Memorandum by the Institute of Directors
(IoD)
INTRODUCTION
This evidence has been prepared in response
to a request from the House of Lords Sub-Committee on the Finance
Bill 2008. It covers the topics on which the Sub-Committee has
said it wishes to concentrate.
CAPITAL GAINS
TAX AND
THE ENTREPRENEURS'
RELIEF: CLAUSES
6 AND 7, AND
SCHEDULES 2 AND
3
1. The original proposals on capital gains
tax, published at the Pre-Budget Report, led to a strong adverse
reaction from the business community. The subsequent announcement
of entrepreneurs' relief went some way to addressing business
concerns. It now seems very unlikely that the whole package will
be changed significantly before enactment of the Finance Bill
2008, so we think that the most useful things to consider are
the extent to which the concerns initially expressed were justified
(because that will have relevance to future policy-making in relation
to capital gains tax), what lessons can be learnt for future policy-making
in general, and issues which might create pressure for change
in future years.
Justification for the initial concerns
2. The proposals naturally caused concern
because they meant that some people would pay significantly more
than under the existing regime, not just because there would be
no opportunity to get the effective 10% rate given to higher-rate
taxpayers by full business assets taper, but also because the
operation of the business assets taper (multiplying gains by 25%
and then taxing them at the full rate) meant that the annual exempt
amount of £9,200 was effectively multiplied by four and because
it was proposed to take away indexation allowance accrued up to
1998.
3. Many significant tax policy changes generate
winners and losers, and the losers always make more noise than
the winners, so some complaints were inevitable. Unfortunately
the choice of rate, 18%, meant that the overall package was projected
to increase total tax revenue. The Pre-Budget Report estimate
of the increase was £900m a year once the system had bedded
in. If the Government had chosen a rate of 15%, that would have
made the package revenue-neutral, allowing the Government to argue
that the winners were as significant as the losers. That would
not however have disposed of the complaint that the losers were
concentrated among the owners of businesses, and the winners among
higher-rate taxpayers who owned non-business assets and were moving
from a minimum 24% effective rate to an 18% rate. It would also
have upset the Government's overall budgetary arithmetic.
4. One important point to consider is the
extent to which the proposals amount to retrospective taxation.
If one taxes gains on disposal of the assets, then any policy
change is going to lead to retrospection in the sense that the
tax regime applying to disposals will sometimes differ from the
regime which applied when at least some of the gain being taxed
accrued. Taxpayers might well complain that if only they had known,
they would not have invested in the assets concerned (given that
additional tax burdens would change the balance between risk and
reward) or they would have disposed of the assets earlier.
5. The six months notice given in this case,
with the changes only applying to disposals after 5 April 2008,
does not entirely address this point because not all assets can
sensibly be disposed of quickly. A business, for example, might
need further development over a period of years before it could
be sold at a good price. Two modifications of the proposals could
have defused complaints of retrospection. The first modification
would have been not to take away accrued indexation allowance.
The second would have been to allow deemed disposals at 5 April
2008, so that gains accrued up to that point were taxed under
the old rules. (A decision would then be needed on whether taxpayers
would have to pay tax immediately on such deemed disposals. Ideally,
they should not have to do so.)
6. Curiously, transitional arrangements
on these lines have in practice been made available, at least
to well-advised taxpayers. Taxpayers who are married or in civil
partnerships have been able to transfer assets to their spouses
or partners before 6 April 2008, converting indexation allowance
into base cost and preserving it. And schemes involving trusts
have been available to allow gains accrued up to April 2008 to
be taxed under the old regime, in some cases without leading to
any requirement to pay tax on those accrued gains immediately.
7. It is not clear whether the Government
was aware of these possibilities at the time of the Pre-Budget
Report, but it certainly was aware of them within a few weeks
afterwards and decided to take no action. Our view is that if
opportunities such as these are to be offered, they should be
made an explicit part of the proposals so that all taxpayers can
take advantage. (Indeed single taxpayers were denied the above
easy route to the preservation of indexation allowance, which
seems unfair.)
Lessons for policy-making
8. It is clear that the Government could
have had an easier time, and the debate could have been conducted
in a much less heated fashion, if the Government had started by
saying "here is a proposal, we are not sure that it is a
good one and we are not committed to it, but we would like to
hear people's views". The reaction might well have been "no,
that is a daft idea" or, more constructively, "we can
see what you are trying to achieve and here is a better way of
achieving it". The Government would have had to be prepared
to say "sorry, that was a daft idea and we won't pursue it".
But if there were no initial commitment to the proposal, it should
be possible to say that. There is no shame in putting forward
daft ideas. We all have them sometimes, and the only way to sort
them from the good ideas is to put them forward for debate.
Issues which might create pressure for future
changes
9. The entrepreneurs' relief is subject
to a lifetime limit of £1 million of gains. While this is
reasonably high at the moment, serial entrepreneurs may well find
that the limit runs out over an extended career. We therefore
consider that the limit should be kept under review.
10. An employee holding shares in his or
her employer was able to obtain the business assets taper under
the old regime, but will not be able to obtain entrepreneurs'
relief unless he or she holds at least 5% of the employing company—which
most will not. This will not matter to the majority of employee
shareholders, who will have their gains covered by the annual
exempt amount or who will be using tax-privileged employee share
schemes. Even outside that class of employee, some rarely obtained
the full business assets taper because they sold shares after
less than two years (the share identification rules meant that
the shares most recently acquired were identified with disposals).
But there will be some employee shareholders who will be made
worse off by the change, and this may create pressure for change,
perhaps through modification of the conditions for entrepreneurs'
relief.
RESIDENCE AND
DOMICILE: CLAUSE
22, CLAUSE 23 AND
SCHEDULE 7
11. The Government's initial proposals,
as announced in the Pre-Budget Report, were changed substantially
over the following months. The final package is a great improvement
on what was initially proposed, although it will still drive some
people away from the UK. Those who have not benefited much from
the changes to the original proposals are the non-domiciled with
overseas income of over £2,000 a year, which will include
many professionals who come to work in the UK and who let out
properties, or have modest investments, in their home countries.
Even though the £30,000 charge for the remittance basis will
not apply for the first seven years in the UK, a period long enough
to cover many secondments to the UK, the loss of personal allowances
in return for the remittance basis will apply from the beginning.
There is a very good chance that the Treasury has scored an own
goal here, harming the British economy and decreasing total tax
revenues.
12. Our other concern is over the policy-making
process. As with capital gains tax, it would have been much better
to announce the proposals as possibilities to be discussed, rather
than as firm decisions which then had to be altered in the light
of protests. It was however fortunate that the initial estimates
of revenue to be raised (in the December 2007 consultative document
Paying a fairer share) did not include revenue from gains made
in trusts, so that the Government could decide to offer a re-basing
to April 2008 without giving up any revenue which had already
been taken into account in budgetary arithmetic. We would also
like to record that once officials did sit down to discuss the
details of the proposals, they did so in a very constructive way.
13. There was also some surprising to-ing
and fro-ing over the draft legislation which was published in
January. A letter of clarification was issued by the Acting Chairman
of HMRC in February, and the press reported unattributed comments
from officials to the effect that the draft legislation had been
published by mistake. We think it most unlikely that it was published
by mistake. The subject matter was well-known to be politically
sensitive, and documents of that nature are not normally published
without careful consideration by very senior officials in both
HMRC and the Treasury.
ENCOURAGING ENTERPRISE:
CLAUSE 28, CLAUSE
29 AND SCHEDULE
11, TAKING INTO
ACCOUNT OTHER
DOCUMENTS PUBLISHED
ON BUDGET
DAY
14. The increase in the maximum relief under
the Enterprise Investment Scheme (EIS) will of course be welcomed
by substantial investors under the scheme, but it is worth considering
whether the extension of existing special reliefs is a sensible
way to develop the tax system. There is a case for using any scope
for tax reductions to reduce tax rates across the board, rather
than to create or extend special reliefs.
15. The exclusions of shipbuilding and of
coal and steel production were forced on the UK by state aid rules.
The exclusions are defined in the legislation by reference to
European Union documents, but there has been concern that the
scope of these exclusions was not immediately clear to potential
investors and investees. For example, is yachtbuilding within
the scope of shipbuilding? It would have been preferable for these
exclusions to have taken effect for shares issued after (say)
5 October 2008, so as to give companies planning a share issue
time to determine their eligibility, rather than, as is actually
the case, the exclusions taking effect for shares issued after
5 April 2008.
16. The consultative document on the EIS
concentrates on administrative obstacles to the use of the EIS.
We agree that this is something worth looking at. Anecdotally,
we have heard that some investee companies do not bother with
the scheme because it is too much trouble to ensure that the companies
will qualify. There is however a widely-used facility to seek
advance assurance from HMRC that one will qualify, and the officials
considering such applications are generally considered to be very
helpful.
17. Another problem is that there are too
many traps for the unwary, innocent-looking transactions such
as repurchases of preference shares which can lead to the loss
of relief. Sometimes the detailed rules which create such traps
are there for good anti-avoidance reasons, but it is not obvious
to the layman that one needs to check for traps in such areas.
18. We support the document Enterprise:
unlocking the UK's talent, which contains several worthwhile
proposals. We are very glad to see, in chapter 5, recognition
of the costs of regulation. But there have been several initiatives
to reduce regulatory burdens in recent years, and we really do
need to see substantial reductions in regulatory burdens this
time, as opposed to the fairly modest reductions that we have
seen hitherto.
19. Chapter 6 of that document covers innovation.
Paragraph 6.17 mentions open innovation. It is important for the
Government to appreciate that very often, the best thing it can
do to encourage innovation is nothing. Open-source software is
a good example of what can happen without official intervention
and without rules beyond the basic legal framework which makes
the GNU General Public Licence possible.
22 April 2008
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