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8.—(1) In this Schedule—
the 1992 Act" means the Taxation of Chargeable Gains Act 1992, and
the old indexation rules" means the 1992 Act as it would have effect if—
- (a) the amendments made by subsections (1) to (5) of section 93 of this Act, and
- (b) the repeal of section 103 (collective investment schemes, etc.) and section 111 (building societies) of the 1992 Act by subsection (7) of section 93 of this Act, had not come into force.
(2) Other expressions not defined in this Schedule but used both in it and in the 1992 Act have the same meaning as in that Act.
(3) References in this Schedule to the reduction of any amount include its reduction to nil.'.
§ Madam SpeakerWith this it will be convenient to take Government amendment No.44.
§ Mr. DorrellClause 93 ensures that for disposals on or after Budget day last year the capital gains tax indexation allowance cannot increase or create a capital loss. The clause was debated in depth during the Committee stage. I explained that the restriction of indexation allowances for losses was an important anti-avoidance measure. Significant abuse of indexation allowances for losses had been identified. We estimated that, unless we took action to prevent the abuse, by the end of the decade we could lose roughly £3 billion a year of revenue on capital gains through both capital gains tax and capital transfer tax.
Several representations have been made about the way in which we are tackling this type of tax avoidance. We have heard arguments that legislation dealing with specific types of avoidance based on indexation allowances should have been introduced. We have considered that, but we have concluded that it is not a viable alternative.
Abuse of indexation allowances for losses is so central to the structure of such allowances that any anti-avoidance legislation would have to be very complex and lengthy and would be unlikely to succeed in the long term.
We also received some representations making a different point—that investors have been badly hit by the change. The main concern is for investors making relatively modest, chargeable gains, who were not significantly involved in tax avoidance. The vast majority of investors are generally not affected by the change to indexation on losses, since their gains were kept out of capital gains tax, either by the annual exempt amount or the operation of personal equity plans.
To meet some of the concerns about the impact of the change, we decided to introduce a limited transitional relief for individuals and trusts, which is provided for in the new schedule. Each individual and the trustees of each trust set up before 30 November 1993 will be able to claim indexation on losses realised up to 5 April 1995, but the amount of indexation allowance that can be claimed under the transitional relief is limited to £10,000 and relief may be used only to reduce CGT liabilities in 1993–94 and 1994–95.
The cap of £10,000 on the indexation allowance on losses for the period 30 November 1993 to 5 April 1995 759 will ensure that the majority of individuals and trusts will be able to claim full indexation allowance on their losses for 1993–94 and 1994–95. That will give individuals and trusts a period to rearrange their portfolios before the full restriction of indexation for losses applies from 6 April 1995. The transitional relief will cost about £45 million, spread over the three years, including 1994–95.
§ Mr. Nicholas BrownAs I understand it, the Government's estimate of the cost of relief is £10 million for the first year, £25 million for the next and £10 million for the final year, giving the figure that the Finance Secretary gave the House. It is important to explain that fact because at an earlier meeting we were told that the relief would cost £25 million in a full year. Stating the figures for the three-year period shows how that figure was arrived at.
This is a modest, relieving measure given that the debate in Committee turned out to be quite controversial. Many Conservative Members were worried about the Financial Secretary's proposals. Some Conservative Members agreed with the reforms that Lord Lawson made in the mid-1980s and took some persuading that the Government were right to return to those matters, not merely to reform Lord Lawson's arrangements but to change them entirely and withdraw in their entirety the arrangements enabling indexation on capital losses to be carried forward.
The measure is a modest, relieving measure—a widows and orphans relieving measure—and will be worth £4,000 to a top-rate taxpayer in any one year. It is limited not merely to £10,000 but to the two-year period during which the provision can be used and, in as much as the measure applies only to individuals and trusts, it is tightly drawn. Critics of the Government's reforms would describe it as a modest concession.
If the Financial Secretary believes that the changes that he is making are right, why is such a concession necessary? If the position, as he explained it to the Finance Bill Committee, was right in principle, why does he not stand by it? Why is he offering this albeit modest relieving measure? It seems to me, as I am sure that it will seem to others, that the Government have lost confidence in the reform that they put before the Committee and are offering this measure as a sop to the many critics of their proposals, not least those from their own side.
§ Mr. BeithThe amendment is a fairly limited response to a great of deal of anxiety that was expressed in Committee.
The Government have abandoned the Lawson reforms, in which they used to take a pride and about which they used to say a great deal. They have abandoned them because they believe that a potential tax loss of about £3 billion could result—a figure which was never satisfactorily explained in Committee, but which no Minister could ignore. My submission in Committee was that it should be possible, if that is the scale of the potential loss, to formulate more specific measures to ensure that the Lawson reforms were not abused in such a way.
It therefore appears that Lord Lawson, when he was Chancellor of the Exchequer, set in train a tax change that could have appalling consequences for the Revenue, and that it has taken several years of Conservative government for that awful truth to come home.
§ Mr. Nicholas BrownEight years.
§ Mr. BeithThe hon. Member for Newcastle upon Tyne, East (Mr. Brown) reminds me that it has taken eight years of Conservative government for that awful truth to come home. Someone in the Treasury suddenly discovered that £3 billion could go down the tubes as a result of that serious miscalculation. The noble Lord made a number of miscalculations, not least about what the combined effect would be of his measures on mortgage interest when associated with the liberalisation of capital and mortgages and the promise of tax cuts, but that is another big Lawson miscalculation.
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I think that in the intervening eight years many people have been persuaded that it was right in principle and logical that there should be indexation relief of that type, and that people who have made losses as a result of the Government's incompetence in allowing too much inflation should not be penalised for the Government's mistakes. That seems to be a reasonable principle, and one which should guide the Government anyway. The Government should not be encouraged in their misdemeanours by the knowledge that if they produce too much inflation they gain through tax measures as a consequence, automatically, without having to come to the House of Commons to raise more tax. The Government remain in the dock for having embarked on the reforms and for abandoning them so totally on the basis of a figure that members of the Committee found slightly hard to believe.
The measures themselves are limited in time scale. The allowance is lost if it is not used in respect of the period until 5 April 1995. It does not solve the problem of retrospection for those excluded from the relief, including companies, and one wonders whether it is right that companies should be exempt from the benefit of the change.
The amount of the relief is also a restriction—£10,000 is a relatively small amount in relation to the losses that can be incurred, for example, in farming. In Committee, I mentioned those people who are trying to set milk quota gains against capital depreciation in land values. Large sums of money are involved which have never been seen by the farmer concerned; they are accounting transactions. On one hand, the farmer has something that he cannot even touch—milk quota—which has a value that he never asked it to have; on the other, his land, which he can see, has greatly depreciated in value as a result of the decrease in land values. We are not speaking about a pile of used notes that the farmer can spend; we are speaking about the effect on his viability, and perhaps on his ability to move from one farm to another, or to retire from farming with any provision for retirement. That viability is affected by the inability to set more than the £10,000 limit against gains.
I have also been told that the schedule is poorly designed and looks as though it was a bit of a rushed job. For example, although individuals and settlements are included, personal representatives are not, with the result that, after a person dies and someone takes on the responsibility of executing the will, they cannot continue to sell the assets of the deceased and set them off with gains against losses. There may prove to be more drawbacks resulting from the way in which the schedule was drawn up.
Obviously, the schedule was drawn up in a bit of a hurry as a result of the amount of criticism that was received in Committee. I am glad that the Government at least made 761 the attempt, but many people, including many small businesses and farmers, will be dealing in sums greater than those that are covered by the proposals and are likely to suffer substantial losses.
It is hard to "read across the column", if you like, from those problems experienced by people in small business to the possibility of companies creating shell companies and off-the-shelf companies to which they can transfer millions of pounds of losses. It is of the latter material that the fears of the Chief Secretary and the Financial Secretary are made —the possibility of companies inventing other companies to which they can transfer considerable gains and with which they can make financial manoeuvres of that type; that is what the problem is about. But that is not the experience of those who may suffer from the limited nature of what the Government are now offering.
We tabled amendments to eliminate the retrospective elements of the Government's original clause 89, now clause 93, which have not been selected, but it will be apparent from those amendments how strongly we feel about the retrospective aspect of this. I remain less than satisfied with the form of the Government's response to the concern expressed in Committee.
§ Mr. John Townend (Bridlington)I strongly support the amendment which gives some transitional relief to individual investors and I thank the Government for that concession. However, it does not deal with the important point of principle at issue here. It is very much like an EC derogation for several years in that it dulls the pain in the short term but it hits one in the end.
The proposal eventually to do away with the indexation of losses is wrong in principle and illogical and I question the motives that made the Government introduce it. As I understnad it, it was introduced at the request of the Inland Revenue in order to stop tax avoidance.
When capital gains tax was set at the internationally high level of 40 per cent., it was argued that that was acceptable as the taxpayer would not pay tax on inflation. That was achieved by allowing the taxpayer to index the cost price of the asset. That was symmetric. It did not matter what happened in the future; the cost price of the asset was adjusted to cover for inflation.
The Government are now trying to make that asymmetric in that the cost price will be adjusted only if a profit is made in the future. The cost price will not be adjusted if a loss is made. That means that an individual's portfolio of shares will no longer be protected against the ravages of inflation. We are breeching an important principle there.
As for the reason given by the Inland Revenue—that the amendment will deal with people who are avoiding tax by complicated means—stopping indexation for everything and everybody is taking a sledgehammer to crack a nut.
I strongly support the efforts of the Treasury and the Inland Revenue to stop artificial schemes and avoidance, but, with due respect to my colleagues on the Front Bench, on this occasion the Inland Revenue has been idle. It has been too idle to draft the necessary clauses to deal with avoidance, so everyone will suffer.
I found the estimated cost of the Government not taking such action rather suprising. The total yield of capital gains tax is £1.2 billion a year, yet the Government are talking about a cost of up to £3 billion a year by the year 2000. I understand that that is partly because the capital gains tax figures relate only to individuals, whereas capital gains tax 762 applies also to companies, but I am told that indexation of losses is expected to cost £1 billion with regard to individuals.
If those figures are not grossly exaggerated, it means that the Government consider that, during the next few years, inflation will rise dramatically, otherwise I cannot see how the estimates can be anything like accurate.
We welcome the concession, but will the Government think seriously by the next Budget and try to bring back some equity? For example, I see no reason why they cannot continue the transitional proposals on a long-term basis and for the individual allow indexation of losses of up to £10,000 a year in perpetuity. That would protect the legitimate small investor. The Government should look at the matter again because there is an important matter of principle here.
§ Mr. DorrellOf course the Government concede that the proposal included in my right hon. and learned Friend's Budget departs from the intellectual symmetry of the Lawson reforms of 1985. That is self-evidently true, as I made clear in Committee. We feel that it is right to depart from that intellectual symmetry because, although we can see the intellectual rigour of the approach taken by my noble Friend Lord Lawson, experience has taught us that the loss indexation provisions introduced by the 1985 legislation open substantial opportunities for tax planning and avoidance in a way that undermines the yield of capital gains tax.
Although it is easy to see the attraction of the Lawson approach, we cannot be blind to the fact that, although capital gains tax systems applied by many other OECD countries provide indexation, there is no example anywhere in the OECD of a country that has successfully allowed indexation of losses.
§ Mr. Nicholas BrownI am grateful to the Financial Secretary for repeating that important point, which he made in Committee with telling effect. Will he explain why it took the Government eight years to discover it?
§ Mr. DorrellThe Government are still attracted to the intellectual rigour of my noble Friend's case. If it had been possible to design rules for operating a symmetrical approach to indexation without undermining the tax yield, we would of course have preferred to go down that road. Experience of the operation of the principle in practice taught us that that is not possible.
Before the hon. Gentleman leaps to his feet and says that the new schedule is another example of the Government acting too little, too late to close a major loophole, I remind the House that the major impact of the indexation provisions on yield is building all the time.
Our projections of the long-term effect on yield extend to the end of this decade not because—to answer my hon. Friend the Member for Bridlington (Mr. Townend)—we expect inflation to recur in the interim, but because the tax planning steps taken by some companies almost immediately, as it appears, after my noble Friend sat down after making his Budget speech in 1985 will have that much longer to mature. It is not the effect of inflation between now and 1998 that is the key, but the cumulative effect of provisions put in place and of tax planners and practitioners climbing the learning curve and exploiting new opportunities for relief. In Committee, I gave a couple of examples of new ideas that are being pursued in both the corporate and—this is important—individual sectors.
763 My hon. Friend the Member for Bridlington asked why we had not made serious proposals to address abuses directly rather than undermine the principles of the Lawson reforms. As I said, we would have preferred to have made such proposals but concluded that none of the methods that we examined could be made to work. I am encouraged in my view that we have not been idle, to use my hon. Friend's word, because most of the ideas that we considered were put to us by outside bodies wanting to argue the case, and none seemed to us to pass the test of addressing the abuse while not undermining the principle of indexation. It is not just us who have been idle, but the lobbying groups that sought to argue the case to us.
§ Mr. John TownendIt seems difficult to believe that the avoidance will be so successful, particularly in respect of individuals, that a tax yielding £1.3 billion would, after several years, yield only about £0.3 billion. That stretches the imagination.
Would not most of the avoidance be covered if we exempted private investors? Most artificial tax avoidance schemes are carried out by limited companies.
§ Mr. DorrellMy hon. Friend is right that some of the best developed examples occur in the corporate sector, but I gave the Committee the example of the capital-certain bonds being developed in the City, the purpose of which would be to fall just the wrong side of the qualifying corporate bond rules so that they figured in capital gains tax. Loss indexation would be available to them, but they would in practice be capital-certain. People would therefore have the interest on the bond and the indexation available on the capital value of the bond, which value would be virtually certain.
Of course it is true that we could have changed the detail of the qualifying corporate bond rules in order to catch a particular bond issue being marketed by a particular house; but that illustrates the sort of opportunity that exists to develop a product whose purpose would be to offer the individual investor the twin gain of a current interest return and protection against capital gains elsewhere in his portfolio. The list that I gave the Committee was not intended to be exhaustive—it was merely indicative of the sort of product that we know is being developed in the City to exploit the rules, not in the corporate sector but in the individual retail sector.
My hon. Friend the Member for Bridlington asked me for an assurance that we would continue to think seriously about the future of CGT, and I am happy to give him it. As I told the Committee, the Government are engaged in a full dress review of the flow of funds through the economy and of how the tax system, among other things, impacts on the availability of finance for industry. One does not need to look far into the system to understand that capital gains tax exerts an important influence on the availability of capital to the wealth-creating sector.
As I said in Committee, it is no part of the Government's case that CGT is a part of the tax system that cannot be further improved. I offer my hon. Friend the assurance that we shall continue to think seriously about the future of CGT as part of the tax system. In the meantime, I believe that we have little choice but to introduce the abolition of loss indexation relief, as 764 provided for by clause 93. I am grateful for my hon. Friend's welcome for the transitional provision that we have tabled.
To answer the hon. Member for Newcastle upon Tyne, East, this in no sense undermines our commitment to the abolition of loss indexation relief. There was a certain inconsistency between the hon. Gentleman's argument and the arguments advanced by the right hon. Member for Berwick-upon-Tweed (Mr. Beith)—
§ Mr. Nicholas BrownWe are members of different parties.
§ Mr. DorrellIndeed, but the hon. Gentleman and the right hon. Gentleman cannot both be right. The one says that we have lost confidence in our proposals; the other says that we are sweeping away the fundamental reforms introduced by Lord Lawson. On this occasion, I side with the right hon. Member for Berwick-upon-Tweed, although not with any enthusiasm because I respect the intellectual symmetry and appeal of Lord Lawson's original proposal. But I have to conclude that we have tried it and it does not work.
§ Mr. John TownendWill my hon. Friend deal with my first point? How does he explain that a tax that yields only £1.3 billion from the personal sector—if nothing is done —will decrease by £1 billion in two or three years' time? That suggests that everyone will have a tax avoidance scheme—such projections stretch the imagination.
§ Mr. DorrellThe figures on which the £3 billion yield were based anticipated the yield from capital gains tax and from corporation tax on capital gains, by the end of the decade, as being about £4.5 billion. We anticipated that virtually all the tax from the corporate sector would by then be at risk, and roughly half the tax from the individual and trust sector would be at risk, as a result of the sort of tax planning devices that I have described. It was the application of those two principles to the underlying anticipated yield of £4.5 billion that left us with £3 billion missing and £1.5 billion still coming in.
§ Amendment agreed to.