329.  We further recommend that HMRC should monitor over the coming year the effect of the increased de minimis level and, if it transpires that there is a large number of lower income workers still with compliance problems, the Government should provide a further increase in next year's Finance Bill, having established to what level the de minimis limit needs to be raised. (para 208)

DETAILED ISSUES

330.  We are persuaded that it is in the interests of the UK economy that something should be done for those in full-time education in the UK. We therefore recommend that the years spent by overseas students in the UK for full-time education should not count towards the test of whether they have been here for longer than seven years out of the last 10. (para 214)

331.  We are pleased to hear that HMT/HMRC are discussing with Ministers the detailed issues which were raised with us. We recommend that, where necessary, HMRC should do all it can to discuss these issues with the professional bodies with a view to resolving them as rapidly as possible and that the Government should bring forward amendments as necessary, certainly not later than the Report Stage of the Bill. (para 216)

A STATUTORY DEFINITION OF UK RESIDENCE

332.  We recognise that it will not be possible to include a comprehensive statutory definition of UK residence in this year's Bill. (para 224)

333.  However, we think this is something which should be taken forward as rapidly as possible so that Ministers are able to come to a view in good time before next year's Bill. We therefore recommend that HMT and HMRC should consult with the professional bodies over the coming months, building on the work which was done in 2003. (para 225)

334.  We further recommend that the Government should carefully consider the case for legislation in next year's Finance Bill to eliminate any uncertainties which are seen to be present in the current regime. (para 226)

ADDRESSING DEFECTS AND ANOMALIES

335.  We recommend that once the legislation has been enacted, a dialogue should be opened up between HMRC and the professional bodies and other interested parties to identify any anomalies or defects which prevent the legislation working as intended. An agreed way should be found of dealing with these. The Government should bring forward amending legislation as early as possible in succeeding Finance Bills. (para 230)

Encouraging Enterprise

THE NEED FOR AN INCREASE IN THE LIMIT FOR THE ENTERPRISE INVESTMENT SCHEME

336.  We are not persuaded that there is a strong case, economic or otherwise, for the increase in the EIS investment limit now. Whilst we accept that the cost of this increase is relatively small, we nevertheless think that the case for change needs to be made and that that case should be published before, or at the same time as, such a change is announced. (para 244)

337.  We recommend that before any further changes are made to the investment limits in any of the venture capital schemes, the economic case for change should be assessed and published, so that it is clear to everyone on what basis the change is being made. (para 245)

THE EFFECTIVENESS OF THE RELIEFS

338.  We find it interesting that there was by no means general acceptance that these reliefs should remain; indeed amongst our private sector witnesses a degree of scepticism existed. However, like those witnesses, we do not know whether the net benefit of these targeted reliefs outweighs the benefits which would flow from a lower rate of tax generally. Only a review which put these tax reliefs in a wider context and had as its central objective assessing their net benefit would be able to answer that. We are firmly of the view that such an exercise would be very worthwhile. (para 253)

339.  We therefore recommend that a review should be carried out, putting these targeted tax reliefs in the context of other schemes targeted at small business, weighing the economic benefits of retaining them against the economic benefit of their removal, so allowing a modest contribution to a reduction in tax rates across the board and getting rid of much complexity. (para 254)

THE TARGETING AND COMPLEXITY OF THE VENTURE CAPITAL RELIEFS

340.  We recognise that the general issue of complexity, and the specific issues around being connected and control, feature in the current consultation on EIS and we are pleased to note that HMRC are entering into a substantive consultation on the details of the EIS and also, by read-across, Venture Capital Trusts. (para 265)

341.  We consider that the point about the target company should be explored further. We do not see why market failure might not be primarily limited to new and start-up businesses. If this were so, it would mean that the focus of EIS/VCT on all small businesses was too wide and money would be being wasted as a consequence. We therefore recommend that the consultation should be extended to include the question of the target company and that the flexibility to refine the target should be explored. (para 266)

THE STUDY BY THE INSTITUTE OF EMPLOYMENT STUDIES, UNIVERSITY OF SUSSEX

342.  We consider that this study into the impact of the Enterprise Investment Scheme and Venture Capital Trusts on company performance is important, particularly as it is the first of its kind, at least in Europe. However, we consider it equally important that the methodology adopted, and therefore the outcomes, should be made acceptable to most commentators. (para 277)

343.  We therefore recommend that the study should be re-examined to see if the criticisms from some of our private sector witnesses are justified and, if so, what can be done to gauge the effect they would have on the outcomes. (para 278)

CONTINUING/FURTHER STUDIES

344.  We see it as very important that a study should be carried out in which the methodology is generally accepted and which can reach a conclusion accepted by as many people as possible. (para 283)

345.  We recommend that HMRC should investigate the best way of continuing the study of the impact of the EIS and VCT schemes on company performance so that generally accepted conclusions will emerge as to their effectiveness. (para 284)

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